WAR IPO Close and what the MHH ‘Raid” Tells You


The WAM Strategic Value IPO closed on 10 June 2021 with investor demand significantly exceeding the $225 million maximum subscription, suggesting solid secondary market support given the consequent IPO scalebacks.

For those not intimate with the IPO, WAR, which commences trading on the ASX on 25 June 2021, will commence with a initial portfolio that includes the likes of TGG, AUI, PAI, LSF, VG1 and now MHH.

In what was its first transaction, WAR acquired a stake in MHH during the second week of June. RRM would describe the buying in MHH as purely a market opportunistic and passive discount capture move given the team at WAR could not conceivably provide anything constructive to Magellan (positive comment regarding both Wilsons and Magellan).

What the buying in MHH highlights to RRM is the spectrum of strategies WAR will employ to crystallise discount capture plays. These will range from purely passive in well managed LICs/LITs (‘well managed’ in the sense of marketing, communications, dividends, accountability to share holders, solid investment teams) to actively seeking to implement some or all of the above ‘well managed’ attributes in less well managed LICs/LITs.

This latter strategy is an activist approach to discount capture. It starts with an approach to help (the ‘carrot’) but if changes are not forthcoming a pivot is required (the ‘stick’), potentially becoming confrontational.

A diversity of the two approaches has a number of benefits. Firstly, hard core activism often involves long and proacted campaigns that, if successful, deliver something of a J-curve and very idiosyncratic returns profile. By mixing these campaigns with passive and benign activist campaigns, the diversification has greater potential to smooth out any inherent J-curve effect.

However, hard core activist campaigns, while arguably inherently higher risk, are also likely to deliver greater alpha and true absolute returns. A decent percentage of these campaigns (as a percentage of the total portfolio) will also be required if WAR is to avoid what would become legitimate criticism that it is partly / materially a double layer of fees, largely passive fund-of-fund vehicle.

But then again, Geoff Wilson is not one to shy away from getting his hands dirty with respect to a IMA take-over or a roll-up. But now WAR has become a separate vehicle, any such campaigns will need to be highly polished in terms of convincing existing share holders why they should vote in the favour of WAR.

MLT – The Transformation of an ‘Old Style’ LIC Giant


On 22 June 2021 Milton Corporation Limited (MLT) and Washington H. Soul Pattison (WHSP) announced both parties had entered into a scheme of arrangement under which WHSP proposes to acquire 100% of the share capital of MLT that it currently does not own.

Under the proposed transaction, which has been unanimously recommended by the Committee of Independent Directors of MLT, MLT shareholders will receive scrip consideration reflecting a 10% premium to pre-tax NTA in addition to two fully franked dividends totalling 45 cps and access to a FY21 dividend from WHSP.

Based on prices on 22 June 2021, following completion of the proposed transaction, existing WHSP shareholders will own 66.2% of the combined entity with MLT shareholders owning the remaining 33.8%. RRM notes however that the WHSP share price jumped 8.5% on 23 June.

It is not RRM’s role on how to advise MLT shareholders but we would note the following. The 10% premium to NTA compares to what had been an approximate 5% discount to NTA. The three to five year investment portfolio plan of WHSP involves a material increase in private market assets. Having spoken to the CEO of WHSP, Todd Barlow, RRM is favourably predisposed to this asset class / portfolio evolution strategy, and in part because we are well aware of the potentially attractive risk-adjusted returns in the private market space in Australia.

The simplest way to view WHSP is like that of a large US-style family office. It is well resourced, experienced and very well connected. And connections particularly matter in the private market space. There is also a very strong focus on capital preservation, which is a common hallmark of family office portfolio management.

The combined entity will also over time, based on the three to five year plan, become more of a true through market cycle investment vehicle given its diversification. That diversification will be by asset class, geography, sector and presumably be relatively ‘factor’ neutral (growth, value, market cap size, etc).

The other point RRM would make is there will not be any material changes to the existing MLT portfolio, at least not in the foreseeable future. Perhaps a better way to state this is that RRM would not anticipate any ‘style drift’ in relation to the existing MLT domestic equities portfolio. This is a friendly merger. The principal shareholder in WHSP, Robert Millner is the Chairman of MLT – i.e., well familar with the style and strategy, not to mention that WHSP is an existing share holder in MLT. Furthermore, the capital account status of MLT precludes any potential material portfolio turnover in any financial year period, even if it was on the cards.

RRM likes this stability – an MLT share holder is not being put in a situation of having to choice here and now type thing. The portfolio evolution will occur over time rather than over the shorter term.

Of course, an existing MLT shareholder can simply sell on market if concerned or unsure about the combined vehicle. A review of the cross-correlation heat map analysis contained in this publication indicates a number of highly correlated strategies, not surprisingly including AFI and ARG, for example. That is, comparable alternatives exist to MLT.

ASX: PIC – And the Inside on Bonus Options from the Best Performing Value LIC

On 2 June PIC announced a 1 for 1 Bonus Options issue combined with an up to $30K share purchase plan (SPP) per share holder. The former is all about market timing, and that timing is good for PIC currently based on: 1) strong performance over, in particular, the last 12-months; 2) a market environment that is providing further investment opportunities according to the manager; and, 3) given PIC currently trading at an 6% discount to NTA.

Additionally, more broadly, we believe the general investor view of the LIC/LIT sector has returned to a more sensibly balanced view after the stamping fees issue (as some rather negative, vested interest views expressed in the media), with a recognition of the potential benefits of a close-ended vehicle structure.

The key terms of the Bonus Options are: Options record date 23 June 2021; for those share holders that participate in the SPP, 1 for 1 bonus options eligibility will also include those additional SPP related shares; Options Exercise Price: $1.35/share; Options Expiry Date: 2 September 2022; and, Options ASX trading date commencement: 30 June 2021. Investors should bear in mind that all bonus option issues are American style options, that is an investor can choose to exercise the option and receive the shares any time up until the Options Expiry Date.

The PIC issue will certainly not be the last material capital raise offer over the shorter term. The timing for a number of investment managers is currently very strong based on some exceptionally strong 12-month performance numbers and, as a corollary, moves to near parity or share price premium to NTA. So, RRM thought it an opportune time to re-examine the pro’s, con’s and ramifications of the (1 for 1) bonus options structure.

This examination is comparative, with the comparison being that of the alternative means of rewarding existing shareholders – an entitlement offer (issued at a slight discount to NTA), which typically comes with a shortfall placement to the broader investment community. Both structures, assuming the share price exceeds the options strike price, are NTA dilutive, and most dilutive to share holders that do not participate. Additionally, with an entitlement offer to raise a comparable level of capital would require multiple offers over different time periods, so there are multiple dilutionary impacts over multiple time periods, and which is precisely the same impact the American style (exercisable at anytime prior to expiry date) bonus options.

Investor Benefits
From an investor perspective, the benefits of the 1 for 1 Bonus Options issued are potentially nine-fold in the view of RRM:

1) Bonus options reward existing investors (and by a greater degree than an entitlement offer) by providing a free ‘kicker’ and provides investors with a free look at the market/fund over the duration of the issue date to expiry date (15 months in the case of PIC). An entitlement offer is a here and now decision.

2) Investors have perfect choice – time window choice on when to exercise, hold or sell the options on-market to raise cash (if the share price exceeds the exercise price and therefore the options have a market value).

3) Bonus options provide an alignment between management and the shareholders as a result of the duration of the 1:1 options. In the PIC case, for example, the exercise price is at a premium to the share price/ NTA and the goal posts change as distributions are paid. This provides management with a clear mandate to perform in order to raise capital.

4) The NTA dilutionary effect overall for the LIC/LIT is based on the time weighted exercise dates of the options multiplied by the premium of the share price to the options strike price when the options were exercised. Through either good luck or a judicious decision, an investor’s exercise has the potential to be NTA accretive for that investor.

5) An increase in FUM scale leads to increased secondary market liquidity and market relevance (broader market interest). PIC currently has 349.381m shares outstanding and a FUM of $486M (based on a pre-tax NTA of $1.39/share). The bonus options issue has the potential to increase the PIC FUM to circa $973M, assuming a 100% exercise rate (the 12th largest LIC/LIT out of 98 in total and factoring in the disappearance of MLT).

6) In the LIC/LIT sector, larger FUM scale is strongly correlated historically to superior premium / discount to NTA performance (read, potential share price upside over and above NTA growth, assuming a recalibration occurs).

7) The greater FUM scale leads to lower fixed costs per share incurred by investors, improving net post costs returns, all things equal.

8) Should compelling investment opportunities present, a manager has greater capacity to seek to capitalise on those opportunities based on the additional capital raised and given bonus options are American style, that capital is not raised all in one hit which may otherwise lead to digestion issues.

9) At a more esoteric level, a canny investor can potentially game options exercise investor behaviours and the consequent cyclical impact on discounts / premiums to NTA for an ‘arbitrage profit’ opportunity (see ‘Trading Bonus Options’ section below)

Investor Risks
Bonus Options do come with some downside risks. The key amongst these are:

1) At least 50% of share holders will ‘suffer’ NTA dilution. NTA dilutionary risk is, in turn, driven by: a) the degree to which the strike price is below the NTA over the full time period in which options are exercised; and, b) the percentage of options that are exercised.

2) The degree of NTA dilutionary risk is an unknown and a function of investor behaviours (when they exercise) and moves in the share price relative to the options strike price. With an entitlement offer, the dilution risk is a known and limited to the offer discount to NTA at the time.

3) An options ‘overhang’, namely the market share price often will factor in some degree of NTA/share dilution risk, leading to all things equal a drop in a premium / discount to (the publish non fully diluted) NTA.

4) Should some share holders exercise options then sell some / all delivered shares on market, the risk of more sellers than buyers than otherwise the case (greater adverse premium / discount to NTA risk).

5) The strong likelihood that the share holder register will go through an unsettled period, with more marginal sellers than buyers than would otherwise be the case (adverse share price to NTA dynamic).

6) Have a lasting adverse impact on the investment vehicles performance metrics over time assuming NTA dilution risks transpired. This is examined further below.

Trading Strategies around Bonus Options
1) If not a pre-existing investor (or wish to top up) and comfortable with the manager and outlook, buy in prior to the Options Record Date – it is a free option, and that has implicit value.

2) Exercise in-the-money options. You will be less diluted than otherwise.

3) To be entitled to an upcoming dividend in relation to option entitlements, a share holder must exercise prior to the dividend record date.

4) Remember that overall dilution risk is a function of when most investors exercise. And most options get exercised in the last three months prior to the expiry date. Other material exercise periods after a period of particularly strong performance or approaching an attractive fully franked dividend entitlement date.

5) All things equal, do not sell during the above periods. Real world examples, noting that RRM has only examined a limited number of examples, shows a distinct correlation between large exercise months and a deterioration in the premium / discount to NTA.

6) Game investor crowd behaviours – buy shares on market during peak exercise months as real world examples show an improvement in premium / discount to NTA in following months.

Bonus Options: RRM’s View
RRM was previously not overly predisposed to the bonus options structure but after speaking to Perpetual and hearing the feedback it has received from share holders (favourably predisposed to bonus options) our views have changed. At the end of the day, there are pro’s and con’s to both the bonus options and the entitlement structures, but in RRM’s view neither is necessarily better than the other.

Upon reflection, our prior negative view was probably that of a more focused analytical view, rather than seeing the benefits for at least some share holders. RRM did not like the adverse impact NTA dilution has on performance and how this led to superficial criticism of the sector as a whole. RRM also did not like that a 1.5 years after the options had expired no one remembers that there was ever NTA dilution, opening up a manager to criticism of poor relative performance.

From an analytical perspective, in an ideal world a manager would also be permitted to published undiluted performance numbers to provide an accurate indicator of manager skill.