Be Aware of Net-Nets with Controlling Owners and Directors – Case Study: Argo Group Ltd

When you buy net-net stock you expect to get margin of safety (because of cheap purchase price) and you hope to get potential catalyst. The biggest risk to lose margin of safety is to invest in companies that constantly lose money and destroy shareholder value. If company’s net current asset value is rapidly eroding, it can burn big hole in your pocket.

But there are also other concerns as continuing losses. Traditionally deep value investors try to avoid Chinese net-nets, companies traded below NCAV for years, companies that don’t have existing operations or selling its own shares. Also gimmick or fraud accounting are existing risks.

What many investors do not think is the importance of the company’s ownership structure. Although insider ownership is desirable, be careful if insiders are able to fully control what is happening in a company. Their interests are often not the same as a small outside investor. Thera are not just one or two net-nets where management team collecting big salaries and letting the firm’s business decline.

 

Argo Group Ltd

Argo Group Limited is an investment company. The Company operates through the asset management business segment. The company manages a number of emerging market fixed income hedge funds. Its investment objective is to provide investors with absolute returns in the funds managed by investing in fixed income and local currencies. Argo is a London AIM listed alternative investment manager offering a multi-strategy investment platform in global emerging markets.

If you screen net-net stocks Argo Group can look almost perfect. Stock price is 0.17 GPD and NCAV is 0.41.  It trades at nearly 60% discount the company’s NCAV and even at a 47% discount to the net cash. In addition to this Argo was able to produce a small profit during the first six months of 2017. Also company’s net current asset value is increasing and it buys back its own stocks. Several very favorable signs, so what’s wrong with the company?

If you look at Argo’s annual and interim reports you recognized year after year management’s comment that the current level of AUM remains below that required to ensure sustainable profits on a recurring management fee basis in the absence of performance fees. Even with some performance fees the operating profit was negative in 2016, but this year it may change positive if the market remains favorable.

Argo’s flagship fund TAF (The Argo Fund) has been successful and has a 17 year track record. Instead Argo Real Estate Opportunities Fund Limited (AREOF) fund has bad debt problems. This fund has a negative equity position. According to Argo’s management these debts are expected to be fully recoverable. As an investor I would be somewhat more skeptical, although the situation has little improved recently.

Boosting AUM has been Argo’s top priority already many years and they are also looking for an accretive acquisition, but nothing essential has happened. What’s worse it seems that the management has not been interested in growing shareholder value which should be their top priority. Management are mostly interested in their own salaries, bonuses and billing Argo for legal and other services.

On top of that company didn’t do their share repurchase program to create value, but to solidify owners control of the company. It permit Andreas and Kyriakos Rialas (major owners of the company) to gain absolute majority control of Argo Group, without paying any control premium to minority shareholders, launch a bid or even put up a single penny of their own personal funds. These buybacks also resulting reduction in stock’s float which probably means that remaining shareholders can look forward to life in a highly illiquid company that’s now completely dominated by management, and that still exhibits no sign of an operational turn-around.

During the years company’s management and owners are completely refused to listen to the opinions of minority owners. A plan to liquidate the company is absolutely not on the table. They have also turned their backs on number of trade and financial buyers who were interested in potentially acquiring Argo Group, its asset management business or its fund investments.

 

Conclusion

I can not say you could not make money investing in Argo Group – but the odds are not in your favor. The stock is certainly cheap and for reason. There is no catalyst as long as controlling owners are not ready to consider any change. Maybe someday they will get an offer nobody can not refuse – but the waiting time may be long and costly.

 

If you are eager to learn more about Argo Group before your investment decision, please read following articles:

https://wexboy.wordpress.com/2016/02/22/recommendation-vote-against-the-argo-group-share-buyback-proposal/#more-14600

https://wexboy.wordpress.com/tag/jeroen-bos/

http://www.oddballstocks.com/2012/12/argo-undervalued-asset-manager-with.html

https://alphavulture.com/tag/argo-l/

https://alphavulture.com/2017/03/03/argo-group-publishes-2016-results/

 

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