Monthly Archives: August 2013

Craven House Capital: cheap, or not?

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While browsing a bit random on the internet I found this post on Craven House Capital at the Investing Sidekick blog. The author is quite enthusiastic about the company with a 30% portfolio allocation. The company in question is an obscure investment trust focusing on frontier and emerging markets. Part of the attraction is the fact that the company has repeatedly issued equity at 1.25p per share while it is trading at ~0.25p. So far all things that I like, so my interest was piqued enough to dig a bit deeper.

Equity transactions

The biggest and most obvious problem that the company faces is it’s size. Readers of this blog know that I’m often attracted to small and obscure companies, but you need some size to cover fixed costs. At the end of this year the company reported a NAV of just £2.5 million while it’s current market capitalization is just £1.78 million (approximately 2.75 million USD). If the company is indeed able to grow by issuing equity at 1.25p per share it’s not going to be a problem, but in order to believe they will be able to do this you need to believe that the shares are indeed worth this much today. Because why would someone otherwise want to buy their equity at that price?

Looking at transactions in the past months it seems that they have no problem using their equity as a currency at 1.25p/share, but there is one big problem. Most of the transactions are structured as follows:

In January 2013, the Company purchased 17,502 shares in Finishtec – Acabamentos Técnicos em Metais Ltda. – ME (“Finishtec”) representing 50.1% of Finishtec’s issued share capital.  The shares were purchased at a price of approximately $57 per share, amounting to a total consideration of $1,000,000, from the founding partners of Finishtec (the “Shareholders”). Simultaneously, the Shareholders agreed to subscribe for 49,739,760 new ordinary shares of 0.1 pence each in the Company for 1.25p per share, amounting to an aggregate subscription of £621,747 (approximately equivalent to $1,000,000).

So if you sell a big part of your company for one million USD would you accept payment in shares that are worth just $200,000 on the market? I wouldn’t, unless of course the stake isn’t worth one cool million but something more in the direction of the current market value of Craven House Capital shares. And this brings us directly to a related problem: can we trust the reported net asset value? Craven House Capital has multiple investments on the books at the original cost price, and with those non cash transactions I’m not really trusting it as a good approximation of intrinsic value.

Incentives

The second big problem I have with the company are the performance fees that are paid to the investment manager. When you read how they are calculated it seems pretty reasonable: they get 20% of the growth in NAV above a 5% hurdle. There is however one big problem: it’s not on a per share basis. Last year NAV went from minus £200K to +£2.5 million, resulting in a £552,368 performance fee.

That would have been pretty insane for a company with a sub £2 million market cap, but the investment manager ‘very generously’ accepted shares priced at 1.25p/share. This resulted in ~8% dilution for current shareholders which isn’t too bad, but it’s still a lot considering it’s based on a largely irrelevant performance metric. A payment in shares also doesn’t decrease the NAV of the company, making it easier to hit the 5% hurdle next year. The performance fees also provides an incentive for the manager to structure deals that artificially inflate NAV: exactly the thing I’m already worried about with the equity swaps.

You also wonder who would want to buy a significant amount of equity if the manager immediately takes a big cut. Makes it only harder to argue that 1.25p is fair for new shares.

Conclusion

Is everything related to Craven House Capital negative? No. The company did for example manage to raise £721K cash at 1.25p/share in 2011, but why anyone would want to pay that for this company is beyond me. Their NAV/share doesn’t even come close, even if you believe it’s accurate, and with the current size of the company I think you would be crazy to pay a premium. I simply don’t see the value here…

Disclosure

No position in Craven House Capital.

Inaction and WSP Holdings

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Earlier this year I wrote about WSP Holdings. The CEO wants to take the company private, and at the time I thought that the spread between the market price and the offer price was attractive. I sold the majority of my position months ago when the spread narrowed, but I did hold on to a few shares in the expectation that the deal would be closed fairly quick.

Since then not a whole lot happened until this month when a Seeking Alpha article was published that argued that the stock was a short. Since the original planning was that the deal would be closed in the second quarter of 2013 it’s reasonable to assume that something is wrong, and it doesn’t help that the annual report has been delayed for months. The financial performance of the company was pretty poor the past two years, and with minimal break-up fees you could imagine that the CEO wants to walk away from the deal if business has taken a turn for the worse.

As a result of the article the share price of WSP Holdings dropped from ~$2.90 to a low of $1.68 while the offer price is $3.20. Yesterday the company announced that the deadline for the merger would be extended to December 31, 2013 instead of August 21, 2013 and as a result the stock price moved back up to $2.49.

Doing nothing

So what did I do when all this was going down? Absolutely nothing… Should I have sold when the deal was significantly delayed while the stock was still trading at a fairly high level? Should I have bought more when it dropped a bunch on nothing but a Seeking Alpha article?

The main reason why it was difficult to act for me was that I simply don’t know what’s going on. If the short thesis would have been built on the assumption that WSP Holdings is a fraud things would have been easy, because I’m convinced that it isn’t. The questions raised by the Seeking Alpha article were however from a different nature.

Taking a high level view there are a few things I know:

  1. The company is real (lots tangible activities outside China)
  2. The CEO had the intention to go private in the beginning of this year because you don’t waste a lot of money on lawyers for fun
  3. The deal price was (at that time) probably a good one for him since the biggest investor choose to retain his stake

With the extension of the deadline I think it’s a good bet that the intention of going private is still there. I don’t know exactly what’s going on, and why the deal is delayed, but when the stock price is moved significantly when a retail investor posts an article on Seeking Alpha I think you can be pretty sure that no-one else really knows what’s going on and how the risk of this deal should be priced.

Conclusion

With the stock at $2.49 and a deal on the table for $3.20 I think you will be getting paid plenty for whatever risk you are taking. So I decided to add to my position again today. I probably should have done it earlier at lower prices, but that’s easy to say in hindsight, and not a reason to not buy once you have figured out what is important and what isn’t. In the end I think most of the concerns raised in the Seeking Alpha article are just minor negatives. The single most important thing is whether or not there is still the intent to do this deal. Thanks to yesterdays press release I think the intent is still there, and what’s left is a stock that no-one dares to touch and knows how to price. Smells like an opportunity to me.

Disclosure

Long WSP Holdings

Earnings season updates (AWDR.OL, PVCS.L, CNRD, ASFI)

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It’s earnings season again, and that’s always an interesting time for an investor since it’s the moment of truth: is your thesis playing out as expected, or is reality throwing a wrench in the wheels?

Awilco Drilling

Awilco reported results for the second quarter earlier today, and they are excellent. Revenue was 59.5 million thanks to slightly higher contract rates and a revenue efficiency of 97.3%. The company also announced a second quarterly dividend of 1 USD, giving the company a dividend yield of more than 20%. Other good news came earlier this week when the company announced that it signed a 3 year contract for the lease of WilPhoenix, increasing the value of the backlog with 424 million to 860 million. If the stock price stays at the current levels I’m probably going to increase my position slightly.

PV Crystalox Solar

Crystalox Solar also reported today, and the results for the first six months of 2013 seems to be alright. The business is in trouble, but the company does have a lot of cash and it anticipated that it should be roughly cashflow break-even in 2013 after restructuring. Cash from operations before changes in working capital is slightly positive while reported earnings are slightly negative. So that look good to me. The return of cash to shareholders is taking more time than I expected, but according to the company that should happen sometime later this year.

Conrad Industries

Conrad Industries reported yesterday and the results were simply excellent, and it appears that the company is on track to earn a record amount in 2013. The backlog is up 218% compared to previous year and the new construction site that was build on the land adjoining the Conrad Deepwater facility was taken in use this June. A slight negative is that it seems that the BP claim is being delayed, although that’s not a surprise given the fraud BP has to battle.

Asta Funding

ASFI reported results a week ago, and the most interesting development is the settlement with the Bank of Montreal on the non-recourse debt that backs the Seneca portfolio. Asta Funding has prepaid $15 million on the loan, and the next $15 million in of collections will also go to the bank. After this Asta Funding can recover the $15 million prepayment, and further collections will be split 70/30 between ASFI and the bank while the interest rate on the loan has also been lowered. Seems like there is a bit of value after all in the Seneca portfolio for Asta Funding, although it’s not going to be a lot.

Disclosure

Author is long AWDR.OL, PVCS.L, CNRD and ASFI