U.S. Markets closed

How to Retroactively Buy Texas Pacific Land Trust

- By batbeer2

This investment idea can be summarized in a couple of sentences. The rest of the article is background I'm sharing so readers can poke holes in my reasoning and data.

Shares of Renn Fund Inc. (RCG) represent an opportunity to acquire a portfolio of publicly traded stocks at a 30% discount. The portfolio is managed for free by capable and shareholder-friendly management, and the discount can be expected to close soon.


Business and history

Originally known as Renaissance Capital Growth & Income Fund III Inc. (RCG), the company was founded in 1994 by Texas investment professional Russell Cleveland. Cleveland raised $40 million worth of capital by selling 4 million shares to the public at $10 a piece. The capital was used to acquire stakes in various small companies, many of which were not (yet) publicly traded.

The company was run with little leverage and business went reasonably well initially. By 2006, the company had paid out $40 million worth of cumulative dividends, and assets under management stood at $40 million. Investors who had stuck with it would have recouped their original investment and now owned a $40 million company for free. The investment advisers could argue they had earned their annual fees of roughly $1 million.

In the crash of 2008 and 2009, the value of the assets dropped to $10 million. From such a small base, it proved difficult to generate satisfactory returns while bearing the costs of being publicly traded and paying the investment advisers a reasonable fee. By 2016, with assets still at roughly $10 million, and shares trading at a discount to Net Asset Value (NAV), the directors decided to liquidate the company.

That would be the end of it if the board had not subsequently received an offer they could not refuse. Horizon Kinetics, founded in 1994 by guru Murray Stahl (Trades, Portfolio) and Steven Bregman, offered to manage the company and its investment portfolio for free.

With its solid reputation, Horizon Kinetics was in a position to raise new capital. Shareholders were in favor of this arrangement and handed Stahl the keys of the company.

Competitive advantages

In addition to the low cost structure and solid reputation of its management, which enables it to raise new capital, the fund has significant tax loss carryforwards that it can use to offset taxes on any future capital gains.

Valuation

Renn last reported its holdings as of June 2018. In addition to a pile of cash and government bonds, the company had two significant investments, $2.5 million worth of stock of Bovie Medical (now Apyx) and $1 million worth of Texas Pacific Land Trust (TPL).

Apyx is one of the fund's legacy holdings and Texas Pacific (TPL) is Murray Stahl's favorite stock. Apyx has doubled since June, and Renn's net asset value (NAV) has run up accordingly. Renn's price has not. The per-share intrinsic value currently stands at $2.20, which represents a 37% premium to the current price.

Another way to put it is that Renn's shares offer an opportunity to retroactively purchase shares of Apyx and Texas Pacific .

Outlook

One reason the price of the shares has languished as NAV has gone up is the fact that the fund has been raising capital. One "feature" of this process is that up until Dec. 28, existing shareholders had the opportunity to acquire additional shares at a 10% discount to prevailing market prices.

Existing shareholders knew this and would not be buying in the open market since they had the option of acquiring additional shares through this rights offering. Many (perhaps all?) potential buyers of this nano cap would not be buying in the open market as they had other and cheaper options to increase their exposure if they wanted.

It is safe to assume that not many others were aware of this peculiar situation or were in a position to be buying shares of this illiquid stock in the last weeks of 2018.

This is a technical effect and it is reasonable to expect this to abate over coming weeks and months, causing the discount to NAV to diminish.

In the long run, the performance of the shares will depend on the investment acumen of Stahl and his colleagues at Horizon Kinetics. Texas Pacific itself is worthy of an article or two. That company (actually a trust) has incredibly low costs and high margins for its size. The trust sits on some 400,000 acres of land in the Permian basin. Such land trades for $20,000 an acre. That's a value of $8 billion. Meanwhile the market values Texas Pacific at $5 billion. Those are the current market prices. Depending on oil prices though, the per-acre mineral rights have a net present value of $50,000 to $200,000.

There are various bearish analyses of Texas Pacific, and they boil down to "This company hasn't been selling much of its land since 1881, so this is dead money for the next few decades. Also, the bits of land that the company has sold must be prime so the rest is worth less."

Financial strength

With net assets of $7.5 million, no employees, no debt and no other costs other than auditing fees, Renn is not going bankrupt anytime soon. Eagle-eyed readers will have noticed the company has $3.5 million worth of borrowings on its margin account. This is not unusual for a fund managed by Horizon Kinetics.

It seems Stahl et al have a habit of borrowing from their broker to invest in Treasuries and money market funds at 2.5%. If ever there is a panic and the market crashes, then more likely than not the Treasuries run up. In any case there is enough cash to take care of margin calls.

Management

How many investors do you know who have positions that have gone up more than 100 times? Of those, how many invested more than 20% in that position and still hold it? Stahl (Trades, Portfolio) did that with Texas Pacific, which he acquired in the 1990s. In his view (and mine), Texas Pacific is still cheap. There are not many investors who make Charlie Munger (Trades, Portfolio)'s portfolio appear overly diversified with too much turnover. The new CEO of Renn does that, and his record is satisfactory.

Cleveland remains on the board. Like Stahl, he is paid nothing for his services but has millions invested in the company. One could argue that mere millions are meaningless to the likes of Stahl, who has $6 billion of assets under management. That is not the case for Cleveland though. In any case, management is doing exactly the right things to maximize value and grow the fund. Both men have a decades-long record of treating minority shareholders fairly.

Specific risk

Market risk: The portfolio is highly concentrated and could run down as fast as it has run up in recent months.

Market risk: There is a chance the company continues to raise capital in small incremental amounts. This would cause a further lag between market price and NAV. It also dilutes existing shareholders who fail to participate in the rights offerings (if any).

Liquidity risk: The company could go dark and stop filing with the SEC to further reduce costs. This too could cause the discount to increase.

Disclusure

This is not a recommendation to buy or sell anything. This is an expression of my views about Renn Fund Inc. with an intent of engaging in intelligent discussion about the company and its stock. At the time of writing I held no position in any of the stocks mentioned.

Read more

Renn Fund reports.

Fundamentalfinanceplaybook.com with more background on the involvement of Horizon Kinetics with Renn.

Some more background on TPL from Bloomberg.

Letter to the board of Renn Fund Inc.

Fund statistics and performance.

Land values in the permian basin.

Tpltblog.com notes from some comments by Mr. Stahl last friday.

This article first appeared on GuruFocus.