Investing with caution

South Africa
Cautionary announcement, Closed period, Insider trading, JSE, Mosaic theory, Price sensitive information
January 13, 2021

You’ve probably seen companies release “cautionary announcements” over SENS, the Stock Exchange News Service of the JSE. This system ensures that everyone gets information at the same time.

The news goes out “on the wires” and the market reacts accordingly.

Today, Alaris Holdings Limited released a cautionary announcement, which is a good opportunity to unpack why such announcements exist and what they mean.

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This is what the announcement says:

CAUTIONARY ANNOUNCEMENT

Shareholders are hereby advised that the Company has entered into negotiations to acquire a business operating in the United Kingdom, which, if successfully concluded, may have a material effect on the price of the Company’s securities.

Accordingly, shareholders are advised to exercise caution when dealing in the Company’s securities until a full announcement is made.

It doesn’t say much, but it does let investors know that there’s a UK deal on the cards and that the eventual transaction could have a significant impact on the share price.

So, what is a cautionary announcement?

A cautionary announcement, commonly just called a cautionary, is the first public step in the dance for a corporate transaction. It’s designed to avoid a situation where some investors know about a potential deal and others don’t.

It’s key to the integrity of a market like the JSE that we don’t have “information asymmetry” i.e. different levels of information among different investors. It all sounds good in theory but doesn’t always work in practice.

Every now and then, you see a share price move substantially for no good reason – no announcement, no major statistical release, nothing. The surveillance people at the JSE investigate these events to see whether any information has leaked that has been taken advantage of by people in the know.

This is called “insider trading” which is a term you’ve probably heard before. It’s rare, but it does happen. It’s a criminal offence and deservedly so, although so is walking on the beach these days.

The way to avoid information asymmetry is for companies to protect their confidential information properly. Listed companies need to have strict policies in place to do so. The existence of an Investor Relations department and policies for restricted access to internal information are ways to make sure that information is shared with the market correctly.

A company would release a cautionary announcement in one of these circumstances:

High-level terms of a deal have been agreed to and parties are moving forward with more detailed negotiations, or
Information has leaked and the existence of a potential transaction is no longer confidential.

As another quick nugget of information, releasing a cautionary announcement immediately puts a company into a “closed period”, which means directors aren’t allowed to trade in the shares for that period.

A cautionary announcement must either be renewed every 30 days or withdrawn. It would be withdrawn where the deal has fallen over or where a detailed terms announcement is being made because the deal is going ahead.

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It’s possible to be too cautious

The JSE gets grumpy when companies release cautionary announcements too easily or with no useful details. It’s obviously totally unhelpful to the market to release what is known as a “bland cautionary” that is devoid of any details.

The Alaris Holdings announcement gives some indication that there is a deal on the table to acquire a business in the UK. Investors have some idea that the international strategy is being executed and that the UK is the country of choice. It has enough details for now.

A cautionary with no details, or released prematurely, causes more harm than good. It creates market speculation and confusion in the market.

What about analysts who do research? Isn’t that information asymmetry?

Yes this is definitely asymmetry, but in an allowable form, provided the research is conducted within the rules.

“Mosaic theory” is the process through which analysts use various sources of public information to join the dots and arrive at conclusions. For example, analysts may do research into the relationship between Stats SA industry data and the actual performance of a company, building a model that predicts performance based on Stats SA releases which are more frequent than financial results announcements by the company in question.

Sure, they might do more detailed research than that (e.g. discussions with private companies in the industry) to arrive at sensible estimates, but they still aren’t operating with “price sensitive information” – you’ll have to forgive me for the jargon, but you need to understand this stuff.

Price sensitive information is specific or precise and will have a material impact on the share price. It’s not “we are considering an acquisition strategy” but rather “we are buying company XYZ next month for R100m, a bargain!”

Most information about a company isn’t price sensitive in isolation.

This is tricky

Yes, but as Chris Martin of Coldplay once opined when asked about public market regulation: