Hybrids v Shareholders (follow up article)

This follows from my last post: Elders Ltd (ELD) v Elders Hybrids (ELDPA): Reservoir Dogs edition. 

Coincidentally, Jonathan Shapiro (who does an excellent job covering this part of the market) from the AFR picked up on Tuesdays proposal by Paperlinx to convert PXUPA holders to equity holders. Like ELD/ELDPA, the PPX/PXUPA situation is a complete mess. And this is similar to the Gunns drama as pointed out by a reader here. 

It really highlights the danger of these capital structures, and in my opinion completely undermines the notion that hybrid holders are somehow safer because they are higher up in the capital structure. 

PPX has even gone to the extraordinary length of reminding PXUPA holders they can't vote. Why this should be a valid reason to set aside the capital structure is beyond me. This really is holding a gun to their (PXUPA holders) head. 

It's a pity: for income seekers, hybrids as a sector have been a great part of the market to be invested. It's a shame to see the image tarnished.  

Kristian

Disclosure: no position in ELD, ELDPA, PPX, PXUPA

Elders Ltd (ELD) v Elders Hybrids (ELDPA): Reservoir Dogs edition

This story reminds me of the famous scene from Reservoir Dogs: 

Directed by Quentin Tarantino, the story involves a diamond robbery gone wrong. The gang starts blaming each other, and in Tarantino style people start dying. I won't say anymore in case you haven't seen the movie. 

Just like Steve Buscemi and Harvey Keitel in the above scene, ELD and ELDPA shareholders seem to be in a similar Mexican stand-off. 

   

And just like the misfortune of our characters in the movie, my previous analysis (some years ago thank goodness!) on ELD/ELDPA was pretty much dead wrong. When it comes to fundamental analysis, getting involved in situations where there is not a decent underlying cash flow or asset backing is so very often asking for a lot of trouble if things go wrong. On reflection, my biggest mistakes have all involved taking a punt on otherwise truly shocking businesses, betting an announced takeover will complete or a turnaround will be successful. 

Over many years, management at Elders have destroyed shareholder wealth with impeccable efficiency. Capital raising's, write-downs, too much debt, asset sales, non-coherent business model. Cyclical business. 

But what really has me intrigued is the relationship between ELD and ELDPA shareholders. 

ELD are the 'ordinary' shares while 'ELDPA' are hybrids: the genetically modified stock which is half-equity, half-debt. ELDPA have a face value of $100, however the current share price is $15. ELDPA distributions have been suspended for a long-time. So for an investment aimed at providing stable income, receiving no income AND copping an 85% write-down in value is truly eye-popping. 

One of the common selling features of hybrids is they sit higher in the capital structure than equity. This should be important if things go wrong and the business needs to be wound-up. In a wind-up, creditors come first and the owners second. Hybrid's sit in between the two. Most importantly, hybrids sit above common shareholders. So let's assume things like secured bank loans and employee benefits are paid. Then comes hybrid holders. If they aren't paid 100% of their 'face value', in theory equity holders are completely wiped-out. 

Okay, it has been obvious for some time Elders has been in trouble. A year ago, ELDPA was trading $30-$40. There appeared to plenty of equity on the balance sheet to cover the full face value of the hybrids. Obviously there was a major inconsistency between the balance sheet and what the market believed. If ELDPA was truly worth say $35, you could be forgiven for thinking ELD should be worth zero. But the one year share price graphs of ELD and ELDPA don't agree with this theory: 

ELD

ELDPA

As expected, the share price of ELD has been awful. But why has ELD outperformed ELDPA in the last three months? And the logic continues: if the market is right and ELDPA is truly worth only $15, then surely ELD should have no value?  

If you arbitraged the capital structure (long ELDPA, short ELD - if possible), life would be pretty miserable for you right now. Even on a 12 month basis, you probably have made no money. 

The half year results (balance date 31 March) announced 31 May indicate there is still plenty of equity to cover the hybrid holders in full.  These figures aren't updated for recent asset sales. 

So what's going on? 

Back to Reservoir Dogs. Friction between hybrid and common shareholders can arise when things go pear shaped. This has happened with Paperlinx (PPX and PXUPA). Previously an offer was lobbed at PPX and PXUPA shareholders. PXUPA shareholders were offered $21.86. Therefore they would have taken a very large haircut on the face value of $100. Not surprisingly, they weren't happy and the deal fell over. But surprise(!) - even more value has since been destroyed and PXUPA are now $8.05. 

Hybrid holders can be better off with a company completely selling the assets off and returning cash in order of the capital structure. But there is one small problem: hybrid holders usually don't have a vote. So even though they are superior in the capital structure, management and ordinary shareholders get to decide how the company is run, and it is safe to assume it will be in their best interest. And if you were an ordinary shareholder, would you really care about the hybrid holders? 

Shareholders get to hold a gun to the head of hybrid holders: "accept a lower payment than face value and give ordinary shareholders cash or risk losing the lot". In reverse: "no way, we'd rather see the company wound-up. You get nothing. We get something". 

No one agrees. Stalemate. Steve Buscemi and Harvey Keitel style. 

This is my best guess as to why the share prices aren't moving as the balance sheet and capital structure would suggest. 

Even if I am wrong, what can be accurately concluded is that hybrid investments are not necessarily safer than ordinary shareholders. When things go wrong, things get ugly. Therefore, even though plenty of hybrids have demonstrated equity like returns for debt like risk (good!), sometimes they give debt like returns for equity like risk (bad!).  

This isn't a gun fight I want to get into and will not be trading either ELD or ELDPA. I just find the whole situation curious.  

And finally - Please let me know if I have missed something. Always happy to be proved wrong! 

Kristian 

Disclosure: no position in ELD, ELDPA, PPX or PXUPA

MacarthurCook Property Securities Fund (MPS)

Most recent posts are here, here and here. To search the blog for more posts, try using the search function at the right of the screen. 

I have now received a few emails from readers supporting my analysis. I very much thank everyone for that. I would also like to hear from people who disagree with my view and who can back that up in a logical, thoughtful manner.    

Following from previous posts, there are several more issues I would like to address.

Stop Press: Capital Initiatives

But first, as I have been writing this post, MacarthurCook has made an announcement regarding two capital initiatives: first is a buy-back of up to 10% of the units for $3.5m. This equates to an average price of 6.9c per unit. Next is the confirmation that quarterly distributions will be re-commenced from the period ending 31 December 2013. We haven't been told what the new distributions will be. Previous guidance indicated the yield would be 6.1% however this was based on a higher NTA (13.6c at the time) which was pre capital raising and we don't have further news on future legal costs and the St Kilda Road property. 

Other AIMS Property Funds

AIMS also manages the Singapore Exchange listed AIMS AMP Capital Industrial REIT. In Australia, AMP is a very blue-chip, household name. It currently trades at a fairly tight discount to book value of 0.89. It is much bigger than MPS: market cap A$714m.  

I find it curious as to why MPS has attracted controversy while AMP Capital and AIMS jointly manage a big property fund seemingly with less issues. The fund even has an official credit rating. AMP Capital still jointly manages the fund and has a small stake in the actual fund. 

Here is the share price graph: 

AIMS took over MacarthurCook in late 2009 - roughly where the share price graph starts. The fund was recapitalised late 2009 (hence the initial share price drop). The share price dropped again in late 2011 was due to a 1 for 5 consolidation. Taking this into consideration the share price appreciation been strong: currently S$1.57 or S$7.85 pre the 1 for 5 consolidation.     

MacarthurCook also manages a number of other unlisted funds. I have not done detailed analysis on these funds. Nor have I done much work on other AIMS activities in securitisation, property and so forth. More analysis could be done on AIMS. The work I done has not revealed overtly untoward action. Am I missing something? 

Liquidity 

One of the key arguments against winding up MPS is illiquidity. The proposed wind-up will be completed over a three year period. Further, MacarthurCook argues the fund should not be wound-up, in part due to an improving property market. If their theory turns out to be correct, then liquidity should increase, negating the illiquidity argument. Therefore current illiquidity is irrelevant as a reason not to wind-up the fund. Liquidity ebbs and flows. It's a matter of being patient. 

I have profited and witnessed wind-ups that have produced high returns and low volatility outcomes for shareholders, so I personally know it can take time, which is in many cases  is driven by liquidity. I have discussed several of these situations elsewhere in this blog.

One Managed Investment Funds

MacarthurCook note the agitating shareholders have a) not provided details as to how One' will achieve best price and b) have not provided One's experience.

These are very reasonable concerns. Yet I can't see how it is reasonable for the Directors to unanimously recommend reject the proposal on this basis.     

Regardless, I wanted to know the answers to these questions myself. So I spoke to One'. One' confirms the strategy would be an "orderly realisation of the assets" and specifically not a "distressed seller". The maturity profile and the composition of listed/unlisted assets were discussed - and this information is freely available from previous MPS announcements. Regarding experience, One' informed me they have wound-up 15 funds and there others in the pipeline. This includes the EBB Income Fund and Alleasing Trust. I am familiar with both of these situations. This all makes sense to me. 

For my money, I can't see liquidity and appointing One' as a reason not to wind-up the fund. The capital initiatives announcement is a meatier rebuttal, yet I would like to see an estimation of future distributions provided. Without further evidence as to why shareholders should keep current management in place, I will vote for a wind-up. But it's clearly now game-on and I'm happy for shareholders about that.  

Kristian

Disclosure: own MPS

RHG Ltd (RHG) - videos not working

Apologies - the Youtube video links on the RHG post worked fine on my MacBook, but did not appear on my ipad or iphone after the post was published. Here are the URL's:

http://www.youtube.com/watch?v=t0AKC3wZdw4

http://www.youtube.com/watch?v=zU9SzOaTpJs

But the joke is probably a bit stale now anyway.

Kristian

Disclosure: own RHG

RHG Ltd (RHG)

RHG has been a really solid trade for a few fund managers I know, and so far happily for me too. RHG was formerly known as RAMS Mortgage Corporation and Australian readers of this blog might recognise this chap from advertisements: 

I don't know why they chose a ram. My parents once had a hobby farm and let me assure you they were never this friendly and were usually looking for a fight. It may have been an attempt to differentiate a very commoditised and generic product, just like insurance comparison websites are attempting to do with meerkats: 

or half-wits:

Anyway, as a very quick history, Rams floated in 2007 and then immediately blew-up as the credit markets dissolved during the GFC. The RAMS business was sold and the mortgage book placed into run-down mode and renamed RHG. The run-down has been proceeding well and shareholders have already received chunks of cash along the way. As noted in previous posts, in order to see if money can be made from this type of cigar-butt, an assessment should be made of the discounted cash-flows as the mortgage book winds-down. 

The way I calculated it was to go back through half and full year company reports and work out an average historical Net Interest Margin (NIM) which I calculated as 2.1% and the average annual historical wind-down rate of the mortgage book which I calculated as 30%. These figures allow the estimation of gross-margin (interest received from mortgage book less wholesale interest paid to finance the mortgage book). Probably the bigger guess was future operating costs which again I took the lead from historical financials and then reduced each year out until 2017 when the book should be close to fully wound-up. There were some further calculations including other interest earned, tax and so forth. Bung this all into a spreadsheet and I arrived at a post-tax NTA of 52c and pre-tax NTA of 64c. Please note the disclaimer at the right of this page. These are my estimations only and should not be relied upon. 

I could be wrong. I calculated these figures in March, and we will soon have six month figures to June so it will be interesting to update the model and see if those assumptions are still valid. Regardless, I think the numbers are fairly right as recently there has been a good old-fashioned bidding war emerge for RHG at prices close to my valuation. The latest firm bid (15 July) is 48c excluding the recent ex 3c fully franked dividend. 

One man's trash is another man's treasure... 

Even if my numbers are right, it doesn't mean there won't be another increased offer. A new owner may be able to shrink overheads faster, work the book harder or even start offering new loans to existing borrowers (if possible). The other big factor is tax. The bid may be sweetened if it is re-configured to include a nice big fully franked dividend. Low tax paying entities such as SMSF's would love this.  

But I am now speculating as to what might happen. Some left field event could come along and everything could go pear-shaped. My logic for buying and holding is value. It will be even nicer to realise that value sooner rather than later with a cash takeover. 

Kristian

Disclosure: own RHG

Guinness Peat Group PLC (ASX: GPG) - the one that got away

I had done plenty of homework on GPG and yet made absolutely nothing when the price subsequently bombed out and became massively undervalued. Why? I watched it like the deer-in-the-headlight as the share price tanked following the announcement of potential regulatory risk, only to see the share price to race straight back up to fair value. 

The purpose of this post is to conduct a postmortem. 

Previous updates on GPG can be found here, here and here (please note you can also use the "Search This Blog" function on the right of the screen). The last post was 22 April. Management was buying back stock at 48c. I estimated the NTA ex Coats at 36c. The share price was then 45c. This was after the announcement of a potentially very nasty infringement by the UK Pensions Regulator. I decided to pass on the investment as I felt I didn't understand the risks enough. I'm actually pretty happy with that analysis. 

Here's the subsequent share price action:

  

22 April was just before the general market sell-off and GPG tanking. 

While not buying at 45c was a solid and well thought out decision, not buying when the price went sub 40c cost money. 

Hindsight bias or just plain wrong? 

I can honestly say this is not a case of hindsight bias: I firmly knew at the time I should be buying or at the least investigate the UK Pensions Regulator issue further. There was fear in the market in general and certainly lots of fear in GPG's share price. Deep-value fund manager Orbis appeared on the register 29 May. I was well aware of the pensions presentation made by GPG, which puts the pensions issue into perspective meaning it is likely it will not not be such a big issue. The issue has not been finalised, so who knows; perhaps it will be a big blow to GPG after all. But the rationale for not buying was fear and not rational thinking. And that was the mistake. 

It was a good idea not to buy when there wasn't enough money on the table and a new risk wasn't fully digested by the market. It was a mistake not to be brave when fear was at it's peak and GPG was very cheap. I really need to remember and apply the Howard Marks quote from my first blog:

"If I were asked to name just one way to figure out whether something is a bargain or not, it would be through assessing how much optimism is incorporated in its price" 

  

Here in Australia we have another textbook case of potential regulatory risk: Mcmillan Shakespeare Ltd (MMS). This case is different: there is a very real chance Labor will get in and strip away part of their business model. I may write a post on MMS if I can see an interesting angle.  

Kristian 

Disclosure: no position in GPG (obviously). Small position in MMS

  

Hastings High Yield Fund (HHY)

Hastings High Yield Fund (HHY)

Quick update on some transactions at HHY. I won't discuss much now as we are heading into reporting season and we will then have some more details on the balance sheet and progress of the wind-down.

• I-Med contracted to sell just above book value. This equates to 2.1c per share. 
• At the last NTA update, NTA dropped 1.4c 'primarily' due to Hyne. As per my previous notes, Hyne was on the books at $5.5m or 5.3c per share. So a 1.4c or a 25% hit to book value surely indicates Hyne is sick. 

Kristian

Disclosure: small position in HHY

Multiplex SITES (MXUPA) - food for thought

This week I met with Fred Wollard of Samuel Terry Asset Management to swap war stories. Fred also seems to be attracted to cigar-butt type situations: like me he also must have done something wrong in a previous life. 

Multiplex SITES (MXUPA) is hardly a cigar-butt - it's an income stock, but nevertheless came up in discussion (I last commented on MXUPA here). We firmly agreed Multiplex/Brookfield had done an exemplary job in managing the balance sheet and continuing to pay distributions, however Fred has a few reservations about the stock. I own MXUPA so I thought I better listen closely to see if I had missed something. 

The first reservation relates to the combined effect of discretionary and non-cumulative distributions and Multiplex itself now longer being a listed company. The potential result could be that suspending distributions will be less of a PR issue should the need arise. 

The second reservation relates to the ability of the issuer to convert MXUPA into Multiplex stapled securities. As Brookfield Asset Management took over the stapled securities, they are no longer listed. I have spoken to Brookfield who have confirmed the conversion facility has no longer been in place since the takeover.

This got me thinking.

In isolation these issues don't particularly bother me as the underlying financials have been and continue to be in good shape. But anything is possible, and as noted in my previous post there is some disparaging research on Brookfield Asset Management. The article is quite scathing, and quite scary if true. If BAM truly is a house of cards which were to fall over - or perceived to be able to fall over - the knock-on effect could be horrendous even to in-direct satellite securities such as MXUPA.

I can see the argument in not bothering with MXUPA and finding other interesting income stocks or even just go for the Australian version of the Dogs of the Dow which pays 7.16% p.a. grossed-up compared to the current MXUPA rate of 7.8% p.a.* I will remain with MXUPA, but it does reinforce the need to constantly question one's holdings.  

Kristian 

Disclosure: own MXUPA.  

*Top 10 Grossed-Up Dividend Yielding Stocks from the ASX50 (Source: SMH 3/8/13):
CBA 6.99%
WBC 7.72%
ANZ 7.26%
NAB 8.39%
TLS 7.91%
AMP 6.91%
WRT 6.29%
SGP 6.63%
ASX 7.06%
CFX 6.48%
Average 7.16%

MacarthurCook Property Securities Fund (MPS)

MacarthurCook Funds Management has now set a time and date for the requested shareholder meeting:

When

11am, Wednesday 4 September

Where

K&L Gates

Level 31

1 O'Connell St Sydney  

K&L Gates are a law firm. The independant directors all recommend voting against the proposal to wind the fund-up on the following grounds: 

I'm not convinced by the first and third points: it's more of a call on the property market rather than a reason to keep the fund open. Regarding the second point, I would like to see some data to support that claim. Which assets are illiquid? What is the potential haircut? The proposal is to wind up the fund over three years, so is illiquidity really that big a problem? Fourth and fifth points: fair questions, however they are easily answerable and therefore not admissible as a rebuttal. 

I must admit I can't get excited about keeping current management in place based purely on these arguments. There is literally no hard evidence presented as to why shareholders should not vote for a wind-up. Just general observations. Strange, considering previous communications outlining the plan to resume distributions and other capital management strategies.  

More to follow. 

Kristian 

Disclosure: own MPS