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Argo Group Ltd. (ARGO:LN)

  • Mkt Price:  GBP 14.5p
  • Mkt Cap:  GBP 9.78 mio
  • % of AUM:  4.0%
  • P/S:  1.3
  • Div Yield:  8.3%      

Argo is an AIM quoted alternative investment manager focused on global emerging markets. Argo’s funds are designed to deliver low volatility absolute returns with lower correlation to wider global markets. It invests primarily in special situations, real estate, high yield corporate credit and distressed debt. The company has a performance track record dating back to 2000, and has won several awards for best Risk Adjusted/Sharpe Ratio performance. Andreas Rialas, the CIO, is Argo’s founder while his brother Kyriakos has been CEO since 2003. Unfortunately, to reach its current listed status, the company has really been through the Symplegades…

In Jan 2007, the Rialas brothers sold Argo (then a private company) to Absolute Capital Management Holdings (ACMH). This was a go-go UK-listed hedge fund management company, co-founded by Sean Ewing and Florian Homm. Ewing’s originally from Donegal (another fallen Celtic tiger) and was the CEO and ‘front man’ for ACMH. I did actually ponder an investment in ACMH at one point, until I saw this photo’Egad, Carruthers, the man was a cad, a real bounder, a damn mountebank…splutter!’ A modern day Flashman (just came across one of these books again recently, marvelous fun to read!). His equally handsome partner, Florian Homm (CIO), was perhaps even more colourful – a 6’8” German ex-basketball player, who Ewing actually described as ‘…a cross between Einstein and Mike Tyson: bright, intelligent, volatile and aggressive’!?

The brothers ended up with an (eventual) stake of 32% in ACMH, with no inkling of what was to come later in 2007. First, Ewing resigned in July ‘…to spend more time with his young family’. A fortunate stroke of luck for Sean, the family man…he wasn’t on watch when the shit really hit the fan: On September 18th, ACMH released a one sentence statement confirming that Florian Homm had resigned. Even this terse admission appears to have been prompted by the fact that Homm’s resignation letter was already plastered across the web. One day later, the board suddenly discovered that certain ACMH funds were stuffed full of US OTCBB/pink sheet stocks, which were estimated to be overvalued by $500 million. Not to suggest the back office was doing a bad job, these stocks were actually marked-to-market…it’s just that those prices were v obviously pumped up.

(Just a word of warning: Very different circumstances, but be v wary of PSource Structured Debt (PSD:LN). Shares trade at GBP 18.75p, while the latest NAV is GBP 100.2p. Pretty attractive, eh? But no bargain when you look under the hood: Despite the name, 78% of PSource’s NAV is actually composed of shares in a green-tech company called PetroAlgae (PALG:US). These shares are valued at $11.56 which seems reasonable vs. a 6 month VWAP of $15.27. Of course, the’6 month’ should ring some alarm bells…yep, they neglect to point out the current market price is $7.25. And this price is generous, it corresponds to the Ask – the Bid’s at $3.50! And even that’s debatable, we’re talking about a company valued at $775 million. Pretty fly for a company with negative Equity and 4 months of Cash on hand…oh, and did I mention, no Revenues!?!)

Needless to say, ACMH’s share price promptly collapsed on these revelations. Spare a little sympathy for the Rialas boys, the value of their shareholding was decimated. Their one stroke of luck was the fact that they’d negotiated to run the Argo fund business on a stand-alone basis after it was acquired. Fortunately this meant their funds were clean…but of course people weren’t prepared to make much of a distinction between ARGO and ACMH. Eventually, the brothers arrived at the best solution, in the circumstances, and proposed a spinoff of Argo to ACMH shareholders. This was executed on a 1:1 basis (in June 2008, followed by an AIM listing in November), so they finally ended up back in control of Argo, albeit with a lower 32% shareholding. Just when the credit crisis was really beginning to accelerate…

Followed shortly thereafter by the news that Argo had been named as an additional defendant in a lawsuit filed by Cascade Fund LLC against ACMH. Cascade was a significant investor in several ACMH funds. This all served to whack ARGO’s share price down from GBP 14p to GBP 3p. Nope, I wasn’t buying there! – still feeling a little too shell-shocked at that point to consider brand new positions…. Eventually, the price recovered to about GBP 12p in April 2010, and then spent a full year trading around this level with the lawsuit still hanging over them. It was during this time that I began building my position.

A lot of message boarders have been v vocal in their criticism of the decline in Argo’s Assets under Management (AUM). But in light of the market crash, the litigation, and the undeserved trashing of their reputation, I was pretty impressed with Argo’s asset retention and financial performance. This doesn’t mean they weren’t hit hard – AUM today is about 43% lower than at the end of 2008 – but a creditable performance in the circumstances. I liked their emerging markets exposure, as always, but I considered this to be a special situation stock for the Event Driven category in my portfolio. Management was keeping costs under control, and exhibited admirable financial conservatism. Fund performance was excellent on a relative basis. I also believed that redemptions would trail off, and some real fund raising become possible once the litigation was behind them. Of course, the litigation was the deal-breaker – a negative judgement was likely to severely impair or even wipe out the company.

After much tortuous reading of legal filings/documents, I gradually came to the conclusion that this litigation did not represent a real financial risk to Argo. The ‘issues’ in ACMH already existed prior to the Argo acquisition, and Argo was run as a completely separate business from the existing ACMH funds post-acquisition. Two years of trading had also passed by in ARGO shares, so their shareholder register was very different than that of ACMH in 2007. Finally, amongst other legal points, I noted Cascade had chosen to file in Colorado. This looked like a mistake, it wasn’t clear that a Colorado court could (or even want to) assert its jurisdiction in such an international (and ex-US) case. Even if jurisdiction was established, one could also question whether any judgement could be executed?

Of course, like politics, the law is never totally predictable so I limited the size of my position. But I still kept adding as the news flow continued in a positive fashion. Finally, in June 2011, Argo issued final confirmation that Cascade was not appealing the Colorado Court order at end-March dismissing the lawsuit against Argo. Unfortunately, Florian Homm was not so lucky – the SEC finally charged him this year for stock fraud. I wonder if he considers this worse than getting shot?! No more visits to Miami for Florian, I guess. But at least there’s somebody out there on his side, if you read this hilarious blog

I subsequently maxed out my ARGO position to 5.0%, the 3rd largest position in my portfolio, at an average entry price of GBP 13.2p. Argo’s small Mkt Cap limited me from adding further to my position. What kind of upside do I see for this position?

Well, let’s begin with the fund business itself: First, let’s look back at ACMH’s acquisition of Argo. They paid GBP 50.5 mio in Jan 2007. This was worth $99.6 mio at the time, which was 11.3% of then current AUM of $882 mio. Wow, most fund management company transactions occur at 2-3.5% of AUM. But this price was justified, as Argo earns the classic 2-and-20 hedge fund compensation on most of its funds. You might argue that was then, what about now? Well, actually, hedge fund/private equity fund management companies are generally valued at even higher multiples these days, ranging from 7.5% to as high as 20% of AUM. If we look closer to home, Ashmore Group (ASHM:LN) is a much larger emerging markets fund manager. A major portion of its funds have regular (non-hedge fund) fee structures, but on an ex-Cash basis it still manages to achieve a 5.3% of AUM valuation. I’m uncomfortable though with what seem like excessive hedge fund/PE multiples, so I prefer to limit my own Fair Values to 7.5% of AUM. But this is all relative, can this kind of valuation be justified on an absolute basis?

Over the past three financial years, Argo’s Operating Margin has ranged from 13.8% to 42.7%, averaging out at 24.5%. Obviously, performance fees (or the lack of them) are the key here. Valuing based on a blow-out year is not appropriate, but slashing value because of a bad year, and no incentive fees, is not appropriate either. Therefore, the average Operating Margin over time is the best indicator of the true earnings capacity and value of the business. A 24.5% Margin deserves at least a 2.5 P/S multiple, which equates to $27.4 mio based on last FY Revenues. This compares very well with a value of $28.5 mio, which is 7.5% of the current $379.7 mio AUM. So, clearly this valuation approach can be endorsed in a number of ways. To be continued…

btw I disposed of a final 2.3% position in Rent-A-Center (RCII:US) today, for an 82% gain vs. my $19.81 entry price. RCII was in the Distressed category of my portfolio, was trading up close to my Fair Value estimate of $40.91, and was basically replaced by my recent Colony Financial (CLNY:US) purchase.