Shares in land developer and housebuilder Inland (INL: 46p), property investment company Urban & Civic (UANC: 242p - formerly Terrace Hill), and engineer Trifast (TRI: 130p) have all doubled in value. But a thumping 55 per cent paper loss on Polo has proved a drag on the portfolio’s performance and has wiped 5.5 percentage points off that 46 per cent total return for the 10 companies in the portfolio. This highlights the importance of spreading the risk across a number of investments just in case one performs badly. It also highlights the important point that equity investing is not a one way bet and even when shareholdings perform well the best of the gains are more often than not made over the long-term.
In the case of Polo, the main problem investors have is the lack of transparency. This has cast serious doubts in their minds as to the true worth of the company’s investments which is why the shares are trading on an eye-watering 65 per cent discount to the last reported net asset value per share of 31.3p as of 7 March 2014. Moreover, based on 276.9m shares in issue, the company’s market capitalisation is little over £30m even though in the latest trading update Polo stated it had $40.2m (£23.6m) of net cash, receivables and short-term liquid investments on its balance sheet. In other words, a quarter of the book value of $160m (£94m) is in readily realisable investments or cash. It also means that 8.5p a share of the 11p share price is fully backed by these investments.
Investor scepticism takes hold
It is therefore clear that investors are attributing very little value to the assets held in Polo’s investment portfolio. In effect the rest of the portfolio is being valued at 3.5p, or less than 20 per cent of its 20p a share book value, even though Polo’s management has been crystallising value in some of the company’s holdings. In fact, Polo received $22.8m (£13.7m) in cash from its 42 per cent stake in Signet Petroleum following Signet’s farm-out deal with Shell in Namibia three months ago. That sum represents more than half the historic cost of the investment in Signet ($42.7m) when you take into consideration Signet's remaining assets.
These include an 80 per cent operated interest in the Mnazi Bay North licence offshore Tanzania where 2D and 3D seismic data indicates an up dip extension of the neighbouring BG/Ophir Chaza 1 huge gas discovery; a 90 per cent operated interest in Block 03 offshore Benin; a 87.5 per cent operated interest in Block C in Lake Tanganyika Burundi; a 10 per cent interest, carried until the first exploration well, in Block SL-7A-10 offshore Sierra Leone in the Equatorial Atlantic Margin; and retained cash to provide working capital and progress a new bid opportunity.
In addition, Polo received contingent bonus rights on the sale of Signet's interests in block 2913A/2914B in Namibia (as part of the Shell farm-out deal) which are dependent upon future resource and reserve levels in these blocks. Polo also received a 42 per cent interest in a second entity formed by Signet to progress a bid for a potential new transaction. Should the bid prove unsuccessful Signet will make a further cash return to shareholders.
But the lack of transparency on these unlisted investments means that’s it’s impossible for Polo shareholders to ascertain the scale of such a capital return, nor the potential upside in the carrying value of the rump of Signet’s interests. My own view is that the total value left in Signet is likely be in excess of the $20m (£11.8m) carrying value, or around 4.2p per Polo share. But in the absence of any reliable analyst research, or guidance from the company itself, it is impossible to be certain this will be the case.
But if I am right then it means we are getting all of Polo’s 8.32 per cent interest in Regalis Petroleum for free. This investment is in the books for around £5m. Regalis has a 70 per cent working interest in Block 2813B Namibia in the Orange Basin, nearby the Kudu discovery and the former Signet Petroleum block. Following the successful sale of Signet's interests in Blocks 2913A/2914B, Regalis is currently seeking a farm in partner for Block 2813B.
We are also getting a free ride on Polo’s other main investment, a 90 per cent stake in the Nimini Komahun Gold Project in Sierra Leone, in which the company holds a 90 per cent stake. The last resource estimate showed Nimini has an indicated gold resource at the site of 550,000 ounces and 340,000 inferred ounces of gold, bringing the total potential resource to 890,000 ounces. The investment in Nimini is in the books for around £33m, or more than Polo’s own market value. Even if it is only worth a fraction of that book value, then it is still supportive of Polo’s share price and the investment case.
Complexity of new investments
The other problem investors have is that Polo has been using some of its cash pile to make some investments in a couple of Australian listed companies: an A$1.2m (£655,000) investment for a 12.7 per cent stake in Celamin Holdings NL (CNL:ASX) a company holding phosphate interests in Tunisia; and an A$4m (£2.2m) investment for a 11.85 per cent shareholding in Blackham Resources (BLK:ASX), a company focused on the development of its wholly owned Matilda Gold Project in Western Australia.
As part of the Blackham Resources investment Polo acquired a 49 per cent stake in an investment company, Perfectus Management, which owns 15 per cent of Blackham’s equity, for A$3m of which a third was paid in cash and the balance of the consideration was settled by issuing 7.3m shares in Polo. As part of the agreement, Polo has an option to acquire a further 49 per cent of Perfectus for A$3m within the next two years by issuing shares in Polo at a price of 15p, a 36 per cent premium to the current share price. There is also a call option on Polo’s interest which if exercised would produce a 50 per cent minimum return on the company’s investments.
Given the extreme risk aversion investors are showing towards Polo’s investment portfolio, then even though Blackham is listed on the Australian Stock Exchange, the share price reaction since Polo’s announced the deal has been so severe that no value at all has been attributed to the £2.2m the company has invested. That is extreme to say the least. Polo’s chairman Michael Tang, who acquired 11.77 per cent of his company’s share capital at 40p a share in May last year through his investment vehicle, Mettiz Capital, clearly sees significant potential for value creation, but other investors fail to see it his way.
Risk aversion to Aim shares
The final point I would make is that investors are showing extreme caution towards overseas Aim-listed companies right now, and resource focused ones in particular. In the case of Polo, the fact that the company has a substantial amount of its book value tied up in unlisted companies means that the discount to carrying value applied by investors in their valuations is more extreme than normal. Furthermore, the board of Polo are using part of their cash pile to make investments in small cap resource companies where there is obviously distrust amongst investors.
That said, with Polo shares trading modestly above the level of the company’s cash pile and realisable investments, and the holding in Signet already producing a cash return to the company, then it seems harsh to attribute no value whatsoever to the all the other investments. But that is exactly what investors are doing right now as Polo shares are now at an all-time low.
Realistically, the catalysts to reverse the share price decline will either be news of a further cash return from Signet, or additional farm-out deals by that company on its interests. Unfortunately, there is no timetable for either. In the circumstances, I have downgraded my recommendation from buy to hold. If you previously followed my advice I would continue holding the shares for recovery, albeit that is only likely to happen once investors have greater visibility on the scale of realisations from the portfolio. The board of Polo should take note.
■ Simon Thompson's new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'
