Ariadne: The Resurrected Raider

It’s reasonably common to see listed investment companies trading at less than net asset value, for good reason. Unless the underlying assets are undervalued, the drag caused by management fees means LICs probably should trade at a discount.  Recently I came across one which was trading at around a 22% discount to NAV, has assets which appear undervalued and is run by an industry legend: Ariadne (ASX:ARA).

Ariadne has an interesting past to say the least.  In the 1980s it was one of the infamous corporate raiders, captained by a Kiwi by the name of Bruce Judge.  Highly leveraged, it crashed in 1987 and was voted one of the top 10 worst stocks in the world by the Wall Street Journal in 1988.  Some time between 1988 and the oldest ASX announcements I can see online (1998) the company was taken over by prominent investors Gary Weiss and Kevin Seymour, cleaned up and recapitalised.  One important part of this process was the ATO agreeing in 2003 to allow Ariadne to keep around 300 MM of carry-forward tax losses of which around 170MM remain today.  These losses are held off balance sheet until deemed likely to be used so they don’t figure in the conventional NAV calculation.

Between 1998 and 2008 ARA carried out a number of residential property, marina and car parking developments.  In the lead up to the GFC the company exited many of its property projects and earlier this year it exited its remaining car park investment.  Most of the cash from these exits has since been redeployed into ASX-listed holdings where ARA has usually taken either an activist role (HGO & AAD) or at least a board seat (CVW until recently).  Where the company has sold real estate projects in the past there has generally been a significant uplift in value versus the carrying value.  ARA’s investments generally seem to have worked out in the past with the exception of the appropriately-named Subzero (ASX:SZG).

Below is my attempt at a sum of the parts valuation for Ariadne.  The potential upside for ARA’s ASX holdings such as Ardent, Hillgrove and Clearview is reasonably simple to find in the ASX announcements for these companies.  The long-term equity method accounted holdings are harder to value, but given ARA’s track record I think there is a reasonable chance that they will sell in future at a significant premium to carrying value.  For example, Oram’s is a large marina in Auckland’s viaduct area that has dry storage, marina berths and slipping/repair facilities for large vessels such as superyachts.  The next America’s Cup defence will be held in Auckland in 2021 and ARA currently has a non-binding heads of agreement with the local government for development of another facility adjacent to Oram’s.  It doesn’t take a lot of imagination to see that the 2021 Cup defence is a possible catalyst to increase the value of this part of the portfolio, particularly if Team NZ win again.  Nevertheless I’ve left these holdings at carrying value below.

Simplified Balance Sheet 30 June 2018, MM AUD
Accounting Method
Carrying Value
Adjustment
Adjusted Value
Justification/Notes
Assets
Cash
23
-5.07
17.93
Deduction of final and special dividends
Ardent (ASX:AAG)
OCI
43.3
42
85
Increase to worst case share price of $3.58 listed in Ardent improvement plan.
Fresh Xtend/Agricoat/
Natureseal
Equity
12.1
0
12.1
Hillgrove (ASX:HGO)
Equity
12.4
3
15
Independant expert’s report.
Tank St JV
Equity
29.4
14.8
44.2
Uplift in valuation on sale. Since converted to cash.
50% Orams NZ
Equity
16
0
16
Clearview (ASX:CVG)
OCI
33.2
9
42
Aborted Sony takeover price, March 2018 of ~1.4x embedded value.
Trading Portfolio
P&L
5.3
0
5.3
Separate out the Shriro & Spring FG holdings
Shriro (ASX:SHG)
P&L
5.14
5.14
Spring FG Ltd (ASX:SFL)
P&L
0.36
0.36
Foundation Life (Loan Note)
P&L
4
0
4
Mercantile (ASX:MVT)
Not known
2.6
0
2.6
Other
4
0
4
Management cost
-50
-50
~4MM/yr in management costs discounted at 8%.
Tax benefit
21
21
Adjustments to carrying value x 30% tax rate
Deferred tax assets
1
0
1
Balance sheet value
Fixed assets &receivables
5
0
5
Total Assets
191.3
230.9
Liabilities
Debt
7.6
0
7.6
Minority interests
5.7
0
5.7
Payables & provisions
1.8
0
1.8
Equity
176.2
215.8
0.88
1.06
per share

I’ve valued the carry-forward tax losses based on the tax saving obtained if the valuation adjustments above are taxed as capital gains on sale.  The losses carried are both revenue and capital in nature so the benefit is likely higher due to the reduction in tax on dividends from subsidiaries.  ARA has minimal franking credit balances so the greater the proportion of earnings retained each year the greater the benefit (in terms of compounding) to shareholders.  I’d prefer it if they retained the earnings, provided they don’t change their capital allocation discipline.

Based on the above calculation we have a company with around $0.88 of NTA which could be worth $1.06 or so if a few of the larger holdings in the portfolio are turned around and sold, possibly more.  Another way to value ARA is to look at past performance.  Whilst past performance is no guarantee of future performance I think it is a better measure than Price/NTA in that I think ARA is unlikely to liquidate any time soon – I think it is more likely to continue to reinvest most of its earnings.  Since 1998 ARA has compounded tangible book value at around 10% (15% if we start instead in 1997) and has paid an average of 3.7% of tangible book in dividends each year since 2006, largely unfranked.  Median TSR figures for activist funds are around 12.4% so 13% return to TBV isn’t likely to be an outlier that can’t be replicated in future. So it wouldn’t be unreasonable to expect around a 13% before tax return on tangible book (NAV) and around a 15% return on purchase price if we buy at the current discount to NAV of around 22% and the discount persists.

Earnings tend to be lumpy so a calculation of the earnings power doesn’t seem appropriate for this company.  Because of this lumpiness, management’s large holdings and the illiquidity of its shares, it seems unlikely ARA will trade at a premium to NAV any time soon.  Having said this, it did so prior to the GFC so it isn’t out of the question but it’s not something I would count on as a prospective source of returns.

In terms of financial risk, the company employs minimal leverage and has undervalued subsidiaries with conservative levels of debt. Management and directors have a significant acreage of skin in the game with holdings of around 45% of the float.   There also appears to be a succession plan with Daniel Weiss (son of Gary) in the role of Investment Officer so there is a good chance the current investment methods continue to be used and management will continue to hold a large stake in the company.

ARA has a good record with respect to capital management – well it does since current management took over in the 1990’s anyway.  Share buybacks have been conducted in recent years when management considers the company’s shares to be priced below intrinsic value.  Interestingly the price paid in these repurchases reached $0.73, higher than the share price at the time of writing.

ARA isn’t likely to give a high double-digit return but I think there is a high chance of returning around 15% in the long term so I’m happy to allocate a portion of my portfolio to it given that I’m not finding much else lately that fits my style.  This is the sort of holding that needs to be put in the bottom drawer for many years so that ARA can do what most of us would like to do but can’t – invest whilst reinvesting most of the earnings without the drag of tax on retained earnings for many years.

PS – I discovered ARA after looking into Mercantile Investment’s takeover offer for ASX:YBR.  ARA’s executive director, Dr Gary Weiss, worked with Mercantile’s Chairman during the 1980’s boom and ARA holds some of Mercantile’s shares.  I was in primary school during the 80’s so I found it fascinating to read about the takeover boom that occurred back then.  Interesting times and well worth further reading.

If you have questions or comments please write to me, Warwick, at oceaniavalue@gmail.com.

Disclosure: I hold ARA at the time of writing.  This is not a recommendation to buy or sell any securities, nor is it financial advice.  All information presented is believed to be reliable and is for information purposes only.  Do heaps of your own research before purchasing any security, especially any that I have discussed.

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