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Venture Capital – There is Something Strange in the Neighbourhood

Investing into Venture Capital could not be further away from the focus of this blog. We are aiming to squeeze out returns from unloved and obscure companies that are trading substantially below their liquidation value and do not require growth or other forms of significant outperformance versus their current status quo to drive our return. If we were writing a blog about venture capital investing we would be looking for the next hot ticket and making investments on the basis of blue sky visions often with no expectation of profitable operations in the near or medium term.

Neither strategy is better (in our opinion) and there are some fantastically successful venture capital investors whose track records rival those of great value investors both in terms of returns but also longevity and consistency of performance. So whilst we would be absolutely awful deploying our capital in VC investments there have been a couple of interesting things we have recently been reading around the VC space that we wanted to highlight and discuss.

1. Andreessen Horowitz Presentation on US Tech Funding

Andreessen Horowitz – US Tech Funding.pdf

Whilst Andreessen Horowitz was only founded in 2009 its cofounders Marc Andreessen and Ben Horowitz were very well known VC investors in their own right prior to joining forces and founding this firm. Today it manages $4bn of capital and is known for playing in the mature end of the market at one point owning four of the highest valued privately held social media companies at the time (Facebook, Groupon, Twitter and Zynga).

This is a great thought provoking presentation whose central argument is that all the recent activity and investor interest in technology companies is not comparable to the tech bubble that occurred in the early 2000s. Core to their argument are the following points:

  1. Whilst tech indices are growing in value this is being driven by earnings and not multiple expansion
  2. You have not seen anywhere near the public market listing frenzy that we experienced in the early 2000s
  3. There has been a step change in the size of the market that tech companies are addressing (internet usage and smart phones). To highlight this they provide an interesting metric of tech funding by person online (this does remind us of the Wall Street research analyst folly during the 2000s bubble of inventing new valuation metrics such as “number of eye ball valuation metrics.”)
  4. US ecommerce and online advertising has increased 15x since 1999 and represents a significant addressable market from an economic standpoint
  5. We have not seen the same surge in VC funding that you saw in the 2000s bubble (lower funding also as a % of US tech GDP vs the previous bubble)
  6. The large fundraising rounds get a lot of focus but the majority of the capital deployed is in smaller companies where it has gotten cheaper to start a new venture

Away from the core theme the presenters also focus on trying to explain the “unicorn” phenomenon in VC (a unicorn is a private company with valuation in excess of $1bn). They make an interesting point that the time to IPO for successful tech start-ups is now substantially longer than in the early 2000s. The presentation also makes a compelling case that today tech IPOs have been delayed or even replaced by private funding rounds and imply that the risk of a bubble is lower as these funding rounds are focused on later stage companies. The big gap in the presentation is that they do not prove that there is not a bubble in the privately funded VC companies as they make their argument for why there has been a shift from the public to private market capital as a source of VC funding.

The biggest question the presentation left us with is whether a bubble has occurred in the private capital markets focused solely on the large capital rounds as institutional, sovereign and corporate investors struggle to deploy enough capital into “attractive” opportunities in this low inflation environment. There are two pages that sum up the key part that is missing in their defence of a tech bubble: (i) “Yes there is more funding for larger deals” (p22), and; (ii) “But this is just a rebalancing from IPOs” (p23). The problem with their arguments about tech contribution being flat as a % of GDP and other metrics about the step change in size of the industry is illustrated on p60 where they show that only $212bn out of a total market value of $3,085bn is represented by unicorns, just 6.9%. It is not inconceivable that irrational exuberance has crept into this part of the market.

The one metric we would love to see that would go a long way to evaluating whether we are in fact seeing a bubble in the unicorn VC deals is a comparison of p/e multiples by funding round to the p/e of the listed companies during the early 2000s bubble similar to what is shown on p7 (our guess is this is difficult to compile due to the private nature of all of these unicorns)

This is probably unfair given the quality of presentation and the thought behind it but after reading it we could not help but be reminded of one of our favourite investing quotes:

When people are saying: “this time it is different” grab your wallet and walk carefully toward the door. History never precisely repeats, but it does rhyme.”

Jesse Livermore

2. The Increasingly Crowded Unicorn Club

The Increasingly Crowded Unicorn Club

Not much to say here (particularly as we do not know over half these companies) other that as always a picture tells a thousand words.

3. The Square IPO

Deal Book – Square, Facing a Chilly Market, Persists in Pursuing I.P.O

In the context of the thought process that the Horowitz piece began we thought this article and process was very interesting for two reasons.

First you are seeing the public markets require a 35% valuation discount to the last private market capital raise valuation in order to get the IPO away.

Second there is another hidden source of losses / potential excess valuation in private VC funding which is the existence of different economic rights for later stage investors such as shares with liquidation preferences or in the case of the square anti-dilution ratchets.

Now a disciple would say that point two is fine as these rights are typically only given to late stage investors and even if there is dilution of early stage investors on a monetisation event they will be making out like bandits regardless. However, given the furious pace of funding rounds we wonder whether there will be some late stage investors who subscribed at similar valuations but get disproportionally hurt in a downdraft as they find themselves sitting on the wrong chair from an anti-dilution perspective when the music stops.


To be clear we are not advocating for the existence of a bubble in late stage / unicorn VC deals, our knowledge and data is simply too skin deep to make any conclusions either way. However, it is always useful to take a critical look at other investment classes as well as your own and ask which offers the best value and risk/return.

Would be great to hear other people’s opinion on VC and any good data they have come across on valuations.

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12 Things We Have Learned From Reading The 25iq Blog

If you have not read Tren Griffin’s 25iq Blog we would highly highly recommend it. The highlight of the 25iq Blog is a series of articles entitled “A Dozen Things I’ve Learned from …” which covers a whole host of value and VC investors as well as some leading entrepreneurs past and present.

Having read the blog cover to cover we thought it would be good to highlight the twelve things we have learned (or at least have had reinforced) from great men and women in a chapeau to a great blog. Thanks Tren

[the lessons below are in no particular order of importance and should be viewed in the round]


1. Keep Things Simple!

“Listen, business is easy. If you’ve got a low downside and a big upside, you go do it. If you’ve got a big downside and a small upside, you run away. The only time you have any work to do is when you have a big downside and a big upside.” Sam Zell

This is an absolutely brilliant quote. Drawing on our limited experience since starting this blog the securities we have spent most of our time agonising over have been related to Sam’s third category (e.g. Unitech Corporate Parks). We are continuously left with the feeling that a good investor really needs to size their best longs aggressively given good ideas are so rare.


2. Don’t agonise over forecasts and recognise the limitations you are working with

“We deal in probabilities, not predictions.” Marty Whitman

“In both economic forecasting and investment management, it’s worth noting that there’s usually someone who gets it exactly right… but it’s rarely the same person twice. The most successful investors get things ‘about right’ most of the time, and that’s much better than the rest.” Howard Marks

Investing is a probabilistic exercise where the frequency of an investor’s correctness should not be the focus but rather the magnitude of correctness. We all need to recognise that there is risk, uncertainty and ignorance involved in investing and diligently focus in on an approach that minimises the risk inherent in uncertainty.


3. Investing is physiologically though, the temptation to lapse into bad habits is ever present

“The biggest investing errors come not from factors that are informational or analytical, but from those that are psychological.” Howard Marks

Psychological mistakes are at the same time the biggest source of danger for an investor and the biggest source of opportunity when other people succumb to those mistakes. Staying apart from the maddening crowds, having stable capital and a long term outlook will put you in a very small club that can exploit the psychological flaws of others.

25iq has an absolutely fantastic post about the 12 most common human psychological flaws. We would encourage everyone to read it and identify past examples of your biases (link


4. Stay within your “Circle of Competence”

People seem more comfortable investing in something about which they are entirely ignorant.” Peter Lynch
We have found it particularly hard not to fall into this trap when we are looking at seemly attractive value opportunities in either technology or financial companies which are both areas where we lack a great deal of knowledge compared to “real world” industries. It is likely that we will post an investment memo in the coming weeks about a financial company that looks incredibly cheap but the biggest risk is that we are not 100% on top of their business model and think it is difficult to be as an amateur investor.


5. The key determinant of a business value is current and future cash generation

“If you don‘t have the free cash flow, you don‘t have anything.” Leon Cooperman

The only unforgivable sin is to run out of cash. At HIPS when we screen for deep value opportunities positive operating free cash flow (or in a few cases a very small burn rate vs the margin of safety) is an absolute must.

Away from investing our other hobby is collecting art and friends often ask if we are doing it is an investment to which the answer is always no. Art’s only inherent value is what at least one person is willing to pay for it. We have picked up cracking pieces at auction because we were the only buyer, similarly we have paid over the odds for rare items because there was one other buyer in the room. Compare this to cash which is globally fungible and can be used to buy anything, particularly other assets that generate more cash. As a value investor should always be looking to acquire the asset that generates the most cash over a long period of time at the lowest risk which is selling for the cheapest price. As usual Warren Buffet put it best in his excellent article extolling the dangers of investing in gold particularly this quote: “if you own an ounce of gold for an eternity, you will still own an ounce at its end.”


6. Spend as much time learning from your mistakes as your successes

“It is fine to celebrate success, but it is more important to heed the lessons of failure.” and “There are many lessons about the dangers of success, and Henry [Ford] is one of them.” Bill Gates

Failure is an opportunity to learn. The more you learn in life the more you learn that there is even more you don’t know and that some things are unknowable.  What you may attribute to success may be luck and vice versa.  Success in one domain does not equate to success in all domains.  Success may cause you to succumb to “man with a hammer syndrome (everything looks like a nail).”


7. Nothing good or bad goes on forever. Don’t extrapolate something indefinitely

“Rule No. 1:  Most things will prove to be cyclical. – Rule No. 2:  Some of the greatest opportunities for gain and loss come when other people forget Rule No. 1.” Howard Marks

“Whatever happens in the stock market today has happened before and will happen again.” Jesse Livermore

When people are saying: “this time it is different” grab your wallet and walk carefully toward the door. History never precisely repeats, but it does rhyme.” That markets will fluctuate in cycles is inevitable; predicting the timing and extent of the cycles is impossible.  Value investing is about putting yourself in position to benefit when the inevitable happens.  Price, don’t predict!


8. “Unless you’re running scared all the time, you’re gone”

“Unless you’re running scared all the time, you’re gone.” Bill Gates

“A steel company might think it is competing with other steel companies. But we are competing with all other companies.” Henry Singleton 

In our opinion Bill’s quote applies to life away from investing. Being paranoid, self-reflective and constantly in search of improvement is the hallmark of the most successful people we have encountered. Given we are apt to buying business that are mispriced due to a structural change in their market Henry Singleton’s quote resonates a lot with us. We have found it difficult to find a moat that we can really underwrite for 100years particularly in the age of disruptive technology. Businesses tend to fail not from a frontal attack, but when they are eclipsed or enveloped.


9. Don’t buy anything that doesn’t have a substantial margin of safety

Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose.” Seth Klarman

“A lot of people talk about risk in the stock market as the risk of stock prices moving up and down every day.  We don’t think that’s the risk that you should be focused on.  The risk you should be focused on is if you invest in a business, what are the chances that you’re going to lose your money, that there is going to be a permanent loss.” “[The] key here is not just shooting for the fences, but avoiding losses.” Bill Ackman

As Buffett says Rule No.1 is “not to lose money,’ and Rule No. 2 is “not to forget Rule No. 1.” The second point to bear in mind is to only care about permanent capital loss and not market to market movements. Permeant loss of capital can only occur if your underwriting of a business was incorrect and something occurs that fundamentally and permanently changes the cash flow generation profile of the assets (think yellow pages when google thundered onto the scene). We are also constantly reminded that the volatility of a stock, known as beta, has absolutely no bearing on the securities inherent risk of a security and anyone trying to tell you otherwise should be rounded ignored.


10. Don’t let your first purchase price anchor your subsequent buying if Mr. Market presents more paper substantially lower

“Your profit is the difference between your average purchase price and your average selling price. Bernard Baruch [a great investor in the 1920s] said nobody buys at the bottom and sells at the top except liars. Your stock will go down after you buy it, and it will go up after you sell it. Being willing to lower your average cost [by buying more when a stock drops] is a great strategy. But it’s difficult.” Ben Miller

Every purchase we made in the HIPS portfolio (albeit we have not made many) has gone down after we purchased it. Probably our biggest asset allocation sin to date has not been adding to Caltagirone Editore when it was in the 0.80s despite the fact that the business had turned EBITDA positive compared to when we initiated the position at EUR 1.00. There are reasons for this and hindsight is always 20:20 but it illustrates Ben’s point. You should not be adding a position to your portfolio that you would not be comfortable buying if it was 50% down without any fundamental change in the facts driving value.


11. Hold a concentrated portfolio of high conviction stocks that represent your best ideas

“Owning stocks is like having children — don’t get involved with more than you can handle. The part-time stock picker probably has time to follow 8-12 companies.” Peter Lynch

“An investor is better off knowing a lot about a few investments than knowing only a little about each of a great many holdings…. you diversify most of the diversifiable risk away from a portfolio by owning 20 or 25 positions.” Seth Klarman

“…for an individual investor you want to own at least 10 and probably 15 and as many as 20 different securities.  Many people would consider that to be a relatively highly concentrated portfolio.  In our view you want to own the best 10 or 15 businesses you can find, and if you invest in low leverage / high quality companies, that’s a comfortable degree of diversification.” Bill Ackman

There are a lot of different opinions amongst proven value investors about diversification. Investors like Walter Schloss and Joel Greenblatt have high 10s to hundreds of securities in their portfolios whilst the giants quoted above are all comfortable with less than 20. Marty Whitman once argued that once your portfolio exceeds 40 names the risk of closet indexing is high. What is clear to us is that you need to find your own style as an investor and just because we gravitate to a concentrated high conviction strategy doesn’t mean you should.


12. Remember the importance of having an “edge”

“To make money, you must find something that nobody else knows, or do something that others won’t do because they have rigid mind-sets.” Peter Lynch

“[At a horse racing track people make] bets and the odds change based on what’s bet. That’s what happens in the stock market.” Charlie Munger

We debated whether to include this as having an information edge is very difficult for the amateur investor. The quote from Munger puts this best as it highlights that betting on a favourite or long shot may or may not be a good bet. What matters is whether it is “mispriced” in your favour because the market is missing something. We believe that the market is efficient most of the time and therefore you need wait for the right pitch and look in areas where market inefficiency is likely to occur more often.

We decided to include it as we believe the amateur can generate edge by digging in the illiquid, obscure backwaters of the stock market where the professional money manager doesn’t tread. When reading other investment websites where both amateur and professional investors pitch their top ideas we are always surprised to see that the majority of the recommendations are large cap stocks that are very well covered by the street research analysts, money managers and newswires. It seems to us that your statistical probability of finding something that gives you confidence that you will outperform on an absolute basis seems very remote compared to less well covered parts of the market. Remember it is mathematically certain that you can’t beat the market if you *are* the market.


We hope this was as helpful as the content on the 25iq blog; it is certainly no match for it. The only thing we did not add as we thought it was too obvious but is definitely something you need to focus on if you do not already is to remember that “A share of a stock is not a lottery ticket. It’s part ownership of a business.” Peter Lynch. The right thing for an investor to love is the process of investing, not the bet itself.  The right process for an investor is to understand the value generated by the underlying business.

Happy hunting

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A Swing & A Miss! (No. 1)

“I call investing the greatest business in the world because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There’s no penalty expect opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it. The problem when you are a money manager is that your fans keep yelling, ‘Swing, you bum!'” Warren Buffett

It is really difficult to find good investment ideas and when you do it is even harder to have the conviction and fortitude to size them appropriately. I read a lot of annual and quarterly reports in a given week and a vanishingly small number show characteristics that warrant further work. Of those that do a depressingly small amount withstand further analytical scrutiny and make it into my portfolio.

This post is intended to be a regular feature of securities that initially peaked my interest but fell down after further analysis. I hope people will find it interesting and hopefully spot things that I have missed in my review that may make them hidden gems.


ACE Aviation (ACE/H CN)

Insufficient upside / downside profile

ACE Aviation is the liquidation of the historic Air Canada holding company. I absolutely love liquidations due to locked box nature of the balance sheet and the aversion they seem to cause in most investors. Alongside determining the asset side you often have to assess a set of associated liabilities, the costs of realising the assets and finally the weighted average life to realise the assets.

Taking a quick read of the ACE reporting the estate is now effectively a cash box with a market cap trading at a c. 12.4% discount to ultimate realisation (when I was looking it was at CAD$ 0.50 vs 0.52 today). Obviously this is not a prospective investment that would set the world on fire but given the difficulty finding good value candidates I was thinking it could have a place in my portfolio as a substitute for cash.

The reason for ACE being a miss is rather embarrassing and relates to me miss reading the units in the discussion section of the reporting believing that the only remaining contingent liabilities, the tax indemnities, were being quoted in CAD$ when in fact they were in CAD$ 000s.

Post dividend I estimate the expected realisation and associated returns for shareholders from the ACG estate as follows:

ACE Aviation Valuation (2015.08.02)

What this analysis doesn’t capture is a remaining contingent liability that relates to a tax indemnity ACE provided to Air Canada in 2010 totalling CAD$ 50.1m. The reporting states that “the large majority of the input tax credit claims covered by the indemnity in favour of Air Canada expired at the 2014, with the remaining reassessment periods gradually expiring by 2016.” Given this the timing of the estate’s first dividend since entering voluntary liquidation (April 2015) makes sense in conjunction with the dismissal of other contingent claims. The liquidator also states that “Future distributions of ACE’s remaining net cash to its shareholders are subject to the expiration or settlement of any contingencies.”

I cannot find in any disclosure exactly how much of the CAD$ 50.1m indemnity expired in 2014 but my guess that something close to the cash retained remains outstanding. This investment is a miss for me due to the lack of downside protection. Whilst no tax claims have been made for c. 4/5 years if any did arise between now and 2016 you could get wiped out and a c. 10% return is no enough to take that risk.

South African Property Opportunities Plc (SAPO LN)

Lack of return for illiquidity and currency risk

SAPO is a listed property fund that is in the process of liquidating. The fund invested in development land in South African focused on Industrial, Retail and residential purposes. The equity is listed in the UK but all the assets are denominated in ZAR. The board changed asset manager in the middle of 2014 to try and manage the costs of the wind down.

See below for my valuation:

SAPO LN Valuation (2015.08.02)

What I really liked about this potential investment is the fact that cash, unconditional sales, and properties under offer net of the non-controlling interest, loans from third parties and the 1.5% performance fee on the expected sale price equates to c. 80% of your purchase price which provides a good level of downside protection.

The problem with the investment is that the upside after taking account of expected cost to realise the assets is not very compelling at 1.42x. Given that jurisdiction and the fact that it is undeveloped and in certain cases non- permitted land I would want 1.75 – 2.00x expected return. Also whilst not having any macro views the ZAR/GBP exchange rate is extremely volatile and has been going the wrong way. It never feels good to be buying a company in a currency different from the currency of its underlying assets and is clearly much harder to hedge.

Finally all of this is pretty academic as it is one of the most illiquid stocks I have ever seen trading only once or twice a month which further points to the need for a meaningful return. I would be a buyer at c. GBp 14.00

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The Risks of Being a Minority Investor & the Importance of Margin of Safety

I wanted to use the example of Beaumont Select Corporation (BMN/A or BMNTF) which was a security I had researched and was going to buy as an example of the risks as a minority investor and also generate some discussion about when being in a minority is a risk worth taking. Beaumont is also a good lesson as to why a healthy margin of safety is required in all investments (and an example of what goes around comes around!)

Background to Beaumont Select Corporation

As with most of the companies I get interested in Beaumont was unusual. It consisted of two principal business lines:

  1. Naleway Foods – Canada’s leading manufacturer of Perogies. Perogies originate from Central & Eastern Europe and are dumplings of unlevened dough which are either served boiled with toppings or stuffed and fried.
  2. Investment Division – consisted of a portfolio of equity securities financed through a combination of cash and margin loans

Naleway Foods was cash flow negative and had been a drag on the performance of the company whilst the investment division had been a runaway success (see details later on). It is unclear how and when these two businesses were married but they have been in existence since publically available records (at least easily accessible ones) began 1997 and when the investment portfolio was only CAD$ c. 600k and the food business had revenues of CAD$ c. 27m

The final piece of background is a word about the controlling shareholder Winston Ho Fat. What I knew at the time of my analysis was that:

  • He was the controlling shareholder in Beaumont and has been since available records when he held in excess of 60% of the stock in 1997
  • He has at various times been CFO, CEO and Chairman of Beaumont
  • Under his stewardship the company had been actively buying back shares to reflect that the trading price undervalued the company in the view of management (I found these comments all the way back to 2000)
  • Through his company Somerset properties he had also been acquiring shares in the company and had c. 94% of the equity ownership when I started my work

I started looking at Beaumont in the middle of 2014 when they announced that they had sold Naleway Foods to its management which I saw as significantly de-risking an investment in Beaumont’s common equity.

My Views on Beaumont’s Fair Value

On the asset side Beaumont had the following assets

1. Equity Portfolio

  • Ten core securities representing 90% of the value of the portfolio with the remaining 10% spread across 48 other securities
  • 42% of the portfolio was made up of one security AutoCanada, Canada’s largest franchised auto dealership
  • I analysed the portfolio back to December 2011 to look at returns by security and holding periods which showed that the holding period was always in excess of a year and that Beaumont would often continuously build positions over a long period of time
  • Across nine securities the return were decent with a win/loss ratio of c. 66% and most money multiples in the 1.5x range
  • What was most striking was that the clear knockout winner was their AutoCanada investment which at the time of our analysis was an 8.4x MoM for a total profit less investment costs of c. CAD$ 26m (to do the proper deep dive I should have dug into AutoCanada but there are only so many hours in the non working day)
  • It is worth noting that disclosure on the portfolio was limited and this was the best I could piece together but it is by no means a robust analysis of Beaumont’s skill as an equity asset allocator

 2. Naleway Foods & associated real estate

  • As part of the sale the business gave management a vendor loan of CAD$ 1.3m which I valued at par
  • Beaumont also retained the warehouse which Naleway continued to rent and I valued at CAD$ 1.65m based on a estimated rent per square metre (using Colliers Canada data and precedents in the same industrial park) and a 10% cap rate reflecting the poor performance of the tenant

From the above I concluded that the underlying asset value of Beaumont was CAD$ c. 65.8m from which I needed to add/(deduct) the following liabilities:

  1. Corporate debt – CAD$ (1.9)m
  2. Margin loans – CAD$ (26.3)m
  3. Cash – CAD$ 3.5m

This got me to a net equity value of CAD$ 41.1m but in order to arrive at the correct value to Beaumont’s shareholders I needed to reflect one final asset

1. Somerset Properties

  • Somerset is a private entity owned by Mr Fat whose business dealings were intertwined with Beaumont both from an ownership and lending perspective
  • At the time of my analysis Somerset had CAD$ 350k left to pay on a loan from Beaumont which I valued at par
  • More interestingly was the fact that Somerset owned c. 63.7% of Beaumont equity (Mr Fat directly owned c. 28.2%) but at the same time Beaumont owned 19.3% of Somerset’s equity. This circular ownership represents additional value for Beaumont’s common equity
  • Unfortunately in answer to my question about getting accounts for Somerset so that I could assess the value of Beaumont’s stake in the business I was told by management that these were not available (again another plea to anyone who knows if there is any mandatory public filing of accounts in Canada similar to UK companies house)
  • Despite knowing that Somerset had its own separate portfolio of securities from comments in Beaumont’s regulatory releases I felt it was prudent to simply value Somerset on the basis of its stake in Beaumont which was 12.3% net (63.7% * 19.3%)
  • This provided a total value for Somerset of CAD$ 5.0m (acknowledging that it could have been much higher or 0)

Making this adjustment gave me a total equity value of $46.1m and a value per share of CAD$ 2.85 vs a trading price at the time of CAD$ 1.70

Beaumont Take Private

On 17th October 2014 Beaumont amounted a take private transaction at CAD$ 2.05 per share a 20% premium to the previous trading price but an c. 28% discount to a conservative fair value.

Normally under Canadian takeover rules when a takeover is proposed by a majority shareholder there are a number of protections for minority holders principally (a) the deal needs to be voted through by a majority of the minority shareholders, (b) an independent valuation needs to be produced for the shareholders, and; (c) a court needs to opine on the fairness of the offer to a minority shareholders

However, in addition to a plan of arrangement and a take-over bid Canadian corporate law also allows for an Amalgamation Squeeze Out. The amalgamation works as follows:

  1. The Bidder (and along with its joint actors), usually a controlling shareholder in a GPT, sets up a new wholly-owned subsidiary in the same jurisdiction of the acquiree (the “BidCo“), to which the Bidder transferred all of its shares of the acquiree;
  2. An amalgamation of BidCo and acquiree is proposed and negotiated between the Bidder and the acquiree;
  3. A shareholders meeting of the BidCo and acquiree is called, respectively, and both BidCo and acquiree shall approve the amalgamation by a special resolution (i.e., 2/3 of votes cast of the shareholders who vote on the resolution);
  4. Upon amalgamation, the Bidder (and along with its joint actors) receives all of the voting shares of the amalgamated company in exchange for its shares in BidCo and all the shareholders of the acquiree receive either cash or, more commonly, redeemable shares in the amalgamated company; and
  5. When the transaction is completed, the redeemable shares of the amalgamated company are immediately redeemed for cash. At the end of the day, the Bidder (along with its joint actors) becomes the sole shareholder of the amalgamated company.

Crucially, in the case of Beaumont, is the fact that an amalgamation squeeze-out for a TSX Venture issuer, does not require a formal valuation (by applying the same exemption as discussed in the plan of arrangement) nor a majority of minority shareholder approval. In other words, a transaction devoid of minority protections is totally fine

It was via this method that Mr. Fat legally acquired a set of assets he could have easily liquidated for at least a c. 28% profit day 1 (almost all the positions in the security portfolio represented less than 10 days trading assuming they were liquidated at 20% of the 15day average daily traded volume of the given security). I have to take my hat off to Mr Fat, it is very rare to find a management team / owner that will mandate a company to doggedly purchase their stock over 14 years to the point that they are the defacto controlling shareholder. Furthermore this was absolutely the right capital allocation decision for Beaumont as despite their stellar performance in stock picking I doubt they would have been evaluating many securities that traded at a 60% or greater discount to fair value. Finally why should Mr. Fat not be allowed to chisel the minority shareholders for the value he had generated for them and also in recognition of a neat and not often used part of Canadian corporate law.

The importance of a margin of safety

Where you might ask in this story is the lesson of the importance of buying assets at a substantial discount to fair value. Well in writing up this piece (months after the event) I went back to my Beaumont model and could not understand why it no longer showed the large discount to fair value but that Beaumont was trading at around its NAV. The answer was that my excel was picking up the current prices for Beaumont’s stock holdings and not those that existed at the time I was buying the stock

Since the take private, assuming that Beaumont’s holdings remained static and Somerset was worth what I think it was worth (which is a stab in the dark), the value of Beaumont’s securities portfolio has declined by 30% which led to a decline in the equity value of 45% due to leverage through margin loans (the one thing I didn’t like about Beaumont)

At the time I was pretty cheesed off at getting taken out at an undervalue but perhaps Winston did me a favour.

Beaumont Memo (2015.03.15)

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Investing in Legal / Litigation Plays

I often come across stub end securities where the remaining asset is either the subject of a dispute between the company and another party or is in the form of a litigation claim against a third party. Despite nearly all the situations trading at a substantial discount to the face value of the disputed assets/claims I have never found a security where I felt that either (a) there was a sufficient margin of safety vs the potential upside to warrant adding it to the portfolio or (b) where I had enough of an edge in evaluating the dispute / litigation to enable me to conclude that the security was mispricing the probability of success.

In this post I highlight two current situations I have evaluated where the investment hinges on the outcome of a litigation and whose securities are trading near a potential buy price. It would be great to hear from investors who have invested in similar situations or anyone who feels they have an edge in valuing the litigation assets in the two cases reviewed or others.

Jubii Europe

BUY @ EUR 0.05

Jubii is a long running liquidation that has priced at interesting levels at various times since the beginning of the liquidation process in December 2008. Today it is in the final stages with only two entities remaining and 1.5 employees.

The valuation of Jubii as of 30 Sep 2014 is as follows:

  • Cash – EUR 18,000,000
  • Accounts receivable – EUR 81,000
  • Prepaid expenses and other current assets – EUR 129,000
  • Accounts payable – EUR (690,000)
  • Other ST liabilities – EUR (281,000)
  • Provision – EUR (1,586,000)
  • Litigation Asset – EUR [?]
  • TEV – EUR 15,653,000

In arriving at this valuation I have excluded current tax assets of EUR 277,000 as the company is loss making (and has no revenue) so it is difficult to see how these could be monetised (outside of winning the litigation). Also worth noting that only the cash balance is as of September 2014 as Jubii only provides balance sheet granularity in their half and full year results.

Jubii has total shares outstanding of 311,576,344 (excluding treasury shares) which would put the current fair value at EUR 0.05 a share. However, this valuation is an overstatement from a margin of safety point of view as the enterprise is not generating any income and is currently burning through c. EUR 1,500,000 a year from a combination of the general running costs and the costs of pursuing the litigation.

Jubii’s litigation is being mounted by their Swedish subsidiary Yarps Network Services AB against the Swedish telecom company Telia Sonera for abuse of a dominant position in relation to the internet access business previously offered in Sweden. In another lawsuit by the Swedish Competition Authority, based on similar facts, a fine was imposed on TeliaSonera by the Stockholm District Court in the amount of 144 million SEK. TeliaSonera appealed the fine before the appellate Market Court and in 2013 the Market Court found that TeliaSonera had abused its dominant position through margin squeeze; however for a shorter period of time and the fine was lowered to 35 million SEK.

In Jubii’s case the face value of their claim against Telia Sonera is SEK385m which is worth c. EUR 41m today. The litigation was started in May 2011 and there still has not been a judgement in a court of first instance. Jubii has stated that delays have been caused by last minute objections from TeliaSonera and in their most recent report dated Sep 2014 Jubii updated that “The Stockholm District Court informed Yarps in October that the responsible judge in Yarps’ proceeding against TeliaSonera has retired and a new judge and assistant judge have been appointed to the case. This might result in further delay.”

Jubii has guided that the face value of their litigation claim is c. EUR 45m which was accurate in May 2011 when the litigation started and the SEK/EUR exchange rate was 0.112 but today the claim value will have diminished slightly to EUR 41m based on the current exchange rate of 0.107 and assuming the claim value is SEK 385m as reported on their lawyers website (Hammarskiold AB)

In order to pursue this claim the estate burnt EUR 741,000 of cash in H1 2014 on top of its normal running costs of c. EUR 250,000 for the period (my estimate). Given that almost four years have passed since the claim commenced and the most recent comments from Jubii on the status of the case a conservative assumption for the remaining time to a decision in first instance would be 3 years. I assume annual running costs of EUR 1,500,000 a year for a total cost of EUR 4,500,000. The one area of upside to this assumption could be that the provisions on the balance sheet already capture an estimation of Jubii’s future costs ex. the litigation which would mean I am double counting. It is also worth noting that in most courts the winner of a litigation will have their costs covered although this could be also be a downside for Jubii (unclear whether they could just liquidate Yarps without a look through claim onto the parent if they lost the litigation).

Adjusting my valuation for the remaining cost to a first instance decision gets me down to a fair value of EUR 11,153,000 or EUR 0.0358 per share. The share price close as of 20th Feb 2015 was EUR 0.052 which gives an enterprise value of EUR 16,199,888 which implies that the market is valuing the outcome of the litigation at EUR 5,046,888 against expected litigation proceeds of EUR 45,000,0000 (I have assumed the EUR 41m face value of claim plus cost recovery of EUR 4m).

In evaluating the risk/reward presented by Jubii I thought about it along two lines. First you could infer the probability the market is ascribing to Jubii being successful based on the implied value the market is ascribing to the claim (current market value less fair value) over the total size of the claim. Doing this maths would imply that the market is pricing in an 11% probability of success (21% if you factor in EUR 4.5m of cost awards to TeliaSonera if they win)

A second way of evaluating the risk reward is to look at your payoff ratio. In the case of Jubii you conservatively stand to loose EUR 9,546,888 (assume cost awards of EUR 4.5m if TeliaSonera wins) against a payoff of EUR 45,000,000 or a ratio of profit to loss of 4.7x.

Neither of these two ratios seem awful (particularly when compared with the Unitech example, albeit it is better in other ways) but my fundamental issue is that I could not do any research on the underlying asset (i.e. the litigation case). A big part of this was the language barrier, I was not even able to find the ruling of the Swedish Competition Authority and compare it with the Yarps claim (assuming either of these things are even public like they would be in the US or UK). Even if I had the competition authority’s case it is likely to be extremely complicated and fact specific making it difficult to assess the merits of Jubii’s case

I would add Jubii shares to my portfolio as a 2% position if the stock go to EUR 0.05 which would represent a 5 to 1 profit to loss ratio and seems like a reasonable payoff particularly as this ratio reflects cost awards to TeliaSonera which I am not sure they would ultimately recover if Yarps is liquidated on a loss (without cost awards it is a 8.9x payoff ratio).

Unitech Corporate Parks Plc

BUY @ £0.025

Unitech Corporate Parks was a London aim listed company that invested in Indian commercial real estate focused on the growing IT sector. On the 11th June 2014 the company announced that it has entered into an agreement with Brookfield Property Partners to sell all the assets of the group and dividend all the proceeds back to shareholders.

In consideration for the sale Unitech received £205.9m of gross assets less £15.7m of disputed assets held by two institutions and £1.2m payments to Unitech prior to completion resulting in £188.9m of cash being received by Unitech

The company made an initial distribution to shareholders of £177.3m on the 16th January 2015 which leaves the following assets

  • Cash – £11.6m
  • Disputed deposits – £15.8m
  • Winding Up costs of – £(3.6m)
  • Cost contingency – £(4.0m)
  • Tax contingency – £(4.0m)
  • TEV – £15.8m

The disputed deposits related to two cash deposits made by two of Unitech’s joint ventures (G2 & G1) into two different funds:

  • SREI Infrastructure Fund (on behalf of G2) – £9.731m
  • Aten Capital Pvt (on behalf of G2) – £0.241m
  • Aten Portfolio Managers Services Pvt (on behalf of both G2 & G1) – £5.791m

Interest is accruing on the SREI deposits of at a rate of 10.6% and 16% for the Aten deposits. In the £15.8m disputed deposits balance £1.14m of accrued interest is included.

One worrying comment in the disclosure is “the board is of the opinion that these transactions were not conducted in accordance with the group treasury policy.” However, more encouraging is the following:

“The maturity date in respect of all amounts deposited and invested has now expired and repayment has been demanded. No repayments have yet been received although the counterparties have failed to provide any justification for not returning the deposits and investments.

The Company has engaged English and Indian lawyers to assist in their recovery. The Board has received legal advice that, in the event that repayment is not forthcoming, the Company has recourse to alternative means to obtain redress and therefore continues to believe that the value of deposits and investments will be recovered. Accordingly, the Board has concluded that these amounts should be recorded in the Statement of Financial Position without impairment.

It is worth noting that G1 & G2 are real estate joint ventures with the Indian based Unitech which was a holder of 16% of the equity in Unitech Corporate Parks and also the source of some major shareholder dissent over loans and other practices that flouted good governance. All of that said they are also owed significant sums from these parties and should be helping on the ground.

In terms of the dispute parties SREI is a listed company and whilst it appears to be very levered based on quick review of market cap to total enterprise value (88% loan to value) it is not clear why they would not be honouring their debts. Aten is a harder company to evaluate as it is private and seems to have a number of business streams from corporate advisory, Indian debt recovery (ironic) and Indian fund management. Aten’s founder was previously the managing director for DE Shaw India and before that a MD at GE India both respectable firms. I cannot decide whether this is a warning sign (why would upstanding firms not pay money owned) or a positive sign that the money will ultimately be recovered.

In terms of the Indian debt recovery process I have very little insight or experience into the process. Turning to the world bank they rank India as 6 out of a scale of 1 to 12 for strength of legal rights. Whilst this might sound average countries such as Ireland, Finland and the Czech Republic score a 7. In the World Bank’s “Doing Business in India” Report (unfortunately dated 2009) they made the following salient points

  • In India, across the 17 cities, it takes on average 961 days to enforce a contract, faster than elsewhere in South Asia
  • Overall court costs and attorney fees across India add up to an average 26.6 % of the value of the claim, similar to the South Asia average of 27.2%
  • There is a material difference in timing depending on which state in India the claim is made 600 days to 1,420 days (Mumbai)
  • India’s population-to-judge ratio is approximately 14 judges per million people. In comparison, the ratio of judges per million people is 51 judges in the UK, 58 judges in Australia, 75 in Canada, and 107 in the US

The cash balance left after the extraordinary dividend was sized to cover the liabilities as outlined. Of those liabilities it is worth noting that the winding up costs have jumped up from a £1.2m estimate provided by the board in September. In the board’s opinion this estimate should cover all costs to achieving a final dividend by way of members voluntary liquidation. The board has received advice that no tax should be payable on the Brookfield transaction but they wanted to hold the £4m tax contingency until the filing of their tax returns on the 31 March 2015.


  • NOSH – 360,000,000
  • Px – £0.02725 (as of 20th Feb 2015 close)
  • Market Cap – £10,980,000

Downside Case

  • Cash – £11,700,000
  • Running costs to liquidation – £(3,600,000)
  • Additional Litigation costs – £(3,950,000) [assumed to be 25% of claim amount as per world bank guidance]
  • Net Recovery – £4,200,000

MoM – 0.42x

Profit / (Loss) – £(5,660,000)

Upside Case

  • Cash – £11,700,000
  • Running costs to liquidation – £(3,600,000)
  • Litigation recovery – £15,763,000
  • Net Recovery – £23,863,000

MoM – 2.43x

Profit / (Loss) – £14,053,000

The share price of Unitech is pricing in a c. 40% probability of success and a 2.48x pay-out to loss ratio. Given the straight forward nature of the claim this would seem attractive, however, I have serious concerns about the jurisdiction and likelihood of recovery and as a result think this represents good risk reward if you are getting a 3 to 1 pay-out ratio on your win vs loss scenario. The strength and straight forward nature of the claim (I gave you cash under terms that have not expired give it back) are offset by the difficult nature of the legal jurisdiction, lack of clarity on the issues as well as time and cost to resolve.

Other articles

Holding Company Discount (Part 1)

4th January 2015

Are Holding Company Discounts to Net Asset Value Justified (Part 1)

In the life of a value investor you will likely uncover multiple holding companies trading at a discount to Net Asset Value (“NAV”). For a long time I have applied a rule of thumb 20% discount to NAV as in-built into the fair value equation but it is not backed up by any empirical analysis. As a result I have written this article to try and narrow down the issue and improve my underwriting process for holding companies.

When I get round to it I also want to chart the discount/premium to NAV for Rallye SA from 2006 to today. Rallye is the French holding company for Casino and Groupe Go Sport as well as a portfolio of equity and fixed income investments. Given the value clarity of Rallye’s assets analysing the evolution of its discount/premium to NAV should yield clear unambiguous results.

In the meantime I have included the below graph which charts the combine premium/discount to NAV of the constituents of an index of UK Real Estate Investment Trusts & other real estate companies. There are some interesting facts that can be drawn from the data, namely:

  • On average the index has traded at a 16% discount to NAV over the last 24 years
  • On five occasions for an average of 7 months the index traded at a premium to NAV. Over the entire data period only 12.1% of total months represented a period where index traded at a premium to NAV
  • The periods between each occurrence of premium to NAV ranged from 2.3 years to 8.4 years showing that discounts can last for a long time
  • Finally one standard deviation in the data set represents 12.2% of NAV. Two standard deviations covers 95% of all recorded data points. Applying two standard deviations shows that the basket of securities traded at a (40.5%) to 8.4% (discount)/premium to NAV showing that it is not uncommon to see securities trading at a substantial to NAV but there are brief periods when the gap is closed. Also for this data set it shows that a 20% discount to NAV is not that cheap

EPRA UK index NAV discount

EPRA UK index NAV discount


As always very happy to debate points with anyone either in the comment section or via email (hidinginplainsightblog@gmail.com). This article is collection of my thoughts that has been informed by other articles and comments. Where possible I have referenced any specific sources where material or ideas have been quoted


What is a Holding Company?

First it is important to narrow down the target of our discussion. Too often I am tempted to call something a holding company when it is actually just a parent company which is a very different animal and valued with reference to precedent transactions, comparable companies or security specific empirical valuation (e.g. Discounted Cash Flow “DCF”).

For me the clearest definition of a holding company is an entity that exists for the sole purpose of owning multiple distinct assets and which has a series of costs (management, reporting, auditing etc.) that are incurred as a result of capital allocation activity / managing their assets. When assessing these costs it is important to confirm that their incurrence results in no direct benefit for the assets themselves (e.g. shared CFO).

The most famous holding company in the world is probably Berkshire Hathaway which as of December 2013 owned 57 separate subsidiaries and had a distinct staff of 25 people in HQ focused on capital allocation and not on the direct business of any of its subsidiaries (to the best of my knowledge) who at the time employed over 340,000 people

Why Do Listed Holding Companies Trade at a Discount to NAV

Below I have listed all the reasons I could think of / find on the web for a consistent valuation discount to NAV for holding companies.

i. Holding companies have distinct costs that detract from the value of the underlying assets

  • In any base case valuation of a holding company which we would use to arrive at my view of NAV we always add holding company costs as a liability based on either (a) an appropriate multiple (usual rule of thumb is 5.0x) or (b) or discounting future costs at the cost of capital of the holding company
  • Even adjusting for capitalised costs we have looked at many opportunities that trade at a discount to NAV

ii. There are liquidation costs to realising the value in the underlying assets

  • Agreed, however, in the absence of significant and specific liabilities such as defined pension liabilities or restoration liabilities (e.g. site clean-up or asbestos etc.) these costs should be captured by capitalising costs in (i) with a large margin of safety
  • In fact any liquidation of a holding company trading at a material discount to NAV is likely to be a positive catalyst for value realisation

iii. There is often a control shareholder or management whose interests and actions are not always aligned with other investors

  • This is the most compelling argument for inherent and long running discounts to NAV in certain securities
  • Almost every holding company we look at has a controlling party and numerous related party transactions which can in circumstances lead to uneconomic value leakage away from the minority shareholders
  • Amit Whadhwaney of Third Avenue (https://www.youtube.com/watch?v=LJ1OIMRvyqc) highlighted the attraction of a holding company to a control shareholder best with the example that control can be exercised with as little as 30% of the stock in some jurisdiction such that a controlling shareholder can control $100m of assets with just $30m of capital. When you factor in that holding companies often trade at a discount to NAV the equity capital required for control of $100m of assets is even less
  • Very careful diligence of the controlling party, their past actions & related party transactions and their degree of alignment with common equity is crucial to avoid land mines (Bumi plc and numerous listed shipping companies come to mind)

iv. Holding companies are inefficient from a tax perspective particularly when it comes distribution of capital (dividends and return of principal)

  • On its face this is a plausible reason but it seems very difficult to empirically demonstrate or imagine that it accounts for a large discount
  • In the US if a holding company owns less than 80% of the subsidiary then they will be subject to federal and state taxes on the profits of both entities
  • This is an area I have not thought about carefully in the past but post writing this article will focus on as a source of both downside and upside in holding companies

v. Lack of liquidity in the underlying assets

  • I have seen this reason quoted in many articles but it makes absolutely no sense to me at all
  • I do think illiquid securities should trade at a higher return to reflect bid ask spread and lower flexibility for the investor but saying that the assets of a listed company are illiquid are therefore there should be a discount makes no sense. Every listed company’s underlying assets are effectively illiquid. This argument also cuts across the idea of a control premium which is a credible concept

Having thought about it a lot I cannot see a good reason for a consistent valuation discount to NAV across a range of different holding company securities. In my mind the valid reasons can be either empirically factored into your view of value (holding company costs) or qualitatively into your assessment of the investment risk and required return (quality of the controlling shareholder)

Checklist for Avoiding Holding Company Value Traps

The exercise of writing this article has led me to a simple check list you need to tick before making a value investment in any holding company

  1. Do you want to own the underlying assets?
  • Are the assets in industries you understand and like
  • Is the inherent value of the assets very volatile and governed by unpredictable external factors (e.g. commodity prices)
  • Do the companies have an enduring competitive advantage or any kind of moat around them
  • Ultimately your desire to own the assets comes down to price which makes point 2 so important but if you can check off point 1 it is a good start
  1. What is your valuation reference point for the discount to NAV (i.e. are the sum of the parts cheap to fairly valued)
  • It is no enough to simply reference the discount to NAV as your margin of safety. A collection of tech stock equities held by a holding company trading at a discount to NAV would look very different at the height of the tech bubble vs after the crash
  • If you do not have enough info on the assets to assess their value it is best to stay away
  1. Are you comfortable with the controlling party or in their absence management
  • The best cures for this concern are jurisdiction and disclosure. Rightly or wrongly I feel much more comfortable investing into securities governed by strong regulators in legal systems that frequently and effective prosecute misdeeds. Healthy disclosure of related party transactions is also helpful
  • Nevertheless relying on the law/regulator is not enough. You need to carefully examine all the related party transactions and if you find anything that would not pass the “red face test” do not invest.
  • You also need to think carefully about the level of alignment the controlling shareholder has with the common equity
    • Have they lent money directly to the company that ranks ahead of the equity?
    • Do they own assets (e.g. property) that is used by the company and from which they earn a return?
    • Are any related parties contracted to provide services at a healthy return?
  • If the controlling shareholder is earning money from the company in any way than through the common equity buyer beware
  1. What is the total leverage through the holding company and how healthy is your equity cushion
  • The highest risk item is leverage at the level of the holding company secured on the value of the assets. If this exists your equity is at risk from a number of things namely:
    • (i) liquidity at the holding company – the interest and amortisation of the debt can only be served by dividends from subsidiaries which can dry up during tough times and readily saleable assets (e.g. securities) which you often do not want to be sold when the going gets tough,
    • (ii) covenants – often lenders will have LTV covenants that may enable them to enforce or demand pay downs if the asset value declines, and;
    • (iii) restrictions on actions of the holding company – external leverage will likely reduce the flexibility of the holding company to structure, monetise and otherwise maximise the value of their investments
  • If the market cap of the holding company only represents a small % of the value of the combined entity then it is plausible that investors would want a very large return for taking such highly levered risk which would be reflected in the discount to NAV

[5.] [OPTIONAL] Existence of a catalyst 

  • Given the length a discount could persist for it is helpful if a catalyst exists that would work to reduce the discount. There are many different types of catalysts but some examples are: share buybacks, liquidation, special dividends and entity acquisition
  • The reality is that if an obvious or material catalyst existed it is it likely it would have worked to narrow the discount before you invested so you should prepare to take the plunge in the absence

[6.] [OPTIONAL] Does the company have a dividend yield that provides some return whilst you wait for the discount to NAV to recover

  • Whilst a lot of commentators have mentioned this I am not convinced this is necessary and it maybe even a false sense of comfort as dividend yields come and go
  • In my mind the size of the discount to NAV should be enough to convince you to invest with the knowledge that it can take years for the market to become rational


Assessing whether a holding company trading at a discount to NAV is a stunning value investment or a horrendous value trap is extremely difficult.

If you calculate NAV correctly and adjust appropriately for features unique to holding companies I currently cannot think of a good reason why a holding company should persistently trade at a discount to NAV. That said there are many examples of enduring discounts which act as a constant reminder of Keynes’ famous quote “the markets can remain irrational longer than you can remain solvent.”

This exercise has left me thinking that you need to really pick your spots in holding company investments, make sure your portfolio is not concentrated in “pull to NAV” investments and finally that if you ever find a holding company trading a discount to NAV with underlying assets you like and a clear catalyst you should load the boat

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