10foot Scuttlebutt: February 2018 edition

Back with another version of scuttlebutt, some stuff I’ve seen or thought recently. I am particularly keen to get thoughts and opinions on alternative investments & the UK fin services sector.

Buffett buys Teva

Has Warren lost the plot? He’s bought a stake in Teva Pharmaceuticals which has an at EV/EBITDA of 12ish and something like $32bn in debt. I first thought he was a) insane, and then b) that this might be validation of my Mayne Pharma purchase (buying pharma when there is blood in the streets, etc) but I realised he’s got something different in mind – job cuts. My guess is he’ll try and gut Teva, which is not nearly so expensive if you can fire half the staff.

There has been some interesting media coverage on the pharma industry recently, including one piece about pharmacy benefit management. It’s made me think Mayne might still be an opportunity, but equally, the media coverage only indicates how complex the situation is – I’m better off on the sidelines.

Bailed up by Bailador? 

Bailador Technology Investments (ASX:BTI) looks similar to Blue Sky Asset Management (ASX: BLA), except it’s wholly a venture-cap/technology style fund.  I was originally interested in it for its ~15% discount to NTA, as well as the underlying tech companies that were reportedly carried at modest valuations or cost.

However there were a couple of things I didn’t like. First it seems very difficult to get any sort of grip on its investment company performance or valuations as that part appears all quite opaque.

Second, Bailador appears to be externally managed, paying 1.75% & 17.5% to an entity controlled by Bailador management – talk about a conflict of interest! To be sure, I’ve seen them mark down at least one investment that wasn’t performing, but if you take a skeptical view (remember the incentives!) that could just be virtue signalling.

Third, related, Bailador has an illiquid portfolio that will probably go without generating cash for several years, as early stage growth companies don’t throw off cash, and sales of holdings should be very infrequent. To me this is problematic as shareholders will be paying annual (hefty) management fees – directly to management! – on an investment portfolio of opaque companies on basically a mark-to-model basis.

Bailador is currently paying a shade over $2m a year to management in management fees alone, and it has only $6m in cash. Portfolio companies seem to require additional investment semi regularly so I suspect Bailador will have to raise capital soon. It will be interesting to see if they are able to raise at NTA.

Sharpening the criticism a little, it appears Bailador will be raising capital at least in part to pay its ongoing management fees. On a positive note, upwards revaluations of some of its investments won’t trigger performance fees on unrealised gains (that is, performance is only payable on cash gains, such as from a sale).

Bailador management also receives director fees directly from subsidiary companies. That is, in addition to receiving management and performance fees, management receives ongoing director fees from portfolio companies. Money is being taken out of shareholder pockets via both the fund manager, and directly out of portfolio companies. Significant shareholdings notwithstanding, management is doing extraordinarily well out of this arrangement.

From the BTI 2017 annual report

This kind of company might be right for some, but it’s not my cup of tea.

Do alternative investments have a future? 

One of my many side projects aims to determine if Blue Sky Alternative Investments (ASX:BLA) is aggressively marking its portfolio (I have NFI*; disclosure is obtuse).

Still, judging by the AFR I’m pretty sure that their investment in Vinomofo is valued optimistically. Vino missed its revenue forecasts by $10m last year, but Blue Sky’s valuation for the Blue Sky Private Equity Vinomofo Fund increased by 3.6% from $4.342 million to $4.5 million while percentage interest remained constant. It was marked up a similar amount in the first half again today.

If I step back and ask myself where all the money looking for a home in a low yield environment is going, it’s not hard to envision some of it going into alternative assets. Plus if you look at BLA’s assets, it owns a decent amount of property and aged care investments (around 17% of net assets – and a lot more if you include student accommodation). I would guess that these investments almost definitely have their valuations inflated by lower interest rates.

Elsewhere BLA owns late stage venture-cap tech stocks, which are also pretty easy to mark to model, given that the underlying businesses are usually opaque and valuations can be pretty woolly e.g. multiples of revenue. I’m on the fence on BLA, but I do wonder how all of these investments would fare in a world where investors have a lot more choice (via higher interest rates). I suspect they would not be nearly so much in demand.

(*NFI = no fucking idea)

Big trouble in little Big Un

AFR has been belting it out of the park these past few months and there has been some really sterling coverage of Big Un (ASX: BIG) by Jonathon Shapiro recently.

Big Un shares dive 30% after financing admission

Big Un revelations as company goes into trading halt

I haven’t done the legwork on BIG but there are some concerning allegations in there. Customers are being filmed for free, one unhappy customer (if I understand correctly) was filmed for free, billed anyway, was unhappy with the service and had the video published by BIG anyway. The company financing BIG’s customers has a claim over Big TV’s assets, which makes the arrangement look a lot like a loan. I’m not familiar with the specifics of debtor finance but I thought it was normally secured solely against the customer receivables.

Reading between the lines I suspect that there’s a lot more to this story.

Given the point we’re at in the market and some of the shenanigans we’re seeing, I have been spending a fair bit of time looking at dodgy stocks with a view to finding one to short. I don’t short stocks (yet), and there’s no BIG shares available to borrow (I checked on the weekend) but if I found some I would have shorted BIG solely on the strength of the AFR’s articles and BIG’s Tipsly transaction. Buyer beware.

UK Fin Services

I’m keen on the UK wealth management space (and have been for a while – since I bought Just Group plc). I am still in the early stage of sieving a lot of companies, but I have a seemingly compelling thematic. UK pension contribution rates are currently around 3% and are rising to 9% in 2019. I also expect there will be additional inflows to the sector coming from the ongoing switch over from defined benefit to defined contribution pensions. I rate it at least a 50% chance that contribution rates go above 9% in the next ~5 years. In that context, prima facie, valuations of ~16x earnings at a bunch of asset manager + financial advisor firms look to be discounting the significant growth that could be coming.

I have not looked closely at any one co yet, as I am casting through a long list of firms trying to find something that is a) small enough to see significant growth, b) scalable, c) well run, and d) relatively future-proof.

Several firms appear kinda backwards here, including one called Brooks Macdonald (LON: BRK). I was interested in Brooks Macdonald and had it on my short list until I saw its fee structure. It charges 1.45% per annum (plus advisor fees, say 0.5%?) for a “Low Risk Portfolio Defensive Income” strategy that is up to 70% in bonds. Performance has been staunch – 13% per annum over the last 5 years (!!) and has more than covered the fees, although I do wonder how defensive it really is to get that type of return. Performance of other strategies has not been quite that good.

There are a few other things I didn’t like. Brooks MacDonald reports its returns gross of fees, and it charges 0.8% per annum (plus advisor fees) to customers in a passive defensive strategy that is 100% ETFs and around 50% Vanguard & similar index funds. Also, “Underlying charges may apply which will vary according to the specific assets within the portfolio.” Not only do you pay 0.8% to Brooks, plus 0.X% to your advisor, you also have to pay the fee for the funds that Brooks invests you in. So you pay a fee to your advisor for putting you in a Brooks strategy, then you pay a fee to Brooks for putting you in a basket of funds, then you pay the management fee for the funds themselves! I am not sure if I understand that correctly (it seems too wicked) but it really reeks.

This LSE-listed BRK gets a ‘no’ from me.

I own shares in Just Group plc. I formerly owned shares in Mayne Pharma but have sold them all. This is a disclosure and not a recommendation.

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