Value Investing

Dundee Capital Corporation: Letter to Management (SCP.TO)

As a general rule….people ask for advice only in order not to follow it; or, if they do follow it, in order to have someone to blame for giving it. –Alexandre Dumas

Sprott Resources Corp. (SCP.TO or SCPZF)

In the recent first quarter report, SCP reported $2.06 Net Asset Value (NAV) as compared to a recent $0.99 cents (Cdn) market price or a 52% discount. The details can be found here:

As a recent investor attracted to the large discount, I find this investment ugly but cheap–like me! But I can’t own much, because I have no way to determine the intrinsic value of ALL the underlying investments held by Sprott. An investment that I own similar to Sprott is Dundee Capital Corporation. This letter/blog post will provide the suggestions of how to communicate to outside investors as partners and the lessons of great capital allocators. I see four ways to close the discount between market price and NAV:

  1. Kill management at the holding company level.
  2. Buyback shares in the open market or make a tender offer
  3. Sell a fully-valued or poorly/unfixable investment and use the proceeds in another investment or buy-back shares.
  4. Communicate to shareholders so they can close the gap between NAV and market price.

Point 1 is both illegal and immoral and thus a non-starter, but my black humor seeks to point out that the market may be wary of the prior or current management’s capital allocation skills. The market places a negative value on management at the holding company level or anticipates further declines in NAV.

Point 2: With only $2 million in cash or less than 1% of the NAV and with $1.7 million in commitments, $300,000 allows for less than 0.5% to be purchased. meaningless. Yes, debt could be taken on to buy-back shares, but where would be the margin of safety if a prolonged depression occurred? With global debt levels at 100,000 year highs, dislocation is not a low probability event.

Point 3: This is a capital allocation decision that can only be made by management.

Point 4: Communicate with your shareholders as partners who are investing every nickel into Sprott. If YOU were in their shoes what EXACTLY would you need to know? If you were reporting to your Aunt Millie once a year about her investment in SCP.TO, what would you tell her?

Rather than give you my suggestions why not learn from the best in the world at capital allocation?

“The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success” tells the stories of eight successful chief executives. You will meet eight indivualistic, iconoclastic CEOs whose firms’ average returns outperformed the S&P 500 by a factor of twenty (no typo). Buy the book!  The Outsiders: Eight Unconventional CEOs and their Radically Rational Blueprint for Success

There is a chapter in the book about the greatest capital allocator of all-time as suggested by Warren Buffett: Emultate Henry Singleton Read the case study: Dr. Singleton and Teledyne A Study of an Excellent Capital Allocator

Next, of course, study the wisdom of Warren Buffett: Complete_Buffett_partnership_letters-1957-70_in Sections and The Essays of Warren Buffett Note the clarity and simplicity of how he describes his investments. I broke out two of them for you: See’s_Candies_Case_Study Sanborn_Map_Case_Study_BPLs

Besides reading the above, why not study other great CEOs like:

Finally, here is an example of an investment–simple and direct:

Can you tell your investors in a similar way the reasons for each of Sprott’s investments?

Mr. Yuzpe, this is the voice of experience calling, are you listening?

This irreverent letter is sent with good intentions, and I hope it is taken to heart.

Best,

John Chew