PGF launches PTrackERS: A new place to put your capital... letters.

We first upgraded PM Capital Global Opportunities Fund (PGF) to Buy back in early 2016. The thesis was simple: This listed investment company (LIC) used investment manager PM Capital, a firm founded by Paul Moore in 1998, that boasted an impressive track record. The same unlisted funds this LIC bases its holdings on had outperformed its benchmark (the MSCI World Index in Australian dollars) by 5.1% a year after fees over that period. At the time, the LIC was trading at a 16% discount to its liquidation value, or post-tax net tangible assets (NTA).

In short, you could buy this market-beating portfolio for far less than it cost to purchase the underlying stocks.

Since then, the stock has risen from our buy price of 91 cents to 132 cents, and investors have received a further 8.2 cents in dividends, representing an average annual return of more than 18%, not including the benefits of franking credits. Two and a half years from our initial Buy recommendation and with an entitlement offer announced that opened last Tuesday, it's time to revisit the stock to see if there is still value on offer.

Non-renounceable entitlement

But first, the new offer. Management released the 110-page prospectus on 2 July, containing the details of a non-renounceable entitlement offer to existing shareholders. The offer, closing on 10 August, means that existing shareholders will be able to receive one PTrackER security for every one PGF share they hold. The costs of the issue will be borne by PM Capital, not shareholders.

PTrackERS are not the latest pair of runners released by Adidas - although at $1.40 per share they would represent outstanding value. It's an acronym that stands for 'Portfolio Tracking, Exchangeable, Redeemable Security'. It's a distribution-paying derivative issued by a wholly owned subsidiary of PGF, with a 'target yield' capped at 4% per annum. Like ordinary shares, holders of the PTrackERS will still be able to sell their securities on the ASX under the ticker P25PA, but they may not be liquid.

The upside is that PTrackERS will have one obvious benefit over regular shares. Unlike ordinary shares, which may trade at a premium or discount to underlying NTA, the holders of any PTrackERS will have the right to redeem their securities for cash in June 2025. On this date, holders that redeem their PTrackERS will receive the lesser of the post-tax NTA and total capital, less $0.01 per security redeemed. If they prefer not to redeem, the PTrackERS will convert back into shares. That means if you redeem your PTrackERS in June 2025, you eliminate the possibility of receiving a discount to post-tax NTA; but you're preserving the possibility of receiving a premium if PGF shares trade above NTA (by converting to shares, then liquidating). This may make for an interesting arbitrage opportunity down the track.

But there is no free lunch here. Not noted nearly as prominently as it should be in the prospectus is the fact that those who take up the PTrackERS will be subject to a significantly increased management fee, hiked from the existing arrangement of 1% to a meaty 1.5%. The performance fee is removed, but this is little consolation as our preference would have been for a lower management fee and a higher performance fee, which is a better alignment of incentives between the investment manager and investor.

Additionally, PTrackERS holders will lose their voting rights and receive distributions that are likely to be similar, but not identical, to those received by ordinary shareholders - particularly related to franking.

So where does this all leave us? Given the offer's complexity, it's easy to get bogged down in the weeds and focus on the details. We recommend you do exactly the opposite, by ignoring the offer and focusing on the big picture: the underlying value available.

Is any value left?

The most recent NTA update stated that post-tax and pre-tax NTA came in at $1.2935 and $1.3954 respectively, with the latter reduced by the $0.016 in franking credits that PGF curiously includes in its reported figure. The LIC isn't going into liquidation any time soon, nor is it likely to hold on to its securities forever, so a blended NTA is probably a good yardstick. This yields a per-share blended NTA of around $1.34 per share.

The LIC still carries a 1% management fee coupled with a 15% fee on any performance above the MSCI Index. Given PGF's historical performance there is a decent chance performance fees will be incurred, but shareholders should hope that happens. Any performance fees should be more than offset by the incremental performance achieved. For that reason, we ignore performance fees and assume an average annual fee of 1% of pre-tax NTA for our valuation.

Expenses excluding finance charges and management fees for the half year ending 31 December 2017 rose from the prior corresponding period, reaching $533,000 from $467,000. It's reasonable to assume operating expenses for FY18 will come in at just shy of $1m, or about 0.3 cents per share.

The combination of fees and operating expenses knock about 14 cents and 3 cents respectively from our view of the LIC's value. That leaves fair value (and our sale price) at somewhere around $1.17 per share, a discount to pre-tax and post-tax NTA of about 16% and 9% respectively. 

What else has changed?

Unlike when we first upgraded the stock, at the current price we're no longer being compensated for the significant fees and costs by a sizeable discount to NTA. The outperformance of the underlying portfolio has also retreated, falling to just 0.1% above the benchmark over the past 5 years.

Despite the historical market-beating returns, the attractive value investing philosophy and the fact that founder Paul Moore still owns over 8% of the LIC, holding at these levels only makes sense if you're expecting some truly outstanding outperformance. When you consider the high concentration in international banks, this is far from a sure thing, so we aren't comfortable making that bet.

After factoring in a margin of safety, we'd need to see the stock trade at less than $1.10 a share to rekindle our interest, representing an 18% discount to its blended NTA. At the current share price of $1.32, we're getting only a 2% discount; we're also recommending you ignore the entitlement offer. We're downgrading the stock to SELL and will be CEASING COVERAGE for now.