Description

MFC Bancorp Ltd. (“MFC”) is a financial services company that focuses on merchant banking that currently sells at a market price that is a fraction of intrinsic value. The above description of MFC’s business is not adequate as MFC wholly-owns, and has investments in a variety of businesses including commodity trading, equipment and engineering services, real estate development/owner, and a host of other operations. Overall, one can think of MFC as an investment vehicle where cash is used to make investments in undervalued assets by a very good capital allocator, Michael J. Smith.

Side Note: This write-up on MFC is in addition, and also stands alone as an idea, to my write-up on Trimaine Holdings (“Trimaine”) from early this year. Trimaine was an opportunity to own MFC at a fraction of what it sold for in the open market. Now, Trimaine is in the process of liquidating, which will distribute the MFC equity that belongs to owners of Trimaine. I continue to own my share of MFC’s business via Trimaine, but also have added MFC equity on a stand-alone basis as I find it compelling.

MFC has a variety of parts so I will go over the consolidated results, then go over details of some of the subsidiaries and smaller investments. This could be long.

Financial Data: (converted from CAD to USD)

Valuations

Sum of the parts: MFC has several parts and it is difficult to value all of them accordingly due to a lack of information. However, it can be conservatively estimated.

MFC’s book value stood at approximately $170 million as of December 31, 2004. For the nine months ending September 30, 2004 MFC generated $23 million in earnings (earnings are a good proxy for free cash flow since capex and depreciation should cancel each other out, going forward this will be different).

The equity consists of a variety of businesses including:

1.) Financial services (includes cash generated as well as investments held)

Free cash flow: MFC has not had material capital expenditures since much of the income has been generated through its commodity trading business, investments, as well as financial services. Depreciation is also minimal. I believe net income is a good proxy for free cash for the owner to allocate accordingly.

(for the 9 months)
2004 2003 2002 2001
(USD$ in millions)
Revenue 389 316 180 134
Free Cash Flow 23 38 32 27

The increase in 2004 revenue and earnings are due to inclusion of the industrial and engineering services business. Going forward MFC will separate financial services and industrial and engineering segments.

Return on equity has averaged over 20% for the past 15 years for financial services. In 2003, financial services generated approximately $38 million in free cash flow. Even though earnings have been growing at high rates I would probably assign a 10x cash flow number to the 2003 value since 2004 figures include a few new acquisitions. But none the less, the financial services business is obviously worth much more than its stated book value.

2.) Book value is also understated heavily regarding investments made in the past that are still accounted for at cost. There is a significant amount of unrealized gains.

For example, MFC acquired a cobalt mine (refer to Trimaine write-up for details) that is currently in the process of going public as a separate entity. MFC will spin-off the cobalt mine operation (Blue Earth Refineries Inc.) at a value of approximately $64 million. Equity will not be affected by this transaction as assets and liabilities will decline by similar amounts with currency adjustments making the spin-off a positive shift for equity. So investors in MFC basically receive an asset that seemed hidden from view.

Furthermore, MFC owns approximately 30% of Cathay Merchant Group (formerly Equidyne Corp) and has options to own much more. MFC has stated plans to build a 160 MW wind farm in China. MFC purchased many of its Cathay shares below net cash using options issued from the credit facility granted by MFC. I would assign the cash value of Cathay to MFC for valuation purposes. The bonus for MFC is they collect advisory fees and credit facility interest in deals like this and end up taking over the company.

3.) Acquisitions: There have been a few acquisitions but I will go over a couple that I think are material. On a side note, most acquisition activities and business has been moved and done in China.

MFC acquired KHD Humboldt Wedag AG (“KHD”) on March 31, 2004. KHD was purchased for $34 million while it generated $105 million of revenue in 2003 and had a book value of $43 million. KHD’s services and expertise are being sent to China via MFC to take advantage of the industrial development. In the second quarter press release it is stated that KHD’s order intake has tripled in the first six months of 2004 compared to 2003. MFC’s merchant banking expertise has complimented KHD and is the cause of the large increase in orders. One could conservatively estimate that KHD is now generating at least double the free cash it had been before and hence is worth at least twice what was paid.

MFC bought a controlling interest in Med Net International on March 22, 2204. Med Net operates 8, and is in the process of building 4 more, eye care centers in China. Med Net also imports and provides eye care supplies to hospitals in China. MFC paid approximately $2.2 million for a 55% interest. Med Net generates approximately $1.25 million in free cash flow on $7 million of revenue. Paying $2.2 million for this type of business and getting a return of $700,000 in year 1 is not such a bad deal.

Now, using all of this (which is in no way all of MFC’s assets but a good start) we can try to come to an estimated value.

Segment Value

Financial Services 10x fee cash flow of conservatively estimated $32 million
(including ind&eng ops) in 2004 or to be more conservative use book (in reality the book value represents mainly the investments made and the cash flow is generated from operations in commodity’s trading and advisory services including loans, which does not use much in fixed assets. You could conclude that not much of book is needed to generate the free cash flow so adding part of book with the free cash flow multiple is not crazy).
Cobalt assets $64 million
Increase in value of KHD estimated conservatively at $20 million


Using just these metrics I would come to a value of somewhere in the ballpark of $250 to $700 million. These values have a wide range but I was trying to look at it from many different perspectives. I feel the value is closer to $700 million than $250 million. If MFC can continue earning 20% on equity the value is obviously much more. Also financial services alone has proven to generate more cash flow than I have estimated for both financial services and ind & eng ops in 2004.

MFC also has its merchant banking operations in Europe and China where it has not been so bad to be a holder of those currency’s and they plan to buy back 600,000 shares out of the 12.7 million outstanding. Management has said at prevailing prices the buyback is a good use of cash.

Now let’s look at the price in which MFC is offered in the open market. MFC’s market value is approximately $250 million. However, MFC has an enterprise value of just $150 million. So you can buy a business that is holding $165 million of cash (smart move for a savvy investor for future opportunities) and generates cash flow of over $30 million (remember very conservative number) that has been growing, all for a price of $250 million. The investment ability of Michael Smith is given to you as a bonus. To look at it another way, you can buy a business generating a growing cash flow stream of over $30 million for $150 million.

MFC is an interesting company but is complicated and hard to follow. I would suggest further investigating. If you do delve further, I believe you will be thinking MFC is worth more than I have suggested when you discover all the nooks. It is also interesting to watch some of MFC’s investments because you can profit from their proven ability to find value and turnaround operations. I have now posted two ideas regarding MFC (Trimaine and MFC) and a third would have been posted if the price had not drastically gone up when I was about to post. The third sold at nearly half of its net cash.

Catalyst

Value