Terra Nova Royalty (TTT) released its half-year results Monday. There are many things that can be said about this company, but the fact is that it is nearly impossible to understand what is going on at the company at first glance. You have to know more about the history of the entity, and fight your way through a thick jungle of obscure filings and very limited disclosure to get an idea of what is really “under the hood.” Charlie Munger would probably put it in his “too hard” pile, yet tracking this company has become somewhat of a hobby of mine.
The company has announced that it will change its name back to MFC Industrial, a name under which its former component KHD Humboldt Wedag (KHDHF.PK) [spun-off last year] used to be known. It is probably a safe bet to assume that the griffin logo that Terra Nova’s predecessor companies have been using (and its subsidiary MFC Commodities still uses) will replace the sailing ship currently used.
the MFC griffin logo
At the same time, CEO Michael J. Smith announced that he aspires to be Noble. What does that mean? It relates to a rather different kind of “peerage” than the ranks of British Nobility – but let me use the MFC logo to attempt an explanation.
Are there Lions in Scotland?
Have you ever wondered why so many coats of arms of medieval knights or even current European countries feature a lion? If you think about it, Scotland, Norway or Finland, are probably among the last countries to search if you were looking to find a lion - yet their coat of arms all prominently feature the animal. The truth probably is that men always yearn for the exotic, supernatural or unattainable.
In the High Middle Ages, the crusades mounted to reassert Christian control over the Holy Land brought young men into contact with things they had never seen before. These knights came back to Europe with tales of arabian lifestyle, mathematics, medicine, exotic fruit and animals. The lion, which had already been a popular motif in the antiquity, made a big comeback. New translations of the Physiologus (the earliest bestiary) into most European languages were made at the time of the crusades. This also greatly contributed to the heraldic representations of beasts with inferred qualities. The European Nobles of the time all rushed to create their own hereditary coat of arms, featuring arrangements of creatures and symbols. This later became a very complex discipline and even created new jobs (the herald and the officer of arms).
Incidentally, the Templar knights that were assigned the protection of the pilgrims also became the first asset managers and bankers of the Christian world after the fall of Rome – well before the merchant bankers emerged in Italy at the beginning of the Renaissance. The order would manage the assets of Nobles while they went on crusades, and the knights invented the letter of credit system that is still commonly used today in trade finance. Pilgrims could deposit their valuables at a Templar office and receive a paper document detailing the value deposited, travel with this early form of cheque to Jerusalem and receive money in exchange for the letter. This made traveling easier and less dangerous (a letter is far less attractive than gold for an aggressor), and the Templars had a lot of funds they could use for proprietary investments. They invested in infrastructure, farms, land, ships – and became a very powerful organisation. The knights were later persecuted and their assets confiscated, but their way of doing business has endured through the ages.
Fast forward to the modern world – corporate logos have displaced coats of arms, and knights have become capitalists. New production and transportation means have made trading on a global scale a possibility. However different the world might be today, the basic business model of merchant banking, trade finance and insurance has not changed a lot since the time of the Templar knights. When Warren Buffett talks about insurance float as nearly free money that can be used to make investments, that is not very different from the gold that the Templars kept in their coffers to safeguard the assets of the traveling pilgrim, and that they used to acquire ships, farms or vineyards while said pilgrim was visiting the Holy Land. Pools of short-term capital (cash and equivalents in today’s speech) are what is driving the insurance and reinsurance business, but also the trading of physical goods and commodities.
Merchant Banking, Supply Chain Management and Proprietary Investments
For example, think of the operator of a coal mine who has to deliver his product to market (generally a coking plant or a power plant). He’s good at mining, but is he efficient in transportation? Can he be sure that the goods in transit will be safe? What happens if the plant refuses to take the goods shipped because it isn’t satisfied with the quality? Also, he will have to wait until he gets paid – can he still meet his fixed costs while waiting? If he sells to another country, he additionally faces currency fluctuation risks. Enter the merchant banker. He takes the commodity, pays immediately. He can get in-between the buyer and the seller and arrange transport. He can provide insurance and documentation for the goods. He can hedge the currencies. He has connections. He knows where to source goods when they are needed, and can make contact between buyers and sellers. Sometimes he even has his own warehouses or elevators, or if he has grown a lot – his own shipping fleet or railway. The merchant banker has loyal customers who value his services. He is their financier, extending credit when it is needed (sometimes he may even take a stake in the business), and he is their sales agent in faraway lands.
Most large banks that have a long history were built on this model. Think of Wells Fargo’s (WFC) stagecoach, or the cotton trading operations of Junius Morgan and George Peabody (JPM). Today, this business is dominated by global companies such as Glencore (GLCNF.PK), Mitsubishi Corp. (MSBHY.PK), Itochu (ITOCY.PK), Mitsui Bussan (MITSY.PK), Louis Dreyfus, Trafigura, Vitol, Bunge (BG) or Gunvor.
Terra Nova, or its predecessor companies (MFC Bancorp, Mass Financial), have always portrayed themselves as a smaller-size Merchant Banking operation. It was for a long time mainly financial (giving loans to enterprises in difficulty, sometimes making proprietary investments, partnering with government entities, or factoring and forfeiting operations) but the company also moved into physical trading in a big way with the acquisition of Hovis Commodities in 2001 (interestingly, Juriaan Hovis who sold his company to Smith ten years ago is currently still in the trade with his company Carbones Holding). Today, the trading of commodities is being carried out by the subsidiary MFC Commodities, headquartered in Vienna. The company mainly deals in metals, wood and plastics. However, Terra Nova owns a bouquet of other assets, including a royalty of a Canadian iron ore mine, businesses dealing in medical supplies and hospitals, minority stakes in various small-cap companies, loans to businesses, real estate in Germany, substantial cash, and probably other things about which we outside investors have no idea.
With the earnings announcement, Terra Nova’s CEO Michael Smith said he wants Nobility. What he means is that the role model for the business going forward is the Asian company Noble Group (NOBGF.PK). Noble falls more or less in the same category as the companies mentioned before, it’s one of the major merchant banking / commodity trading companies, and in many ways Terra Nova (or should I already say MFC Industrial?) pursues similar (although much smaller) operations. For example, Terra Nova has proprietary investments in an iron ore mine in India, or Aluminum and Zinc processing facilities in Europe. What it doesn’t have is the openness and transparency that Noble gives to investors. Noble has a map on its website showing where its operations are. Noble gives a detailed list of its processing facilities, its ports terminals, storage facilities and mining operations. Terra Nova discloses as little as it possibly can about its assets and operations. If Mr. Smith really aspires to be Noble, he will need more than a griffin on his coat of arms – the company will have to conform to the old adage “noblesse oblige” (nobility constrains to honorable behaviour) and start giving more details about the company’s operations. Even Glencore, renowned for its secrecy, is now providing very detailed informations on its operations following its IPO. If the “new” MFC Industrial really wants peerage with Noble, this is one of the main ingredients it will take. The privileges of a Noble (higher rating in the stock market) come with responsibilities (better disclosure practices). The objective of the management has always been to do good and profitable business, and it has achieved that, but it has always been in the dark. Now is a chance to come to the light – maybe the griffin can finally greet the sun as the medieval bestiary wrote (This is what the Physiologus says about the griffin):
The griffin is the largest of all flying birds. He [lives] in the eastern land in the River Ocean. When the sun rises out of the water depths and the sun dawn breaks, he, having spread his wings, welcomes the sun dawn. Another griffin comes to him and, standing by his side, welcomes [the dawn], and they speak so: "Come, enlightener, give the world light."
(Medieval South Slavic Physiologus, Byzantine recension, translated into English.)
A treasure from the griffin’s claws?
The lion is considered the king of the beasts, and the eagle the king of the birds. The griffin – which is a combination of both, with the body of a lion and the head and wings of an eagle – is thus a very powerful creature, a combination of intelligence and strength. Next to welcoming the rising sun in the East, griffins are often said to be guarding treasures, and the MFC griffin will be releasing a part of its treasure to shareholders.
Before the end of the year, Terra Nova plans to distribute to shareholders about $100m in assets that the management thinks should not be part of the “new” MFC. My guess is this will mainly be the real estate situated in Dessau and Stendal (which has no synergies with the supply chain management operations) along with some other assets or excess cash which still have to be announced. This will reduce the net worth of the company to about $450m, an amount that the company is comfortable with to achieve further growth.
From the financial standpoint, shareholders really have nothing to complain about. Based on the management’s valuation (which we have to trust since there is little transparency about the assets), the book value of the company is $8.91 per share, and the company earned $0.38 per share in the first half (if the share-based compensation expensed in Q1 is backed out). The royalty rate on the Wabush Mine increased compared to last year, but shipments or iron ore pellets from the mine are still below the historical average (see my previous article for details about the royalty asset). If production ramps up again after maintenance and repairs, and iron ore prices stay favourable, the royalty could earn the company an extra $0.20 per share as Mr. Smith indicated in the telephone conference yesterday. If this materializes, and the rest of the business performs in-line with the first half, the new MFC Industrial could earn $1 per share this year. So at about eight times earnings, a discount to book value, lots of cash on the balance sheet ($413.8m, or $6.62 per share) and a $1.63 special dividend or spin-off distribution coming later in the year, the valuation is not demanding.
Mr. Smith, let the griffin spread his wings and welcome the sun dawn. Let transparency and profitability be your path to nobility. The stars are aligned for a great future.
“O my brothers, your nobility should not look backward but ahead! Exiles shall you be from all father- and forefather-lands! Your children’s land shall you love: this love shall be your new nobility—the undiscovered land in the most distant sea. For that I bid your sails search and search. In your children you shall make up for being the children of your fathers: thus shall you redeem all that is past. This new tablet I place over you.”
( Friedrich Nietzsche, Also sprach Zarathustra, Part III, Chapter 56)