Unlocking Hidden Small-Cap Value in Marwyn

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One of my favourite hunting grounds for stocks that offer deep value is the small-cap and micro-cap segment of the UK stock market. We can define stocks as small-cap if they belong to the FTSE UK Small-Cap index (over 500 constituents of stocks whose market is typically smaller than those in the FTSE 100 or FTSE Mid 250 indices). Micro-caps typically belong to the FTSE Fledgling index or the AIM market.

Unlike many other stock markets around the world, the UK offers a broad and rich variety of small- and micro-caps that are liquid enough to trade without suffering bid-ask price spreads that are very wide, as long as you are patient when accumulating a significant holding. Typically, these companies are not covered by mainstream investment banking research analysts, and are often simply too small to interest most professional fund managers, who tend to invest in more liquid companies. It is precisely for these reasons that we are able to uncover very interesting value and growth investment stories in this arena. Academically speaking, small- and micro-cap stocks should outperform large-cap stocks in the long-term due to the existence of an “illiquidity premium”, i.e. an investor should be compensated for the risk of holding a stock which he or she cannot sell quickly by superior long-term investment returns from this type of stock.

I believe that one such interesting company is a closed-end fund company called Marwyn Value Investors (MVI). This company, listed on AIM, has a current market capitalisation of £119m (as of 18 December 2013). According to the company’s website (www.marwynvalue.com), this fund “participates in acquisition-led growth strategies by investing in diversified portfolio of European small- and mid-cap businesses”.

The Value Argument: A Sizeable Discount to Net Asset Value

With closed-end fund companies like investment trusts, a key value criterion is the fund’s discount to underlying net assets. Put simply, this is the concept of buying a pound’s-worth of assets for substantially less than a pound. This sounds like quite a sensible strategy, doesn’t it?

Well, Marwyn Value Investors (MVI) ticks this valuation box as it trades at a wide discount to its underlying net asset value, in fact a near-33% discount to net assets according to my latest calculations! So in theory you are buying economic exposure to one pound’s-worth of assets for just over 67p…

But what assets are you actually buying exposure to? In the case of Marwyn Value, there are two key assets, holdings in UK-listed companies Entertainment One (ETO) and Breedon Aggregates (BREE).

1.  Entertainment One (ETO)

Entertainment One (www.entertainmentone.com) is a leading independent entertainment group focused on the acquisition, production and distribution of film and television content rights across all media throughout the world. In film, eOne’s recent theatrical release pipeline has included this year films such as The Place Beyond the Pines and is due to include the blockbuster The Hunger Games: Catching Fire and Ender’s Game. In TV, eOne has a Canadian TV business that creates and produces its own programmes, and generates upside from international distribution for a number of successful TV series including Haven and Rookie Blue.

The continued growth in online video-on-demand services such as Netflix and Lovefilm (owned by Amazon.com) is increasing the value of eOne’s film and TV library, valued currently by analysts at research house Edison at around $800m, or £500m. This represents around 70% of the current market cap of eOne and thus provides a very solid floor to the company’s valuation. In addition, the recent interim results (reported 18 November) were slightly ahead of Edison’s estimates with strong growth in underlying sales and profits.

eOne itself sits at an attractive P/E valuation of under 13x next year’s earnings, and an enterprise value (market cap + net debt) to sales ratio of 0.8x, both at substantial discounts to an international film and TV company peer group average.

Marwyn Value holds nearly 27% of eOne’s shares, giving a stake value at eOne’s current 260p share price of £196m, or 239p per MVI share.

2.  Breedon Aggregates (BREE)

Marwyn Value also holds a substantial stake in Breedon Aggregates (www.breedonaggregates.com), the UK’s largest independent building aggregates company left in the UK (all the larger aggregates competitors have already been taken over by foreign building materials companies from France, Switzerland and Mexico). They produce asphalt, concrete, sand and gravel for use in construction in the UK.

As with eOne, Breedon also recently delivered an upbeat assessment of its current trading performance (26 November), highlighting that trading performance had been “very encouraging” and that full-year profits to end-2013 were likely to be “somewhat ahead of market expectations”.

Consensus forecasts for Breedon expects a strong progression in both sales and pre-tax profits both for end-2013 and also again for end-2014.

Marwyn Value holds a little under 15% of Breedon’s shares, worth an aggregate £52m at the current 39.5p share price.

A Near-33% Discount to current Net Asset Value

Adding these two stakes in quoted companies together, adding other small investments and then subtracting the debt held by Marwyn Value gives a current estimated net asset value per share of 267p. With MVI’s current share price sitting at only 180p, that represents a 32.5% discount to current NAV. As is evident from the chart below, this is the widest discount to NAV that MVI has reached since late 2012. Moreover, this is after subtracting 6.5p per share form MVI’s net asset value as the result of the recent write-down of its stake in quoted company Silverdell to zero following poor financial performance.

MVI Discount to NAV at widest for 2013

Source: Bloomberg, Author

The Growth Argument: Upbeat prospects for eOne and Breedon

Not only have recent results announcements been very encouraging for both eOne and Breedon, but the growth outlook for both companies would seem also to be bright. In the case of eOne, there should be future profit growth from the current pipeline of film and TV projects in which eOne has already invested, with strong demand for film and TV media library content both from online VOD services as well as global satellite and cable TV operators. It is clear that content is king in the pay-TV and cable TV business, a situation that eOne is in a strong position to exploit.

As for Breedon Aggregates, it is clear that the UK construction backdrop remains buoyant, with a strong domestic housing market and also UK construction industry confidence reaching new highs in the November reading of the Markit UK construction confidence index.

Long-Term Share Price Uptrend

Marwyn Value and its two underlying quoted assets Entertaiment One and Breedon Aggregates all exhibit a rising long-term share price trend:

Breedon’s Share Price Has Been the Outstanding Star

Source: Bloomberg, Author

While Marwyn Value’s share price has kept pace with its largest holding Entertainment One over the last two years, it has noticeably not kept up with the sharp rise in Breedon’s share price this year, one of the reasons behind MVI’s widening discount to NAV.

Since October, there has been a divergent trend in share price trends: while the value of MVI’s stakes in eOne and Breedon have continued to rise by nearly 50p per MVI share (see chart below), MVI’s own share price has actually fallen back by around 10p (over 5%).

Divergent Share Price Trends since October

Source: Author’s calculations

We could try to explain this recent divergence by the disappointing news of the write-down of the Silverdell stake to zero – but this is only worth 6.5p per MVI share, while the divergence with its two major quoted assets since October has been more of the order of 60p.

Potential Catalysts: a Simpler Investment Story

First of all, Entertainment One should benefit from improved liquidity and investor attention following its recent promotion to the FTSE Mid 250 index in the last quarterly index review in September.

Secondly, MVI has reduced its portfolio of significant company assets to two following the complete disposal of its remaining stake in quoted company Advanced Computer Software plc for £25m, representing a 5.9x cash return on investment. Theoretically, a disposal of assets to simplify the investment portfolio should result in a narrowing of the discount to net asset value given the simpler investment story and the lower debt level (and thus lower financial gearing, meaning lower financial risk).

Thirdly, it could well be the case that following the reduction of its net debt position, that MVI is in a position to reduce the discount to net asset value through a share buyback programme, a tactic used frequently by investment trusts to reduce NAV discounts for shareholders.

On a more speculative note, following the historic acquisitions of UK construction materials companies Aggregate Industries, Hanson and Blue Circle by larger foreign construction competitors could point to the potential attractions of Breedon itself as an acquisition target for larger construction materials companies, now that it is experiencing a strong recovery in sales and profits.

Summing it all up

Marwyn Value Investors is a closed-end fund quoted on AIM that offers a historically high discount to net assets. It has simplified its investment portfolio and lowered financial risk on its balance sheet. Finally, it holds large stakes in two companies in very different industries, Media and Construction, that are both experiencing strong growth and also improving profitability against positive industry backdrops. This seems to me a very interesting investment opportunity for the patient investor, and I heartily recommend perusing the Marwyn Value company website for more details.

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