APEN's share price is ~50% of NAV.  This discount is too severe.  Some discount may be warranted, perhaps 15%.  If so, then there is 65% upside to the investment.  Buying at current levels appears to offer a tremendous margin of safety.  This opportunity exists because APEN is tainted, hard to uncover, small and not super liquid. 

 

 

APEN is small.  The company has 5,363,717 shares outstanding.  The top three shareholders own 53% of the shares.  That leaves a free float of only CHF 49 million based on the current share price of CHF 20.  So many institutional funds cannot take a position large enough to make an impact on performance. 

 

APEN is not super liquid.  Only a few thousand shares trade per day. If you care about making tens or maybe hundreds of thousands of dollars, then the stock may interest you still. If you need the possibility of making millions or tens of millions, then this opportunity will prove unsatisfying. 

 

APEN is tainted.  APEN stands for AIG Private Equity.  The company changed its name in 2009 after its long-term association with AIG ended.  AIG was APEN's largest shareholder until 2013 and the investment advisor through 2009.  In addition to the AIG affiliation, APEN is tainted because it defaulted on its bank credit facility in 2008.  The company did eventually repay the banks in full, however.

 

APEN is off the beaten path.  No brokers sponsor the company with research coverage.  The stock is listed on the SIX Swiss exchange.  I found the company because GP Investments is now the investment advisor and the largest shareholder.  One can learn this information right here on the VIC website in a highly rated post by skw240 on GP Investments.

 

NEW OWNERSHIP HAS A STRONGER INCENTIVE TO CLOSE THE PRICE VS VALUE GAP

 

During 2013, ownership of APEN changed dramatically.  Three private equity firms raised their holdings to 53% of the shares.  GP Investments bought 32% to become APEN's largest shareholder.  Fortress added to its stake to bring its ownership to 13%.  In total, APEN issued 1.4 million shares at CHF 21.80 per share for aggregate proceeds of CHF 31 million to finance new investments.

 

So today one can buy APEN below the cost basis of these PE firms (though each of these PE firms derives additional value from APEN beyond through share ownership alone).

 

According to the chairman of the board, "the large discount of the stock price to NAV is unsatisfactory and its reduction is another priority for the Board and the Manager for the current year."  He may take inspiration from the fact that the share price traded between 90% and 125% of NAV from listing in late 1999 through mid 2008. 

 

To my mind, the most likely reason that GP has not bought in more shares of APEN for itself is the following: GP desires to keep APEN listed so that third party APEN shareholders can fund future investments that are managed by GP, from which GP will earn lucrative management and possibly performance fees.  Consider the fee arrangement that GP has with APEN.  The management fee is fixed at CHF 5.1 million per year for the first five years 2014-2018.  Beginning in the sixth year, or mid 2018, the fee will be 1.5% of NAV.  In order to keep the fee at CHF 5.1 million, NAV will need to increase from CHF 224 million to CHF 340 million. 

 

 

The legacy portfolio is in run off. According to management: "We expect that the legacy portfolio will continue to generate strong cash flows which should allow further reduction of existing indebtedness and the creation of additional liquidity for new investments." 

 

"As of the end of 2013, the investment period of all funds but one (SFW) has expired. Going forward, funds will only have the ability to draw down monies for add-on investments to existing portfolio companies and for management fees and fund expenses.  The company believes that a substantial part of the current unfunded commitments will not be drawn down at all." 

 

So within the next several years, the CHF 322 million of investments should be converted into cash, and the CHF 98 million of borrowings and the CHF 40 million of estimated liabilities owed on the Class A shares will be extinguished.  

 

Base case: if this takes three years and NAV does not change, then the IRR is 28%.

 

Negative case: if this takes five years and NAV falls by 50%, then the IRR is 0%. 

 

Positive case: if this takes 18 months and NAV increases by 10%, then the IRR is 39%. 

 

This investment opportunity seems to rhyme a bit with AP Alternative Assets LP.  I hope that it proves as lucrative as that one did for folks who read ele2996's post on April 27, 2012 and invested. 

 

 

The reported NAV per share is simple because there are only three components.  Assets consist of CHF 7 per share in cash and CHF 60 per share in investments for a total of CHF 68 per share.  Liabilities consist of two obligations to Fortress.  The first is CHF 18 per share in borrowings.  And the second, the Class A units, is a derivative of the investments equal to 12.5% of the investments fair market value, or CHF 7.50 per share.  (In other words, this liability is variable and depends on the value of the investments.)  Netting results in the NAV per share of CHF 42.

 

Reported NAV per share of CHF 38 subtracts a third liability to Fortress, a put option.  The company granted Fortress the option to put its ~700,000 shares back to the company until 12 June 2018 at CHF 21.80 per share.  GP has a right of first refusal to buy these shares.

 

Asset #1 = Cash.  The cash is CHF 39 million, or 7 per share.  The investment advisor, GP Investments, is also APEN's largest shareholder (31.7% ownership), and will be directing cash toward private equity investments in emerging markets.  The plan is to make both direct investments and to purchase fund investments in the secondary market (roughly 50/50 split). GP has a decent long term track record, so perhaps CHF 1 of cash today will be turned into CHF 1.5 of cash later.  

 

GP Investments, historical returns

 

	GPCP I	GPCP II	GPCP Tech	GPCP III	GPCP IV	GPCP V	WTD Avg
Multiple	1.6x	2.0x	6.8x	2.6x	0.8x	0.7x	1.5x
Gross IRR (R$)	23%	15%	55%	36%	-7%	NM	9%
Size (US$)	543	800	17	240	1,188	710

 

Asset #2 = Investments.  The investments of CHF 322 million, or 60 per share, can be analyzed in various ways. 

 

The largest part is what the company reports as investments in 51 "funds" and totals CHF 302 million.  Disclosure seems pretty good.  Each fund is named with the cost, fair market value, cumulative gain/loss, unrealized gain/loss, realized gain/loss, unfunded commitment, and vintage.  The largest exposure is to PineBridge and Blackstone, with each of whom APEN has invested CHF 32 million, or 11% of total.  The top five managers have 41% of the investments, and the top ten have 64%. Based on discussions with industry contacts, a liquid secondary market exists for at least three of the company's larger fund investments (Apollo VI, Blackstone V, and Madison Dearborn V)  that total CHF 55 million or 18-19% of total.  These investments trade at or above NAV.  

 

The second part is direct investments in 12 companies and totals CHF 20 million.  The two largest are Uplifting Entertainment at CHF 7 million and Knowledge Universe Education at CHF 6 million. 

 

The trend in the fair market value of investments has been upward.  In each of the past four years, realized gains far exceeded realized losses, and unrealized gains far exceeded unrealized losses.  According to management, "the upward valuation trend is supported by the fact that most portfolio companies are on track with their business plans and comparable publicly traded companies are showing solid stock performances."

 

One possible headwind for growth in NAV is that funds enter the catch up phase for performance fees so that the general partner garners 100% of the fund returns for the next ~10% of so of distributions.  That risk is evident for APEN's largest fund investment, Blackstone Capital Partners V (BCP5).  On April 17, Blackstone stated: "BCP5 had a very good quarter in the first quarter...you can see that just by watching the deficit, if you will call it that, to earning full carry going down from $1.4 billion to $916 million just in the last few months...EBITDA growth in BCP5 is accelerating each quarter...we are 3% away from where we are fully in carry on the enterprise value of the overall portfolio." Based on Blackstone's disclosure (slide 25 of 1Q handout) BCPV has an IRR of 7%.  

 

APEN, key changes in value of investments, 2010-13

 

 

	2010	2011	2012	2013	2010-13
Unrealized gain	71	66	64	59	261
Unrealized loss	(22)	(18)	(21)	(15)	(76)
Net unrealized gain	50	48	43	44	184
Realized gain	34	49	49	43	176
Realized loss	(0)	(1)	(0)	(1)	(2)
Net realized gain	34	49	49	42	174

 

 

 

 

 

 

 

 

 

 

Another way to analyze the investments is to separate them into listed and non listed companies. The company discloses the top 20 holdings (on a look through basis), and seven of them are in listed companies.  The fair market value of the company's stake in these seven companies was CHF 36 million at 12/31/13.  Updating for current market prices, the value is closer to CHF 33 million. 

 

Company	Fair market value	% of investments
Kinder Morgan	CHF 9.5	3.0%
Hilton	6.9	2.1
Nielsen Company	5.0	1.6
Czerwona Torebka	4.0	1.2
Sprouts Farmers Market	3.8	1.2
Shinsei	3.6	1.1
Norwegian Cruise Line	3.4	1.1
Total of largest seven listed holdings	CHF 36.2	11.3%

 

Fair value of the investments is determined by the corresponding fund manager in accordance with IFRS 13.  APEN's board of directors reviews and approves the valuations.  APEN calculates the NAV per share based on these fair value inputs on a monthly basis, and from 2006 through 2009 management disclosed the company's NAV to the public each month. 

 

PricewaterhouseCoopers is the company's auditor and has been since at least the first annual report in 2000.  The auditor reviews the valuation procedures applied by the board and the underlying documentation for the valuations. 

 

 

APEN listed in October 1999 as AIG Private Equity Ltd with a CHF 230 million portfolio of holdings that had been acquired during the previous 13 years.  Roughly half the fund was invested in North America and half in Europe, with less than 5% in Asia.  

 

NAV per share started 2000 at CHF 119.  Since then there have been two cycles.  In the first cycle, NAV increased by 15% to a peak of CHF 137 at the end of September 2000, and then declined by 36% to a trough of CHF 88 at the end of March 2003.  In the second cycle, NAV increased from the trough by 108% to a peak of CHF 183 at the end of September 2007 (+54% versus the origination point in 1999), and then declined by 79% to a low of CHF 39 at the end of 2013.  

 

For the first eight years of trading, the share price remained within 20% of NAV, between 90% and 120%. But in the third quarter of 2008, a huge gap opened between price and NAV.  The gap has closed somewhat but remains at nearly 50%.  This discount is noteworthy because NAV is updated quarterly (it was reported monthly between 2006 and 2009) based on market prices and appraised fair market values submitted by private equity fund managers. 

 

NAV collapsed for two main reasons.  First, the market prices and appraised values of the investments declined.  These were mostly unrealized losses.  For example, SandRidge Energy (SD) was a top 10 investment that accounted for 1.1% of NAV at June 30, 2008; and then the share price declined by 70% in the next quarter. 

 

Second, the company experienced a liquidity squeeze that made it a forced seller while asset prices were collapsing.  This resulted in permanent realized losses. 

 

Management stated the following in the 2006 annual report:

 

In this way, AIG Private Equity was (poorly) positioned for the financial crisis of 2007-08-09.  At the end of 2006, the company had CHF 37 million of cash and no debt on a USD 35 million line of credit, but it did have CHF 762 million of unfunded commitments (an off balance sheet liability).  During the next seven quarters, the portfolio was NOT self-funding.  Distributions amounted to CHF 367 million, but capital calls totaled CHF 695 million.  The funding shortfall was CHF 262 million.  Cash declined to zero, and debt increased to CHF 139 million, with the company also issuing CHF 158 million in preferred shares.  Ka. Boom. 

 

Cash flow	1Q07	2Q07	3Q07	4Q07	1Q08	2Q08	3Q08	4Q08	1Q09	2Q09	3Q09	4Q09
Beginning cash	37	35	26	4	0	2	4	0	15	0	11	2
Beginning debt	0	0	31	49	108	139	106	139	102	113	105	81
Purchase of LT assets	78	114	94	128	81	79	110	12	28	25	28	26
Return of invested capital in LT assets	33	45	17	51	25	45	6	90	16	43	40	11
Net realized gains	32	31	26	22	12	16	6	(25)	(2)	4	1	2
Net increase in borrowings	0	31	18	59	43	(36)	23	(32)	(2)	(4)	(13)	25
Issue of pref shares	0	0	0	0	0	79	79	0	0	0	0	0
Issue of treasury shares	0	0	0	8	0	0	(5)	2	0	0	0	0
Ending cash	35	26	4	0	2	4	0	15	0	11	2	7
Ending debt	0	31	49	108	139	106	139	102	113	105	81	15

The company's lending group responded flexibly at the outset.  They increased the line of credit in August 2007 from USD 35 million to USD 50 million. By the end of 2007, the facility was fully drawn and the company was relying on overdraft facilities in place with Bank of Bermuda (HSBC) and AIG Private Bank.  Then in January 2008 a new facility was established for USD 100 million.  

 

While the company was out of cash and out of borrowing capacity, capital calls did not stop.  In fact, they remained high relative to distributions from existing investments until the fourth quarter of 2008.  This was a problem for the company.  A first bandage was obtained from AIG, which purchased USD 150 million of preferred stock in June-July 2008 on terms that were highly favorable to the issuer -- the cost to APEN was AIG's cost of funds plus a margin of 1.0%.  

 

Thus far, AIG Private Equity Ltd had found the liquidity in order to meet its capital calls from the bank group and from AIG.  But in September 2008, the shxt hit the fan.  The company's stock price declined 33% that month, and on September 30 the company breached covenants relating to borrowings/market cap and unfunded commitments/market cap  The parties agreed to a prepayment schedule in December that made AIG Private Equity a forced seller of fund interests in the secondary market.  During 2009, the company sold part of all of 31 funds to generate proceeds for debt repayment and to reduce unfunded commitments.  By selling below NAV, these forced liquidations reduced NAV per share by CHF 30.  

 

Despite the sales, the company was not able to meet its prepayment obligations.  By May 2009, the bank group had terminated the credit facility and had requested repayment of the full balance outstanding: USD 86 million.  The company looked for new investors and made small repayments so that borrowings were USD 72 million by August 2009.  Finally, in October 2009, a new USD 200 million unsecured credit facility was obtained from Fortress Credit Corp.  The loan carried a cash pay interest rate of 8% and a payment in kind interest rate of 12%.  With this second lifeline, APEN had USD 35 million in Cash, USD 100 million in undrawn credit from Fortress, and USD 350 million of unfunded commitments.  Also, Fortress obtained "Class A Units" which were classified as a minority interest and were economically a 10% ownership in APEN because Class A units were entitled to the first 10% of any cash flows once the Fortress credit facility was repaid.  

 

In 2013, APEN recapitalized.  AIG exited its ownership position. GP Investments and other PE firms bought new shares.  And Fortress provided a new credit facility.  

 

The following table illustrates the significant progress that APEN has made reducing its off balance sheet liabilities and improving its liquidity.

 

Year	Unfunded       Commitments	Liquidity	Cash	Available Credit
2006	762	80	38	43
2007	966	0	0	0
2008	744	15	15	0
2009	345	120	7	113
2010	139	135	23	113
2011	103	155	38	117
2012	79	212	69	117
2013	47	75	39	143

Liquidation and runoff of legacy PE fund investments and reinvestment in non 2006-07 vintage funds.