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batbeer2
batbeer2
Articles (53)  | Author's Website |

Value Idea Contest: Dundee Corp

Dundee Corp has rebuilt its balance sheet and trades at a deep discount to liquidation value. Fears that the company will be unable to redeem debt coming due in June 2019 are unfounded

This article has taken me four years to write. Back in 2014 I promised a fellow GuruFocus contributor I would share my views on Dundee Corp. (TSX:DC.A)(OTCPK:DPMLF). The stock traded at 0.5x book and management had been compounding book value at double-digit rates for decades. Yet after reading some annual reports, I found that neither the assets nor the liabilities of the company were simple enough for me to understand. That meant the stock was (to me at least) unsafe.

Thankfully, management has since rationalized the balance sheet. What’s more, the stock dropped from $13 to $1.50 per share. I guess now is as good a time as any to deliver on my promise. In sum, it is my view that at current prices, an investment in the stock of Dundee Corp. offers a fair chance of doubling within 12 months and a very low probability of a permanent loss of capital.

Dundee Corp. trades on the Toronto Stock exchange in Canada as well as over-the-counter market in the U.S. Unless indicated otherwise, all amounts are in Canadian dollars.

Business and history

Dundee is a holding company with activities in the areas of investment advisory, corporate finance, energy, resources/commodities, agriculture, real estate and infrastructure. The corporation also holds a portfolio of investments in both publicly listed and private companies.

Dundee traces its roots to 1957 when Ned Goodman and business partner Austin Beutel started an investment club. Goodman and Beutel capitalized on the club’s success by creating an investment counsel firm. By the 1990s, Goodman & Company Investment Counsel Ltd. was publicly traded as Dundee Wealth Inc. and managing $5 billion in assets. Assets under management at the Dynamic mutual funds division eventually grew to $50 billion. The company also had significant real estate operations.

In 2011 the division managing the mutual funds was sold for over $2 billion to Scotiabank, and in 2014 the real estate operation (DREAM) was spun out to shareholders. This left a holding with hodge-podge assets including stakes in publicly traded and private companies. In his last years as CEO, Goodman held a strong conviction that the world would face hyperinflation and the U.S. dollar would devalue. This led him to invest heavily in commodity businesses (oil and gas, gold, mining and so forth). After decades of heading the company, the founder stepped down as CEO in 2014, handing over to his son, David.

David Goodman restructured the organization into two divisions: wealth management and merchant capital. The wealth management division was an attempt to rebuild the wealth-management operation that had brought the company so much success in the past. The company was once again free to do this after the non-compete agreements with Scotiabank had ended. On the merchant capital side, Dundee continued providing capital to and supporting companies from incubation through to development, operation and monetization. The attempt at rebuilding the wealth management division did not sit well with Jonathan Goodman, Ned’s other son who worked at the company. Jonathan Goodman resigned.

Rebuilding the wealth management business proved difficult. Many of the investments Ned Goodman made in his last years as CEO had to be written down, and the stock dropped 90%. Investors became increasingly concerned about Dundee’s ability to redeem its preferred series-five notes coming due in June 2019.

2014 balance sheet

With the company reporting massive losses and the stock trading at a steep discount to net asset value (NAV), David Goodman decided to reduce costs by scaling down the wealth management division and simplifying the balance sheet by culling the investment portfolio and paying down debt.

This year, David Goodman took medical leave. His brother, Jonathan, returned to head the company. Jonathan is even more focused than David on simplifying the balance sheet. The company is aggressively selling non-core assets. Jonathan Goodman has been very clear that in his view Dundee is first and foremost an investment holding company.

Financial strength

For a holding, the balance sheet as reported under Generally Accepted Accounting Principles (GAAP) can be a poor indicator of the financial strength of the company. That is especially the case at Dundee. Dundee’s most recent financials show that the company has cash and investments of $415 million. At the holding level, liabilities stand at $110 million. The holding has excess liquid assets of more than $300 million! That is as strong a balance sheet as you’ll ever see.

2018 balance sheet

The highly leveraged subsidiary, Dundee Securities, has been eliminated in all but name. That was by far the largest and most problematic subsidiary. Now that the other highly leveraged subsidiary, Dundee Energy, has been sold, the balance sheet is much simpler and stronger. In 2014, total liabilities exceeded cash and investments by $200 million. Today, cash and investments exceed total liabilities by almost $ 200 million.

Total liabilities (including the liabilities of the subsidiaries) are reported under GAAP at $341 million. That's including $83 million worth of series-five preferred notes. Unlike the other series of preferreds the series 5 are accounted for as debt. The sale of Dundee Energy eliminates another $115 million worth of debt at that subsidiary.

Even if one assigns zero value to the assets of the remaining subsidiaries and elevates all liabilities to the holding level, Dundee has roughly $190 million worth of excess cash and investments.

Profitability

A balance sheet, with hundreds of millions worth of excess assets, is of no use if the company continues losing tens of millions of dollars per annum. This is exactly what has been going on at Dundee. Management made some dumb investments and one by one the mistakes within the investment portfolio are realised and become reported losses. The company has lost tens of millions each year since 2014 which is probably why the company trades at such a steep discount to liquidation value.

The fact that shares trade at a clear discount to liquidation value is however irrational in light of the fact that the company is, for all intents and purposes, in liquidation. It has been for a number of years, selling hundreds of millions of non-core assets to pay down debt.

The key is figuring out how much cash, if any, remains for shareholders after taking care of all liabilities. In his latest conference call, Jon Goodman indicated that he expects to generate $100 million to $200 million from the sale of non-core investments in the second half of 2018. That's excluding DPM. By Christmas, the company would then be left with:

  1. $110 million worth of debt at the corporate level (including the series-five preferreds).
  2. $130 million worth of cash at the corporate level.
  3. A 20% stake in publicly traded Dundee Precious Metals (DPM), worth $120 million.
  4. United Hydrocarbon, a royalty stream from oil produced in Chad by Delonex.
  5. A 40% stake in Parq Vancouver, two hotels and casino in Vancouver.
  6. Various subsidiaries, including Blue Goose, Agrimarine and Sustainable technologies.

The first three items together result in $140 million worth of excess liquid assets after assigning no value whatsoever to the remaining investments, United Hydrocarbon, Parq Vancouver or Agrimarine. That's a lot of excess liquidity for a company with a market cap of $90 million.

It is worth noting that United Hydrocarbon expects to collect $20 million to $50 million from Delonex if the wells that company is currently drilling in Chad actually produce some oil this year. What’s more, Dundee extended a $15.5 million loan to Parq Vancouver at 20%. That loan was due Oct. 1. Parq Vancouver recently announced an investment by a third party. There is a chance that the loan has been repaid, leaving Dundee Corp. with even more cash.

Management

Earlier this year, Jonathan Goodman left his job as CEO of DPM to fix the family business he previously left. Jonathan founded DPM in 1993. That company is publicly traded and worth $600 million (seven times more than Dundee Corp.). As its CEO he was earning $600,000 per annum, slightly more than the $550,000 he currently earns as CEO of Dundee Corp.

Jonathan’s father Ned Goodman still owns roughly 10% of Dundee Corp. and his four sons -- Jonathan, David, Mark and Daniel -- through a company called Jodamada, jointly own another 10%. Taken together, the Goodman family owns roughly 20% of the company. Because they own almost all the super-voting “B“ shares, they control 85% of the votes.

Jonathan Goodman has roughly four times his annual salary tied up in stock, and of course he has to answer to his siblings who are unable to easily bail out of their holdings. They look to him to salvage what’s left of the family fortune.

All in all, this is not the best management team imaginable. Having said that, the current CEO is obviously capable and his interests are reasonably well aligned with the interests of minority shareholders. At current valuations management has to be both incapable and unlucky for investors to lose money. Jonathan Goodman is obviously not incapable. He is the inverse prodigal son who has returned to help out the family after leaving to create a fortune (hat tip to James Roumell).

Value and Price
At the holding level, Dundee has cash and investments of about $415 million, $120 million of which is in Dundee Precious Metals (DPM) stock. Jon Goodman has indicated he intends to generate $100 million to $200 million from the sale of some of the other investments in H2 2018. One core holding (DPM) has a mine producing 200,000 ounces of gold and is ramping up a second mine (expected to be in production by year-end) for an extra 100,000 ounces. These mines produce gold at an estimated all-in cost of roughly $500 per ounce. At current gold prices that’s $200 million to $300 million worth of cash flow for a company trading at $600 million. This single investment is worth more than the market cap of the entire holding.

After closing the sale of Dundee Energy Limited Partnership (DELP), the company is left with $225 million worth of debt. That includes $115 million worth of debt that remains at the subsidiaries.

A very conservative estimate of the excess cash of the holding is 415m-225m = 190m.

per share that's 190/59 = $3.22.

Excluding debt at the subsidiaries, the excess cash of the holding is 415m-110m = 305m.

per share that's 305/59 = $7.17

It is important to note that the series-two and series-three preferred shares rank ahead of the A shares in liquidation. These preferreds are carried at par (roughly $120m) but never come due. One way to value this liability is at market value. The preferreds are publicly traded and currently trade at 0.5x par. The company could theoretically buy back the series-two and series-three preferred in the open market at a cost of $60 million.

It is more conservative and realistic to value the preferreds as an annual expense of roughly 6% of $120 million. That's $7 million worth of future annual earnings that are perpetually siphoned off before the owners of A shares get paid.

Of course, these preferreds have not stopped Dundee's management spinning out hunderds of millions worth of value to shareholders in the past. That is exactly what happened when the comany spun out Dundee Realty (now DREAM office REIT) in 2012. Spinning out the DPM stake in a similar fashion today would unlock $2 of per-share value in an instant.

In short, management would have to be both incapable and unlucky to destroy this much value. Again, the current CEO is clearly quite capable.

Catalysts

One way or the other, by this time next year, the uncertainty surrounding the series-five preferred shares will be removed.

DPM reports good progress on its new mine.

Delonex starts producing some oil in Chad.

The company announces share buybacks and/or buybacks of the series 5 preferred.

Specific risk

Cash diversion. Management may use excess cash to shore-up struggling subsidiaries that subsequently fail.

Family affairs. The Goodman family quarrel, leaving the company with a leadership vacuum.

Why is this cheap?

The company was cheap before, but a lot of assets ultimately proved worthless. This is now percieved to be a value trap. Though the current assets are much more liquid and easier to value, the “usual” value vultures have lost confidence, leaving very few investors interested in the name.

Disclosure

This is not a recommendation to buy or sell anything. This is an expression of my views about Dundee Corp. with the intent of engaging in intelligent discussion about the company and its stock. At the time of writing, I owned shares of Dundee Corp.

Any and all questions welcome as usual.

Read more:

https://divestor.com/?p=8229 - discussion about the preferred

http://www.marketwired.com/press-release/dundee-corporation-announces-proposed-distribution-dundee-realty-corporation-shares-tsx-dc.a-1737765.htm - spin out of REIT in 2012

https://www.sedar.com/GetFile.do?lang=EN&docClass=7&issuerNo=00001786&issuerType=03&projectNo=02807305&docId=4370737 - sedar filings

http://dundee.financial/dc/-/media/DGC/DC/DC-Q2-2018-FS.pdf - latest financial report

About the author:

batbeer2
I define intrinsic value as the price I would gladly pay to own the business outright. With current management in place. For most stocks, that value is 0. I can be reached at batbeer AT hotmail DOT com

Visit batbeer2's Website


Rating: 4.6/5 (9 votes)

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Comments

batbeer2
Batbeer2 premium member - 1 week ago

A couple of readers have contacted me asking if the preferreds might be a superior investment. Here are my thoughts on the prefs.

1) The series 5 (DC.PR.E.PFD). These preferreds are carried on the balance sheet as debt and come due in June 2019. They trade at C$19 or so. This price implies they will be swapped for A shares at maturity. Management has the option to swap them at a floor pice of $2 per a-share. This leaves the former owner of a series 5 pref with 12.5 A shares plus some dividends. In this first scenario, the series 5 preferreds and the A shares are currently more or less equivalent.

There is of course a second scenario where the series 5 get redeemed for cash at par (C$25). Interestingly, that is exactly what management did in january when they tendered for and redeemed a chunk of the series 5 prefs.

https://globenewswire.com/news-release/2017/12/18/1263364/0/en/Dundee-Corporation-Announces-Notice-of-Redemption-in-Respect-of-its-Series-5-Preferred-Shares.html

At current prices, investors in the series 5 get the possibility of this second scenario and a quick 30% return for free. The price is depressed because management is scaring the owners of the prefs. Perhaps it softens the owners of the prefs and opens them up to a conversion of the series 5 into some a security more similar to the series 2 and 3. Given that the CEO has indicated a preference for 0 debt at the holding level, the possibility that the series 5 simply get redeemed for cash seems most likely. It is in line with management's previous actions and also with their stated long-term view for the business.

In my view it is irrational to swap the series 5 for A shares at the floor price of $2. You screw the holders of the prefs out of $20 million or so but you hurt the owners of the A shares to the tune of $100m by diluting the shares at such a large discount to NAV.

A third scenario consists of management swapping each series 5 share for 12.5 A shares and subsequently making a bid for the 40 million new A-shares at a then-depressed/diluted price (of say $1). That would be wicked. By going that route, management might be able to get rid of this $83 million liability at a price of $40 million. Another way to think of this is that management would be enriching one group of shareholders at the expense of others. While savvy and legal, it is IMHO not wise. As a minority investor I wouldn't want to be in business with management that thinks along those lines. At some point one finds oneself at the wrong end of management's priorities.

One final scenario I can think of the A shares running up. For the sake of this discussion, let's assume management thinks the per-share NAV is significantly north of $7. What's to stop them from making a tender offer for say.... 8 million A shares @ $6 in may 2019. The shares run up to $5, the series 5 get swapped in June (that's 5 A shares for 1 series 5 pref). That way you get a hybrid outcome where the company conserves some cash, spending just $48 million to eliminate that liabillity and issuing 18-8 million new A shares (20% dilution) which is less onerous to current owners.

2) The series 2 and 3 (DC.PR.B.PFD and DC.PR.D.PFD) are inferior securites. The argument for their value goes along the lines of "they trade at 0.5x par and come ahead of the common shares so if the common are safe, the prefs should be good investments."

Firstly, for the series 2 and 3, par value is almost meaningless. Bear in mind that common shares too have a par value. No one ever looks at that. In the case of the series 2 and 3 preferreds, they have no maturity date; the company never has to come up with par value to redeem them. The company can and does redeem these preferreds when they can do it at a significant discount to par.

Secondly, the preferreds come ahead of common shares in the sense that the common don't get a dividend if the preferreds aren't paid first. But the company is not in default if they simply decide to not pay the dividend on the prefs. Whereas the dividend is cumulative, it is not interest, it is a dividend at the discretion of the board. So what is this preferred right worth if the common are in distress and/or wiped out?

Not very much.

In theory, management could cancel the dividend on the prefs and subsequently make a tender offer at steep discounts to par. There would be legal issues and the reputation of management would be severely damaged but in a liquidity crisis I believe that is exactly what they'd do.

The chances of that happening are remote though. For an investor looking for income the cash/dividend stream seems as safe as any I've seen (at any rate safer than GE's dividend ;-) and that is IMHO how the series 2 and 3 should be valued. As a relatively safe stream of cash. But again, par value is irrelevant.

In sum, the series 2 and 3 are cheap but as a security they have none of the advantages of bonds and none of the advantages of common stock either.

stephenbaker
Stephenbaker - 1 week ago    Report SPAM

Batbeer, why is the company consistently losing money?

batbeer2
Batbeer2 premium member - 1 week ago

Hi Stephenbaker, thanks for your question.

It is less than perfectly accurate to say Dundee has been consistently losing money. The company has returned billions to shareholders since they became publicly traded. Not many Canadian companies can say that. But yes, for the last 16 quarters or so they have been reporting severe losses.

The cause of these losses are:

1) A bloated corporate structure with lots of investment analysts/advisors.

2) Even worse, as a group they made large, leveraged and dumb investments.

Almost all the advisors have been let go and there have been no major new investments in years. Instead, current management has been liquidating those dumb investments. It is the sale of the mistakes embeded in the portfolio that have caused the massive reported losses.

Given that the current portfolio is simpler to value and much less leveraged, I expect the losses to become less severe. Whether or not Dundee ever returns to making profitable investments is beyond the scope of this analysis. The point here is that the company could wither and die and the A shares would still be worth more than the current price.

stephenbaker
Stephenbaker - 1 week ago    Report SPAM

Hi Batbeer,

Thanks for the quick reply! I guess the thrust of my question is why, and whether we can trust current management to do any better than prior management - particularly when the same family makes up both management regimes. The fact that the Father (who evidently was responsible for a lot of the investment mistakes) is still involved would give me pause. Yes, on a net-net basis, the company looks extremely cheap, but to what extent to you believe that the family has any intention of essentially liquidating what can truly be deemed a "famly business"? If the investing mistakes continue, the asset value there now can evaporate. I can understand one or even several mistakes - we're all human. But when it appears that most of their investment ideas in recent years have failed (particulary during a time period when cheap money and other stimulus should have provided a springobard to success) I would prefer to invest in a company whose management demonstrates more ability. The fact that this is an investment holding company makes the point all the more poignant.

batbeer2
Batbeer2 premium member - 1 week ago

>> but to what extent to you believe that the family has any intention of essentially liquidating what can truly be deemed a "famly business"?

Good point.

My belief in their willingness to liquidate is based on the evidence that they are in fact liquidating. At least partially. It is important to note that they have treated the holders of the A shares fairly in the past. Most likely, Jon sees some core value somewhere in there and would want to build on that after cutting all the rot. If so, he'll have to show us (and his siblings) the money. By now the family too must be a bit fatigued and a some of them may want out. The way it is currently structured they sink or swim together. Some of them might want to get rid of that structure their dad saddled them with.

Let's imagine for a moment that the four sons don't agree 100% on the way forward (this problem becomes bigger with each generation). Then the rational approach would be to salvage as much value as possible, liquidate and call it a day. I'm not saying this is the case but it would be consistent with what Jon has been doing. He

1) simply sells everything in a controlled fashion (takes another year or two),

2) retires all the debt,

3) makes a tender offer for the A shares if they're still trading at a discount to NAV

and

4) finally spins out any remaining excess cash plus DPM shares. He then returns to DPM owning a larger part of that company and leaves his siblings to make their choices. That way business does not get in the way of family affairs and vice-versa.

I'd argue that he has made good progress on the first two steps.

Yes, there may be some incentive to keep the family business for the sake of it; there often is. But in this case I believe there is evidence to the contrary. Had they wanted to build a Loews-type family empire they would have gone about it very differently. As it stands, the family takes out cash or spins out shares of succesful subsidiaries everytime they get a decent offer. This time might be different but I see no evidence of it (yet). I'll be tracking that risk like a hawk though.

stephenbaker
Stephenbaker - 1 week ago    Report SPAM

Thanks again for your commentary, Batbeer. I'll do some digging myself since it does look interesting in an overvalued market.

(But the more I think about this, the more this company reminds me of borrowing money to buy a car and thinking of it as an investment; financing any depreciating asset is a double whammy and an investment in this stock goes against my two most most important initial investment criteria: (1) very low or preferably no debt; and (2) profitable companies.)

batbeer2
Batbeer2 premium member - 1 week ago

>> this stock goes against my two most most important initial investment criteria: (1) very low or preferably no debt; and (2) profitable companies.)

Pehaps Kone Oyj is more to your liking then. Elevators, escalators etc. Once they are installed you get 30+ years of maintenance income. You are loath to rip out and replace the elevator in your building with a totally different brand (what's the ROI on that?) and you are not going to use cheap generic parts for maintenance. If something goes wrong you're screwed so you use certified OEM parts. Also, if all the escalators and elevators at say.... McCarran airport are Kone, how do you fancy Schindlers' chances for getting the contract for the new moving sidewalk?

Of course the escalators at your airport/subway/train station/mall must be well-maintained and must be fixed within minutes when they fail. But you need a significant installed base to justify having 20 maintenance guys running around a given city. A new entrant has to install hunderds of new escalators with dozens of customers before they have the scale to keep that maintenance network going. That's the main barrier to entry.

Kone is growing its installed base at a fair clip, is highly profitable and has a bullet-proof balance sheet. Schindler and Otis are pretty good too but IMHO Kone is the best. Maybe I find some time to write about that one sometime.

But it is not as cheap :-(

Also, it has nothing to do with Dundee :-)

Just a rant about a company I like that is probably not going to double within 12 months.

stephenbaker
Stephenbaker - 1 week ago    Report SPAM

I hear you Batbeer. The problem with trying to find cheap, profitable companies with no debt is.... there are none. Or if they look cheap on the surface, there are issues under the hood.

Still, I'd rather sit in cash than buy stocks in debt-ridden companies that are losing money and that by definition, are worth less tomorrow than today.

raj123456789
Raj123456789 - 1 week ago    Report SPAM

Batbeer, Thanks for excellent article. How is the The series 2 and 3 (DC.PR.B.PFD and DC.PR.D.PFD) dont have atleast as much advantage as common stock? I see how they dont have as much advantage as bond. I dont understand how they are not better than common stock. Management that want to play games with preferred stock can also play games with common stock.

batbeer2
Batbeer2 premium member - 1 week ago

Hi Raj123456789,

Thanks for your questions.

>> Management that want to play games with preferred stock can also play games with common stock.

Yes, except that they own common and not prefs so the incentive is different.

>> How is the The series 2 and 3(DC.PR.B.PFD and DC.PR.D.PFD) dont have atleast as much advantage as common stock?

Well, the prefs are worth at most C$25, that's par value, roughly twice the current price. The common is worth at least twice the current price (by my estimates that is).

Of course my estimates could turn out to be way too optimistic. If that turns out to be the case then neither the prefs nor the common are worth anything so that's par for the course :-)

Rodbhar
Rodbhar - 6 days ago    Report SPAM

I agree with Batbeer that if the worst happens then both the common and the prefs will go to zero. I also agree with him that if everything goes great, the common will do better than the prefs. But I would add that there are many outcomes between those two extremes where the prefs do better than the common, in some cases, much better. That is why I currently own the B/D prefs not the common.

batbeer2
Batbeer2 premium member - 6 days ago

>> But I would add that there are many outcomes between those two extremes where the prefs do better than the common, in some cases, much better.

Fair point. Both the common and the prefs are cheap. The common is cheap because they fear their valuable shares will be diluted by the prefs and the prefs are cheap because they fear they will get worthless common.

Somebody (perhaps everybody) is wrong.

We shall see.

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