|Shares Out. (in M):||22||P/E||0.0x||0.0x|
|Market Cap (in $M):||204||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||-153||EBIT||0||0|
Mass Financial is now in the midst of its fourth year as an independent company after being spun out of KHD in January 2006. Over this time, Smith has gone about building value in a fairly extraordinary manner. Book value per share has grown from essentially zero in January 2006 to $2.43 by the end of that year, then to $4.39 at year-end 2007 and $5.71 at year-end 2008. As of December, 2009, the company reported book value per share of $9.72 (all figures are adjusted for a 9% stock dividend declared in late December 2009).
Smith has a long and very successful track record of investment and corporate takeovers dating back to his control of Mercer International in the late 1980's. In a way, MFC is the original Michael Smith vehicle, and was originally formed via the takeover by Smith of a small, publicly traded real estate company in 1984. Smith later used MFC to take over a large wood pulp fiber company called Mercer International (MERC), and in 1996 Mercer spun MFC out as MFC Bancorp out to shareholders. Smith again showed his excellent investing skills when MFC Bancorp acquired KHD Humboldt Wedag in March 2004 for $34 million, which at the time had revenue of $104 million and book value of $43 million. In a move reminiscent of the Mercer spin-out more than a decade earlier, KHD spun out MFC in January 2006, while KHD went on to produce a couple of very big years at the height of the commodity boom, reporting over $500 million in revenue and FCF that topped out at $126 million in 2007.
Smith has a history of setting up obscure, publicly traded vehicles, often in international markets, and then making various counter-cyclical investments. More often than not the market doesn't recognize the value, and sooner or later Smith does something to cash out investors. Interested readers may wish to look up Sasamat Capital and TriMaine Holdings, which were both featured in previous VIC write-ups.
MFC is almost a prototype Smith investing vehicle - small (around $200 million market cap), obscure (a merchant banking company that uses very little leverage, is based in Vienna, primarily does business in Europe, and trades on the pink sheets in the U.S.), and tax efficient (MFC is domiciled as a Barbados company and pays virtually zero taxes). It's also cheap - at least until Smith decides he's accomplished whatever he wants to do and then cashes out. MFC is also, like many of Smith's past vehicles, a bit of a mystery.
MFC publishes annual reports that run 60 pages or so, along with brief mid-year updates to investors, but Smith seems to believe that his investing operations are best pursued in a proprietary manner - he doesn't disclose much in great detail, at least until there is a liquidation event. After the fact, the disclosure is pretty good. Unfortunately for MFC investors, it isn't always exactly clear what you are buying, which makes it pretty hard to value the business. Nevertheless, there is enough information disclosed to make a rough guess at what the assets might be worth - and if MFC is at all like the previous vehicles Smith has run, there will be significant hidden assets that emerge at the point at which Smith chooses to lay his cards on the table and cash in his chips. Given that Smith still serves as Chairman to KHD and Terra Nova Royalty, he has a hand in three publicly traded pots. It is hard to know whether or to what extent there might be significant conflicts here that could negatively affect MFC shareholders, but it must be considered a minor risk factor to the thesis. Smith, now 54, is apparently based in Hong Kong.
While the exact details of MFC's activities are a bit lacking, the company's website provides an overview of the company's business and serves as something like an "owners' manual" for shareholders. The company's merchant banking activities focus on specialized financial services, such as extending trade credit lines, corporate advisory services, and proprietary investments, including some where the company takes an activist stance. The company's commodity trading operations include acting as a middleman for commodity end user clients, and to a lesser degree trading for its own account. MFC also has full and partial ownership in a number of subsidiary businesses, including a joint venture that operates advanced eye care centers through arrangements with government-controlled hospitals.
Whatever it is MFC does, it apparently does it extraordinarily well. Net revenues were $406.4 million, and the company reported net income for the full year 2009 of $75.2 million, or $2.70 per share, and a 65% return on equity. The company pays virtually no income taxes due to its Barbados domicile anyway, and in 2009 actually booked a small tax recovery. Operating cash flow was equally as impressive: $77.7 million, with cap-ex of $2.7 million. Add in $5 million in distributions from its various joint ventures, and FCF at the MFC level was a cool $80 million. In reviewing the source of the company's income, MFC divulges the following revenue breakdown:
Commodities $ 191.3
Trade / financial services $ 113.9
Interest and dividends $ 14.4
Securities/ investment property $ 10.1
JV Equity Income $ 3.6
Other* $ 57.7
TOTAL $ 406.4
* Other income for 2009 includes a $49.1 million gain on the extinguishment of debt securities repurchased from KHD.
While 2009 was a very good year for MFC, the company has done well every year since its separation from KHD. MFC reported 2008 revenue of $598.8 million, with net income of $23.3 million, or $0.99 per share. In 2007, MFC did $543.9 million in revenue, with net income of $48.5 million, or $2.09 per share. The company has produced an outstanding ROE on a historical basis - 65% in 2009, 28.5% even in the tough 2008 year, and over 100% in 2007. MFC has also accomplished this feat without anything like the typical investment banking leverage - MFC ended 2009 with a debt to equity ratio of only 0.28.
Valuing MFC is also bit of an exercise in guesswork and imprecision. However, as long as we can show that the value of the assets are likely much more than what we are paying for them, and that there is a margin of safety, precision may not be a necessity. Of its total year-end 2009 assets of $512.3 million, MFC held cash and equivalents of $329.6 million, investment securities were $17.2 million, restricted cash was $2.5 million, long term and restricted securities were another $15.3 million, and equity method investments were $4.1 million. That adds up to $368.7 million. In addition, MFC had two different real estate investments, one listed as for sale of $13.6 million, and the other investment property of $41.3 million. This is a total of $423.6 million. Major liabilities included $141 million in short-term loans and $74 million of short term and long term debt issuance. Total shareholder equity at Dec 31 was $210.3 million on 21.65 million shares, or $9.72 per share. The stock trades for $9 and change, and has a market cap of approximately $200 million. In the last four years, MFC has averaged over $40 million in net income and over $50 million in free cash flow. Given the body of evidence available, I would think that paying a discount to December 2009 book value is a pretty reasonable proposition. I think that ultimately MFC can and should trade at 1.25X book value, and I also think that it is highly likely Smith will continue to grow book value per share at a decent clip for a couple more years before he takes some action to heighten the company's visibility.
It appears that Smith is already taking action to extend the profile of the company beyond its listing on the pink sheets in the United States. In the summer of 2008, Smith wrote in his mid-year letter that "it is now time to start creating market awareness and liquidity for our shareholders." The first move was to list the shares on the Vienna Stock Exchange in addition to its US pink sheet listing. The stock dividend in late 2009 was designed to increase the float a little bit. I expect the next move will be a listing on a larger pan-European exchange.
There are several risk factors to consider for MFC. The first is simply not being able to know exactly how much risk the company actually takes in its commodity trading business. While it is clear that the company is more like a middleman in terms of extending its credit and buying power to purchase commodities on behalf of purchasers and taking a spread rather than some prop desk at an investment bank, nevertheless one doesn't want to under-estimate the fact that MFC likely does take some price risk for the purchase commitments it makes on behalf of its customers. However, the company's performance in a year like 2008 that showed incredible commodity price swings has allayed my fears that MFC is conducting a risky business here. The other risks are not knowing exactly what kind of proprietary investments Smith is making, the general risks that come with the portion of MFC's business ventures in China, and the potential conflicts that Smith has related to his dual roles as the Chairman of both KHD and MFC, as well as whatever other ventures he may have at any given time. Smith is a bit of an enigma - information on him is scarce given his long track record at multiple public companies, and I don't have any insight as to what motivates him. But he has been very effective at creating value for shareholders in his various entities, though he tends to introduce some complicated and indirect schemes to get there (see recent Terra Nova / KHD split as an example). A last major risk for any investor of size in MFC is the illiquidity of the stock.
In terms of recent developments, MFC has made some interesting investments in the last year or so. In early 2009 MFC entered into a partnership to acquire and expand a manufacturer of specialty medical vehicles located primarily in Germany and Poland whose products are sold on a global basis. MFC expects to finance and rent these vehicles to cities and towns. In early 2010, MFC purchased the assets of a company called 4-D Neuroimaging, which apparently sells develops technology to help localize epileptic spikes prior to epilepsy surgery and brain mapping prior to tumor surgery. The company's customers are specialized epilepsy surgical centers, neurosurgical hospitals, and research centers.
There has been a fairly important new development for MFC that happened here in mid-2010. On April 19, it was announced that MFC had entered into an agreement with a tiny micro-cap Canadian company called Canoro Resources, which is building an oil and gas exploration business in India. MFC agreed to buy 24.8 million shares of Canoro for C$0.13 per share, or an 18% ownership in the company. In addition, MFC will backstop a rights offering to be conducted by Canoro at $0.10, for which MFC will receive warrants equal to 25% of the number of shares that MFC has agreed to backstop. As part of this financing, Canoro has agreed to reduce its board to five members, one of which will be Michael Smith himself. In addition, MFC has agreed to provide up to $35 million in a senior convertible financing facility that may be used to "fund approved capital expenditures" relating to projects in India. In addition, MFC agreed to provide Canoro with another $40 million credit facility to "fund additional projects on terms to be agreed." Clearly, Smith covets the Indian oil and gas assets that Canoro owns, and though the language in the press release makes it sound like a really big bet ($80 million), I suspect that MFC will have to approve each capital expenditure for which MFC extends credit, as Smith does not come across as a major risk taker on this scale.
On the same day as Canoro's press release was issued, Canoro's Indian JV partner, Assam Company, made an all-cash buyout offer for Canoro at C$0.21 per share. Nevertheless, Canoro management apparently opted to go with the MFC financing, which closed on April 28th. On May 26th, Canoro filed the prospectus for the rights offering. Drama has since ensued. On May 31, a very jealous sounding Assam issued a press release "reminding Canoro shareholders of risks associated with the proposed transaction with Mass" and that the transaction is subject to a recent High Court of Delhi court decision that "could have a material adverse effect" on Canoro shareholders in that the High Court could rule the transaction be un-wound. Apparently, Assam has petitioned the High Court to require the transaction be unwound, as it believes that under the production sharing agreement between Assam and Canoro, Canoro was required to give notice to Assam and offer a right of first refusal in any asset sale or financing by Canoro. Assam also noted that Canoro did not respond to Assam's offer to buy the company nor did it allow shareholders to vote on the offer, with the likely result being the "transfer of control of Canoro to Mass at a discounted value."
Later on the same day, Canoro commented in a press release of its own that Canoro management had met four times with Assam and that Assam never presented a definitive and binding offer to the company, nor did it offer any evidence of the ability to finance an offer. Canoro's position is that Assam's offer basically amounted to a risk-free "call option" on whether or not to make an offer. Canoro further stated that Assam had withheld money owed it, which caused Canoro to seek a financing in the first place, and that Assam has been a "less than satisfactory" joint venture partner. Canoro has answered Assam's litigation in India with its own suit against Assam in Alberta. In addition, Canoro states that it appeared at the High Court in Dehli on May 18, 2010, at which time the Court heard the arguments on both sides and refused to grant the injunction requested by Assam, but instead posted an order stating that the Mass transaction is subject to challenge and may ultimately be overturned by an arbitration tribunal in India. Canoro also stated that it learned at the court appearance that Assam had previously attempted to obtain an injunction against Canoro without notice or presence on the part of Canoro, which was denied by the Court.
In any event, on June 9th the shareholders of Canoro voted to approve the Mass Financial transaction. On July 2, the transaction closed with the result that Mass Financial owns 146.7 million shares or 52.9% of the total shares outstanding. In addition, Mass owns warrants for another 34.7 million shares, which if exercised will result in MFC owning a 58.1% interest. MFC's total cost is about $15 million. We'll have to see how this drama plays out, but it certainly appears that Michael Smith has managed to acquire an intriguing set of assets and control of a publicly traded company for a very low price. It will be interesting to see how this one plays out.
Overall, it seems to me that while MFC has substantial asset value that should more than support the current price, to some extent this idea is more about the "jockey" than the horse. Smith is a bit of a mysterious character and comes across as a bit of a curmudgeon. MFC does not issue financial reports quarterly as Smith believes this to be "unproductive" but does adhere to the rule that if a major material transaction occurs it will be disclosed immediately. So investors have to wait six months between substantive business updates. While the limited level of disclosure represents a risk factor, and there is always the chance that what we don't know might hurt us, Smith's long track record of rewarding shareholders (at least eventually) is a decent counter-weight. He has obviously done extremely well with MFC since its spin-off from KHD, and of course his investment in KHD in 1996 worked out rather well. Going back further, prior to folding MFC into KHD, Smith grew the company (then called MFC Bancorp) from 1984 to 1995, during which stretch he grew book value from $1.49 per share to $17.09 per share, which is a pretty impressive performance. In summary, I can't see any reason why this company should trade at a discount to book value, and would think that the track record would merit a valuation closer to 1.25X book value, which would imply a $12.15 stock price based on December 31, 2009 book value.