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Cadence Capital – I’m Confused

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On 20 September, Cadence Capital Limited (ASX: CDM) issued a presentation proposing a possible hiving off a specific international investment into a separate LIC – Cadence Global. The proposed demerger would encompass moving CDM’s entire holding in the The Metals Company Inc. (NASDAQ: TMC) into the Cadence Global entity plus $15m in cash.

This development occurred after the NASDAQ listing of TMC on 10 September 2021 at an IPO price of US$10/share which, on the day after listing, valued CDM’s holding at A$85m from an initial investment of A$6m, and accounting for almost 20% of the CDM portfolio. The issue for CDM is, according to the presentation, the entire holding was in escrow for a period of either 20 days trading above US$12/share (TMC was last trading at US$5.11/share after peaking at US$12.45/share on 13 September 2021) or a period of 180 days.

However, somewhat confusingly, on 22 September CDM announced that it had divested approximately one third of its holding in TMC and which was not subject to escrow. The remaining two thirds remains subject to escrow, as per the restrictions detailed above.

The position was traded on 23 September (US time), suggesting a sale price in the vicinity of US$5.46/share (the closing price on that date). TMC closed at US$5.11/share on 24 September, which we approximate equates to a residual value for CDM of A$33m, or approximately 9.0% of the total CDM portfolio.

The partial divestment in itself, tied with the residual holding as a percentage of the total CDM portfolio, suggests the initial proposal of a demerger will not proceed. CDM would have also received considerable share holder feedback following the announcement. RRM understands the rationale for the proposal – it what was then a near 20% position of the portfolio, the TMC holding was ‘problematic’ from a portfolio diversification and downside risk perspective. Being (at least partly) escrowed, placed the CDM management between a rock and a hard place.
And this ‘rock and a hard place’ needs to be partly put in the context of CDM’s investment in Melbourne IT which ran up to a significant portion of the total portfolio only to subsequently lead to a period of material underperformance. With this in mind, investors were no doubt somewhat uncomfortable with the high portfolio position of TMC.

While the manager’s rationale was / is understandable, it is also somewhat problematic. It would create at least initially a single stock portfolio and, as evident from the sell-off in TMC post the IPO, an inherently very high risk investment vehicle, notwithstanding the intention to diversify the investment vehicle over time. On the flip side, it would allow existing CDM share holders to choose their degree of exposure to TMC.

In the interim, should CDM proceed with the proposal it will take time and there is a lot of water to pass under the bridge. If the sell-off continues, the whole portfolio exposure issue may become a moot point. Equally, TMC may rebound. Should the proposal not proceed, from current share price levels, it would appear likely that CDM is locked in to its remaining position for the full 180 days.

By our reckoning, the approximate pre-tax NTA/share of CDM based on share price moves in TMC is around the $1.24/share level, equating to a rough 9% discount to NTA. The CDM share price moved up solidly in the lead up to the TMC IPO, with the CDM discount to NTA largely being removed. It appears it was a degree of the old ‘buy the rumour, sell the fact’.