Wm Osler Apex Partners Investment Fund CENTRAL SECURITIES CORP (CET:US) ELEVATOR PITCH: "Venerable CEF trading at a double digit discount to NAV, despite several
catalysts on the horizon and an undervalued level 3 asset…"
CURRENT PRICE
REPORTED NAV/SHARE
REPORTED DISCOUNT TO NAV
DISCOUNT TO CALCULATED NAV
3-YEAR MEAN REPORTED DISCOUNT
MARKET CAP
EV
FULLY DILUTED SHARES OUTSTANDING
MANAGEMENT OWNERSHIP
DIVIDEND YIELD
TOTAL EXPENSE RATIO
$21.76*
$26.13
15.6%
28%**
17.7%
527MM
509MM
24.12MM
36.5%***
VARIABLE****
0.77%
*
All currency values are denominated in Canadian dollars and are current as of 11/28/2014
**
Mean calculated discount derived from SOTP analysis
***
34% held in trust by the Johnson Christian A Endeavor Foundation (controlled by Mr. Kidd) and
2.5% by management team
****
See chart below for 6 year sample history of distributions; distributions are semi-annual and
discretionary
Year
2014
2013
2012
2011
2010
2009
SHARE PRICE
$22.98
$21.72
$19.98
$20.46
$21.98
$17.98
DISTRIBUTION
$1.75
$3.70
$0.90
$1.00
$0.90
$0.65
YIELD
7.62%
17.03%
4.50%
4.89%
4.09%
3.62%
PREAM BLE :
Outside the oil patch and its derivative businesses, value opportunities in the broader North American
publicly traded markets are few and far between. As a result, we have been looking in the dustier corners
of the CEF market for some asymmetric risk profiles. We believe that CET represents such an idea.
Due to illiquidity of the underlying security and an indeterminate time horizon, this idea is only appropriate
for PA’s and smaller funds. As discussed below, it may be preferable to hold CET in a tax-sheltered
account: if a liquidation scenario does play out, a large capital gain distribution is expected ($325MM or
$13.47/share). Expert tax advice is recommended before considering holding CET in a taxable account.
B ACKGROUND :
NYC based Securities Corporation (“CET”) is a closed-end fund that was founded in 1929 by Christian A.
Johnson. Over the ensuing 86 years, it has been predominately a non-diversified US-focused mid-cap
equity fund, although it has an unrestrictive mandate. In 1974, Wilmot H. Kidd took over as CEO after
working at the fund for only one year (he had married the Founder’s daughter…) and remains at the helm
today.
1 Wm Osler Apex Partners Investment Fund A HIGH QUALITY, YET DEEPLY DISCOUNTED PORTFOLIO:
Despite taking over as CEO during an entrenched bear market in the US, Mr. Kidd delivered a solid longterm fund performance that beat the S&P 500 benchmark by 255 bps over 25 years. That outcome put it in
the top percentile amongst its CEF peers –which is even more impressive when one considers the impact of
survivorship bias over a forty year period. (Data prior to the mid-1980’s was not available for analysis).
Mr. Kidd and his cronies are a relatively frugal lot, particularly when compared to their CEF peers: the
MER is amongst the lowest in the CEF universe, with a total expense ratio of 0.77%. Unlike many
managers who espouse the ‘buy-and-hold’ strategy, Kidd’s portfolio history is an extreme example of such
an approach, with the mean ‘top-ten’ holding period being 22 years!
As one can see from the graph above, there is a persistent, large NAV discount that averaged about 18%
over 10 years, achieving par only for a few years during those frothy late 90’s markets. The discount
remains about 240 bps below the long-term mean today.
2 Wm Osler Apex Partners Investment Fund There are five reasonably obvious factors that contribute to the large discount to NAV:
1.
2.
3.
4.
5.
The recent relative underperformance of the portfolio compared to the S&P 500 benchmark (-200
bps @ 5 years);
A 20% portfolio allocation to The Plymouth Rock Company Inc, which is a privately held
restricted stock holding;
The overhang of a very large unrealized capital gain tax liability;
A variable distribution policy that generally dissuades stable yield seeking investors; and
A largely unknown investment management/lack of brand.
A POTENTIALLY UNDERVALUED LEVEL 3 ASSET:
The Class A restricted shares in the Plymouth Rock Company are by far the largest and longest held
position for CET. The 32 year-old Massachusetts and Connecticut based auto insurance carrier is headed
by Founder/CEO/Chairman James Stone, a conservative and highly respected owner-operator.
CET was the initial outside investor in the fledgling insurer. The investment has paid off nicely with a 30year book value CAGR of just over 18% (which exceeds BRK’s performance, interestingly). ROE dropped
down to 12% as a result of Hurricane Sandy in 2012, but Plymouth’s results rebounded nicely to nearly
20% for 2013 and appear to be putting in a similar performance for 2014.
In our opinion, the Chairman’s letters reveal an obvious long-term focused, owner-operator orientation and
are a recommended read for any value investor. In terms of the investment portfolio, Mr. Stone has shown
superior capital allocation skills: a 31 year compound annual equity return of 16.3% compared to 13.3%
for the S&P benchmark. Remarkably, the portfolio has never booked a capital loss on any of its sixteen
holdings since inception.
Despite healthy ROE’s, an under-levered balance sheet (D:E 0.1x), excellent long-term investment returns
and real estate holdings with fair market values double GAAP book value, the conservative CEF managers
value Plymouth at 1.2x book value on their balance sheet, after applying a 20% discount for ‘lack of
marketability’. This may seem reasonable until one considers that:
1.
2.
3.
4.
In late 2013, Plymouth bought back 30% of its outstanding shares from Progressive Corporation,
the Capital Group Charitable Foundation and the Morgan Stanley Private Equity Group at an
estimated $2650/share or just under 1.2x 2013 year-end book;
Peer publicly traded auto insurers with similar ROE’s trade at multiples to book of 1.4x and
higher;
Historical private equity illiquidity discounts for firms with in excess of $1B in revenues are
generally in the order of 15%, well below the 20-40% discount CET utilizes historically (see chart
below);
In the 2013 Chairman’s Letter, James Stone implies that further liquidity events at favourable
prices are likely in CET’s future (see excerpt below):
“So, this past year, your Company bought back all the Plymouth Rock shares
owned by Progressive, the Capital Group Charitable Foundation, and the
Morgan Stanley entities. We could prudently afford to buy back only half of the
shares owned by Central Securities, but Central has made clear that it would like
us to repurchase its remaining shares, over time and at the right price.
We have had a blessed relationship with Central and Wil Kidd over the years,
and nothing about the completed or contemplated transactions diminishes in any
respect our permanent gratitude for Central’s initial bravery and subsequent
patience.”
3 Wm Osler Apex Partners Investment Fund Unfortunately, there are no truly comparable publicly traded firms to our knowledge. Allstate (ALL) and
Progressive (PGR) trade at 1.42 and 2.3x book value respectively, although these companies are more than
an order of magnitude larger in terms of market capitalization. Both ALL and PGR trade at about 13x
TTM earnings. As a sanity check for Plymouth’s valuation, if we discount Plymouth’s earnings by 3 full
P/E multiple turns, then we get a value for CET’s stake at 10 x $398.34/share (Plymouth’s 2013 net
income) x 34,660 shares (CET’s position size) = approximately $138MM. We attribute no incremental
value to the increased value of the real estate held by the company (although Mr. Stone estimates that this
would add another $15MM to NAV if sold at FMV).
O W NER /O PERATOR
→
ORIENTATION :
Excerpt from Forbes September 1997:
“Kidd earned an M.B.A with distinction at Northwestern University’s business school and had risen to
vice president at Hayden, Stone, an old-line brokerage that was absorbed into what is now the
Travelers Group.
After he married Julie Johnson, Kidd took the reins of the Central Securities portfolio in 1974, in the
midst of a ferocious bear market. Central had only $34 million in assets and its shares traded at a 40%
discount to asset value. “We were not really sure the fund was going to survive,” Kidd says.
But under Kidd it has grown 13-fold and now trades on the American Stock Exchange at a 2.8%
discount to net asset value. The family owns 12% of the fund, worth about $50 million. The Christian
A. Johnson Endeavor Foundation, run by Kidd’s wife, has about 40% and uses dividends for grants to
outfits like Colby College in Maine and the Metropolitan Opera.”
4 Wm Osler Apex Partners Investment Fund → Today, Mr. Kidd is 73 years old. He controls 34% of the company through the family trust. As far
→
as we can tell, there are no relatives in line to take over the Chairman/President position and no
obvious legacy plan for the fund.
The CET management is not adverse to returning capital to shareholders. In the H1 of 2014, they
bought back 93,000 shares when they hit 52 week lows. The distribution record also speaks for
itself.
C ATALYSTS
1.
Buybacks: as described above, when the share price drops to attractive levels, CET has
participated in several opportunistic open market bids in recent history
2.
Activism: Phil Goldstein, principle at Bulldog Investors and renowned CEF activist, threw
down the gauntlet with this letter (filed with the SEC in October of this year)
“The last time the Fund’s shares traded at close to net asset value was 1997. Since then, the
discount has generally been in double-digits and shows no signs of narrowing. In fact, the
discount has exceeded 15% on the last day of every quarter over the past five years and is
generally one of the widest discounts in the closed-end fund universe. Consequently, we think
it is appropriate for the Board of Directors to now consider whether it is time for the Fund to
be liquidated so that shareholders can realize the intrinsic value of their shares.
If you agree that it is time to implement measures to address the Fund’s persistent doubledigit discount, please vote for this (non-binding) proposal.
Very truly yours,
Phillip Goldstein
Chairman”
We note that is the respected value firm Ruane Cunniff (managers of the Sequoia Fund) has started to build
a small stake in CET in September. Although Sequoia is not known as an activist firm, the managers have
participated in activist endeavors in the past and may choose to cooperate with Mr. Goldstein’s efforts.
IS
IT
M ISPRICED ?
While using conservative (albeit dated and extrapolated) inputs, we calculate the current discount to NAV
to be somewhere in the range of 21-27%. In view of the potential catalysts above, the deep discount is not
entirely warranted. Barring any broad-based US stock market melt downs in the interim, we think that the
portfolio could easily be liquidated in an orderly fashion over an 18 month period. Alternatively, the more
liquid majority of the portfolio could be sold off into recent market strength and the remaining shares that
Mr. Kidd doesn’t already own could be tendered at a small discount to NAV. We’re reasonably certain that
Mr. Goldstein (and possibly others) will persist in their efforts to close the gap to NAV by encouraging
shareholder-friendly and timely liquidity events.
5 Wm Osler Apex Partners Investment Fund SOTP Analysis for Central Securities Corp
Cash & Equivalents1
Cash-liabilities
Tbills
Securities:
Level I2
Level II3
Level III4
NAV
Shares O/S
NAV/share
CET Market Price
Discount
Bear
Base
Bull
$10,025,660
$54,999,885
$10,025,660
$54,999,885
$10,025,660
$54,999,885
$481,597,814
$44,714,112
$91,849,0005
$481,597,814
$55,892,640
$132,500,0006
$517,600,000
$67,071,168
$143,631,0407
$683,186,471
24,119,825.00
$28.32
$21.93
22.58%
$735,015,999
24,119,825.00
$30.47
$21.93
28.04%
$793,327,753
24,119,825.00
$32.89
$21.93
33.33%
We suspect that CET’s much lower reported discount of 15.6% (or $26/share) would be used as a basis for
a tender price. An orderly liquidation over 18-24 months would likely fetch closer to $30/share or a NPV
of $26/share (r = 8%).
R ISKS &
M ITIGANTS :
•
As far as we can tell from existing public filings, Bulldog Investors stake in CET is currently still
immaterial at 0.57% of the share float. The controlling shareholder could easily repel his value
creation efforts for the intermediate-term, which would obviously significantly impair IRR for the
investment. Mr. Kidd’s age, lack of a clear legacy plan, large personal/family stake and Bulldog
Investors’ historic tenacity are all somewhat reassuring mitigants in this regard.
•
Poor capital allocation decisions by Messrs Kidd and Stone could destroy shareholder value,
although a long shareholder-friendly track record mitigates this concern considerably.
•
Exposure to Beta: Morningstar’s regression Beta (vs. the S&P 500 index) is 0.59x with a R2 fit of
0.66; a broad based US market downturn would impair intrinsic value although this could be
mitigated with a partial hedge using an appropriately weighted position in SPY puts or a short SPY
position.
S UM M ARY :
1 Liquid
assets as of June 30, 2014
2
Bear and Bull scenario figures derived from June 30 statement. Bull case Level I asset appreciation extrapolation calculated using
Beta regression estimate of 0.92 (referencing SPY)
3
Geomet Inc. Series A Convertible Redeemable Preferred Stock; Base case is CET FMV estimate; Bear and Bull scenarios are +/20% Base
4
The Plymouth Rock Company & Aerogroup Int’l; Aerogroup’s contribution to CET’s valuation is de minimus
5
Derived from Plymouth’s 2013 buy-back price of $2650 or 1.2x 2013 estimated book value
6
CET’s FMV estimate or 1.2x estimated 2014 book value (20% discounted due to ‘lack of marketability’)
7
Unadjusted Plymouth Q4 2013 FMV appraisal
6 Wm Osler Apex Partners Investment Fund Central Securities Corp is definitely not an exciting investment and time is not our friend here.
Nevertheless, we believe that it offers an asymmetric opportunity to participate in further upside in the
fund’s US centered, mid-cap equity portfolio exposure (with minimal commodity content) and dividend
distributions as well as the planned orderly liquidation of Plymouth Rock Company, a potentially
considerably undervalued asset. The realization of value through serial liquidity events should be
accelerated by the efforts of an assertive activist.
DISCLAIMER: WILLIAM OSLER CAPITAL AND THE AUTHORS MAY HAVE A LONG POSITION IN THESE SECURITIES. THEY MAY BE SOLD OR BOUGHT WITHOUT NOTICE. PLEASE VERIFY
DETAILS BEFORE MAKING INVESTMENT DECISIONS. THERE IS NO GUARANTEE OF ACCURACY OR COMPLETENESS. WILLIAM OSLER CAPITAL AND ITS MANAGING PARTNERS ARE NOT
LIABLE FOR ANY LOSSES OR DAMAGES, MONETARY OR OTHERWISE THAT RESULT FROM THE CONTENT OF THIS WRITEUP.
Appendix (Derived from June and September 2014 Corporate Interim Reports)
Definition of Fair Market Value inputs:
•
•
•
•
Level 1—Quoted prices in active markets for identical investments;
Level 2—Other significant observable inputs obtained from independent sources, for example,
quoted prices for similar investments or the use of models or other valuation methodologies such
as amortized;
Cost for certain short-term investments;
Level 3—Significant unobservable inputs including the Corporation’s own assumptions based
upon the best information available. Investments categorized as Level 3 include securities in
which there is little, if any, market activity. The Corporation’s Level 3 investments consist of the
Plymouth Rock Company, Inc. and Aerogroup International, Inc.
7