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wexboy.wordpress.com A blog about value investing, mostly in UK, Irish and US listed stocks. Interested in individual company stocks, investment funds, risk arbitrage, event driven/special situations, fixed income and even some natural resource stocks.
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  • Seduction…and Neglect?! How About A Catalyst? (Part III)

    Continued from here:

    i) Liquidations are top of the heap for catalysts! They're usually only announced after a company has sold all/the majority of its assets (or occasionally its business(es)). They offer the best prospect of a highly certain final asset value, to be realized within a reasonably short/well-defined timeline. They're usually concluded within 6 months to 2 years, and any decent BoD/management will provide an estimated total distribution amount (net of all expected liquidation expenses) and schedule.

    Of course, if they've an ounce of sense, they'll be as conservative/pessimistic as possible with their forecasts, so any surprises should hopefully be positive… (In fact, they should recast the B/S with all future expected liquidation expenses included as a provision - i.e. accounting on a liquidation basis, not a going concern basis). In aggregate, these features mean that liquidations have v attractive IRRs and Expected Value Returns!

    There are only two real negatives: First, these can be very difficult to pick up! A wide spread/high offer price will slice away/eliminate your potential return. Also, market-makers/hedge funds like these, and will bid them up to levels that won't make sense for you. Yes, their end result is exactly the same as yours, but their lower dealing costs and ability to actively trade, bid for, and leverage their purchases mean their average entry prices and IRRs will be dramatically better. Second, liquidation stocks will often delist - which creates a bit of a dilemma for many investors. However, considering the facts and presuming you've done your analysis, you should have no anxieties about this.

    Also, usually, the level of disclosure from the company and/or liquidator will continue to be reasonable after a delisting. (Although I'm still having problems with Veris plc (VERI:ID) - this was a very successful liquidation for me to date, but there's still some money left on the table and Mazars, the liquidator, have been atrocious in their poor execution, disclosure and general response to shareholders (their employers!). Who do they bloody think they are? Management of an AIM company?! ) Some recent or current liquidation examples are:

    Nordic Land (NLD:LN)

    Economic Lifestyle Property Inv Co (EPL:LN)

    JSM Indochina (JSM:LN)

    FRM Credit Alpha (FCAP:LN)

    FRM Diversified Alpha (DIVA:LN)

    Siteserv (SSV:ID), on the other hand, is a recent example of a different type of liquidation! Avoid these situations! Company management finally responded to the newspaper reports by stating, rather hilariously, that "At this stage it is not possible to predict the outcome of this exercise nor quantify the financial impact for shareholders. However the exercise is not expected to have any negative impact for staff, customers, key business relationships or suppliers." So, glad to see they have the key stakeholders covered… That figures: The value of directors' shareholdings last week - EUR 260 K. The value of their annual remuneration? EUR 1.221 million! But they can't manage to assess the impact for other shareholders? What do they need, a guide dog and a f**king abacus?! Huh, there's not a hope in hell shareholders will get a penny back from this debacle.

    I usually find news of liquidations as I go along, or they're companies I'm already tracking. If you plug in 'liquidate', 'liquidation' and other related phrases as a keyword or free text search on Investegate or the RNS section of the LSE website you'll come up with a list of announcements that should reveal an occasional gem.

    ii) Wind-downs are an extended form of liquidation, usually where the company still has all/the majority of its assets (or business(es) to sell. In fact, wind-downs will occasionally precede a liquidation. They're usually concluded within 1 to 3 years, there's usually no clear distribution timeline provided (as it will depend on divestitures), and expect that asset values can change radically over time. You need to be a lot more careful with these as (oddly enough) during a wind-down, asset values never seem to rise..!?! If there's Debt involved, be v aware of how quickly a small decline in Assets can translate into a larger decline in Net Assets.

    Of course, another reason for 'asset volatility' is that management's often still stuck in the wishful thinking stage when a wind-down strategy's announced (sometimes reluctantly), and/or they're a little embarrassed to mark down a balance sheet so quickly when they said it was fairly/under-valued just a few months earlier!

    If you have enough information to hand, you may be able to calculate an appropriate 'haircut' or asset value, allowing you to determine if your price target (and timeline) offer a sufficient upside on an IRR basis. This worked really well for me recently with Dhir India (DHIR:LN) - a wind-down strategy had not been definitively announced, but it was obvious this would be the end-game. Despite an NAV of GBP 134p, I calculated a much lower adjusted NAV of GBP 69.6p as a Fair Value Target, which still offered a gross Upside Potential of 335%. In the event, the Investment Manager actually launched a GBP 42p Cash Offer shortly thereafter - which I accepted. This might seem a poorer (relative) price, but in terms of certainty and a much shorter time line, this offered a hugely better IRR in the end. Otherwise, much of the time (I must confess!), I simply use the latest NAV/Book Value as a price target - if/when the share price begins to close in on the NAV, I become conscious of the increased risk and may sell/switch to a more attractive situation, so there's a natural 'haircutting' process involved anyway.

    Here's a selection of stocks currently in wind-down mode:

    Investment Companies:

    Guinness Peat Group (GPG:LN): Price - GBP 28.5p, Latest NAV - GBP 52.8p, Discount to NAV - 46%

    Gresham House (GHE:LN): Price - GBP 285p, Latest NAV - GBP 493p, Discount to NAV - 42%

    Trading Emissions (TRE:LN): Price - GBP 24p, Latest NAV - GBP 76.7p, Discount to NAV - 69%

    Property Companies:

    Trinity Capital (TRC:LN): Price - GBP 15.25p, Latest NAV - GBP 30.7p, Discount to NAV - 50%

    Ottoman Fund (OTM:LN): Price - GBP 43.5p, Latest NAV - GBP 74.7p, Discount to NAV - 42%

    South African Property Opps (SAPO:LN): Price - GBP 53p, Latest NAV - GBP 109.7p, Discount to NAV - 52%

    Private Equity/Venture Capital Companies:

    LMS Capital (LMS:LN): Price - GBP 56.5p, Latest NAV - GBP 89p, Discount to NAV - 37%

    Eurovestech (EVT:LN): Price - GBP 9.125p, Latest NAV - GBP 16.9p, Discount to NAV - 46%**

    Spark Ventures (SPK:LN): Price - GBP 7.125p, Latest NAV - GBP 13.5p, Discount to NAV - 47%

    Private Equity Investor (PEQ:LN): Price - GBP 151.5p, Latest NAV - GBP 241.7p, Discount to NAV - 37%

    Avanti Capital (AVA:LN): Price - GBP 83.5p, Latest NAV - GBP 150p, Discount to NAV - 44%

    ** Wind-down strategy not formally confirmed, but company is in distribution mode.

    You'll note I've grouped all of the above by company type, for your guide - while every company is unique, it wouldn't be the best idea to load up on 5 different private equity companies, all in wind-down mode..! I tend to suffer as a result of this proviso - I feel like I have to find and track every last wind-down out there, but then I have to discard most of them in the interests of diversification!

    One last warning: Be v careful how distributions are characterized in a wind-down. Don't be fooled by the words dividend, distribution, or even special dividend - what you need to see is 'capital return' or 'return of capital'. Why? Well, the former are subject to Income Tax, while the latter are subject to CGT. There's nothing worse than investing in a wind-down situation (this is not an issue with liquidations) and discovering that your invested Capital will be returned to you as Taxable Income!?! And obviously it can really screw up your expected returns! Don't hesitate to check in with a company for clarification, though God knows whether you'll get a decent response…

    Heaven knows why companies do this? If I'm charitable, I guess they've got large/tax-free pension funds/offshore hedge funds snapping at their heels for the quickest/cheapest distribution process possible. But in many cases, I'm sure it just boils down to executive laziness and/or simple shareholder neglect. JSM Indochina (JSM:LN) was an example of this for me - during its wind-down (it's now switching to a liquidation), I was aghast to discover that distributions were, in fact, dividends and I was only saved by the NAV discount I'd captured in the first place. I collected a couple of distributions but ultimately disposed of this investment as I feared I'd suffer Income Tax the whole way down on the NAV (which would have turned out to be the case).

    OK, I'll return shortly with more catalysts.

    Disclosure: I am long OTC:TRDGF.

    Jan 24 12:20 AM | Link | Comment!
  • Seduction…and Neglect?! How About a Catalyst? (Part II)

    Continued from here:     OK, so we’ve defined what a stock catalyst is, and also recommended you evaluate catalysts from an IRR perspective.  This is the best way to highlight how they can deliver a dramatically improved return, due to the (potential) acceleration of value realization.

    If you really want to complicate your life, you could also layer in an EV approach…the analysis that is, not the blog! Let’s not dig into the math/mechanics here, but it spotlights another attractive feature: A catalyst may prompt you to attach higher probabilities to positive/specific/increased return scenario(s), thereby increasing the Expected Value of your investment return. For example, Risk Arb (and many Event Driven) opportunities offer a specific price ‘target’ and timeline, with a high probability attached to this outcome, so EVs (and, of course, IRRs) can be pretty tasty!

    Let’s look at a Risk Arb Investment I’m currently working on, for which a Recommended Cash Offer has already been announced. I can’t disclose the name yet, as I’m still painfully building up my position, but I can walk you through the math. Based on the average purchase price to date, and presuming the Cash Offer price is realized, Gross Return will be 16.3%. Considering all aspects of the deal (reputation and financing of the bidders, irrevocable undertakings, conditions and terms of the Offer, etc.), I attach a 96% probability to the Offer going through, and 4% to a deal failure. Hmm, such precision..!?!  I estimate failure would lead to a 30% loss, so the Expected Value of the Gross Return works out at 14.5%. In terms of a timeline, I expect receipt of Offer proceeds in 35 or 55 days, so assuming the later date we can arrive at an annualized Gross IRR of 170%+. Wow!  Of course, actual evaluation on a Net basis is recommended, factoring in your specific dealing costs, stamp duty, any FX spreads/risk etc.

    OK, still a little fuzzy so far? Sorry, it’s me, not you… Let’s just get some misconceptions out of the way first, and then we can start running through some examples. Don’t mistake most aspects of a business story as a catalyst, even if something’s a little unique or unusual. It depends on size and circumstance, of course, but in most instances management changes, rationalizations, new products/services or market entries, acquisitions/divestitures etc. are what you’ve already paid for – it’s in the price, or at least in your price target. I don’t consider high dividend yields a catalyst either; they’re usually just a function of a depressed share price.

    But then again, who can resist a good yield?! I don’t home in on dividend yield much, but occasionally when it’s a specific focus for me, I demand a pretty hefty 8.0%+ yield. On the other hand, I’m probably a bit softer than most when I look at Dividend Coverage. Presuming the business isn’t in some obvious distress, I prefer to measure the Coverage provided by Gross Cash rather than Earnings. Of course, this does imply a significant judgement call on management’s strategy and attention to shareholder value..!

    Interior Services Group (ISG:LN) is an excellent example. There’s no apparent catalyst, but it has a great Margin of Safety in its GBP 36.1 mio of Net Cash (vs. a GBP 49.0 mio Mkt Cap) and a whopping 10.3% dividend yield. With an annual cost of GBP 5.0 mio to ISG, and Gross Cash of GBP 44.6 mio on hand, management could merrily pay this dividend for the next bloody 9 years even if the company never earned another penny!

    Timeweave (TMW:LN) is an even better example. It has GBP 28.5 mio of Cash (and no Debt) vs. a GBP 52.1 mio Mkt Cap, an even better 11.3% dividend yield (covered for 5 years), and yes, it has a lurking great catalyst in the form of a key activist shareholder. Joe Lewis has a 29.99% stake in the company. After an initial flurry about a potential bid, Lewis has been pretty quiet to date, though his fingerprints appear to be all over some management changes in the past year or two. Interestingly, Leo Fund Managers recently turned up with a 4.9% stake. They joined in the whole Mitchells & Butchers kerfuffle, alongside Lewis and Magnier & McManus, so I think we can assume they’re activist in their intentions also (…perhaps in concert with Lewis?!). Also, GAM Holding and Goldman Sachs have 9.2% and 6.0% stakes respectively. They’re not known for public activism, but they’re clearly sharp (elbowed) shareholders and would obviously play a role in the event of any corporate activity.

    So, TMW has 4 v savvy/activist shareholders who’ve been pretty quiet to date, but must surely be losing patience at this point..? Obviously, they can trigger significant value appreciation at any time through pushing for a substantial return of capital and/or by scaring up an offer for the company. Lewis obviously has the firepower to bid himself, or he may just prefer to shop the company ‘round. Meanwhile, there’s the dividend yield to enjoy.

    I’ll continue on from here a little more systematically, with examples to match.

    Jan 20 8:32 AM | Link | Comment!
  • Seduction…and Neglect?! How About a Catalyst? (Part I)

    Lewis (at Expecting Value) and I started a convo here about stock catalysts. I thought it best in the end to tackle this (a little better?) in a blog post, as it’s something I’ve tried to focus on/prioritize in the past year. And he challenged me to give some real examples!

    First, let’s highlight two particular problems with value investing/stocks. How do I describe them..?

    Seduction:  How many times have you been itching to buy something, and been seduced by the siren call of 20 different cheap stocks? Umm, how to choose..? Or you’re feeling your value investor oats, and begin to fall in love with a particularly unique, difficult and undoubtedly complex stock. Jesus, ever date girls like that? Yes, yes, you’re such a wonderful guy - the only one who recognizes how misunderstood she is, the only one who sees the heart of gold beneath the vodka, smeared lipstick and hysteria. Yeah, I’ve known a few, including one where my mother finally posed the question ‘God, why couldn’t you just sleep with her, why’d you have to bloody date her?!’ I won’t forget that day in a hurry... So, how do you avoid this type of tragedy?**

    Neglect:  You buy a marvelously undervalued stock, and then…and then nothing happens, for years! Why the hell doesn’t the market close the valuation discount? In fact, why does the price keep sinking? Hmm, maybe somebody will swoop in with a takeover offer. Perhaps you are forgetting that unsolicited bids are usually flushed out by unprecedented declines in the target stock price. So, that momentary surge of joy at a 30-40% bid premium may well be very fleeting when you remember it just gets you back to breakeven. How come the best hedge funds don’t seem to have this problem?

    I’m sure, like me, you’ve suffered from the above on more than a few occasions. What’s the solution? I believe that focusing on stock catalyst(s) is the answer. That’s what the best/most aggressive hedge funds do and/or, failing that, they become a catalyst themselves! What exactly do I mean by a catalyst? Hmm, tough – I guess I’d say:

    A catalyst is any kind of transaction/fact/event/etc., actual or potential, that offers the opportunity for a full/partial realization of value in a stock, within a (reasonably) accelerated timescale.

    Think about all of this in terms of an Internal Rate of Return (NYSE:IRR) on your investment – and that’s why I mention hedge funds, their performance anxiety pretty much forces them to think about stocks in this fashion. Having a catalyst can radically alter expected or actual IRRs, and/or provide defensive price support.

    Take your average value investment: You’ve found a neglected jewel, and based on your value investing acumen (and a decent Margin of Safety) you confidently expect that will ultimately capture an upside of, say, 75%. But when will that happen? In 3 yrs, 5 yrs, 7 yrs..?! Those periods equate to IRRs of 20.5%, 11.8% and 8.3% pa respectively. Now assume a catalyst exists that’s successful in prompting a realization of that full 75% upside within 1 year. That is, of course, a 75% IRR! Wow, radically different investment results from the same stock/upside.

    You’ve 20 stocks to choose from? At its simplest, a catalyst can represent the deciding factor in making a stock choice. (And a catalyst would be a v compelling part of a 2 minute monologue – see Richard Beddard’s NY’s resolution here). It may also enhance your Margin of Safety. Even better, it can be a marvelous stock selector in terms of respective IRRS. It’s simple to see that a catalyst that shortens your prospective holding period can easily produce the most attractive IRR, even for a stock with only half the upside potential vs. some other stock choices. And what about that difficult stock you fell in love with? Same thing. You better goddamn have a gigantic upside pegged for it, ‘cos otherwise it’s not going to stack up so well (in IRR terms) against any kind of (demure) stock you find with a catalyst.

    Of course, you will recognize that any type of Risk Arbitrage or Event Driven investing is a very specific form of investing in stocks with a catalyst, and IRR is the de rigeur analytical framework for this type of investing.

     

    Part II:  I'll cover the various types of catalysts I look out for, and provide and discuss as many real-life examples as I can come up with.

    ** The (other) obvious answer is to MOVE ON! If a stock’s (too) difficult, don’t take it up as your own personal crusade. There’s always going to be a much better/friendlier stock, with just as much upside, right ‘round the corner – you might just need to look a little harder.

    Jan 13 11:23 AM | Link | Comment!
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