Most shareholders in Argo Group must have noticed that the company has launched a proposal to buy back shares that requires shareholder approval because it could increase the stake of insiders to a controlling stake. I think that this would not be a positive development if management is unwilling to cash out minority shareholders at a fair price, among other things. Wexboy makes the case to vote against the proposal in a lot more detail here, and I would urge every Argo shareholder to read it (and vote accordingly)! Unfortunately, I’m not able to vote against the proposal because my broker (Binck) doesn’t support it, but if I could I would certainly vote against the proposal.

Disclosure

Author is long Argo Group

Argo Group, an alternative asset manager, has been one of my first write-ups on this blog, but certainly not one of my most successful investments. I initiated my position at 14.69p/share only to see it drop 60% in the following years to a low of 6.00p/share a few months ago. Unlike some of my earlier investments that I sold because I thought that my initial analysis was flawed this was one idea that I kept believing in, and adding along the way. Not that this means that my first Argo write-up was flawless (far from it!) since the Indonesian investment, that is the subject of this post, isn’t even mentioned.

What I learned later is that Argo Group manages a very concentrated portfolio, and a major holding was a minority stake in a troubled Indonesian refinery. How big this asset is as a percentage of The Argo Fund has never been disclosed, but it has to be very big. In the latest interim report, Argo already reduced the carrying value of their stake in their own fund from $18.2 million to $13.8 million based on the agreed sales of an “important asset”. That’s a 25% write-down! My educated guess is that their TPPI stake is now approximately 65% of the Argo Fund, and with the sale of this asset almost completed there is now a large amount of liquidity:

Argo Group Limited (“AGL”), the independent alternative investment manager offering a multi-strategy platform for investing in global emerging markets, announces that certain funds it manages (“Argo Funds” or “the Funds”) have reached an agreement for the sale of a significant investment they hold in Indonesia (“Indonesian Investment”). The transaction conditions precedent are now fulfilled and the Funds has received a part of the sale consideration with the balance due over the next two weeks.

Because of the previous illiquid nature of the Argo Fund it has a large amount of accrued management fees outstanding ($5.8 million!) that now can be paid to Argo. With a market cap of $10.2 million (based on a 10.18p share price) that is big news. In addition to this the company also owns a $13.8 million stake in their own fund that is now mostly liquid as well. If we simply add these two numbers we get a total value of $19.6 million, implying a liquidation value that is almost twice the current market cap, and it gives zero credit to their other assets and (potential) earnings power. I still see a lot of value here, and I think the completion of the sale of their Indonesian investment will act as a catalyst since the company has indicated that they intend to resume their annual dividend and/or implement a share buyback:

Once the full sale consideration has been received by the Funds, the Board will consider a resumption of annual dividend payments and or a potential return of capital to shareholders via a share buyback subject to a review of AGL’s future strategy and working capital needs.

What the following, from the same press release, is supposed to mean, no idea…

The disposal of the Indonesian Investment improves the liquidity of the Funds and creates an opportunity for further transactions with the same counterparty that could in the future mitigate the impact of the book value losses incurred by the Funds as a result of the disposal.

Disclosure

Author is long Argo Group

Wexboy has sent a follow-up letter to Argo Group with a more focused and concrete proposal to create shareholder value. With the company trading significantly below net cash/investments per share management has a great opportunity to create value by buying back shares, or paying a special dividend. So this is certainly a proposal I fully support!

Disclosure

Long Argo Group

Argo Group has the questionable honor of being the worst performing stock that I bought and have blogged about: it’s down ~33% since the beginning of the year. Fellow blogger and Argo owner Wexboy decided to not stand idle at the sidelines, and send a letter to Argo to urge management to take action. If you are a shareholder you should check it out.

I don’t fully agree with all suggestions, but buying back shares when the company has 20.9p/share in cash and investments while it is trading below 10p/share is something I absolutely want to see! Better disclosure on what’s exactly inside the Argo fund is also a good suggestion since it is such a huge part of Argo’s balance sheet. I don’t think management needs to be urged to increase AUM. I’am sure that they know this, and will try to do this if they can since it’s already in their best interest to do so. The launch of a new emerging market fund earlier this month is a good sign in this direction. I also don’t really care about promotional investor relations activities. Influencing the share price of the company is in my opinion not managements job. They just need to run the company, and if they are doing a good job the market will take care of the share price.

Disclosure

Long Argo Group

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