A riddle wrapped up in an enigma

Glancing at Coats‘ half-year results shows the book value of its equity minus non-controlling interests was $539m last June, which at current exchange rates is about ''340m. It’s not listed, but the investment company that owns it, Guinness Peat is. The market values Guinness Peat at ''470m, but there’s a lot more to Guinness Peat than Coats and I’m wondering if a complicated story is obscuring an undervalued gem…

Guinness Peat is liquidating its other investments, probably all of them except Coats, and the book value of Guinness Peat last June was an eye popping ''1.1bn.

In the first half of the year, Guinness Peat disposed of ''98m of investments, receiving ''4m more than their collective book value. In a statement on 17 November the company revealed ''34m more in disposals, and that it had returned ''80m to shareholders. Since then it’s sold its stake in Autologic, and perhaps other investments.

So the value of Guinness Peat is difficult to pin down, it depends on what it gets for its investments as it liquidates them and the growing value of Coats.

But already the market value of Guinness Peat is approaching the book value of Coats, and that I think makes it a very interesting proposition.  Adding shares to the Thrifty 30 soon, could net an undervalued company plus the proceeds from further liquidations.

The wrinkle in the market this time might be investors’ indifference towards a company (Guinness Peat) selling off undervalued assets (Guinness Peat was a value investor) when the timescale, although leisurely, may not be sufficient to realise their full value.

And perhaps the market is unaware of the value in Coats, which has a chequered past, is hidden inside Guinness Peat and doesn’t get the attention it will if it’s listed on its own.

Judging by Coats’ 2010 annual report, it’s worth a look.

Coats was founded in 1755, and is still in the same trade, supplying yarns, sewing and needlework products. Now it sells in 100 countries and one in five garments are held together using Coats thread, so it has some of the qualities of a hidden champion (it’s a big, global player in a niche market). Being three times the size of rival firms, it dominates the industrial thread and yarn market and it’s smaller crafts division is six times the size of its next largest rival.

It supplies zips, produces designer fabrics, and its threads and yarns are found in surprising places including fibre optics, passports (the company describes tracer threads as "a huge growth opportunity"), human beings (medical stitches), cricket balls, air bags, seat belts and tea bags.

The front pages of the annual report are quite a showcase, billing Coats as the world’s first multinational. Return on equity was 23% in 2010, although the company is indebted. In June 2011 the ratio of equity to assets was 34%.

I can see why Guinness Peat might want to expose this ‘jewel’ to the market and get a better valuation by ridding itself of the rest of its portfolio.

But the jewel has required some polishing. Profitable in 2010, it made a loss in 2009, and the previous six years of Guinness Peat’s ownership have been marked by the extensive restructuring of what was once a FTSE 100 company.

Guinness Peat’s management have high hopes. According to the FT, a stepped incentive plan granted to Coats executives last year would give them 15% of any increase in Coats’ value above $1.35bn by March 2014 up to a maximum of about ''100m. The likely cost of the incentive plan, estimated in Coats’ half year results at ''12m, may give a better indication of expectations.

A director describes the scheme as "win-win" for shareholders and management if the targets are met, typical of private equity situations. I say it’s a gamble on a cyclical recovery and turnaround in the business, and, if it happens, it will be very hard to determine how much the bonus is down to the skill of the turnaround and how lucky the executives were to be in the right place when its industrial and craft markets recovered.

Guinness Peat’s defined benefit pension schemes are also off-putting, two of which belong to Coats. The total obligation in 2010 was nearly ''2bn, which dwarfs even the target value set for Coats.

Even so, Guinness Peat could be a very good investment, and I may have to decide whether to walk away on principle or be a critical ‘shareholder’.

Since full year results for both companies, Guinness Peat and Coats, should be published in a week or so, I’m preparing to take a closer look.