Thursday, July 7, 2011

Aberdeen International

Aberdeen International (AAB) owns a myriad of public and private small-caps in the resource sector. The value of its portfolio has risen significantly over the last few years, as strong commodity prices have bolstered this sector. But Aberdeen's price has risen to the same height as its portfolio, creating a potential opportunity for value investors.

While the company trades for just over $70 million, it has assets of almost $170 million (including its investment portfolio) against liabilities of just over $30 million. Included in the assets are $14 million of cash, and $86 million of publicly traded securities. The rest of the assets, including private securities, loans receivable and royalty interests booked at $100 million, are therefore thrown in free!

There are, of course, risks with such a portfolio. Though the prevailing market wisdom is that commodity prices can only go up (e.g. due to never-ending demand from emerging markets), this could turn out to be false. Companies that are highly leveraged to the prices of commodities could see dramatic falls, and small-cap resource stocks fit this bill perfectly. If a company has no other operations but owns a property from which it can extract a resource for $X/unit (not an uncommon scenario for small-caps in this sector) and the commodity price falls below $X/unit, that company would lose a lot of value.

For this reason, since commodity prices are volatile, one can expect resource stocks to be very volatile. As such, value investors should demand a massive margin of safety when investing in a portfolio of such stocks.

This is particularly true considering the costs Aberdeen charges to manage this portfolio. The top three managers made a total of $6 million last year. (Recall that the company's market cap is just $70 million!) As such, the first few percentage points of returns on the portfolio are needed just to break even!

And investors can forget about someone coming in to buy this company out at anywhere close to book value. The top three officers will receive awards of over $8 million if there is a change of control.

Finally, there is $10 million in dispute between Aberdeen and a 3rd party. Aberdeen claims the money is owed to them, while the other company claims it is not. But Aberdeen includes the full $10 million on its balance sheet. Investors should be careful not to blindly include this amount in their valuations, as it may never arrive!

One can make money by investing in companies at a discount to the assets the company owns. We saw this done successfully with Envoy Capital not long ago, and it is currently being attempted with Urbana Corp. as well. But to avoid risk of loss, one must try to ensure the assets can hold their values. In the small-cap resource sector, it's difficult to say with any certainty what an asset is worth.

Disclosure: No position

No comments:

Follow by Email