Monthly Archives: September 2012

Last minute odd lot arbitrage (IFN)

Thanks to a reader I was alerted just in time that the India Fund (IFN) is buying back 5% of the outstanding stock for 98% of NAV (SEC filing). The fund is buying back shares at 98% of NAV and had a NAV of $24.51/share yesterday. Today the shares are up 3.6% and trading at $23.23. Assuming that the discount hasn’t changed this would imply that the EV of buying and tendering an odd lot is approximately (24.51 * 1.036 * 0.98 – 23.23) * 99 = $164. Unfortunately for my readers who want to participate, the deadline is today, and most brokers require you to buy and tender the shares multiple hours or even days in advance (IB has the deadline at 13:00).

Luckily for my readers the reason that I almost missed this opportunity also means that it’s coming again. Unlike other funds that buy back shares irregularly (and file a form SC TO-I) the India Fund has a regular tender offer program in place. They are buying back shares two times a year and file a form N-23C3A. The only other fund doing this that also always has an odd lot provision is the Asia Tigers Fund.


Long IFN

American International Group

AIG is a company that doesn’t need an introduction and the involvement of the US government since the financial crisis is also well known. The government owned as much as 92% of the company, but is aggressively reducing it’s stake. It already sold three blocks of shares this year worth ~$5.75 billion each and has planned a $18 billion sale for this month. This would bring the stake of the government down from 53 to 21.5%, and underwriters have the option to sell 83.1 million more shares the next 30 days. If exercised it would bring the government stake down to 15.9%. The US Treasury has a cool infographic online that shows the history of the government involvement, and the restructuring at AIG the past few years.

I assume that most of my readers are familiar with Joel Greenblatt’s “You Can Be a Stock Market Genius”. Despite the cheesy title it’s an excellent book, so read it if you haven’t already! A common theme in the book is that whenever there is a situation with a forced seller there is a potential opportunity. And while the government is not truly a forced seller, they are definitely happy to get rid of AIG as fast as possible as long as it can report a profit to the tax payer. Selling tens of billions worth of stock without negatively impacting the share price would seems quite an accomplishment.

AIG itself is one of the largest buyers when the US government is selling. It bought $8 billion worth of stock this year already and it is intends to buy another $5 billion in the current public offering. Since AIG is selling at a big discount to book value these buybacks have a meaningful impact on the book value per share. The company is currently trading at ~$33.00, representing a 45% discount to the $60.58 book value per share reported last quarter. The Q2 Financial Supplement contains the following table:

Since June 30 AIG bought 98.36M shares on August 3 for $30.50/share and the company has agreed to buy 153.8M more shares in this months offering for $32.50/share. This would bring the total common shares outstanding to approximately 1.476 billion and AIG’s shareholders’ equity to 96.7 billion for a book value per share of approximately $65.51 dollar. That’s a lot of (book?) value creation a short time frame!


While I have had AIG on my watchlist for months I have been hesitant to buy a position because it isn’t easy to fully understand it. The latest 10-K is more than 400 pages long and contains a lot of detailed information about reserves, discount rates, credit exposure and all kinds of other things I don’t really know enough about to understand what kind of impact it has or could have on future profitability.

The question is of course how important details are compared with the big picture. Just as with any other company you can look at higher level statistics such as book value, earnings and return on equity. The fact that historically stocks with a low P/B, low P/E or low P/FCF ratio have outperformed the market supports the view that the big picture determines the value for a large part.

Bruce Berkowitz’s thesis, who’s firm is betting big on AIG, also doesn’t provide a lot of insight beyond the high-level view. They assume that AIG will be able to earn a 10% return on equity and simply is worth book value because of that. I usually don’t spend a lot of time thinking about relative valuations, but seeing that other US insurers trade close to book currently is reassuring. The 10% is a number that AIG itself is also targeting, and based on the historical earnings (close to $10B annual) of Chartis and SunAmerica, the two core assets of AIG, it doesn’t seem to be an unreasonable target. AIG is facing some headwinds though: low interest rates hurt profitability, and they are also facing increased regulatory oversight. That might not be too bad though if it prevents another 2008 like screw-up.


I’m less worried about bad corporate governance with a large cap company than with an obscure micro cap, but I think it’s nevertheless important to take a look at what insiders own and what they are doing. Most of AIG’s management is new since 2009 and as a group they own very little of the company: just ~$25M worth of shares, mostly because they get paid a big part of their salary in shares. If I would correctly be thinking that AIG is undervalued, why wouldn’t insiders buying shares?


An interesting alternative to investing in AIG common stock is purchasing the warrants (ticker: AIG-WT) that were issued in the beginning of 2011 as a part of the recapitalization of AIG. They expire in January 2021, have a strike at $45 and unlike regular options they are adjusted downward in case of a dividend:

The initial exercise price is subject to anti-dilution adjustment for certain events, including (i) future stock dividends, distributions, subdivisions or combinations; (ii) the issuance of below market rights, options or warrants entitling the holder to purchase AIG common stock for a period of sixty days or less; (iii) dividends or other distributions of capital stock (other than AIG common stock); rights to acquire capital stock, debt or other assets (subject to certain exclusions); (iv) per share cash dividends in excess of $0.675 in the aggregate in any twelve-month period; and (v) certain above-market issuer tender offers for more than 30 percent of the then-outstanding AIG common stock.

If AIG is able to grow book value at a 10% rate the next decade, and is trading at book value at that point in time the warrants could provide some awesome returns. After nine years BV would be ~$153. With the warrants trading at $14.6 and having a $45 strike this would be close to a 640% return or an 23% annualized return. The common stock would return ‘just’ 340% or 15% annualized. But since AIG is probably going to pay a dividend soon the warrants return is going to be a bit lower since the strike price is only adjusted for dividends in excess of $0.675 yearly (would probably lower the annualized return with almost a percentage point).

While I do think warrants are attractive it’s not a bet I’m comfortable making because it’s also adding leverage the opposite way. Lets assume that the market is valuing AIG correctly right now – and that’s something I always see as a very real possibility – and the next decade the company is able to grow value at 8% a year. If you hold the shares you still come out ahead with an 8% annualized return, but if you own the warrants you get less than 6%. And somewhere between a 6 and 7% growth rate you start losing money with the warrants. That kind of range of outcomes doesn’t really look that superior to me than the common stock.


I have been thinking a long time about buying AIG knowing that I would be buying something that I can only understand from a high level perspective, but finally decided to buy some shares because it seems that the company is undervalued and creating a lot of value by buying back shares in large numbers. Despite this the share price went down this week when the treasury announced another public offering and that AIG would be buying $5B more in shares. So thought that this week would be as good of a time as any to jump on-board.


Author is long AIG shares

Ingram Micro (IM)

Ingram Micro is, to quote their fact sheet: “the world’s largest technology distributor and a leading technology sales, marketing and logistics company for the IT industry worldwide.” Value investors screening for companies trading below NCAV have probably seen the company before since it’s probably one of the largest, if not the largest, net-net trading in the US. Some quick stats from Yahoo Finance:

Last Price: 15.80
Shares outstanding: 150.08M
Market Cap: 2.38B
Trailing P/E (ttm): 8.78
Price/Book (mrq): 0.70
EV/EBITDA (ttm): 3.50

Asset value

For a net-net the discount to book value isn’t very big: almost all their assets are current assets. The balance sheet is easy to understand and looks as follows:

It’s a healthy looking balance sheet with 517M in net cash after accounting for the short-term and long-term debt, or $3.45 per share. All this cash is however already gone: IM decided to acquire Brightpoint for $840 million (including $190 million in debt). Both are distributors of IT products, but Brightpoint is focused only on mobile products while Ingram Micro sells a lot of ‘traditional IT products’ used in personal computers and servers. For now I’ll talk about Ingram Micro as it is today, more about Brightpoint later.

One problem for IM is that most of the cash (~$720M) is located outside the US. Since the value of a company is ultimately determined by the dividends it is able to pay, and overseas cash cannot be used to pay dividends (or buy businesses in the US), I think the cash on the balance sheet needs to be discounted. I’m not sure by how much however since I don’t exactly know how much taxes IM should pay if it want to repatriate the cash (35%?), and at the same time there is a decent opportunity that there will be a tax holiday in the future so it could be done tax free. So question for hopefully a more knowledgeable reader: by how much should the cash be discounted?

The biggest items on the balance sheet are accounts receivable, inventory and accounts payable. These are assets that cannot be separated from the business without liquidating the company, so it makes more sense to value the company based on it’s earnings power. I also don’t think you should have the idea that these assets provide a large margin of safety. If you start discounting some of the receivables or the inventory a bit – reasonable in a liquidation scenario – you find that the adjusted book value of the company drops quite fast because it does have a lot of liabilities compared to it’s total assets.

Earnings power and the Brightpoint acquisition

Being a bit lazy I grabbed some key statistics from Morningstar for the past 10 years. It’s clearly visible that Ingram Micro has razor thin margins, but it does have a decent history in growing book value per share, but it’s not great with a CAGR around 8.5%. Average earnings for the past ten years and the past five years are respectively $0.74 and $0.95 per share. Given the revenue numbers using the average of the past five years seems reasonable since it seems that growth has stalled since 2007.

Including the 2008 results depresses the average earnings, but I do think it’s appropriate. The already mentioned Brightpoint acquisition is not Ingram Micro’s first acquisition, and in 2008 they had to write down a significant amount of goodwill. Management is obviously expecting good things from the Brightpoint acquisition

In July 2012, we announced that we had signed a definitive agreement to acquire BrightPoint, Inc. (“BrightPoint”), a global leader in providing device lifecycle services to the wireless industry. We believe, this acquisition will greatly enhance our global position in mobility as well as our fee-for-service logistics offerings. We expect to realize annual cost synergies and efficiencies in excess of $55,000 by 2014, and the transaction is expected to be accretive to earnings per share by $0.18 per diluted share in 2013 and $0.35 per diluted share in 2014, excluding one-time charges and integration costs.

I’m a bit more sceptical though. The two companies are similar and have thin margins: Ingram Micro has a relatively stable gross margin that averages 5.5% the past 10 years (currently at 5.3%) while Brightpoint has a slightly higher average margin at 6.9% (currently at 6.8). Net margins are really razor thin: IM has an average 0.83% operating margin while Brightpoint has an average of 0.68% (a number that’s depressed because of a really bad 2008).

Obviously Ingram Micro’s management is expecting synergies and cost savings by combining the two businesses, but buying a similar business for more than 2x book value while your own business is trading for ~0.7x book value doesn’t seem to be a smart allocation of capital to me. An alternative valuation metric is to look at price/sales multiple. Ingram Micro is currently trading at a 0.07 multiple while it is willing to pay a 0.14 multiple for Brightpoint. And that is ignoring the different capital structure: IM has a significant net cash position while Brightpoint has significant debt. Seems to me that you need a lot of synergies just to make the Brightpoint acquisition equally attractive as investing in your own stock.


Insiders own an insignificant part of the company (5.6%) and the history of insider transactions also doesn’t give a lot of confidence. It’s mostly a lot of small option exercises directly followed by a sale of the shares acquired.

Positive is that the company is investing a decent amount in repurchasing shares. They started a 400M repurchase program two years ago and have bought 15.2M shares so far for $276M (~10% of outstanding shares). It at least shows that management is willing to return money to shareholders, but for this to be truly great you of course need a company that’s undervalued.


Providing a narrow range for the intrinsic value of Ingram Micro is though for me, but I think one key question is how much faith you have in the current Brightpoint acquisition and possible future acquisitions. In that case you could build a valuation on the performance of the years after 2008, and include management expectations of increased earnings per share after 2013. In this case IM is obviously undervalued. It does currently have a PE of 6.9 excluding cash, and if you expect good return on the money spent on Brightpoint and future acquisitions that’s too low for sure.

That wouldn’t be an expectation based on historical performance though. If we would expect that the company will in the future grow book value at the same rate as in the past it probably deserves to trade at a discount. The company managed to grow book value at 8.5% the past 10 years, and that would probably be a bit too low expected rate of return for some investors. It’s not that terrible though so a big discount to book value doesn’t seem to be warranted.


An, admittedly superficial, look at Ingram Micro reveals a company that has thin margins, but a reasonable history of profitability. You certainly shouldn’t expect high returns on equity, and I don’t think it deserves to trade above book value. Question is: does it deserve to trade at the current 30% discount?

If I would be forced to create a range of the intrinsic value of Ingram Micro the current price is probably on the low end of that range: I think it’s harder to make a case that the company is currently overvalued than that it is undervalued. I don’t think there is a large margin of safety at the current price though. It’s far from certain that the Brightpoint acquisition is going to be a success, and the lack of insider ownership or buys isn’t a vote of confidence. The current price is probably reasonable close to fair value.


No position