Description

Dundee Bancorp is a Canadian holding company (all numbers in Canadian dollars) whose main interests are in financial services, real estate and natural resources. Dundee is an interesting undervalued asset play and long-term value creation investment. Essentially, at a $28 price, an investor is paying for the value of Dundee Bancorp’s stake in Dundee Wealth and Dundee Precious Metals and getting the rest of the investment stakes (worth roughly $13) for free (on a pre-tax basis). The stock trades at approximately a 31% discount to Net Asset Value (NAV).

There are essentially 2 ways that the discount can narrow/disappear:

- the market at some point will realize that a large part of Dundee’s investments are public and as such there is less valuation risk in each of the investments as compared to the past and consequently the valuation will rise, or

- management could monetize its various investments/dividend them out to shareholders. If management monetizes the different investments, it can use the cash to buyback undervalued stock and/or dividend cash out to shareholders.


Net Asset Value Calculation

Stock Net Asset NAV/
Shareholdings Price Value(C$mm) share(C$)
Dundee Wealth
Common Shares 61.3 mm $9.50 $582 $23.10
Preference Shares 55 2.18
$637 $25.28

Investment Portfolio
Great Plains Exploration 9.3 mm $1.35 $13 $0.50
Dundee Precious Metals 11.3 mm 7.43 84 3.33
Breakwater Resources 51.9 mm 0.49 25 1.01
Dundee REIT 7.7 mm 25.25 194 7.72
Other Equity Acctd
Investments 7 0.28
Marketable Securities (at market value) 17 0.67
Other Porfolio Investments (at mkt val) 121 4.80
461 18.31

Other Assets (net of debt) (72) (2.86)

Net Asset Value $1,026 $40.73

Notes to NAV Calculation

Marketable Securities and Other Porfolio Investments are at the market values as at September 30, 2004. Marketable Securities may be invested in Dundee’s own mutual funds, closed-end funds or in other investments. Other Portfolio Investments may still include 2 million shares of the Laurentian Bank (LB.to) (market value at September 30, 2004 of $52.2 mm and market value today of $50.0 mm) and 10.3 million shares of IAMGold (IMG.to) (market value at September 30, 2004 of $104.2 mm and market value today of $82.4 mm). However since management does not provide updates on these holdings since they own less than 10%, they have been left under Other Portfolio Investments and not separated out. The current market values of the Laurentian and IAMGold stakes result in a potential $1 deduction from the NAV calculation (not included above). Because IAMGold has been the subject of numerous takeover attempts, this investment may have been sold already (either partially or in its entirety). Furthermore, adding up the market values at September 30, 2004 of Dundee Bancorp’s original stakes in both of these investments ($52.2 + 104.2 = $156.4 versus $121 for Other Portfolio Investments) shows that there were probably partial sales of these investments.

Other Assets represents other real estate investments as well as investments in oil & gas properties.

The above analysis does not include potential taxes on the sale of any investments. I have assumed that the NAV discount won’t go below 20% to account for this (see below).

Description of the Major Holdings

Because the majority of the gross asset value resides in Dundee Wealth, I will provide a brief overview of Dundee Wealth as well as Dundee REIT.

Dundee Wealth

Dundee Wealth Management operates in 2 main areas – investment management and advisory services/capital markets. Dundee Bancorp owns 67.4% of Dundee Wealth Management (DW.T), which in turn owns 83.7% of DWM Inc. through which the investment management and advisory services operations are conducted. The remainder (16.3%) of DWM Inc. is owned by CDP Capital – Financial Services, a subsidiary of the Caisse de Depot et Placement du Quebec (the Pension Plan that operates in the province of Quebec).

The investment management operations of Dundee Wealth consist of the following:
a) Management of mutual funds branded under the names of Dynamic, Commonwealth, Hathaway and Cartier
b) Management of tax-advantaged investment products
c) Management of private client accounts through Goodman Private Wealth Management and Viscount Wealth Management
d) Management of numerous closed-end funds such as DiversiTrust Income Fund Units

The investment management operations generated $24 million in EBITDA for the quarter ended September 30, 2004. These operations had $14.0 billion in Assets Under Management (AUM) as at November 30, 2004.

The advisory services/capital markets operations are structured as follows:
a) Dundee Securities – an investment dealer providing capital markets services such research, institutional sales and trading and investment banking
b) Dundee Private Investors – provides wealth management advice and products
c) Dundee Insurance Agency and Dundee Mortgage Services – provides other products and services to Dundee’s clients.

There are 2,200 financial advisors and 600 insurance-only advisors.

The advisory services/capital markets operations had $26.5 billion in AUA (Assets Under Administration) as at November 30, 2004. This division generated negative $4 million in EBITDA for the quarter ended September 30, 2004.

In terms of valuation, Dundee Wealth trades at 6.33% of November 30, 2004 AUM and 9.3x Q3 annualized EBITDA. However, at the end of 2003, Dundee acquired Cartier, a well-established Canadian financial planning firm that gave Dundee Wealth critical mass in distribution. If we assume the advisory services/capital markets business goes to break-even EBITDA and operating costs related to the Cartier acquisition fall by $25 million (according to management’s estimates), then Dundee Wealth’s 2005 EBITDA could be $121 million. Dundee Wealth currently trades at 6.2x 2005 EBITDA versus 6.9x for the industry. Assuming Dundee Wealth trades at the industry multiple, it would trade around $10.50, adding $2.40 to Dundee Bancorp’s NAV.

Dundee REIT

Dundee REIT (D.UN on TSE) owns a portfolio of office, industrial and shopping centre properties. Their strategy is to focus on well-located Class B commercial properties that offer reliable current income as well as opportunities for income and value growth. The REIT has properties mainly in Toronto, Montreal, Ottawa, Calgary and Edmonton.

In terms of valuation, Dundee REIT trades at a 9.5% yield and a price/2005 AFFO of 12.9x. Dundee REIT is fairly valued and should not add to NAV other than through intrinsic value growth.

Control / Ownership Structure

Dundee Bancorp is controlled by its founder, Ned Goodman. His family in total (including his own shareholdings) owns 17.3% of the publicly traded subordinated voting shares and almost all of the common shares. Since each common share has 100 votes and each subordinate voting share has only one vote, the Goodman family has 82% of the votes at Dundee. Ned Goodman personally has about 69% of the voting control at Dundee.

Major Shareholders

Other than the Goodman family, shareholders include Private Capital Management (Bruce Sherman) which owns approximately 21% of the subordinate voting shares and AIC Limited which owns 20% of the subordinate voting shares. Including the Goodman family’s 17% stake in the subordinate voting shares, the top 3 shareholders control approximately 60% of the subordinate voting shares.

Investment Case

Dundee Bancorp’s current NAV $40.98
Add: Upside from Dundee Wealth 2.40
Potential 2005 NAV $43.38

The potential 2005 NAV assumes no NAV growth in the other investments.

Assume the following 5-year investment scenarios:

1) Downside: Dundee has traded at an average discount of 43% to NAV since 1997. So, given the current discount of 31% and assuming no NAV growth, Dundee Bancorp could fall to $23 if it reverts back to its average NAV discount (a decline of 17%). Please note that the widest discount that Dundee has ever traded at was in the mid-50% range to NAV (during the tech hey days in early 2000). Assuming the NAV discount went to 55%, the stock would trade around $18.50, a 35% decline. Given the fact that most of Dundee Bancorp’s investments are now in public companies versus the past, it is unlikely the NAV discount would get that wide. Furthermore, Dundee has grown NAV by 18% from late 2003 ($34.59) to today ($40.73). Both of these downside cases are offset by the fact that Dundee Bancorp can initiate a stock buyback program that would be very accretive to NAV per share.
2) Dundee has traded as low as a 20% discount to NAV (assume that the NAV discount won’t get any lower due to potential taxes on the various investment stakes). Given the fact the majority of its asset value is now publicly traded (much less was publicly traded in the past), there is a high likelihood of the discount narrowing and this scenario taking place. This would result in average annual returns of 3% per annum assuming no NAV growth.
3) Assume Dundee Wealth is successful in integrating the Cartier acquisition and thus Dundee Bancorp’s NAV rises to $43.38 by the end of 2005 and then NAV grows by 5% per annum for the 4 years after that. Therefore, NAV will be approximately $53 in 2009. If we assume the discount stays at 31%, this results in annualized returns of 6%.
4) Assume scenario 3 happens, but the discount falls to 25% and NAV grows at 8% per annum after 2005, then NAV will be $59 in 2009 with annualized returns of just under 10%.

Please note that the above scenarios do not include any potential tax-free dividends of the investment stakes to shareholders. Obviously, the returns will be higher if the discount narrows faster than over 5 years or NAV increases faster than the assumed rate. The best case scenario would be if the NAV discount disappeared due to a tax-free distribution of the investment stakes in the various public entities and NAV grew better than 5% to 8% per year.

Also, Ned Goodman is an experienced natural resources investor and this investment offers that future natural resource/commodity upside potential for those who want that exposure in a value investment.

Risks

1) Because of the voting structure at Dundee, an investor has very little say in the company’s affairs. Historically, however, Dundee has made very profitable investments. Because of the voting control structure, it is unlikely that the NAV discount will disappear in its entirety.
2) The management at Dundee maintains a very long-term perspective on value creation, so the investment can be frustrating for investors with shorter-term horizons.
3) The stock is illiquid.
4) Ned Goodman is 64 years old and he makes the final capital allocation decisions, so there is succession risk despite the fact that each of the operating companies has independent and experienced management.


Conclusion

Dundee Bancorp is an undervalued asset play with low downside risk. Management has historically handled their capital allocation responsibilities very well. Given the fact that most of Dundee Bancorp’s investments are now public, there is a high likelihood of the NAV discount narrowing. Even if the market is slow to narrow the NAV discount, management can monetize/dividend out its public equity stakes, buy back stock and make NAV enhancing investments, all of which should cause the NAV discount to narrow and NAV to increase.

Catalyst

- market realization that most of Dundee Bancorp’s investments are now public, sale of investments stakes, dividend out investment stakes directly to shareholders, stock buybacks