Tetragon continues to trade at a wide discount
Tetragon’s 10-year average discount to its reported NAV stands at c 41% and since mid-2013 until recent sell-off it remained in a broad corridor of 30–50%. Since December 2017, the discount widened gradually from 33% and reached 51% at the brink of the downturn. While recent volatility has brought the discount to a 10-year record of 72%, Tetragon’s share price recovered in line with the broader market and the discount stands at 63%. It is worth noting that the actual discount is likely to be lower, because the end-April NAV does not fully reflect the valuation impact from the recent market downturn on Tetragon’s assets due to the frequency of revaluations in some asset classes as described below.
Exhibit 6: Share price discount to NAV over five years (%)
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Source: Refinitiv, Edison Investment Research
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The discount to NAV is quite high relative to the broad listed investment trust space. We understand that investors highlight the following factors as potential justification for the above-average discount:
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Uncertainty around the carrying value of portfolio positions (which are mostly unlisted and less liquid).
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High fees (particularly the performance fee).
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Listed shares are all non-voting.
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Distributions in the form of buybacks/scrip dividends executed below NAV.
We address each of these concerns in the later part of this section.
Carrying value of portfolio holdings
TFG Asset Management valuation
The largest position in Tetragon’s portfolio (31% of NAV at end-April 2020) is TFG Asset Management, with its value derived from the valuations of its asset manager holdings. These are prepared by external independent valuation appraisers and are predominantly based on a discounted cash flow (DCF) model (blended with the market multiples method in the case of LCM) and are subject to an illiquidity discount of 15–20%. An exception here is Hawke’s Point, which is valued at replacement cost, and Banyan Square Partners, which had not been valued by the valuation specialist and was not included in the Q120 NAV. TFG Asset Management’s valuation at end-2019 amounted to US$747.5m (up 12.9% y-o-y), which together with its FY19 reported earnings (EBITDA equivalent) attributable to Tetragon of US$59.5m implies a market cap/EBITDA ratio of 12.6x. This is below the average for the broad group of listed asset management
companies of 13.7x at end-FY19, implying an 8% discount, which could be explained by the liquidity discount applied by Tetragon.
When examining Tetragon’s valuation of its stakes in asset managers, we need to highlight that on merger of GreenOak with Bentall Kennedy back in 2018, Tetragon’s investment in GreenOak has been subject to an 89% valuation uplift. Having said that, the above conclusion is underpinned, for instance, by the 89% valuation uplift on Tetragon’s GreenOak holding following its merger with Bentall Kennedy back in 2018. The new valuation of Tetragon’s 13% stake in BentallGreenOak was based on a number of components, including an upfront cash payment received by Tetragon, subsequent fixed quarterly distributions, certain variable distributions, carried interest from existing and future funds and Tetragon’s put option. We acknowledge the value of some of these components may change.
Having said that, since end-2019 TFG Asset Management valuation decreased by 8.3%, which was a result of the quarterly update from appraisers. We note that quarterly updates cover only model assumptions, while earnings forecasts are updated annually. In Q120 revaluation, the rate used to discount future projected cashflows was increased by 100–225bp and the P/E multiple used in LCM (and part of BentallGreenOak) valuation was decreased by approximately 10%. We calculate that since end-2019 the peer average multiple decreased to 12.4x (which already captures the recent rebound in April) amid broader market weakness, which may also reflect concerns around prospective fee income. Tetragon may conduct an IPO of TFG Asset Management at some stage, though the timing and IPO valuation are uncertain at this stage.
Fees at underlying funds are collected by TFG Asset Management
With respect to other positions within Tetragon’s portfolio, we have decided to examine the discount/premium to NAV at which listed investment trusts with similar exposure are normally traded. Similar to other investment companies, these positions are subject to external independent valuations. In this context, we note that 49% of Tetragon’s NAV (or 73% of the portfolio excluding TFG Asset Management itself) at end-Q120 represent fund investments, which at first glance suggests that our peer group should be largely composed of listed fund of funds. The remaining 19% of the portfolio comprises Tetragon’s direct investments and net cash position.
However, 42% of Tetragon’s total NAV at end-Q120 (or 62% of investment portfolio excluding TFG Asset Management) are investments in funds whose asset managers are majority owned by TFG Asset Management (except for BentallGreenOak where TFG Asset Management has a 13% stake). The management/performance fees charged at the underlying fund level constitute a corresponding fee income for TFG Asset Management (fully owned by Tetragon). In FY19 TFG Asset Management received US$19.3m in fees related to capital invested by Tetragon. At the same time, Tetragon’s fund investments managed by external entities made up only 7% of Tetragon’s NAV at end-Q120. Consequently, we treat Tetragon as one-layer fee structure for the purpose of our analysis, and we have broadened the peer group to include funds with a direct strategy. We also exclude Tetragon’s investments from TFG Asset Management’s fee income. As this is minor (c 10% at end-2019, see Exhibit 4), it translates to a 3% discount to Tetragon’s total NAV.
We acknowledge that the current discount to last reported NAV is affected by the recent high volatility in asset prices. NAV comparability across investment trusts may be limited due to different timing of NAV publication, as well as varying revaluation frequency among the various asset classes. While we present current discounts as a main reference point, we have also examined the discounts on a three-year average basis.
Three-year average peer discount for remaining asset classes at c 4–27%
Tetragon’s second-largest exposure by asset class (22% of NAV) are investments in hedge funds covering predominantly event-driven equities including special situations and M&A (74% of this subgroup’s value at end-Q120, managed by Polygon) and to a lesser extent convertible bonds (17%, also managed by Polygon) and quantitative strategies (9%, position to be redeemed soon with c US$52m cash proceeds). We have eased the peer group criteria to funds investing broadly in publicly quoted assets, as direct peers to Tetragon’s strategy tend to have an open-ended structure or are privately held. Listed equity funds tend to trade at a discount of around 4% to NAV (three-year average) and currently trade 10% below NAV. We note, that as the underlying assets are marked to market, valuations in this asset class largely reflect the recent broader market sell-off.
Tetragon’s exposure to bank loans (c 14% of NAV at end-April 2020) consists of investments in CLO tranches and funds specialising in CLO investments (with a focus on majority positions in equity tranches). We have selected a peer group of funds that predominantly or exclusively invest in CLOs (both debt and equity tranches). They trade at a discount to NAV of c 19%, with a three-year average of c 9%. It is important to highlight that CLO tranche valuations may be either marked to market based on market quotes (received, for example, from arranging banks or services such as JPM’s PricingDirect) or marked to model and based on models provided by external valuers (Tetragon applies the latter approach). While we acknowledge that quotes (especially from arranging banks) sometimes respond to market conditions with a lag and can be inconsistent between providers, they still have the advantage over mark-to-model valuations of being market driven (potentially warranting a lower discount to NAV).
We note that, for instance, Blackstone/GSO Loan Financing and Marble Point Loan Financing, which also use the mark-to-model approach, have been trading at a similar discount to peers applying the mark-to-market approach, with a three-year average discount at 1% and current discount of 8%. After examining the underlying valuation assumptions applied to Tetragon’s CLO investments at end-2019 (latest available data), we conclude they were broadly in line with peers, although the assumed recovery rate was somewhat higher (at 75% compared to Volta Finance at 65% as per FY19 report or Blackstone/GSO Loan Financing at 70% as per its Q319 report). Moody’s expectations with respect to recovery rates for first-lien leveraged loans stand at 61%.
We also note that on a look-through basis (including Tetragon’s investments through TCI II and TCI III funds), LCM manages 68% of the CLOs Tetragon was invested in at end-2019. Such a high exposure to a single CLO manager may translate into a higher collateral overlap (same issuers across different structures) and potentially lead to higher losses in a corporate distress environment. However, some of the peers we have selected share that characteristic with Tetragon, such as Blackstone/GSO Loan Financing and Marble Point Loan Financing, which operate as risk retention vehicles and all instruments in their portfolios are managed by their respective investment managers).
Private equity made up 14% of Tetragon’s portfolio at end-April 2020. The broad listed private equity funds spectrum (represented by the LPX Direct index) historically traded at a 0–20% discount and now trades at 25% discount after recovering from 45% amid the coronavirus outbreak. For our selected narrower peer group, these figures stand at 27% (three-year average) and 38% (currently). While we assume a discount in line with peers for the purpose of the analysis, it is important to highlight that US$158.3m, or 52% of the carrying value of Tetragon’s private equity holdings, represents its recent investment in Ripple Labs (described above), which is valued in line with Ripple’s series C funding round concluded in December (through which Tetragon acquired its stake in the company). Tetragon holds Ripple as a direct balance sheet investment; it also invests in private equity and venture capital through third-party private equity funds and co-investments (total exposure at 16% at end-Q120) and into private equity funds managed by TFG Asset Management managers (26%), in particular Hawke’s Point and Banyan Square. Tetragon’s private equity positions based on end-2019 valuations amount to US$60m according to the management.
Tetragon’s real estate investments (7% of NAV at end-April 2020) are executed through or alongside BentallGreenOak, except for the Paraguayan farmland managed by Scimitar. Similarly to private equity investments the real estate assets are accounted for at end-2019 valuations. We benchmark Tetragon’s real estate assets to a peer group that is characterised by a three-year average discount to NAV at 6% and a current discount at 34%.
The remaining 12% of Tetragon’s NAV comes from publicly traded assets, which are valued at market price, and its net cash position. To publicly quoted assets, we apply the discount of funds investing in public assets to maintain our one-tier fees approach.
Blended three-year average discount of 17% compared to Tetragon’s 44%
Based on the above discounts to NAV at which pure-play peers within the respective asset classes are traded, we arrive at a current weighted average discount of 27% and a discount based on the three-year average of 17% (see Exhibit 7) for a target portfolio matching the same allocations as Tetragon, as described above. This compares with 63% and 44% for Tetragon, respectively.
Exhibit 7: Tetragon’s portfolio valuation in comparison to various peers
Asset class |
Share in TFG’s portfolio |
Charges* (peer average) |
Three-year average discount** (peer average) |
Current discount (peer average) |
TFG Asset Management |
31% |
1.8% |
34%*** |
45%*** |
Hedge funds |
22% |
0.8% |
4% |
10% |
Bank loans |
14% |
2.6% |
8% |
19% |
Private equity |
14% |
1.9% |
27% |
38% |
Real estate |
7% |
1.6% |
6% |
34% |
Other |
8% |
0.8% |
4%**** |
10%**** |
Cash |
4% |
0.0% |
0% |
0% |
Weighted average |
- |
1.5% |
17% |
27% |
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Charges* |
Three-year average discount |
Discount |
Tetragon |
- |
4.5% |
44% |
63% |
Source: Tetragon Financial Group, Refinitiv, Edison Investment Research. Note: *Total charges including incentive and performance fees, based on peers that reported the figure later than June 2019. **Three-year average discount of respective peer group. ***Average discount of private equity funds adjusted for TFG’s investments. ****Average discount of hedge funds investing in public equities.
At the same time, we underline that the high level of portfolio diversification reduces the volatility of Tetragon’s NAV returns. Over the last 10 years, 79% of Tetragon’s monthly returns have been positive, while the largest single monthly decrease was 5.8%. Moreover, Tetragon generates sizeable and regular fee income from managing over US$20bn of third-party capital (end-2019) through majority-owned asset managers. This, in our view, makes the structure more resilient to market volatility than regular PE funds, as it is less likely to make forced disposals to finance its ongoing charges; over the last three years income generated from TFG Asset Management covered 1.2x Tetragon’s costs (excluding incentive fee) on average. Having said that, the fee income would decrease if TFG Asset Management’s AUM declines due to the weak price performance of underlying assets, or outflow of external investors’ capital.
The above comparison shows that Tetragon’s discount to NAV is wider than that for the pure-play peers We note that there may be other potential factors explaining this, some of which we discuss below.