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QUALIPORT
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You always need a company with 'good management' to succeed on the stock market -- or do you? For long-term investors who like their businesses to possess a bit of quality, money can still be made after hapless directors have done their worst. Even Warren Buffett has prospered from investing in a company that was run into the ground by foolish managers. We are of course talking about the 'mismanaged franchise': a business with a good competitive advantage but has suffered from a boardroom populated by monkeys. To recap, Buffett's 'bad management' investment centred on insurance firm GEICO in the mid-1970s. At the time Buffett started buying, the company was on the verge of bankruptcy following years of inept operational decisions. Buffett though recognised the company's new boss would re-focus GEICO on its traditional niche (providing motor insurance to government workers) and believed the firm would eventually return to its pre-eminent industry position. Needless to say, Buffett was right and cashed in big time. Read more. SSL Over the past few years, the Qualiport has occasionally noted the goings-on at SSL International (LSE: SSL), the healthcare products company. SSL definitely falls into the 'mismanaged franchise' category. Famous for Durex condoms and Scholl footwear, SSL certainly owns some attractive brands, yet its investment merits have been far from clear. Acquisitions, restructures and a trade-loading scandal -- SSL became a terrible mess and the clowns in the boardroom who caused all the grief ultimately got the chop. New management was installed in 2001 to get SSL back on track. But the revival wasn't plain sailing. SSL's subsequent fortunes highlight the three main issues of investing in a badly managed franchise: 1. Even with fresh blood, things can still go wrong: After a promising start by the fresh management, a surprise profit warning in mid-2002 devastated shareholders' newly found confidence. Though SSL's products were seemingly attractive, maybe they weren't all they were cracked up to be? After hitting a 2002 high of 581p, SSL shares ended the year lurching towards 250p. 2. A big margin of safety is needed when setting a buy price: Prior to the profit warning, the Qualiport's target buy price for SSL was 297p based on what was considered a healthy margin of safety. The 2002 profit alert and the manic bear market subsequently dragged the shares to 166p in March 2003. 3. Patience is required: Only recently has SSL shown signs of a revival. Investors that jumped aboard when the new management were recruited have therefore endured two long and painful years. However, after some disposals, there could be light at the end of the tunnel. SSL has now attracted the attentions of a mystery predator, rumoured to be either Reckitt Benckiser (LSE: RB.) or Kimberly-Clark (NYSE: KMB). At the moment, SSL shares are 337p. Though everything depends on the outcome of the bid talks, only those investors that took advantage of the market madness earlier this year have so far been rewarded by SSL. Tying up money All of these issues emphasise a significant problem that investors face with mismanaged franchises. Business difficulties take plenty of time to sort out, which means money is tied up in an under-performing company and not ready to spend when great -- and trouble-free -- businesses get marked down to silly low prices. Still, the likes of SSL can make for big rewards. The legacy of bad managers can drive share prices to extremely low valuations and -- at the right price -- the attractive nature of the company can often prompt a bidder to generate a sizeable short-term gain. But in general, 'mismanaged franchises' and other so-called 'special situations' should be reserved for times when there's no obvious value to be seen in more favourable areas. SSL, for example, was first considered by the Qualiport when the FTSE 100 stood at 6,000 in February 2001. 'Coverage' was then dropped in September 2002, a time when the FTSE 100 stood at 4,000 and many better quality shares were getting cheap.