Bearing that in mind, I still believe investors have yet to fully grasp the value in the shares of Marwyn Value Investors (MVI: 177p), a company I first advised buying shares in eight months ago when the share price was 143p ('A highly profitable arbitrage play', 11 Feb 2013). True, the price has risen 24 per cent in the intervening period, and is closing in on my initial target price of 185p, but I am now of the view there could be considerable more upside to come from this special situation than I first envisaged.
Marwyn's successful formula
To recap, the company was created in April 2008 through the amalgamation of two Marwyn funds and was admitted to trading as a closed-end investment company on the Specialist Fund Market of the London Stock Exchange in December 2008. The investment objective of the company is simple: to maximise total returns through the capital appreciation of its investment in Marwyn Value Investors LP, an open-ended fund domiciled in the Cayman Islands, which was launched in March 2006 with backing from more than 60 leading institutions and alternative funds.
Marwyn Value Investors LP specialises in the acquisition of growth businesses by taking significant stakes in quoted portfolio companies and has to date invested in 13 portfolio companies which have together completed 68 transactions, with an aggregate transaction value in excess of £1bn. The fund managers operating the fund have been very successful, having generated net asset growth of well over 140 per cent in that seven-year period.
They have also been hugely successful at crystalising these gains for shareholders. In fact, in the past seven years cash realisations for investors have generated an eye-watering internal rate of return on invested capital of 30.2 per cent. Realisations include holdings in the following Aim-traded companies which succumbed to takeover bids: Talarius, Inspicio, Concateno, Melorio and Zetar. The last of which also proved a successful investment for followers of this column after Zetar was taken over in October last year. The holding made us a 62 per cent total return in little over five months after I reiterated my buy recommendation last April. In fact, I used Zetar as one of my 32 case studies in my new book, Stock Picking for Profit, in a chapter dedicated to what I look out for to identify potential takeover targets. That's because having screened the company for specific characteristics, Zetar appeared to be a classic undervalued recovery stock that would either be re-rated or be taken out. As it turned out I was right on both counts.
Clearly, Marwyn made hefty gains from the holding in Zetar too. And it has just repeated the feat with Aim-traded Advanced Computer Software (ASW: 87p), the healthcare software specialist, albeit the company didn't have to wait for a bid to realise the value in its investment. In fact, following a partial disposal in March, this final disposal has generated net aggregate proceeds of £18.4m for Marwyn Value Investors, and in the process has delivered a cash return of almost six times its investment over the life of the investment. This translates into an impressive gross internal return of 31.3 per cent, in line with the previous five disposals I have mentioned above. The investment in Advanced Computer Software was offloaded at 83p a share, or 84 per cent higher than the share price at the start of last year.
True, the exit price was slightly below Advanced Computer Software's end-September closing share price of 87p when Marwyn last reported its net asset value. But on the basis the stake accounted for around 12.5 per cent of the company's investment portfolio, it was quite some feat offloading the holding at close to the market price.
Hidden value in Marwyn
As I alluded to at the start of this article, investors have yet to cotton on to the neat bit of work Marwyn has carried out in offloading the stake in Advanced Computer Software. Clearly, this frees up cash to make other potentially successful investments.
Moreover, Marwyn's last reported book value of £153m, or 232p a share, at the end of September, clearly doesn't reflect the share price upside the company has enjoyed in the rest of its investment portfolio, the largest of which is the holding in FTSE 250 film producer Entertainment One (ETO: 233p). This stake accounts for over 75 per cent of Marwyn's investment portfolio, so is material to the company.
Blue-sky territory
As regular readers of my columns will be aware, I have been a fan of Entertainment One for quite some time, having first highlighted the investment case when the price was 199p ('Three special situations', 2 Jul 2013) and subsequently repeated my buy recommendation since then. It has proved worthwhile with the shares riding an all-time high of 233p, up over 5 per cent since Marwyn last announced its net asset value. Factor in the rise in Entertainment One’s share price in the past fortnight and this adds 9.5p alone to Marywn's net asset value to take it to 241.5p a share.
Importantly, the ongoing re-rating of shares in Entertainment One is well underpinned. In a second-quarter trading update to the end of September, the media group revealed that digital revenues in its film division more than doubled in comparison to the prior year which, alongside savings from the acquisition of Alliance Films, helped boost gross profit and cash profit margins.
Notable releases in the six-month period include: Now You See Me, Rush, The Place Beyond the Pines, Scary Movie 5, Insidious: Chapter 2 and Behind the Candelabra. Entertainment One now expects to release over 250 films during the current financial year to March 2014, including The Hunger Games: Catching Fire, Prisoners, 12 Years a Slave and Ender's Game. Investment in content and programmes is expected to increase to over £250m in the financial year, up 14 per cent year on year on a pro-forma basis.
There is also substantial value in Entertainment One's library which includes more than 35,000 film and television titles, 2,800 hours of television programming and 45,000 music tracks. It also offers solid asset backing as the library alone is worth around £406m at current exchange rates, or the equivalent of 64 per cent of Entertainment One's market value. Or put it another way, around 148p of the current share price of 230p is in the library alone.
The shares are also underrated on an earnings basis. Ahead of a first-half results on 19 November, broking house N+1 Singer expects Entertainment One to report a 40 per cent increase in pre-tax profits from £53.8m to £76.7m on revenues up almost a third to £829m in the 12 months to the end of March 2014. On that basis, EPS rises from 16p to 19.6p. So, even after the recent re-rating, Entertainment One shares are still modestly priced on a prospective PE ratio of 11.5.
Furthermore, my target price of 240p is starting to look too conservative and I would not be at all surprised to see the shares run up beyond this level in the coming weeks, especially as they are in blue sky territory. A further rise in Entertainment One's share price to 240p would add a further 6.5p a share to Marwyn Value Investors book value.
For good measure, we can realistically expect some decent upside in Marwyn’s other major holding, Breedon Aggregates (BRE: 32p), the largest independent aggregates business in the UK. The company owns 37 quarries, 22 asphalt plants and 48 concrete batching plants in England and Scotland. Underlying profits in the first half of the year shot up 69 per cent and the business is heavily asset-backed. What's more, there is considerable potential for broker earnings upgrades due to the sensitivity of the business to any pick-up in its end markets and from further earnings-enhancing acquisitions. With the UK economy on a recovery path, both look real possibilities and can only be good news for Marywn's share price. Breedon is a current live Investors Chronicle buy tip.
Unwarranted discount to sum-of-the-parts valuation
By my reckoning, Marwyn's current net asset value is actually nearer 242p a share which means that the share price discount is chunky at 27 per cent. It's also wholly unjustified as Marwyn has been performing well, having increased its net asset value by 30 per cent in the past 12 months alone. In my opinion, this valuation anomaly offers an obvious arbitrage opportunity to buy into Marwyn as a cheap way of playing the upside from the ongoing share price re-rating of Entertainment One, and from a narrowing of its won share price discount to book value.
Needless to say, I continue to rate Marwyn's shares, trading on a spread of 175p to 177p, a value buy and have upgraded my price target from 185p to 200p. Even that could prove conservative if Entertainment One's results are well received next month, as I anticipate will be the case. I have also upgraded my target price for Entertainment One to 250p and continue to rate the shares a buy at 233p.
Finally, since the start of last week, I have published seven other articles on the following nine companies or trading strategies:
■ Inland ('Property plays with foundations, 7 October 2013)
■ Terrace Hill ('Property plays with foundations, 7 October 2013)
■ Sanderson ('A smart tech share', 9 October 2013)
■ Pure Wafer ('Time to chip in', 10 October 2013)
■ US debt ceiling deadline looms ('Debt ceiling dilemma', 11 October 2013)
■ Air Partner ('Gaining altitude', 14 October 2013)
■ Polo Resources ('Targeting special situations', 14 October 2013)
■ Greenko ('Targeting special situations', 14 October 2013)
■ Randall & Quilter ('Bargain shares flying', 15 October 2013)
■ Oakley Capital Investments ('Bargain shares flying', 15 October 2013)
■ NetplayTV ('Punting on new highs', 16 October 2013)
