Henry Morgan Pirates still uninvestable after another 100% gain
A few months ago, I had cause to look at the Pirates again. This time they were launching a new LIC on the Australian Stock Exchange (ASX), Benjamin Hornigold Ltd (BHD.ASX), I had turned my nose up at Henry Morgan Ltd (HML.ASX) that listed in early 2016, then watched the share price rocket from $1 per share plus a free option to $1.64 with the options now trading at 54c and the payment of a 20c dividend. It subsequently hit a closing high of $2.09 plus $1.10 option price (albeit on low volumes).
Those unfamiliar with the Pirates should read Part 1, but in short, a group of companies have been launched over the last couple of years, each named after a Pirate, promising outsized returns with a “99%pa” track record. Indeed, HML had increased its Net Tangible Assets (NTA) by over 100% since listing a year prior, so I was curious as to whether we had missed an opportunity for our clients.
I am naturally suspicious of Investment managers who claim to have produced such a high return and I am particularly suspicious of an Investment manager who claims this without any formal background or experience in managing money. I am also suspicious of a fund named after a pirate. It’s an Investment manager’s job to convince me to use them as I don’t suffer apprehension from money burning a hole in my pocket. I review Investment managers every day, there are hundreds of them. It is my job to understand the relative risks versus returns and investment bias of each manager and form a view on how good they are and whether they can contribute to the goals which we have devised for a client portfolio.
Following are the reasons I opted to avoid the Pirates;
What’s in a name?
“Pirates are very mobile and very flexible in decision-making,” Stuart McAuliffe, Managing Director is quoted as saying, “And the whole focus is on profit.”
Yet the term ‘pirate’ is someone that commits piracy, an act of robbery or criminal violence by ship or boat-borne attackers, and raises as many questions in the choice of name as the source of the investment returns.
To be fair, they had lost me on the name alone. Would you invest in a company if it were named after famous Ponzi Schemes, Charles Ponzi, Bernie Madoff or Yilishen Tianxi? We wouldn’t think so. Visions of an investment gone bad and having to sit in front of the Australian Securities and Investment Commission (ASIC) to explain why I had recommended something named after a pirate shivers me timbers.
A quick glance at HML’s NTA and you could see that they had done incredibly well with their NTA (31/01/17) at $2.12. The difficulty in looking at the returns was that unlike most other investment companies, HML does not disclose its top 10 investments but it does disclose investments that it had a substantial holding in. These consisted of a $3 Million investment in Simonds Group (SIO.ASX) at an average price of 42c per share, $1.65 Million investment into Hunter Hall (HHL.ASX) at an average price of $2.56 per share (post 31st Dec), $6.25 Million investment into the unlisted JB Broking Ltd (a related entity later renamed JB Financial Group), and a further $1.2 Million into Bartholomew Roberts Ltd (another related entity). As of 31st December, SIO was down around 10% and had not contributed to returns so could be discounted. The remaining assets remained undisclosed but you would expect their previous LIC, listed on the National Stock Exchange of Australia (NSX), John Bridgeman Ltd to give some clues as to the performance;
Interestingly, John Bridgeman in the half year to Dec 15 made a trading loss (page 2 of accounts)
An overall loss of 3c per share.
The Full year accounts show a loss of $930,922 with an investment loss of $194,397 and an NTA of 56.7c per share, yet they raised $10 Million at $1 per share? It doesn’t make sense.
A deeper look shows that prior to listing, the company had approximately 7 Million shares issued with no value, hence the reduction in NTA. Conclusion – The spectacular returns of the unlisted fund Aliom Managed Futures Fund no.1 (AMFF) seemed to have vanished in JBL in the year 15-16 and had made a loss for this period.
What I found alarming was the number of related party investments and loans. It is a mess and many of the market disclosures make little or no sense, often referring to investing in liquidity events. Liquidity events are generally fire sales where unlisted/illiquid assets are being sold at a discount and typically where you anticipate an opportunity to exit within a short period of time (I would expect a matter of weeks). However, JBL is 90% owned by Stuart McAuliffe and associates, so my view is it’s up to them what they do with their money, but it just doesn’t seem to make sense;
- They have ditched the successful 99%pa trading strategy that now seems to be making a loss
- They set up a series of new companies
- Then sell their companies to HML and other related entities at seemingly inflated prices
- Some of the investments were in broking, some were in restaurants, some were in Risk and Security and investigation, this scattergun approach to investing is not what I would expect from a successful manager
I struggled to find any of their unlisted investments which were making any money
Of note, JB Broking Ltd (25% owned by Bartholomew Roberts, which in itself is a subsidiary of John Bridgeman Investments), bought Aliom Pty Ltd for $150,000 for its shares plus around $50,000 adjustment for cash on hand. A coincidence that the $150k is in line with what I had estimated in Part 1 as the amount invested in Aliom Managed Futures Fund no 1.
You can spend forever digging into these and if you want a headstart, a good place to begin is the 10footinvestor blog which picked up on the inconsistencies in May this year.
At this point I have already established that these series of companies was un-investable, the rest of my analysis was out of curiosity.
A look at Henry Morgan
The first thing to look at is the NTA and the progression over time (I’ve updated the chart to show the disclosures post Feb 17 and estimated the growth in NTA had the disclosures continued on the same (undiluted for options) basis as pre Feb 17).
It certainly looks impressive, but there were a couple of inconsistencies in the disclosures.
Firstly, 2015-16 accounts showed a profit of $2.5 Million on roughly $15.6 Million of assets (16% gain), yet the disclosed NTA shows a gain of somewhere between 4% and 8.7% (its difficult to say since the 20th July ASX disclosure states 8.7% but looks to have a typo stating as of the 14th March, so the date is unknown). This may be due to a larger profit at the end of the month/financial year then a subsequent loss to the date of announcement.
Looking at the half year accounts a further inconsistency appears. The disclosed NTA to market states $2.08 yet the half year audited accounts state an NTA of $1.15 (with an explanatory note that the NTA disclosed to market is an indicative NTA based on their estimated assessment of the value of the Company’s investments). Accounting standards permit them to apply artistic licence to the valuations. It seems odd considering that they stated that they invested in managed futures, so I looked back at the disclosures and can see that the Company had adjusted their mandate in October 16 to allow them to invest in unlisted assets.
The disclosures in December and January show that this is JB Broking Ltd and Bartholomew Roberts Ltd for $6.25 Million and $1.2 Million respectively, both look to be related parties. I view this as a huge conflict. Conclusion – The conflicts alone make this un-investable. I see the Jolly Roger rising.
A successful 99%pa strategy walks the plank?!
Very odd, so in short, the manager had previously run an unlisted strategy that produced 99%pa, and had up until October produced approximately 50% (NTA) return for investors in HML, yet now felt that they could improve on the 99%pa return for investors by purchasing an unlisted related party entity.
What became clear is that the increase in the NTA was as a result of management significantly re-valuing the unlisted assets (while the listed assets presumably gave up most of the pre October gains). Since JBL.NSX disclosures show that JB Broking Ltd (renamed JB Markets Ltd) was a new company that bought Aliom Pty Ltd for approximately $200k (I expect from Stuart McAuliffe since he was the founder), it seems odd that 12.8% was purchased for $6.25 Million a year later and 36% of Bartholomew Roberts Ltd was purchased for $1.2 Million only 6 months after it was formed from JBL.NSX (another related party entity).
This looked like an exercise in purchasing unlisted assets from related parties and revaluing them at much higher multiples? Conclusion – Un-investable. There may be some explanation for this, but the vast number of related party transactions are conflicted at best and may be a breach of ASX rules.
Anomalies within annual accounts and ASX rules
Related party transactions – ASX listing rules 10.1 require shareholder approval to purchase shares from a related entity. This is to protect investors from company directors using shareholder funds to purchase their own assets at inflated prices. There doesn’t look to be any resolutions passed for this purpose. Addendum 12th December 2017 – Exceptions under ASX rule 10.3 allow investments into a related party without approval where this is not a Substantial Asset or where there is an issue of securities for cash. HML stated at the AGM that all investments in the unlisted related entities were capital raises (and would explain why rule 10.1 does not apply)
No disclosure of investments held as of 30th June 16 – HML’s annual report did not contain a disclosure about the investments held.
Having invested in numerous LICs, I have a strong relationship with a number of managers and I am very aware that investment managers would prefer not to disclose their individual holdings. However, ASX listing rules (4.10.20) require an investment company to disclose all listed securities held, this includes futures contracts and options.
Addendums to the Accounts confirmed that all investments held at this time were listed securities and what the portfolio consisted of the following, yet the individual holdings are not disclosed:
Currency – I note that there were no foreign currency gains/losses within their annual accounts which seem unusual since they were trading global futures and would likely have to hold margin in a foreign currency. This in itself may just be an accounting anomaly but nevertheless seems odd.
Strange dividend strategy
HML had declared a 20c dividend that was in excess of the previous year’s profits. Distributing $3.5 Mill ($6 Mill after options were exercised), when they had just raised an additional $2 Million in capital in October 16 is at odds with common sense.
Discussions with managers
One of the benefits with having relationships with fund managers is I can call them up when things like this look odd, there’s often an explanation. So I made the calls, “What am I missing”. “Nothing” “It doesn’t add up” was the common response, many having been aware of HML by their own shareholders asking questions at AGMs.
Conclusion – Abandon Ship. There are just too many inconsistencies, and in any normal circumstances, I would question the manager on any one of these points to clarify my understanding, but with so many, it’s a pointless exercise.
I subsequently did a little more digging around and came to the same conclusion. At best this looks to be poor corporate governance.
HML has been suspended for the last 4 months with the ASIC and the ASX applying the Cat o’nine tails to the Pirates leading to a series of corrective disclosures. This document referred to yet another seemingly related party transaction with Genesis Proprietary Trading that subsequently completed in September!
Overall, despite the 240% rise in the Henry Morgan IPO, this Company had enough warning signs to avoid, even if it is just poor corporate governance. The risk does not justify the reward.
Oddly, BHD.ASX and JBL.NSX continue to trade. We’ll continue to keep an eye on these Pirates…..
We later provided an update to investors in Part 3 of this analysis