Update No. 237 – 16/10/15

Some weeks when there seems to be nothing of particular interest to write about in the weekly missive that accompanies your EGP share price update, the market steps in & writes a story for me…

Those of you that go straight to the asset value tables at the bottom of the blog each week will have noticed our share price is at an all-time high today. One of our holdings announced a takeover offer at a rare 130% price premium, causing it to rocket up the holdings list from our 22^nd largest holding to our 11^th largest, resulting in the fund adding over 1% in a week when the market was slightly down. Even a 1% position can make a difference if the change in price is large enough… It feels like it’s been a hard slog over the last 12 months, but we’ve generated over 13% including dividends. Over the same period, the market is up about 6%, neither of these are meaningfully below longer run averages.

I’ve mentioned our holding in Coffey Limited (COF) before in Update No. 176. I postulated in that blog 14 months ago that if business continued to improve as it seemed to be, that a share price of 50c in 12 months or so was conceivable. Naturally, business immediately took a substantial turn for the worse and the share price has recently been around 15c, reminding me that when it comes to speculating price, it is better to keep your mouth shut… The share price was more recently at 18.5c before the offer, making the takeover bid of 42.5cps very compelling indeed.

We were buyers of COF again in the first half of 2015, as Mr. Market again presented clear undervaluation. If you look at the recent business updates, and the record contracted revenue and the like, good times are clearly ahead for COF, but the bid still remains fairly compelling given the many false-start recoveries the business has made already.

We appear to have gotten a little lucky in this situation, rarely will such large premiums be offered, but Tetra Tech will do very well out of the purchase I expect.

I mentioned in Update No. 176 that at the time we had generated an IRR of about 22.7% out of our COF holding. Well if the takeover closes at 42.5c, our IRR will now be just a shade under 30% on the holding, which is not ‘spectacular’, we have certainly had better, but which I would take anytime it is offered to me (30% annually doubles your money every 2 and 2/3 years) for a holding of reasonable size over a reasonable duration.

The COF takeover has caused me to return to a pet soap-box issue of mine, which is the under-utilisation of the Franking Credit rules within the Australian taxation system. Tetra Tech (the acquirer) is a foreign firm, as such they will likely be unable to make use of the Franking Credits COF has accrued, but the exiting Australian shareholders would. COF has about $14m in its Franking account, which amounts to nearly 5.5cps. The takeover offer, if it were suitably structured, could result in a superior result for the existing shareholders, at no detriment to the acquirer. If, rather than a 42.5cps cps cash bid, the takeover price was instead structured as a 30c cash takeover, with a 12.5cps fully franked dividend accompanying, existing shareholders would be receiving 12.6% more economic value for their share via the distribution of the Franking balance. If you know any COF shareholders, you may wish to alert them to this prospect, and have them contact COF investor relations. As the steward of your capital, naturally I already have – Tony Hansen 16/10/2015

P.S. In between writing and publishing this Update, I have been contacted by a representative of COF. The bond-holders have some dividend rights that could complicate the franking issue and Tetra Tech is evidently keen to keep the bid as simple as possible. Probably nothing will come of the Franking Credit matter, but if they simply vanish into the ether, you’ll hear an anguished ‘Nnnnooooooooooo’ coming from my general direction…

EGP Fund No. 1 Pty Ltd. Up by 3.93%, leading the benchmark by 4.37% since July 1^st 2015. Since inception, EGP Fund No. 1 Pty Ltd is Up by 92.97%, leading the benchmark by 57.18% all-time (April 1^st 2011).