Argentina or how to adjust for Nationalization risk (Cresud edition)

And now to something completely different…

The story of the seizure of YPF, the Argentinian subsidiary of Repsol was on the news everywhere.

Accounting “Uber-guru” Aswath Damodaran had a great piece up yesterday about how to reflect Sovereign risk. He openly admits, not to have though too much about this issue before.

He brings up several possibilities to reflect this risk in intrinsic valuation, which are:

Option 1- Use a “higher required return or discount rate”:
Option 2: Reduce your “expected cash flows for risk of nationalization:

Option 3: Deal with the nationalization risk separately from your valuation: Since it is so difficult to adjust discount rates and cash flows for nationalization risk (or any other discrete risk), here is my preferred option.
Step 1: Value the company using conventional discounted cash flow models, with no increment in the discount rate or haircutting of the cash flows. The value that you get from the model will be your “going concern” value.
Step 2: Bring in the concerns you have about nationalization into two numbers: a probability that the firm will be nationalized and the proceeds that you will get if you are nationalized.
Value of operating assets = Value of assets from DCF (1 – Probability of nationalization) + Value of assets if nationalized (Probability of nationalization)

Intuitively I would also prefer option 3).

So let’s look at a real world example: Cresud

Cresud is an Argentinian company which according to Bloomberg

purchases and leases farms in Argentina’s Pampas region, and produces agricultural products. The Company cultivates grains including wheat, corn, soybeans, and sunflowers, raises beef and dairy cattle, and produces milk.

As one of the few “pure” agricultural plays and has traded ADRs, Cresud is a favourite of some very well known value investors like Fairfax and Monish Pabrai.

Now we can see what Damodoran described in “real world action”:

One US ADR reperesents 10 Argentinian shares.

As of yesterday, the US ADRs were traded at 10.90 USD, which would be 1.09 USD per share. The Argentinian shares were traded at 6 Argentinian Pesos which translate at the current rate of 4.40 ARS/USD into a price of 1.36 USD per share. A discount of around -25% for the foreign shares compared to the local shares.

If we look at the historical spread graph, we see that with the exception of the panic in 2008, the ADRs tracked the stock pretty well, so the current divergence definitley reflects Nationalization risk.

I have no idea if Cresud is in danger of being nationalised and if it is an interesting “special situation”, but it is still interesting to see how this one will turn out.

4 Kommentare

  • Your calculation implies that the argentinian Cresud shares are not affected by a possible Nationalisation of Cresud.
    I have another explanation for the Discount of the Cresud Adrs.
    Because of the Currency Controls there is a black market for arg. Pesos with a lower rate than the official rate.

    http://www.reuters.com/article/2012/03/27/argentina-peso-idUSL2E8QR46S20120327

    • Hi derivatus,

      yes, this could also be part of the explanation. However if you look at the price divergendce, this started well after currency controls were implemeneted.

      At the moment, both securities are declinign significantly as the Argentinian Government has lost teh remianing credibilty via investors. The US ADRs are still 25% cheaper, but I guess arbitrage is not easily possible.

      MMI

  • Hi MMI,

    For a long time I loved Cresud, but hated Argentina (well, except their women, steak & wine..!). Bit of a dilemma, but Cresud’s opportunity and cheap valuation won. Until the YPF nationalization…that’s the last straw!! Cresud now feels like one of those cheap value stocks you think want to own, but which everybody else will keep selling and where the opportunity/catalyst to extract its intrinsic value looks increasingly remote:

    http://wexboy.wordpress.com/2012/04/17/nope-not-going-any-further-with-that-drag-queen/

    But hey, one plus: I almost feel like Ukraine’s a safe place to invest these days, when I compare it to Argentine government insanity… ;-)

    • hi wexoy,

      I read your posts about the Ukrainian Egg producer, very interesting. However I got already cold feet with Magyar Telecom from Hungary.

      Nationalization is a risk I don’t feel really comfortable with. Same applies for countries with very limited Corporate Governance rules (CHina).

      it is very unpredictable and a lot of people ignore it in good times.

      MMI

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