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