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Price – 350p        Market Cap – £227m/ $363m

NAV reported at 31st October – $9.09/ £5.73

Price/ NAV – 61%

I am a Bear; it’s actually quite a disheartening activity, I’d rather be something else. Every sporadic spurt higher in the market singles you out for slightly mocking, slightly pitying platitudes from colleagues and clients. Let history be my judge.

I have a hearty cash balance of north of 20%, some substantial short positions and macro hedges but yet still I feel loathe to take risks or to make positions too large. Because of this I currently find myself attracted to special situations, spin offs and to investments which offer a much greater margin of safety than would appear on first glance (see my write up on Gravity – http://kelpie-capital.com/2011/11/09/gravity-an-irresistible-force/ ).

This is how I arrived at this prima facie very unappealing idea! Private Equity? Maybe a decade ago! But, when you look under the bonnet I think JZ Capital Partners offers the opportunity for us to buy the proverbial $1.00 for maybe as little as $0.40. JZCP is now a 3% position in my portfolio.

Description

JZCP is a closed ended investment company advised by JZ Capital Partners, a small & microcap private equity fund invested in a broad range of industries across the US and more recently Europe. Its investment strategy includes buyouts, mezzanine loans, second lien loans alongside equity stakes in smaller businesses that are stock market listed. Up to 20% of the fund can be invested in European Situations.

The Managers

JZ Advisers was founded in 1986 by Jay Jordan and David Zalaznick, they were later joined by Chief Investment Officer Gordon Nelson who has been with them for 20 years. In lieu of a character reference, Mr. Zalaznick is a vice chairman of Cornell University’s board of trustees.

The managers use their extensive and mature rolodexes along with their track record to source their deal flow. They also co-invest with other private equity firms on occasion.

In their 30 year track record in the micro cap space JZ Advisers has had over 70 realisations or exits with an IRR of 40%.

JZCP focus their investments in 5 narrow “verticals”: industrial service solutions, sensor solutions, speciality foods, water treatment and finally testing services. The aim is to target high margin, low capital and technology intensity businesses that are scalable.

The managers said in the recent report sounding suitably value oriented.

“Our basic premise is that we can continue to achieve superior returns by maintaining our investment discipline, and investing your (and our) money in a diversified portfolio of good quality niche businesses at reasonable prices.”

Unlike most Private Equity businesses too they do not pour leverage upon leverage, they may take on moderate debt within the operating businesses to enhance returns but at a portfolio level there is none except some outstanding zero div preference shares.

 

The Portfolio

Listed Equity –

Safety Insurance Group, the largest position in the fund at around 9%, is a $650m property and casualty insurance company specifically focused on the Massachusetts market. JZCP owns around $50m of stock in the company. Insiders own another 10% of Safety stock.

TAL International Group is one of the world’s largest lessors of shipping containers

With 810,000 containers leased out of 216 depots across 39 countries. It is a top 5 holding representing around 6% of assets as of August 31st.  TAL has a market cap of just over $1bn. JZCP now own circa 3% of the equity after selling 22% of their TAL stake in April 2011 realising a gain of $7.7m on their investment. This demonstrates some good portfolio management realising gains at prices almost 30% higher than the current market price. Lord Abbett LLC owns 7% of the equity and the CEO has $11m invested.

 

Micro Cap/Private Companies –

Wound Care Solutions provides management services for the operation of wound healing centres. These are specifically designed outpatient departments in hospitals for the treatment of patients wounds. JZCP committed $38m of funds to Wound Care Solutions and this is currently valued at $41.1m. As of the most recent report this holding is around 8% of the portfolio.

Accutest Laboratories provide full service independent testing labs delivering legally defensive data and analysis on water, soil or air for use by industry, consultants or government clients. JZCP originally invested $48.2m and this is now valued at $42.1m sitting at around 8% of the portfolio. I take comfort from the fact that the valuation has marked the company down – this avoids any accusation of “upwards only reviews”.

Continental Cement Company mines, manufactures and processes limestone and clay into cement. This 5% investment is part of the Mezzanine Portfolio, the bulk of which has been repaid. The company report as of 17thOctober said the company was performing well and continuing to pay interest as per the terms of the loan.

Factor Energia is the largest of JZCP’s European investments, it is an energy/utility distribution and reselling business in Spain focusing on the SME sector.  At $27.7m the investment is around 5% of the JZCP portfolio.

As you can see from these 6 investments constituting 41% of the portfolio JZCP runs a concentrated portfolio. The top 10 investments are cumulatively 63% of assets.

Broadly in the portfolio operating performance seems resilient, all but 4 of the 15 businesses posted positive EBITDA growth YoY. The portfolio as a whole has posted 12 consecutive quarters of NAV growth increasing to $9.09 (£5.73) per share as at 31st August.

From the shareholder report on the portfolio

“All of these investments employ low leverage, currently at 1.3x EBITDA of debt senior to JZCP’s position. The average multiple used in valuing these entities (for NAV) continues to be low at 6.9x”

The managers believe (although I suppose they would) that their calculation of NAV is conservative.

 

Recent Exit

October 25th the WSJ reported that JZCP has exited its holding in Dantom Systems Inc for $40.5m to a larger buyout firm. This was previously the 4th biggest holding in the fund as of the 31st August report and it appears as if it was a complete exit. I imagine these proceeds are currently sitting in cash or short term Gilts/Treasuries.

http://online.wsj.com/article/BT-CO-20111025-713020.html

 

The Margin of Safety

As at 31st August the Total Assets in the Portfolio were $684m (£427m) compared to the market cap of £227m. The balance sheet for JZCP is very clean excluding the $85m of Zero Div Preference shares in issue costing around $6m a year in interest.

$155m (£97m) of the $680m is invested in Treasury Securities, UK Gilts or Cash. Compare £97m of cash or risk free securities to a market cap of £227m and you get 42% of the market cap. If the proceeds from the Dantom Systems sale are actually sitting in cash then you could likely be looking at £122m of cash or risk free assets against £227 or 53% of the market cap. But let’s just ignore that for the sake of being conservative. Now we remind ourselves that we are paying only 61 cents for every $1 of total NAV due to the discount.

I think we should net off the cash and near cash instruments to see what kind of discount we are getting on the actual portfolio. So take $155m off the portfolio of JZCP leaves us with “invested assets” of $525m across the listed and unlisted equity and debt. If we take $155m off

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