Tag Archives: URB.TO

Urbana Corp: one year later

Urbana has been one of the first stocks I wrote about on this blog, and it’s also one of the few investments I have realized a loss on. But after selling my position at the end of last year the fund has gained more than 100%, and a reader asked me a question worth a blog post: “Are you still happy with your decision making process? Should you have had more patience? Should you have re-bought when the company started repurchasing shares again?”

Urbana trading history

Background

I have a lot of new readers since discussing Urbana for the first time, so to summarize the story: Urbana is basically a closed-end fund with the majority of holdings in a few publicly listed financial companies (mostly exchanges, but more recently also banks). When I first bought Urbana it was trading at a ~45% discount to NAV, and buying back ~10% of the outstanding shares/year. Because closed-end funds incur overhead and management costs they should trade at a discount, but when you can buy back your own shares at a substantial discount you also make a lot of easy money. Because of the buy backs I estimated that a fair discount should be between 15% and 20%. Despite this estimate I sold almost a year later while the fund was still trading at a 45% discount.

What happened since?

Urbana is now trading at a 33% discount and NAV/share is up 70%: combine these two factors and you are looking at a >100% return that I missed. I didn’t have a strong opinion on the value of the assets that Urbana owned a year ago, or what they own today. The big increase in NAV/share is in my opinion mostly a random result, and a big contributor to the good result was their position in NYX that was acquired at a premium this year by ICE.

Shrinking of the discount

I don’t feel bad that I didn’t anticipate the good performance of the fund, but at the same time it does show that my initial thesis was roughly correct. Investor sentiment does change, and when you buy something at a big discount there is a decent probability that you can sell it at a smaller discount at some point in the future. It’s not a surprise that this occurs at the same time as the outperformance versus the market (even when it is just a random good year). Closed-end funds just seem very inefficiently priced: when the underlying assets are hot investors are willing to pay a premium, and when they are out of fashion the fund starts trading at a discount. This doesn’t make a lot of sense since changes in value are already reflected in the market prices of the underlying assets: there shouldn’t be a huge variability in the discount itself.

So why did I sell?

I haven’t really changed my thinking about closed-end fund discounts between two years ago, and today. The reason I sold Urbana was a combination of factors that made me believe that a bigger discount than I originally calculated was warranted.

  • Management was investing money in questionable assets: the amount of money invested in this wasn’t big, but when I saw that the fund manager was putting money in leveraged gold ETF’s I thought my assumption of neutral alpha might be too optimistic. I still think this is true: portfolio turnover jumped from 5% in 2011 to 22% in 2012, and the trading expense ratio jumped from 0.08% to 0.63%.
  • Management started investing in a private company that had Urbana’s CEO as a major shareholder. I still think that’s super sketchy.
  • The company was buying back 10%/year of the non-voting class A shares. With the share count of this class getting lower the percentage of outstanding shares that is bought back each year is shrinking. Instead of 10%/year it’s now closer to 8%/year.
  • They use a little bit of leverage, and the interest they pay on their margin loan is relative high. As a small private investor I can borrow on margin a couple hundred basis points cheaper than them.

So when they stopped buying back shares at the end of 2012 that was the proverbial drop that made the cup run over. Every single negative in the list above isn’t huge, but they all add up, and do make Urbana less attractive. I also think that the fact that Urbana resumed the share buybacks doesn’t mean that I was really wrong.

The big question is: what would they have done if NAV/share would have continued to deteriorate? Management had stated that they didn’t want to reduce the size of the fund too much, and the fact that almost no shares were bought back at the end of 2012 when they were trading at all-time lows seems to support that possibility. I think the timing of the repurchases are a further indicator that management isn’t value neutral. They are now buying back shares at full speed while the underlying is up and the discount is smaller.

Conclusion

The above might all sound very negative, but you have to realize that most of those negatives are just minor compared to how big a 45% discount was. But those negatives were enough of a reason to think that I could find a more attractive idea, and I don’t regret my decision to sell just before the big run-up. If I would have had the choice to put either 100% of my money in the S&P 500, or 95% in the S&P 500 and 5% in Urbana I would have gone for the latter, but with many more options available I thought I could find something better.

In hindsight I would have wished I would have been a bit more patience, but I don’t think I made a bad decision. I was just a bit unlucky to miss some positive variance. With value stocks you often buy something cheap, and you just bet that at some indeterminate point in time something will happen that will realize that value. In the case of Urbana that catalyst came early with a great result, but there were many more possible outcomes that were less favorable. Would they have continued buybacks if NAV/share remained low? What would have happened if the underlying assets didn’t outperform this year? What would have happened if the market itself didn’t have a great 2013? The shrinkage of the discount could just as easily have taken 5 or 10 years, and the value of the underlying assets could have gone down as well as up.

Looking at the good results from 2013 is in my opinion simply a form of results oriented thinking. Urbana was a slightly above average investment, but not a great pick. If I made a mistake it was investing in it in the first place.

Disclosure

No positions in any stock mentioned

Urbana update

Urbana Corporation issued a press release yesterday announcing that they have bought a 15.6% stake in Caldwell Financial Ltd. Urbana is managed by Thomas S. Caldwell who also owns 45.14 percent of Caldwell Financial. So this transaction looks in my opinion pretty bad: it could be a nice way for insiders to cash out of Caldwell Financial at the expense of the Urbana shareholders. I don’t know if this is indeed what happened. The press release is short on details and while insiders own a total of 69.3% of Caldwell Financial they could have bought the 15.6% stake from a third party.

While my initial thought was that as an Urbana shareholder I was getting screwed pretty bad the potential loss of value seems minimal. In the weekly NAV update the company already disclosed earlier this week that they own 700,000 shares of Caldwell Financial with a cost price of just 1.5M (just a bit more than 1.3% of NAV) and based on Urbana’s latest Annual Information Form this position is indeed the 15.6% stake. It discloses that TSC owns 45% or 2.2M shares of Caldwell Financial. Based on this the 700,000 shares would translate to a 14.4% position: close enough to the announced 15.6% number.

So while I still think the transaction is very questionable there is no big loss of value, and I’m not yet selling my position. But Urbana is certainly moving up in the list of things I could sell if I find another good idea.

Disclosure

Long URB-A.TO

Urbana Corporation update

Urbana Corporation, in essence a closed-end fund focused on stock exchanges, released it’s annual report for the year 2011 previous month. Initially I didn’t intend to write an update because the report didn’t really contain any news. The company is publishing an overview of it’s NAV and portfolio holdings every week, so there are no surprises with regards to the portfolio performance or the number of shares bought back. Urbana is steadily buying back shares, reducing the share count from a peak of 87.5M in the beginning of 2010 to 72.5M now. Since the company is trading at a significant discount to NAV those share buybacks add to the value per share for remaining share holders in a meaningful way (the discount was around 45% when I initiated my position in November, and is currently still around 40%).

The reason for this post is that my original write-up didn’t include an estimate what a fair discount for Urbana is. It’s easy to understand that the current discount is too high: the company is buying back 10% of shares per year, and with a 40% discount that would result in a growth of NAV/share of 4.44%:

(InitialNAV - CostOfBuyBack) / NewShares = NewNAV
(1 - 0.06) / 0.90 = 1.0444

At the same time the company has ~3% in overhead costs per year, so thanks to the buybacks Urbana should currently have a portfolio that is capable of outperforming the market with 1.44%/year. And a fund that’s capable of outperformance should trade at a premium! But this of course can’t be true for Urbana since the outperformance can only be realized while trading at a discount and it certainly should trade at some discount because of the high fees. What we want is to find an equilibrium where the fees of the Urbana corporate structure are exactly cancelled by the share buybacks.

Before we can do that we need to take a look at another variable: the expected return of the portfolio. If you would for example expect that the equities in the Urbana portfolio have a return of 6%/year in the long run it would imply that a discount of 50% would be fair if the company would not be buying back shares. With a 6% return and a 3% expense ratio you would basically have a situation where 50% of the earnings are siphoned off. With a higher return assumption a fair discount would be smaller since you would need a smaller part of the asset base to cover the fixed 3% costs.

Major assumptions:

  • The expected return of the URB portfolio is equal to ‘the market’ minus 3%
  • A fair discount for URB is when it returns ‘the market’ after fees
  • The company continues the share buybacks indefinitely
  • The company does nothing else to close the gap to NAV (liquidate, self tender)

With some crude Excel work to include the effect of share buybacks I get a fair discount of 14% when we assume that the expected future market return is 10%, and a fair discount of 20% when the market return is 4%. So I think it’s safe to say that a discount around 17% would be appropriate for Urbana Corporation.

And while I’m waiting for the gap between the current ~40% discount to close to less than 20% I’m owning an asset that should outperform the market with ~1.4%/year. So unlike a lot of other asset based plays I don’t really care how fast value is realized. Either the discount remains big and I can make money because the company can grow intrinsic value at above average rates by buying back shares, or the discount simply gets smaller. I would prefer the last option, but it’s not a situation where you will end up with terrible returns if it’s going to take ages before this happens.

Disclosure

Author is long URB-A.TO, and short a little bit CBOE and NYX as a partial hedge

End of year portfolio update

The end of the year is always a good time to look back, and even though I started this blog a little bit more than a month ago there is actually something to talk about since two of the three companies in the blog portfolio have released new financial reports.

Asta Funding (ASFI)

Asta Funding reported its results for the fiscal year 2011, and financial performance was roughly as expected. The cash flow from the zero basis portfolio’s remains strong and predictable and the company had as of 14 December $108.8M in cash and securities versus a market cap of 122M right now.

What they are doing with the cash is a more mixed story though. The results of the share buyback program have been very disappointing so far: they practically didn’t buy any shares back. On the conference call the CFO indicated that this was because of liquidity and legal constraints, but personally I find that hard to believe. If this doesn’t improve next quarter I’ll probably reduce my position a bit, since the share buy back for $20M was originally one of the attractive points of the stock. At the same time 13M of cash has been moved in securities, and 3.5M has been invested in the litigation funding business, something the company had never been active in previously. While it’s hard to know how this is going to work out I think it’s positive that the company is starting relatively small.

Allen International Holdings (0684.HK)

Allen International released it’s Interim Report 2011/2012 in the beginning of this month, and while sales for were up 5% compared to the previous period net profit was down 43.5% (but still above the 5yr average) due to the following factors:

The increase in raw material costs, double-digit increase in labour wages in Guangdong Province, the PRC and the continuing appreciation of Renminbi were amongst the adverse factors that contributed to the erosion in the gross profit margin. On top of this, the shortage in both electricity and labour supply had further increased the difficulties and challenges in our operations.

Most of these factors would also impact competitors and should not permanently impact the viability of the underlying business. We should never expect great profit margins from a commodity business like this, but there is also no reason to be overly negative, and the company remains cheap with a very strong balance sheet.

Urbana Corporation (URB.TO/URB-A.TO)

The discount between NAV and share price has increased a bit more the past month. The share price for URB-A.TO is currently 0.88 while NAV/share is 1.73. Even though it currently doesn’t look pretty in my portfolio it’s actually positive news. The company is steadily buying back shares, and the bigger the discount the better for remaining share holders. I bought the company less than a month ago and since then the share count has already been reduced from 75.5M to 74.4M (December 16 report date).

Disclosure

Long ASFI, 0684.HK, URB-A.TO

Urbana Corporation (URB.TO)

Today I’ll be looking at Urbana Corporation, another idea previously covered this year at various blogs (reading material @ Free NPV, Kerrisdale Capital, Barel Karsan). At the time I seriously considered buying, but in the end decided that it wasn’t quite attractive enough. Since that time plenty has happened that warrants a fresh look. Urbana is an easy to understand business that is actually not really a business: it acts as a closed end fund that invests in stock exchanges world wide. They invest in exchanges when they are privately owned and try to realize value when they are transformed to a public company. The company reports it’s NAV weekly, and was at 18 November trading at a discount of 46% to NAV. Frank Voisin has created a nice spreadsheet that updates the NAV in real time.

The majority of the assets sit at the moment publicly traded securities, making it easy to confirm that the reported NAV is actually correct. The biggest holdings of the company are CBOE and NYX, good for 31.75% and 35.64% of the portfolio value. It also holds some smaller public investments, while 26.95% of the value is in private exchanges. By far the biggest holding in that category is the Bombay Stock Exchange that represents 13.42% of the portfolio value. Most of the holdings in the private exchange category have been written down significantly the past years (in line with the public holdings) and seem to be fairly valued. A discount due to the liquidity of the holdings, and the uncertainty of the market value is probably warranted, but since these holdings are just a small part of the portfolio it’s not going to materially alter the investment case. Some key statistics about the company/the portfolio:

Last Price: 0.95
Shares outstanding: 75.5M
Market Cap: 71.7M
Value of public investments: 103M
Value of private investments: 38M
Debt: 14.3M
NAV: 133.7M
NAV/share: 1.77

Results have been pretty poor since the start of the financial crisis, not only as a result of the crisis it self (high trading volumes are good for profitability), but trading volumes are also moving to alternative stock exchanges in the US. NAV has dropped with nearly 50% from a peak of 260M at the end of 2007 to the current 133M. The company has been buying back reasonable amounts of stock at a discount since the beginning of 2010, reducing the shares outstanding from 87.5M to 75.5M (14%). The following graph shows the historical NAV, the amount of shares outstanding, and the NAV/share.


While results have been bad since the financial crisis, historical results have been pretty good. The company reports that since October 1, 2002, when Caldwell Investment Management Ltd. started managing the company’s investment portfolio, to December 30, 2010 it achieved a CAGR of 15.69%. Because of this it used to trade at a (ridiculous) premium before the financial crisis, but has been trading at a discount ever since that recently hit record highs. All numbers are based on the share price of the common shares, the Class A shares are often trading at a higher discount.

So far it’s looking good: we can almost buy a dollar for 50 cents here, and if we don’t particularly like the companies Urbana invested in we can fairly easily hedge our self against the NAV dropping because the majority consists of two big liquid companies.

 Expenses

Unfortunately not everything is perfect about Urbana. There is a investment management fee of 1.5% for the equities in the portfolio (note: this generates an incentive for management to keep the prices of the private investments artificially high on the books). There are also trading expenses and other corporate overhead creating a total expense ratio of roughly 3 percent: making URB.TO an expensive way to hold CBOE and NYX. The latest annual report provides the following table:

To get the TER we need to add the management expense ratio and the trading expense ratio together. A positive note: the portfolio turnover ratio is very low, resulting in low trading expenses. The most logical way to calculate what kind of discount the shares should trade at based on these expenses, is trying to calculate what percentage of the NAV is required to cover the fees. If the annualized return on equity in the long run is 3%, and it costs 3% to run the portfolio the investment in the company is basically worthless, because it doesn’t generate a single cent of intrinsic value growth or cash flow for share holders. In that case there would only be value if the company gets liquidated at some point. With an expected annualized return on equity of 6% a discount of 50% seems suitable, because basically just half of the value generated by the business goes towards shareholders and with an expected annualized return on equity of 9% a discount of 33% is warranted. Given an average annualized return on the S&P500 of roughly 9% from 1900 till today the discount of 46% seems on the high side, but is actually not that crazy if we don’t expect that the company is going to liquidate.

In the past the company significantly outperformed the S&P/TSX Composite Index that they use as benchmark, so maybe assuming market returns is a bit harsh. They have returned a CAGR after fees of 15.69% while the benchmark returned 9.98%. But with such a concentrated portfolio benchmarking doesn’t make a lot of sense.

A sanity check is see at what kind of discounts closed end funds trade. Morningstar provides a list of several CEF that can be sorted on premium/discount. The biggest discount in that list is 35%, confirming that a 46% discount is big. Bit off-topic: a fascinating article I found while checking this at Morningstar is about some CEF from Cornerstone Advisors that does nothing except destroying shareholder value, and it trades at a 30% premium (don’t bother checking if it’s shortable, borrow cost is ~60%).

Shareholders versus Management: it’s complicated

A shareholder friendly management could easily generate great returns for share holders by simply buying back shares at a discount, and the company has been doing that for the past two years. If you look at the first graph in this post you see that since 2010 NAV/share has been diverging from NAV thanks to the buy backs. They have been buying back shares at a rate of 10%/year, and at today’s prices and with today’s 45% discount, that would add 7,548,950 * (1.77 – 0.95) = 6,190,139 dollar in value per year. Divided over the 67,940,550 remaining shares it would create an increase in NAV/share of 0.091 dollar, or 5.25%/year (while dropping total NAV with 5.36%). This is more than enough to compensate for the expenses! And if the discount drops: that is great, since that would imply that the (relative) market value of our shares is going up.

The problem – for management – with the share buybacks is that buying back shares is equal to slowly liquidating the company, and the destruction of a valuable management fee. Thomas S. Caldwell made 2.4M in fees in 2010, and if we assume a zero growth rate and a 10% discount rate, the net present value of that cash flow is 24M. The management of Urbana owns 4,456,161 shares (The CEO owns the majority with 4,231,161 shares), and his son owns 1,031,163 shares for a total of 5,487,322 shares with a value of 5.1M dollars. So even though management owns 5.5M shares, there is no incentive to liquidate the business since that would result in a gain of ~5M on the shares (and freeing up 5M of capital), while giving up a cash flow that worth 20M+.

The fact that Thomas S. Cardwell bought 1M shares in March this year is also not directly a positive indicator. The company has a dual class share structure with 10M common shares that have all the voting rights, and 65M Class A shares that have equal economic rights, but no vote. With the latest purchase TSC controls 47.59% of the votes, so it looks more as a buy designed to keep control over the company, and the cash flow from the management fee. But in case of a take-over bid the Class A shares would temporary get voting rights, so unless he owns more than 50% of all outstanding shares his position remains vulnerable. I’m no expert on Canadian security laws, so take this with a grain of salt.

With that fact it is actually interesting that URB-A.TO is often trading at a discount relative to URB.TO. The voting rights aren’t that valuable with TSC effectively in control, and they are a lot more liquid because of the higher number of shares outstanding. In the past the voting premium has been as big as 30%, but it’s also capable of moving into the negative territory. That doesn’t have to be irrational, the higher liquidity of the URB-A.TO shares should be worth something too, but I don’t think there is a rational explanation for the rapid changes in the discount. But it might offer some opportunities in the future to profitably switch between the two share classes.

In one important aspect share holder interest are aligned with the CEO, and that is with regards to not do anything stupid with the assets under management. Since he is paid a fee based on the size of the assets, he does have a strong incentive to not destroy value, since it would imply destroying their cash flow. And management having shares worth 5.1M doesn’t hurt either.

So what will happen? In the beginning of this month shareholders sent a letter requesting more aggressive buybacks, and TSC replied:

We do plan to build this company and our goal is significantly above its current size. I would not like to run our size down too much.

So we don’t have to count on a fast arbitrage from the company between it’s share price and NAV. This event could very well explain why the discount is currently at record highs, although it has been getting higher in the previous months as well. But on the other hand, there is also no reason to believe that the current share buy backs will be stopped. In the latest annual report TSC wrote the following (released May 31, 2011):

In regard to Urbana’s share price, the environment of the past three years was further exacerbated by a few major Fund holders of the “A” shares becoming sellers in order to match their own fund redemptions. The nature of this selling tended to be in larger blocks directed straight into the market. The resulting discount of Urbana’s share price to the underlying asset value represented a significant opportunity for Urbana to profitably buy back and cancel “A” shares. Urbana purchased and cancelled in excess of 10% of its outstanding “A” shares as of the date of this report.

Urbana’s management anticipates continuing this program, to the extent allowed under Toronto Stock Exchange regulations, as long as a significant discount continues to exist.

Since then the company also announced a new share buy back program on August 25, 2011 to buy back 10% of shares. The discount between price and NAV has only grown, so I think we should expect that the share buybacks are going to continue in the foreseeable future. A good thing about that is, that it also slowly aligns management interests more with share holder interests. It increases the value of the shares of management, and it decreases the value of the management fee. But there is a limit to the amount of shares we should expect management to buy back since they don’t want to liquidate a too big part of the company.

Another important consideration is the fact that Urbana is actually not a big part of the CEO’s income or wealth. Caldwell Securities, founded by Thomas S. Caldwell, list Urbana Corporation as just one of eleven funds that they manage. They also have other activities such as wealth management for high net worth individuals/institutions. He owns 44.90% of Caldwell Securities while his son owns 22.58% of the company. Screwing over share holders in URB would presumable not be good for the more important business, especially not if he ever wants to launch a new CEF in the future.

And a final note about the CEO: TSC has been governor of the Toronto Stock Exchange in the past, explaining the focus of Urbana. Caldwell Investments (founded in 1980) actually runs three other funds that are exchange focused.

Conclusion

So how exactly should we value URB? If we assume no alpha generating abilities from management a big discount because of the ~3% TER is in order. With the current discount the assets are priced as if they are able to return a CAGR of roughly 6/7% in the long run, roughly 3% below the average CAGR of the S&P500 giving us a reasonable margin of error at today’s prices. But this alone would not be enough for me.

The fact that the company is buying back approximately 10% of shares/year on average, and is expected to continue this program while the discount between NAV and the share price is big, creates significant share holder value each year. The stock buy backs would add 5% to the NAV/Share, while the expenses reduce it with 3%. At the same time we are able to buy stock for almost 50 cent on the dollar. It’s not as great as buying something for 50 cent, and reselling it for a dollar in a short period of time, but it’s still pretty good. If the share buy backs would be stopped the current valuation is reasonable conservative, and if management is actually capable and able to maintain the historical CAGR the current share price is truly a steal.

On a scale from 1 to 10 I give the stock an 8: buying a dollar for 54 cents is always fun and management interests are not terrible misaligned with shareholder interests. There is no true downside protection, but we can buy it ourself.

Disclosure

Author is long URB-A.TO, and short a little bit CBOE and NYX