Last week marked the successful conclusion of my first liquidation investment – Terra Nova Financial (TNFG).

I originally picked up the stock back in October 2010, when the stock was trading below the lower bound of the director’s estimated liquidation range.

On August 15, the company distributed a press release announcing a final liquidation distribution of $0.103 per share payable on August 19, 2011.

This was a pleasant surprise, as TNFG’s March press release had estimated a final stub payment in the range of $0.04 – $0.07 per share.

Here are the final results of the workout:

Not stunning, but a nice result for my first attempt at this type of investment.

Joe Ponzio at F Wall Street summed up a good maxim for investing in workouts:

“The question is: Upon thorough analysis, do they offer safety of principal and a satisfactory return. To answer the first part, you must know the deal; to answer the last part, you must know the timeline.”

If you have followed the series of posts on TNFG, the one constant is my utter inability to predict the timing of the various payments – but I at least had a timeline and worst-case scenario in mind.

The lesson here is to always be extremely conservative when estimating the timing and return possibilities for these type of investments.

While the returns are certainly welcome, the best part about these types of opportunities is that they are largely uncorrelated with the rest of the market.

In these volatile times, I’d be very happy putting a much larger percentage of my portfolio into these types of scenarios, and will be actively searching for similar situations.

Note: This is my 100th post at ValueUncovered.com. Thank you to everyone who has visited and supported the site!

On Friday, Terra Nova (TNFG) announced a second dissolution payment as part of the company’s continued wind down. This second payment consists of $0.28 per share, payable on March 22 to shareholders of record on March 14.

TNFG was added to the Value Uncovered portfolio back in late October, when the original liquidation plan was announced. The initial plan estimated total distributions of $0.95 to $1.07 per share.

This second payment is on top of the initial payment of $0.72 per share in late November, bringing the total distribution to $1.00 per share.

At least one additional distribution between $0.04 – $0.07 per share will follow.

I’ve included a section of the press release below:

“Including the dissolution distribution announced today, the Company has declared cumulative dissolution distributions to shareholders of $25 million, or $1.00 per share, since the approval of its Plan of Dissolution. Based on TNFG’s current estimates of its post-closing expenses, assets and liabilities, TNFG estimates that after this distribution it will in time have approximately $1.0 million to $1.6 million in cash available for distribution to its shareholders (approximately $0.04 – $0.07 per share). One or more additional distributions are expected to be made in connection with the continued winding up of TNFG.”

Return Scenarios

The latest payment will recoup the initial costs for the transaction ($0.94) and guarantee a positive outcome. The timing and amount of the final distribution will affect the total gain on the transaction.

Here was my initial scenarios:

(My forecasting skills are not my strong suit!)

The timing of the distributions went mostly according to my initial plan, but the first distribution was much smaller than I anticipated, reduced the annualized return.

Here are the revised scenarios:

Definitely a positive result but not quite as attractive as I had initially hoped.

Conclusion

Estimating the breakdown and exact timing of distributions is a difficult task, so ensuring a strong margin of safety is very important.

With the market continuing to shoot-up over the past few months, these annualized figures do not appear quite as attractive.

However, in a downward market, these transactions shine by offering a level of protection from broad-based market losses. I’m constantly on the lookout for additional qualifying transactions – contact me if you run across something interesting.

While they might cause the portfolio to underperform slightly in the short-term, they will be a nice protection during the inevitable pullback.

Disclosure

Long TNFG

Terra Nova Financial Group Inc (TNFG) is another liquidation investment that recently completed a sale of substantially all of its assets.

Following the asset sale, TNFG will formerly dissolve the company and liquidate remaining assets, with estimated total distributions to shareholders of between $0.95 to $1.07 per share.

With the stock trading at $0.94, the high-end of this range represents a possible return of almost 14% in only a few short months.

History

Terra Nova is a registered broker dealer based out of Chicago. The stock has languished since the internet bubble popped back in 2000, and the company has a storied history – it was investigated for failing to maintain adequate procedures regarding automated trading in client accounts in 2008.

Most recently, TNFG was linked to the unusual trading action in Proctor & Gamble stock during the flash crash in May 2010.

On June 16, 2010, the company announced that it would sell 100% of its membership interest to Lightspeed Financial, Inc. for a total of $27.6m.

The purchase would be payable with an initial cash payment of $22.6m, followed by a $5.0m promissory note due within six months of closing.

After the sale, TNFG’s only assets would consist of cash that would be distributed to shareholders as part of the dissolution and liquidation of the company.

The transaction required approval by the company’s shareholders along with regulatory clearance (a voting agreement for approx. 44% of shares agreed to vote for the asset sale, almost ensuring the vote would be approved)

Timeline

On September 15, 2010, Terra Nova announced that the asset sale was approved at a special meeting of shareholders.

On October 20, 2010, the companies announced the formal completion of the asset sale for the agreed-upon price of $27.6m.

According to the press release,

“TNFG expects to make an initial distribution of cash soon after the closing of the sale of Terra Nova Financial and the dissolution of TNFG, with a further distribution being made in connection with the expected liquidation of TNFG following receipt of cash payment on the Lightspeed promissory note. “

Based on these results, the initial cash distribution should be announced and distributed very soon, likely sometime in late November or December.

Final distribution should occur by April, although possibly several months sooner if TNFG can finish clearing out all trades and obligations.

Liquidation Value

While the company hasn’t released audited financial statements breaking down the account values for its liquidation estimates, management currently estimates that shareholders will receive cash distributions between $0.95 and $1.07 per share.

With 25.05m share outstanding, the full purchase price of $27.6m would translate into a per share price of $1.10 – obviously there will be additional liabilities and expenses to wind down the company but management’s estimates look reasonable.

Return Scenarios

Note: These return scenarios do not account for transaction and commission costs, which could significantly affect the return calculations.

Risks

In any liquidation, the biggest risk is an inaccurate estimate of the total amount of distribution proceeds, causing a capital loss on the workout. The transaction could also get held up in legal or regulatory hurdles which could significantly delay distributions, potentially by years.

The risk in TNFG’s case is mitigated since the company expects to distribute a large portion of cash early in the process, allowing an investor to put that money to use elsewhere.

Specific to this transaction, there is also a risk that Lightspeed backs out of the final promissory note, although I view this scenario as remote.

Conclusion

The TNFG stock liquidation presents a solid risk/reward scenario for investors looking for special situations investments or workouts.

I have made several assumptions regarding the timing and amount of the initial distribution – modifying these assumptions will significantly affect the annualized return on this investment.

By buying now, investors are getting an (almost) free call option to roll the dice for future gains.

I’m adding TNFG to the Value Uncovered portfolio at Friday’s closing price of $0.94.

Disclosure

Long TNFG