Description

Reinet Investments is a buy because you are buying an attractive set of assets at an unwarranted 48% discount to a highly conservative estimate of net asset value. There is good potential for underlying growth rates to accelerate as high-growth assets are becoming a larger part of the pie. Reinet Investments spun-out Richemont in 2008. The legacy vehicle was turned into an investment vehicle which mostly held Richemont’s interest in British American Tobacco.

The opportunity exists as the company trades only in Amsterdam, Luxembourg and South-Africa. The company owns legacy tobacco assets that were held by luxury conglomerate Richemont and a number of unlisted financial assets where true value exceeds their book value but this isn't readily determined.

For retail investors it is a challenging company to understand while institutions could back away from governance issues, limited float or because of the tobacco interest.

On a casual glance its fund investments can also be mistaken for a fund of funds type structure that is quite common among CEFs. As an investment company it may be disadvantageous to some investors due to tax considerations. Finally, the mix of tobacco, insurance and asset management assets turn it into a tough mix to analyze for specialists.

Structure

The easiest way to understand Reinet Investments is to view it as a closed-end fund type of structure.

My highly conservative estimate of Reinet’s assets and liabilities looks like this:

With 196 million shares outstanding trading at €16.1 Euro a piece, total market value of Reinet is €3155.6 million Euro.

Because fund structures tend to apply a layer of fees to assets under management (as is the case here) these usually trade at a discount to net asset value. There are a large number of factors that play a role in the exact discount. In my experience the most important factors are liquidity, the height of fees. Recent massive underperformance usually related to a lot of terrible press can also have an large effect.

A discount to net asset value of 47% is unusual. Even without the adjustments I’ve made to arrive at the above conservative valuations the discount is enormous. To give you some context: not long ago I calculated the average discount applied to London-listed closed-end funds which added up to  a 7% discount with a sample size of 500+ funds. I didn’t do the calculations for the U.S. markets but believe CEFs discounts tend to be smaller. Although the U.S. market contains a fair amount of funds containing fixed income assets. While a decent amount of London listed funds contain illiquid or private assets.   

British American Tobacco

For the British American Tobacco stake I’ve gone with market value. If you have a view on British American Tobacco it should be an important consideration. The value of the stake is roughly equal to Reinet's market cap. Historically total returns have been higher vs the British market but lagged the Tobacco space:

Source: Morningstar data

There are two additional important stakes:

1. Pension Insurance Corporation

Reinet fund holds a 43.5% stake in Pension Insurance Corporation (PIC). PIC provides pension insurance buyouts and buy-ins, or bulk annuities, to the trustees and sponsors of defined benefit pension funds. Its active exclusively in the U.K.

Pension funds can be a headache for publicly traded companies as the volatility of liabilities obscures the results of the actual operating business. Pensioners can be better off by being taken care of by a dedicated and specialized firm.

PIC was founded in 2006 and is growing at an astounding rate; growing EBT by an average of 27.5% per year over the last 4 years, growing assets under management by an average of 43.5% over the last 4 years (36% over the last 8 years), embedded value (management KPI) is growing by by 32.61% per year over the last 4 years. As the firm scaled expenses have decreased to 0.33% of assets under management which is a big driver of EBT. 68% of longevity risk is reinsured and the company has a solvency ratio of 164%.

Even though this is a private company it discloses a fair amount of numbers as it helps their marketing efforts. I helps pension funds acquire the required confidence to do a transaction. Even though the figures are readily available they aren’t through screeners which may explain why they are overlooked.

The second largest investor after Reinet is the finance focused private equity firm J.C. FLowers & Co. The presence of this specialized shop helps me to be more confident on risk management.

Reinet accounts for its stake being worth €1286 millio. As you can see I’ve taken the liberty to mark it up slightly in my estimate. I’ll argue even my markup is highly conservative.

The Reinet valuation is based on a mix of its embedded value and industry multiples and adjusted downwards by 10% due to illiquidity of the investment.

Merely going by embedded value, a management KPI, I’m arriving at €1.250 billion. € 1.13 if adjusted downwards for illiquidity. The multiple comparison has lifted the value of the stake slightly which makes sense.

The company uses the MCEV way to calculate its embedded value. It disclosed that:

-if we were to assume that pensioner longevity risk is hedgeable, this would increase embedded value by £158 million. (€ 177 million)

-If we additionally treated unreinsured deferred longevity risk as hedgeable, this would increase the embedded value by a further £620 million (€ 694 million)

For some context:

PIC owns € 4.26 billion in surplus asset. PIC has € 21.2 billion of assets allocated towards meeting claims and expenses.PIC holds €1.34 billion towards reserves and to deal with downgrades.

Embedded value reflects the value of the current assets appropriately. But as the Embedded Value (EV) represents an NPV of future profits plus adjusted net asset value it is not a good reflection of the value of a life insurer that is growing very fast by adding profitable business.

With embedded value having grown 32% over the last 4 years and assets under management outpacing that, I suspect a more fair multiple of would be 2x Embedded Value.

Keep in mind that although the company is successful in acquiring profitable business it did need to raise capital to allow for this rapid growth.

I think the investment portfolio is one of the risks. It is composed of 35% government securities, 5% cash and liquidity and 56% corporate securities. 97% of it is investment grade but with the caveat that it put 40% of its corporate securities in BBB rated bonds.

40% of  €25.33 billion means there is nearly €10.09 billion in gilts and cash. With only €21.2 billion allocated towards meeting claims and expenses and a further €15.24 billion of corporate bonds and other assets the embedded value won’t be impaired all that easily. If you value this stake at only embedded value, you are giving yourself a large margin of safety. If you mark it up towards a more “fair” number there is substantial risk you need to readjust it downwards when there’s bond market turmoil.  

I’ll just go with the company’s valuation with the illiquidity penalty removed for 4 reasons 1) to make it easier to keep track of the premium/discount 2) I demonstrated why it is likely highly conservative 3) so I don’t have to adjust it every market move. 4) I don’t care about the illiquidity.

Conclusion

The stake is conservatively worth €1428 Million. This holding is of critical importance because it already represents a sizeable asset on the balance sheet while it is growing fast. If you go by my conservative value it is now exceeding half the value of the BAT stake. If you would apply a 2x multiple to MECV it would exceed the BAT stake in value.

Because of the critical size PIC has grown to, the growth rate here will increasingly drive growth of Reinet its “true net asset value”. Management is compensated on AUM and total shareholder return so will want to see this value reflected at some point. I haven’t seen any indications of management trying to mark up asset values though. So far capital has been going only one way; from Reinet towards PIC. When this flow reverses, and I hope it doesn’t for a while, the market will likely start giving credit for this important value driver. I’d expect Flowers and Reinet could be interested in an IPO at some point as well.

It is noteworthy that Reinet’s CEO is on the PIC board. PIC acquired 14% of Reinet its shares in a “ninja buyback”. This further complicates a valuation but as I view Reinet’s shares as substantially undervalued it makes PIC more attractive which in turn makes Reinet more attractive.   

The fund investments

The third asset class that adds up to a lot of value are Reinet investments in alternatives. Reinet invests in funds as a limited partner but often has a stake in the general or managing partner as well. Sometimes the regular fund investments are on terms as a cornerstone investor. Fees are reduced and Reinet sometimes even shares in carried interest on the entire fund.

In fact where Reinet pays fees on capital committed it doesn’t charge fees at the Reinet level (it only charges if fees paid are below the Reinet management fees and makes up the difference).

Generally returns on private equity stakes (if you don’t pay fees or limited fees) aren’t bad. The value of these stakes is based on the reporting by these hedge funds and private equity companies.

When the market is real bad these stakes tend to get marked up but recently my experience is these are often undervalued. Exits often result in markups. The visibility into these funds is extremely poor and I expect this is contributing to the discount to NAV at Reinet. The table below shows Reinet’s estimate of fair value for these holdings as per 30 September 2017.

Trilantic Capital Partners

Trilantic Capital Partners is one of the higher valued stakes. In April 2009, Trilantic acquired LBMB out of the bankruptcy estate of Lehman Brothers with the help of Reinet Investments. They have about $6 billion under management. I believe Reinet may own 49% of the managing partner. It’s not disclosed in the annual report but the press release about the transaction in 09’ suggests so. Funds under management have grown by 100% since April 2009. Funds are raised infrequently and it has been a while since a fund has been raised. Possibly because we are nearing the end of the cycle. The stake is valued at €214 million and if Reinet owns such a big slice of the manager it should be a lowball estimate.Reinet also contributed large amounts of money towards the funds in a limited partner capacity which are lobbed in there.

Snow Phipps

Snow Phipps is a middle-market private equity firm. In 2011, Reinet is invested in Snow Phipps II, L.P. and Snow Phipps III L.P. Reinet committed to invest in two further co-investment opportunities.

Vanterra investments

Vanterra investments is a macro hedge fund investments. Reinet invested in the management company as well as the funds but they are shutting down. Presumably the valuation is about accurate as per September 2017.

The GAM Real Estate Finance Fund

The GAM Real Estate Finance Fund used to be Renshaw Bay where Reinet originally invested before it was acquired.

Fountainhead Expert Fund

The Fountainhead fund doesn’t have great performance since inception. The fund is running a concentrated value investing strategy with high active share. I know others in that category who’ve had a bad run of late. It should be a good strategy over time. Manager has a lot of money in the fund. Fees seem excessive.

Milestone Capital

Reinet has invested along with Milestone Capital in a management company based in Shanghai. Milestone Capital manages the Milestone China Opportunities Fund I, II and III, L.P., as well as the Milestone Kunshan Investment Fund, L.P. (the “RMB Fund”) which invest primarily in established high-growth companies seeking expansion or acquisition capital in China.

At least part of Milestone’s game is to take private companies public either in China or in the U.S. I imagine that is a strategy that creates value for investors and the general partner over time in excess of what you would expect from the market.

Prescient

Prescient is another Asian management company. It now has €11 billion under management. Reinet invests both in the management company and the funds. Given Reinet has contributed capital to these funds the carrying value of the combined stakes seems very low.

36 South

The estimated fair value of the investment in the 36 South fund management and distribution companies amounted to €42 million in  September 2017. 36 South is a long volatility shop with a long term track record. Given its strategy it should have made a killing last month. March 2017 it still managed €582 million. This stake may have increased in value substantially with the short vol trade blowing up early February. 36 South should have made a killing in performance fees as well as enjoyed an increase and potential influx into assets under management.

Nanodimension

Reinet invested in a biotech venture capital fund called Nanodimension. Reinet is a limited partner in NanoDimension I and II Limited Partnerships. The focus of each fund is to invest in and support companies working on new atomic and molecular structures. Product applications range from molecular diagnostics, immuno-oncology, immuno-tolerance, organs on chip, DNA synthesis to energy storage and electrochromic glass.

From my research into the above assembly of asset management stakes and investments  I lean strongly towards the view these are carried below fair value. This adds to the attractiveness of this investment.

Other assets

Otherwise I did not bother adjusting valuations of assets or liabilities except for the tiny biotech which is publicly listed.

Risks & Problems

The fund is externally managed by a management company charging a 1% management fee on assets under management and a 10% performance fee on total returns generated on NAV. There is a high watermark type structure so it’s not completely horrible. However holding mostly BAT shares while paying 1% management fees and 10% of the total return obviously warrants a discount to BAT shares.

About 15% of the shares are owned by the Chairman Johann Rupert through a trust. Another 9.18% of the shares is held by heirs in the Anton Rupert Descendants Trust. Then there’s another 15% held by PIC where Reinet’s CEO is on the board. At this time it looks practically impossible to launch an activist campaign to unlock value quickly.  

Tobacco stocks face fat-tail risk. the businesses are stable but government intervention is a threat with high potential impact. Pension insurance has a similar risk profile with the potential for a blow-up. In addition not all longevity risk has been reinsured.

The Brexit adds substantial uncertainty. It could influence the value of UK businesses or increase default rates which could negatively affect PIC. In my view BAT should be able to weather even a tough Brexit, but it won’t be fun either.

Summary

Buy a strange collection of public and private assets that are expected to generate positive shareholder value at a 47% discount to fair value. Because you are actually buying quality assets the discount to NAV doesn’t need to get closed to get a good return. It is likely to narrow over time as the private seed investments mature and become recognized. It’s that ultimate move that will really turn this from a good investment into a great investment. Tobacco, insurance, Brexit and more general market risks can be mitigated through hedging if desired.

Catalyst

I’m afraid there’s nothing great here. Because you are actually buying quality assets the discount to NAV doesn’t need to narrow to get a good return. A buyback would be one very easy way to accomplish that but given the external management’s compensation is tied to NAV they aren’t likely to go big.    

The company paid  € 0.165 in dividends last year. Up 2.4% vs the year before. This doesn’t do much to unlock value  in the short term but a dividend policy does show the board is interested in developing a relationship with minority shareholders.