PMP Ltd (PMP)

Charlie Sheen on answering a question as to why he used prostitutes - "I don't pay them for sex, I pay them to leave". And just like Charlie had a clearly defined exit strategy with women, we need a good exit strategy with stocks. 

PMP has been a wonderful investment over the last number of years, despite a business that is in long term decline. However, the business is in decline and unless something major happens like industry consolidation, it's hard to see the glory days returning. So this will probably remain a business that will not grow in value and therefore has a ceiling on its valuation. I modelled a basic scenario of declining revenues of 8% p.a. (it's average decline since 2012), maintaining EBITDA margins (which is probably generous - you can't cut costs forever!) and assuming the business has a terminal value in 5 years time of 4* PBT, and discounting back at 10% I get a valuation of 75c. This number of course is based on some pretty simplistic assumptions and could of course be wrong. 

But at 50c, and assuming my numbers are roughly right, the discount rate being factored in by the market is over 20%. Given PMP re-financed a bond at 6.43% p.a. plus generous terms in its favour, it looks like the equity market is treating PMP pretty harsh.  While this may be all true, what is also true is the market may never want to pay up for a declining business: it could easily be 'cheap' forever, and a stock trading at a discount to valuation alone without a catalyst is rarely a good enough reason to buy at least in my experience  - unless it is a huge discount. 

The other issue I consider far more these days is return on my time. I would prefer to spend my time on ideas that will yield a much bigger ROI such as companies that can grow and get re-rated by the market and value opportunities that represent massive value.  

Hence the reason for recently selling PMP. 

Kristian 

Disclosure: no position in the above name

Devine Ltd (DVN)

Follow up post to comments on the previous DVN post...

As noted by other people and my follow up comments, the situation with CIMIC smells. And the smell gets worse. A separate, non-binding offer has been made for DVN for 90c, which of course trumps CIMIC's 75c offer. As the takeover would be via Scheme of Arrangement and therefore requires 75% of votes, CIMIC can matter-of-factly block the deal as it owns 50.63%.

So this has truly forced CIMIC to show its hand. CIMIC has responded by saying they are proceeding with their offer, effectively confirming they want to buy DVN for a song. Typically with takeover trades you can justify buying a bit above the bid price in the hope another bidder comes along. That probably won't work in this case given CIMIC's stance. I suspect it would take a much higher bid to dislodge CIMIC and your guess is as good as mine as to whether that might happen.

At 80c it is a tough call. CIMIC can block any other deal and the share price could drop plenty when their offer expires. I've been selling recently, and I'm out completely.

Kristian

Disclosure: no position in the above.  

Devine Ltd (DVN)

Some good news (albeit a bit lucky) from DVN: major shareholder CIMIC has announced an intended takeover for the remaining shares it doesn't own. The offer price is 75c cash and will have minimal conditions. Successful or not, CIMIC is rolling the board and will appointing a new CEO to turn the business around, and as it already owns 50.6%, CIMIC effectively controls the company and can call the shots. 

Good to see a major shareholder taking an active position.  

This leaves the question of what to do with DVN shares. As CIMIC owns such a large stake, it's not likely another bidder will bother coming along. This means CIMIC will end up with all the company (if it gets to 90% it may just move to compulsory acquisition) or end up with somewhere between 50.6% and 90%. 

Given the offer is 50% of book value, you could argue that CIMIC is being opportunistic, but I wouldn't be doing anything different if in their shoes. If you decline the offer and hold your shares, you are taking the view new management will come in and clean the place up, and there is always a possibility CIMIC will come back later with a higher offer to mop up residual shareholdings. That's not an unreasonable bet. 

Kristian 

Paperlinx (PPX and PXUPA)

On better news (than the previous post), the PPX AGM was held in Melbourne last week which I attended. 

PPX is one of the more talked about and controversial stocks, however I think one has to agree that at least they are making the big decisions to try and fix the business. Europe is all but done and I as understand there may be some relatively minor lease obligation residual after Germany is finished. Maybe VW can rent it to store some of their cars that no one wants to buy.

Clearly the traditional paper business in ANZA has done okay but is in structural decline. PMP, another company facing structural decline has tackled the issue by savaging costs across the board. PPX's response has been to cut out the cancerous parts and diversify into other areas such as sign & display and commercial packaging.

Diversification could go really well, or really bad as in the case of Peter Lynch's diworsification. Unfortunately I don't have any particular insight as to how well management and the new CEO will execute this strategy. With $43m in net cash (less some allowance for a potential German lease liability), they have ammunition to go buy more sign & display type businesses which in the private market ought to be no more than 4-5 EBIT. It would be a great result to see management turn the business around and navigate past an extremely difficult period.    

Corporate costs last year were $11.5m and they wouldn't provide guidance as to what these costs will be this year. To be fair, they probably in part don't know exactly themselves. If another PXUPA holder throws a legal grenade at them, PPX is responsible for the PXUPA Responsible Entity's legal fees.

In addition, there were no numbers around the Q1 update. Noting that Australia got off to a 'difficult' start (Asia stable and NZ good), it was hard not to be a little bit alarmed about the short term earnings of the business. If the old business declines faster than what they can build the new business, then the result just isn't going to be pretty in the short run. 

Finally, there is the issue of PXUPA. Management did seem genuine in their expressed desire to resolve the PXUPA issue, yet at the same time made it clear the fiduciary responsibility of the board was to PPX shareholders. So my read is that PXUPA shareholders will not be offered the farm, if any deal is made.

After the AGM, I'm just not sure with how much confidence we can value the business. If we don't know what the corporate costs are and they aren't telling us how Q1 went, then just what valuation do we use? Book value isn't going to be overly useful if the assets are in an industry declining. Crassly, if we take the $43m net cash and assume no liabilities outside of ANZA and assume last years EBIT of $14.7m will be earned again this year and also assume corporate costs reduce to $5m to produce net EBIT of $9.7m and give this an EBIT multiple of 5 (which is generous considering you can buy PMP on 4*), you get a sum of part of the parts valuation of $101m. This is even more conservative than previous valuations I have arrived at. This of course is all a bit of a stab in the dark!

Given that both PPX and PXUPA have both rallied pretty hard, the combined value of those securities is now $63.8m (PPX $22.5m and PXUPA $41.3m). So regardless of how the pie gets split between PPX and PXUPA and if you adopt a more conservative valuation because we just don't know what the numbers are, then the upside is not necessarily that big from here.

I've taken a more conservative approach and sold my PXUPA into the recent price strength and been happy with that decision. Also happy to get back in if I can get comfortable there is plenty more upside to come - I just can't see it right at the moment. If I am proven to be too conservative, then so be it.    

Kristian 

Disclosure: own PMP

Devine Ltd (DVN)

In my last post on DVN, I noted "Well, I got this one completely and utterly wrong". It turns out I was even wrong about that. Some trades you (I) just get wrong from start to finish. DVN is mine. After deciding to hold on to most of my holding after the sale process fell over, DVN released a shocker profit downgrade last week noting their forecast profit of $10-$13m for the year 31 December will now be zero. 

And this is despite a strong property market. 

Clearly, this business is run poorly and clearly I should have seen this a bit sooner. The share price has been sold-off more to the current price of 55c, representing a good loss (my biggest in a long time) yet an absolute monster discount to NTA. NTA (30 June) was $1.55, so if that number roughly holds true, the discount is 65%. That's pretty incredible in an otherwise normal market. 

To add on top of that, plenty of people now think we have passed the top of the housing cycle, which if true means there are potential macro headwinds facing DVN. And as noted in previous posts, companies tend to upgrade and downgrade in cycles meaning there is potentially more bad news to come from DVN. 

Tough situation: it feels hard to sell a stock selling at such a big discount to hard assets yet the fundamentals of the business have gone backward and management have been incredibly shy in providing transparency to the market and there are better businesses out there. It's a situation I'm pondering. 

Kristian 

Disclosure: own DVN

Keybridge Capital Ltd Convertible Notes (KBCPA)

I discussed KBCPA recently in July. When writing this update I reviewed that initial post and I am quite embarrassed about the incredibly poor grammar - profuse apologies! 

I noted the convertible notes issued by KBC and the pretty decent return on offer (10% including franking credits on the issue price of $1) and also noted that although they were interesting, I was not buying because I was looking for more upside and would prefer to wait for a lower price. Interesting to see the price since come off to 96c and as a result KBC have announced a partial buy-back of the notes to help prop up the price. This is good for KBCPA holders and to be frank cheap buying by management. Unfortunately however it will probably mean they won't get to be a true bargain to get me buying. 

Kristian 

Disclosure: no position in the above names

Feedback Loop

Over the last three years I have kept a record of trade decisions - and importantly that also includes decisions to not buy or take any further action. I have been reviewing these decisions over the last few weeks looking for areas of improvement. 

This is quite confronting, and to be frank down right embarrassing on occasion. But this feedback has been highly informative and most definitely worth the effort. So much so, I have incorporated in to my weekly list of things to do a quick review of some previous decisions. It feels a bit like going over video replay a few times before going out and swinging at the ball. 

I have listed some of my observations below. There are plenty of other observations - enough to write a small book probably. None of these are necessarily new, but I thought you might find them interesting anyway.  

• Be careful of writing off a situation because it looks superficially expensive. Funnily enough, this has been one of the main reasons for not getting more big winners (i.e. multi baggers). If something is growing quickly and is now getting the full benefit of operational leverage, a high PE stock can rapidly become a low PE stock. Key point - do more digging before concluding a stock is 'expensive'. MFG is a perfect example. 
• Be careful of getting too excited because it looks cheap.  It's amazing to see just how many value traps are out there - far more than you think. Usually a stock is cheap for a good reason and sometimes it takes a while to uncover why. The irony is cheap stocks are often dangerous - at least in terms of getting caught in a long term value trap.
• Big winners almost always have 'winner' people somewhere in the mix. This might be at management level and/or shareholder level. Jim Collins makes a compelling argument for quality management in Good to Great and after reviewing my decisions it is hard to disagree. Usually the biggest asset or liability on the balance sheet is not shown - the quality of management. What I would also add is there are plenty of times where management may not be great but good shareholders can get in and shake things up. Whether good people are involved from the inside or outside, I can't really think of examples where a stock has moved up multiple times where an A-Grader isn't involved somewhere. 
• Finding an interesting situation, getting bored, forgetting about it and moving onto the next latest-and-greatest. Often, a company may not be ready for buying when you discover it. I decided not to buy AAPL around the lows at $64 in 2013 on not unreasonable grounds (was incredibly cheap but quarterly earnings weren't going the right way). I moved on and forgot about it looking for something more complicated. Carl Icahn bought a few months later and the stock doubled over the next two years - an unbelievable trade given the size, value, quality of AAPL and green light given by one of the smartest smart-money men around. If I kept an eye on the situation, buying when Icahn announced and started pushing for a buy-back was an easy trade. Key point - keep an eye on interesting situations, even if it means being across less stocks. 
• Price volatility. This one cuts both ways. It's easy to get scared by prices falling. It's also easy to get put off by a price that has increased recently. Stocks that are turning around or are reaching an inflection point and moving into profitability may have moved up 50-100% and still be an incredible opportunity as there still might be multiple lots of upside to be had. However the cheapskate in me finds it tough to buy a stock that has already moved a lot. Price volatility also really depends on the trade. A bombed asset play will inherently have an upper bound in terms of value and quite often will never reach fair value. So buying one of these after a price run is usually not brilliant - unless there is still a very long way to go to NTA. 

Kristian 

Paperlinx (PPX and PXUPA)

Management response to Blue Pacific's argument the terms of PXUPA are in breach: 

Well, we can all be glad that issue is sorted. Belligerence seems to be the company motto, which has cost both PPX and PXUPA huge sums of money. Maybe it's time for David Thodey to become CEO and work amicably with stakeholders. 

Kristian 

Disclosure: own PXUPA

Paperlinx (PPX and PXUPA)

This is a quick post on a issue that was brought to my attention last night (Tuesday night, Sydney time). 

Christopher Sommers and his team/advisers at Blue Pacific (New York) look to have uncovered a potentially significant issue for PXUPA holders. 

The full press release can be read here. 

I won't regurgitate the press release fully, however in summary the argument is that a change in capital structure has taken place (2013 and 2014) triggering an event allowing Paperlinx SPS (PXUPA) to convert into preference shares. The preference shares have a face value of $100, so depending on how these are converted (cash or ordinary PPX shares) it potentially means PXUPA finally end up with control (at least 95%, if not 100%) of the business.  

If the argument holds true, it is an incredible slip by the company and incredible slip by the rest of the investment community to not pick this up. I am working through this issue (along with everything else!). Any comments appreciated - feel free to email if you prefer private discussion. 

Kristian 

Disclosure: own PXUPA

Please help - study group required

I'm looking at a company that installs an electronic reward based system in small businesses such as cafes, gyms and restaurants. The company is rapidly piling in merchants on a free trial basis however the key issue is whether these businesses will be happy to start paying this company once the trial ends. 

If you run a small business like the ones above or if you know someone who does, I would love to get your feedback. Please contact me directly on the email listed under my profile. 

Thanks,

Kristian 

SoulCycle

I have an interest in the fitness industry, and have just spent some time in the states looking at different operations. Fitness has long been dominated by the traditional 'big-box' style gyms such as Fitness First. Over the last 10 years this model has been tweaked with the rise of the 24/7 gyms utilising a smaller footprint, no classes (reduces rent and salary), less front-desk staff and of course are open 24 hours. In Australia, Anytime Fitness pretty much won the race thanks to a great business model and first mover advantage. 

The next wave of change in the industry has been the rise of boutique operators specialising in group training. Think CrossFit, F45 Training, Orange Theory, Barry's Bootcamp, Fhitting Room and the focus of this post - SoulCycle. These are literally businesses that specialise in providing classes and nothing else. There are classes for all tastes including barre, strength, spin and HIIT (high-intensity-interval-training). 

Side note: there is now even a new sub-industry aggregating classes provided by different providers such as ClassPass. ClassPass members gain access to a wide range of classes across different gyms. So you can choose between boxing at one place, cardio at another and barre at another place. This will potentially end up like the travel industry - the aggregators (agents) will be the ones who make money by clipping the ticket without having to bother with investing in physical property at the expense of the gyms. But that is a separate post altogether. 

Group training is turning into big business. And it doesn't get much bigger than SoulCycle which has filed for IPO. See here for the preliminary IPO.

SoulCycle is a mixture of spin class and ra ra. So it's literally a spin class, but the lights are turned down and the feel good factor is turned right up - lots of positive affirmations and American energy in the room. The prospectus itself is a good bit of propaganda. Try this on (page 2):

It sounds a bit cheesy, but let's face it the Americans do the positive stuff really well. And culture, along with a good dollop of celebrity pulling-power, is the competitive edge here - the actual product is literally a spin class and is therefore a commodity. But the positive vibes is what allows them to absolutely print money and the growth in earnings is phenomenal. Again, from the prospectus (page 2):

To break that down a bit more, in 2014 there were 2.9m rides (across 81,317 classes). Studio fees were US$91.8m meaning each ride generated US$31. $31 is a big number for one spin class! Standard classes are $35 and gets a bit cheaper if you buy class-packs. Classes can actually cost up to US$70 for the premium concierge service called SuperSoul. And I understand cancellation fees apply. So each bike can clip the ticket three ways: cancellation fees, standard fees and the SuperSoul service. Plus there is plenty of money made by selling merchandise, water, shoes etc - just another $18m revenue.

SoulCycle works on a corporate store model with 38 stores across the states mostly in NYC, Los Angeles and San Francisco.  Interestingly, they don't work on a franchise model but instead invest heavily in their staff training and career development. It's quite a feat to develop a big, growing network and still deliver outstanding service, and one that I am genuinely in awe. This speaks volumes about the underlying culture of the organisation. Starbucks and Chipotle are other organisations delivering great, consistent service across a corporate store model which again, I find incredibly impressive.

Being a preliminary IPO, the selling price is not disclosed, so there is plenty of speculation about this - I've heard some obscene numbers thrown around that I won't bother repeating. How much would you pay? Rapidly growing business, great margins, but a product that could easily lose it fizzle if the culture starts fading. This could of course all be a bit of a fad and an attempt to cash-in on strong equity markets. Well, the equity markets were strong when the listing was made! This feels like a bit like when Virgin Blue listed in Australia - lots of razzamatazz but ultimately an airline selling a commodity product in a highly competitive industry.  I wouldn't be surprised to see the listing pulled if the markets continue their shank.

It's not for me, but the rise of SoulCycle is nonetheless a fascinating tale.

Kristian

Boom Logistics (BOL)

Since my last post on BOL (where I had a decent whinge), the company has reported yet another deteriorating set of full year figures and in my opinion a continued lack of genuine action at the board level. To get it out of the way, I recently sold my position - before the market really went into free-fall. Absolutely nothing to do with timing, just pure analysis. My point is the recent market issues didn't have an influence on my rationale. 

In no particular order, here are some of the key issues as I see it: 

• NTA is slipping, and quickly. BOL is an asset play, pure and simple. However the ideal asset play has at least a stable or growing book value. BOL dropped from 49c to 41c in one year alone. Is 41c the floor? Who knows. I can't see how the valuation will hold up if the return on the assets remain poor. 
• Revenue is disappearing quickly. Again, in one year alone, revenue has dropped from $273m to $207m. That's a huge drop.  
• CEO is still on a big salary (despite a 10% pay cut last year). $675,000 p.a. is to just too big considering the performance of the business.
• Bullish forecast. Management has not delivered earnings growth, yet now forecasts a decent turnaround in a tough environment. FY16 forecast EBITDA is $20m-$30m, which is higher than normalised FY15.   
• Another change in CFO. 
• Taken management a long time to admit the real reason for not conducting the buy-back is debt covenants. 

Obviously the business could turn around from here. To me, that's fine. I'm happy to jump back in when there is some evidence to support re-purchasing.  

Kristian 

Disclosure: no position in BOL 

Paperlinx (PPX and PXUPA)

You may have seen recent some media articles about some new shareholder agitation around the no-win capital structure at PPX/PXUPA. I have been commenting on this situation for some time now and as noted in my last post on the topic bought some PXUPA in May. 

As noted previously, the 'trimmed down' PPX is basically owned by PXUPA shareholders. The face value of the PXUPA is $285m v my balance sheet estimation of $210m. Therefore PPX are basically worthless at the moment. At the time of the last post, I couldn't see why PPX was performing better than PXUPA however that trend has corrected itself (at least for the time being) with PPX falling from 3.6c to 2.6c and PXUPA holding up okay rising from $9.50 to $10.46. 

The new main agitator, Blue Pacific Partners, has outlined what I think is a pretty reasonable plan and can be read in full here. 

The key proposal is to offer PXUPA shareholders 1,000 PXP shares for every PXUPA. This means PXUPA holders (assuming 100% converted) would collectively own 2.85bn PPX shares. There are 609m original PPX shares bringing the total share count to 3.459bn shares of which 82% would be owned by former PXUPA holders and 18% by the initial PPX shareholders. 

What I really like about the proposal is that it delivers a win-win for both PPX and PXUPA holders. Using Blue Pacific's conservative value of $125m (much less than the $210m I noted above), each share is worth 3.6c. So the PXUPA would be worth $36 each and PPX shareholders actually have a genuine value of 3.6c (and not just the pure lottery ticket value they currently have which will sooner or later expire like a decaying option).  

As a PXUPA holder, I have zero expectations of every receiving $100. However $36 is a decent hair cut and if it allows the situation to be sorted out I would accept it. 

But of course this is all just theory. Management actually have to themselves adopt such a plan, and based on the track record we can't hold our breath. However my reason for buying a few months ago was the Board stepping in and shedding everything non-ANZ. This has been done, so let's see now if they step up and sort out the capital structure. 

Kristian 

Disclosure: own PXUPA

Keybridge Capital Ltd Convertible Notes (KBCPA)

Regular readers will know of my interest in different types of securities like bonds, preference, hybrids, convertibles and so forth. As noted in previous posts, I wish there were more of them. Well structured and well priced alternate securities can offer investors a cracking deal especially in circumstances where downside is structurally limited (think WESN (now longer listed) and AFIG for example) and fundamentally limited with upside potential. Unfortunately there aren't many on offer (in Australia) and none really at a decent discount in this market. 

But please don't take my word for it - just look at the doyen himself, Warren Buffett. A great example of an alternate investment he made is Goldman Sachs (GS). Back in 2008 Buffett bought US$5bn of GS 10% p.a. preferred stock which included warrants to purchase a further $5bn ordinary GS shares at at a strike price of $115 anytime up to five years from date of issue. So that gave him the right to buy 43.5m shares for $115 which based on the current price of US$212 would have been a profit of $4.2bn. Interestingly, the deal was amended in 2013 so Buffett ended up with 13m shares but didn't have to pay for them (now worth $2.8bn plus his preferred's). That's a great deal.   

Apologies, I digress - back to the story. 

One new stock that doesn't fit the bill of upside optionality, but is interesting nonetheless is KBCPA. KBC is issued by the mother-of-all magnets to the value community - Keybridge (KBC). KBC itself is a collection of all sorts of investments all over the world. Please note it is not the purpose of this post to explore KBC - that is a long story in itself. KBC has a market cap of $27.8m (17.5c). The new KBCPA were issued at $1 in June and there are 5m on issue. 

KBCPA were actually issued to existing KBCPA shareholders as an in-specie (non-cash) distribution on a 1 for 36 basis. Why? There are a number of reasons. It provides additional funding in the future - i.e. issue more KCPA to help fund a project. This is smart - the notes are unsecured and provide debt without the banks placing restrictive debt covenants. More directly, the notes appear to have been a way to return some excess capital to shareholders without actually handing over any cash! Instead of KBC's cash going down, debt goes up. The effect to net equity is the same however they retain the cash to invest. And also quite smart is the new channel it creates to pay out franking credits. The notes are 7% fully franked meaning lots of franking credits for holders. 

So on a grossed up basis, the yield is 10% p.a. which is really attractive in today's market. A 10% p.a. yield is roughly the same as the long term combination of growth and dividends from the stock market - so you can understand if investors interested is piqued (especially if you think KBC is pretty safe). Even as I write, a few have trade above the issue price. 

For me, I want upside potential. Either through favourable conversion terms such as a fixed exercise price (see the Buffett deal) or a discount to the face value (in cases where the maturity term is fixed as is the case with KBCPA). Who knows, maybe the market will get really scared for some general reason or Nick Bolton stuffs something up and they get sold off well below face value. But for the time being these conditions are not present so it's a pass for me. 

Kristian 

Disclosure: no position in the above names

Redhill Education Ltd (RDH)

RDH was recommended to me by a friend about 5 years ago. I didn't buy and haven't really followed the stock for years now, however I  was recently reminded of it when researching another education company. Anyway, I've just finished reading through the annual reports back to 2010 (when it commenced life as a listed company), along with the 2010 prospectus and the cataclysmic earnings downgrade in 2011.  

The stock has presented tremendous opportunities to both lose and make money, and I think its history is both incredibly interesting and informative. You can see what I mean from the graph below: 

Source: Yahoo Finance

RDH listed back in September 2010 for an issue price of $1. 

RDH was already an existing company of two education businesses. The $16m capital raising was to buy two more education purposes and so creating a horizontally integrated business of what looked like quite different educational units. The CEO and CFO were new to the business. Original shareholders do not sell their shares into the float and put their stock in escrow. The prospectus (August 2010) forecast pro-forma 2011 Revenue $21.4m, EBITDA $4.9m, NPAT $3.4m, 12.6c EPS and a 3c DPS. No debt. Compared to an initial market cap (non-diluted) of $27m, this all looks pretty cheap and the stock rallies to $1.24.

So far, so good. 

7 February 2011 was a shocker. RDH downgraded in a massive way. FY11 forecast EBITDA was cut down from $4.9m to $1.1m. That's massive. All sorts of reasons were given for the downgrade: 

The stock tanks from 77c to 23.5c (note it had been drifting down from $1.24 to 77c from September to February). The CEO resigns later that month. The price keeps drifting lower to 10c in June 2011 tallying a 90% loss for investors in the float. FY11 does indeed turns out to be a shocker posting a pre-tax $3m loss although operating cash-flows are only just negative. The market cap is $3.5m v book value of $15.1m. 

Fast forward to FY12. New CEO (one every year so far). Lots of restructuring. Lots of write downs to assets. Book value drops from $15m to $6.7m. The stock wallows at 9c. Operating cash-flow is actually slightly positive - most of the P&L is hit by write-downs to the balance sheet in different areas. 

So what it looks like so far is a revolving door of management, macro issues and all at the same time trying to bed down two simultaneous acquisitions. You wouldn't touch it with a barge poll, right? 

FY13. The stock has more than doubled to 21c when the preliminary full year figures are released (July 2013). The numbers are looking much better. Revenues up, EBITDA is positive and operating cash flows are an impressive $1.6m. Lots of cost-cutting, new products, re-structure and possibly a better macro environment. At a market cap of ~$6m, the stock is starting to look cheap. 

FY14. The company reports a blinder and the share price has moved up to the $1.40 range. Revenues up 19%, NPAT is finally positive, EBITDA $2.7m and $3.2m in operating cash-flows and $6m in the bank. Just think the whole company was worth $3.5m in FY12. 

And forecast FY15 has more of the same big improvements. 

Note the original prospectus numbers have still not yet been met. 

So there was potentially a 14x return there. More conservatively 5-7x if you were buying as the positive news started rolling in 2013. 

Kristian 

Disclosure - no position in the above name(s)

United Overseas Australia Ltd (UOS)

This is probably the best Australian growth stock you've never heard of. Full credit to Nigel and Max (who also works at Harness) for pointing this stock out to me. The long-term performance of this stock is truly outstanding and its future continues to look bright. I recently took a position on a long-term view, and if you are looking for a good write up on the stock, please check-out the article on the Harnesss website. 

Kristian 

Disclosure: own UOS 

Do you know which stock this is?

Imagine you bought the stock below roughly near the bottom at 40c on the left hand side of the graph. 

That was March 2009 and the bottom of the GFC when the sky was falling on our heads. As we know, the market then rallied in a big way and this stock went nuts climbing up to $1.94; a close to 5 bagger on your investment. Can't think of anyone who wouldn't be happy with that. 

Move forward to 2011; a grinding year where the S&P ASX 200 almost hit 5,000, but didn't and then just headed south for the rest of the year to breakdown below 4,000 and wallowed there along the bottom. So too has the stock retreated all the way back down to $1.20; a spicy 38%. 

Throughout this time the stock was never 'cheap' on a traditional value basis. In fact, even though it had been around for a while, it was still not making money in 2009 and was hardly making any in 2010 and 2011 giving it a PE in the 30's. It wasn't paying a dividend during this time until September 2011 when it paid 1.5c. The fixed cost base was high for its industry. Management had an excellent reputation but this was a relatively new venture for them and had to yet prove themselves. 

Traders were probably already stopped out at this point. Fundamental investors might be wondering why they are holding this thing. If you hadn't already bought it, and as a good contrarian value investor your wonder who would buy a stock that has already moved up in orders of magnitude and wasn't cheap. You would look pretty silly if you bought it and it went down, right? 

Check out the graph below, which shows the continuation of the graph above - i.e. the subsequent performance of the stock:

You can see the subsequent performance is outstanding. And during this time the stock started paying dividends, so Total Shareholder Return (TSR) is actually much higher. Let's put some numbers around this performance. Assume you bought it at $1.50 in May 2011 - roughly halfway during it's decline after peaking at $1.94 in early 2011. The current price of this stock is $18.49 and has paid out $1.47 in dividends including franking (all of the dividends have been fully franked) so the total pre-tax return is $19.96. Not bad for a $1.50 investment. That's a 13 x return on your investment. IRR is  a blistering 142% p.a.

And remember, this is buying it after it had already increased several times over, so you have by no means picked the bottom.

This is not a nano cap that nobody had heard of.

So which stock is this? 

The stock is Magellan Financial Group (MFG). MFG is a funds manager that was launched after the founders noted that Australian investors were underexposed to international shares and Platinum had that part of the market to themselves at the time. That was correct - I was once-upon-a-time a financial planner and Platinum was seen by many as the only real serious international equity manager that wasn't a closet index hugger available on investment platforms. MFG have done a superb job at building a quality team and have built the business into a serious funds manager with $37.2bn FUM. It's an outstanding success story.

For investors, I think there are several lessons from the meteoric returns of MFG:

Scaleable businesses are amazing but patience is required

Funds management is massively scaleable. Just like software and franchise businesses. However they may not make much money to start with, so it's important to take a long term view of the company. More importantly than the short term financials is the top line growth. Can management build revenue? Is there macro head/tailwinds? What is the competitive environment to stop the top-line being grown? If the business is genuinely gearing itself up for massive growth, then quite possibly the short term financials may actually be quite poor as investment is made into product, people and marketing.

Don't be afraid of heights

It doesn't really matter if the stock has already increased several times over if the story stacks up. You would still have made a massive amount of money even if you bought at the interim top in early 2011. Personally I think looking at charts can sometimes cause false vertigo as it puts a frame around your perspective. Look again at the first chart and honestly ask yourself whether you would have thought the performance would have been what you see in the second graph.

Diamonds in your back yard

Ironically, MFG was set up as an international funds manager yet itself has proven to be an absolute diamond of an on the ASX. And just look at how many fund managers are pushing their clients to invest overseas using the sales pitch of a bigger pool and more growth offshore. This may be true, but you only need one MFG in your life...

Inverse of a cigar butt

As noted, MFG never looked particularly cheap on standard value investor metrics. You really needed to take a longer term, DCF view to see the potential. This is the same with most growth stocks to be able to get your head around paying a PE of 20+ (if it's making money at all). Sure, growth stocks have been bid-up, so perhaps you could argue MFG and other similar growth stocks may not otherwise be at their current prices. But even a decent pull back in prices has still yield MFG investors obscene returns. However the main point is the reliability of the DCF. With a 'concept' stock it's a crap shoot. With simple(r), observable businesses like MFG, DMP and REA predicting growth is easier yet not obviously not fool-proof. 

Kristian 

Disclosure: no position in MFG. 

Contango Microcap Convertible Notes (CTN, CTNG)

It's been a while since I've had a good look through the ASX listed interest rate securities. These are found at the back of the tables in the AFR. See below for this weekend's (6-7 June): 

I tend to call all of these securities 'hybrids' including the corporate bonds, floating rate notes and convertible notes, although this is not strictly correct in some cases. As noted in previous posts, hybrids have been good hunting although the by and large the market is now more comfortable with this sector than five years ago and therefore there are less opportunities. Again, as previously noted I think there is room for more of these types of securities as there are a lot of investors who really just want income to help fund their retirement. 

One security that I like (but don't own) are the AFIG convertible notes: AFIG. I've written a few posts up on AFIG before here, here and here. On a similar note are the Contango Microcap Convertible Notes CTNG. Let's look at these in a bit more detail - starting with fundamentals and then structure.  

Fundamentals  

Contango Asset Management is a fund manager of both unlisted trusts and the listed Contango Microcap (CTN). The underlying performance of CTN has been solid (note these are pre-fee figures):

Source: Contango Quarterly March Update 2015

As you can see, CTN has been around over 10 years, and the market cap is $176m with 160m shares at a share price of $1.08. Pre-Tax NTA is $1.17 and post-tax NTA is $1.132. 

The company holds no debt except the CTN notes which we will come back to shortly. 

Like other good LIC's, CTN pays a healthy dividend stream of a minimum of 6% of NTA each year. Forecast full year dividends are 7.7c partly franked. So at $1.08 that gives a yield of 7.1%.

Anyway, all of this is pretty straight forward as a background to CTN. Let's move on to CTNG itself. 

Structure

CTNG is very similarly structured to AFIG. To be honest, if I were running a LIC I would seriously thinking about raising some debt in a similar fashion. 

In summary, here are the key features of CTNG: 

• Face value $100
• Current Price $102.85
• Unsecured
• Fixed interest of 5.5% p.a. (on face value, unfranked)
• Interest Payment dates are March and September each year
• Convertible into CTN shares at each Interest Payment date at a rate of $100/$1.30 = 76.92 CTN shares (i.e. each CTNG allows you to buy 76.92 shares)
• Final maturity date 31 March 2020 of $100

Like AFIG, CTNG has allowed CTN to take on some leverage without the annoying standard margin loan features such as the lenders ability to just remove a stock from a margin lending list. There are some gearing covenants which should be noted - see page 17 of the prospectus. However CTNG is hardly an Alan Bond style debt-ears-pinned-back move: there are $26.5m CTNG on issue versus CTN gross assets of $206.6m (31 December). 

So, what's to like from an investors point of view? Firstly, the yield is okay which is currently 5.3% p.a. (remember this in context of an RBA rate of 2%). Secondly, the twist in the tail is the embedded optionality. You get exposure to upside in the CTN share price above $1.30. Remember, CTN is $1.08 and is trading at a discount to NTA. And you have four and a half years to achieve this - even a mediocre investment performance by CTN would get you there. The biggest point to like is a floor in the price of $100. It's unlikely CTN will blowup, so the more probably worst case scenario is a mediocre investment performance and you just get your $100 back in 2020. 

Imagine some basic scenarios of CTN being $1.50 in March 2020. Your CTNG shares are worth 76.92 *$1.50 = $115.38 each. Throw in the interest payments of $5.50 p.a. and assuming you paid the current price of $102.85, your pre-tax IRR is 7.6% p.a. If the CTN moves to $2 then your pre-tax IRR is 13.4% p.a.  

What's not to like? Well if you think interest rates will move up then fixed rate securities aren't so fun. And Cantango could hold the share price down by increasing dividends and/or issuing dilutive options. And obviously we don't know if the CTN share price will move above $1.30 in the future. 

Also, CTN is not a pure-play Listed Investment Company (LIC). Contango internalised management and the proceeds of the fund are invested in another Contango vehicle Contango Income Generator fund which itself has not yet listed. This is potentially confusing to investors and distracting for management. 

However I think the main point is that CTNG is ultimately a bearish trade. If you just buy CTN you immediately get a higher dividend yield 7.1% p.a. (plus some franking). And if the CTN share price moves up to $1.50 your pre-tax IRR is 13.4% and for $2 it is 19.5% p.a. So unless CTN moves south in a decent way, you are better off with CTN rather than CTNG. However, I've been through the GFC and the appeal of a floor in the price has decent appeal and obviously everyone has their own preferences.    

It's tough to get excited by CTNG. For me to buy CTNG I would need to see a bigger divergence between CTN and CTNG so there is more value in the security.  

Kristian 

Disclosure: no position in any of the above securities. 

Devine Ltd (DVN)

Well, I got this one completely and utterly wrong.

My reasons for buying DVN were a) big discount to NTA, b) improving/firming general property market, c) the first upgrade in years (the end of the profit downgrade cycle), c) the company putting itself up for sale (following major shareholder Leighton wanting to cash out) and d) plenty of good gossip that a firm bid would be made. 

I wrote this is in detail almost a year ago when the price was 93c. 

The company sales process has fallen over and the share price is now 75c. So that adds up to a decent loss and makes me a schmuck.

Two questions:

With hindsight, would I do the trade again? Probably. There were two decent catalysts being an earnings upgrade and the company putting itself up for sale. And plenty of value in the stock with a decent margin of safety - even taking the view the company would be sold for less than NTA.

Checkout the share price movements over the last year:

The price-action makes it pretty obvious the deal has been dead for some time and insiders have been well ahead of the market. What I would do differently is be attempting to reconcile why the share price kept sinking in the face of good news. These are tough situations to judge. As often as not, selling because of poor-price action can also be the wrong thing to do, however a stop-loss rule would have made the decision a lot easier.

The second question is what to do now. The fall-through of the sale process is the loss of a big catalyst, so to continue holding really requires some damn good reasoning.

DVN is cheap. NTA has actually pushed up a bit from $1.52 to $1.55 (31/12/14) so at 75c you get a whole bunch of property for half price. However: value alone is not a great reason to buy, and as noted in my last post (BOL) a value stock without a catalyst is a value trap. For example AV Jennings (AVJ) has been a long-term dog trading at a big discount to NTA for years. DVN's fundamentals have been improving, free cash flow has really pumped along over the last 12 months helping to get debt rapidly paid down and put a chunk of cash in the balance sheet, forecast profit looks pretty good (and is a good jump from current levels) so it's really quite eye opening to see the price where it is.

Anyway, I haven't made a decision as to what to do with DVN. The commitment I made to myself in starting this blog was not to sweep losses under the carpet - so I wanted to publicly discuss this trade. Please feel free to contact me if you have any views on DVN (or other stocks).    

Kristian 

Disclosure: own DVN 

Boom Logistics (BOL)

Value trap = value stock without a catalyst

BOL so far has been a perfect value trap, and if I didn't already appreciate what a value trap was, being a BOL investor has certainly has taught me that lesson. I apologise if anyone has followed me so far on this one and not made money. To recap on the original reason for buying (see some of the original posts here, here and here), the core idea was the huge gap between market cap and NTA. It is still monstrous: market cap $57m (12c/share) v Net Equity of  $227.5m*; a 75% discount. *Estimate based on the last management update of net debt $72.8m and gearing of 32%. Note that most of the intangibles have already been written down, so NTA is within ~1% of net equity. 

BOL has lots of exposure to mining which you don't need me to tell you is in a world of hurt. So BOL keeps the bad news flowing and has completely failed to initiate the stock buy-back and has instead kept on paying down debt, helped partly by the sale of surplus assets. 

This isn't news. The question is what to do: a company that will probably continue to experience an indefinite period of operational toughness thanks to mining, a slow Australian economy and unions sucking the life out of the business YET trades at a massive discount to NTA. 

We are missing a catalyst.

Management need to get their heads out of the sand and act. As noted in previous posts, if the NTA is anywhere near correct, then speeding up the asset sales process and simultaneously buying back it's own stock at a fraction of physical cost just has to be a smart move - it's called arbitrage! At the current prices, the arbitrage difference is 4 times, or sell something for a $1 and buy it back for 25c. Management have fobbed off the buy back until once the company has a more stable earnings outlook and current volatility in pricing pressures and activity levels have settled (page 5, half year report to 31 December). This business will always inherently be cyclical thanks being exposed to cyclical industries. But with an opportunity to buy-back the farm at 25% of the balance sheet value, who cares about stability or the earnings outlook - in fact if the earnings outlook is that bad then surely it makes even more sense to sell more assets at current prices? Surely there is plenty of risk to the downside to asset prices if the tough times continue? The argument to buy-back only gets stronger as debt levels continually reduce and management keep proving that either they can't run the business effectively or the macro headwinds are just too strong. Again, as noted in previous posts, as the market cap is so small, it won't take a massive buy back to move the price along.

Other than management, we can of course hope for a lucky break through a takeover/merger or a big uptick in the economy and crane hire business. That however we would be exactly that - a lucky break. Unfortunately I'm not the lucky type of guy. I don't know what other catalysts can get the price moving.

Shareholders have simply not been rewarded for their investment and therefore I believe it's now time for a change of management to shake things up. I hope the board agrees. 

Kristian

Disclosure: own BOL

Paperlinx (PPX and PXUPA)

I last wrote about PPX/PXUPA late 2013.

The company has since been sputtering along and as a result, the board has clearly had enough and has been busy over the last six months selling Spicers Canada, sacking CEO/MD Andrew Price and most recently deciding to close its European operations.

Paperlinx is a lot like Elders: a crappy business with a crappy capital structure. This hasn't stopped ELDPA in particular being a superb trade. I noted in August 2013 the anomaly of ELD outperforming ELDPA for several months (it made no sense to me why ELD should be worth anything while ELDPA was valued at only a little bit). Since then, ELDPA has moved up by 356% while ELD has moved up 204%.

Today we are not in a dissimilar situation with PPX and PXUPA. And with both stocks selling at pennies-in-the-dollar and the company now in drastic weight-loss mode, I think the situation is worth a closer look.

Note the performance since the shares begun trading again April 15: PPX is up 106% v PXUPA up 34%. Again, this doesn't make sense to me. PXUPA stand in front of PPX for dividends and a wind-up, however PXUPA is being valued at 9.5% of face value yet PPX doubles in value, while PXUPA 'only' goes up by 34%? Someone is wrong here. Here are the market caps of PPX and PXUPA:

PPX: 665m shares @ 3.6c = $23.9m
PXUPA: 2.85m shares @ $9.50 = $27m

The face value of PXUPA is $100 per share (or $285m) however the market cap is less than 10% of that. So with PPX at $23.9m, I guess the market is punting lottery ticket style that assuming the company survives and PXUPA holders agree to a big haircut or the company does REALLY well that PPX shares might actually be worth something.

The company has traditionally had three operations: Europe, Canada and Australasia. Canada has been sold. Europe has long been a cancer to the business, however this is now being finally cut-out with businesses either being sold-off or placed into administration. The company has noted on several occasions that ANZA is financially separate from Europe. On this basis and assuming no skeletons in the closet (a big call), the slimmed-down company ought to be okay. FY2014 underlying EBIT for ANZA was $15.3m and has actually been pretty good: underlying EBIT for the last few years are FY13 $12.6m, FY12 $14.9m and FY11 $11.1m. Corporate costs have been tracking around the same level as the profit of the ANZA business, however that of course should be slashed drastically especially as Europe winds-down.

On a simplistic basis, wiping out Europe from the balance sheet and adding the C$63m from the sale proceeds of Spicers Canada to the net assets for ANZA of $146.7m (A $225.2m and L $78.5m) adds up to $209.7m - which is still well short of the face value of PXUPA. Looking at it another way, assuming corporate costs get wiped out entirely, ~$15m EBIT can't service interest on the remaining debt and potential PXUPA interest obligations (4.65% + BBSW - ~$18m p.a.). So even on a slimmed down basis it's hard to see much equity value left for PPX at the moment. It is much easier to see a very big capital raising for PPX to help pay down debt and try and come up with a deal for PXUPA holders. Note we have seen multiple capital raisings at ELD which have only helped ELDPA. 

I recently read a good blog post from Canada demonstrating the link between a clean capital structure and share price performance. As a generalisation this makes some sense. Lots of share issues, options, use of preference shares all show either a company in lots of need for finance and/or management being a bit clever with finance and not just growing a business. Compare that to a company with a relatively low and stable number of shares on issue tightly held by management: supply and demand dictates that if the company is doing well, the small free-float will be highly sought after by the market. PPX/PXUPA doesn't fit this category! These difficult situations are just that - difficult.

However after following this situation for years, I finally mustered the confidence to buy a few PXUPA. This is probably more out of curiosity to see how this all finally pans out! 

Kristian 

Disclosure: own PXUPA

Berkshire Hathaway Analysis - Follow Up Post (Part 2)

Happy Easter holiday.

This post follows from my post last week. In this post I look at Buffett's performance a bit more closely and discuss some strategies. This discussion isn't meant to be exhaustive - it is just some observations I have made over the years.

The central point of discussion is Buffett's Alpha, an article which decomposed Berkshire's performance for the period 1976 - 2011. Berkshire, with Buffett at the helm, has been going much longer than that. And previous to Berkshire, Buffett was more of a traditional fund manager via a series of partnerships from 1957 to 1969. This period is probably a better time to analyse his performance as no debt was involved. I say probably because there are stories of him finding good quality growth stocks selling for a PE of 1; you don't see that everyday! 

Anyway, his estimated pre-fees performance* over this time was 29.5% p.a. v the S&P500 performance of 7.4%. You would agree that's a truly extraordinary performance. That was during a time when Buffett managed a much smaller amount of money, and could therefore easily trade in and out small-cap situations and make great returns without leverage. That edge slowly disappeared as his funds grew and therefore his strategy had to evolve to the model we now see in Berkshire. 

So, if you aren't interested in using debt, however you want to really make a lot of money, then you will need to find investments that will deliver outsized un-leveraged returns. That may come from sources such as a job (a job with upside from commission, revenue or profit split is actually pretty cool: as an employee you risk absolutely no money, get trained, don't need to be loyal for a long period of time and still get upside potential), own a business or in the case of shares, go for the small cap space (as the younger Buffett did) where higher returns can be made (and lost). Un-leveraged property can work, but leverage is usually required unless the timing is bang-on. 

Let's consider using leverage. Would you go and get a margin loan to buy a portfolio of shares? After having gone through the GFC and seeing how badly both big-cap company's share prices and margin lenders themselves can act, I'm personally a bit iffy about it. In good markets the strategy can be amazing, however it gives you pause when it all goes pear shaped and you talk to a story of a postie who lost his life savings as he had a big fat margin loan against property stocks, Babcock & Brown and other similar stocks that are like Nassim Taleb's turkey just before July 4th. At the least, to use leverage in stocks you should have some other form of safety net such as using stop-losses, sticking to big relatively safe blue-chips, hedging through puts or shorts, an appropriate cash buffer etc. 

Personally (as an Australian), I think the Buffett-leverage model works pretty well with residential property for ordinary investors. Property is one of the very few assets that will undoubtedly be around in 10 years time (which is one of Buffett's criteria for an ideal investment) and bought cheaply should meet the 'value' criteria and bought in a location bound for growth (capital and rental) should meet the 'quality' criteria. Leverage on property is usually not a problem at all - in fact, banks love lending money against residential property. The major point of contention is the lack of cash-flow. Does neutral or negative gearing really fit the Buffett-leverage model? In isolation, no. However in context of overall income, tax minimisation and getting exposure to a relatively large amount of capital then I think it does. 

This is all obviously horses-for-courses and there are other considerations such as personal circumstance, experience, liquidity requirements, income requirements and appetite for debt. Naturally people should do their own research and please don't take this post as financial advice - it's not! 

Kristian 

*Estimated post-fees performance of 23.8% p.a. after paying 20% of profits above 6% threshold. 

Berkshire Hathaway Analysis - Follow Up Post (Part 1)

Just over two years ago I wrote a post called Berkshire Hathaway Analysis. I don't think I could have come up with a more boring title if I tried.  

That post has been sticking-in-my-side for some time now, and finally I had some headspace to go back and re-consider it. I started the initial post by asking just why so many smart people in finance don't know or admit to what impact leverage has had on Berkshire.

Well, as discussed in that post, some researchers attempted to answer that very question in a superb paper called Buffett's Alpha. Tim Ferriss would be proud of the attempt to decompose just how a world-class performer has achieved his remarkable success. Until now I actually can't think of any other article that I have read that quantitatively decomposes his returns - every article focusses on his stock picks, witty comments, insightful and extremely written letters and him as a person.  

There has long been a general consensus that Buffett has an X factor about his ability to synthesise information, develop insight and translate that into outstanding stock picks. After reading the article a number of times, I concluded that he does have an X factor, however not specifically as a traditional stock picker (e.g. a fund manager) but as a strategist: he developed a simple yet very powerful system at an early stage and had the stomach to see it through.

The research paper covers the period 1976 - 2011 and notes the excess return (over the T-bill rate) of the S&P500 was 6.1% v Berkshire 19.0%. The S&P500 (like all stock market indexes) have the privilege of a 0% tax rate, yet Berkshire is a tax-paying entity and therefore the pre-tax return is likely higher, however the paper does not split out tax (this would be a very difficult exercise).

The paper decomposes Berkshire's performance into a few different quantitative components.

Firstly leverage. The S&P500 is un-leveraged whereas Berkshire uses leverage. The paper estimates leverage to have averaged around 1.6:1 or a gearing ratio of a bit less than 40% based simply on assets and liabilities on the balance sheet over time. That's pretty significant, and the researchers estimate the index return would jump from 6.1% to around 10% if it was leveraged on a similar ratio.

So that still leaves around 9% excess return to account for. The next component is a quantitative screen for stocks based on value and quality. i.e. they were looking to decompose the Buffett stock picking X factor into a repeatable formula based on value metrics (P/B,CF,E etc) and quality (ROE, margin etc). What they found is that controlling for these quantitative metrics almost entirely removed the 9% excess.

That's pretty interesting.

The real magic seems to be the combination of leverage with relatively safe instruments such as cheap, quality stocks. A high beta portfolio does not work particularly well with leverage. This magic itself has a few ingredients. One is time. It's outstanding that Buffett thought of this idea at a relatively young age and had the stomach to stick with it over good times and bad and just let compound interest work its wonder.

The next is conditioning his fellow shareholders to think along his lines and not revolt during periods when it appears not to be working (e.g. the dot com era) therefore creating true 'permanent capital' - the holy grail of funds management. Never does he need to worry about fast money coming nor scared money leaving. I'm absolutely willing to bet that plenty of other good fund managers could achieve similar returns if they used a bit of leverage and had truly permanent capital.

The other ingredient is cheap debt. It is widely known that he invests the float of his insurance businesses. Most insurance companies lose money on their float however Buffett and his managers have often managed to actually make money on the float meaning they have had a negative cost of capital.

In the follow-up to this post I will delve into Buffett's performance a little more deeply and discuss how us ordinary investors can implement these ideas and delve into Buffett's performance

Kristian

AIMS Property Securities Fund (APW)

Apologies for the lack of posts. Been a little busy with some projects. 

In my last post on APW (December 1, 2014 click here) the unit price was 11.5c and I took the view it was worth on holding on for further gains given the massive discount to NTA and lots of cash.

That view proved to be correct.

The price has marched forward to 14.5c. NTA has also marched forward to 18.52c, thanks to further buy-backs and movement in the underlying NTA.

Controversially has management changed its investment guidelines to allow it be 100% invested in one security or manager. I read this as meaning APW could be fully invested in other AIMS securities. Management has stated previously it intends (and has done) to invest in other AIMS securities. Some people despise this given the potential conflict of interest it creates. Judging by the strengthened share price, it seems that on-balance the market seems to be fairly comfortable with this. As previously stated I am little more indifferent to this: I can see both sides of the argument.

I have gradually sold down my position completely, although regrettably less than the current price. I took the view - possibly incorrectly - the price may never reach NTA. I tend to find with these types of situations you need to be really cheap and sell cheap. Please don't take that as gospel, and clearly I was premature in this case. My original investment case was buying at ~50% discount to NTA and the view the NTA should grow over time. The discount has closed (but not fully) and the NTA has grown, so the investment case has worked out. Personally I'd be happy to buy back-in at cheaper prices.

Kristian

Disclosure: no position in APW

Australian Foundation Investment Company Ltd Convertible Notes (AFI, AFIG)

Happy New Year, 

Please click here for last post on AFIG. 

Here's a quick recap on how AFIG works: 

• Pay a fixed coupon of $6.25
• Current price is $117.49
• Current yield therefore 5.3% p.a. 
• Face value $100
• Maturity 28/2/17 (mature for $100)
• Investors can convert into ordinary AFI shares before maturity at a rate of $100/$5.09 = 19.6 AFI shares 

At the time of my last review (May, 2013), the AFI share price was $5.72. It is now $6.08. So what this means is the conversion value of AFIG to AFI shares are currently worth 19.6 * $6.08 = $119.17; a small 1.4% premium to the current AFIG price. 

The biggest risk, I think, is the AFI share price sags and AFIG shareholders basically lose $17.49 in capital value over the next few years until maturity. AFI is a very conservative listed investment company and is a loose proxy for the overall share market. Of course the stock market could go down over the next few years, however what I like is the limited downside in these notes. 

The flip-side of course is full upside exposure to AFI. That makes AFIG an asymmetric bet and an interesting vehicle for people looking to bet the market is going up over the next few years but wanting to remove some downside exposure. 

I'm personally chasing more alpha in my portfolio, however I can still see the case for AFIG in cash/fixed interest portfolios. 

Kristian 

Disclosure: no position in AFI or AFIG