This website presents my analysis of macro economics trends and individual companies.

Tuesday, September 7, 2010

Aberdeen International (TSX: AAB) Part 2

As mentioned in the previous post, management's actions regarding accretive issuance and repurchasing of shares have been exemplary in adding shareholder value.  However, the general incentive structure of the company and its associates at Forbes & Manhattan is less remarkable and unfortunately much to similar to those that pervade Wallstreet.  AAB uses the policy of awarding large incentive bonuses for success but no symmetrical downside exposure for failure.  One can argue that management does have some downside exposure through their equity ownership in AAB but even that is tenuous because if they were stock grants originally then the individual has none of his own capital at risk.  For example, according to the most recently filed Proxy Circular,
    "Executive officers are also eligible to receive a bonus based on the performance of the Corporation’s portfolio; and the Corporation has established a practice of paying aggregate performance bonuses equal to 10% of any realized gains."  
Thus, even if there is a net-realized loss, management will still receive a bonus for any investment that realized a gain.  For example, in fiscal year ending Jan. 2010 incentive pay of at least $1.8m was awarded while AAB recognized a $4.6m net-realized loss.

Simmer & Jack Loan
One of the items on AAB's balance sheet is an outstanding loan, held as an asset in the amount of $10m, that management of AAB is currently in litigation to force collection of from Simmer & Jack.  According to AAB
    During the fourth quarter of fiscal year 2006, the Company loaned US$10,000,000 to Simmer and Jack Mines, Limited (“Simmers”). The loan had a three-year term maturing December 31, 2008, a 3% coupon at gold prices up to US$400 per ounce (2.5% at gold prices above US$400 per ounce) and a net smelter royalty (“NSR”), tied to the price of gold, ranging from a 0.5% NSR at US$300 per ounce to a 4.75% NSR at gold prices of US$750 per ounce or higher, on a graduated scale. The NSR was payable against gold produced from Simmers’ northwest assets and included First Uranium Corporation’s (First Uranium”) Mine Waste Solutions tailings recovery operation. 
    The loan also had an option that allowed Aberdeen to call for its conversion into equity of Simmers at ZAR 0.80 per share at any time from January 1, 2007 to December 31, 2008, subject to Simmers shareholders’ approval. On October 16, 2008, the Company called for conversion to equity and a shareholder vote was held on February 16, 2009, where the Simmers’ shareholders voted against the conversion as unanimously recommended by Simmers’ board of directors. As a result, it is Aberdeen’s position that the US$10,000,000 loan was due, as of its maturity date of December 31, 2008, and Aberdeen was entitled to a 1% NSR on the gold produced on the underlying assets starting October 16, 2008. In addition, it is the Company’s position that a payment of approximately US$1,363,000 is due from Simmers which is the interest and graduated royalty calculated at a rate of 4.75% on the gold produced between October 16, 2008 and December 31, 2008, the maturity date of the loan, in addition to a 1% NSR royalty on gold produced starting October 16, 2008.
    However, it is Simmers’ position that the request for conversion into equity has caused the loan facility to terminate, ending the remaining graduated royalty payment and forfeiting repayment on the US$10,000,000 principal and remaining interest payments. Accordingly, Simmers’ management contends that the shareholder vote to deny the conversion request has resulted in Aberdeen receiving only the 1% NSR, but not the US$10,000,000 principal.    
Aberdeen’s balance sheet, as at April 30, 2010, reflects Aberdeen’s interpretation of the agreement. As a result, the US$10,000,000 ($10,158,000) loan was still outstanding at April 30, 2010 and is recorded on the balance sheet. In addition, as at April 30, 2010, the Company had recorded receivables from Simmers and First Uranium totaling US$1,626,434 ($1,652,132). This includes the amount related to the interest and graduated royalty for the period between October 16, 2008 and December 31, 2008. It is Simmers’ contention that these amounts are not due.
 Turning now to the actual Loan Agreement from March 30, 2006 we find the following:
2.10 Conversion of Facility. The Borrower acknowledges that the Lender, in its sole discretion, has the option at any time following the one year anniversary of the first Advance, to convert the amount of the Facility outstanding to ordinary shares of the Borrower at a  conversion rate of  RandO.80 (eighty cents) per ordinary share, subject to the approval of the shareholders of the Borrower. In the event that the approval of the shareholders of the Borrower has not been  obtained within a reasonable period of time, the Lender shall be entitled to a 1.0% net smelter royalty on gold produced from the Borrower's Northwest assets (all properties held by the  Borrower through Buffelsfontein Gold Mines Limited, listed in Schedule "B", will be subject to a net smelter royalty in favour of the Lender with the royalty being calculated on the revenue of those properties), which is in addition to the net smelter royalty referred to in Section 2.9, with such additional royalty to be payable in perpetuity.
Although I am not an expert in law I would interpret the loan conversion in the same way that Simmers & Jack Ltd did.  Consequently, in my analysis I would henceforth write-off the value of this loan on AAB's balance sheet.  We shall find out how the courts in S. Africa will rule on this matter by late November, 2010.

Conflict of Interest Example
Although it is clearly disclosed that the potential for conflicts of interests exist between F&M, AAB and their subsidiary investments through cross-directorships, cross-management, cross-dealings and such, one should monitor these deals to make sure that none of them are being excessively exploited to the detriment of shareholders.  One could argue that the fees that Mr. Stan Bharti is pulling from each of these investment subsidiaries is excessive or one could say that they are compensation for consulting services that F&M is performing.  It is hard to say without knowing explicitly what the services are so I will leave that as an open question.  However, I did find another clearer example of a conflict of interest within the filing of Dacha Capital (TSX: DAC). 
During the fiscal year ended March 30, 2010, Dacha entered into an agreement to loan Forbes & Manhattan Asset Management Corporation (“FAMCo”) up to $3,500,000. FAMCo is an asset management company with a business plan to identify and acquire other Canadian asset managers which FAMCo assesses as undervalued. A director of Dacha is also a director of FAMCo. As at March 31, 2010, the Company had advanced $2,937,493 to FAMCo. The amount outstanding was originally due and payable on April 30, 2010 and has been secured against assets held by FAMCo under a secured debenture loan agreement. Interest on amounts outstanding under the debenture accrue at a rate of 12% per annum, payable on maturity. Dacha has the option, exercisable at any time, to convert the principal amount outstanding under the debenture into 33% of the outstanding equity of FAMCo as at the time of conversion.

During the first quarter ended June 30, 2010, the Company extended the maturity date on the loan outstanding to FAMCo to April 30, 2011 and advanced an additional $52,500 under the facility. At June 30, 2010, the principal outstanding, with the additional advance of $52,500, totalled $2,989,993 and accrued interest totalled $165,836. The Company has agreed to advance an additional amount up to $310,000.

FAMCo currently does not have sufficient assets to repay the secured debenture and has no operating cash flow to service the interest payments. The payment of interest on the secured debenture and the repayment of the principal are dependent on FAMCo’s successful implementation of its business plan.
Considering that the sole purpose of Dacha Capital is to invest in rare-earth-metals and hold them as inventory, why are they loaning their precious money to FAMCo in the first place.  And furthermore, why would they lend to a company that "does not have sufficient assets"  nor "operating cash flow" to even service the interest payments on the debenture?  This deal this is a clear example of how Stan Bharti and F&M are using their position at Dacha to further their own interests at the expense of Dacha shareholders.  Unfortunate but true.

Despite these shortcomings, I would still see AAB as an attractive investment considering the large discount to NAV that it currently has.  However, as that discount diminishes, so will my interest in AAB.

No comments:

Post a Comment

About Me

Los Angeles, California, United States
Chris Rutherglen is a scientist and engineer by profession and pursues financial & investment analysis on the side. In 2011, he completed lever 3 of the CFA program.