A Safe Bargain for 70 Cents on the Dollar

Posted on Posted in Investment Ideas & Company Research

I talk a lot about compounders–businesses that produce lots of cash flow and have opportunities to reinvest that cash flow at high rates of return. Such businesses that produce high returns on capital can compound their intrinsic value at above average rates over time, and the stock price follows intrinsic value over the long haul.

But while I spend time reading and researching great businesses, occasionally I come across an opportunity to buy a bargain–a stock trading for less than the value to a private owner. Sometimes these opportunities are created through special situations such as a spinoff.

Associated Capital (AC) is an example of this type of bargain. It trades for less than the net cash on its balance sheet, for about 70% of tangible book value (a portion of which is hidden due to an accounting rule), has an insider with over $500 million invested in it who wants to close this value gap, and a recently announced buyback.

AC is basically a big pile of cash worth about $40 per share that can be purchased for the current stock price of around $29. This $40 per share of tangible value gives no value to a $1 billion hedge fund that AC manages.

Given the insider incentives, future buybacks which will add to value per share at these prices, and a stock price that is trading at far less than book value, I think the stock is certainly a safe and cheap bargain.

This post is just a snapshot of the idea. I wrote a post on Seeking Alpha that covers this investment in more detail as well as my thoughts on how the situation came about.

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John Huber owns shares of AC. Clients of Saber Capital Management own shares of AC. This is not a recommendation. Please do your own research.  

John Huber is the portfolio manager of Saber Capital Management, LLC, an investment firm that manages separate accounts for clients. Saber employs a value investing strategy with a primary goal of patiently compounding capital for the long-term.

I established Saber as a personal investment vehicle that would allow me to manage outside investor capital alongside my own. I also write about investing at the blog Base Hit Investing.

I can be reached at john@sabercapitalmgt.com.

 

8 thoughts on “A Safe Bargain for 70 Cents on the Dollar

  1. As always, great writeup and interesting idea. I just went an read their recent 10k since it seems promising. However, I want to do some due diligence on GBL since ~15% of AC is in GBL stock, and then ~25% in the GBL note. This is 40% of AC’s total value tied to GBL, which inherently has some risks.

    I was curious if you’ve done any research on GBL? While I know Gabelli is a well respected value investor, many value investors also held 10%+ of assets in Valeant or Horsehead Trading. And while the fair value of AC’s GBL holdings may not be reflected in the current stock price, if GBL is holding overvalued securities, AC might not be as attractive an opportunity as it appears. Kind of how I felt about Yahoo and their BABA holdings.

    Just playing devil’s advocate here as I fundamentally do think this is a good idea, but I wanted to get your take.

    1. Thanks for the question, and yep, AC and GBL are certainly tied to the same horse (Gabelli). I don’t have much of an opinion on where GBL should be valued, other than to say I think the valuation is fair here (it actually has traded much higher than where it is now in the last year or two). I think generally speaking, asset management is a very good business. GBL takes in lots of recurring management fees, and the business has huge operating margins, lots of free cash flow, and doesn’t take hardly any capital to operate, which are all attractive aspects of the business. Regarding GBL holding undervalued securities, most of the cash and securities now sit inside AC (which is partly why Gabelli spun it off), so GBL’s balance sheet is much lighter than it was pre-spin. What’s basically left is the fee generating business (GBL collects fees on its roughly $47 billion of AUM). That’s a good business. Investment performance in the funds GBL manages is average, and I would expect it to continue to be average (not much you can expect from mutual funds). But as long as the company keeps its AUM, it will continue bringing in revenue from management fees. One might argue if investment performance is poor in the funds, AUM will likely leave. I think that is true, but Gabelli has proven to be a good enough investor (maybe better capital raiser) to grow his AUM over time. Either way, the value of GBL stock is relatively small in relation to AC’s balance sheet (AC owns 4.4 million shares of GBL, worth around $162 million. So certainly meaningful enough, but for each 10% move in GBL stock up or down, it will affect the value of AC’s book value (marked to market) by about $0.65. The loan is certainly a bigger piece of the pie (worth about $10 to AC), but I don’t see any way that the loan has much risk at all, since Gabelli has around half a billion invested in both firms, and GBL has plenty of earning power and liquidity. Thanks for the comment.

      1. Thanks for the reply and all makes sense.

        So would you then value GBL more on the operating components of the business (e.g., management fees) or their investment holdings like one would with AC? Seems like the latter were mostly spun off into AC so my guess would be it’s more of an operating business and therefore not so tied to book value.

        AC’s management and research fees on the other hand are mostly nominal and don’t seem central to the AC thesis in my opinion. Rather, it’s all about book value here and what investments are held by AC.

        Sorry again for speaking from a position of ignorance as I will be reading GBL’s 10k this weekend, and I’m sure many of these questions will be answered once I do. But since I greatly respect your expertise, figured I would ask.

        Also, really looking forward to your talk at my company next Friday!

        1. Thanks SA. Yeah, I’d look at AC relative to book value assuming that shareholders will see the fair value of that cash and investments because Gabelli understands capital allocation and value, and he is certainly motivated given his $550 billion stake in the company. I am not sure exactly how everything works out regarding the operating business or the capital allocation (buybacks, tender offer, dividends, etc…), but I’m confident that this is a situation that has very little downside given the clean balance sheet and the large discount to the assets the company owns. Lots of good things can happen, but not a lot of bad things. My favorite type of investment situation. Thanks for the comments.

  2. Thanks for the post, John, the balance sheet looks very attractive, however I am not sure if buyback will be the best growth strategy (as they stated they would do in their 10/12B). What addition do you think they can do to deploy these cash on other strategic moves?

    Also a random question: why do you think they tried to disassociate from the name “Gabelli” by renaming them as “Associated Capital”? Just trying to get your thoughts.

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