Mongolia Growth Group: Like a Perpetual Call Option [Analysis]

“The power of value investing flies in the face of anything taught in academics. Value is the way stocks are eventually priced. It requires the perspective of patience because the market will eventually gravitate toward value.”

– Joel Greenblatt

Thesis (full document embedded below):

Mongolian Growth Group (“MGG”) is an obscure, underappreciated micro cap franchise with an attractive highly skewed risk/reward equation and substantial downside protection.


Investment Highlights:

An investment in MGG around the current price possesses nearly all the qualities we look for in a great long-term investment.  These include: (1) a low valuation (2) a good, incentivized management team backed by a savvy board, (3) near to medium-term operating momentum and (4) multiple internal and external high-probability catalysts which we expect will drive substantial upside.

Other attractive attributes of MGG include:

  • A simple business model with an unlevered balance sheet and tangible assets
  • A strong competitive position in a rapidly appreciating niche market
  • Improving economics on an attractive and fast growing asset base
  • A high likelihood of experiencing meaningful improvements in profitability and cash flow
  • Leverage to strong expected growth in the Mongolian Economy
  • Relatively low correlation to the general market
  • Opportunity to deploy capital at high ROIC’s for an extended period of time

MGG owns city-center real estate assets in Ulaanbaatar, Mongolia (“UB”).  Due to the development of the country’s mining sector and certain capital market related factors, we expect per capita income in the country to substantially increase over the next 5-10 years.

This growth in the real earnings power of Mongolian citizens will be a function of a multitude of factors, but primarily driven by:

(1) The continued development, and commencement of production at two world-class “mega” mines within the next 1-2 years. Mines expected to garner over $10B in development capital over the next five years, as well as create tens of thousands of new high paying jobs (salary’s that pay ~10x the present average), not to mention generate $5-7B billion in recurring export revenue on a tiny economy whose current run rate GDP is only ~$8.6B. Additional capital devoted to further discovery, defining, developing, and bringing into production, dozens of other mines within the near to medium-term should augment per capita incomes further.

(2) Various capital market developments, such as the creation of liquid, fully functioning mortgage, bond, and stock markets should be an additional positive aiding the growth in average incomes, by helping further facilitate foreign direct investment and in turn to grow the economy. There is also the upcoming IPO of TT, where the equity of one of the world’s largest, low-cost coal mines will be distributed amongst the citizenry -allowing Mongolians to participate directly in the success and growth of the asset or if they choose and/or sell it back to the government for cash.

Basically, as mines turn on and progress on the capital market front continues, we expect a dynamic, (positive) feedback loop to develop and reverberate throughout the Mongolian economy as a whole, triggering the development of all kinds of different businesses that will benefit from a higher level of economic activity. As the Mongolian “snowball” starts to roll down hill, it should give way to a virtuous cycle that drives down interest rates/funding costs, which frees up capital to fund more businesses, which in turn provides government with higher tax revenues to invest in critical infrastructure/related projects, which will drive down manufacturing and transport costs, increasing productivity and so on, all of which will cause GDP to grow rapidly and per capita incomes to grow even faster.

With that in mind and considering the direct correlation between per capita income growth and Mongolian real estate values, we expect MFG’s diversified portfolio of high quality retail, office, and redevelopment property in downtown UB to compound at 30-50% per year going forward undergirded by a combination of rapidly rising rental yields and compressing cap rates. By purchasing the stock today at ~1.25x our estimate of “true” book value, MGG offers investors a direct way to get outsized leverage to Mongolian per capita income growth, a highly attractive theme and durable, multi-year tailwind.

Viewed from a different angle Mongolian real estate, as the largest direct beneficiary of growth in GDP and average incomes, typically appreciates at ~3x the growth rate of the underlying economy. With Mongolian GDP set to more than double over the next 5 years irrespective of either macro or micro factors – so pretty much regardless of the health of global financial markets or political developments at home – an investment in Mongolian real estate offers low-risk growth in a no growth world, basically a stable shelter from any oncoming economic storm. Evidence of this can be gleamed from the fact that even in a contracting economy that lacked the tremendous embedded growth tailwinds of the next 5 years, Mongolian real estate was flat (read held up like a champ) amidst the great recession.

Given that, we view Mongolia Growth Group Ltd. (PINK:MNGGF) conceptually as a LEAP or long-term call option on near certain growth within the Mongolian economy with a high probability of expiring deep in the money irrespective of the macro – a rare vantage point offering investors a chance to dance in the rain in a risk-fraught global economic environment.

Why the Opportunity Exists

We believe there are three key reasons why Mongolia Growth Group Ltd. (PINK:MNGGF) is mispriced.

1.  Macro Concerns Regarding Economic Sensitivity

Given various recent data points from the first couple of quarters this year, fear surrounding Mongolia’s vulnerability to commodity prices and a Chinese hard landing seem overblown, especially given the imminent ramp of Oyi Tolgoi, the primary driver of Mongolia’s near to medium-term economic growth. To be clear, OT is a game changer, 100% financed and given its abundant level of gold byproduct, actually has negative cash costs on its copper production.

Notably, OT, as well as most of the other larger tier 1 projects set to come online within the near to medium-term, are all low cost producers with dominant competitive positions driven by a structural cost advantage relative to traditional sources of Chinese supply. This reality should all but ensure that they continue to take a larger and larger share of Chinese demand over time. Given its coming off such a low base, we don’t think its a stretch to say that the Mongolia’s prospects and embedded economic growth will be by and large relatively immune to 1) the state of global capital markets 2) near to medium-term cyclical swings in commodity pricing and/or 3) a Chinese hard landing. These are important points.

Understated Book Value

With a stated BV of ~$1.63/share the company doesn’t appear statistically cheap upon first glance, certainly not cheap enough to look particularly interesting in the world we live in and/or without digging a bit deeper. Yet for various reasons we believe that true economic BV by YE ’12 is easily north of ~3/share and set to appreciate rapidly. In other words, what appears to be trading at something closer to 2x BV is in reality trading at a depressed multiple approximating 1.25x.

A small premium to BV (all things considered) is simply way too cheap in our opinion, making MGG one of the more remarkably mis-priced investments we’ve come

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