David Lamm, Executive Chairman and Chief Investment Officer of NGE Capital Ltd (ASX: NGE), a 10foot holding, recently agreed to an interview. I’m grateful and appreciative that he took the time to answer the questions of a very small shareholder.
Before I get into that, there is obvious potential for an anonymous entity (me) to spruik stocks that they hold. I have been extra stringent with my disclaimers and disclosures in this interview as a result. Please make sure you read the full disclaimer at the bottom.
Please also do not go out and blindly buy NGE Capital shares on the basis of this interview. NGE is a relatively new, small, and thinly traded LIC with a high expense ratio and a concentrated portfolio. Any would-be shareholder should first look to understand NGE’s portfolio and the risks. NGE’s most recent list of its largest holdings was, I believe, disclosed to ASX as part of its presentation on 19 October 2017.
In the interview below, I have shortened my original questions substantially in order to maximise the focus on the answers. I have not made a single change to David Lamm’s responses, other than to add a hyperlink to the October presentation on the ASX website. I do not believe my changes have in any way changed the meaning conveyed in either the questions or the answers.
I asked David Lamm several questions on behalf of some high net worth NGE shareholders, and these are sprinkled in towards the end of the interview. David was aware of this and answered all of their questions that I put to him.
Without further ado, here’s the interview:
Q: You’ve sold some positions quickly when they reprice. What’s NGE’s target holding period when it takes a position?
A: We generally intend to hold investments medium to long term (meaning 3-5+ years). However we continually re-assess each of our holdings and we will certainly be happy to also sell positions quickly if the price has changed or the story has changed and we no longer feel we can generate a strong risk-adjusted return by continuing to hold the position.
Q: Where do you see NGE Capital in 10 years time?
A: We will aim to grow NGE organically by generating investment returns and continually re-investing in new opportunities. If we can grow our asset value at 15% p.a., then in 10 years NGE would have around $100m of NTA, or roughly 4x our current NTA. I think that would be a great outcome and put us on par with some of the best fund managers globally.
Q: Is there a set of circumstances where your style of investing may be more risky than otherwise?
A: We have a value bias, so there will be periods of market exuberance where we would likely underperform the broader market as we’re unlikely to invest in internet/tech stocks on PE’s of 100x or on revenue multiples of say 20x. Of course we are still investing in the markets and whilst we are generally defensive investors we would still be negatively impacted by a stock market correction or crash.
Q: In a concentrated portfolio, mistakes or unforeseen events will have a more severe impact on performance. How do you mitigate this risk?
A: We feel strongly that investing in a concentrated way will produce the best returns over the long term as we can focus our capital on our best investment opportunities rather than buying “a little of everything”. However, this does mean that we have to be more careful with each large position we take and the risks of a mistake are magnified. So to mitigate this risk firstly we do a substantial amount of due diligence before making a large investment and secondly we acknowledge that any single investment we make can have a negative impact on our performance if we have made a mistake, but will still not be terminal. If we make 6 or 7 investments and 1 goes very wrong we can still generate strong returns from the portfolio. This year was a great example of that, we made a big loss on our investment in Godfreys, but we still generated around a 25% return for the year.
Mathematically we can only lose 100% of any single mistaken investment, but we can make multiples of our capital on a great investment, so we focus on picking likely winners so we can live with the occasional error or unforeseen event.
Q: You’re a qualified actuary. Relative to other investors, does this give you an advantage in managing risk?
A: I’m not so sure about that. Investing in the stock market involves a lot of softer elements and strategic understanding. We don’t generally apply complex mathematical models to our investments and most often the best investments we make are those we can explain simply and calculate the company’s future cash flows without Excel or even a calculator.
Q: Tell us a little about your corporate governance. In what circumstances might you be replaced as Chairman?
A: We are very transparent in the way we operate, we are a very simple company with a very simple and flat structure. We have a Board of 3 and a CFO/Company secretary, but of course we have corporate governance policies to ensure that our shareholders’ rights are well protected.
If shareholders or the Board decide to replace me as Executive Chairman they can of course do that at any time. However, I think as NGE grows larger, whether organically or inorganically, we may be able to justify increasing the size of the Board and potentially even appointing an independent Chairman.
Q: Who’s your favourite rapper?
A: Don’t have one.
Q: Tell us about Godfrey’s. Does the thesis involve a view on Godfrey’s competitive position (e.g. vs. Amazon)?
A: Godfreys was trading on very low PE and EV/EBITDA multiples, making it one of the cheapest stocks on the ASX. Of course it is in a tough sector and has been going through some management and strategy changes as well.
Unlike some retail categories Godfreys primarily sells their own designed products, therefore there is little risk of going to Godfreys and then finding the same product cheaper online. In terms of Amazon we were of the view that it will not be helpful for Godfreys, but won’t take too much business away either. You could already buy a vacuum cleaner online before Amazon came to Australia, so we think the impact will be limited.
Having said all of that we have still made a significant loss on our investment and so far we have effectively been very wrong. The business remains profitable, cashflow positive and incredibly cheap on all traditional valuation methods. Should the business make just slight improvements to performance we think there would be a big re-rating in the share price. Whilst we are less confident of this than when we first invested we still think there is a reasonable chance of this happening in the next year.
Q: How many bitcoins do you own?
A: Zero. And I don’t think that will ever change.
Q: Would NGE Capital ever engage in short-selling?
A: Shorting stocks is a particular art and whist we see very overvalued stocks all the time we are unlikely to short sell stocks, it’s not part of our strategy at NGE.
Q: What discount to NTA do you need to justify buying back shares? An LIC with a ~3.2% expense ratio is arguably fairly valued at a significant discount to NTA. Related, do you ever expect the NTA discount to normalise?
A: We have bought back some shares at a 25-30% discount to NTA, which is a very large discount in my opinion. However your points are valid that we are a small fund and have a relatively high expense ratio, so we are inclined to grow our NTA rather than shrink it via buybacks. It’s for that reason we haven’t been more aggressive with our buy-backs.
I think fair value is our NTA, and the discount isn’t justified. Yes, we have a high expense ratio, but we are also small which allows us to invest in a way that we can generate very strong returns. Furthermore we have significant tax losses which are not captured in our NTA, these are unique for a LIC and very valuable.
Finally, yes, I certainly expect the discount to normalise. As older shareholders from our days as New Guinea Energy continue to sell out and new shareholders who believe in our strategy continue to buy into the company I think we will see the share price much closer to NTA. In fact I believe there is potential for NGE to trade at a premium to NTA.
Q: Does NGE ever expect to pay dividends?
A: Eventually yes, but over the next few years a dividend is unlikely. We are trying to grow our NTA rather than shrink it as discussed above, but more importantly we are able to utilise our tax losses and therefore we won’t be generating many franking credits, so any dividend would largely be unfranked.
Q: Do you intend to raise capital, and if so, how do you intend to do it?
A: We would consider raising capital at some point to improve the expense ratio, however we haven’t yet considered the timing or method. However it would be very unlikely for us to dilute investors at a discount to NTA.
Q: How do you stand to benefit from strong performance from NGE over time?
A: In our presentation from 19 October 2017 we disclosed the KPI’s showing that I could earn a 100% bonus for achieving a 25% return for NGE (after running costs). I think this is a rather high hurdle. Of course I am also a large shareholder in NGE and that makes me very motivated to generate a strong return.
(Editor’s note: David Lamm has an indirect interest in ~10m NGE shares, approximately 27% of the company, via three controlled entities.)
Q: Is NGE able to use its prior tax losses (from before it became an LIC) to offset future income?
A: Yes, we believe we can.
(Editor’s note: NGE Capital was formerly New Guinea Energy, a failed oil explorer that incurred substantial unused tax losses. There was some uncertainty as to whether losses from NGE’s days as an oil explorer were able to be applied to its new business as an LIC.)
Q: Any other comments?
A: Please feel free to send us investment ideas for us to consider which you can do via our website www.ngecapital.com.au.
I would like to thank David for his time. I found that interview very useful and I hope that readers did also.
At the time of David Lamm’s response to my emailed questions (18.01.2018), NGE Capital owned shares of Godfreys Group Ltd (ASX:GFY). NGE Capital is an active LIC that may trade in any mentioned securities at any time, without notice to readers of this interview. NGE Capital may change its mind on its held positions at any time and there is no guarantee that the company will continue holding any mentioned securities.
David Lamm is the Executive Chairman of NGE Capital Limited and owns shares in NGE Capital. He may also personally hold positions in individual securities mentioned in this interview.