Monthly Archives: August 2012

Argo Group update

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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

Exited Origen Financial

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Haven’t been really busy this month looking at stocks thanks to some vacation time, but wanted to post a quick update that I sold the last few shares of my position in Origen Financial today. The majority of my sell order was already filled earlier this month.

If you read the comments below my original write-up you can see that my analysis missed some relevant facts. It’s going to take longer that I originally thought before the trusts hit their optional redemption threshold. The first trust to reach this threshold is the 2004-A trust when less than 20 percent of face value of the contracts is outstanding. In the past twelve months this amount dropped 12% from 88.7M to 78.1M. At this rate it will take roughly four years before the 47.8M redemption threshold is reached

The trusts taking a bit longer before the optional redemption thresholds are hit isn’t a big problem, but it’s also not so clear what will happen at that moment. The Origen Financial corporate structure has high overhead costs: last year the company generated ~13M in cash flow while paying out ~11M in dividends. The ~2M difference are costs related to running Origen Financial. If you are confident in a liquidity event in a few years time these costs wouldn’t be a big problem, but if the assets remain locked up in an inefficient structure this would be a good reason for a big discount, and it would in fact be easy to argue that the company is currently overvalued if you don’t expect a reduction in overhead costs in the future.

Taking these new insights in consideration I would not have bought Origen if I didn’t already own it, so I decided to sell my position. I’m going to continue to follow the company, and maybe there could be an opportunity to re-enter a position if there is more clarity about future costs.

Disclosure

No position in ORGN.PK anymore

Lottery arbitrage post-mortem

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It’s not uncommon for lottery games to become +EV at some point in time when the jackpot is getting bigger and bigger, but it’s hard to make a profit: you still need to win the jackpot to realize your EV. The Massachusetts State Lottery’s Cash WinFall game on the other hand had an unique feature: when the jackpot reached a certain level and  wasn’t hit, the money was distributed to lower tier prize winners. The Inspector General released a report on the subject today, and Kid Dynamite posted some tidbits.

Lottery arbitrage is for example not for lazy people:

“While Mr. Selbee’s use of Quic Pics saved some time, he did not have shortcuts when it came to collecting his group’s winnings. Mr. Selbee said he and his wife sorted the tickets by hand into winners and losers. This process – visually inspecting approximately 60,000 paper betting slips, each with five panels of six-number bets printed on them – took days. Mr. Selbee said he and his wife would cull the winning tickets while still in Massachusetts and then drive the losing tickets back to Michigan where they would sort through the losing tickets again because they invariably missed some winners. He said he and his wife spent 10 hours per day for 10 days examining the losing tickets a second time.”

But it can be quite profitable:

The August 16, 2010 drawing was a one-of-a-kind event in the history of Cash WinFall when a single high-volume betting syndicate, the MIT group, took the Lottery, the other syndicates and everyone else by surprise. They single-handedly bought enough tickets to push the jackpot to $2 million, triggering a roll-down that no one else was expecting and that was never announced to bettors on the Lottery website. As a result, the MIT group virtually monopolized the winnings from this drawing.

[…]

Lottery records show that the MIT group claimed 18 of the 21 match-five $30,282 prizes, or $545,076. Of the 1,002 tickets sold that matched four of the numbers, the MIT group cashed in 868 of them, or $1,003,408. Because match-threes and match-twos can be redeemed at any Lottery agent, it’s impossible to say how many the MIT group had. Based on its winning percentages in the higher tiers, it’s likely that the MIT group had at least 15,000 match-three winners, each worth $37, as well as 105,000 match-twos, worth about $210,000 in future free bets. In total, on its $1.4 million wager, the MIT group made a $700,000 cash profit.

Competitive dynamics are also at work in the lottery arbitrage ‘industry’. Multiple betting groups started to buy tickets at a large scale, reducing the profit margin. The profit is coming from people buying tickets in earlier rounds when the jackpot does not hit the threshold and smart money doesn’t participate. When more people play the final round you get a smaller piece of the dumb-money-pie, and when the final round becomes too popular the opportunity could disappear completely.

Interesting story, and shows that you can find value in some unconventional places!