activist investors, Baker's Dozen, CLOs, closed-end funds, delisting risk, Everest Capital, intrinsic value, investment companies, Leverage, Livermore Investments, NAV discount, Net LTV, Owner-Operator, principal-agent problem, private equity funds, real estate, safe-havens, share buyback, TER
Livermore Investments Group Ltd. (LIV:LN) is one of my 2012 Baker’s Dozen stock picks. And doing v nicely too…up +79% YTD! This post isn’t just specifically about Livermore – LIV also offers great perspective on owner-operators, share buybacks & shareholder value. Oh, and – shhh, draw the blinds – I’ll whisper it: De-listings...
LIV is a London-listed (closed-end) investment company. Its portfolio is focused on 3 different investment areas:
i) Real Estate: The major holding is $38.2 mio (net of related debt) invested in Wyler Park, a commercial/residential Swiss property. It’s fully let, on a gross 5.1% rental yield, with development potential for another 37% of floor space. The other significant investment is $14.7 mio of convertible debt in SRS Charminar, an Indian real estate company. Unfortunately, the stake’s been subject to long-running litigation. But with ample initial over-collateralization, and an agreed settlement this year, continuing uncertainty’s now hopefully related to timing & expenses, rather than recovery value. Net of interest rate swaps, total net property investment is $45.9 mio, or about 32% of NAV.
ii) Private Equity: Mostly invested in half-a-dozen or so third party private equity funds, mostly focused on India & China, totaling $17.7 mio and 12% of NAV.
iii) Credit Strategies (56%): Along with corporate bonds, the main focus here is on active investment (& trading) in the US senior secured loan market, via Collateralized Loan Obligations (CLOs). Last year, US CLOs [plus Residential Mortgage Backed Securities (RMBS) & Commercial Mortgage Backed Securities (CMBS)] offered rather extraordinary 20%+ IRRs. Rather bizarrely, this was far higher than what was on offer in Europe.
2011 US credit returns started strong, but were derailed by the European sovereign debt crisis later in the year. Fortunately, LIV’s portfolio significantly out-performed. In 2012, investors woke up & realized how much further along the US is vs. Europe in the current cycle. Not surprising – considering the financial crisis originated there, and the more pragmatic (and/or spendthrift?) US attitude to bankruptcies, bank re-capitalizations, and fiscal & monetary stimulus. As a result, H1 2012 performance from US credit strategy hedge funds was top-notch, and hopefully bodes well for LIV’s own returns. Net of some minor hedge fund/equity investments, plus additional leverage, this portion of the portfolio totals $81.8 mio, or 56% of NAV.
At the time of my initial write-up (at GBP 14p), LIV traded on a perplexing 64% discount to NAV. This made no sense to me, but I’d hazard the following:
– Performance: In its current form, LIV was launched in 2006/07. Like many peers at the time, it confidently ploughed most of its funds into private equity/PIPE investments. The prices paid, the J-curve effect, the financial crisis/recession, and the lack of direct control were all far too destructive of shareholder value… However, I’d argue: i) this legacy PE impact is hopefully near an end now, ii) direct investment performance (i.e. in property development & credit strategies) has been v encouraging. LIV’s directors are clearly aware of this, with no further investment/recycling of funds into private equity in the past few years – the focus has been firmly fixed on credit strategies & share buybacks.
– Leverage: At end-2011, Total Liabilities stood at 46% of Total Assets – pretty high for an investment company! However, the majority of this is property debt, and non-recourse to the rest of the portfolio. Stripping out net property assets, liabilities are limited to 21% of assets – quite acceptable! By comparison, the property Loan-to-Value (LTV) is 69%, and a steeper 76% if one includes interest rate swaps. This scale of property leverage would normally be a little uncomfortable for me, but c’mon, we’re talking about Swiss property yielding 5.1% here..!?!
Look at the current strength of safe-haven currencies, and especially their yields – do you really think they couldn’t sell this asset at a premium & in a heartbeat?! [Incidentally, I think they’d prefer to realize the remaining development potential first]. And if their bank really kicks up, LIV could easily drop in some extra cash from Credit Strategies to improve leverage ratios. Therefore, I don’t see a real financial threat posed by Livermore’s leverage – but, of course, it’s prudent to note the impact of any decline in asset values would be accordingly magnified.
– Insider Ownership: Perhaps this might be the primary reason for the discount… At year-end, directors owned 66% of net outstanding shares. This level of insider ownership/control usually has most investors running scared – I’ll return to this point. From my perspective, I was actually v encouraged by the added shareholder value arising from the company’s smart & v chunky share buyback programme, and by the presence (until recently) of an activist shareholder, Everest Funds**.
– Total Expense Ratio (TER): Livermore’s self-managed, and focused on alternative investments – not surprisingly, its TER is high at a minimum of 3%. If you consider certain legal costs as ongoing/un-exceptional, the TER’s significantly higher. Normally, I deal with excessive investment company TERs (say, 2%+) by adjusting NAV for a year’s expense (I do something similar for cash-burning companies). However, LIV’s focus on property & high-yielding and/or discounted debt, enhanced by leverage, means its P&L is v positively skewed vs. the avg. investment company…
For example, 2011 interest/dividends/rent amounted to $24.6 mio, corresponding to a 9.1% yield on avg. assets, and an astounding 17.1% on avg. NAV! Of course, LIV has to pay higher than average TER, net interest expense, and even taxes – but should still earn an expected net annual 9.3% return on NAV. Whether this impacts expected capital gains/losses is debatable, but I see no need to apply a TER haircut in this instance.
Despite the mitigating factors mentioned above, and due to competing investment opportunities, I limited my eventual investment to 3.3%. [Note: I’d only begun building my stake, at 1.6%, when I published my Baker’s Dozen. I completed my stake-building in March]. In my mind, the stock was completely neglected, the far higher NAV was also being ignored by investors, and there was a fair chance further share buybacks might actually prompt investor selling, based on an increasing inside ownership stake. This might have presented opportunities to add to my stake…
It wasn’t to be, unfortunately…but who can complain when faced with a 91% increase in the share price (to GBP 26.75p) in a mere 6 months?! 🙂 Which prompted me to recently tweet/comment I’d cut my stake in half, bringing me back to 3.2%, essentially my original stake. This price rally illustrates the impact of their aggressive share buybacks – in terms of an increasing NAV, the shift in the supply-demand equation, and ultimately the positive impact on investor sentiment.
I’ve already highlighted share buybacks as a much better (and more tax-efficient) shareholder return than dividends. But there’s a huge difference in execution when management are Agents, vs. when management are Owner-Operators. [I’d simply define owner-operators as management with an equity stake that far exceeds their compensation package, which tends to change their perspective & actions quite radically..!] Agents generally view buybacks as a means of offsetting option dilution, as a way to smooth or juice EPS and, best of all, as a share price booster to increase the value of their options – intrinsic value‘s usually ignored and/or completely irrelevant.
On the other hand, owner-operators are v aware of intrinsic value per share, and far more interested in increasing this value than indulging in earnings management. Their objective is to buy at a discount to intrinsic value, thereby increasing the resulting intrinsic value per share for themselves & other remaining shareholders. They’re often not even interested in boosting the share price..! And why should they be?! If the price stays low, it’s a great opportunity to execute even more share buybacks… And owner-operators are always confident intrinsic value will be recognized eventually – after all, they are in the perfect position to prompt that value realization, if necessary.
In LIV’s case, they retired 10% of their shares last year at v substantial discounts to NAV. This year, it’s more of the same, but they’ve actually accelerated the pace significantly. It’s only August, but they’ve already bought back 22% of outstanding shares YTD! All other things being equal, this has improved NAV per share by 14% YTD to $0.649, or GBP 41.5p. Even at today’s more elevated price, retiring 1% of outstanding shares would increase NAV by another 0.4%.
But are there any negatives to this process? Well, first, the funding for these share buybacks has to be raised from the Credit Strategies portfolio. No problem – US credit markets are doing well, so they offer improved liquidity & tasty profits to harvest. Cash should be extracted to also reduce non-property debt, otherwise the non-property leverage ratio will ratchet up. The portfolio will also become a little more biased towards illiquid strategies – but PE will remain a minor allocation and, as I said, I can’t imagine prime Swiss investment property being too hard to sell..! We also have the elephant in the room – insider ownership! With the share buybacks, insiders now own 84.6% of Livermore!? Gulp…
To be continued…
** My previous link was correct, but above I originally (& accidentally) linked to Everest Capital – note this was incorrect, Everest Funds was the recently departed Livermore shareholder.
Incidentally, Everest Capital are well worth keeping track of for some v interesting emerging & frontier market insights. I recall years back receiving some fascinating shareholder letters from their founder, Marko Dimitrijević – his ability & flexibility to invest right across the capital structure also illustrated some interesting investment alternatives.