Before tackling the next batch of stocks, some readers may want to revisit my first TGISVP post. This project’s not about doing a detailed writeup/valuation on each stock. Sure, I spend ample time on each stock (on a best efforts basis)**, but less than if I were making an investment and/or doing a detailed writeup. That’s why I label these rough and ready valuations! On average, yes I’d expect detailed and rough & ready valuations to be similar, but ‘average‘ is key here..! Take a closer look at any company, and my new valuation could be (possibly significantly) higher, lower or unchanged vs. my original valuation.

What this project is designed to do: i) Illustrate the wide variety of valuation assumptions/approaches that can be applied depending on each individual company/situation, and ii) provide a cheatsheet to highlight the potentially best (and worst!) Irish stocks, on an absolute (or relative) basis, that may merit further research and potential purchase/sale.

I’m not writing specific stock recommendations here, and I prefer readers to DYOR and examine the exact valuation/math for themselves (and prices/upsides can change quickly), so I limit the figures/info. I include in any stock commentary. I hope this encourages people to download/utilize the latest Excel file – feel free to refresh prices, and/or revise any valuation formulae to fit your own perspective(s). OK, let’s finish off the ISEQ listed stocks:

The Great Irish Share Valuation Project V     (xlsx file)

The Great Irish Share Valuation Project V     (xls file)

Ryanair (RYA:ID or LN):   I’m a shareholder (I tweeted I’ve sold down to a 0.9% stake as the price appreciated), but hadn’t done a detailed blog writeup as I’ve been more interested in selling than buying since the end of last year.

This holding now matches up with my Petroneft (PTR:ID) shareholding. I’m looking for others (chemical stocks?), but I like transport stock(s) as a natural hedge for oil stock(s). Before we argue correlations, yeah it’s a little rough & ready but there’s an obvious negative correlation there, and it’s worked well for me in the past. Of course, I’m still looking for alpha – ideally each pick appreciates over time but with some of the underlying commodity price volatility/impact eliminated. So if you can’t find a stock you want to own anyway, don’t try this!

Ryanair made compelling sense even as a stand-alone investment at my average entry price. If I end up adding to my oil stocks, I’d like to also increase my transport holdings. Ryanair and Irish Continental (IR5A:ID) don’t offer enough upside, tanker stocks are an absolute disaster, and coach/rail/cruise-line stocks don’t seem so compelling – it’s a riskier stock, but Dart Group (DTG:LN) has potential, and has been on my Potential Buy list for a long time… And it’s caught plenty of blogger’s eyes recently: kelpiecapital, Expecting Value, Richard Beddard, valuestockinquisition, Valuhunteruk. Hmm, maybe a good stand-alone investment anyway?!

I’ve a 15 P/E on Ryanair – might seem a touch low, considering current earnings growth, but bear in mind historical earnings volatility and the headwinds RYA faces with oil next year. I similarly arrive at a 1.33 P/S ratio (vs. a 15.3% Operating Profit margin). It also reflects the fact operating free cashflow has historically been severely lower than operating profit. No longer the case, with capex on hold (yes, I’m sure another special dividend’s coming…), but who knows when that might change? When O’Leary feels like he’s beaten Boeing into submission..?!

Siteserv (SSV:ID or LN):   This little puppy’s so distasteful, you might have noticed I couldn’t resist writing a separate post about it earlier this week.

Smurfit Kappa (SKG:ID or LN):   So, definitely not a widows and orphans stock! But its valuation is intriguing… Latest pre-exc. EPS stands at EUR 1.00, and I’m reminded of the rule: With cyclical stocks, never pay more than 5-6 times peak earnings! But it’s not clear where Smurfit stands in this regard – there are certainly fresh threats to global growth, and debt overhang will restrain the developed markets for years to come – on the other hand, Smurfit’s now a dominant player, emerging markets continue to perform well, and Western central banks continue to pump out a tsunami of liquidity to combat debt deflation. All in all, I think the risks are finely balanced, and certainly do not imply we’re definitely seeing peak earnings now – you should certainly factor in your own growth outlook into this valuation.

What’s much more relevant is that Smurfit’s still pretty much a distressed situation. Debt’s far too high, and debt reduction needs to be the primary focus for such a cyclical stock (I’m actually disappointed at the recent dividend announcement). As I’ve mentioned too many times, the only safe way to value a distressed stock is through the balance sheet and cashflow statement, simply ignore the P&L! Of course, risk control goes hand in hand with this – even if a distressed stock’s v under-valued, it may be wise to limit your stake in light of the continuing risk its excessive debt presents.

Looking at Smurfit in the past 3 years, I’m impressed at their capex. spending control, which has only risen from a net EUR 235 to EUR 262 mio. This hopefully suggests that if end-market prices start to reverse, similar discipline will be applied to reduce/cancel spending plans. Average operating free cashflow margins have been 8.0%, which deserves a 0.67 P/S ratio. However, debt/derivatives are far too high at EUR 3.7 bio (resulting in a net EUR 245 interest bill) – vs. the latest operating free cashflow of EUR 697 mio, a 57% reduction in debt would bring interest coverage back to reasonable levels.

There’s also a EUR 655 mio pension deficit, but this is more than offset by ample cash of EUR 845 mio. Putting all this together, we’ve a substantial (debt) haircut to the implied P/S valuation of EUR 4.9 bio, but Smurfit still presents a v attractive upside if you’re prepared to bet on an economically sensitive stock still in the midst of a debt reduction programme.

Total Produce (TOT:ID or LN):   This one should be v familiar to regular readers! Please read here, and here. My Fair Value Price Target is much unchanged at EUR 0.941, offering a low risk, but hefty, upside. Price action in the past week has been intriguing – we broke EUR 0.41, which quickly led to EUR 0.44. A break above that level would signal a significant move higher. I currently have a 5.1% stake, my 3rd largest portfolio holding now.

Tullow Oil (TLW:LN or ID):   Uhoh, I’m really going to put my f***ing foot in it this time… Tullow’s valuation makes no sense to me! I tie myself up in knots, but I still can’t reach it – like that old joke…if I damn well could, I’d never leave the bloody house!! In the end, I tried 3 different approaches – to show I’d spent enough time poring (not ‘pouring‘ as so many idiot publications spell it!) over the figures, and to see if any individual valuation wildly contradicted the others.

‘Fraid not! My preferred approach is balance sheet/reserves based: Tullow has $403 mio of cash, plus $72 mio from its Ghana offering, less $89 mio for EO purchase, an expected $2.9 bio from its Uganda farmout, less $405 mio net 1 year cash burn, less $3.1 bio of debt/derivatives. It has 152.7 mio boe of Proved Reserves (assuming a 50:50 Proved/Probable split) I value at $10 per boe, another 152.7 mio boe at $5 per Probable boe, and 684.6 mio (post Uganda farmout) boe at $2.50 per Contingent Resource boe. This amounts to about a $3.8 bio Fair Value.

Now let’s try a P/S approach: With the prior volatility and recent ramp-up in revenues, and the variability of operating profit margins, I think I’m being pretty generous working off the latest revenues of $1,666.3 mio and an operating profit margin of 41.9% (10% to be allocated to minorities). Current debt’s manageable, in theory, based on these metrics so no adjustment needed there. I’ll put Fair Value at a 4.25 P/S ratio, which equates to about $7.1 bio.

Finally, we’ll look at EPS: For the same reasons as above, I’m not prepared to place Fair Value any higher than a 12.5 P/E, which corresponds to $3.95 per share based on latest LTM EPS of $0.316.

I therefore come up with an average Fair Value of GBP 338p per share, which threatens a substantial downside for the share price. Despite the misleading headline, this is reflected in a Bloomberg article today that highlights ‘They’re paying about 33 times expected profit for Tullow shares, the highest price to earnings ratio on the 19-member FTSE All-Share Oil & Gas Producers Index.‘

Let’s crush it in a couple more ways: Tullow’s currently worth about $25.1 bio (inc. net debt). It has 1,509 mio boe (pre Uganda Farmout). This implies each boe’s worth almost $17 (incorporating no discount for Probable Reserves or Contingent Resources). Far too rich for me! Alternatively, if we derive a valuation based on Tullow’s own deal-making skills, the 519 mio boe Uganda farmout is worth $2.9 bio, which implies a value of $8.4 bio on its total reserves/resources, and that’s before net debt! ‘Nuff said…

TVC Holdings (TVCH:ID or LN):   I wrote some brief commentary about TVC here. TVC’s come a long way from its roots as an Irish technology VC fund… It hasn’t made a new investment in almost 4 years, a fresh tech investment since it listed, and most recent non-cash portfolio value/gains derive from 2 listed companies. Norkom‘s been taken over since, while their 18.0% stake in UTV Media (see below) is by far their largest investment. Idle cash (at 66%) is the largest portion of their overall portfolio.

The market’s been disappointed at the lack of transactions here, the loss of its tech focus, and the drift into listed companies. The significant discount to NAV is understandable, as a result, but still v much unwarranted. The only discount arguably to be applied is on the unlisted portfolio. Even if we apply a 30% discount, the unlisted allocation at 11% is so small Fair Value‘s still close to the published NAV, so we still have some decent upside.

Jon Moulton‘s the obvious solution..! What? Moulton’s well-known in the PE industry, and likes distressed/turn-around situations. He has a listed fund, Better Capital (2009) (BCAP:LN), and has raised GBP 170 mio for a second Cell of the company, Better Capital (2012) (BC12:LN). He’s also shown a predilection for Irish companies, so now is the perfect time for him to swoop in and scoop up some bargains. What better way to achieve that…than to buy TVC!

For once, I think a Share Offer would be more attractive than a Cash Offer. Considering Moulton’s record, exchanging TVC shares at a nil premium would still be an attractive proposition. With a takeover complete (and cash preserved on both sides for acquisitions), Moulton could just fire most of the TVC dead-weight. Once that’s done he just has to check the remaining TVC team still remember how to actually buy (into) a company, and then send them out as his Irish investing vanguard. (Almost) everybody’s a winner!

United Drug (UDG:ID or LN):   Poor old United Drug… Long gone are the days when they proudly included compound growth tables in their annual reports! Tables that illustrated 14 to 20% pa revenue/earnings growth over the past 10-20 years. Considering the ridiculous closed-shop feather-bed Irish pharmacies were over the years (to the Irish consumer’s cost), I’m sure there was plenty of cream to go ’round, so United clearly benefited for years from this situation. It also had the reputation of being a rock-solid business.

But that was then…this is now! It’s a much harsher world these days, and people now see how much governments, and large pharma, can squeeze the entire healthcare supply chain. In the last 4-5 years, revenues, adjusted operating profits and diluted adjusted EPS have gone absolutely nowhere (although debt has almost doubled..!), accompanied by a comprehensive (and expensive) diversification out of Ireland and into related business lines. There’s probably some empire-building here from Liam FitzGerald, CEO, but I suspect this acquisition/diversification spree was mostly necessary just to offset declining revenues/margins. What’s that sound? Yes, it’s a business sucking wind..!

Unfortunately, even if headwinds slacken, they’re still going to be faced with continual pressure and regulatory/governmental uncertainty. This is not the bluest of blue chips anymore. I would therefore only award a P/E of 10, and its 4.4% adjusted operating margins only gets me to a 0.375 P/S ratio – both of which confirm United Drug’s only a little undervalued. Interested investors may still see another chance to pick up the shares between EUR 1.80-90.

UTV Media (UTV:LN or ID):   I criticized TVC Holdings above for their UTV Media investment. You might conclude it was a bad investment, but I was really making a very different point! One, TVC Holdings shareholders didn’t sign up for investment in public companies, and two, style drift generally signals other/underlying problems and often seems to end in tears…

UTV Media actually presents an interesting investment opportunity. I was always fond of the niche they were in, and it also struck me as a pretty well run company, at least on an operational basis. Of course, nowadays, this type of media company doesn’t get much respect, but I still think the immediacy of TV & radio is far more attractive and relevant than newspapers. I do think however that many stand-alone media companies would probably now be better off in private equity hands, or swallowed up by a larger media conglomerate. It’s interesting therefore to see UTV’s largest shareholders are both PE houses, with Organo Investments‘ 14.1% shareholding not much smaller than TVC’s. Organo is a Peter Crowley & Neill Hughes vehicle – they’re founding partners of FL Partners, owner of the Racing Post.

If we look at UTV’s recent history, they went on an acquisition spree about 5-6 years ago, and are still paying the price… EPS declined from GBP 23.08p in 2006 to the most recent FY of 16.7p – reflecting an increased interest bill plus a painfully dilutive rights issue, rather than significantly poorer performance. This is evidenced by the fact Revenues and Operating Profits have grown marginally in the period. Then again, one has to wonder what these would have looked like if the acquisitions did not occur..? Perhaps much worse?!

This may prove v relevant, as UTV’s finally got debt back under control due to strong cashflows, the rights issue and a steady/aggressive paydown of debt. They’re now at a point where they can run the business for maximum cash returns (the PE approach), or contemplate bolt-on acquisitions to shore up/grow revenues. On balance, a valuation based simply on current metrics seems neither too harsh nor too optimistic – there are still plenty of higher TV/radio M&A multiples to reference, but I think a 12 P/E and a 2.0 P/S ratio (based on a 21.8% operating profit margin) are pretty neutral values to apply. With net interest expense now standing at about 15% of operating profit, there’s no need for any debt adjustment to my valuation, positive or negative. Plenty of upside present if you can bear to buy an ‘old media‘ stock..?!

Worldspreads (WSPR:LN or ID):   You know, this was my favourite Irish wish-list share some years back. I was just figuring out how to buy it (volume is crap), when I got some incomprehensible news… How do I explain? Well, let’s set a little challenge: If you looked at a stand-alone/fast-growing company with EUR 8.0 mio Revenue, EUR 4.4 mio EBITDA and EUR 4.3 mio PBT, what kind of price would you buy (or sell) it for? Think about it for a minute…

A hell of a lot more than EUR 11.2 mio (with EUR 3.2 mio of that deferred), I would venture?! I was flabbergasted! The fact the buyer was Brian O’Neill, COO, didn’t help either. Knowing both parties, but not the circumstances, I concluded – rightly, or wrongly – there was a colossal falling out with Conor Foley, the CEO. This somehow mutated into the announcement, in Aug-2009, of a sale of the Irish spread-betting division to O’Neill (now called Marketspreads, with O’Neill no longer at the helm). The primary reason cited was a rationalization of costs – running two separate staffs and trading desks (out of Dublin and London) was expensive and inefficient. How this absurd situation arose in the first place was never discussed…

Obviously, the fact that Worldspreads was losing its crown jewel, and at a price that royally f***ed its shareholders, wasn’t discussed either…

This is a little bizarre, considering Foley’s own 18.0% stake in Worldspreads. Somehow, he appears to have decided that ditching O’Neill and the original Irish division, and pursuing a hell-bent chase for international growth, was more important than shareholder value at the time. This has proved costly, with the business now running at cashflow neutral/negative (note: you need to exclude customer deposit inflows when analyzing the cashflow statement) to fund its growth strategy. This obscures the fact, however, that Worldspreads used to earn 30%+ operating profit margins (similar to those of Paddy Power (PWL:ID)) before the Irish division was sold. In fact, the Irish division had 50%+ margins, which gloriously illustrates what’s possible!

So, clearly, margins could significantly improve if there was a move to consolidate their current business. On the other hand, Worldspreads might just continue to be stretched a little too thin, and it feels like a bit of an also-ran vs. some of the other actual/potential players out there. A sale, or takeover bid, looks somewhat inevitable in the end. In light of all these factors, a 1.33 P/S ratio could prove conservative ultimately, together with its Net Cash (again, exclude customer deposits), Net Derivatives position (which could be quickly liquidated) plus the Deferred Consideration (with a 50% haircut) that was due to be collected in Dec-11 (no news on this). Not as compelling as it was pre-disposal, but now the share price is lower and the upside’s looking pretty good again!

Zamano (ZMNO:ID or LN):   I remember bastard stocks like Monstermob - they do the same type of ring-tone/smart phone content/advertising as Zamano provides. Similarly, margins can be heaven or hell, with the usual direction being subterranean… It seems like low barriers to entry, and the eternal quest for the next new/big thing, create a pretty toxic business environment.

Zamano’s revenues have collapsed over 65%, and it’s not yet clear they’ve stabilized. This is another distressed company, so focus should again be on operating free cashflows, which are currently negative. And there’s no guarantee Zamano will ever regain its average (peak) margins of 14.6%.

The presence of Pageant Holdings with a 24.0% stake, however, likely ensures the survival of the company. We may see more (slightly) dubious related party transactions, like this, and I wouldn’t be surprised if we hear of some kind of hook-up with Digital Reach (previously funded by Pageant). However, it doesn’t necessarily imply other shareholders will retain much value. Balancing current risks, I’d only put a 0.3 P/S ratio (or EUR 4.0 mio) on the business right now, and this is unfortunately exceeded by Zamano’s current debt of EUR 4.7 million…

** Except stocks I tag as (significantly) over-valued…I just throw them in for a bit of variety and, of course, to simply offend as many stock holders as possible…

To all Wexboy readers, a big thank you. Page views are increasing rapidly, so it looks like more and more people are becoming regular readers. I hope you’ve found some good investing ideas here, and some topics that challenge and motivate your own investing analysis and approach. That’s certainly what I look for – and find – when I read some of the excellent blogs out there. If you’ve any questions, comments, or suggestions, please don’t hesitate to reach out to me.

I’m launching a donation appeal – officially for March 2nd, but I thought it a good idea to begin with this advance post. If you read, enjoy and/or feel like you’ve benefited in some small way from this blog, I’d like to ask you to please express that appreciation by making a donation, however small, to Console.

Console is an amazing Irish charity – who are they?

‘Console was established in 2002 by Paul Kelly after he had experienced the grief of losing a loved one by Suicide. Through his loss, Paul recognised a need for a dedicated Suicide Prevention, Intervention and Postvention Service here in Ireland.

Since then Console has developed into a National Organisation supporting people in Suicidal Crisis and those Bereaved by Suicide through Professional Counselling, Support and Helpline Services.

Console is a National Service with Centres in Dublin, Cork, Galway, Limerick, Athlone, Wexford and Kildare.’

This is their mission statement:

‘Console seeks to respond to the Spiritual, Emotional and Psychological needs of our Clients. Our Mission is to provide Professional Therapeutic Counselling, Support and Helpline Services to those bereaved through suicide with respect, dignity and compassion.’

Why is Suicide Bereavement different?

‘To lose someone close to us is one of the most difficult life experiences we ever have to face. When the death is through suicide, family and friends must cope with the sadness of their loss plus all their additional, heightened feelings like confusion, questioning of self, anger and coming to terms with the element of choice.

Loss takes time to cope with and we all respond differently. Family and close friends are often left with the same inner turmoil and try to understand it in their own way. People will respond to the impact of the death individually and there is no right or wrong way to grieve.’

You may know of other similar (and deserving) organizations, but Console is very special to me, so your donation to this particular charity would be deeply appreciated. I’d be delighted, of course, if you’d email me about your donation, so I can thank you personally. If you prefer not to disclose exact details of your donation, that’s perfectly understandable too, but please email me anyway so I can still thank you. My email is:

wexboymail@yahoo.com

Here is Console’s Donations Page. They accept:

Paypal

Credit Card:       Plse phone 01-610-2638 and donate.

(Internationally, plse call XXX-353-1-610-2638 where XXX is your Intl. Access Code, usually it’s ‘00‘ or ‘011‘)  [No EUR credit card? No worries, it's just like an overseas purchase - but rem you'll likely pay an extra 1-3% fee on your donation]

Cheque/Draft:       Plse mail your cheque/draft (in any major currency) to:

Console, Console House, 4 Whitethorn Grove, Celbridge, Co. Kildare, Ireland

[I'm checking, but assume Console has a deal for lodging any non-EUR cheques - if necessary, I'll personally shame the bank into waiving all fees]

Tesco Clubcard:       [Looks like this may only work in Ireland]

Text:       [Not sure if this works everywhere - just give it a try, I expect your text will fail, or you'll receive no response, if this isn't valid in your country]

Direct Debits:       [Expect this to only work in Ireland and the UK]

Corporate Donation:       [If you work for a company who might make a donation, plse just ask, it would be greatly appreciated - if you would prefer Console to contact your company directly to discuss this, plse just email me and I'll arrange it]

If you have any suggestions or questions, plse don’t hesitate to comment or email me. My sincere thanks, folks, in advance – it means a lot.

In my previous post, I highlighted over a dozen listed activist investor vehicles (some at v interesting discounts) you can invest in. Additionally, you might also want to look at individual company situations – as I commented about activists: ‘Use them wisely (and profitably) to cherry pick and/or endorse your conviction stocks.’ Here are some interesting examples:

Timeweave (TMW:LN):   I’ve written here about Timeweave, which has Joe Lewis on board with 29.99%, with another 5% in the hands of Leo Fund Managers. TMW has a steady business, pots of cash, and a whopping 10.4% dividend yield. If you strip out cash, it’s actually on a 4.7 P/E! Despite all this, it can’t seem to get any respect – take a look at the share price. But we all know shares like this, and wonder when we’ll see a decent return…

The difference here is the presence of an activist with a substantial stake (along with other savvy/activist investors). This is a secret weapon for a private investor, as a committed activist is capable of prompting a realization of value within an accelerated timescale. In TMW’s case, value realization could be a return of cash, a sale of the company or business, or a re-investment of their cash. The latter strategy’s debatable. We all know companies who enjoy a windfall…only to have management piss it away on beer, drugs and hookers. I’m sorry, I meant on egotistical, over-priced, empire-building acquisitions… Sorry, I meant, zzzzzz…oops, I nod off thinking about management double speak.

Minco (MIO:LN) investors suffered this fate recently. They waited for God knows how long, at least 10-15 years…to crystallize value from their Pallas Green lead-zinc project. Their reward? A hasty sale at an (apparently) bad price to Xstrata (XTA:LN), their exploration partner, then radio silence, and finally the realization their board were dead set on embarking on another decade long odyssey! C’mon…don’t shareholders know management have houses to buy, and cellars to fill?

When you’ve an activist investor on board, however, this kind of arrogance is often curbed, sometimes simply through management’s own new found self-restraint. If management’s suitably restrained, cash re-investment can be just as good a source of value realization/enhancement. It will obviously improve earnings (vs. the current pathetic returns on cash), possibly enhance scale/existing business, and may be just the spark needed to improve market sentiment.

Since my last post, TMW announced a GBP 3.1 mio acquisition of DCD Media (DCD:LN) convertible loan stock (which would convert, if exercised later this year, to a 29.99% stake). I need to look closer, but I’ve always liked content businesses. Their finances are sometimes a little shaky, and true performance is often obscured, but a history of being taken out at whopping premiums attests to the underlying value creation in this sector. This purchase has been welcomed by the market (prompting a 10% rise in TMW’s share price), and perhaps even by DCD (cautiously!).

Coupled with a small acquisition in 2011 (of SportingWins), this suggests a new acquisition strategy for TMW to enhance existing business and/or broaden its media portfolio. There’s been no comment from Lewis, but he prefers to stay behind the scenes – I’m quite sure he initiated or OK’d this new strategy. I’d still like to see a (partial) return of cash – to highlight the (unchanged) earning power of the business – but, as I’ve said, this deployment of cash can significantly improve returns. TMW’s plenty of firepower left, and more news developments may finally spark a growing interest in the shares and the company’s inherent value.

European Islamic Investment Bank (EIIB:LN):   I’ve written in detail about EIIB here and here, and most recently here. HBG Holdings, with a 15.6% stake, promised to be operational activists from day one, and they’ve clearly followed through on this with the CEO, Chairman and another non-executive director all HBG staff/nominees. The recent Rasmala acquisition is another confirmation that HBG have now cemented EIIB’s focus on being a private equity investor/asset manager (don’t be alarmed, ladies and gentlemen, we’re not dealing with a bank here..!).

I like the geographical focus also – when you hear about stockbrokers selling sandwiches, it’s definitely time to buy, no matter how unpalatable at the time! Stocks, I mean, not sandwiches… btw This applies in other markets too! The looming possibility of another oil price spike helps too, in addition to the underlying secular trend in oil demand and prices.

To date, the share price has failed to respond to this new operational focus, but with HBG now firmly in the driving seat I’m confident we’ll see further operational developments and/or shareholder friendly actions. The banking license still presents possibilities, but maybe the best solution would be to sell it, and ideally maintain some kind of most favoured nations status with the bank. Another (larger) tender offer would also be obvious: It enhances NAV, and would be welcome news for the share price, while still leaving plenty of cash on hand for prospective private equity investment. In fact, I think a tender offer would be a decent quid pro quo for shareholders in return for accepting there’s a new strategic plan in place for the company (rather than a liquidation).

My current Fair Value is basically unchanged at GBP 8.09p per share. It therefore trades at a colossal 60% discount to estimated NAV, with an Upside Potential of 151%, vs. today’s price of GBP 3.22p. I currently have a 5.1% portfolio stake.

Quintain Estates & Development (QED:LN):  Haven’t actually mentioned QED before on the blog, let’s take a closer look. QED’s a London-focused urban regeneration developer and fund manager. They rabbit on about the fund management a lot – yeah, it’s a nice little operation, but its stand-alone valuation is fairly immaterial. Another bull market’s needed to really suck in funds here. The development business is the real meat here, focused primarily on two schemes, Wembley City and Greenwich Peninsula.

I’ve always been drawn to developers as the best play on property (in theory!). London’s good in this regard, as it has plenty of listed developers – they’re often sadly lacking in other markets. With a developer, I believe you get the same underlying exposure/returns as with a property investment company/fund (aided by some judicious leverage), but you also enjoy a stream of v attractive development profits – the real icing on the cake! Of course, development attracts the more speculative/optimistic players (and cowboys) – the only way to weed out the field is to have a good sense of long term successes and reputations in the industry. This often boils down to ‘follow the man‘, not the sector, or even the company. For example, I’m a huge fan of Max Property (MAX:LN) for one simple reason (to be fair, there are other good reasons) – Nick Leslau.

I think Quintain’s got a reputation as a smart/successful developer over the years. Oh dear…before somebody blunderbusses me on that statement, let me make an important point! I’m focusing on their property development skills only here. Let’s look at the management of most property companies: What do they eat, sleep, and drink? What do they think is the best asset in the world? What happens if they stop buying property (they get fat…and impotent)? See what I mean? You can hardly blame them for their enthusiasm, their risks, their leverage, their excesses… Your job is to supervise and control all this!

Investing in a developer means being even more careful about monitoring leverage and cashflow. I’d argue you should demand a lower average Loan-to-Value (LTV) ratio for a developer, in light of the additional risk and reward. And you have the luxury at all times to pick when you buy, and sell, a developer. If the market’s getting frothy, projects are getting too ambitious and leverage is being assumed with reckless abandon, don’t rely on management to necessarily bail you out! It’s up to you to figure out when to sell, ‘cos they probably won’t. The best time to sell? When you, and everybody else, are starting to feel invincible, and you’re loath to sell at what seems like such a cheap price..! Incidentally: When I start getting cocky about the market, my wife’s on standing instructions to warn me (and slap me!) – then I know I need to start selling some stuff…

Yes, QED’s NAV collapsed by about 80% – I’m glad I didn’t have to suffer through that… But I don’t think this is necessarily an indictment of their property skills, what really put the boot in was too much confidence, too much leverage and (most of all) a massively dilutive rights issue to set their finances straight. Situations like this (whether it’s property or not) can present an amazing opportunity after the event – financial risk’s been eliminated, asset values and/or goodwill have been slashed, and yet the share price is still cratered because people have grown to hate the stock so much.

Now Quintain management seems suitably chastened, and more risk averse. They’ve set a transparent list of targets, and are actively tracking against them. Balance sheet values have been marked down significantly in the past few years, and QED trades at a massive 66% discount to NAV (averaging the latest NAVs). Recent progress/activity appears to confirm the latent value now embedded in the portfolio. With leverage now under control (and further news flow), there’s no reason decent returns can’t be extracted simply from discount compression alone.

Net LTV is around 51% (up from 41%). This bears monitoring, but appears a natural consequence of their new approach to phased development. If I understand correctly, and they’re consistent in their new approach, we should expect to see Net LTV move within a range. In the past year, it’s cycled up as they progress development – we should then see it drop back down as they realize value from completed phase(s). And repeat. Cash coverage is often ignored with developers, as they’re constantly buying and selling things, but I estimate QED has about 1.3 years of cash on hand to cover annual expenses. Put all this together, and QED certainly appears a cheap (medium risk) property stock.

And now the catalyst: Laxey Partners! I’ve written about them in previous Catalyst posts – they’re a pretty aggressive/successful fund manager, focused mostly on closing asset discounts. They’ve been involved in some pretty high-profile, and acrimonious, shareholder/takeover battles. Property’s a sector they’re fond of, evidenced by their activist property vehicle, Terra Catalyst (TCF:LN). Between TCF and other funds, they now have an (increasing) 13.1% stake in QED (Taube Hodson Stonex (and here), another respected investor, also have a 4.9% stake). QED now appears to be Laxey’s largest listed property investment.

Despite appearances, Laxey are relatively conservative, so we can be sure they’ll be actively monitoring QED’s leverage. Early last summer, it looked like the market was ready to recognize QED’s fundamentals, Laxey’s significant presence, and rumours of a possible takeover bid. The share price rallied sharply from the mid-30s to the mid-60s, and was then overwhelmed by the EU Winter of Our Discontent. Now, it looks like we could see the same trajectory again – if not, expect Laxey to become impatient before too long and push for a sale, or wind-down strategy. In fact, Laxey could scare enough capital/support to launch a bid itself, as it’s done a number of times before. These bids included a successful bid for Spazio, which had almost EUR 800 mio in property assets at the time (and is making excellent progress with a wind-down strategy since).

Sirius Real Estate (SRE:LN):   I’ve written a detailed piece about Sirius here, with some follow up here. Since then, they’ve completed an internalization of their property/asset manager, via the acquisition of Sirius Facilities GmbH from Kevin & Frank Oppenheim and the Principle Capital Group. I’m bemused at this constant cycle of internalization and externalization in the industry. It’s like Coke & Pepsi buying and selling their bottlers every decade, among other examples! The lengths management will stoop to simply to generate some heat and light (and investment bankers, to earn some fees) no longer surprises… Oh well, they claim the purchase price will be made back v quickly in savings.

I’ve v mixed feelings that the majority of this EUR 5.1 mio purchase was funded by a 15 million treasury share issuance. Since the current price was used to value the shares, this is a dilution. Shame on management! Net assets (attrib. to shareholders) increase by EUR 3.2 mio to EUR 189.2 mio, while net shares outstanding increases to 317.2 mio, reducing NAV by about 3% to EUR 59.6 cts. EPRA NAV drops in a similar fashion to EUR 64.5 cts. This purchase will be recorded mostly as goodwill, but it’s a tiny % of assets and represents future savings, so I don’t see fit to remove this asset from my calculations. Net LTV remains stable, at just under 61%. At the current share price, SRE trades on an equally stupendous 61% discount to average NAV.

On the other hand, the Oppenheims and Principle Capital have increased their SRE shareholdings, as a result – this I like! And definitely an interesting share register development! We have 3 classes of shareholders here – let’s summarize: i) The smart/non-activist money: Alpine Woods at 4.0%, and Taube Hodson Stonex (again) with 3.4%, ii) The in-betweeners: The Oppenheims (9.6%), with no activist history but obviously with a v personal/vested interest in SRE’s strategy and market value, and iii) The activists: Good Lord, the register’s a veritable orgy of activists..! Yes, that’s the collective noun, just look it up (and I believe the noun for a gathering of senior corporate management is a ‘bloat of hippopotami’). Karoo/Clearance Capital has 25.0% and a board seat, Weiss/Brookdale has 15.2% and 2 board seats, Principle Capital has 11.1%, and Laxey has 9.6% and a board seat. If this witches’ brew of capital, egos and naked aggression can’t produce some real value, I don’t know what will..!

It looks like this process has now started, albeit still somewhat politely. Sirius made a recent announcement – bizarrely buried at the bottom of the ‘Management Internalisation‘ RNS they released. I swear a lot of people may never have actually noticed or heard about this..!? It stated they appointed another Principle Capital/Oppenheims vehicle (PCSREAM) to act as advisers in relation to the sale of a EUR 100 mio portfolio of non-core properties. This is quite a development, and an incredibly low-key way to announce it..!

Whether this is the beginning of a wind-down strategy, or simply a transaction to highlight/catalyze the intrinsic value of SRE, I don’t know – and I don’t really care! I think shareholders win either way. This isn’t a fire-sale (the contract lasts ’til a sale is completed, or Jan-2014), and at an overall average EUR 427 per sq mtr valuation I see no reason they can’t shift the portfolio out the door at book value, or better. While I’m comfortable with SRE’s current 61% Net LTV (due to the unique characteristics of German property I’ve commented on before), a lower LTV would be v welcome. And a great news and value realization event to grab the market’s attention..! I estimate a sale would bring SRE’s Net LTV down to 52%, or lower, with only a minor NAV impact.

Hell, let’s be pessimistic and look at an alternative scenario: Assume they sell the portfolio for EUR 84.5 mio (3% in fees, and a 12.5% loss on book value). Net LTV would drop to about 55%, but NAV would be diluted by almost 8%. Not so hot? Well, I don’t see a problem! Sure, NAV would be a little lower, but I think the odds of the share price closing in on NAV would increase dramatically upon a sale.

I see no reason to shift my Fair Value away from 1.0 Price/Book, which is a equivalent to a current EUR 62.1 cts. This offers an Upside Potential of 159% vs. current EUR 0.24 market price. Prompted by this development, and an increase in Weiss’ stake, I increased my own stake earlier this week from 3.7% to 4.4%.

Two more catalysts to come, folks!

Instead, I wanted to revisit my fondest love, Trinity Biotech (TRIB:US). How did she win my heart? Well, she’s never let me down, about 40% of her market cap consists of cash, I currently have a 265% gain on my average entry price, I see 30% upside from the current price (with a secondary price target that offers 68% upside), and it’s my largest portfolio position at 7.6%!

Actually, very little has changed since I last wrote about TRIB:

We should see Q4/FY 2011 results released very shortly. TRIB did receive FDA approval of its new Premier diabetes instrument, but this was expected (as much as anything by the FDA is predictable, or timely..!). A further $2 million was spent on share buyback in the 4th quarter, which I estimate retires approx. 0.205 mio ADRs. And from a technical perspective, we certainly seem to be closing in on a breakout, with the share price trading in an ever tighter range since last summer…

My previous writeup is still (hopefully) a comprehensive introduction to TRIB. If you’ve read it already, perhaps you’ll take another (quick) look – I’ve refreshed all my figures, ratios and targets. Note I’ve adjusted my outstanding share count lower (to reflect the incremental share buyback), but I haven’t actually reduced cash accordingly. This seems fair when you consider TRIB is currently generating about $1 mio per month in free cashflow.

A Happy Valentine’s Day to all readers!:

• Mkt Price:  $10.19
• Mkt Cap:  $214.2 mio
• P/E Ratio:  14.4
• Ex-Cash P/E:  10.0
  
• P/S Ratio:  2.7
• Ex-Cash P/S:  1.7

Trinity Biotech specializes in the development, manufacture and marketing of diagnostic test kits. These kits are used in the clinical laboratory and point-of-care segments of the diagnostic market to detect infectious diseases, sexually transmitted diseases, autoimmune and hemoglobin disorders, and to detect, monitor and control diabetes. It’s also a significant provider of raw materials to the life sciences industry. TRIB is headquartered in Ireland, with Irish and US manufacturing facilities, and quoted on NASDAQ. Through R&D and acquisitions, the company’s assembled a portfolio of over 400 products to date. It has a direct sales force in the US and UK, and sells in 75 other countries via a network of distributors.

TRIB recently issued a Revenue Plan (not a forecast) flagging 10% Sales growth for 2012 & 2013, presumably a conservative forecast. Growth’s expected to come from the recent European launch (and FDA approval) of their Premier diabetes instrument, a new Vitamin D test, and a near term pipeline of 8 other tests. Longer term, TRIB’s an aggressive growth story, interrupted by a bad patch in 2007-09 when they suffered declining sales and P&L writedowns. This can be mainly ascribed to problems in its former Coagulation business. This division was sold in early 2010 to Stago for a $94 mio total consideration. Since then, Operating Profit has improved from 11.2% in 2009 to a current 20.7%, due to Gross Margin improvements and aggressive G&A expense reductions. EPS has also improved steadily, hitting $0.177 diluted earnings per ADR in the last quarter.

Considering the recent growth, it’s fair to use the latest quarter to calculate annualized Sales of $79.3 mio and diluted EPS of $0.708. Based on the Mkt Cap, this gives us a current 2.7 P/S and a 14.4 P/E ratio. Actually, the Mkt Cap needs explanation:  TRIB has both A and B Ordinary Shares outstanding. There are 700 K B shares, with twice the rights/entitlements of A shares. Only ADRs are quoted, however, and are equivalent to 4 A shares. Therefore, the total ADR count at end-Dec was:

83.509 mio A shares + (0.700 mio B shares * 2) = 84.909 mio equivalent A shares = 21.227 mio minus 0.205 mio Q4-11 Buyback = 21.022 mio ADRs

What’s interesting is that after paying Debt down to de minimis levels, TRIB’s retained the majority of the Coagulation proceeds on its B/S. This $71.1 mio of Cash, plus bank guaranteed deferred consideration of $11.25 mio (to be paid in 2012), is equivalent to $3.92 per ADR. Stripping out, we have much cheaper Ex-Cash ratios:

($10.19 Mkt Price – $3.92 Cash) * 21.022 mio ADRs = $131.8 mio Ex-Cash Mkt Cap equivalent to a 1.7 Ex-Cash P/S

($10.19 – $3.92) / ($0.1561 Ex-Financial Income EPS * 4) = 10.0 Ex-Cash P/E

[ Note: For Ex-Cash calculations, Tax affected Financial Income should be excluded from EPS to properly evaluate the underlying business – as follows:

$0.177 qtrly diluted EPS * (1 - ($0.549 mio Financial Income * (1 - 15.3% Tax Rate) / $3.935 Net Income)) = $0.1561 qtrly diluted Ex-Cash EPS ]

Looking back, the Coag divestiture was a hell of a deal! 2009 Coag Sales were about $47 mio, so management achieved a 2.0 P/S multiple. And that’s for a business with pretty much a zero Operating Profit margin. More astonishing is the fact the price actually exceeded TRIB’s entire Mkt Cap at the end of 2009! This reflects the quality of management. They’re a little generous with the magic options wand, but stewardship of the company is otherwise excellent. But I expect that from Owner-Operators:  Ronan O’Caoimh (CEO) owns a 5.8% stake, with other directors/management (inc. Kevin Tansley, CFO) holding an additional 4.1% stake.

One concern I’d highlight is Cash Management:  With an average $71.3 mio Cash, $0.549 mio of qtrly Financial Income implies an annual 3.08% yield. A little perplexing, this kind of yield would normally imply credit/principal risk and/or a much longer duration. However, the remaining deferred consideration earns interest, so Cash interest’s more like 2.6%. Still remarkably high vs. current 3 mth USD LIBOR of 0.47%. This appears mostly due to the crazy deposit rates Irish banks are paying, despite the support of the ELG Scheme. Makes sense, I guess – we’re really talking about Irish government risk, so these rates are a bargain for the banks vs. Irish bond yields! That’s acceptable though, I believe retail deposits are far safer than corporate deposits, which in turn are far safer than government debt. This Income looks like a (temporary?) windfall, so I won’t include it in my Fair Value calculation. Incidentally, FBD Holdings (FBD:ID) have been remarkably astute here, having already switched a major portion of their portfolio into Bunds.

My only other complaint is the slow pace of share buybacks this year, with only $6 mio spent by end-Dec. When you ponder the usual (rather bizarre) institutional neglect of sub-$10 stocks in the US, TRIB really needs to step up buybacks aggressively and blow away the $10 level for good. (Although institutions have really gotten used to sub-$10 stocks in the past few years…!?) That strategy could well bring a few new shareholders on board. In fact, if the share price reached the 5 year high of $11.75, some buying power there could easily break resistance and drive the price considerably higher. So, taking these technicals,  the buyback program, engaged Owner-Operators and the longer term growth story (plus 16% YoY growth in YTD Net Income), I think the underlying business deserves a Fair Value 15 P/E. Still pretty undemanding:

$3.92 Cash per share + $0.1561 qtrly diluted Ex-Cash EPS * 4 * 15 P/E = $13.28 Intrinsic Fair Value

This presents us with a 30% Upside Potential vs. the current Mkt Price of $10.19. TRIB’s currently my largest portfolio holding, at 7.6%.

You may ask why I’ve such a large position relative to the Upside Potential? Well, the first reason is I sleep v soundly holding TRIB, not a bad attribute in this market! The second reason is my average $2.80 entry price – my position would be even larger only for some reluctant share sales. I say ‘reluctant’ because of the discount to Intrinsic Fair Value, but also because I have a secondary price target for TRIB. I guess I’d describe it as Relative Fair Value. Straying into dangerous territory perhaps, but well supported by the multiples paid in numerous diagnostics/medical device company acquisitions.

I’ve already highlighted TRIB achieved a 2.0 P/S multiple for a division with no Operating Profit. Another recent transaction was the Clearstream Technologies takeout by C.R. Bard, Inc. On Sales of GBP 15.7 mio, and an Operating Profit of 7.8%, shareholders received a 2.8 P/S multiple. Are you seeing a pattern here? Generally, takeout multiples in the space range between 2.5 to 4.5 P/S. I’m at a bit of a loss to explain this from an intrinsic value perspective, but sometimes we just have to roll with the punches… Many takeovers are by (larger) US companies and price just doesn’t seem an issue – perhaps they’re stuck in the groupthink of a certain range of values? And egged on by their investment banking cheerleaders?! The only other rationale I come up with is that diagnostics/medical device businesses can potentially offer dramatically higher margins to an acquirer. This makes some sense:  It’s a dirty secret, but in many cases an acquired company’s production can be switched to an existing facility, management trimmed, G&A halved and the entire sales force pretty much wiped out. Whatever the reasons, there’s ample market evidence that a 3.5 P/S Relative Fair Value multiple for TRIB is eminently reasonable, plus of course the Cash on hand, which offers:

$79.3 mio Sales * 3.5 P/S + $82.4 mio Cash = $359.9 mio / 21.022 mio ADRs = $17.12 Relative Fair Value, offering a (Secondary) Upside Potential of 68%

No need to worry yet, but if the share price reaches my Intrinsic Fair Value target of $13.28, I plan to cut my position in half. I then plan to hold the other half on a tight stop loss, monitor for new developments, with my $17.12 Relative Fair Value as a secondary price target. Good luck!

• Target P/E:  18.8
• Tgt Ex-Cash P/E:  15.0
• Tgt P/S:  3.5
• Tgt Ex-Cash P/S:  2.5 
• Intrinsic Fair Value:  $13.28
• Upside Potential:  30%

Any chance the Exchange could put a health warning on this PoS?! Management muppets were recently forced (in response to media comment!) to come out with a statement. The key sentence is: ‘At this stage it is not possible to predict the outcome of this exercise nor quantify the financial impact for shareholders.‘ Don’t be fooled, there’s only one way this ever works out: Zero value or absolutely massive dilution for shareholders.

They had some good news, though: ‘However the exercise is not expected to have any negative impact for staff, customers, key business relationships or suppliers.‘ Aah, so all the primary stakeholders will be taken care of then…

Shareholders should have known better… While Siteserv’s revenue dropped sharply in 2010, their balance sheet’s been financially strained for years. But how can I blame shareholders when you read their latest results (only 2 months ago!?). Financial highlights included ‘Revenue growth of 9%…Operating profit growth of 4%…Profit after tax up 60%…revenue visibility of circa €265m‘. More relevant highlights might have been:

Debt increased 2%

Operating Cash Flow declined 58%

Operating Free Cash Flow turned negative at EUR (677)

Capex increased 84% vs. the prior 6 months

We borrowed 100% of our latest EUR 4.2 mio Interest bill

Actually, they did comment a little on cashflow: ‘Working capital had a negative impact on cash flow in the period reflecting the Group’s continuing focus on driving revenue growth….Net capital expenditure…also reflects the Group’s commitment to fund growth.‘ Oh, so that’s alright then…

There is plenty of management corporate speak to rip apart, but let’s keep it simple – this is an absurdly distressed company, but instead management preferred to focus intently on:

‘Growth‘ – mentioned 16 times in the latest report

Growth derivatives: ‘up/strong/expand/increase, etc.’ – 12 times

‘Wins‘ – 7 times

Win derivatives ‘secured/awarded/launched, etc.’ – 17 times

This kind of copremesis is absurd. Have these joeys any idea they (should) answer to shareholders, or are they just f***ing clueless..?! The banks aren’t much better – we’ve read plenty about their breathless f***wittery regarding their property loans (check out Matt Cooper’s ‘Who Really Runs Ireland‘, and Simon Kelly’s ‘Breakfast with Anglo‘, among many others). Siteserv, however, is a wonderful example of them losing their minds in their regular lending business also. How they ended up in this situation, then let it continue, and even permitted further working capital/capex investment in the past year simply defies belief…

In the past twelve months, Siteserv had revenues of EUR 176.2 million. Presuming the bankers can scare up some, as is rumoured to be the plan, don’t expect any potential buyers to bother much with historic results or management’s helpful commentary. There are no free passes here. Recent cashflows are going to be a key determinant of value. Operating free cashflow for the last twelve months was EUR 4.6 mio, for an OP FCF margin of 2.6%. The last FY OP FCF wasn’t much better at EUR 5.8 mio, for a 3.4% margin.

I don’t see why anybody would pay more than, say, a 0.25 P/S ratio for this kind of business. Sure, they’ve revenue visibility of EUR 265 mio – but most (non-contract) companies could reasonably expect to capture 1.5 years worth of revenues through repeat/fresh business anyway. I also don’t see any particular reason to believe significantly higher margins are embedded in Siteserv’s future book of business. This P/S tag equates to about EUR 44 mio – compare this to EUR 156.4 mio of debt. I’d estimate buyers would have to be confident of a rapid quadrupling of (operating free cashflow) margins to even contemplate paying a price that bails the banks out. And that, of course, is wishful thinking – even if there’s a buyer who can envisage that happening, do you really think they’ll be keen to pay up accordingly?

So I think we can safely (and unfortunately) assume there will be nothing left over for shareholders either way. Despite that, Siteserv’s market cap has been trading at EUR 2.2 mio (or higher) – whoever’s selling is at least salvaging something of their investment, but who’s buying?! Ignorance, or blind hope, are never friends of one’s portfolio…

Hmm, then again…with management’s annual compensation worth a multiple of their shareholdings value, I’m sure they’ll be motivated to fight the good fight for shareholders! If they can persuade the banks to carry on, say for the next decade or two ’til their retirements, they could probably pay down debt to manageable levels and make some real money…

What? Oh, for the shareholders, of course…!

OK, time to tackle another batch of 10 Irish stocks. First, let me insert the Excel files. Again, all market prices (and FX rates) are updated, so this is a live snapshot of all stocks covered to date (with each stock’s upside/downside potential also recalculated vs. its valuation).

As I’ve mentioned before, please feel free to provide your own Price Targets on the Template sheet – it would be greatly appreciated by me, and many of my readers. If you disagree with some of my valuations, this is a great way to express yourself! I think we can all learn a lot more from divergent rather than convergent views on stocks..! Here are full notes/instructions if you wish to submit any Price Targets.

The Great Irish Share Valuation Project IV     (xlsx file)

The Great Irish Share Valuation Project IV     (xls file)

Merrion Pharm (MERR:ID):   Merrion’s been offered a reprieve, with $5 million of debt being bought out by Irelandia Investments, a vehicle of Declan Ryan (son of the late Tony Ryan, the founder of Ryanair (RYA:ID)). Ryan is also Merrion’s largest shareholder, with a 14% stake.

Debt already exceeds cash, and even if we temporarily ignore the debt (Irelandia offered greater flexibility and a cheaper rate), cash will be exhausted within 15 months. Merrion continues to talk to interested parties about possible sales/licensing of their intellectual property, but there’s no way to discern what upside this process might offer. No matter how I spin it, I can’t find any value in Merrion. On occasion, I notice biotech stocks that pop up with a market cap lower than their net cash on hand. If you want to bet on biotech upside, this type of stock offers a free bet – Merrion isn’t one of them.

Origin Enterprises (OGN:ID):   Origin went through a recent period of slow growth, as they restructured to focus on Agronomy Services & Agri-Inputs. This aspect of the process is now largely complete, as evidenced by their most recent 16% boost in earnings. The focus on agricultural yields and efficiencies, and related cross-selling opportunities, presents a marvelous investment opportunity. This is particularly true of the agronomy services, Origin’s the only listed stock I know of that offers this type of exposure. Additionally, the business is far less capital intensive than most other agri-businesses I’ve surveyed/written about to date (causing cash flow/burn issues).

On the other hand, Origin’s divestment process hasn’t made much sense. Management appears incapable of letting go of any business! Now they’re stuck with anything from a 24% stake in Continental Farmers Group (CFGP:LN) (which I’ve written about here), a 32% stake in Valeo Foods, to a 50% stake in Welcon (a JV with Austevoll (AUSS:NO)), Europe’s largest manufacturer of marine oils and protein.

Yes, you can argue they’ve smartly cashed out on a portion of their investment and/or traded a large stake in a small business for a smaller stake in a larger business. But I’d argue a complete divestment of all non-core businesses would be the far more obvious strategy, with proceeds paying down debt and funding a more aggressive core business ramp-up. Instead, investors have been left to worry what happens next with all these playthings, while interest coverage gets worse as direct control is lost over their cashflows.

I’m sending management some popcorn, and a season of Hoarders to watch – maybe after watching, they’ll finish what they’ve started..!

Ormonde Mining (ORM:LN):   Ormonde seems reasonably valued right now. Unfortunately, this makes no allowance for how they’ll actually fund their Barruecopardo tungsten project. While further progress might offer the prospect of an improved reserves/resources statement, I’m not sure this will offset the necessary dilution hit for shareholders when Ormonde tries to come up with a decent level of funding.

Ovoca Gold (OVG:LN):   Ovoca’s an interesting stock. It’s now more of an investment company – makes sense when you consider Tim McCutcheon, the CEO, is an ex-investment banker. It has significant cash on hand, 0.8 million shares of Polymetal (PMTL:LI), and a $10 mio gold equities portfolio (managed by GLG). These assets resulted from a sale of the Goltsovoye silver deposit to Polymetal in 2009, at a 194% premium to the company’s market cap at the time!

To date, McCutcheon’s been an excellent steward of shareholder value, conserving the Goltsovoye proceeds, focusing exploration efforts on just 3 gold projects, and launching a share buyback (which could be a little more aggressive!).  I’m not much of a gold (wing) nut at this point (there are plenty of better real assets & opportunities out there to buy into), but I wouldn’t be surprised to see a $2,000 price spike. Ovoca could be a cheap entry into this exposure. But what’s really fascinating is that Ovoca’s current gold resources could potentially be proved up within a limited period of time at a relatively limited cost. Success in this regard would likely prompt another step-change in valuation for Ovoca.

Paddy Power (PWL:ID):   To me, Paddy Power’s the Ryanair (RYA:ID) of the betting world! Like Ryanair, years ago they appeared to be just another also-ran – they had a chain of bookies in Ireland, an expensive build-out in the UK, and it seemed like they were firmly in the sights of the big boys. Then they launched themselves online, and progressively adopted a Ryanair publicity approach featuring plenty of wackiness, and lots of pretty girls and partial nudity.

Well, I’m not sure who came first! When you think about, the approach seems a lot more suited to a betting company, rather than a bloody airline…how on earth do we trust an airline like that?! A similar approach with their annual reports makes for a fun read (personally, I was always dying to buy Limited Brands (LTD:US) myself…take a look here. I challenge you to send me a better AR link!).

Now Paddy Power makes three quarters of its profit online, and earns two thirds of its profits outside Ireland. Earnings growth has been amazingly consistent over 5 and 10 years, at a 26% cagr in both cases. Unfortunately, I cannot bring myself to put a P/E higher than 20 on any stock. I’ve become far too wrapped up in the past in stocks with high growth rates, and low PEG ratios, and then suffered an earnings slowdown…and a P/E multiple de-rating. This (agonizing) combo. can easily deliver a 70% collapse in your favourite growth stock, so anything above a 20 P/E (regardless of the growth rate) offers too little of a Margin of Safety.

On the other hand, operating free cashflows have consistently exceeded operating profit in the past few years, so I was happy to utilize a higher 3.25 P/S ratio (plus an upwards debt adjustment to reflect inherent debt capacity – perhaps to pursue other acquisitions like Sportsbet in Australia). Despite this, my valuation fell quite a bit short of the market price – Paddy Power looks like it’s priced for perfection…

Petroceltic (PCI:LN):   Petroceltic’s a big spender, with annual cash outflows of around $100 million, but unfortunately has not yet achieved any proving up of reserves. This is the key to value creation here, as PCI has a little less than 1 year’s cash on hand. However, the underlying value of one of its prospects is highlighted by the farm-out deal on its Algerian Isarene permit to Enel (ENEL:IM).

Enel is Italy’s largest energy provider, and payment(s) for its 18.375% stake in Isarene point to an implied value of $1 billion on the project. This is a major endorsement, but then again big companies take bets too..! At this stage, I’ll incorporate only 50% of this valuation, reflecting the lack of any proved and probable reserves. Taking into account PCI’s 56.625% stake, this suggests Petroceltic is close to Fair Value right now.

Petroneft (PTR:LN):   I own a 1.0% stake in PTR, and have recently written about it here. Petroneft’s in an enviable situation compared to most other resource stocks, with plenty of proved and probable reserves. This is the underlying basis for my valuation, but the market price illustrates how critical cashflow is with an asset based investment. Any value investor likes to pounce on a stock which trades at a large discount to asset value. This can be sometimes be a big mistake. Why?

Well, if the company involved is suffering from significant cash outflows, and has insufficient cash/debt to reach its expected cashflow positive inflection point, you’re probably going to see that share price hammered. There’s nothing the market hates worse than this kind of funding uncertainty, or the risk of actual company failure. And this is the problem – Petroneft has plenty of asset value, but is running out of cash/debt capacity. Problems with initial production have compounded this – these will be solved with time, brains and money, but the funding issue is unlikely to be solved without dilution for the shareholders.

Purely on an asset basis, I calculate Fair Value of about GBP 75p per share. If I assume a share placing large enough to fund 1 year of cash burn (302.6 mio shares @ say GBP 10.25p, a 35% discount, to bring in $49.1 mio), I come up with a diluted value of GBP 48p per share. Which is correct? Well, I’ve already pointed out the best solution (now that PTR’s missed the boat on a decent share price) – a sale/farm-out of reserves, or preferably resources. In fact, I don’t include resources in my valuation, so any resources sale (and they have 100s of million of boe) would improve my (higher) valuation due to cash received and retention of their reserves. It would also eliminate any near term funding issues, hopefully granting the room for a ramp-up in production. Therefore, I think an average of the two approaches is justified, which is a GBP 61p per share Fair Value, and a Potential Upside of 293%.

Prime Active Capital (PACC:ID):   PAC is a private equity vehicle, launched by Peter Lynch (formerly Fin. Director with Eircom), focused on company restructuring, and/or operational improvement. It’s now focused solely on a chain of cell phone stores in Georgia/Alabama and Pittsburgh/Ohio regions – not exactly inspiring stuff! However, this business has now reached a scale where it’s earning a 2-4% EBIT margin, which is offset by almost a EUR 1 million HQ cost (outrageous for such a small company). I don’t like the sector, I don’t like the geography, but a 0.2 P/S ratio seems achievable on a sale, especially to a competitor. The best course of action would be a sale of the US business, collect deferred consideration PAC is owed (from a previous sale), pay off debt and liquidate/distribute net proceeds to shareholders asap! This stock has an unattractive story, but presents an intriguing valuation and upside.

Providence Resources (PVR:LN):  Say O’Reilly and some people will shudder, say Atlantic Resources and even more people will shudder..! Providence Resources is the bastard child of both. See my prior Independent News (INM:ID) comment for some useful Irish investing advice… But to be fair, let’s go ahead and value it: Debt exceeds available cash. Cash burn’s relatively low, but will accelerate as Providence moves forward with a more aggressive drilling programme. Non-Irish/UK assets have now been divested ($16 mio realized from Nigeria). Despite the 100s of millions of barrels Providence casually throws around, the level of P50 reserves is much more limited. It still adds up though, with over 40 mio boe identified. Presuming a 50:50 Proved:Probable split, these are worth over $300 million, so there’s actually some valuation upside at Providence’s current share price!

Readymix (RYX:ID):  I owned this share at one point, and sold at a loss when I realized I was in far too early. The end-game now appears to be here with a possible EUR 0.25 bid per share (up from EUR 0.22) from controlling shareholder, Cemex (CX:US). I suspect v few shareholders have a profit even at this level, considering the stock’s price history. The destruction of shareholder value here has been a terrible shame. People may forget there is actually enduring value in quarries, aggregates, cement factories etc. – the trick is to preserve this value during a downturn…

The wrong way (let’s call this the Readymix strategy!) is to continue operating as if nothing much has changed (in the Irish construction industry?!?), attempt some cost savings, and still lose money hand over fist… The right way is to shut everything down asap – literally lock the gates if you can – and wait it out. I call this the timber strategy: When you can’t sell trees for a good price, don’t panic, just shut the forest gate and forget about them for a few years! It’s not as simple as all this, but I think you get my point!

This wanton value destruction has finally reached a point where Cemex can saunter in with an  offer (actually, absurdly generous…vs. the prior market price, that is) to buy out the remainder. Presuming this takeover goes ahead, expect to see a savage rationalisation pushed through, and then pretty much a watch and wait attitude until eventual signs of growth encourage them to throw the gates open for new/more business. It’s a shame that we likely will never see the level of profit Cemex will squeeze out of this puppy in the next boom.

On the face of this, valuation’s binary: Either the EUR 0.25 per share Potential Offer is realized, or the Offer fails and Fair Value equates to the current estimated Equity (after over EUR 50 mio of losses and writedowns in 2011!) less another year of operating losses. I’m opting for an average, which is a little shy of the current market price. Incidentally, I think RYA presents a dreadful Risk Arb opportunity – even if the underlying value is there, the reality is you can make a v small return against the Offer Price, while risking a likely immediate 50%+ price decline if the Offer doesn’t work out.

Any feedback, or questions, please don’t hesitate to comment or email me. Cheers!

OK, only kidding…one of my regular readers, Arturo P (who’s Spanish and currently living in London), emailed me recently to discuss republishing some of my posts in Spanish. Sounded like a good idea, and I was interested that Arturo highlighted that the simple act of translation enhanced his understanding and insights. This is fascinating, and I think an excellent reminder that all forms of writing enhance your analytic skills and understanding when investing. I know this is one of the motivations for my own blog – sure, writing/research take time, but overall it’s definitely a net plus for my investing process and performance.

No need for you to take up blogging, however, if that’s not your thing! Before pulling the trigger on a stock purchase, just take a little time to write down a summary of key points about the company, its current valuation metrics and (ideally) your target valuation, any relevant events/catalysts, and of course your actual investment thesis for buying the stock. Do you find yourself almost immediately double checking the numbers, re-thinking your assumptions and/or wondering about what you’re missing..?! It all might seem a little strange at first, but I promise you’ll find it well worthwhile. Here’s another perspective:

Have you ever noticed (after the dust settles on an investment disaster) your opinion and perceptions about a stock changed oh so seamlessly to fit the (ever worsening) facts..?! Oh yeah, I’ve experienced that too many times, to my pain and cost… Thank God, these days I appear to have killed the desire to buy a stock all the way down to zero, but still working out how to best sell off the duds. Writing helps you keep better track of all this! And you’ll be amazed how much more honest an investment writeup will make you…

And so, to Arturo’s post – here’s the link to the original, but let’s mark the occasion here with his full post (btw he’s doing something right, he’s got more comments than me..!):

Seducción y … ¿Abandono? ¿Qué tal un catalizador? (Capítulo I)

Inicio aquí una espero que interesante serie sobre los Catalizadores. Es una traducción prácticamente punto por punto de un blog que me gusta mucho y que recomiendo a todos quienes dominen la lengua de Shakespeare: Wexboy – A Value Investing Blog. Wexboy es un inversor a tiempo completo que me ha autorizado gentilmente a publicar traducciones de sus contenidos. Iré publicando partes según el tiempo y las ganas que tenga, y mi motivo personal por hacerlo es un poco meterme los conceptos en la cabeza e intentar adaptar (aunque no está nada claro que lo consiga) los casos a un ejemplo más cercano, aunque no estoy seguro de que siempre sea esto posible o más bien de que sea yo capaz de conseguirlo. También espero que lo disfruten tanto como lo he hecho yo, y si es posible que sirva de tema de debate / discusión.

Este primer artículo corresponde a Seduction…and Neglect?! How About a Catalyst? (Part I)

Lewis (de Expecting Value) y yo entablamos un diálogo aquí sobre catalizadores de inversión. Pensé que esto quedaría mejor en forma de post, ya que es algo en lo que me he concentrado bastante en el último año. Además Lewis me retó a que planteara algunos ejemplos reales.

Destaquemos en primer lugar dos problemas específicos con la inversión value. ¿Cómo puedo describirlos?

Seducción: ¿Cuántas veces te has muerto de ganas por comprar algo, y te has visto seducido por los cantos de sirena de 20 valores baratos distintos? ¿Cómo elegir? ¿O cuando sientes la llamada del value investor que llevamos dentro, y empezamos a enamorarnos de un valor especialmente único, difícil y con toda seguridad complejo? Dios, ¿habéis salido con una chica así alguna vez? Sí, sí, eres un chico maravilloso – el único que la entiende, el único que ve el corazón de oro que yace bajo el vodka, el rímel corrido y la histeria. Sí, he conocido a unas cuantas, hasta aquella que hizo que mi madre por fin preguntara “Dios, ¿no te bastaba con acostarte con ella, por qué te tuviste que empeñar en que saliera contigo también?’ No olvidaré fácilmente aquel día… Entonces, ¿cómo se evita este tipo de tragedia?**

Abandono:  Compras un valor magníficamente infravalorado, y… ¡pasan los años sin que nada suceda! ¿Por qué demonios el mercado no cierra el descuento de la valoración? De hecho ¿por qué el valor se sigue hundiendo? Hmm, puede que alguien llegue con una buena oferta de compra. Quizá se te olvide que normalmente las ofertas sorpresa aparecen como consecuencia de caídas sin precedentes en el precio del valor objetivo. Así, ese momentáneo subidón que te produce una oferta a una prima del 30-40% puede desinflarse de repente cuando recuerdas que lo único que consigues es vender al precio al que compraste. ¿Cómo es que a los mejores hedge funds no parece que les pasen estas cosas?

Seguro que, como a mi, os ha pasado esto más de una pocas ocasiones. ¿Cuál es la solución? Creo que concentrarse en los catalizadores es la respuesta. Eso es lo que hacen los mejores / más agresivos hedge funds o, en ausencia de otro catalizador, ¡se convierten en uno ellos mismos! ¿Qué entiendo exactamente por un catalizador? Hmm, difícil – me figuro que diría:

Un catalizador es cualquier tipo de transacción/hecho/acontecimiento/etc., real o potencial, que ofrece la oportunidad de una puesta total o parcial en valor de una acción en un intervalo de tiempo (razonablemente) rápido.

Let’s throw in a final negative – hmm, again, I’m not sure it’s a negative, maybe we should tick it as a neutral?!:

d) I was surprised to see a recent announcement confirming Bernard Olivier‘s been appointed CEO of Bezant Resources (BZT:LN) (which has granted an intriguing option on its Mankayan project to Gold Fields (GFI:SJ)). He wants to be CEO of two companies simultaneously?! Jesus, my ambition is to be CEO too…but just for one day, and then gracefully retire on a quite modest package..!

Then again, I note he was already Technical Director of Bezant, an Executive Director position. And Bezant doesn’t have a CEO!? So, I’d have to assume Olivier has been (virtually) running 2 companies for the past couple of years, quite successfully. Also, Richland Resources (RLD:LN) is technically a holding company, its main operations are managed in its TanzaniteOne Mining Ltd. sub. Perhaps we can give a pass, but it’s an unusual situation, and it behooves the Richland board to justify it to their shareholders. Now, let’s look at the positives:

i) Richland’s a unique company, in a unique niche of the gemstone industry. Mostly by design, it’s become the mini-De Beers of the tanzanite industry.

It cuts and polishes its own stones, and appoints its own sight holders. It has created a unique retail/tourist offering in Tanzania with The Tanzanite Experience (with possible opportunities to franchise it internationally in the future).  Don’t forget the Waterford Crystal Visitor Centre is one of the Top 10 most popular tourist attractions in Ireland! More importantly, it also created The Tanzanite Foundation which promotes and develops tanzanite through its marketing efforts, grading system, education and exposure, and collaboration with leading designers and jewelry manufacturers.

Much like De Beers, Richland’s in a position to significantly influence perception, pricing and development of the global tanzanite market. This is a long term positive. In fact, in light of tanzanite’s rarity, Richland’s shareholders could possibly be better served (at some point in the future) by a restriction in production, rather than a continued increase. We may discover some day that Richland is a luxury goods stock hiding within a junior miner.

ii) Richland’s expanding its portfolio. In Jan-2011, it released the maiden JORC compliant resources statement for its 75% owned tsavorite project. Tsavorite is a brilliant green gemstone, also first named and marketed by Tiffany & Co (TIF:US). It’s harder than tanzanite (at 7-7.5 on the Mohs Scale), with a correspondingly higher price (2-4 times that of tanzanite).

This resource may potentially be the world’s largest single-source of tsavorite. On an Indicated resource basis only, it’s estimated to contain 1.4 to 3.5 million carats. Richland’s now performing bulk sampling. With the project only 20 km from existing operations, this has the potential to be a low risk/low cost operation.

In Jun-2011, they announced an option on an established sapphire project in Australia. I’ve already cited this as a negative..! But of course it could also be greeted by the market as a positive catalyst if a deal is finalized. Yes, the upfront exercise cost is (in theory) inexpensive, but if completed my opinion would depend on the level of disclosure regarding capex/working capital required, plus the quality of any resources/reserves statement (if any).

Finally, they recently announced a new JV structure with a group of local miners who own 18.75 ha located only 2.5 km from Richland’s mine. Richland will take on all mining & exploration costs and, after a 40% cost recovery, will split profits 60:40 in its favour. This deal seems pretty generous, but the annual economics will improve over time. Also, it may serve as a model for further consolidation locally (with less upfront cost), presumably will improve overall mine cash costs, and may even prevent some unauthorized undermining.

iii) I previously mentioned Gemfields (GEM:LN), a peer company to Richland. In fact, it’s a little more than that – it has a 10.1% stake in Richland!. This is a legacy of a failed, and acrimonious, takeover attempt in 2008/09 at GBP 45p per share. Rather bizarrely, during the takeover battle, there was a re-nomination effort for Ian Harebottle (ex-CEO of Richland, who departed in Feb-08) to Richland’s board. Shortly after, he was actually appointed CEO of Gemfields, who also brought on board Adrian Banks, ex-MD of TanzaniteOne Trading.

Harebottle replaced Sean Gilbertson as CEO. Gilbertson’s the son of Brian Gilbertson, who was ex-CEO of BHP Billiton (BLT:LN) and now heads Pallinghurst Resources (PGL:SJ), Gemfields’ 63% controlling shareholder. Gemfields has also been broadening its portfolio recently, adding rubies and amethysts, and has plenty of firepower now with cash on hand comfortably exceeding Richland’s market cap. What more can I say? Gemfields is the v definition of an informed activist shareholder!

iv) Now a little detour into technical analysis: For the past 6 years, the share price has been relentlessly declining, and now trades 97% lower than its ’06 high. This obscures the fact the price has been basing/flatlining for the past 3 years, and has actually traded in an absurdly tight GBP 7.75 p to GBP 9.5-10.5p range since last summer. This has all the makings of a significant breakout and, considering the technicals and fundamentals, I’d bet that would be on the upside. If we do see a break above this range, I’d venture we see a sharp initial move to GBP 14.5p, or even GBP 16.5p.

I’m also heartened to see Richland doesn’t feature in the Top 100 over on Aim Soiree..! Another good sign! (Also encouraged to see Petroneft (PTR:LN) now in 99th place – maybe if it falls off the list, we’ll actually have a good buying opportunity in due course). OK, let’s tackle valuation:

Richland Resources     (xlsx file)

Richland Resources     (xls file)

P/E Ratio:  First, I’ve annualized Richland’s H1 2011 figures. Normally, I focus on a company’s Last Twelve Months’ (LTM), but as we’re in 2012 and Q3 Revenues were up 24% YoY, I think this is entirely reasonable. At the current GBP 9.625p price, Richland’s worth $17.97 million. This puts it on a current P/E of 5.7. Seems entirely undeserved. I’m opting for a Fair Value P/E of 15, which equates to a GBP 25.3p share price.

Shocked? Well, I’d be more shocked at the 5.7 P/E! A 15 P/E seems reasonable in light of the current high level of revenue/earnings growth, the medium term 9.4% carat production growth rate and the still depressed tanzanite price. In theory (!?), producing/profitable miners should be priced on a decent/premium P/E multiple, as earnings usually represent only a small (realized) slice of their total reserves/resources value. It’s a little more complicated than that, but P/E multiples should correlate with the expected life of a company’s reserves/resources.

P/S Ratio:  Let’s try a more corporate approach. The current operating profit margin is 21.6%. Obviously, historic OP % has been terribly volatile but, for the reasons mentioned above, let’s accept the current margin as somewhat sustainable. This seems a good consensus – the market appears to be in an upswing, but this approach ignores that margins could easily hit 30%+ again – of course, it also ignores some poor/negative historic margins…

Current OP % deserves, say, a 1.75 P/S, which is conservative against my own mental scale. However, Richland has Net Cash of $0.4 million on hand, and a v low annual interest bill of $142 K. This financial strength/capacity prompts me to bump up the Fair Value P/S to 2.0, corresponding to a GBP 22.3p share price.

Asset Value:  As I’ve mentioned before, Asset Value is a key valuation driver for a natural resource stock. By this, I don’t mean B/S Equity – you need to calculate a Fair Value for Reserves/Resources in the ground, plus/minus certain B/S items. I also don’t mean use any mine/project NPVs that the company may provide either… Bit of a tall order, eh?!

As I’ve been writing recently (see Kenmare), I’ve (painfully) arrived at some rules of thumb for resource stocks over the years. In short, using 10% of the price above ground (i.e. the spot price) is a useful guide to valuing what is below ground. This might seem ultra-aggressive (damn the media who focus on the above ground end-price of a resource – yeah sure, dig up every last speck of that resource tomorrow, for free, and sell it..!) It reflects a suitable discount for the political and mining risks involved, the costs (and lost yield) of extraction, the uncertain future price direction/volatility and, of course, the long timeline involved.

Remember, mining companies think v differently about acquisitions – they don’t pay v much attention to current revenues or earnings! My rules of thumb just skim the surface of their approach, but if you’re in the mood for calculating DCF/IRR analyses for multiple companies, and/or monitoring deal metrics, I think you’ll see over time that they are a reasonable approximation.

Also, if the spot price is dramatically different from medium or long-term prices, think about opting for the medium term price, or some combination of both. I also haircut Probable Reserves (vs. Proved Reserves), and only include some Resources on occasion. You can generally wipe your arse with most miner’s statements on Inferred/Contingent/Mineralized/etc. Resources…

The big problem with Richland is that they’ve no Proved/Probable Reserves..! However, this is not uncommon for tanzanite, or the wider gemstone industry (inc. diamonds). The specific geology of gemstone deposits often appears to make it problematic for companies to upgrade Resources to Reserves. I’m not thrilled about this. But considering the industry, and the fact Richland has mined 2+ million cts pa on average in the past 4-5 years (with no decay in yield), I’m prepared to live with it.

So let’s look at what they do have: (btw I’m going to completely ignore the tsavorite resource for valuation purposes). Their Competent Person’s Report (CPR) confirms a Recoverable Resource of 63 to 83 million carats, or an average of 73 million carats. On the other hand, they’ve regularly stated that their mine has an estimated life of up to 20 years, at an average 2.2 million carats per year. This is significantly lower than the Recoverable Reserve, so let’s assume the 20 year life will be reached. This gives us an average Resource of 58.5 million carats. Let’s haircut this by 50%, to reflect the fact we’re dealing with Resources, not Reserves (this is a fudge, but like I said, it’s the best we can do here – and Resources that are throwing off 2+ million cts a year are a lot more reassuring anyway).

Medium term revenue per carat is just over $15. This would suggest a suitably discounted $1.50 per carat value in the ground. But let’s haircut this also, and opt for a lower Fair Value of $1 per carat, actually close to 10% of the company’s current revenue per carat. Hopefully we’ve hacked/slashed enough now, so we just need to include some other B/S items: Inventory‘s at $6.3 million, and should be easy to realize. Adjusted Cash is $4.7 mio – reasonable to include $3 mio of Receivables due within 6 weeks from their Jun-2011 sales. Finally, we’ll include $1.4 mio of Debt, and what have we got?:

(58.5 mio carats * 50% * $1.00) Resources + $6.255 mio Inventory + $4.746 mio Adj Cash – $1.371 mio Debt = $38.9 million = GBP 20.8p Fair Value per share

Incidentally, and rather bizarrely, this is exactly equal to the company’s Equity of $38.9 mio. Wow! With an overlap on the various approaches above, averaging a final valuation is the most obvious thing to do:

(GBP 25.30p P/E Val + GBP 22.25p P/S Val + GBP 20.82p Asset Val) / 3 =            GBP 22.8p Fair Value per share, for an Upside Potential of 137%

If you prefer some pie-in-the-sky, just look back to peak figures and estimate a potential valuation if that kind of performance can ever be revisited… Vs. the relevant Peak metrics, Richland currently trades at a 1.8 P/E, a 0.4 P/S, and a Dividend Yield of 66%!

Considering everything, Richland presents a relatively low risk investment opportunity in real assets. It appears to be significantly undervalued based (mostly) on current metrics, and could potentially offer exponential upside based on its prior share price history and a possible return to peak revenues/earnings. I now have a 1.7% portfolio stake.

• Richland Resources (RLD:LN)

• Mkt Price:  GBP 9.625p
  
• Mkt Cap:  GBP 11.4 mio
• P/E:  5.7
• P/S:  0.9

• Tgt P/E:  13.5
  
• Tgt P/S:  2.0
• Fair Value:  GBP 22.8p
  
• Upside Potential:  137%

Tanzanite was first discovered (as a Zoisite) in the late ’60s, and it took off when Tiffany & Co (TIF:US) renamed it and began marketing it. To date, the US has been the biggest market, with tanzanite often chosen as a birthstone for new mothers. In 2002, it was also designated as a December birthstone, the first revision since 1912 in the AGTA‘s birthstone list.

Last year’s Royal Wedding also provided an unexpected boost for tanzanite. Kate Middleton’s ring (formerly Princess Diana’s) is an 18 ct sapphire and diamond ring, and jewelry manufacturers and consumers were quick to realize that tanzanite was a cheaper but v acceptable substitute for sapphire. There are also high hopes in the industry that an increased Asian preference/acceptance for coloured gemstones, coupled with increasing incomes/aspirations, means there is huge untapped potential to sell tanzanite in China, India and the rest of Asia.

Interestingly, the ascendancy of diamonds in the Western world has really only been a phenomenon since the Second World War. Before that, coloured gemstones were equally popular and as valued as diamonds – Royal jewelry collections world-wide attest to that. This diamond supremacy can almost certainly be ascribed to the control and influence of De Beers.

Taking a closer look, I learned that gemstone prices mostly appear to be correlated with their degree of hardness. I did not know this – unlike the fairer sex, who seem to intuitively divine what gem is the hardest…to pay for! There’s a scale for this – the Mohs Scale. This ranges from 1 for talc (yes, a stone!), to 10 for diamonds. Sapphires are at 9, while emeralds are at 7.5-8. By comparison, tanzanite is at 6.5-7, which of course is ‘hard’, but is actually relatively soft for a gemstone. While I can see some merit to this hardness premium, above a certain point I’d have expected pricing to be actually based on rarity?!

This is an interesting thought, as tanzanite is far rarer than diamonds – in fact, it’s often cited to be a thousand times rarer! Who knows for sure, but you get the point. This comes down to the fact that tanzanite can only be found in one place on earth – the Merelani foothills of Mount Kilimanjaro in northern Tanzania. And it’s generally estimated that the total resource will be exhausted in another 20-40 years. This presents an intriguing prospect for future tanzanite prices, relative to diamond prices, for example.

This tanzanite resource is divided locally into 5 blocks. Blocks B and D are mined largely by small artisanal miners. Medium scale mining is undertaken by Kilimanjaro Mining in Block A and Tanzanite Africa in Block D-extension. Finally, Richland Resources (RLD:LN)** undertakes larger scale mining in Block C, and is considered to be the largest and most advanced miner and supplier of tanzanite in the world. It is also Bermuda registered, and publicly listed on the London AIM market. This is the company we want to focus on. First, let’s take a look at their historic figures:

Richland Resources     (xlsx file)

Richland Resources     (xls file)

On the production front, things look good. Carats produced, despite hiccups, has been increasing by 9.4% per year. This has been accompanied by a rock steady cash cost of $3.67 per carat, on average, while the yield has stabilized in the 50-60 carats per tonne range for the past few years. We see a very different story on the revenue and earnings front, however, all of which can be traced back to the crunch year of 2008. The best way to see this is by calculating an estimated revenue per carat. (If you’re interested in the math, I’ve adjusted for changes in inventory. To keep it simple, I’ve assumed inventory carrying value is at 50% of sales prices). There has been a changing business mix (of rough, polished and jewelry) over the years, but v clearly the credit crunch/recession caused a price crash in tanzanite (to $5.69 per carat in 2009), with a slow recovery to $8.89 since then.

This was, of course, also seen in the diamond market, and in the wider coloured gemstone market. Gemfields (GEM:LN), a peer company which focuses on emeralds, has provided some interesting recent disclosure. For their recent lower quality auctions, price per carat has gone from $0.31 in Mar-10 to $1.12 in Nov-11, while higher quality has jumped from $4.40 in Jul-09 to $42.71 in Jul-11! It should be noted, however, that auction prices/results are notoriously volatile based on the specific characteristics of the inventory offered, so one should not conclude that prices have multiplied from their lows! Diamond miners also reported a dramatic surge in prices from 2008/09 to mid-2011, which has been tempered by some degree of price retracement since then.

All in all, considering the diamond/gemstone price increases, gold up 170% in the past 5 years, and a possible (very) inflationary (and/or alternative asset friendly) environment to come, the pecking order and price outlook for tanzanite appears neutral (at worst) to decidedly bullish. Wider appreciation of its increasing rarity would provide another powerful tail-wind, but this may take a lot longer to unfold.

Management appear professional and generally shareholder friendly. This is seen in the high level of dividends paid out pre-2009 (almost unique among the junior miners), while since 2009 I would consider that management have righted the ship as quickly and efficiently as possible. There has been no continual call on shareholders for more funding either, the other big problem in the sector. There is an unusual A class of shares, but these are being steadily reduced and are not dilutive in any way to ordinary shareholders. They have also appointed advisers to add a listing on the Dar Es Salaam exchange, which should encourage new interest and shareholders.

The CEO is Bernard Olivier is a geologist – his PhD dissertation actually covered all aspects of the Merelani tanzanite deposit. He’s been closely involved with tanzanite mining/geology since 1999 and, prior to becoming CEO, was a consultant and then director to the company. Ami Mpungwe is Non-Exec Deputy Chairman (having swapped the Chairmanship with Ed Nealon), but remains Chairman of the company’s Tanzanian sub. – he’s a director on a number of Tanzanian boards, and has served 25 years in the diplomatic service, including 6 years as the Tanzanian Ambassador to South Africa.

I’m also delighted to see some recent share purchases by the directors, including a receipt of shares in lieu of salaries/fees. They now own 14.5% of Richland. This collective stake is worth about $2.6 million, which far exceeds their $0.67 mio of emoluments in 2010, so we can rest assured that their incentives are appropriately aligned with shareholders. Now, let’s take a look at a couple of negatives:

a) Let’s tackle the biggie: Richland’s current Special Mining License expires in July! The license will be extended for a further 25 years providing Richland is in compliance with the Tanzanian Mining Act. Clearly, this presents (in theory) a critical risk for Richland. Oddly enough, when you consider that the share price was already down 93% three years ago, it appears that nobody’s actually pricing in this risk! On the other hand, I don’t think the reverse is true – in fact, news of an SML renewal would likely be seized on by the company and investors as a significant positive development. So how risky is this decision/event?

Well, Richland has consistently stated it’s been compliant. It appears to be a good corporate citizen: It funds local community needs and projects, it’s created a unique tourist attraction in The Tanzanite Experience, and it funds The Tanzanite Foundation which promotes the entire tanzanite industry in Tanzania. They have Ami Mpungwe, a well-respected local figure, on board. They’ve created a new JV structure that may prove to be a model for working with local artisanal miners. And they’ve suffered from unauthorized local undermining, so perhaps they’re more sinned against than sinning? Additionally, despite investor fears, refusal of a mining license renewal is pretty rare for an established producer and is generally preceded by plenty of warning signs/rhetoric.

Like all politics, this one’s unpredictable – but Tanzania is generally considered a low political risk country (at least in an African context!), and the risk of license non-renewal appears to be low.

b) Of course there’s also mining production risk, but this exists with all companies, so I won’t discuss it further. Perhaps the most obvious other risk is the renewed fears of recession/slow growth in Europe and the US. That’s the billion dollar, sorry trillion dollar, question..! Yes, that’s a real risk, but I think if the (global) economy starts tanking, we can rely on another Tepper rally to bail us out..! Not that central banks and governments losing their collective minds is really going to solve anything longer term.

I’ll write about this more another day, but suffice it to say I’m not tempted to sell stocks en masse (i.e. I’m not afraid of recession), but I certainly will continue to re-allocate a significant portion of my portfolio to natural resources and other real assets (i.e. I’m afraid of inflation). Fortunately, there are plenty of these type of assets still going cheap – just like Richland? And with the price of tanzanite still sufficiently beaten down since 2008/09, I’d venture that a recession wouldn’t necessarily impact it further at this point anyway…

c) Hard to say if this is a positive or a negative: In mid 2011, Richland announced it had entered into (for a small fee) an option to potentially acquire an established sapphire project in Australia. This has previously been partially mined and produced significant quantities of gemstone quality sapphires. They’ve recently extended their due diligence period on this project. If they exercise the purchase option, the consideration will be a relatively small $4.0 million.

I am concerned however that this purchase would be mostly funded with the issuance of shares. At the current low share price, this would appear to imply a dilution of shareholder value. Additionally, even though the project’s been previously mined, it’s not at all clear what level of project capex and working capital might be required to bring this project online? Finally, sapphires should certainly be within the company’s existing circle of competence, but I’m concerned about the additional costs and distraction of setting up/operating in another country.

OK, I’ll continue from here on Friday – we shall take a look at any key positives for the company, take a stab at a couple of different valuations, and then we’ll draw some conclusions about Richland as a potential investment opportunity.

** Richland Resources Ltd. was formerly known as Tanzanite One (TNZ:LN) (name changed in Aug 2011). It should not be confused with a small listed US oil & gas exploration company named Richland Resources Corp. (RRCH:US).

Not true at all! In fact, natural resources in the ground are maybe one of the few things in our history that politicians and central banks have not been able to debase. You should definitely grab some (more) for your portfolio, especially now the Fed seems hellbent on reflating the US, and the entire world. (I recommend you watch this quantitative easing primer - v precise, and hilarious too!).

But if you stray from the industry giants, buying into the oil & gas/mining sectors is like entering the lion’s den. Be wary! The old quote ‘A mine is just a hole in the ground with a liar on top‘ still holds true far too often, except now the miners have such cushy numbers they actually believe their own hype…

And the other problem is valuation – I don’t hate them, I just find that 9 out of 10 resource stocks are absurdly over-valued, and I wouldn’t touch them with a barge-pole! Expressing this can be problematic – there is an awe-inspiring asymmetry between people’s pleasure and displeasure when you venture that ‘their’ stock is undervalued or overvalued… I guess I just don’t have enough faith (let’s look it up: ‘Faith: Belief that does not rest on logical proof or material evidence.‘). My grandmother will be disappointed…yet again.

But I was on the road to Damascus the other day, and I tripped over a little stock… Yes, a natural resource stock!

No, not quite a (complete) revelation to me…I came across this stock years ago, was intrigued and thought: Good story, good company (maybe), bad price! I’ve patiently kept an eye on the stock (plus God knows how many others) for the past 7 years or so, and finally reached the point: Good story, good company, good price! These are the three fundamental building blocks of any successful investment.

It is a producer, with increasing production (and available capacity). It’s bringing online/evaluating new projects. It has been profitable nearly every year of its existence. It’s currently on a 5.7 P/E ratio, and a 1.8 P/E ratio versus its peak earnings. Of course, earnings and P/E ratios would mean v little if a company exhausts its resource in a few years time… So I’ve taken my best shot at estimating the total value of the company’s assets, and I’m reassured to see the same level of under-valuation. A potential acquirer does exist. And, forgetting the fundamentals for a minute, its share price is trading close to a major break-out level, which could offer a fast/significant move to the upside. Oh, and by the way, did I mention this stock is down 97% from its high?

I will be writing in detail about this stock asap – meanwhile, major kudos to any reader who thinks they can name this stock?!