Opportunistic Value
The High-Yield Spread, AssetCo, and ARN Media.
So far in 2023, my portfolio has taken a kicking! More like death by 1000 cuts, than any obvious downward spiral. After selling the largest holding - Kiland Ltd., which is being taken private - almost a quarter now sits in cash. As always, I’m in no rush to re-deploy, content to collect a reasonable yield, whilst seeking only those few opportunities where the odds are stacked heavily in my favour.
In this post, I’m trying something different. There’s a couple of oddball ideas, alongside a tool that might interest the opportunistic investor. Let’s kick off….
The High-Yield Spread
I’m a strong believer in Absolute Return investing, especially when combined with buying smaller and more illiquid companies. This counter-cyclical approach requires the patience to hold cash (or similarly liquid assets) in most environments. The obvious cost is lower returns, especially during rising markets, but the benefit is retaining the optionally to switch to a more aggressive allocation during periods of financial panic. When asset prices are cheapest, miss-pricing more prevalent, and future investment returns are highest.
The most difficult aspect is knowing when to switch from patience to aggression. Partly this comes from analysing new opportunities and investing only when expected returns go above a pre-defined hurdle rate. But another potential indicator of excellent future returns is the High-Yield Spread.
This ‘spread’ represents the difference between the return lenders receive from owning government bonds compared to lower quality, or ‘junk’ bonds. When the spread is narrow, it’s easier for even the most indebted companies to borrow. But when it’s high, there is often stress in the financial system, as lenders demand a larger premium to hold risker debt.
I’m no quant. But I also want to fish in the most lucrative pools - and to follow strategies that have worked historically. On this point, I came across the High-Yield Spread in this excellent research article by Dan Rasmussen on Crisis Investing. To define a ‘crisis’, he used a High-Yield Spread that was one Standard Deviation above the historic average - defined as 6.5% in the US and 8.5% in Europe. What I found most interesting is the excellent performance of Small Value strategies when the High-Yield Spread reaches crisis levels. Small Value significantly outperformed all other asset classes. For example, in Europe the average two year return was over 50%! Wow!
Clearly, this doesn’t need to be rigidly applied. Instead, I use the High-Yield Spread as a helpful tool to think about when to more aggressively allocate capital.
If you’d also like to follow along, here are the two links I’d recommend:
AssetCo
This is a real oddball. In 2020, the UK AIM listed company AssetCo had ~£30 million in cash but no underlying business (after the loss of a contract providing fire fighting services to the UAE). Fast forward a few years and AssetCo has transformed. It’s now an Asset Management business with ~£2.5 Billion in Assets Under Management (AuM).
AssetCo also has one of the most experienced micro-cap management teams I’ve come across. Martin Gilbert is Chairman. The same Martin Gilbert who founded Aberdeen Asset Management in the early 1980s and grew it into the largest Asset Manager based in the UK. When he left Abrdn (as it’s now called) in 2020, he convinced his Global head of Investments (Alex Hoctor-Duncan), Head of Private Markets (Peter McKellar), and Head of EMEA/UK (Gary Marshall) to join him at AssetCo.
The general strategy has been to acquire small (sub £1Bn AuM) active equity managers with good track records. Many are family owned and lack the scale to complete with their much larger peers. In theory, AssetCo pays ~2-3 x Sales, then reduces compliance costs, integrates back and middle office functions, and cross sells the funds under a single brand. Ultimately, targeting an Operating Margin of ~20-30%.
The team has made 7 acquisitions over two years, spending over £100 million using not only the cash on hand, but both debt and equity financing. You only need to look at the historic share price to see it’s been a bumpy ride. Mistakes have been made. The most obvious being the purchase of Rize ETF, a racy thematic manager, for 17 x sales in 2021. Growth remained low and it was recently sold to Cathie Wood’s ARK at a cut down price.
Away from this ‘moon-shot’ investment, the other acquisitions averaged ~3 x Sales and focused more on traditional active ‘Value’ strategies (here’s a link to AssetCo’s current funds).
Thinking about valuation. As a rule of thumb, Asset Managers are rarely sold for less than 1% of AuM. This conservative approach would value AssetCo at around the current Market Capitalisation of ~£50 million. Consisting of ~£25 million for the AuM and ~£20 million of Net Cash (as of the last reporting date, the 31st March 2023).
The kicker, and most of the upside, comes from AssetCo’s 30% ownership of Parmenion. A platform for Independent Financial Advisors that is majority owned by the Private Equity firm Preservation Capital Partners and was bought from Abrdn in 2021 (yes, the same Abrdn that Martin Gilbert had left a year earlier!).
Parmenion’s results continue to impress. AuM has grown from ~£5Bn in 2018 to over £10Bn today, and Net Income has gone from around breakeven to £12 million in 2022. In a recent interview, Martin Gilbert gave the current run-rate EBITDA as between £20 million and £25 million. A figure that would support an ‘independent’ valuation of AssetCo’s stake at between £75 million and £90 million (Yes, you read that correctly - considerably higher than AssetCo’s entire Market Capitalisation!).
The catch here is timing. Firstly, there’s cash burn. Full year results (ending 30 October 2023) will be released in early 2024 and I expect the overall Net Cash position will have fallen to ~£10-15 million. If you believe management, the business is nearly cash flow positive, but if you conservatively use the historic cash burn, AssetCo will require financing in less than 2 years. Secondly, the Parmenion sale rumours have been circling for some time. If true, the sale would provide a catalyst for a sizeable re-rating of the stock. If not, the stock could well continue to tread water for years.
Overall, investing in AssetCo feels uncomfortable due to the rapid changes and the ongoing uncertainty. However, it’s difficult to come up with a feasible scenario where you might lose money over the long-term. For those with the stomach, and the patience, I think it’ll work out pretty well.
ARN Media
A decade ago, ARN Media was an over-leveraged and sprawling conglomerate that owned everything from daily newspapers to outdoor advertising. Today, after multiple divestments there’s very little debt and a singular focus - to become the largest Commercial Radio company in Australia.
But Radio is dying, right? What was that song again!?…..video killed the radio star!
Yes - I thought exactly the same thing. However, after spending some time researching, I’m much less convinced of radio’s decline. For example:
In Australia’s main Metropolitan areas (i.e. Sydney, Melbourne, Brisbane, Adelaide and Perth) total commercial radio listeners have actually grown in every year since 2016, from 10.3 million to 11.9 million in 2022.
According to the Australian Entertainment & Media outlook (produced annually by PWC), Radio has slipped from 9% of all advertising spending in 2012 to around 5% in 2021. However, due to the growth in total advertising spending from A$12Bn in 2012 to A$20Bn in 2021, spending on radio advertising actually increased from A$1Bn in 2012 to around A$1.1Bn in 2021.
Global advertising spend on radio has been fairly static for around 20 years. https://www.visualcapitalist.com/evolution-global-advertising-spend-1980-2020/
In summary, Commercial Radio is not a high-growth industry! But even if you adjust for inflation, it also doesn’t seem to be rapidly declining.
The Australian market is well established and fairly lucrative for incumbents, who enjoy stable market share and high operating margins of 20%+. Given the population density, Metropolitan radio receives the majority of advertising spending. Metropolitan radio is essentially an oligopoly - where the three largest incumbents take over ~80% of all spending (ARN Media is ~30% of this). The smaller Regional market is even more concentrated with only two companies, Arn Media and Southern Cross Media, taking over two thirds of all advertising dollars.
Today, ARN Media’s Market Capitalisation is ~A$260 million and Net Debt (including leases) is ~A$50 million, giving an Enterprise Value of ~A$310 million. In 2022, the Radio Division, including all central costs, earned ~A$65 million in Operating Profit.
This is clearly a low price (Earnings Yield of 20%+), but what really caught my eye is the dividend. With a policy to pay out between 60-80% of Net Income, ARN Media’s current Dividend Yield is north of 10%! An unusually high payout, especially given the durability of the business and the low leverage.
Up to now, it all seems great. However, last month ARN Media (together with the Private Equity firm Anchorage Capital Partners) made a bid for Southern Cross Media. This is ARN Media’s main rival, and if the deal is completed, it would undoubtably create a dominant force and almost monopolise Australian Commercial Radio. Yet, it’s fairly complex and not without risks.
I’ve already bought a starter position. But I’ve stopped buying because I’m struggling to think about the potential of the combined entity. Maybe you’re a Commercial Radio expert (or maybe you just like/hate the idea) - if so, please feel free to share your thoughts! I’m all ears!
Here’s a few links to get you up to speed:
Disclaimer. This article is for informational purposes only, and should not be seen as investment advice. Please do your own research before investing in any company mentioned.