To put the extent of the undervaluation into some perspective, at the end of June the company was sitting on short-term investments, cash and receivables of 6.4p a share, or 30 per cent of its current share price of 21p. Strip out those liquid resources from the company's book value of 36p a share, and assets worth 29.6p a share are in effect being valued at only half their carrying value in Polo's accounts. This is an extreme valuation considering earlier this year a new investor, Michael Tang, acquired 11.77 per cent of Polo's share capital at 40p a share - almost double the current share price and 11 per cent above book value of 36p a share - through his vehicle, Mettiz Capital, an investment company with corporate and financial experience in natural resources, power generation, manufacturing and real estate. Mr Tang is the company's largest single shareholder with a 14.55 per cent stake, so he clearly sees the potential in Polo's investment portfolio.
As I have previously pointed out this is a highly unusual situation where private investors are able to buy into an undervalued company on substantially better terms than a large fund can. Or put it another way, Polo's shares would have to double for Mr Tang's investment to turn a profit! That is no forlorn hope either since there is still a very realistic chance of some positive newsflow to kick-start a well overdue re-rating in the shares.
Realising value in African oil assets
That's because at the start of last month Polo's board issued an update concerning the company’s investment in Signet Petroleum, the independent African oil exploration company with interests in four prospective assets in Benin, Burundi, Namibia and Tanzania. Polo has a 46.94 per cent holding in the company that’s in the books for £28.1m, or the equivalent of 10.4p a share.
To recap, Signet has four prospective assets in Benin, Burundi, Namibia and Tanzania. Signet's main investment is an 80 per cent interest in Hydrotanz, a company that has a production-sharing agreement with the United Republic of Tanzania and the Tanzania Petroleum Development Corporation on the offshore North Mnazi Bay Block. This prospect is adjacent to BG and Ophir Energy's offshore Chaza 1 gas discovery well, which is targeting an eye-catching 12 trillion cubic feet of gas.
First Energy Capital Corporation has been appointed by Signet to assess strategic alternatives for Mnazi Bay, including potential farm-out opportunities. True, potential farm-out deals are clearly taking longer than expected to close, which explains the weakness in Polo’s share price as investors lose patience. However, it's worth noting that the sale process "is progressing well with a high level of participation from a broad spectrum of high quality potential bidders." Mr Tang has gone on record as saying that he sees "substantial upside for Polo as a major Signet shareholder". I have little reason to doubt that assertion. It would be irrational for Mr Tang to have paid such a premium to the share price unless he thought substantial value could be realised from the company’s holding in Signet.
It’s also worth pointing out that there should be decent upside potential in Polo’s largest investment, the Nimini Komahun Gold Project in Sierra Leone, in which Polo holds a 90 per cent stake worth £33.4m. The last resource estimate showed an indicated gold resource at the site of 550,000 ounces and another 330,000 inferred ounces of gold, bringing the total potential resource to 880,000 ounces. On that basis, the £33.4m carrying value on Polo's investment values the project at only $53.8m, or the equivalent of $61 an ounce. That's hardly an exacting valuation and means that Nimini is commercially viable even after factoring in a gold price around $1,284 an ounce. The next update from Nimini will be the release of the Preliminary Economic Assessment (PEA), the date of which is dependent on the outcome of discussions with the government of Sierra Leone regarding the terms applicable to the project, the first large-scale underground gold mine in Sierra Leone. Clearly Mr Tang expects a positive outcome and so do I.
Unwarranted large discount to sum-of-the-parts valuations
As frustrated as I am with the lack of progress in Polo's share price this year, no matter which way I look at it the shares are substantially undervalued. That’s because the holdings in Signet and Nimini are in the books for £61.5m, or worth more than Polo’s market value of £56m. That leaves cash and marketable investments worth £17.2m, or 6.4p a share, in the price for free as well as interests in four other companies worth a further £18.5m, or 6.9p a share.
True, investors are only likely to warm to the company when Signet finally closes a farm-out deal, or when there is concrete news regards the PEA on Nimini and discussions with the government of Sierra Leone. But at the current bargain basement the risk looks firmly skewed to the upside if you have the patience to await the catalyst to spark a well overdue re-rating.
From a charting perspective, there are some positive signs emerging even though the share price is close to its lows for the year. The 14-day relative-strength index (RSI) is now in oversold territory showing a reading well below 40. Interestingly, the last major rally in mid July - which saw the price rally almost 40 per cent from its low point around 18.5p - started when the RSI was this oversold. True, the 14-day RSI was showing a reading of 30 in late April when the rally started from a low of around 19p. But what is clear to me is that if a potentially lucrative deal is signed by Signet, the technical set-up favours a significant price move from what are very oversold levels.
In the circumstances, I would use the unwarranted low valuation of the company as a buying opportunity. On a bid-offer spread of 20.5p to 21p, Polo's shares continue to rate a buy and my fair value estimate remains 35p.
How Simon Thompson's 2013 Bargain Shares Portfolio has performed
| Company | TIDM | Opening offer price on 8 February 2013 | Bid price on 20 November 2013 | Dividends paid (p) | Total return (%) |
|---|---|---|---|---|---|
| Inland Homes | INL | 23.5 | 48.5 | 0 | 106.4% |
| Terrace Hill | THG | 15.4 | 30.75 | 0 | 99.7% |
| Trifast (see note four) | TRI | 51.9 | 83.5 | 0.80 | 62.4% |
| Randall & Quilter (see note one) | RQIH | 113.3 | 173 | 8.40 | 60.1% |
| Fairpoint (see note two) | FRP | 98.25 | 129 | 5.70 | 37.1% |
| Oakley Capital Investments | OCL | 139.7 | 182 | 0 | 30.3% |
| Noble Investments (see note three) | NBL | 199.4 | 256.5 | 2.50 | 29.9% |
| Cairn Energy | CNE | 287.2 | 270 | 0 | -6.0% |
| Heritage Oil | HOIL | 202.3 | 184 | 0 | -9.0% |
| Polo Resources | POL | 24.53 | 20.5 | 0 | -16.4% |
| Average | 39.4% | ||||
| FTSE All-Share | 3275 | 3563 | 11.6% | ||
| FTSE SmallCap | 3659 | 4344 | 20.2% | ||
| FTSE Aim index | 742 | 810 | 9.4% | ||
1. Randall & Quilter returned 5p a share on 3 May 2013 to shareholders through the issue of 'L' and 'M' shares and proposes a return of 3.4p a share through the issue of 'N' and 'O' shares on 28 October. 2. Fairpoint paid a final dividend of 3.55p a share on 20 June and an interim dividend of 2.15p on 25 October. 3. Noble Investments paid a dividend of 2.5p a share on 19 July. 4. Trifast paid a final dividend of 0.8p a share on 18 October. Note: Latest prices taken on Wednesday 20 November 2013 | |||||
Finally, and in response to recent newsflow, I am currently working my way through a large number of updates on the following recommendations: Eurovestech (EVT), Bezant Resources (BZT), Amino Technologies (AMO), Eros (NYSE: EROS), PV Crystalox Solar (PVCS), Crystal Amber (CRS), API (API), Mountview Estates (MTVW), Daejan (DJAN), Bovis Homes (BVS), Town Centre Securities (TCSC), Raven Russia (RUS) and WH Ireland (WHI).
MORE FROM SIMON THOMPSON ONLINE...
Since the start of last week I have published articles on the following nine companies:
■ Macau Property opportunities ('Hot property plays', 12 Nov 2013)
■ First Property ('Hot property plays', 12 Nov 2013)
■ Inland ('Bargain shares updates', 12 Nov 2013)
■ Terrace Hill ('Bargain shares updates', 12 Nov 2013)
■ LMS Capital ('LMS worth capitalising on', 18 Nov 2013)
■ Trifast ('A bolt-on purchase', 18 Nov 2013)
■ Global Energy Development (Awaiting pay dirt, 19 Nov 2013)
■ Entertainment One ('Blue sky territory', 20 November 2013)
■ Marwyn Value Investors ('Blue sky territory', 20 November 2013)
