Sunday, 8 March 2015

Cash at a discount from the Swiss Alps

Spice Private Equity (previously APEN) is a listed private equity fund that makes secondary and co-investments in emerging market funds and is listed on the SIX Swiss exchange, trading at a significant discount to NAV. While there are plenty of examples of closed end funds trading at large discounts I believe there are catalysts that could help close the discount.

APEN started out as AIG Private Equity in the late 1990s to invest in developed market PE funds (North America and Western Europe) and Asia to a small extent. Things were quite rosy, however starting in 2006/07 the company experienced NAV declines and found itself in a tight situation liquidity-wise amidst substantial capital calls, as the expectations of a largely self-funding portfolio did not materialise. The company raised debt and equity (via preferreds) from a group of banks and AIG itself. Then the crisis came, the capital calls didn’t stop, APEN began looking for new sources of liquidity and finally found prince charming in Fortress (which of course didn’t come cheap).

In 2013 the company went through a restructuring with GP Investments and Newbury Partners (Brazilian and US PE funds) taking a controlling stake and buying out AIG, selling assets and refinancing debt. They also issued 1.4m shares at CHF21.8 (virtually equal to today’s share price) and raised about CHF31m. At the same time the company set up a new investment guideline and decided to liquidate what they call as the “legacy portfolio” (mostly developed market funds) and focus solely on EM.

This actually happened a lot faster than expected, as early this year APEN concluded a sale of the legacy assets (as well as the debt on the balance sheet) to Blackstone’s secondaries business for $192m. The net receivable amount will be around $187m or $37m over 5 instalments through 2017 (more details on the transaction here). This transaction represents a 14% discount in USD terms to the fair value as of June 2014. Following the transaction, the company is switching to a reporting currency of USD (instead of CHF, including the share price over the next few months), which is more representative of the underlying investments. In addition, it recently changed its name from APEN to Spice (which sounds more like a late night TV channel, but I get the concept). Following the divestment, the NAV essentially consists of cash and receivables, with a few investments in emerging market related funds and companies.

These steps have created a simpler story around the stock, yet the discount and share price moved exactly nowhere. Potential reasons are that Spice is (i) small: c. $120m market cap with no analyst coverage; (ii) illiquid - close to 60% of the company is held by the controlling group with a few other funds having 3-5% positions and only a few thousand shares trading daily and (iii) history - earlier association with AIG and a hodgepodge of funds probably didn’t help.

Let’s look at some simple math. The Q4’14 guided NAV is CHF37.5 ($37.7) or c. $200m. Following the transaction, this is made up mostly of cash and receivables. Current market cap is $120m, which translates to a discount of 40%. Assuming that the 14% transaction discount is representative (and some discount is fair as you’ve to take taxes into account, mgmt. fees and other opex etc) there is a 40% upside i.e. a share price of $32. I don’t think that this number is crazy as looking at historical trading patterns the stock used to trade at a slight discount to premium to NAV prior to the mess that started in 2008. One additional item to add. As part of the restructuring, Fortress received an option (valid through 2018) for about 700k shares to put back to the company at CHF21.8 and the company has a call option to purchase these shares at CHF41.8. The PV of this is treated as a liability on the balance sheet to the tune of CHF15.6m ($16m) or around $3 per share. This is already calculated in the NAV figures and GP has the first right of refusal on these shares.

There are two ways to reduce the discount: (i) deliver on what you set out and the market should eventually recognise it or (ii) destroy NAV. I do believe that with the new group of shareholders there is change on the horizon. Mgmt stated their intention to close the gap on the NAV and considering that they have a substantial stake they’d have the incentive to do so (though they do benefit in other ways as well). GP Investments, which is associated with the founders of 3G Capital, subject of the Dream Big book, receives fee of CHF5.1m ($5m) for the first five years and a performance fee of 10% on the NAV increase (after a 5% hurdle), which after year five will convert to a flat 1.5% fee. There is a bit of (what I call) fleecing of the minority shareholders, however it is hard to avoid paying fees in money management. Consider, that to earn the same $5m fee after year 5 the NAV would have to be $340m vs the $200m currently. Assuming they can deliver on the transformation I can live with this.

The restructuring of Spice has set it up for a solid path and while it looks like an attractive public investment opportunity, eventually it might make sense for GP to own the whole thing outright and build it out as their PE secondaries platform. In the meantime, if the board is serious about their commitment to shareholders they could take steps and buy back shares, while they are trading at such a large discount, to increase their ownership and eventually take it private (at a fair valuation to minorities) in the near to mid term.