Description

Dunedin Enterprise Investment Trust (LON:DNE) is a closed end private equity fund of funds trading in London. The trust provides equity financing to facilitate management buyouts and management buyins. It trades at ~38% discount to net asset value. It is winding down. The reported NAV of the private equity portfolio likely understates intrinsic NAV.  

The large discrepancy between intrinsic NAV and the market price can be explained by a number of negative drivers: the trust’s results over the past years have been anything but impressive, the Brexit, the trust getting thrown out of the FTSE-index and the opaqueness of the private equity investments and investments in fund of funds.

The bad

1. Directors have given themselves up to seven years to oversee a wind-down. -On the majority of NAV investors are paying 1.5% on investments and 0.5% on undrawn commitments.
2. The fund is encumbered by over $120K in directors fees and $500k in administration fees on an annual basis.
3. About 30% of investments are in the active investment phase which means these may require further investments. Management estimates $20+ million will be drawn going forward.
4. These commitments are covered by an undrawn bank lien but these commitments will prevent the company from any near term returns of capital.
5. Uncertainty surrounding Brexit will make it more difficult for the trust to sell funds outright and or realize highly accretive exits.

What you are buying for $0.70 cents on the dollar

The balance sheet is ostensibly very simple:

Balance Sheet

The unaudited balance sheet as at 30 September 2016 edited for subsequent exits by author is noted below:-

But how solid is the value that’s so easily observable but so heavily discounted?

It is predicated on directors valuations that are based on international private equity valuation guidelines and based on either a normalized earnings multiple or in one case; asset value.  The ten largest investments make up nearly 90% of NAV.  

On average they are valued at an EBITDA multiple of 8.5x or EBITA of 9.8x. In general the assets are invested towards capital light business models in the service industry

Checking back every exit back to 2011 the returns from exits exceeded the last available directors valuations by a significant amount except for one occasion when the company sold an entire fund investment at once for an 8% discount to NAV.

The trust has a history of tendering for shares at a discount to NAV. The last time this happened when the trust bought back a chunk of shares from index funds that were forced to exit the trust when it was thrown out of the FTSE. I wouldn't be surprised by further tender offers but reluctant to participate unless insiders were participating in a meaningful way. Most of the value is likely to accrue to the holdout shareholders.

A number of insiders have been buying throughout 2016, admittedly in modest quantities, which is still a remarkable at a fund/company that’s winding down.

Opaque

When there’s information asymmetry market prices are vulnerable and in this fund of fund, that holds private equity positions and funds in tiny companies, this theory plays an important part in the trust’s mispricing.

When looking at the available data of the underlying private companies the conservative nature of the director’s valuations appears to be confirmed. Most notably the value of stakes in the firms Hawksford and Pyroguard are understated by the corresponding directors valuations while I would not argue against the value of Kee Safety being reduced aggressively.

Dunedin owns 17% of Hawksford which generates $28 million in revenue and $10.7 million in cash flow as a financial services company. The directors valuation implies the stake is worth $12.5 million.

At Pyroguard cash flow has been shrinking the past three years to $3.5 million. The directors valuation of the 41% stake implies a cash flow multiple of just 3.76x. Together the two make up almost 20% of NAV.

Timeline

One reason for the absence of market excitement for the wind down could be the depressing timeline. The trust is set to invest $25 million before there will be returns of capital to shareholders. In addition management has set a guidepost up to seven years into the future. As far as the market is concerned it might as well have been light years.

Granted, if the fund were liquidated only seven years into the future, we suffered through fees and the fund keeps up with its historical dismal performance, in the end returns would be “ok” but unspectacular.

However, the portfolio is rather mature and only a minority of investments will remain unrealized for seven years. There’s great uncertainty around timing of realisations but it reasonable to expect seven years to be an absolute worst case scenario. The image below from a company presentation shows the company’s portfolio maturity profile as of mid 2016:

In 2016 a director was added to the board with a background and network in private equity. Private equity specialist funds have started buying into Dunedin Enterprise Trust. One of the avenues the company could explore in addition to realizing exits is to sell off entire funds. This has happened before at a 8% discount to NAV. Although the absolute return of this idea would likely diminish the annual return could potentially be much better.

Summary:

Trust trading at ~38% discount to reported net asset value.

Trust is winding down which should close gap to NAV.
The reported NAV likely understates intrinsic NAV.  

If intrinsic NAV > reported NAV the discount is much larger.

Catalyst

Realizations of exits (especially Hawksford and Pyroguard) 

Sale of funds