The WAM bid for CIE – a new model of listed investment corporate action?

Last week I wrote about the importance of net tangible asset backing (NTA) in listed investment companies (LICs), including a comment on some corporate activity around Contango Income Generator (ASX: CIE).

CIE is a LIC trading at a discount to NTA and with a poor performance record over the past few years, this is a double blow for investors.

CIE had proposed a change of management for the LIC to try and improve the situation, and on Monday evening, things became even more interesting.

Wilson Capital (ASX: WAM), a strongly performing LIC that trades at a premium to the value of the underlying portfolio and that owns 14 per cent of CIE, lodged an off-market takeover bid.

Part of my story last week considered what happens for investors when an LIC trades at a discount to the value of the portfolio for an extended period of time, particularly on the back of poor performance – how do investors recover their value?

This bid by WAM provides a model for corporate activity that might help investors in underperforming LICs unlock value.

The CIE/WAM takeover offer

The background to Contango Income Generator is that it has been trading at about a 15 per cent discount to the value of their assets. This comes on the back of poor performance by the fund, returning -4.44 per cent per annum to the three years to the end of June 2020 compared to the return of the index of 5.45 per cent per annum over the same period.

To try and remedy these two problems – poor performance and poor market sentiment that sees CIE trade at a discount to the value of the portfolio – CIE had suggested, and had shareholders vote to approve a change in management to the WQM Quality Global Growth Long Short strategy.

In the context of this situation, it is important to understand that WAM had expressed an interest in taking over the management of CIE, however, this had not been put to shareholders in their vote.

This is where Geoff Wilson and WAM stepped in – having not been put forward to CIE shareholders as a possible alternate manager for the CIE listed investment company, WAM lodged a conditional off-market takeover bid for CIE shares, conditional on a number of items including getting to a position of holding 50.1 per cent of the value of CIE shares.

The takeover offer is 1 WAM share (trading at the time of the offer at $2.22) for 3 CIE shares (trading at the time of the offer at 63.5 cents per share).

At a price of $2.22 per WAM share, the offer implies a value of 74 cents per share for the CIE shares – an attractive premium to their pre-takeover trading price and a price very close to the value of the assets of CIE (i.e the CIE NTA).

In the morning trading following the offer, WAM shares were up almost 1 per cent – a little more than the overall market. CIE shares were up 10 per cent, suggesting that market participants see that there is a strong possibility of WAM being successful with the takeover.

What do CIE investors do?

There is no rush to make a decision. Both WAM and CIE will be putting forward information for investors.

That said, some inpatient and frustrated investors who have endured three years of poor performance, topped off by seeing CIE trade at a discount to the value of the assets, might decide that a 10 per cent jump in share price is enough to sell the shares on market and move on to other pastures.

For those CIE investors who think WAM are potentially a good match as an LIC manager, then they can wait until further information arrives. For those CIE investors happy with the new investment manager, they can do nothing and hope that WAM doesn’t get to the 50.1 per cent level needed to make the deal happen.

Why WAM seems to be so far ahead in this situation

There is a strong argument here that WAM have put themselves in a strong corporate position, and one that potentially has positive impacts for a lot of stakeholders.

Firstly, they have bought up about 14 per cent of the shares in CIE which gives them more ‘corporate clout’ when it comes to voting and getting to the 50.1 per cent level for the deal. More than this is that (assuming they bought the shares recently) they will have picked the CIE shares up at a significant discount to the value of their assets.

If the deal goes ahead, and the CIE shares are moved into WAM shares trading at a premium to the value of the assets, they will have created significant wealth for the existing Wilson Asset Management funds that own CIE shares.

Secondly, Wilson Asset Management have built a strong record of managing LICs that trade at a premium to the value of their assets, and that pay attractive income streams.WAM, for example, is paying 15.5 cents per share of fully franked annual dividends.

There must be an argument that for CIE investors, who had invested looking for reliable Australian share income, that WAM is a much better fit as an investment manager than a global long-short fund.

Indeed, CIE’s proposed change of strategy from being an ‘income-focused listed investment company… selecting companies that, in aggregate, have a history of paying consistent dividends’ (CIE’s June 2020 investment update) to a global long-short fund is a fairly radical change in investment philosophy.

Lastly, WAM’s shares are trading at a premium to the value of their assets, so it is a clever use of this premium to use WAM shares as consideration for CIE investors.

The 74 cents per share offer is a strong premium to where CIE shares had been trading, but still only around the NTA of CIE, meaning that the implied price is roughly equal to the value of CIE assets – a sound offer from WAM’s perspective.

The bigger picture

This corporate activity provides a possible model of an exit strategy for LIC investors in poorly performing funds that have traded at a discount to NTAs.

In the article last week, NSC was mentioned as another fund that trades at a 15 per cent plus discount to the value of the portfolio, on the back of a number of years of investment underperformance.

As well as the CIE example we have looked at, Wilson Asset Management is involved in similar corporate action with the Concentrated Leaders Fund (CLF) (whose independent board committee have recommended against the Wilson bid).

My suspicion is that LIC managers with a history of poor performance, and with LICs trading at a discount to the value of their portfolio, will be watching this corporate action, and particularly the level of support of investors, play out with some nerves.

Indeed, as a well known Queensland politician used to say, they will be as nervous as a long-tailed cat in a room full of rocking chairs.

Conclusion

The listed investment company sector of the Australian sharemarket has a long history of providing strong investment opportunities.

One of the risks of investing in LICs has been investors getting caught in poorly performing funds that trade at a discount to the value of the portfolio – the only exit strategy is to sell on market at a ‘double loss’, the loss caused by poor performance and the loss caused by trading at a discount.

WAM have provided an interesting exit option for CIE investors and it will be interesting to see how the situation evolves, both for WAM and CIE shareholders, and also for shareholders caught in other poorly performing LICs trading at a discount to the value of their assets – is this a new way out?

N.B. Scott Francis owns shares in Wilson Capital (ASX: WAM).