Andreas Rialas, Argo Group, Argo Real Estate Opportunities Fund, Cyprus bail-out, EU economy, European sovereign debt crisis, Eurozone, fiat money, Greenspan/Bernanke put, intrinsic value, Kyriakos Rialas, Lehman Brothers, Price/Cash, The Argo Fund
Obviously, I’ll be returning to Argo Group (ARGO:LN) in greater detail another day, but news of a Cyprus bailout deal has prompted scads of emails & questions to me about Argo. A post is certainly justified…
OK, Cyprus – what a God-awful mess… At this point, years into the European debt crisis, it’s hard to believe EU politicians can attain new heights of stupidity. Whenever politicians: i) do something on the cheap, ii) kick the can down the road, or iii) (perhaps the worst) enforce some obscure point of principle, haven’t we learned it comes back to bite you far more savagely & expensively?
I have to concede the US is pulling ahead of Europe – they’re much quicker to recognize failure & to learn from mistakes. The collapse of Lehman can be ascribed pretty much to one man (Paulson) & his pig-headed intention to prove a point. Oh boy, and what an expensive point it was… Of course, everybody ignored it, lessons were learned & the Greenspan/Bernanke put was accordingly (and infinitely?!) strengthened.
And now we have EU politicians deciding that soaking bank depositors is a good idea. And the fact this plan may include small insured depositors is pure insanity! You can hear their little minds working like rats in a trap: Cyprus is only 0.2% of EU GDP…so it’s irrelevant. And clearly they want to express their disdain for the unique nature of the Cypriot banking system (and the Russians, who apparently weren’t consulted at all). But I’m afraid size is irrelevant (as Greece proved) – they’ve created a political/monetary beast, the Euro, from which there’s no exit (at least notionally) & no turning back. And they delivered it into an increasingly fragile fiat money & banking world, held together purely by faith (and spit & baling twine).
Symbolism really matters in a world like that…
All traditional savers have left (now interest rates have vanished) is faith. Faith their deposit’s safe in a bank, particularly when it’s an insured deposit. Destroy that faith, and what’s left? I’m reminded of the housing boom, when people couldn’t be dissuaded from their blind belief house prices always rise…despite plenty of historical facts & figures to the contrary. And when it comes to bank deposits, there’s also a history of failures, confiscations, defaults, governments reneging on insurance/guarantees, etc. But a depositor’s faith can’t accommodate such heretical facts – just like the Euro, it’s become an all-or-nothing deal.
So which is more important for the EU: Hammering out a better deal the Cyprus parliament might actually vote to approve (and the people can live with), or sticking to their guns and seeing how fast Cyprus & its banking system melts down..?! Want to figure out the cost of that? Oh, I think not… And that’s the reason, just like in the US, there has to be an ultimate EU/ECB put.
OK, let’s turn from the macro to the micro: What does this mean for Argo, if anything?
First, let’s look briefly to Argo’s results. As I had expected, operating cashflow & investment gains on The Argo Fund (TAF) made a contribution – total year-end cash & investments increased to $23.6 million. I calculated Assets under Management (AUM) had increased to $313 mio, but also anticipated (say) a 5% increase across the board due to performance gains. To be prudent, I didn’t include this component, but that would have pushed AUM up to $328 mio.
Which was extraordinarily close to actual year-end AUM of $326.4 mio. Of course, that was a lucky guess to a fair extent – any distinct bias in subscriptions & redemptions would have thrown me off, and one would expect Argo funds to have less correlated (or ‘lumpy‘) returns vs. the market. [Note the Argo Distressed Credit Fund (ADCF) produced a stunning +28.1% return in the second half of 2012!] It also wasn’t clear to me if the new Argo Local Markets Fund (ALMF) was seeded internally or externally – it seemed safer to assume it was Argo funded, so I’m delighted to see that wasn’t the case. This confirms my long held belief, and my own experience, that manager seeding of funds is actually a low priority when it comes to client marketing & investing.
As of today, I would peg the following values for Argo (again, refer back to my last post):
Net Cash/Investments per share = $5.1 mio + $17.6 + $0.4 + $0.1 = $23.3 mio / 1.5104 = GBP 15.4 mio = GBP 22.9p per share
[The $0.1 mio above reflects a small new investment in the Argo Special Situations Fund LP (SSF). The $0.4 mio is a reduction from the $0.8 mio yr-end value of their Argo Real Estate Opportunities Fund (AREO:LN) stake, which reflects the current EUR 0.03 share price].
Intrinsic Value per share = $23.3 mio + $326.4 mio AUM * 3.75% = $35.5 mio / 1.5104 = GBP 23.5 mio = GBP 34.9p per share
[btw We can probably expect some YTD performance gains to make a further contribution to AUM in 2013, but let’s save that up for a happy surprise].
The share price has gained nicely in the past week, but underlying values have obviously increased also. At the current GBP 16.75p closing price, ARGO still trades at a huge 27% & 52% discount to these values (thereby offering 36% & 108% Upside Potential), respectively.
Now, of course, we have the question of a potential Cyprus bank deposit levy – a proposed 9.9% for deposits over EUR 100 K (or possibly 12.5%, to ‘pay‘ for a reduction/elimination of the levy for small depositors). Argo has Cyprus operations & bank a/cs, so what does this mean for the company & shareholders?
In my opinion, this should actually be an irrelevant question..! We’re talking about an investment manager who primarily focuses on (distressed) debt investments – who should be supremely qualified to evaluate the risk/reward of investing its own shareholders’ funds! The risks here were bloody obvious – while rare, there is plenty of historical precedent for bank depositors getting screwed. Easy for me to say today, perhaps – is this just Monday morning quarter-backing? No, it’s bloody not… Cyprus’ debt-GDP ratio, its bloated banking sector (vs. GDP), and the looming threat/promise of a bail-out have all been long telegraphed. Sure, a deposit levy may not have been expected, but bail-outs are never as expected – and why even make a bet on a situation so fraught with risk?
Which is actually the wrong question to ask, anyway… What reward are we even talking about here? Corporate cash is intended for operations & future investment – it’s not intended to be a source of speculation (as many companies & banks/brokers sued re auction rate securities losses have discovered). It’s also shareholders’ money – are you currently investing your spare funds in Cypriot banks?! [Of course, in general, this & other potential risks offer more compelling reasons for excess cash to be returned to shareholders]. Anyway, what on earth’s the reward for depositing the money in a Cypriot bank, versus say a TBTF bank in London? A few extra basis points?! The relative/absolute reward of a (better) bank deposit rate will never justify the risk of losing any portion of your principal, however small that risk might appear.
If you look back, Argo’s cash balance also appears to be quite steady, so the idea management could possibly get caught with significant cash-in-transit in Cyprus – let alone due to a deliberate investment policy – seems ludicrous. I think it’s only reasonable to assume this is NOT the case. Management would certainly have a difficult case to answer to shareholders if there are any actual losses to report.
That being said, rather than respond individually to emails, let me model a couple of scenarios to assess their potential impact:
Scenario A (Argo cash & cash portion of Argo’s investment in funds is NOT on deposit with Cypriot banks): See figures above!
Scenario B (Argo cash & cash portion of Argo’s investment in funds IS on deposit with Cypriot banks):
For this & the following scenarios, my understanding is that TAF is generally fully invested (as you’d expect with most investment funds) – but let me assume 3% of the fund’s currently in cash. I’ll assume the same for SSF, and ignore AREO (since I’m already valuing it at the current share price). A 9.9% levy would imply:
Net Cash/Investments per share = $23.3 mio – ($5.1 mio + ($17.6 + $0.1) * 3%) * 9.9% = $22.7 mio / 1.5104 = GBP 15.0 mio = GBP 22.3p per share
Intrinsic Value per share = $23.3 mio – ($5.1 mio + ($17.6 + $0.1) * 3%) * 9.9% + $326.4 mio AUM * 3.75% = $35.0 mio / 1.5104 = GBP 23.1 mio = GBP 34.3p per share
Scenario C (Argo cash & cash portion of Argo’s investment in funds IS on deposit with Cypriot banks, AND levy is 12.5%):
Net Cash/Investments per share = GBP 22.2p per share
Intrinsic Value per share = GBP 34.2p per share
Scenario D (Argo cash & cash portion of Argo’s investment in funds IS on deposit with Cypriot banks, AND 100% of deposits are blocked):
Seems like some people want to imagine the v worst..! This scenario envisages no bailout deal – who knows what Cypriot deposits would be worth then?! Let’s just assume they become inaccessible & are considered worthless for accounting purposes. That would imply:
Net Cash/Investments per share = GBP 17.3p per share
Intrinsic Value per share = GBP 29.3p per share
Of course, in the real world, this scenario’s about as likely as the Fed discontinuing QE tomorrow! For similar reasons… If Cyprus calls the EU’s bluff, we shall immediately see it was just a bluff – the EU has to close a Cyprus deal, whatever the cost. Because that cost is far far cheaper than the horrific alternative, and investor & depositor faith in the Euro & the European banking system must be preserved at all costs.
OK, to sum up: There was huge potential risk, and essentially no reward, if management invested corporate and/or fund cash in Cypriot banks – so, in all likelihood, I believe Scenario A is the obvious & logical strategy any prudent management would follow (i.e. Argo cash is invested with safe London banks). If Scenario B or C actually turn out to be true, cash/investments & intrinsic value per share values are only haircut by 2-3%. You can model for other scenarios, of course, i.e. higher deposit levies/losses & higher fund cash levels – but I don’t think they’ve been flagged, or are warranted.
Finally, Scenario D isn’t an alternative I believe can actually happen (and if it does, we’ll all be worrying about more than the value of ARGO shares…). Even in this v worst-case scenario, I believe Argo’s cash/investments per share would remain in excess of the current share price, and intrinsic value per share would still offer a highly attractive 75% Upside Potential.
I suspect news in the next few days from Cyprus & the EU will probably be more relevant to your entire portfolio & its prospects, rather than Argo. So far, the markets have remained relatively calm…