With this thought in mind, in my third column this week, I am revisiting the investment case of three companies I have recommended buying shares in this year, all of which were trading on deep discounts to net asset value when I identified their investment potential.
Bumper capital returns
As regular readers of my columns will be aware, I have been a keen buyer of shares in Aim-traded carbon credit investment company Trading Emissions (TRE: 17.5p) for the past 18 months.
This particular company is of interest to me again because it is in the process of returning £37.5m of its cash pile to shareholders. In fact, a 15p-a-share capital return should be credited to shareholders' Crest accounts on Tuesday 30 July and some investors may be wondering whether or not to reinvest the proceeds in the shares. The answer is quite simple: yes.
To recap, the company is in the process of selling off all its assets and returning the cash to shareholders. This 15p-a-share issue of 'B' shares represents the second capital return to shareholders in less than six months after 6p a share was returned through a 'B' share issue in January. It also vindicates my decision to advise buying the shares in February last year at 25.25p in my annual Bargain Shares Portfolio ('How the 2012 Bargain Share Portfolio fared', 8 February 2013) and again at 19.5p in last summer's rout ('Time to capitalise on LMS', 25 June 2012). I was so convinced of the investment case that I reiterated my advice to buy the shares at 23.5p at the end of March this year ('Small-cap trading plays', 27 March 2013), shortly before I went on sabbatical to write my new book.
So with the company paying out 21p a share this year alone, you should all be in profit and still have paper worth 17.5p a share. In fact, some of you will have doubled your money. The key point here is that anyone reinvesting the previous distribution in January into Trading Emissions' shares has done incredibly well. There is little reason to think things will be differently this time. That's because, if my sum-of-the-parts valuations prove on the ball, there should be further share price upside.
Assessing upside potential
By my calculations, Trading Emissions had a pro-forma net asset value of 52p a share at the end of March after factoring in the aforementioned 6p-a-share capital return. Book value consisted of a carbon credit portfolio with a negative liability of £14m, or 5.6p a share; a private equity portfolio worth £105m, or 42p a share; and net cash of £39m, or 15.6p a share. However, in April the cash sum was bolstered following the drawdown of a €31m (£26.5m) loan by Trading Emissions' wholly-owned subsidiaries, TEP Solar Holdings and Solar Energy Italia. Of this sum, at least €26m was passed on to Trading Emissions. In other words, after the payment of 15p a share this week, the company's cash pile could potentially be around 9p a share.
This means Trading Emissions' share price of 17.5p is trading at a hefty 53 per cent discount to pro-forma book value of around 37p, of which around 9p could be in cash. That discount is way too deep given the scope for additional capital returns, especially as the company is actively looking to dispose of its portfolio of carbon and private equity investments. In my opinion, fair value is far nearer 25p a share, which would represent a share price discount to net asset value of 33 per cent.
Trading on a bid-offer spread of 16.75p to 17.5p, and offering over 40 per cent share price upside to my fair value estimate, I rate Trading Emissions' shares a deep value buy ahead of full-year results at the end of October. Frankly, if the company continues to make progress with its asset sales, I would not be surprised at all if it announces yet another distribution to shareholders at the time of those results.
Cashed up and undervalued
Shares in Aim-traded investment company BP Marsh & Partners (BPM: 134p) continue to mark time close to a 12-month high of 128p, but at a hefty 30 per cent discount to net asset value of 191p. This is completely unjustified given that the company has just completed the sale of 80 per cent of its stake in global insurance broker Hyperion Insurance Group to private equity firm General Atlantic in a £29.2m deal.
BP Marsh now has net funds of £20m, worth 68p a share, and still holds a further 45p a share of equity and loans in Hyperion. General Atlantic has an option to purchase the balance of BP Marsh's stake for £7.3m when Hyperion undertakes an initial public offering (IPO) and, under certain conditions, there could be a further £2m cash payout for BP Marsh if Hyperion undertakes an IPO within 12 months.
This not only means BP Marsh's net cash is worth more than half its market capitalisation of £37.6m, but it means investments in another eight investee companies, worth £16.7m or 57p a share, are in the price for free.
Capital returns
True, the payment of a 1.25p-a-share dividend on 23 August (ex-dividend: 31 July) may seem a tad stingy in light of the burgeoning cash pile. However, I would not be surprised at all to see the company use part of the cash pile to authorise a share buyback in due course. And if you followed my advice to buy shares in Aim-traded investment company Crystal Amber (CRS: 133p), you will be all too aware of the dramatic impact this can have on a small-cap company's share price. In fact, shares in Crystal Amber are up by almost 50 per cent since the end of last year, during which time the discount to book value has been almost wiped out.
To recap, I first advised buying BP Marsh's shares at 88p ('Hyper value small-cap buy', 25 Jan 2012), reiterated the advice at 90p ('Hyper value buy', 26 Oct 2012) and at 125p before BP Marsh's financial results a couple of months ago ('Deep value small-cap plays', 28 May 2013). So although it may be tempting to take some profits, I would resist the temptation and wait for BP Marsh's next results in October and to see whether it will adopt an active share purchase programme to reduce the share price discount to net asset value. By then we should also have a clearer idea of how the board intends to deploy its cash pile. As I have stated previously, the share price discount to book value is anomalous. I retain my fair value estimate of 160p.
Copper bottomed investment
Shares in Bezant Resources (BZT: 16p) have drifted down since the company paid out 8p a share as a special dividend at the end of May. This means that, after accounting for that payment, I am slightly under water having first advised buying at 25.5p in March ('Double your money on a copper bottomed investment', 20 March 2013). The shares also trade on less than half the intrinsic valuation of 37.9p per share attributed to the company by analyst Shamim Mansoor at brokerage N+1 Singer. That valuation is not pie in the sky either.
That's because Gold Fields, the major gold miner which earlier this year acquired a 21 per cent stake in Bezant at 25.97p a share - over 60 per cent above the current share price - has the right to acquire the company's flagship Mankayan copper/gold project in the Philippines for $60.5m (£39.5m). Gold Fields had an option to buy the project in January this year, but had been adversely impacted by the recent industrial action in South Africa. Factoring in licensing delays being experienced by miners in the Philippines, Gold Fields decided to extend the option until 31 January 2014. As part of the extension, the mining company paid a further $2.5m non-refundable upfront payment to Bezant; funded the 2013 licence commitments on the Mankayan project; and invested $7.5m in new equity in Bezant. The revised consideration of $60.5m (£39.5m) will be paid on the exercise of the option.
This means that Bezant is now flush with cash. By my reckoning the company is sitting on net cash of £4.6m, or 5.5p a share, which will easily see it through until the expiry of the Gold Fields option. Importantly, it has no funding issues.
Moreover, assuming Gold Fields exercises its option, Bezant's board has stated that half the cash received will be returned to shareholders. Or put it another way, for an investment of 16p a share you could potentially be in line for a further cash return of 24p a share early next year and still end up holding shares backed by 16p a share of cash after adjusting for tax liabilities on the disposal, Bezant's operating costs and capital expenditure over the next year.
And of course, Gold Fields may well decide to launch a bid for Bezant instead. Holding a 21 per cent stake in the company, it is well placed to do so. I think this is highly likely since it would be the far cheaper option for the mining group. But even then a take-out price double the current share price is not unrealistic. That would still only value Bezant at £26.5m, or two-thirds of the value of the option on the company's flagship Mankayan copper/gold project. Moreover, a bid at double the current share price would only cost Gold Fields £21m since it already owns 21 per cent of Bezant's equity. And that's before you take into consideration the aforementioned cash pile on Bezant's balance sheet.
South American potential
The investment case and likelihood of a bid for Bezant becomes even more compelling once you consider that Gold Fields' has already made significant investments in the region, having invested $220m to acquire 40 per cent of the adjacent Far Southeast Project in the Philippines last year. It also has an option over a further 20 per cent interest, so is clearly committed to the region as the $17m total investment (including equity) to date in Bezant would indicate. In my view, this makes it highly likely that Gold Fields will do a deal and either exercise its option by the end of January, or bid for Bezant. For its investment it will get JORC compliant Probable Ore Reserves of 189 million tonnes grading at 0.46 per cent copper and 0.49 grammes/tonne gold and total recoverable metal reserves of 811,000 tonnes of copper and 2.21 million ounces of gold.
On a six-month basis, Bezant shares rate a very deep value buy on a bid-offer spread of 14.5 to 16p.
Finally, please note that I updated the investment case on seven small-cap shares in two other online articles today: Small-cap trading buys and Small-cap wonders. My next article will appear online tomorrow morning.
