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Mongolia Growth Group

Mongolia Growth Group (TSXV:YAK, OTC:MNGGF)

(All figures in CAD)

YAK came into being in February 2011 as a “holding company owning subsidiaries engaged in the businesses of real estate leasing, and property and casualty insurance” in Mongolia. Harris Kupperman, the company CEO, is also the President of the hedge fund Praetorian Capital Management since 2003.

Kupperman says, “…in August 2010, I went to Mongolia with the goal of finding appropriate investments for my hedge fund. While there, I learned of two unique facts; the Mongolian economy is far more robust than I had ever imagined and there was no suitable way to gain investment exposure to that economy. Unable to find an ideal way to invest in Mongolia, I have instead set out to build my own diversified entity.” – 2011 Annual Report (emphasis added).

In 2011, the company raised $51.5 million and used the capital to go into business, acquiring real estate for $26.4 million and building out its insurance business. The properties the company acquired for investment purposes went up ~28% for the year, and the company ended 2011 with $21 million in working capital, $30.4 million in real estate and total equity worth $53.3 million. That was the high point for the company.

The insurance business was the first to go downhill, and the company ended up exiting the business completely by year end 2013. The fair value of the real estate holdings continued to decline as the Mongolian economy proved far less robust than Kupperman had imagined when he formed YAK at what was in hindsight the peak of the last commodity cycle. Regime change and depreciation of the local currency didn’t help matters any.

A glance at the stock chart tells the rest of the story.

“The worse a situation becomes, the less it takes to turn it around, the bigger the upside.”

– George Soros

2020 was in all likelihood the bottom for this company. YAK marked down the value of its real estate holdings by $2.7 million and announced its intent to exit its “non-core” Mongolian property portfolio, potentially acquire North American assets and wait for the Mongolian economy (and therefore property prices and rental income) to bounce back.

While waiting, the company is making money on securities speculation. Not surprising as the CEO is a hedge fund manager. The company’s securities portfolio generated $7.5 million in profits in 2020 and an additional $6.4 million in profits in Q1 this year. At the end of April, the company had $17.7 million in its securities portfolio. As of Q1 2021, the fair value of the real estate holdings is around $15.25 million. Throw in roughly $2.5 million in cash net of liabilities and the company is worth around $35.45 million. Divided by shares outstanding of 30 million, the NAV per share is $1.18. The current share price of 48.5 cents represents a nearly 60% discount to calculated NAV.

Value investors often get excited over such numbers and rush in expecting the discount to close, but I have learnt over the years to not do that. The market is forward looking. If it looks too good to be true, there is probably a reason that opportunity exists.

So let’s look at a worse case scenario. The company disclosed that it is in default on its obligations relating to a property with a current carrying value of $3.6 million. The company is facing difficulty in collecting rent and lease payments from its tenants following the covid lockdowns last year. Let’s say the company’s Mongolian real estate is only worth 50% of its assessed fair value. And assume trading losses erase 25% of the value of its securities portfolio. The calculated NAV then drops to 78 cents. That’s still a substantial 38% discount to the current share price, but this exercise also indicates why the discount to NAV exists. There are too many unknowable factors which go into valuing a company like this and a few tweaks to the assumptions can completely change the valuation.

But there are other factors that tilt the scale in favour of the investor.

The company has been buying back shares. In 2020, the company re-purchased 1.64 million shares at an average price of 20.7 cents. In Q1 2021, the company re-purchased 1.06 million shares at 42 cents, and subsequently purchased an additional 599,000 shares at 50 cents. The CEO Harris Kupperman purchased 14,500 shares at 36 cents in the open market in January and followed that up with a purchase of 35,000 shares at 46 cents in April. This was his first major addition to his holdings since 2018.

Insider selling can happen for multiple reasons, but insider buying on the open market is almost always a good sign. Clearly, Kupperman also considers these shares to be undervalued at current levels. He has skin in the game, with 21.9% ownership interest in the company. He also demonstrated this with his compensation structure. After waiving cash compensation from 2011-17, in 2018, Kupperman began drawing a base salary of $150,000 per annum. For 2020, he received an additional $12,500 in bonuses. A mere trifle, considering a hedge fund would have charged 20% of the trading profits, or $1.5 million. YAK shareholders benefit from the investment skill of a hedge fund manager, while paying almost nothing in fees. That’s an added value, on top of the discount to NAV.

In my opinion, the company’s buyback program and CEO purchases indicate share prices are going to close the discount to NAV. The market agrees – the stock is already up 70% year-to-date. We’re not catching falling knives here hoping for a bottom.

There’s at least 60% upside from current levels, even assuming my worse case scenario valuation of 78 cents per share. And the stock can always surprise to the upside as investment profits accumulate and the Mongolian economy recovers. Emerging markets tend to attract investor capital during a dollar bear market, and this time should be no different.

2011 marked the top of the last commodity cycle, but the copper price has rallied back to the old highs. Not that Mongolia has become any friendlier to mining, recently upping its threats to international mining firm Rio Tinto, operator of the Oyu Tolgoi copper mine.

So there are certainly risks. But the stock is priced to reward shareholders willing to take that risk.

Note: This article was written for information purposes only and should not be construed as investment advice or recommendation.

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