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Argo Group Ltd. (ARGO:LN)

  • Mkt Price:  GBP 13.375p
  • Mkt Cap:  GBP 9.0 mio
  • % of AUM:  4.5%  (of $325.4 mio)
  • P/C:  0.6
  • P/S:  1.3
  • P/E:  10.0  (Pre-Amortisation/One-off Fee)
  • Div Yield:  9.7%      

Please read my previous investment write-up here & here. Wow, it was December when I last wrote about Argo! But not so surprising – the pace of news from the company is astonishingly low… In fact, we’ve only had one news item since, their Final Results. Shouldn’t complain though, I guess this contributes to the market’s neglect of the stock. Anyway, it’s a pleasure to write about Argo again…and marvel at just how bloody cheap this stock is!? If you haven’t read my prior posts (which provide plenty of useful background, some of which has contributed to ARGO’s cheapness), I think you’re in for a treat!

There’s actually nothing too dramatic to report from the annual report. The first thing to home in on, as with any asset manager, is the Assets under Management (AUM) figure. Not unexpectedly, judging by other reports, AUM was down 19% to $325.4 mio. Despite that, the Rialas brothers manage to pull a rabbit out of the hat again and produce another good set of results. The emphasis on controlling costs, and maximizing any incentive/other fees, has producing an Operating Margin (pre-Amortisation) of 25.2%. If we exclude the flagged one-off fee of $1.1 mio (though they’ve earned similar fees in the past), the operating margin’s still reasonable at 15.3%. I was a little unfair above, ARGO’s actually trading on a 6.1 P/E, based upon their actual (diluted pre-amortisation) EPS of 3.55 cts. To be conservative, if we exclude the one-off fee, EPS came in at 2.17 cts for a 10.0 P/E (fyi the same EPS, on an ex-Cash basis, is 2.13 cts).

In fact, my only real complaint is the continued emphasis/focus on cleaning up & restructuring existing funds/fund investments. All very necessary I’m sure, but the ship has been pretty much righted and the company’s life-threatening litigation has been out of the way for a year now. It’s time for an aggressive fund-raising push! The disasters in the past few years possibly obscure the fact that Argo has a v creditable investment record. Their flagship fund, The Argo Fund (in which the majority of the company’s Investments are placed), has returned a cumulative 134% (or an 8.65% CAGR) since inception in Oct-2000. Their emerging markets/distressed/private equity investment approach is perfect in the current environment. Incidentally, it’s almost identical to Ashmore Group (ASHM:LN), their much larger peer. This type of strategy/flexibility would be ideal for a new frontier markets fund (and I’d also like to see more investments and/or a fund directed towards the higher growth Asian economies).

But first, the obvious fund to launch would be focused on the European periphery, and the distress caused by the European sovereign debt crisis. ARGO’s experience & investments to date are ideal prep. for investing in restructuring/deep value/distressed opportunities in Eastern Europe, the Balkans & the Flub Med economies.

Meanwhile, we can rely on ARGO’s valuation & margin of safety for comfort. I see no reason to change my prior valuation methodology, which is essentially Cash plus a (severely haircut) hedge fund valuation of AUM. Before laying out the figures and calculation, let’s just revisit some other (more qualitative) ARGO positives:

ARGO management’s been consistently shareholder friendly to date. They’ve increased the dividend by 8% YoY to GBP 1.3p, for a colossal 9.7% dividend yield. I prefer to focus on cash not earnings coverage for dividends (unless there’s a secular earnings decline): It’s comforting to know ARGO can fund this dividend for the next 17 years even if they never earn another penny..! They also spent as much on share repurchase last year as dividends, retiring 8.5% of outstanding shares. They did put in place a pretty large option scheme (about 9% of outstanding shares), but I was v impressed to see a GBP 24p option strike price set (a 100% premium). Directors also own 38% of the company – not too large to be abusive to minorities, but between this stake & the new option scheme there’s a clear financial alignment with other shareholders.

Finally, while we still await AUM growth, there’s a huge margin of safety embedded in ARGO’s current profitability (on much reduced levels of AUM), its large discount to Cash & Investments and the complete absence of any Debt. At worst, I believe the Rialas brothers could launch a take-private bid – the size of their stake, and ARGO’s underlying value, should produce an attractive premium in this scenario. Of course, I’m also sure Ashmore Group and/or quite a few other investment houses would be more than willing to make a bid if they can lock down key staff. Remember, in an asset management company acquisition, profitability’s fairly irrelevant – the standard metric is to pay a % of AUM (if you’re set up on ADVFN, there’s more ARGO comment here). The potential for immediate cost cuts, ARGO’s specialized skill set & experience, and its PE/hedge fund fee structure more than justify a 3.75% of AUM price tag – which is at a significant discount to other PE/hedge fund asset managers’ current market valuations. btw By comparison, Ashmore trades on an ex-Cash 6.2% of AUM!

Speaking of ex-Cash, it’s always great fun (yes, this is what I do for fun..!) to take a fresh look at ARGO’s current metrics on an ex-Cash basis (i.e. net Cash/Inv stripped out to isolate the underlying business value). See how absurd they are (yes, those ratios are all negative!):

  • Ex-Cash Mkt Cap:  GBP (6.3) mio
  • Ex-Cash % of AUM:  (3.2%)
  • Ex-Cash P/S:  (0.9)
  • Ex-Cash P/E:  (7.2)

My valuation is still pegged at Cash/Investments + 3.75% of AUM which equals:

$24.9 mio Inv/Cash + 3.75% * $325.4 mio AUM = $37.1 mio / 1.6218 GBP/USD / 67.4 mio shares = GBP 33.9p Fair Value per share

This offers 154% Upside Potential for a safe & cheap business, which also ideally offers long term (low volatility) emerging markets exposure. I’ve just increased my portfolio stake from 4.2% to 5.0%, and would have been happy to go higher only for ARGO’s small market cap. Let me wrap up with some target metrics (I obviously recommend focusing on the ex-Cash metrics!):

  • Tgt % of AUM:  11.4%
  • Tgt P/S:  3.3
  • Tgt P/E:  25.4
  • Ex-Cash Tgt % of AUM:  3.75%
  • Ex-Cash Tgt P/S:  1.1
  • Ex-Cash Tgt P/E:  8.5
  • Tgt Price:  GBP 33.9p
  • Upside Potential:  154%
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