% of AUM, activist investors, alternative assets, AREO, ARGO, Argo Group, Argo Real Estate Opportunities Fund, Colony Financial, distressed assets, emerging markets, European sovereign debt crisis, Fortress Investment Group, intrinsic value, Investor Relations, Kyriakos Rialas, Livermore Investments, Mello Central, Price/Cash, Rialas brothers, share buyback, special situations, sub-advisory, The Argo Fund, Universe Group
OK, sorry to disappoint… This definitely isn’t a review of Ben Affleck’s new movie ‘Argo’! [I haven’t seen it yet, but it’s on my list – the reviews are uniformly good, and Affleck displayed a sure hand with ‘The Town’.]
No, this post is about Argo Group Ltd. (ARGO:LN), whose share price is also trapped in a rather evil state… Specifically, the price has steadily declined 35% in recent months to GBP 10.125p – when the company is profitable & has net cash/investments on hand of GBP 20.9p per share! Operational execution & performance ultimately offer the best escape route for Argo. [I’m delighted to see Argo has now launched a new liquid emerging market debt fund. This offers attractive exposure, I’m sure it will clock up a good performance, but real success will come down to the level of fund-raising that’s achieved.] But there a number of additional actions & strategies that may offer considerable assistance in making this escape. Here’s a copy of a recent letter I sent to Kyriakos Rialas, CEO of Argo:
‘November 07, 2012
FAO: Kyriakos Rialas, CEO
Cc: Andreas Rialas, CIO
Cc: Michael Kloter, Chairman
Argo Group Limited
33-37 Athol Street
Isle of Man
I’ve been a shareholder for 18 months now, and have a 4.5% portfolio stake in Argo Group Ltd (ARGO:LN). My stake’s far smaller than you & your brother’s, of course, but well in excess of some of your fellow directors’ stakes. You may be familiar with the Wexboy blog (wexboy.wordpress.com): I’ve posted a no. of Argo articles (for example, here, here & here).
Summarizing my investment perspective may be useful: Argo’s an alternative manager focused on emerging markets, and investing in special situations, property & distressed debt – an investment focus I find v appealing. The past few years & the timing of certain fund launches has proved challenging. However, the performance of The Argo Fund (TAF) (7.8% pa since ’00) is testament to the long-term value of your investment process & experience. This is mirrored operationally, with an admirable focus on costs & profitability when faced with declining Assets under Management (AUM) & performance fees. But the market refuses to consider any positive investment thesis – Argo’s share price is now GBP 10.125p & market cap’s £6.8 million (or $10.9 mio). This seems v shortsighted: i) it’s a 52% discount to Argo’s $22.5 mio (GBP 20.9p per share) of cash/investments, and ii) true alternative fund managers regularly command (ex-cash) valuations of 7.5%+ of AUM. It’s also worth highlighting Argo remains profitable! In my opinion, a far more sensible (longer term) valuation for Argo is:
$5.0 Cash + $17.5 Inv + $302.4 AUM * 3.75% = $33.9 mio / 1.60 GBP/$ =
GBP 21.2 mio / 67.4 mio shares = GBP 31.4p intrinsic value per share
I only count cash/investments (zero debt), and ignore the remaining net equity. [But I hope to see improved conversion of receivables to cash, which would improve valuation.] I’ve haircut my asset management valuation to 3.75% of AUM, reflecting the more recent trajectory of AUM, revenues & margins vs. the underlying/longer term value of the business (e.g. in a sale transaction – see here). AUM trends, or the stability of Argo Real Estate Opportunities Fund (AREO:LN), might present risk(s) to this valuation, but one could also speculate on a higher valuation based on share buybacks, rising AUM & margins, and a higher market valuation multiple. I consider GBP 31.4p to be a fair median valuation, which offers the prospect of v significant upside potential.
I am writing to put forward some suggestions/recommendations, which I believe might close the current valuation gap & offer shareholders the potential for further intrinsic value enhancement:
i) The Argo Fund: Argo owns 20%+ of TAF – a $16.8 mio stake worth far more than Argo’s market cap! One might argue an Argo investment is basically an investment in TAF. Despite that, the semi-annual TAF review in your reports is v limited. This lack of transparency is a clear negative for current/prospective investors, prompting some to severely haircut the value of this stake (incorrectly, in my opinion). More detailed info & commentary is essential for Argo shareholders. The solution may simply be access to your regular TAF investor reports. If this presents issues, shareholders could perhaps request (password) access via your website/IR team?
Will you please commit to providing more regular/detailed TAF commentary & fund info?
ii) Share Buyback: A possible sale/takeover isn’t necessarily the ideal exit now for shareholders. With the share price at a severe discount, a deal premium won’t realize this valuation gap. An aggressive & opportunistic share buyback, conducted on a sustained basis, may be far superior. It may drive the share price higher, transform investor sentiment, offer reluctant holders an exit, and significantly enhance value for remaining/long term shareholders.
Directors with meaningful stake(s) often have a similar misconception – to them, launching a takeover might seem an attractive proposition. But a major buyback may again prove the better deal: It potentially offers significant appreciation in the market (and intrinsic) value of their own shareholdings, it increases & consolidates their ownership, but demands none of the financial risk (or cash outlay) a takeover requires! Livermore Investments Group (LIV:LN) is a textbook example in the past year or two (a 2.9% holding of mine). The company has some striking similarities to Argo (minus external fund management), and the 80% YTD increase in their share price is an overwhelming endorsement of their aggressive share buyback policy.
Let’s examine a major Argo buyback: Assume 50% of outstanding shares were ultimately retired, at a generous 30% higher (GBP 13.2p) average buyback (or tender) price, costing just $7.1 mio. It would require a (partial) TAF redemption, but that’s attractive: A TAF investment (at fund NAV) simply can’t compete with an ARGO purchase at a huge NAV discount. This buyback would result in GBP 28.7p of cash/investments per share, a 37% increase, and increase my intrinsic value estimate by 58% to GBP 49.7p per share. I think it’s reasonable to expect a far larger increase in the share price!
Will you plse commit to announcing an aggressive share buyback, to be executed on a sustained basis at opportunistic discounts to NAV/intrinsic value?
iii) Fund Raising: I get the distinct impression the Argo business & funds are now being run in a rather defensive fashion. Performance & profitability are v important, of course, but I’d like to focus on the big picture here. The recent fund-raising success of large US alternative managers, the cheapness of emerging markets, and widespread pockets of distress in Europe, the PIIGS & Emerging Europe offers the opportunity to launch a renewed TAF fund-raising drive, or even a new fund launch. Quite frankly, the success of some v average mutual fund managers in the US, for example, highlights effective sales & marketing are just as important as performance. This prompts some questions: Is increasing AUM now Argo’s top priority? Are the team & resources in place to support this key objective? Have new opportunities, compensation incentives, partnerships or relationships been explored/considered to accelerate this objective?
If it’s a question of increased investment, I’d be perfectly happy to see that investment absorb 100% of the company’s profitability for the next 3/4 years! This may seem an odd perspective – but such a strategy might be premised on, say, the prospect of doubling AUM. A restoration of margins would then be targeted – hopefully achieved via increased economies of scale, an easing off in costs & investment, and ideally an economic/performance tailwind. Your prudent management of Argo in the past few years under-writes the likely success of such a strategy. And eventual shareholder returns could be v impressive. After 5/6 years – presuming AUM actually doubles, plus the buyback described above – I see no reason one couldn’t utilize the same valuation methodology. That suggests an estimated intrinsic value (and share price) of GBP 70.8p per share might be possible at that point, under this scenario.
Will you plse provide a clear strategy, timeline & set of objectives for increasing AUM?
iv) Sub-Advisory: The current European economic & investment climate might prove ideal for a more mainstream application of Argo’s unique distressed/special situations skills & experience. It also promises a multi-billion fund-raising & investment drive from large US alternative managers. We’re already seeing Blackstone & WL Ross making European investments, while Fortress Investment Grp (FIG:US) (a 4.7% holding) is targeting a significant scale-up in their European business. I sat with Colony Financial (CLNY:US) (another holding) some time back, and again they see great opportunity in Europe (but are seeking more realistic pricing). But this is only the tip of the iceberg – I believe we’ll see far wider US & global investment interest in European distressed assets for years to come.
This may offer a rather intriguing business opportunity to explore: Sub-advisory fund management (or consultancy) agreements. Perhaps an unusual strategy, and fee rates would obviously be lower: But it requires no fund-raising on your part, and the possible AUM to be captured could be a multiple of Argo’s current AUM. A win of this nature could prove v lucrative.
Will you plse consider & explore this business opportunity?
v) Investor Relations: I’m not sure if Argo conducts any enhanced IR activities, such as presentations & investor meetings? Considering the current share price, this offers an easy win for Argo to increase visibility, improve investor understanding & sentiment, and hopefully attract fresh buying interest. I’m sure Panmure Gordon would be happy to host an occasional investor/institutional client meeting. I’d also suggest Mello Central, for example, as another small but influential forum for presentations – another holding, Universe Group (UNG:LN), recently met with a good response there.
Will you plse highlight your current IR activity, and consider stepping up those activities?
I’m available at email@example.com, or by conference call, if you wish to discuss further. I’d like to thank you in advance for your consideration of these recommendations. I’d also appreciate your immediate reply to acknowledge receipt of this letter, and to confirm when you expect to be able to respond properly. Please note I intend to publish this letter on the Wexboy blog in due course.
Readers: You’ll note I haven’t assigned any particular priority to the recommendations above. This recognizes opportunities can change quickly, the effectiveness of a strategy may depend on the market environment, and the various ‘actors’ involved (investors, management, potential partners/acquirers, etc.) may have v different perspectives. Personally, here’s my current perspective:
– Recommendations i) & v) are simple IR ‘housekeeping’, and pretty easy to implement
– Recommendations iii) & iv) are longer term/higher risk strategies, but potentially far more rewarding
– Recommendation ii): Share buyback represents the most immediate & compelling opportunity to positively impact the share price and investor sentiment
Many will consider a buyback as an end itself – I perhaps consider it more as a means to an end, i.e. the potential boost in share price & sentiment a buyback can provide lays the foundation for longer term strategies to raise AUM significantly.
If you’re a private investor/adviser/fund manager with a direct (or indirect) shareholding in ARGO, and in broad agreement with some/all of these recommendations, I’d like to hear from you.
Please comment below and/or email me at firstname.lastname@example.org