Added a position in Aberdeen Int’l (AABVF)
I’ve recently added a small position in Aberdeen International (AABVF). The idea is not original; it comes directly from Kelpie Capital. View his post here for background.
I’ve been wanting some exposure to gold and, now that everyone is cooling to the precious metal, I think its just the time to take the plunge. My reasoning is based on a macro view that goes something like this. We have abundant liquidity in US markets now and are likely to continue to enjoy this state of bliss at least until the elections next Fall. Equities should therefore do OK barring any unforseen global negative event, like say an Israeli incursion into Iran. Such an event is unknowable so I remain positioned with a positive bias to the market in the short term. However, once the election is done I think somewhere in the next couple of years the global economy will be forced to confront the growing problem of debt that we have collectively been kicking down the road for the past decade. I’m still convinced that Greece will have to default even after the huge bailout package currently being prepared. That may not be the event that triggers a market maelstrom but it is a symptom of the worldwide problem. I’m figuring that just when joe investor gets sucked back into the market something will precipitate the market downturn. At that point it will be a good time to be holding cash or perhaps a little gold or gold-related equities, so I’m beginning to prepare now.
Why the position in Aberdeen and why now? Well, I could buy physical gold. But I kind of agree with Buffett that gold just sitting in a vault somewhere doesn’t really do much except shine. I want something that throws off cash or at least has some operations, and I want to buy it cheap. Gold has a market price and no one is going to sell it to me for a discount. On the other hand, gold miners can be bought for less than their intrinsic value. But the problem is that I know nothing about how to value them. Aberdeen is an interesting alternative. It’s kind of a closed-end fund with investments in small cap and microcap resource companies (at the moment primarily junior gold mining cos) and mineral royalties. It is managed by Forbes & Manhattan, a fairly successful Canadian natural resource investment bank. Most importantly, it is selling at a substantial discount to its book value and net asset value. As of Oct. 31, 2011 (the latest quarter for which detailed information is available) Aberdeen had an investment portfolio of about CAD $80 million, $8 million in cash, $8 million in loans and $6 million in receivables plus royalties valued on the books of $27 million. Against this there were $14 million in tax liabilities. Shares outstanding were 87 million, plus 7 million options and 38 million warrants. Because the warrants have an exercise price of $1 and expire in June 2012, I consider them non dilutive and likely to expire worthless. Excluding the warrants, book value per fully diluted share is about CAD $1.23 or about USD$1.20. With the ADRs selling below USD $.60 on the pink sheets this means a discount of over 50%.
Usually I’m a bit skeptical of closed end funds since management’s interests are not well aligned with those of shareholders. Management is generally compensated based on a percentage of assets under management (AUM). This means growing the assets under management is first priority, but not necessarily growing them organically. When returns are sub-par, and therefore assets under management are declining, management is often tempted to raise capital to stem a decline in fees. Unfortunately sub-par performance often leads to a fund trading at a discount to NAV. If the capital raise is done through a rights issue, shareholders are confronted with an uncomfortable choice; either subscribing and dedicating a larger percentage of their funds to an underperforming asset or seeing their interest diluted. If the capital raise is done through a private placement, even worse; the current shareholders can’t avoid being diluted. In the case of Aberdeen, this structural issue is somewhat mitigated. Forbes & Manhattan own about 15% of the shares. Thus, management has to balance out their interest as shareholders against their interest as managers receiving a fee.
Aberdeen management laid out their goals in a presentation last month. Priority one is to get rid of the value gap between NAV and market price (we like that). If you look at their charts, however, the gap has existed for the past 5 years and the strategy they have laid out to reduce the gap, “tell our story”, is a bit weak. Priority two is to grow assets under management (to $250-300 million). They list organic growth, the warrants and selling the royalties as a means to do this. Unless I am missing something, it appears to me that the warrants will not be exercised as they expire in less than 3 months at a price significantly above today’s market price. Let’s see if they are able to sell the royalties at anything resembling book value. Priority three, manage capital structure, seems a bit at odds with priority two. Here they list share buybacks (which reduces AUM, rather than increasing it), increasing the dividend (which also reduces AUM) and ‘pursuing other corp. growth opportunities’, which is not particularly specific.
Despite the shortcomings of management’s stated strategy and the fact that NAV declined significantly during the first 9 months of fiscal 2012, I still like this opportunity. Of course, I’m looking to build a position at prices lower than my initial purchase so that the margin of safety is even greater. But before that my next step is to look more closely at the investment portfolio, which I’ll do in a subsequent post.