A Profitable Scrap With The King

By The Noble Contrarian on May 24, 2011 in Other

On August 16, 2007, mortgage company Rams Home Loans released an announcement to the stockmarket. Undated and on plain paper, the mysterious one-pager carried an innocuous heading: ‘XCP Market Funding Update’.

The information to which it referred meant the end of Rams as we knew it. The company, at the time listed on the ASX for all of 14 business days, was telling its shareholders that the major source of funding for its home loans had, as of that day, ceased to exist.

I remember the day clearly. RHG’s listing price was $2.50. After the announcement, The Intelligent Investor’s then research director, Greg Hoffman, spent the next two hours yelling at me: “Rams: 90 cents. Rams: 80 cents. Rams: 70 cents. Rams: 60 cents…you might want to take a look at this”.

Thus began what has been a long, frustrating but ultimately very profitable association with the company now known as RHG Limited. We bought it at $0.60, $0.30, $0.20 and $0.07. The share price hit a low of 4.6 cents on June 30, 2008, at which point I have to admit to being somewhat nervous.

My entire investment thesis was based on the fact that the loans were non-recourse to RHG. If it couldn’t refinance them, RHG could simply hand the relevant loans over to the funder and continue on its merry way with the remainder of the portfolio. More than a third of the portfolio was funded with long-term loans that matched the length of RHG’s home loans. In the worst case, it could lose the rest of the portfolio but still be left with a valuable portfolio of profitable mortgages. My estimate of the value of the business under this worst-case scenario was $0.30 per share.

As it turned out, RHG lost some funding but not enough to sustain much damage. The portfolio of mortgages from which it generates a profit was still $4.5 billion as at December 31, 2010. In the three years since its funding crisis, RHG has generated more than $300m in cash (at the share price low of 4.6 cents, investors were valuing the whole company at $20m).

This is what I do for a living. I find companies trading on the stock exchange for substantially less than they are worth, and then I wait for that value to be realised. More often than not, it’s the ‘realisation’ part that is difficult. And so it proved with RHG.

For years we were having a running battle with the company to get it to pay out the cash. Despite generating hundreds of millions of dollars in profit, the company’s chairman and largest shareholder, John Kinghorn, refused to pay a dividend. We tried to meet with Kinghorn but he refused, we called a meeting of shareholders, ran for the board and failed, we wrote critical reviews and we whinged to the newspapers.

None of this seemed to make much difference, until last month.

Finally Kinghorn did enough to upset the institutional fund managers too. His threat to delist the company after a low-ball buy back offer was too much for even the most risk-averse of instos to stomach.

When it came time to vote this time around, fund managers Geoff Wilson and Karl Siegling had convinced most of the insto investors not to approve the buy back. I had done my best to rally retail shareholders, and the result was an overwhelming rejection of Kinghorn’s offer (123 million against, 18 million for).

Not only did we reject the buyback, we also showed that we have the votes to change the board if we wish. Kinghorn capitulated, declared a $0.79 fully-franked dividend to all shareholders, committed to returning the rest of the company’s assets to shareholders as soon as possible and agreed to appointing a number of independent directors to the board.

As I write the share price is $1.24 (it will be at least $0.79 lower once the dividend is paid). It’s been a rollercoaster ride – but a fun one to say the least.