Monday, August 15, 2011

Argo Group Revisited

Argo Group (ARGO.UK)

Price 15.25p (8/15/2011)

I wrote a post about Argo Group here and it garnered a lot of attention, a lot more attention than I expected at the time.  There was some great information captured in the comments regarding some valuation methods that I wanted to discuss, secondly I wanted to talk about some new developments in the troubled Argo Real Estate Opportunities Fund.

Argo Group previous post link

Valuation

One of my readers Wexboy posted a comment

btw my valuation approach to asset management companies is to generally value them at Cash & Investments plus X% of Assets under Management. If you look at asset manager purchases, this X% approach is far more relevant than evaluating revenues, operating margins, eps etc. (although in most cases these can be used to support the valuation anyway) - this makes perfect sense, as the economics of any fund management business can often be changed radically/quickly after a purchase, i.e. a small fund management business that is breaking even, can quickly achieve the same operating margins as the rest of the purchaser's business, for a number of reasons but mostly, to be blunt, by firing people

I have been thinking about this a lot and it's a great way to model out asset managers.  This view was further confirmed later in the comments along with a quote referencing the same framework in Barrons a week or two ago.  I went back and put together a small spreadsheet showing different asset managers and the percentage they're currently trading at after learning about this valuation method.


The comparison is interesting, the spread goes from around 3.80% for Fortress up to 14% for Och Ziff.

One really interesting data point is RAB Group who's trading at 9.28% of AUM.  What's interesting about RAB is that they've been hemorrhaging assets, they've lost 50% of AUM this year alone, and they're down 93% since 2007.  RAB is facing a delisting from the AIM and yet still trades at double the percentage that Argo trades at.  RAB also is trading at a discount to NCAV but I would make the argument that Argo is probably a much better investment considering AUM is stable.

The commenter also suggested the best way to value a company such as Argo is cash + investments + % of AUM.  Using the current trading metric for Argo I get the following value:

$44.9m + $18.4m = $63.6m or £38.66 which equals .55p per share

While this amount seems a bit on the high side I think it's interesting that management granted options that exercise at 24p/sh.  What I like about the 24p/sh is that this is the same value as NCAV per share which I think is realistic, a company shouldn't trade for less than NCAV.  While I'd be happy with 55p/sh I will also take 24p/sh as well.

Real Estate Developments

I noticed a RNS for Argo mentioning a share offering for the Argo Real Estate fund.  To give some background the Real Estate fund purchased some shopping centers in Eastern Europe (Romania, Ukraine, Moldova) at inflated prices and now that real estate has crashed the fund is experiencing some problems.  Argo is the manager of the Real Estate Opportunities Fund.

The problems are really two fold, the first is that asset values are down which has been impairing the NCAV of the fund and preventing the high water mark from being hit.  The second is that the tenants have been asking for rental concessions (and Argo is granting them) which is putting a crimp on the operating income of the fund.

The management of the fund believes that the NCAV has bottomed, and that the real estate market has hit bottom in Eastern Europe as well which is good.  The hope is that they can dig out of the hole they're in.  Looking at the past interim statement for the fund they are slightly cash flow positive.

So why all the background?  Management released a circular (proxy?) stating a few things:

  • A secondary offering doubling the size of share capital
  • The purchase of two shopping centers in Romania
  • The revision of the Real Estate fund highwater mark downward to .15/share (current NAV is .12/sh).  This makes it more reasonable that management will be able to get the performance earn-outs in the next few years.
  • A proposal to extend the life of the fund five more years.
In addition the circular also includes some details with regards to the working capital constraints the real estate fund expects to hit in June 2012.  The notes indicate that Argo has provided a letter of credit which they hope to be sufficient to get £4m in borrowings, and if that doesn't pan out Argo themselves will lend the £4m.  While this isn't ideal it also doesn't seem like an endgame scenario for Argo.

My take is that the Real Estate fund management is hoping that the market will turn enough that they'll be able to work out their financing problems by possibly an asset sale.

Hopefully the two items in this post are helpful to a prospective Argo shareholder. 


Disclosure: I ended up purchasing a small position after my previous post.  I haven't decided on if I want to increase my position yet, I'm still digesting some of the circular notes.

1 comment:

  1. Nate - i've pared back because of my increasing stake in ARGO, but i also have 90,000 shares of charlemagne capital (CCAP), another emerging markets asset manager - if you strip cash/investments out of the current market cap. CCAP is effectively valued @ 1.4% of AUM - i see 100% upside from current share price(GBP 16.125p)

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