Argo Group Ltd – HY 2016

LON:ARGO – 15,00 GBX

1kr50öreArgo Group Limited is an investment company. The principal activity of the Company is that of a holding company and the principal activity of the Company, along with its subsidiaries, is that of an investment management business. The Company operates through the asset management business segment. The Company’s investment objective is to provide investors with absolute returns in the funds that it manages by investing in, inter alia, fixed income, special situations, local currencies and interest rate strategies, private equity, real estate, quoted equities, high yield corporate debt and distressed debt, although not every fund invests in each of these asset classes. The Company’s subsidiaries include Argo Capital Management (Cyprus) Limited, Argo Capital Management Limited, Argo Capital Management Property Limited, Argo Property Management Srl and North Asset Management Sarl. – Google Times.

1. The company is currently a net-net with an adequate margin of safety: 

a)

  • P/NCAV < 1x
    • 0,39x 
    • MoS = 61 %

Assessment of why I think the margin of safety is adequate in relation to NCAV:

ARGO is a classic deep value stock, i.e. you can buy a dollar for fifty cents. In this case it is even better since you can actually buy a dollar for 43 cents (P/Net cash = 0,43x). With that in mind it is important to note that ARGO is an investment management company with an NCAV consisting of no inventory and only a small amount of accounts receivables (10%), the rest is cash (38%) and cash equivalents (52%). What I like about these types of net-nets is that the NCAV-burnrate (or more specifically the net cash-burnrate) tends to be quite low and/or directly beneficial to shareholders. What I mean by that is that the burnrate to a large extent can be controlled and managed by the company (employee costs for example) and/or benefit shareholders directly (dividend and/or buybacks). In the case for ARGO they have over the years used their cash to invest in their own market funds but also used significant amounts to pay dividend and buy back own shares. Nonetheless, ARGO’s NCAV-burnrate for the last twelve months has been positive , +49%.

So ARGO is a big pile of cheap cash, but what about earnings and profitability? Actually, the profitability has been quite good over the eight years that data exist for. On an operating income level ARGO has been profitable for seven out of those eight years, P/EBIT8y = 5x. Also, ARGO is selling for a P/E-ttm of 2x while not taking into account that the company has an negative enterprise value. In other words, ARGO is not only cheap on an asset basis.

When it comes to ARGO’s management there is quite a bit to be said, especially on the negative side. Both Alpha vulture and Wexboy have written about this so I won’t go into any details (see links to their posts below). Nonetheless, management today own about 54% of the shares outstanding and therefore control the company. Because of the of the current share buyback program that amounts to £2 million this position could materially increase in the future.

directors-ownership-argo
Source: Regulatory share information

Even though management today has control over the ARGO I would still argue that their interests are somewhat aligned with minority shareholders. The reason behind this argument can be found in the 4,840,000 options outstanding with an exercise price of 24 GBX (se picture below). In order for these to have any value for management the share price would have to increase by 60 % from the current price of 15 GBX. So even though the options would dilute minority shareholders with about 10% I don’t see this as negative factor given todays circumstances.

optioner-argo
Source: Half-year report

I would argue that the buyback programs that the management has implemented is one attempt to make these options valuable. With the current buyback mandate of £2 million the company could given todays market price in theory buy back ~28 % of the shares outstanding.  However, it seems that there has been some difficulties finding shares for sale as only 375,000 shares has been bought back as of current date. My speculation is that if this continuous to be a problem we might see a tender offer from ARGO to minority shareholders at a price at least in the range of the exercise price of options.

2. The risk of permanent loss is low:

2.1 The risk of bankruptcy is low (criterion a) or b) must be met):

a)

  • Debt/Equity < 25 %
    • 0 % 

b)

  • Z-score ≥ 3
    • 18,4 

2.2 The company’s business model has historically been profitable (criterion a) or b) must be met):

a)

  • Positive retained earnings:
    • -1,4 M$ X

b)

  • Positive aggregate operating income for the last five years:
    •   3 M$ 
      • Operating income data exist for the last eight years = 13,5 M$

3. The company does not have a shareholder unfriendly capital allocation (i.e. not diluting shareholders):

  • Shareholder yield TTM ≥ -2 %
    • Dividend yield TTM = 0 %
    • Net buyback yield TTM = +29 %
      • =  +29 % 

MoS

Other analysis of Argo Group Ltd:

Disclosure: The author is long LON:ARGO when this analysis is published. Also note that LON:ARGO is a nano-cap stock (9 M$ in market capitalization). The trading is very illiquid.

6 thoughts on “Argo Group Ltd – HY 2016

  1. I like & own Argo and mostly agree with your analysis but I think you are wrong on one point. Management is not aligned with shareholders. In my opinion the options really don’t matter because management owns a majority stake. If they want, they can issue new options with a lower strike. Or just pay themselves a $5m salary.

    As a minority holders you are at their mercy. However, royally screwing over their minority holders to earn a quick million might not be the smartest move if they want to continue managing outside money. Reputation might matter more than the (relatively) small gains to be made.

    Like

    1. Good to hear from another ARGO owner, are you a long time shareholder?

      First, note that I wrote “somewhat aligned with minority shareholders” 😉 I’m aware of the management history as both Wexboy and Alpha vulture has explained it in detail. Regarding your comment on options I will have to disagree with you. They can issue new options but probably not at a lower strike price than 24p. Reason being that a company is required to strike options at the fair market value of the company at the time the option is granted. Since they have not issued any new options since 2011 I would argue that they have probably come to the conclusion (made a valuation) that a lower strike price is not possible to issue options at. Thats why I argue that the buyback program is an attempt to make these options in the money.
      Also, I don’t think the salary suggestion is a probable outcome from management. As majority shareholders they will probably like to see the company share price increase but also grow the business. If they are not stupid, paying huge amount of salaries to themselves is not a good plan to reach that goal. Also, as you note that is not a good plan if they want to keep their reputation intact.

      Thanks for your comment!

      Like

  2. What are your thoughts in the use of cash? In the 2015 AR they clearly state their intentions – boosting marketing spend and looking for an acquisition. This reminds me a little of UPGI

    Like

    1. Good question!

      Well, I would argue that ARGO needs to increase their AUM if they would like to show positive figures on the bottom level of their income statement. The intentions you state are intended to do just that:

      “Boosting AUM will be Argo’s top priority over the coming year. The Group’s marketing efforts will be focused on the re-launch of TAF which has a 16 year track record as well as identifying acquisitions that are earnings enhancing.” (p.6)

      So although I’m a bit skeptical of managements ability to succeed with these intentions I find them economically rational. Finally, given that they have recently spent a lot of money on buybacks and intends to do so going forward (almost all of the £2 million buyback mandate is still unused) I would argue that the ARGO situation is not that similar when compared to UPGI.

      Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s