The end phase of a company following its bubble phase.

The end phase of a company following its bubble phase

by tonytran2015 (Melbourne, Australia).

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(Blog No. 3xx).

1. Why does a Private Company want to become listed on some Stock Exchange?

When a company goes public (has become listed on some Stock Exchange), it is often hyped up with future and imaginary potentials. They often are:
a. Better tax treatment for share holders,
b. Better management by complying with the rules of Stock Exchanges.
c. Better access to capital from Superannuation Funds (Pension Funds) looking for somewhere to invest.
d. Better access to loans from banks to maximize the return on investment on every of its projects,
e. Better opportunity in taking in projects which would otherwise be too big for an unlisted company,
f. All the above enhance the price of its current shares.

2. What may happen to an Exchange Listed Company during its Bubble Phase?

a. Once listed on a Stock Exchange, the Management of the company grows and gains higher payments. When this is not carefully controlled, as is often the case, managers may demand god-like status and excessive payments which eat up a large proportion of income of the company.

b. The company is often operated with no “lazy(?) capitals” (such as lands, buildings), no “lazy(?) reserve” (such as cash or treasury notes) so that its earning to capital is kept high, justifying the high payments to its manager.

c. The company in its high gearing state is then valued by “market analysts” and it will be highly praised for being “lean”.

d. It share price (in its high gearing state) is compared to those with stable earnings (and in low gearing state) and said by “market analysts” to be undervalued. After the praise, its share price increases and become highly overvalued.

e. The (overvalued) company with high market capitalization is then offered loans, which are small compared to its (over-valued) capitalization but too big for its earning, and offered big projects its management has no previous experience with.

f. The highly paid management knows the appropriate time to and often does parachute out with golden handshakes when the company is still going strong.

3. The end phase of an over-valued company.

a. The replacement management team is then faced with a company on its last phase of solvency: High interest repayments and difficulty in issuing new shares at now suspected(?) overvalued prices.

b. High interest rates, high management payments are setting up an insolvency trap for the company.

c. Often personnels of the management team can sense the incoming disaster and many of them follow their colleagues and quickly resign from their jobs.

d. Any unexpected problem in operation or in trading condition can trigger insolvency of the company.

e. As the company is lean, with no lazy reserve, no lazy capital, it can only end up in bankrupcy.

e. Investors and creditors often lose ALL of their investment in the company.

4. Should investors avoid over-valued companies?

Yes, avoid them as they often fail spectacularly or at best slowly deflate to sustainable levels.

It is interesting to watch the development of events surrounding the Chinese developper giant Evergrande.

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