Damille, DiamondCorp, discount control mechanism, doughnut boy, EIIB, HBG Holdings, Laxey, marathon, NAV discount, Qannas Investments, quid pro quo, QVT, Rasmala, share buyback, sukuk, tender offer, Total Expense Ratio, track & field, Weiss
C’mon, you’re kidding..? No, seriously, you’re taking the mickey?! In March, the European Islamic Investment Bank (EIIB:LN) (which I last wrote about here) share price looked ready to challenge the GBP 3.9-4.25p resistance zone. This has capped EIIB for almost 3 years now. But here we are, 1 month later, and the price hit GBP 2.8p just in time for Easter – off 24%! No change in volume, or holdings…what’s going on?! And it’s not clear the board have noticed… But I’m sure they’re well aware of EIIB’s intrinsic value, and are focused on the marathon task of their new operating strategy…
All very well but, as any health professional will tell you, before embarking on (and to be successful in) a marathon, you should first do a health check and then scale up with plenty of walking, exercise, jogging, running and even some fartlek. So health check first, then track & field, and then marathon..! But the current share price (and NAV discount) certainly don’t present a healthy diagnosis of the budding athlete…
So why is this? Well, EIIB’s got a rather unhealthy legacy to date. It v fortunately raised a ton of money in the 2005-06 boom, reporting Net Equity of GBP 184.2 mio (or $292 mio) in its first public results. Compare that to Qannas Investments (QIL:LN) which only raised $18.5 mio recently… Since then, EIIB’s reported steady losses, with Equity now down to GBP 151.1 mio. Actually, this is good (relative) out-performance – but only because the bear market terrified management before they’d invested too aggressively. The share price doesn’t help either... The shares closed down 38% on day one from the GBP 25p IPO price! That’s a first, I’d say!? And now it’s down a colossal 89% since…
EIIB’s also embarking on a new/more focused strategy as an Islamic asset manager/investor (& investment banker). Trouble is, they’ve only one real success to date (TriTech, with a 35% IRR) out of a string of otherwise poor (or unrealized) investments. With HBG Holdings now in the driving seat, perhaps we can look to their record instead? They’ve had some favourable press commentary, and they bring a PE perspective to the table – but there doesn’t appear to be a public performance record available to examine.
All in all, this leaves most investors (and the media) somewhat dubious about EIIB’s business and prospects, and obsessing over its perceived negatives. It’s a bit like that doughnut boy working down the hall from you – he claims he’s going to train up & complete a marathon within the next year! Sure, anybody can complete a marathon if they put their will to it, but based on history & form to date, you just don’t bloody believe him..! And you think he might just drop dead first… There are three immediate concerns EIIB (& HBG) should perhaps be focusing on, before the marathon to come:
i) The new strategy: After the recent restructuring, I’d estimate current underlying net cash burn to be around GBP 4.0 mio pa (a 2.7% Total Expense Ratio, not extraordinary). With staff halved to 17, a a further expense reduction would be hard to achieve, while any income increase may get eaten up by incremental expense (at least initially). Getting to break-even will take time, while creating positive intrinsic value from fund management (and monetizing the banking licence in some way) will take even longer.
The recent Rasmala sukuk fund launch doesn’t move the needle much. If it’s comparable to other money/bond funds, this might only earn 30-40 basis points for Rasmala on an institutional basis (with no performance fees). At best, fees could be 100 basis points on a retail basis. Then again, this is a good anchor for a wider fund platform. But I was disappointed at the $25 mio seed investment from EIIB. I’ve plenty of experience buying, and selling, similar funds and I know seeding helps sell a fund (esp. to investors who limit their % ownership). But I also know fund growth comes down to time, performance and, most of all, sales force success – seeding matters little in the end. Unless Rasmala announces a quick $250-500 mio in fund assets, I’d consider this investment excessive or even unnecessary.
Stepping back, this begs the obvious question: Does EIIB, as an Islamic investor/asset manager, need GBP 218.4 mio ($347 mio) in Assets to develop/support a successful business? There’s a simple answer – absolutely not!
ii) Discount to NAV: EIIB’s share price is now at a colossal 59% discount to my latest NAV estimate (see below). This is particularly absurd when you consider the low risk nature of the current balance sheet – most assets are in cash/’deposits’/bonds, and debt can be repaid at a moment’s notice. HBG’s an operational activist with a vision for the future, so they may just consider this price decline a temporary aberration that will be overcome in due course with improving operational success.
But they should be v aware of other/more aggressive activists lurking out there… I’m amazed EIIB hasn’t attracted the likes of Laxey, Weiss (Brookdale), QVT, or even Damille. EIIB is basically a liquid/low-risk investment company, with a poor operational & share price history to date and a (fairly) disaffected shareholder base – classic fodder for these activists. Sure, liquidity’s low, but EIIB has some lumpy shareholdings and the NAV discount would permit a potential activist to be pretty aggressive in placing bids/hitting offers to build up a stake.
And these guys have a short time horizon – 9 times out of 10, they’ll agitate for the quick kill, and just grab whatever immediate value is realizable, rather than opting for a much higher intrinsic value down the road. For EIIB/HBG, there’s no point in thinking about breaking through ‘the wall‘ and/or their 5 year growth plan, if an activist pops up with a stake & an agenda and trips them up at the very first hurdle…
iii) Shareholders & Control: I’ve hinted at this before: ‘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).‘ Let me be more specific. HBG’s acquired effective control (with a CEO, Chairman & 1 NED now in place) of EIIB, with only a 15.6% stake and without paying a premium… This is unusual, to say the least! This type of ‘takeover‘ usually generates plenty of investor/media resistance and negative commentary. But that never happened with EIIB…I think shareholders were too dazed!
But consider this ‘transfer of control‘, the likely timeline for success with their new strategy, the ultra-cheap share price and the obvious surplus capacity on the balance sheet… A quid pro quo is now definitely due to shareholders, and in fact can be achieved without impairing HBG & EIIB’s vision or success in any way.
So how could EIIB go about this? Well, we first have to think about a target balance sheet. I’d argue $100 mio in Net Equity is more than enough! But I’d be comfortable with 20-30% leverage in the company. (In fact, EIIB currently has a similar 24% leverage, now the TriTech tax liability and non-controlling interest should have been eliminated). So let’s bump up the numbers: Presume $159 mio (or GBP 100 mio) in Assets and $40 mio in Liabilities, for $119 mio in Net Equity.
$159 mio in firepower seems plenty generous for EIIB to assemble an attractive portfolio of private equity & seed investments for shareholders, and to support its growth as an asset manager. But could management/directors argue more funds are needed? Possibly..! But I’d argue you first need to walk, not run – in due course, with a fully invested balance sheet and some investing & operational success(es), I’m convinced EIIB will have plenty of opportunity to tap more capital. But I think there’s another more obvious, and elegant, solution available to us:
The average share price in the past year’s about GBP 3.3p. Could EIIB return this amount to shareholders (backed up by a share buyback) and retain sufficient investable assets? This strategy would likely have a dramatic impact on share price & sentiment, and offers the company & shareholders a ‘free ride‘ on HBG’s new operational strategy. What would the balance sheet look like after? Well, let’s lay out the steps first:
a) Dividend: Buried in one of EIIB’s TriTech announcements was the little noticed line: ‘The result of this transaction is expected to potentially put EIIB in a position to pay a dividend in respect of 2011.’ This was supported in the half-year results, with GBP 18.1 mio in Retained Earnings. Remember, investment gains are recorded as revaluation reserves and only transferred to Retained Earnings when an investment’s actually sold. So, in H1 2011, the TriTech sale bumped up Net Equity by GBP 8.1 mio, but Retained Earnings by a much larger GBP 17.5 mio. All other things being equal, I’d estimate Retained Earnings will fall to around GBP 14.0 mio at year-end, which would permit a max. dividend of about GBP 0.8p per share. They might as well characterize it as a special dividend (as a 2012 dividend’s unlikely), but so what, it should attract plenty of positive comment/interest regardless. This is a simple/fast/cheap return of funds to shareholders – it’s a no-brainer!
b) Tender Offer: The next step – with some minor tweaks, a repeat of the previous tender‘s the most obvious approach, and it looks like it would take 3 mths or less to organize. That offer was pitched at GBP 7p per share, so with (pre-dividend) NAV roughly unchanged since, a GBP 6.2p (recognizing the div. paid) tender offer would make sense/be on similar terms. The tender amount would be limited to GBP 44.1 mio, equiv. to about GBP 2.5p per share for total shares outstanding. This is much larger than the last tender (at GBP 7 mio), but offers a substantial premium again to the current share price – I think we could be assured of a full take-up..!
c) Share Buyback: After/concurrent to the div/tender (which quickly/efficiently returns the intended GBP 3.3p to shareholders), a share buyback’s a great extra to throw in! Regular readers might be surprised I didn’t suggest this first, as it’s a great strategy to return funds and enhance NAV. Unfortunately, EIIB’s trading volume presents a stumbling block (and perhaps opportunity)! In the past year, volume’s only about 80 mio shares. If EIIB was paying up, and absorbed this kind of volume, at most it would only cost say GBP 3.6 mio! Actually, let me assume a 98.6 mio share buyback (you’ll see why below), at a max. cost of say GBP 4.4 mio.
This buyback offers about the best (legal!) form of market manipulation I’ve ever seen..! Think of the positive sentiment already engendered by the div/tender, plus the impact of a share buyback for a year’s worth of volume..!? EIIB could easily absorb sellers, if any, and almost inevitably march the share price up to NAV… In fact, it presents a pleasant dilemma: Should EIIB sit on the bid and buy shares at a huge NAV discount, or aggressively march the share price up as quickly as possible? One enhances the NAV, the other ‘enhances’ the share price – on top of a div/tender, either is a plus for shareholders! In all likelihood, EIIB might find it hard to spend the money…I think the market would be happy to bid up the shares itself.
If the share price did trade up to the NAV, I’d envisage the buyback being retained as a ‘discount control mechanism‘. This would provide useful support for the share price until the intangible intrinsic value/benefits of the banking licence/asset management business eventually kick in. At that point, the share price should be well capable of trading at a consistent premium to NAV.
Assuming a full share buyback, this would represent a total GBP 62.5 mio return to shareholders, which can be easily funded from current cash & funds due from financial institutions of GBP 109 mio. Note: EIIB’s subsequent Diamondcorp (DCP:LN), Rasmala and sukuk fund investments are already funded from the net TriTech proceeds and closure of the Turath Fund. This implies a new Net Equity of GBP 88.6 mio, or $141 mio. Assuming 25% leverage, this supports Total Assets of $188 mio (10 times what Qannas has available to invest), and a reduction in Liabilities to $47 mio. With 2011 Final Results to be announced v shortly, all of the above steps could be executed within 3 months or so, resulting in:
i) Shareholders (inc. HBG) would receive at least GBP 3.3p per share,
ii) The share price should be trading at/near the new NAV, and
iii) EIIB/HBG still has $185 mio in firepower to invest/support their new corporate strategy.
Right, I’ve taken another look at my NAV estimate. As I’ve highlighted before, I like to include a full year of cash burn (which I’ve re-estimated a little more conservatively) and an up-to-date Diamondcorp write-down (based on its current GBP 5.5p share price). It’s not clear when they’ll be issued, but EIIB’s unfortunately committed to a dilutive issue of 98.6 mio shares. This is in return for another GBP 3.5 mio of Rasmala shares (from Mr. Ali al Shihabi, Chairman of Rasmala’s Supervisory Board). I’ve now factored in this dilution up-front, although I hope this issuance & some/all of the dilution can be ultimately offset by a share buyback, as described above.
Overall, there’s only a small decline in my Fair Value per share to GBP 7.74p. In the past few days, I’ve been adding shares at GBP 2.8p, increasing my stake from 6.1% to 7.4%. The share price has now closed a little higher at GBP 3.18p but, despite that, EIIB presents what I’d consider to be a low-risk Upside Potential of 143%.