Drilling for Deep Value Down Under
10/07/2010 10:00 am EST
Andrew Sleeman, manager of the Mutual International Fund, expects more buyout bids as corporations put cheap cash to work.
MoneyShow.com: How do you select stocks for your deep-value fund?
Sleeman: We’re looking for businesses that are trading at a discount to intrinsic value. In the financial sector, for example, we’ll typically look at the price-to-book-[value] ratio. In other sectors, we’re principally focused on cash flows and asset values—things that can be monetized. Intrinsic value is what an industrial buyer would pay for a company.
Q: So, is this a fun time for you with so much cash on corporate balance sheets?
A: It is a very interesting time. You’re starting to see mergers and acquisitions come through, and I think you’ll see a crescendo in 2011, because shareholders are demanding that [companies] do something with their balance sheet. There’s very cheap capital [available] and plenty of good cash-generating companies. The investment banks will tell you that their books of M&A targets are growing.
Q: What themes are getting the most attention from corporate buyers?
A: In the West, the consensus view is that growth is going to be challenging in the coming years. So, if you can find a business that fits strategically with what you want to do and where you can also perhaps garner some synergies, that’s a pretty safe way to go.
One of the names that we own in Europe is Resolution (London: RSL), a life insurance company that is acquiring UK life insurers. They think that by consolidating an inefficient industry they can generate lots of cash and synergistic benefits. We think they will be a winner, because they’ve shown the discipline to extract cost.
Q: Are there particular industries or locations where you are finding bargains right now?
A: Property and casualty insurers is one area where we see a lot of businesses trading at a discount to tangible book value, which implies that they have no ongoing franchise value. On a lot of these names—RSA (NYSE: RSA, London: RSA), Zurich Financial (Frankfurt: ZFIN)—we're getting a dividend yield of 6%-plus while we wait for the market to recognize the value in the stocks.
Another industry that we have a fair bit of exposure to is mining services. We own Boart Longyear (Sydney: BLY), an Australian-listed company with headquarters here in the US, and they’re the biggest drilling company in the world. The majority of what they do is copper-and gold-related. Supply of copper is light, and it looks like it will [remain that way]: There haven’t been a lot of big deposits found in the last couple of years. So, people are going to get out there to find more copper, and these guys are beneficiaries of a healthier balance sheet and improving copper and gold prices.
Q. Can they still be a bargain given what’s happened to copper and gold prices?
A. The stock hasn’t done much at all. It [had an initial public offering] a couple of years ago. And when it came [public,] it had been owned by private equity and had a lot of debt on the balance sheet. So, they suffered when the market collapsed.
But they recapitalized to where they’ve got no debt. I think the market is waiting for evidence of improvement, but we’re seeing it: There’s certainly more [drilling] activity out there.
The other indirect mining play we own is Seven Group Holdings (Sydney: SVW). They own 49.5%, with KKR, of the largest free-to-air television network in Australia. They also have the largest print media exposure in Australia, [and] they own the largest Caterpillar (NYSE: CAT) dealership in China and [in] Australia. They own the dealerships in
Western Australia and New South Wales, where most of the mining takes place, as well as in the north of China, which is the most mined region there. Over the years, the heavy margins are in servicing the equipment. I think it’s a fantastic business.
Q. Another interesting name among your top holdings is Aozora (Tokyo: 8304)—you don’t often see a Japanese bank in a deep-value portfolio.
A. Japanese banks [have] very large balance sheets with very thin capital. Aozora’s the opposite: It’s got a lot of capital, and they’re very prepared to shrink their balance sheet. Aozora was taken by [private equity firm] Cerberus through a recapitalization period, and [now] you have a bank with an interesting deposit franchise but not a very interesting asset franchise. [That’s] absolutely the right way to think about a bank, in my view: We will write loans at economic spreads, and if we don’t get the spreads, we won’t [do the loans]. So, you’ve got a very nicely shaped balance sheet. If we can extrapolate the first quarter’s earnings for the rest of the year—and that’s a big if—we've got a stock trading at five times earnings and half book value.
Q. Thank you.