Tag Archives: ARGO.L

A follow-up letter to Argo

Wexboy has sent a follow-up letter to Argo Group with a more focused and concrete proposal to create shareholder value. With the company trading significantly below net cash/investments per share management has a great opportunity to create value by buying back shares, or paying a special dividend. So this is certainly a proposal I fully support!

Disclosure

Long Argo Group

Wexboy’s letter to Argo

Argo Group has the questionable honor of being the worst performing stock that I bought and have blogged about: it’s down ~33% since the beginning of the year. Fellow blogger and Argo owner Wexboy decided to not stand idle at the sidelines, and send a letter to Argo to urge management to take action. If you are a shareholder you should check it out.

I don’t fully agree with all suggestions, but buying back shares when the company has 20.9p/share in cash and investments while it is trading below 10p/share is something I absolutely want to see! Better disclosure on what’s exactly inside the Argo fund is also a good suggestion since it is such a huge part of Argo’s balance sheet. I don’t think management needs to be urged to increase AUM. I’am sure that they know this, and will try to do this if they can since it’s already in their best interest to do so. The launch of a new emerging market fund earlier this month is a good sign in this direction. I also don’t really care about promotional investor relations activities. Influencing the share price of the company is in my opinion not managements job. They just need to run the company, and if they are doing a good job the market will take care of the share price.

Disclosure

Long Argo Group

Argo Group update

Argo Group, a small asset management firm that runs several emerging market funds, released the interim results for the first six months of 2012 yesterday. The share price of the company is down 28% since I bought my position in the beginning of the year, so a good moment to re-evaluate my thesis and check if maybe picking up some additional shares makes sense.

Valuation review

My original thesis on Argo Group was quite simple: the company was profitable while trading at a discount to it’s cash and securities position. To evaluate what’s happening I think there are three key metrics that provide the most insight: net current asset value, operating profit and AUM. First a look at NCAV and operating profit (US$’000):

Net current asset value has remained fairly constant the past years. I expect that in future years there is going to be some more variance because the company has been using cash to invest in their own emerging market funds. The company has currently 17.5M invested, mostly in “The Argo Fund”, and 5M in cash. NCAV is currently 25.8M while the market cap is just 11.3M USD: a 56% discount. It should be noted that the historical development of NCAV does not paint the complete picture with regards to value creation and destruction at Argo Group. The company spends a significant amount of money paying a dividend, has used cash to repurchase shares and there is of course a lot of variance in short term investment results.

Earnings are down a bit compared to last year, but the company is still solidly profitable. It’s total asset under management continue to drop though and are at the moment 302.4M, down 7% compared to the start of the year. This is mainly the result of negative fund performance in the past six months, not because of investor outflows. The company has also been cutting cost as a reaction to the declining AUM:

In line with last year, the Group has continued to keep its cost base under review with total costs falling to US$3.2 million (six months to 30 June 2011: US$5.2 million). Further cost savings and efficiencies have been identified including the closure of the Buenos Aires office, with investments in Latin America continuing to be covered by the Group’s investment teams operating out of its London office. The Group’s cost base will remain under constant review whilst ensuring efficient deployment of Group resources and safeguarding of the requisite infrastructure.

Given the profitability of Argo Group I don’t think the company deserves to trade at any discount to NCAV. NCAV consists mostly of cash and investments, and those could in theory easily be extracted from the business and returned to shareholders without really damaging the earnings potential of the company. So I actually think that the company is worth even more: cash + investments + 2.5% ~ 5% of AUM seems to be a more reasonable estimate (this would imply a valuation between 30.1M and 37.7M).

Noteworthy developments

    • The company stopped buying back shares this year (negative development, especially given the depressed share price today).
    • The company increased it’s dividend from 1.2p per share to 1.3p per share (positive development, and giving Argo currently a 12.3% yield).
    • The company has provided the AREOF fund with a notice of deferral in relation to amounts due from the provision of investment management services (US$2.8M). Obviously not a positive development if one of the main funds of the company has liquidity issues…
    • Some funds were restructured and a new fund with 107.8M of AUM was formed in the beginning of this year, also resetting the high-water mark. A positive development: just look at the earnings in 2008 to see what an impact performance fees can have.

Conclusion

I don’t think that the intrinsic value of Argo Group has changed a lot between the beginning of the year and now: a cheap company lost a little bit of value and became even cheaper in the process. I’m going to try if I can pick-up some additional shares.

Disclosure

Author is long ARGO.L

Argo Group (ARGO.L)

Today I’ll be looking at Argo Group, a small asset management firm that runs several emerging market funds. The company is trading for significantly less that net current assets, is profitable, paying a healthy dividend, and buying back shares. It’s listed on the AIM market in London, but reports results in USD, so all numbers in this write-up will be in dollars unless otherwise noted. Some key statistics of the company:

Last Price: 14.50p (0.226 USD)
Shares outstanding: 67,428,494
Market Cap: 9.8M GBP (15.25M USD)
Trailing P/E (ttm): 7.91
Price/Tangible Book (mrq): 0.57

The biggest attraction of the company is the balance sheet. The biggest items are 10.25M in cash, and 15.72M in investments while the market cap is 15.25M: roughly a 40% discount. The 15.72M in investments are all in “The Argo Fund”, the main fund of the company. The company last reported for the period that ended 30 June 2011, and the value of these investments most likely dropped since (The MCSI Emerging Market index is down 15%). The company does not disclose the holdings of the various funds. If we would apply a big discount of 30% to the value of the investments we still have a company with 20M in assets trading for 15M.

The Business Value

That discount is not directly huge, but the best thing about Argo is that unlike most net-nets it does have a profitable business that should have significant value as well. It’s not a pile of cash doing nothing, or a company burning cash. They currently have almost 400M in AUM. Traditional asset managers trade on average at 2.5% of AUM. If we discount the value of the AUM with 15% we would get a business value of 8M, add back the already discounted 20M of assets and we get a conservative valuation of 28M versus a market cap of 15M.

This valuation is pretty pessimistic since Argo Group is a hedge fund with a 2+20 fee structure, making the AUM way more valuable than those of a traditional asset manager that might have an 1~1.5 percent fee on AUM. With a more hedge fund like multiple of 10% of AUM the company should be worth 32M, and with 20M in assets we would get a valuation at 52M. This is too optimistic though since most funds are significantly under the high water marks, and it’s questionable how succesfull the company will be in attracting new assets (more on this later). The company disclosed that at the end of 2009 the Argo Fund needed to increase NAV by 51% reach the high water mark. It gained 12% in 2009, and 8.5% in 2010, and possibly dropped in 2011, so there is still a long way to go before they will start earning performance fees again. The following table provides an overview of the various funds the company runs, and the AUM:
While checking some multiples is a nice way to get a ballpark figure for the business value I prefer looking at the actual cash that the company is producing: that is what matters in the end. The table belows shows the income statement for the past 3 years:

The income statement clearly shows how management fees have dropped after 2008 as a results of NAV/share dropping below the high water marks. The company has remained consistently profitable though, and there are some items that make things even better. The company has a significant amount of intangible assets on the balance sheet, and the amortisation reduces the reported operating profit, but it does not influence the cash flow. There have also been significant legal costs, but these should be something of the past. The company reported on 7 Jun 2011 that the plaintiff that initiated litigation against the company would not appeal, concluding the matter in favor for Argo (more about the back-story later).

If we would remove these costs from the picture, the company would be generating a free cashflow of 2.5M per year. Throw in a conservative 8.5 multiple on those earnings and we get a business value of roughly 21M: accidentally almost exactly between the 8M and 32M estimations based on AUM.

Why is it cheap?

Usually a stock is cheap for a good reason. For Argo that reason can be found in it’s history. The company was founded by Andreas Rialas in 2000, and sold to ACMH in 2007 for 50.46M GBP (6M GBP in cash, remainder in ACMH shares). Unfortunately for the Rialas brothers the ACMH stake was not worth much. The founder, Florian Homm, promptly quited in a spectacular fashion that resulted in the stock price crashing down with more than 90%. Besides that it became also apparent that he stuffed various funds with worthless illiquid OTCBB/pink sheet stocks, and manipulated the stock prices. He has been charged in the beginning of 2011 by the SEC for “portfolio pumping”.

The Rialas brothers were obviously not happy that their funds got in the mess Florian Homm created, and in 2008 the Argo business was quickly demerged from ACMH. Since the brothers had a 33.2% stake in ACMH, they only got back 1/3 of their original business as well (they currently hold 36%). ACMH itself was taken private by the Rialas family with a tender offer of 2.5p a share (it traded as high as 576p before all the troubles). Because Argo was briefly part of ACMH, it was sued by a major investor in the ACMH funds. The court dismissed the claims of the plaintiff, and the company released 7 June 2011 the follow update:

Further to the Company’s announcements of 1 April 2011 and 12 May 2011, the Company is pleased to announce that it has learned that The Cascade Fund, LLLP (“Cascade”) will not appeal the order of the Colorado court issued on 31 March 2011 dismissing its claim against the Company.

This development concludes this matter.

So it seems that Argo can finally leave the past behind. There is my opinion no reason to believe that the Rialas brothers had anything to do with what happened at ACMH, and that we should expect that Argo is heading towards a similar future. They got burned just as badly as investors in the company and it’s funds. It serves as a good reminder that a risk of fraud is always a possibility though.

What will happen with the cash?

Unlike most net-nets the company is actively creating shareholder value by buying back significant amount of stocks, and paying a big dividend. The company paid a 1.2p dividend per share this year (giving it a 9.2% yield) and in addition they also cancelled 8.5% of all outstanding shares. The latest regulatory news items reported at the LSE are all significant share buy backs.

Also positive is that management and share holder interests are aligned. Not only do the brothers have a 36% stake in the company, the directors and employees have 5,900,000 options outstanding that have a strike at 24p. Twice the share price when they were granted, and still 65% below the current share price. It would dilute current share holders by almost 9%, but given the strike I don’t see that as a negative.

Conclusion

Argo is an obscure company with a troubled past, but with the litigation out of the way there is less risk, less money is wasted on lawyers, and maybe they will finally be able to attract new AUM. But even if that’s not the case the company is very cheap based on both book value and cash flows, and best off all management is incentivized to create shareholder value, is paying a big dividend and buying back stock. It would be nice though if they disclosed more information, such as fund holdings and current NAV.

On a scale from 1 to 10 I give the stock a 8.5: the downside is well protected thanks to the balance sheet of the company, management interests are aligned with shareholders and they are using the cash productively. Liquidity is very limited though.

Disclosure

Author is long ARGO.L

More reading

Wexboy has two good posts (part one, part two) online with his thoughts on ARGO.L.