Value Investors Club / Urbana Corporation (URB-A.TO)

Description

COMPANY NAME: Urbana Corporation

TICKER: URB-A.TO

DATE: February 25, 2019

PRICE: C$2.36

SHARES: 50 million (10 million voting, 40 million Class A non-voting)

MARKET CAP: C$118 million

NAV (Feb 15, 2019): $4.40 (estimated Feb 26, 2019)

DISCOUNT TO NAV: ~47%

INTRODUCTION

Urbana is a Canadian publicly-traded investment corporation that operated as a closed end fund until changing its structure in early 2015. Despite the structure change, for all intents and purposes Urbana remains a publicly traded investment fund that invests in a mix of public and private securities with a significant emphasis on financial companies and securities exchanges.

As of this writing, the stock trades at C$2.36 per share. (Please note all dollar amounts in this document will be in Canadian unless otherwise specified). The NAV of the underlying fund was reported as C$4.25 as of February 15, 2019 and by my calculations should be about 15 cents higher based on market changes since then. The discount to NAV is therefore around 47%. I’ve been following Urbana since 2011 which was the last time it traded at such a wide discount. Back then, Urbana’s portfolio was primarily in private

securities. Today, Urbana’s underlying portfolio is much more heavily invested in liquid, publicly traded stocks such that I can see no reason for a discount of this magnitude to exist.

The stock is obviously a low dollar security (about $1.80 US) and not very liquid, so obviously is likely only to be of interest to investors running small funds or personal accounts.

COMPANY HISTORY

Urbana has been managed by Caldwell Financial, an investment management company operated by Tom Caldwell, since the 1980’s. Historically, Urbana was a public vehicle for investors looking to gain exposure to seats on various exchanges, or private investments in various global exchanges. Over time many of these exchanges converted to public equity holdings either by public listing or by merger. Urbana continues to hold meaningful positions in some of these exchanges, and also continues to invest in privately held exchanges as opportunities become available.

Urbana was originally listed as a mining issuer on the Toronto Venture Exchange but in July 2005 converted from an operating company to an investment company, starting with an initial portfolio of a handful of membership seats on the NYSE. The value of these seats increased dramatically that year as the NYSE took steps to demutualize and complete its transformation to a for-profit public company.

The Urbana portfolio appreciated by 77% during 2005 on what started as a $6M portfolio despite taking a write-down of over $1M on the company’s resource holdings that year. In 2006, the value of the portfolio more than doubled again.

In 2007, Urbana took advantage of the sudden surge in investor interest in stock exchanges by raising more than $235M in new capital in 2007 through two secondary offerings of

stock and warrants. Shares outstanding increased from 10 million at the end of 2006 to over 78 million at the end of 2007.

NAV per share increased to $3.37 at year-end 2007, and Urbana put a lot of the money it raised to work in ownership stakes and seats on securities exchanges around the world. As the year 2007 ended, investors were willing to pay a nearly 50% premium to own Urbana shares, presumably due to the desire to get exposure to the holdings in non-public exchanges. On December 31, 2007, the closing price of Urbana voting common stock was $5.40 and the Class A shares was $5.15 and the NAV was $3.37.

After the really great years from 2005 to 2007, Urbana’s portfolio performed poorly for the next four years, with NAV per share declining by 38.9% in 2008 and then suffering single-digit percentage declines in each of the next three years as well. The stock had fallen to roughly a 47% discount to NAV by the end of 2011, and the discount to NAV only gradually worked back to the mid-30s after a series of good years.

Urbana put up six excellent years of compounding NAV beginning in 2012 and running through year-end 2017, before suffering a -15.8% decline in NAV (dividend adjusted) in 2018. At December 31, 2018, Urbana’s reported NAV per share was $4.15, while the Class A shares traded for $2.21, or a roughly 47% discount.

Overall, Urbana has put up a very good historical track record. In its historical return figures cited in monthly press releases, Urbana calculates its inception-to-date track record back to October 1, 2002 and therefore includes three years of performance from when Urbana was very small and included some natural resource exploration assets. From what I can tell, the track record for the public company effectively started in July 2005.

In any case, from its inception on October 1, 2002 through January 31, 2019, Urbana had compounded NAV per share at 14.0%, which assumes the reinvestment of all dividends

and also includes taxes paid at the corporate level by Urbana. However, Urbana did have a very poor year in calendar 2018 that saw NAV per share decline by 15.8%. Looking back prior to 2018, if one were to look at Urbana’s inception to date performance through year-end 2017, the compound IRR was 16.1% since inception, beating the S&P500/TSX Canadian index by about 700 bps per annum.

The table below shows the year-by-year NAV per share, the change in NAV on a percentage basis each year, and the shares outstanding at the end of each year.

Year Ended NAV/Share NAV % Chg S/O

2005 $1.26 77.5% 9.000M

2006 $2.69 113.5% 10.000M

2007 $3.37 25.3% 78.062M

2008 $2.06 -38.9% 77.100M

2009 $2.00 -2.9% 87.526M

2010 $1.83 -8.5% 81.066M

2011 $1.70 -7.1% 74.408M

2012 $1.86 9.4% 69.579M

2013 $2.89 55.4% 60.525M

2014 $3.25 14.3% 57.548M

2015 $3.48 8.7% 53.389M

2016 $4.48 30.8% 52.863M

2017 $5.03 14.8% 50.000M

2018 $4.15 -15.8% 50.000M

Note: NAV/Share and % change is adjusted for the impact of dividends beginning in 2014.

The management of Urbana has always demonstrated their awareness of the discount and has taken reasonable steps over the years in an effort to close the discount. Urbana first applied to the TSX to do a Normal Course Issuer Bid (NCIB) in August 2008 and began buying back stock for the first time. There were 77.5 million Class A (non-voting) shares and 10 million common (voting) shares outstanding at that time for a total of 87.5M shares. Today, there are 40 million Class A shares and 10 million common (voting) shares for a total of 50 million, such that total shares have been reduced by 37.5 million on an

original 87.5 million base, or a 43% decline in shares outstanding in a space of about nine years.

The table below shows the historical share repurchases done for each NCIB period. It is interesting that Urbana has not bought back shares in the past couple of years, but Urbana has applied for an NCIB program for the period ending in August of 2019.

Normal Course Issuer Bid Period Shares Purchased Avg Price

Aug 28, 2008 – Aug 27, 2009 1,336,582 $1.28

Aug 28, 2009 – Aug 27, 2010 3,083,920 $1.32

Aug 28, 2010 – Aug 27, 2011 7,431,300 $1.27

Aug 28, 2011 – Aug 27, 2012 6,636,033 $1.01

Aug 28, 2012 – Aug 27, 2013 5,989,067 $1.18

Aug 28, 2013 – Aug 27, 2014 5,386,000 $1.78

Aug 28, 2014 – Aug 27, 2015 4,700,000 $2.02

Aug 28, 2015 – Aug 27, 2016 1,332,400 $1.98

Aug 28, 2016 – Aug 27, 2017 2,967,600 $3.12

Aug 28, 2017 – Aug 27, 2018 0 -

Aug 28, 2018 – Aug 27, 2019 0 -

Also, back in February 2014, Urbana initiated a dividend policy and paid its first annual dividend to shareholders of 5 cents per share in March 2014. Following the strong portfolio performance in 2016, Urbana added a special dividend of 5 cents in 2017 (for a total payout of 10 cents). In 2018 Urbana increased the regular dividend to 7 cents and added a 3-cent special dividend to keep the total payout at 10 cents. However, in early 2019 Urbana declared only the 7-cent regular dividend and omitted any special dividend. The 7-cent dividend represent about a 3% yield at today’s stock price for the A shares of $2.36.

URBANA’S PORTFOLIO TODAY

As of February 15, 2019, Urbana’s portfolio was roughly $225M in assets. Roughly 68% of the portfolio is invested in liquid securities, and 32% are invested in private investments. The portfolio is predominately invested in financial companies. The top 12 holdings comprise roughly 75% of AUM.

The biggest publicly traded holdings were Bank of America (7.7% position), Morgan Stanley (6.8%), Real Matters (a Canadian listed company that had previously been an Urbana private investment, 6.7%), the Bombay Stock Exchange (which Urbana invested in when it was private back in 2010 and 2011, 6.7%), CBOE Holdings (6.3%), Citigroup (6.1%), TECK Resources (5.6%), and ICE (5.6%).

The biggest holding and largest private company investment is the Canadian Securities Exchange, of which Urbana owns a 49% stake. Urbana increased its valuation of CSE in late 2018 from $1.29 per share to $2.00 per share due to the strong growth of the exchange. CSE is roughly an 11.8% position.

Another privately-held exchange position is the Minneapolis Grain Exchange, which is about a 4% position for Urbana.

The other non-public ownership positions include a 15.6% stake in Caldwell Financial itself, which through its subsidiary Caldwell Investment Management (CIM) is the advisor to Urbana and which is otherwise 100% owned by its own employees. Urbana closed this transaction in mid-2012, and paid a price which is equivalent to what Caldwell employees would pay, which was set at a price which Thomas Caldwell noted in a letter to investors is likely “a half to a third of the estimated price which would be received for a full sale.”

Also, Caldwell tends to distribute much of its earnings each year to its employee-owners (presumably making distributions to Urbana as well) and as such this should be a decent holding for Urbana. In its fair value disclosures, Urbana notes that it values its stake in Caldwell Financial as prescribed by a formula in its shareholder agreement, which is defined as 1X net fees plus net assets. This is listed as a 1.1% position, but my guess is that the value is understated in the NAV calculation.

It is somewhat typical for Urbana to have a smattering of smaller positions in Canadian-listed energy and gold companies, but these positions tend to be somewhat shorter term investments and change frequently.

Finally, Urbana still owns mineral claims in Urban Township, Quebec from back in the days when it was a mining issuer. Urbana holds 44 claims in the area totaling 2,852.7 acres. Some exploration work has been done to determine if the claims contain any gold or other metal resources, and Urbana has incurred expenses of about $1M over the past couple of years. No proven resources have yet been reported, and Urbana expects its capital spending for further exploration to be immaterial. Urbana issued a press

release back in early 2015 to announce a joint exploration agreement with a junior Canadian miner called Beaufield Resources. Beaufield was acquired by Bonterra in mid-2018. I assign no value to this asset, but I guess it represents a call option of sorts.

URBANA MANAGEMENT FEES & EXPENSES

I noted above that Urbana is managed by Caldwell Investment Management, which is owned by Caldwell Financial, which in turn is 15.6% owned by Urbana. CIM is paid an asset management fee of 1.5% of the market value of Urbana’s investment portfolio. As a publicly traded company there are also some additional professional and administrative expenses. In addition, Urbana has to pay Canadian withholding taxes on the dividend income of its non-Canadian investments. These expenses total about $1.7 to $2M per year. Dividend and interest income from the portfolio has been about $2.5M per year in

recent years and is generally easily sufficient to pay for the non-management expenses.

Urbana also runs its trades through Caldwell Securities (CSL), which is a sister company of Caldwell Investment Management, and a registered broker-dealer. Urbana also pays CSL for some administrative services and certain corporate functions.

My view is that 1.5% is not terribly excessive for a company that has proven to add some value from its private investment activities and which seems to be reasonably accomplished in its specialized niche of investing in securities exchanges. Given that Urbana shareholders also own 15.6% of Caldwell Financial, in this case I think that one would be hard-pressed to argue that Urbana shareholders are unduly penalized by the management fee and expense ratio charged to the fund.

I will mention that Urbana issued a press release in June 2018 that stated that CIM was “the subject of an Ontario Securities Commission proceeding” but that CIM had been “in discussions with the OSC and is attempting to resolve the issue.” I don’t know any further information and didn’t notice further disclosure in the Q3 financial reports for Urbana. My guess is that it isn’t a terrible risk for Urbana shareholders.

I mentioned the structure change that occurred in 2015 under which Urbana reverted from a closed end fund to an investment corporation (which it had actually been earlier in its history from 2002 to 2005 prior to converting to a closed end fund). This was in response to a Canadian securities regulation passed that year regarding closed-end funds that restrict CEFs from taking 10% or greater ownership stakes in underlying companies, as well as some other rules that would prevent Urbana from pursuing its strategy of occasionally investing in private companies with meaningful ownership percentages.

I haven’t noticed any meaningful impact in terms of Urbana’s investment activity and reporting since the change was implemented.

Urbana’s website provides very thorough information regarding the portfolio and the company history. The website contains all the annual reports from 2005 to today as well as a full archive of news items and financial filings.

Finally, I should briefly explain the share structure. There are 40 million Class A shares which are non-voting. There are 10 million common shares which have voting rights. This write-up focuses more on the Class A shares simply because they are more liquid, but the analysis applies equally to the common shares. As of this writing both classes of shares were trading at around $2.36.

The bottom line is that at the current price of ~$2.36, an investor can buy a portfolio worth about $4.40 or so (based on latest stock prices) for a discount of about 47%. Put differently, each dollar of shares buys you about $2.12 worth of securities. I can’t see any rational reason for the discount to be this wide. I also have no idea why the discount has widened to such an extent, nor when it will narrow (or if it will). I do think that Urbana management will take further action at some point to close the discount, such as a

resumption of the share buyback activity. The currently indicated dividend of 7 cents per share is roughly a 3% annual yield. I think it’s a reasonable investment opportunity for investors who can play a small, not very liquid idea.

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

Not sure of the timing of any specific catalyst, but a 47% discount to a decent portfolio of mostly liquid securities is just too wide.
I do expect Urbana to resume buying back stock under the new buyback plan sometime in 2019.
If the discount persists at this level, eventually somebody is going to do something, whether it be Caldwell or some outside investor.

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			2019	2020
Price:	2.36	EPS	0	0
Shares Out. (in M):	50	P/E	0	0
Market Cap (in $M):	118	P/FCF	0	0
Net Debt (in $M):	0	EBIT	0	0
TEV (in $M):	0	TEV/EBIT	0	0