Two Deep Value Special Situations Down Under; Seasoned Liquidations
I’ve recently come across two deep value situations in Australia. Both I own. The first one:
Deep Value Situation #1 - Pacific Current Group (PAC.AX)
I first became aware of Pacific in July 2023 when major shareholders Regal Partners and River Capital offered to buy them at $11.12/share. Pacific owned 16 stakes in numerous tier 1 and tier 2 boutique asset managers, one of them being at the time GQG. This was then followed by GQG Inc. (who Pacific had an investment in and is itself publicly traded) indicating they would submit a bid as well. PAC then ran a strategic process and received multiple offers. Regal withdrew their offer in September 2023 and GQG Inc. submitted a bid for $11/share all cash in November 2023 without having obtained River Capital’s support. River Capital then got back in with a bid, but this time for $10.5/share in cash. Long story short, Pacific’s strategic committee disbanded in November 2023 as it wasn’t able to get any binding offers.
What’s happened since then? Essentially a public liquidation, selling down to 11 boutiques as of August 2024.
The company has announced even more sales since August. All of these sales have changed the NAV percentage of the business dramatically:
Cash went from 2% of NAV last year to 43% as of June 2024 and this is still a growing amount. The company is now proposing to repurchase 25m shares in an off-market share buy-back, which equates to 47.9% of the shares outstanding. The shareholder vote is to take place January 30, 2025 with the 3 major shareholders representing 49% voting for it. However, they have not decided if they will tender their shares into it which creates a bit of a risk of the full buyback being used.
In order to determine potential returns, I’ve tried estimating the adjusted NAV as of this write up along with a scenario where all the shares are and aren’t bought back. There are a ton of moving pieces in the underlying NAV since last reported on June 30, 2024. Not only the recent sales but also some of the sale proceeds are to be collected over a period of a year or two. On top of that, the majority of the funds under management are reported in USD but the stock trades in AUD which must be accounted for.
Based on the assumptions above, I am getting to $14.38/share of adjusted NAV since the June 2024 NAV of $13.47/share. Below are the IRR estimates assuming a 2 month hold:
If the company is able to fulfill the full repurchase authorization, there is barely any downside with some upside depending where it trades after repurchase. The IRR on this, assuming a 2 month hold, could be a respectable 62% if it trades at a 20% discount after.
What happens if the tender is only able to be filled for half the amount allocated? Assuming only 12.5m shares can be repurchased, there is still a small IRR to be made if it trades at a 20% discount to adjusted NAV.
I’ll note that the stock is trading just below $12 so the IRRs on these numbers could be a bit greater than what I have from using the $12 beginning price. I didn’t account for any fair value uplift in potential sales as well that could provide a bit more return to the stock/NAV. Also, if the company isn’t able to get the full allocation, I imagine they could possibly do a special dividend or just sell it all/wind it down completely. The CEO is still listed as “Acting CEO” which makes you wonder what the end game is here.
The real risk that could reduce the IRR is any delay in shareholder vote and rulings from the Australian Tax Office as these have caused a delay since May. But with the vote at the end of the month I would think this happens in March when scheduled.
I am long and see this as an extremely low downside bet with some upside and the chance of earning a high IRR. The opportunity is available because it’s a small company with 3 shareholders making up almost 50% of the shares which creates limited liquidity for larger funds to enter into.
Deep Value Situation #2 - Merchant House International Limited (MHI.AX)
Merchant is a textile manufacturer that makes boots, shoes and other home products. It is based in Hong Kong and listed on the ASX but domiciled in Bermuda. It has the “ick” factor in an investment that people turn their noses up at but I think this cigar butt has one last puff. They decided in August 2024 to liquidate the company, distribute the proceeds to shareholders and delist from the ASX once they sell their last remaining property. The liquidation announcement sent the stock from $0.04 to $0.15. As you can see, the business is of extremely low quality with declining sales and net tangible assets in the prior 5 years.
Merchant has 94.2m shares outstanding and currently trades at $0.15 for a market cap of $14.13m. The average volume for the shares is 100,000 shares or $15,000 a day.
The business consisted of 3 real main businesses with a couple other small/dormant subsidiaries:
Footwear Industries of Tennessee Inc. (FIT) which was sold in 2023 for gross proceeds of $3.28m USD and net proceeds of $2.63m for its fixed assets net of liabilities. The land and buildings in this sale had a book value $US 788K and sold for profit in the sale of $1.965m USD, amongst some other small assets. The main thing to note is the property sold above book value here.
Forsan Limited (Forsan) was a 33.79% ownership in a JV with Mr. Wu Shu Xin for Tianjin Tianxing Kesheng Leather Products Company Limited based in China. This was sold on May 30, 2024 for $8.3m AUD before taxes, costs and other payments. The company completed the sale on January 9 2025 for $4.9m USD.
American Merchant Inc. Most of the value of the overall company is in this subsidiary as it holds a large piece of textile PP&E located in Bristol,VA. It was recently shut down as of September 30, 2024 and to be put up for sale. According to their website they have invested more than $24m in state-of-the-art equipment in the plant. This article also gives some background of the facility, equipment owned and its sale. Below is a picture of the plant:
And a location of the factory from google earth:
4. Various subsidiaries - Pacific Bridges Enterprises Inc and Loretta Lee Limited. I am assuming Pacific Bridges is not worth anything. Loretta Lee Limited currently has a contingent liability of US$994,996 that must be returned plus interest owing from a court case.
The company has recently stated in their September 2024 Half-Year report release in late November that they have received expressions of interest from potential buyers and expects the sale process to be complete within 12 months.
Liquidation Proceeds
So what can you expect to get in the liquidation? I lay out a bear, base and bull case with various assumptions on the amount the plant will sell for. Even in a draconian scenario where it only goes for 50% of stated book value, you would still get a decent return.
I haven’t been able to really find any precedent transactions for this type of asset in the area. But as stated earlier they were able to sell their FIT division for above book value. In 2022 they sold their 30% interest in Jiahua for $AUD 3.3m and it was carried on their books at $AUD 1.9m. And in April 2021 they disposed of their subsidiary Carsan for net proceeds of $AUD 21m for roughly 1x revenues and 3.8x book value based off my calculations from the segment’s book value of $AUD 5.5m as disclosed on page 20-21 of the 2021 annual report. In my model I have 4 boards of directors but one resigned in August but I left 4 in to be conservative.
The CEO owns 61.2m shares or 65% of the company and should be highly incentivized to get the best price and the company liquidated as quick as possible.
Many things can go wrong with this investment:
The sale process can drag out which will eat into your IRR.
The plant may not sell for 50% above book or might not be able to find a buyer thereby wiping out your downside. These are not very “attractive” assets but they have garnered some interest as per the release and the company has a history of selling these types of assets.
The company might have to sell off pieces of equipment each before they can sell the entire plant. This would prolong the amount of time it takes to liquidate.
Management can change their mind about liquidating and hoard the cash for an acquisition.
Management can pilfer the company by paying out large salaries leaving shareholders left with nothing. This risk is the one that I worry about the most because you are always on the outside looking in in non-control liquidations like these in foreign jurisdictions. However, the release did state they wish to distribute the proceeds out to shareholders so hopefully there is no pound of flesh taken before that occurs.
I have a small position in this because while I don’t love the asset they have to sell, their history of getting north of book provides such a large discount to fair market value that you are well compensated for that risk. It also helps that this situation is uncorrelated with the overall market.
This investment brings me to a topic I’ve read about and think is extremely interesting in liquidation scenarios.
Seasoned liquidations
I read about a technique called “seasoned liquidations” in the book Merger Masters: Tales of Arbitrage. In the chapter about John Bader from Halycon Capital Management, he explains that a seasoned liquidation is one where the assets have actually been sold and are just sitting in cash waiting to be distributed to shareholders. All that needs to be accounted for in this situation is claims the company still has to pay out and the timeline. I think this technique is extremely smart, especially in situations where the assets have not been sold yet and it can be hard to put a value on the assets. There might not be as much upside using a seasoned liquidation approach, but your risk decreases dramatically because you are not relying on valuing the remaining asset to be sold. Just the cash in the register essentially.
This situation can be applied in the Merchant House pitch above due to the nature of the remaining asset. Once the price of that asset is sold, your risk of capital impairment would go dramatically down as you will be in a better position to see all the cash less payments to be made, the timeline of receiving your capital back and the stock price. Of course the stock will move before you are able to purchase it but the idea is to squeak out a few percentage points of return with minimal downside as it will most likely trade at a discount to full value. It is a very valid approach to liquidation investing and can be used in your special situation arsenal.