Thursday, December 27, 2012

Argo, an undervalued asset manager with a potential catalyst


Some of the best investment opportunities are the hardest to write about, the stocks are plain cheap and there isn't much to say.  I've heard it said in the past that there are stocks that make good stories and there are stocks that make good investments.  My goal on this blog has always been to find stocks that could potentially be good investments, and if they have a great story attached all the better.  Argo has a mixture of both.

I first came across Argo and wrote about them a year and a half ago.  They came up on a net-net screen I ran for profitable net-nets trading in the UK.  I spend a few hours reading their annual reports and ended up purchasing shares.  At some point between then and now I doubled my investment, the date or reason doesn't matter because the thesis (and price!) has stayed the same since then.

The Argo Group Limited (ARGO.London) is an alternative asset manager.  The company manages a number of emerging market fixed income hedge funds.  In their admission document to the AIM they make they claim that they seek to be fundamental value investors in the emerging fixed income space.  The funds invest in fixed income, special situations, local currencies, interest rate strategies, private equity, real estate, and quoted equities.  The only things I didn't seen mentioned in that list were gold and farmland.  As most investors know asset management is a great business model, fixed costs are low and the business is scalable.  

The company came into being publicly traded through a strange set of circumstances.  Initially Argo was founded by the Rialas brothers, Andreas and Kyriakos.  The company was privately held and was fairly successful.  Assets under management grew significantly, and their funds won a number of awards.  The success didn't go unnoticed as they were acquired by Absolute Capital Management Holdings in 2007.  Absolute Capital Management Holdings Limited was a Swiss hedge fund firm that traded in London.  Absolute Capital Management hit a rocky patch as the founder left in 2007 and it was revealed that he put more than half of their biggest funds' assets into highly illiquid pink sheets.  Not only did they invest in illiquid stocks they also worked with another party to manipulate the price of the pink sheet stocks to inflate the NAV of their flagship fund.

While Absolute Capital Management hemorrhaged assets the Rialas brothers wanted a clean break from the troubled parent.  They engineered a spin-off of the Argo assets before Absolute Capital Management folded.  

There are some other aspects of the company's history that are fascinating, but ultimately they aren't relevant to the main reason why Argo is worth considering.  The biggest attraction to Argo is that they're a net-net, and not only a net-net, but a net-net with a decent asset management business along for the ride.

The company has a NCAV of £15.98 against a marketcap of £8.34, the company's NCAV is almost double the last trade.  The company had an operating profit of £411 in the first semester this year.  They reported a loss due to a goodwill write down.  The company's balance sheet has almost no liabilities and assets consist of cash, receivables, and an investment in their flagship fund.  

The company has significant earning power even at their lower asset levels, last year they earned £1.36m on close to $400m in assets.  The first semester this year they paid out £870,000 in dividends. 

Before moving on I want to highlight that Argo is trading at half of their net current asset value.  In addition they have reasonable earning power for a fund their size, and pay out most of their profits as dividends.  While shareholders sit and wait for Argo to appreciate towards its true value they're paid close to a 10% yield, the dividend yield alone is satisfactory for most investors.

I'm not going to sugarcoat Argo, the only reason the company is attractive is because they're selling at such a low valuation.  If someone presented me this company selling for £35m I wouldn't be interested, but at £8m I am.  The company has considerable headwinds, the biggest are the slide in assets and problems with their real estate fund.  The asset outflows stem from below average performance in some newer funds right after the lockup expired.  The Argo Fund (TAF) has performed acceptably well.  The Special Situations Fund, and the real estate fund both have done poorly.  The Real Estate Opportunities Fund (AREOF) invests in entire real estate projects in Eastern Europe.  

The AREOF purchased two shopping centers in Romania in the past year stating that they believed the malls were bargains.  The only problem is the fund was short on cash and was having trouble obtaining credit.  At one point they were in default on some of their loans.  The fund was able to secure lending with Argo backstopping the fund.  Even working through the numbers with the backstop factored in Argo is still cheap.

Another issue is that Argo operates out of Cyprus while being listed in London.  Cyprus has been in the news recently as a potential trouble spot in Europe.  At one point the company had offices throughout the world.  Before any reader is impressed my initial impression when seeing eight or so world offices for a company of 30 was that regional offices such as Buenos Aires were nothing more than an analyst working out of their apartment.  The company's address is on the Isle of Man, and I have a suspicion one would be very hard pressed to find a physical office for Argo.  A distributed company doesn't concern me, but some might believe management is up to no good.

With all the problems the company is facing a valid question to ask is whether they are actually worth any more than NCAV?  The valuation gap between the current price and NCAV is enough for an acceptable return, but some investors aren't satisfied playing for doubles, they want triples and home runs.  

The standard way to value an asset management firm is a percentage of AUM.  A great asset manager might be worth 7% of AUM, a poor one 1-3% of AUM.  I would expect Argo to be worth at least the low end of the valuation scale, so $3-9m for just the asset management business alone.  Add in the cash and securities and they're worth a bit more than double.  A side note, the company's functional currency is the US Dollar, all trading stats are in Pounds.  

If the valuation gap between NCAV and the current price isn't enough there's a potential catalyst for Argo.  A fellow blogger Wexboy has been in communication with the Rialas brothers about ways to unlock value for shareholders.  He's written two letters to the Board.  Guy Thomas, the author of Free Capital has also become a significant shareholder and has signed onto Wexboy's campaign.  The first signs are encouraging, management has been receptive to communication. 

When considering Argo and their valuation gap, plus a potential catalyst I'm reminded of a Walter Schloss quote "something good will happen."


Disclosure: Long Argo




Margin of safety
So many things wrong, cyprus, aum, real estate fund
Not many need to go right, activist (wexboy link)

2 comments:

  1. Hi Nate,

    great blog!

    I have the following two questions regarding Argo.
    In the H1 report they describe the merger of two smaller funds into the new Argo Special Situations Fund. Additionally, they write that the high-water mark for the new fund was reset to zero.
    Do I get this right: Does that mean that as soons as the deliver a positive performance the 20% performance fee will become active?

    Besides that, the fund is an closed-end vehicle with a three year duration (extendable upon request). This means that Argo risks loosing USD 107m or 1/3 of AuM in 2015?

    Best regards

    ReplyDelete
  2. Don't forget that ARGO also has 8% of issued share capital alloted as options which are exerciseable 25p.

    Once 25P gets hit, and management exercise their options, the issued share capital will get diluted by 8%.

    This however is not bad as the share price will have risen 100% from these levels.

    I must also add that the options were alloted at 25p when the share price was trading around 15p ( from memory ). So kudos to management for not following the crowd and alloting options at the (then) current share price or lower.

    ReplyDelete