Value Investors Club / JZ Capital Partners Limited (JZCP)

Description

JZ Capital Partners is an UK-listed private equity-style investment company structured as a closed-end

fund. The fund is heavily weighted towards controlled ownership of smaller private US companies,

though JZCP made a timely entry into European private company buyouts in 2010 and 2011 and has also

recently begun to build a portfolio of real estate investments in Brooklyn, New York. JZCP shares

recently traded for roughly 405 pence, or $6.25 at today’s exchange rate. The NAV per share was $10.12

as of December 31, 2014, such that the discount is nearly 40% to NAV.

Structure and Background

JZCP is domiciled in tax-friendly Guernsey in the UK and listed in London under the ticker JZCP. The

company also has a listed zero coupon preference share class (called ZDP shares) that matures in 2016

and trades under the ticker JZCN. The JZCN shares will be redeemed for 369.84 pence on June 22, 2016.

JZ’s history goes back to 1986. The predecessor vehicle to JZCP was called JZ Equity Partners (JZEP)

and was a typical private equity fund. JZCP acquired the assets of JZEP on July 1, 2008 as part of its

public share listing, which served to convert a limited-life PE fund to a permanent capital vehicle.

JZCP is advised by Jordan / Zalaznick Advisors (JZAI), which is run by Jay Jordan and David Zalaznick,

two veterans of middle market buy-outs with a nearly 40-year history of managing private equity

vehicles. Jordan and Zalaznick also each own roughly 9% of JZCP common stock. Jordan has

longstanding ties to Leucadia and was mentioned in the 2012 Leucadia annual letter that described the

history of that company. The shareholders of JZCP are also a pretty strong value group: After Jordan and

Zalaznik (about 18.5% of the shares) the major owners are Abrams Capital (nearly 20%), Leucadia

(18%), Third Avenue (8%) and Goodhaven (3%). This is a pretty good reason why there isn’t a lot of

liquidity in the stock, as these named shareholders own roughly 2/3 of the shares.

JZCP’s public listing really couldn’t have come at a worse time. JZCP’s stock was hit hard by the credit

crunch in late 2008 and early 2009 and JZCP found itself in the unfortunate position of having $185

million worth of preference shares coming up for redemption in June 2009 and didn’t have enough cash

to redeem it. Given that the investment portfolio was tied up largely in highly illiquid micro-cap buyouts

and high yield debt, JZCP would have had a terrible time getting enough liquidity from its portfolio

holdings to redeem the preferred shares, and the credit markets were gridlocked. It seemed that the only

options were to hold a fire sale of the company’s assets at a terrible time or try to raise additional cash and

take the dilution. The company elected to do a secondary offering in June of 2009 at a massive discount

to NAV, which of course diluted its existing investors substantially. The secondary offering was priced at

a 75% discount to the reported NAV at the time.

The good news was that JZCP was able to raise a substantial amount of capital - $229 million -- which

enabled the company to redeem its maturing ZDP shares, issue a new class of zero dividend preferred

shares (the current JZCN) and still have substantial cash left over. JZCP also did a reverse stock split on a

5 for 1 basis. Jay Jordan and David Zalznick each subscribed for $12.5 million worth of the new common

shares. Overall, JZCP sold 227.6 million new common shares, redeemed 29.7 million ZDP shares at par,

and issued 4.7 million new ZDP shares. Following the secondary, there were 65 million JZCP ordinary

shares. The new ZDP shares were issued at 215.8 pence at June 2009, and will be redeemed for 369.84

pence on June 22, 2016, which represented a gross yield of 8% from the date of issuance. The ZDP shares

required that JZCP maintain minimum asset coverage of at least 3 times the outstanding ZDP amount.

After the dust settled from the offering, JZCP reported that its NAV as of August 31, 2009 was $6.65 per

share, and the common shares traded at that time for $3.60, a discount of 46% to NAV.

Below is a comment written by Curtis Jensen, who bought 1.7 million shares in the secondary offering, in

the Third Avenue Small Cap Value Fund letter written in the summer of 2009 describing the investment:

“London-listed JZ Capital Partners is a closed-end investment company focused on investments in,

including buyouts of, U.S. small and micro-cap companies. The Fund (Third Avenue Value) acquired

additional shares via the company’s rights offering at a fraction of the pro forma NAV. Proceeds of the

offering were used for a combination of re-financing preference shares and to expand the company’s war

chest (i.e., growth capital). Generally speaking, JZ has distinguished itself from other buyout sponsors by

using judicious amounts of leverage within its portfolio companies and by maintaining some semblance

of discipline with respect to valuation and what it’s willing to pay for acquisitions. JZ’s management

participated in the rights offering, adding to their economic interest in the company and signaling

confidence about the company’s future. At present, the portfolio boasts an enviable slug of cash following

the financing. Broadly speaking, the buyout market remains under considerable stress and many busted

deals are in need of undergoing repair work. With capital generally scarce for the small and micro-cap

companies like the ones JZ targets, it seems like a particularly good time to introduce fresh funds to a

liquidity-starved arena like the one in which JZ plays, especially if it can be done at a discount. JZ

common trades at a 40% discount to NAV as reported at June 30, 2009.”

One can certainly consider the dilution caused by the re-cap to be a black mark against the management in

that they did not consider the possibility that the credit markets might be closed to them when they issued

debt against a portfolio of illiquid assets. On the other hand, since August 2009 JZCP’s portfolio has

performed rather well. Reported NAV has increased from $6.65 per share at August 2009 to $10.12 at

December 31, 2014, which is an increase of about 52%. In addition, JZCP has paid out about $1.35 in

dividends, for a total return of just over 70%. Also, I would note that this appreciation lags the market in

part because JZCP has not dramatically increased the internal value estimates for its private company

investments to anything close to the EBITDA multiples that the market might pay today, so I feel that

there will likely be some gains coming if JZCP sells some of its older vintage investments. As of

November 2014, JZCP was valuing its US private company portfolio at 7.4X EBITDA. JZCP’s US

portfolio of businesses generated an aggregate 17% EBITDA growth rate in the first half of FY2014

versus FY2013.

JZCP has appeared to be very timely in its investment activity since 2009. In early 2010, JZCP

announced the formation of a European private company buyout fund called JZ Europe Fund, and that

JZCP would co-invest in this fund (with no “double fees” to JZCP investors). JZ International is the

manager of these investments, is affiliated with JZAI, and this entity dates back to 1999 and had delivered

very impressive returns from 1999 to 2009 (roughly 32.5% annualized, according to JZCP). As a result of

this initiative, JZCP has made what appear to be some decent investments in European companies over

the last three to four years.

In June 2012, JZCP announced a plan designed to help reduce the discount to NAV. One of the biggest

problems for JZCP was that its legal structure capped the ownership percentage by US investors of 50%.

As part of the elimination of this restriction on US investors, JZCP moved its share listing from the LSE

to trade on the LSE’s specialist fund market (i.e., over the counter). JZCP also increased the limit on

investing in businesses outside the US to 30% of gross assets from the prior 20% limit. A final change

was a move to a defined distribution policy rather than haphazardly paying out gains each year. JZCP

now sets its dividend to pay 1.5% of NAV every six months, or 3% of NAV per year. The dividends are

paid in $USD unless the investor elects to receive sterling. Given the current 40% discount to NAV, this

means that investors will get about a 5% yield at the current price.

Beginning in late 2013, JZCP began to partner with a real estate investing firm to make investments in

real estate with “value-added” conversion or build-out potential. Almost all of these investments thus far

have been made in Brooklyn, New York. As of mid-2014, JZCP’s real estate portfolio consisted of 22

properties in Brooklyn with a total capitalization of $460M, of which JZCP held $126M in equity. Most

of these are in and around the up-and-coming areas close to the new Barclays Center, which is where the

Brooklyn Nets play. JZCP has since made additional investments in Brooklyn and recently announced its

first real estate investment outside of Brooklyn, that being in Miami.

In mid 2014, JZCP began to look towards the redemption of its zero-coupon preferred securities that

come due in mid-2016. JZCP raised $68M from the sale of a new “convertible unsecured loan stock” or

CULS that yields 6%, mature in seven years and convert at a price of roughly $9.28, which was a slight

premium to NAV at the time.

The Current Portfolio

As of November 30, 2014, JZCP’s portfolio consisted of 40 US micro-cap company buyouts valued at

$370M, or about 41% of the investment portfolio. There were 11 European micro-cap investments,

valued at $217M, or 24% of the total portfolio. The real estate portfolio was worth about $153M, while

other private investments were $66.5M. All told 89% of the portfolio is in private investments. JZCP

also has some listed investments, including about $15M in corporate debt, $11M in bank debt, about

$40M in UK gilts, and $34M in cash. The total portfolio was valued at $906M, and there was about

$243M in total debt (ZDPs, CULs, and a $50M loan facility with Jeffries). NAV was $663M.

JZCP’s US private investment portfolio is divided into five industry verticals, each of which is run by a

senior buy-out executive / operator. JZCP’s October 2014 presentation showed TTM revenue and

EBITDA by vertical through the first half of 2014. The largest vertical is Industrial ($220.8M revenue and

$34.5M EBITDA), followed by Testing ($112M revenue and $14M EBITDA). Other verticals are water,

healthcare, and logistics. Altogether, the five verticals totaled $462M in revenue and $68.9M in EBITDA

for the TTM period. More information on the company’s investment portfolio is available on the

company’s website and there are good profiles of the European companies at JZI Europe’s website:

http://jzcp.com/home

http://www.jzieurope.com/

Fees and Risk Factors

As mentioned above, JZCP is externally managed with a fee structure comparable to that of most U.S.

traded BDCs. The management fee is 0.375% per quarter (1.5% annually) on gross assets, along with an

income fee of 20% of the amount of net investment income exceeding 2% per quarter (or 8% annualized).

The advisor then receives 100% of the income between 2% and 2.5% per quarter, and then 20% of any

incremental income beyond that point. In addition, there is a 20% carry on any capital gains net of capital

losses with a high water mark based on cumulative gains and losses from inception. The fees are a little

high in my opinion.

Among the risk factors with JZAI are the potential conflicts of interest and lack of full attention to JZCP

investments due to several other investing funds that Jordan and Zalaznick are involved in. JZAI is

affiliated with two large U.S. private equity fund advisors. The first is Bolder Capital, a multi-billion shop

engaged in the typical private equity activities of sourcing, buying, and operating businesses in

partnership with the existing company management. JZCP invests in ideas sourced by Bolder Capital

through a 50/50 joint venture between JZCP and The Edgewater Funds, one of the vehicles managed by

Bolder. The other affiliated management firm is The Jordan Company, which is a New York-based

private investment firm also owned by Jordan and Zalaznik, through which JZAI manages its US based

investments. Then there is the non-US oriented JZ International, which is where JZCP sources its non-

US investments. In all of these cases, JZCP appears to co-invest with these entities on fair terms, but

there is some potential for conflict of interest with so many vehicles vying for investment opportunities.

As for leverage, JZCP typically does not carry a lot of leverage on its micro-cap portfolio companies,

usually averaging debt senior to JZ of less than 2 turns of EBITDA. The reported portfolio leverage has gone

up lately, likely due to the easy access to capital. Regardless, the company should have plenty of liquid

assets to redeem its zero coupon preferred shares in 2016 and the maturity should lower JZCP’s borrow

costs as it taps lower cost sources of credit, such as the new CULs.

There is one recent negative piece of news to mention, though I don’t believe it is a meaningful indicator,

and that is that one of the two principals of JZCP’s investment advisor, David Zalaznick, sold 1.716M

shares in late November for £4 per share. Following this sale, Zalaznick owns over 6M shares or 9.23%

of the total outstanding. I have no insight into what would motivate this sale, but I don’t think it

represents any kind of impending trouble.

JZCP also recently announced that it would be recommending changes to the company’s investment policy to

allow for more flexibility in buying opportunities, including allowing for more real estate and European

investments, which are currently limited by the existing policy. JZCP notes that it considers the

opportunities for “micro-cap businesses” in the US to be expensive and a “seller’s market” but sees

attractive opportunities in Western European private companies and in real estate. However, the company

will continue to manage a diversified portfolio across its areas of expertise, including small company buy-

outs, real estate, and occasional mezzanine and distressed debt opportunities.

Valuation and Summary

Despite strong performance coming out of the financial crisis, JZCP’s stock now trades at nearly the same

discount to NAV that it traded at following its recap in late 2009, despite an attractive investment

portfolio and several years of good results. The recent insider sale notwithstanding, I can see no reason

for the stock’s deep discount. Buying a portfolio of PE investments run by a seasoned manager with a

very strong long-term track record and a 5% dividend yield at about 60 cents on the dollar seems like a

decent proposition. JZCP values its private equity portfolio at roughly 7.5X EBITDA; at the current

discount, we are paying about 4.5X. I would very much expect to see further realizations in the US

private equity portfolio given the “seller’s market” and would expect to see some further NAV per share

accretion as a result. I also expect that JZCP’s European investments, most made in the 2010-2012 time

period, will do rather well. Finally, the real estate investments in Brooklyn have probably picked up some

value already and I am not against having this exposure given the price we are paying. Though I have no

reason to believe that the stock market will get excited about JZCP in the near term, there are three ways

for us to win: 1) NAV continues to grow over time; 2) discount to NAV narrows for some reason; 3) we

continue to get paid a decent yield while we wait. There is a possibility that one of the large value

shareholders may begin to clamor for more aggressive policies designed to close the discount. Overall, I

find JZCP to be an attractive investment. If I could buy the whole portfolio at today's quoted market price, I

wouldn't hesitate to do so.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Possible catalysts are: 1) NAV grows over time as JZ sells some of its US control businesses at good prices; 2) discount to NAV narrows to something more reasonable, like 20-25%; 3) JZCP management takes some aggressive action to reduce the discount; or 4) large investors pressure some kind of action to reduce the discount.

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			2015	2016
Price:	4.06	EPS	0	0
Shares Out. (in M):	65	P/E	0	0
Market Cap (in $M):	410	P/FCF	0	0
Net Debt (in $M):	0	EBIT	0	0
TEV (in $M):	0	TEV/EBIT	0	0