Argo Group’s (ARGO:LN) Final Results should be released shortly (I’ll try confirm the exact date). In my most recent Argo posts, I published two letters I’ve sent to Kyriakos & Andreas Rialas (CEO & CIO, respectively). I encourage you to review both letters before continuing:
Argo’s share price rallied +6.2% in the following week.
This was sent on behalf of myself, Guy Thomas & some other (smaller) shareholders, representing an aggregate 5% shareholding in Argo. The letter focused on a single specific shareholder distribution proposal. ARGO subsequently rallied +6.5% (in the following week). [In fact, the share price is now up an impressive +36% since my November letter. Despite the rally, I believe Argo remains just as compelling an investment proposition - I currently have a 5.4% portfolio stake].
My recommendations & proposal require little (further) explanation, and I expect shareholders will enthusiastically support all efforts to realize & enhance Argo’s intrinsic value. But I will revisit them in the context of an upcoming results preview – plenty of current & prospective shareholders have emailed me about Argo, so I hope you’ll find this useful. Let’s first consider Argo’s existing funds:
The Argo Fund (TAF, $82 mio AUM): TAF is Argo’s flagship fund, racking up a great performance over the past dozen years. Despite this, AUM has continued to decline. So, what do TAF’s prospects & AUM look like now? Focusing existing fund-raising efforts on TAF is the obvious strategy here – so what new resources are required to increase AUM?
Argo Distressed Credit Fund (ADCF, $24 mio): Considering ADCF was launched into the eye of the credit crisis storm, performance has been respectable. However, the fund’s size begs the question: With the right resources, can fund AUM be doubled/tripled in the medium term, or would a fund merger (e.g. with TAF) make better long-term sense?
Argo Special Situations Fund LP (SSF, $108 mio): This fund’s a 2012 merger of two other Argo Funds (AHL & ACPF), with its high-water mark (for earning performance fees) reset to zero. SSF’s a closed-end fund, with a 3 yr realization period (now about 2.3 yrs, subject to extension). What are the plans/prospects for retaining these AUM (ideally) within a new/rollover investment vehicle?
Argo Real Estate Opportunities Fund (AREOF, $88 mio): AREOF’s a listed fund, AREO:LN. AUM is based on an adjusted NAV of EUR 70 mio, now equivalent to $92 mio. But recent loan-related news hasn’t been encouraging – considering AREO’s 82%+ Net LTV, this is unsurprising (but still unwelcome). This presents two distinct threats: i) with AREO’s leverage, asset write-downs would have a disproportionate impact on NAV/AUM, and/or ii) AUM could be eliminated if AREO’s lenders seized control.
Unless AREO’s directors believe an equity fund-raising is viable, the first step here is to de-list – a public listing’s an expensive waste of time & money for a distressed company. Next, Argo needs to pitch its continued appointment as investment manager – I’m sure this process has already begun. The most likely proposal is to run AREO as a wind-down vehicle, over a number of years, to repay all loans & maximize return for shareholders. This could be a compelling proposition – Argo has the necessary AREO/distressed experience, AREO’s directors are there to protect shareholders’ interests, and the banks surely want to avoid taking on (more) direct property investment/management.
Now, let’s consider new fund opportunities:
Argo Local Markets Fund (ALMF, $7 mio): This is a new long/short emerging markets local currency bond fund, launched in Nov-2012. It’s not clear if the fund was seeded internally, or by clients – let’s assume it came from Argo. Noting the weekly liquidity, and judging by the multi-billion dollar inflows into emerging market debt funds in the US (in the past year or two), this fund could be a resoundingsuccess if marketed aggressively.
Other Fund Opportunities: The ALMF launch is encouraging, but Argo has otherwise highlighted the challenge of raising funds in the current environment (though things have clearly improved since last June). If we hear the same complaint in 2013, it begs the question: What changes in strategy are needed? Frankly, Argo’s future as an asset manager can’t depend (solely) on performance & client/AUM retention – ultimately, success requires fresh fund-raising on a significant scale. I’ve suggested some strategies to consider:
- Argo’s exercised admirable cost control in the face of declining AUM, but has this been the correct approach? Personally, I’d be perfectly happy to see Argo’s margins invested into new fund-raising! I’m certainly not advocating wasting money – but if significant fund-raising success boils down to allocating new/increased resources, I’d say: Tell me the plan & let’s get rolling! Then again, Argo may simply need some fresh blood in their sales & marketing team?
- Argo’s investment experience, and the current economic environment in Europe, might suggest a more mainstream fund-raising approach. A new fund focused on W European distressed assets & work-out situations might be an incredible opportunity to raise AUM & re-establish Argo’s performance record.
- In similar vein: Noting the ongoing multi-billion fund-raisings by US private equity/alternative managers, much of which is earmarked for Europe, there may well be white-label/consultancy/sub-advisory contract opportunities to be explored & won. This would be a departure from Argo’s current in-house fund focus, but it’s certainly not unusual in the fund management world. Fee rates would be lower, of course, but scale could potentially be far larger (vs. existing AUM) – and it might require v little fund-raising effort/expense from Argo.
[Also, it's certainly worth highlighting the markets as another plus. Lower market volatility, increased liquidity & good performance all offer enhanced investment flexibility & returns since last June. I think it's perfectly reasonable to presume 5%+ returns across the Argo funds in H2-2012. However, let's not count our chickens yet - but hopefully this shows up as another offset to any potential AUM decline(s)].
Let’s take a look at Argo’s investor relations:
TAF: Argo’s market cap is $13.9 mio, but it has $16.8 mio invested in TAF – an investment in Argo is basically an investment in TAF! Despite this, TAF disclosure’s been limited to a few sentences each year – this is unacceptable. Shareholders deserve to know how/where their money’s invested – detailed TAF info & commentary is just as important as any discussion of Argo’s asset management business.
Dividend: ‘The company intends, subject to its financial performance, to pay a final dividend each year.‘ The caveat’s pretty redundant – Argo’s cash/investments could fund 17 yrs of payouts, so maintaining/increasing the current dividend (a 9.5% yield!) presents no difficulty.
General IR: ‘Stick to your knitting‘ is obviously the most important thing management can do. But when there’s a huge value gap between a company’s market value & its obvious intrinsic value, a little promotion can be v rewarding. As a private investor, I’ve never seen an article, an interview, or even a presentation about Argo – I have to wonder whether institutions have had any exposure either? There’s an easy fix & an easy win here…
Next, let’s refresh my valuation (ref. prior posts for background):
With no fresh info/figures from Argo, I’ll presume an unchanged value for TAF, a decline in their AREO stake to $0.4 mio & an increase in AUM to $313 mio. [I'm also assuming no change in cash, so any operating cash generated and/or collection of the AREO management fees receivable would be a plus. Together with a likely investment gain on TAF, this potentially offers a meaningful bump-up to come for Argo's total cash/investments]. I’ll use an unchanged 3.75% of AUM valuation*** for the asset management business:
Net Cash/Investments per share = $5.0 mio + $16.8 + $0.4 = $22.2 mio / 1.5023 = GBP 14.8 mio = GBP 22.0p per share
Intrinsic Value per share = $22.2 mio + $313 mio AUM * 3.75% = $33.9 mio / 1.5023 = GBP 22.6 mio = GBP 33.5p per share
The current GBP 13.75p share price trades at a colossal 37% & 59% discount to these values (thereby offering 60% & 144% Upside Potential), respectively.
Increasing Argo’s AUM will obviously take time, and the share price has been neglected for years – more immediate & aggressive action is clearly required to realize the current value gap & enhance shareholder value. Hence: My shareholder distribution proposal to Argo – worth repeating in full here (NB: Figures are updated in the 2nd bullet point):
‘- Commit to a minimum return of $12.5 mio to shareholders (approx. equal to Argo’s current market capitalization), within a reasonable time-scale.
- Initiate a tender offer to retire (at least) 1/3 of Argo’s outstanding shares, priced at 18.7p (a 15% discount to current net cash/investments per share). This would cost just $6.3 mio, about half the total commitment. It would also enhance net cash/investments per (remaining) share to 23.6p, and my estimated intrinsic value to 41.0p per share.
- Determine the most efficient return of the balance of the commitment to shareholders – via regular share buybacks, a return of capital, or perhaps a special dividend. Obviously, share buybacks at a continued discount to NAV/intrinsic value would further enhance those values.
- Ensure adequate liquidity (of [approx.] $10.0 mio) for the continued success of Argo’s business operations & seeding of its funds.
- Allow shareholders to realize the company’s current market capitalization, while continuing to participate in Argo’s long term success.’
Finally, it’s time to hear from you, the reader:
If you’re a private investor/adviser/fund manager with an (in)direct shareholding in ARGO (large or small), and are in broad agreement with this proposal (and/or my prior recommendations), I’d like to hear from you.
Please comment below and/or email me at firstname.lastname@example.org
*** [Note: I've received quite a few questions & 'what if' emails from readers & shareholders - some further explanation of my asset management valuation (at 3.75% of AUM) is clearly warranted. Note that only amounts to $11.7 mio, so Argo's cash/investments still comprise the major portion of my total valuation. It's also (potentially) a cheap valuation! To explain: Argo's LTM revenue was $8.8 mio based on average AUM of $336 mio. This is a hefty 2.62% of AUM in fees - which clearly confirms a v attractive hedge fund fee structure!
If you invest in asset managers, or have read some of my prior posts, you'll know a 3.0 Price/Sales multiple can actually be a cheap price for an alternative asset manager. Which implies Argo's asset management business could be worth $25 mio+!? But I'm trying to capture (recent) history, risks & prospects for their AUM, so my actual valuation only amounts to a 1.4 P/S multiple (vs. the current revenue run-rate). For example, losing an investment mandate is a binary event - it happens, or it doesn't - which forces me to take a risk-weighted/expected value approach. If AUM did happen to decline by a certain %, it doesn't necessarily imply a similar decline in my valuation - my assessment of risks & prospects may quite possibly have changed/improved significantly at that point].
Filed Under: Value Investing,