A LinQ to an excellent return?

We're fixated with certainty. This obsession drives us to dig deeply into the mysteries of the universe. Sometimes though, regardless of how deep we dig, there are no concrete answers. Some things are inherently uncertain. This frustrates most of us, your author included.

It's a dangerous tendency when it comes to investing. Successful investing is, at its heart, the search for mispricing, and our love of certainty means uncertain situations are often fertile ground for value investors.

Warren Buffett puts it like this, 'you pay a very high price for a cheery consensus. Uncertainty actually is the friend of the [investor]'. In investing when the outcome is known the price is never cheap. Or, so I thought.

LinQ to delist

Yesterday I read with interest that LinQ Resources Fund (LRF), a small listed investment company, plans to delist (see here) (a big thanks to one of our members who sent us the lead). LinQ plans to facilitate investors exiting the fund at net tangible asset backing (less costs).

I thought there might be a chance that this new and valuable information might not have been fully appreciated by the market.

A quick check of LinQ's NTA revealed that even after the share price soared over 50% following the announcement LinQ was still trading at a 24% discount to its last reported NTA. This warranted digging deeper. It was either a bargain, or I was missing something. After spending a few hours researching the stock I'm more confident it's the former. Here's why.

LinQ owns a portfolio of listed Australian resources companies (see Table 1), which once adjusted to reflect current market prices is worth around $61m. In addition it owns stakes in five unlisted resources companies worth around $24m; principally Ferrous Resources, a Brazilian iron ore miner. Add to this around $6m of cash and $7m of other assets (Zambezi Resources convertible notes, listed options) and you arrive at an estimated value of $97m, or 84 cents per share. A 23% premium over yesterday's closing price.

This is 7% less than LinQ's reported July 2012 NTA. The gap either represents the movement in underlying stock prices, or a reassessment of the unlisted investments since the June 2011. We won't know until LinQ reports later this month.

However, a discount of at least 19% appears attractive. But not so fast, what are the risks?

Initially I thought there might have been an issue with liquidity—if LinQ had to sell a large portion of its assets swiftly realising prices close to NTA might prove difficult. But this is unlikely. The responsible entity, LinQ Group, owns around 60% of the fund. Another strategic shareholder, IMC, owns a further 30%. This only leaves around 10% of the outstanding stock, or ~$11m worth, that might need funding via redemptions. A quick scan of the portfolio reveals this shouldn't be a stretch.

Another risk is the underlying assets themselves. As many Doddvillagers will be aware, resource asset valuations have been falling significantly over the past year, especially in the iron ore space. Further falls are possible. A serious deterioration in the value of LinQ's assets is a risk, but the current discount affords a certain level of comfort.

There's also a risk that once the initial redemption process is completed (which today's buyer wont be entitled to) the facility could be axed and investors could be stuck in an unlisted vehicle with limited options for redemption. This, though, seems quite unlikely considering that the company has committed to an 'ongoing redemption facility' and remains an operating business with a reputation to protect.

An opportunity for the right investor

Unknowns, though, remain. The exact NTA is unclear, and the company is yet to release detailed information about how the redemption process will work or how long it will take. But if the case was clear the stock wouldn't be trading at a large discount to NTA.

This type of investment won't appeal to every investor, but for those who are willing to bear the risks, conduct their own research and become comfortable with the assets, there's a reasonable chance of 20% upside in a relatively short period of time.

Whilst we won't be providing an official recommendation, LinQ looks like an interesting investment;  a classic case of uncertainty granting opportunity.

LinQ plans to release more information in the coming weeks and, if I'm right, once it does the opportunity will close.

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