Sprott Resource (SCP.TO) – Trading below NAV but I’m not buying it

Sprott Resource Corp is somewhat similar to a publicly-traded closed-end fund.  It is a vehicle for generating asset management fees for Sprott Inc. (SII.TO).  SCP is currently buying back its shares as they are trading at a ~21% discount to NAV.  Normally I like situations where undervalued companies are buying back their shares.  However, I’ve been learning (the hard way) that management matters.  While SCP’s management is not the worst in the business, I am not enthusiastic about it.

Agriculture

If you own farmland, you can rent it out to a farmer and generate positive yield on your investment.  In my opinion, something is terribly wrong if you lose money farming.  The sensible thing to do is to avoid farming, unless you know farmers who are really good and can farm profitably.

SCP’s agricultural segment has lost money every year it has operated (since 2009).

Performance

At the end of 2007 when Sprott took over, book value per share stood at around $3.33.  Current book value per share is around $3.47.  The company has more or less moved sideways in six years while commodity prices have gone up.

Does management have integrity?

In my opinion, few parties in the financial industry take their fiduciary duty seriously.  Sprott is no exception and could do better.  The various Sprott entities often arbitrage their own shareholders or allow them to be victims of arbitrage.  For example, there have been times where PSLV (Sprott Physical Silver Trust) has traded at a large premium to NAV (this blog post explains the situation).  Instead of trying to protect new shareholders from overpaying for PSLV, Sprott is advertising/pumping the trust on Google Adwords and trying to profit from the situation (e.g. through secondary offerings).  The physical silver trust is a silly product that is harmful to its buyers.  I disagree with its existence.  To keep things in perspective, this isn’t the worst behaviour in the world.  Sprott is still far better than the Sheldon Inwentashes and Stan Bhartis of the world, who are better than the Robert Friedlands out there.  But what Sprott does is still gimmicky and tacky.

In general, I would like to see the financial industry put more of a focus on value creation.  The financial industry could be creating value by putting capital in the hands of competence people, such as farmers which know how to farm profitably.  Unfortunately, Sprott-related entities have often put capital in the hands of incompetent people (one of my older blog posts covers this).

As far as SCP goes, SCP is run by Kevin Bambrough and not Eric Sprott.  It may be unfair of me to blame Bambrough for everything that other Sprott-related entities have done.  My snap judgement is that SCP is more of the same.  SCP’s website and annual reports are beautiful and promotional.  They know that they will make more money if they grow assets under management and sell shares in secondary offerings.

As far as insider compensation goes, it is fairly high.  SCP pays roughly 2% of NAV and 20% of profits to SII (at least I think it does; I did not read very closely).  If the management agreement is terminated, SII gets 5% of assets under management and 20% of the premium of SCP’s share price over NAV.  I don’t think that’s fair to shareholders as Sprott would be rewarded for being fired even when it has done a bad job.

The big picture

Ex ante, I don’t think that Sprott Resource will post great performance.  The 2 and 20 is a huge drag on performance.  If there were no discount to NAV, I would rather own a S&P 500 index fund.  (To be fair, I think that SCP will likely outperform the S&P 500 before fees.)  The problem is that the fees make this a bad business.  The undervaluation has to be extreme before I would be interested in buying SCP.

*Disclosure: No position.

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