To tender or not to tender

Terravest Income Fund has announced a tender offer to buy back 5 million units (representing 25% of all outstanding units) directly from shareholders for cancellation. They are offering $2.75 per unit, which is 51% premium of today's closing price of $1.82.

It must be noted that the three major unitholders of Terravest comprise of close to 50% of outstanding units. The largest of them being Clarke Inc which commands ~33% of the votes (which includes George Armoyan, CEO's units).

As of my original post on Terravest, the company has paid two special dividends totaling $1.65. These dividends were categorized as return of capital, which are taxed very favorably.

Based on my 2009 purchase price, if I were to tender my units at $2.75, it would represent about 83% profit

Decision Time

On the surface this sounds like a great deal, but digging slightly under the surface reveals more.

Based on the company's Q1 numbers, the book value is 3.27/unit and tangible book is 3.11/unit. The business is profitable and is regularly producing a nominal profit. Based on very modest estimates, I computed that the intrinsic value of this very simple business is between $3.6 and $3.8.


The tender offer is at a 11.5% discount to tangible book, which is akin to the management buying a dollar for 88¢. This is an accretive buyback decision for the business, but not a very good one for the unitholder who tenders their shares below book value.

What would you do if you find yourself in this position?

I look forward to comments or messages on twitter.


[EDIT (July 13, 2012): After above announcement, the stock jumped a sizable amount and very close to the offered tender price. I sold all my units today for a nice profit. Total gain: 77% (over 3 years). Annualized gain: 21%]

Dangerous quest for yield

Over the last year or so, a lot of well respected [value oriented] fund managers have successfully identified the danger of holding US Treasury bonds. The yields are at or close to their all time lows. The supposed "risk free returns" come with a "return-free risk"-- an eloquent quip from James Grant, I believe.

I must say that I don't disagree with that.

When asked how to mitigate this risk, some but not all, fund managers have suggested the answer may be US stocks that have a long history of increasing dividends and currently yield much higher than the 10 year treasury. This sounds like an excellent alternative to the bonds of a heavily indebted nation.

But caution is warranted here.

According to the Q2 2012 commentary from Oakmark funds:

...over the past 60 years, the 100 highest yielding stocks in the S&P 500 have on average sold at about three-quarters of the S&P 500 P/E multiple. The high yielders[sic] are typically more mature, slower growth businesses that deserve to sell at a discount P/E... Historically, high-yield stocks have been cheap stocks.

Today’s high-yield stocks are quite a different story. The 100 highest yielders in the S&P 500 have a much higher yield than the index – 4.1% vs. 2.5%. The S&P 500 today sells at 12.9 times expected 2012 earnings. If the high yielders sold at their 60-year average discount, they would be priced at less than 10 times earnings. Instead, today’s top 100 yielding stocks sell at 13.9 times expected earnings, more than a 40% relative premium to their historic average. The only reason they yield more than the rest of the S&P is that they pay out so much more of their income – 57% vs. 32%.

It appears that the well meaning advice those fund managers has worked. The valuation of these high dividend payers is well above the historic norms, thus exposing them to major price correction.

An intelligent investor must not sacrifice valuation in favor of yield, no matter how reliable the dividend appears.

Full Disclosure: N/A