Spectrum's Spin-Off and Reverse Split Creates Opportunity - SPGZ

Spectrum Group International is undertaking a complicated spin-off/deregistering transaction. Spectrum will first spin off A-Mark Precious Metals, its consistently profitable precious metals trading business, separating that good business from Spectrum's smaller and loss-making collectibles business. Shareholders will receive 1 share of A-Mark for every 4 shares of Spectrum they currently hold. Immediately following the spin-off, Spectrum will execute a 1 share for 1,000 shares reverse split, reducing the number of shareholders in the remaining collectibles business below 300 and ending the company's financial reporting obligations. Fractional shares resulting from the reverse split will be cashed out at $0.65 per pre-split share.

In my opinion, the market has failed to accurately price Spectrum's shares for the value that will be delivered to shareholders as a result of the transaction. This is a classic scenario in which a company's earnings power will no longer be obscured by a struggling segment, potentially leading to appreciation once the albatross has been removed.

First, a brief overview of Spectrum's existing operations is due. Spectrum is a dealer of precious metals, including bullion and coins. While I believe the investment value of such items is dubious at best (and I think I am in good company), many seem to disagree and gold, silver and platinum coins and bullion are in demand world-wide. Spectrum serves as middleman between buyers and sellers of these items and also provides secured loans to precious metals collectors, dealers and investors. Spectrum's collectibles division deals in rare and antique coins and wines. It must be noted that Spectrum is not a precious metals speculator, and does not attempt to profit by trading precious metals futures or physical metals. Spectrum profits regardless of metals prices, simply earning a spread on transactions.

Spectrum has been consistently profitable, though its profits have ranged widely in recent years. On average, Spectrum earns the majority of its pre-tax income through its lending operations. The historical results shown below are adjusted for one-time items like goodwill write-offs and litigation expenses.

Spectrum's consolidated historical results tell only part of the story. In reality, Spectrum's strong A-Mark business has been subsidizing heavy losses from the collectibles business. The figures shown below are adapted from the company's proxy statement dated February 7.

The collectibles business accounted for 38.7% of Spectrum's total gross profits for the twelve trailing months, but a whopping 68.3% of operating expenses. The segment's adjusted pre-tax net loss has exceeded the entire company's adjusted pre-tax income since at least fiscal 2012.

Clearly, Spectrum's reported profits would look much better if the collectibles division's losses were excluded. And that's exactly what will happen once shareholders receive shares in A-Mark, the precious metals trading business. Spectrum has provided pro forma historical earnings data for the A-Mark business alone.

For each share of Spectrum currently held, shareholders will receive 0.25 shares in A-Mark. The implied look-through A-Mark EPS per share of Spectrum is $0.42. At Spectrum's current share price of around $2.60, the implied valuation of A-Mark is extremely conservative, especially when the value of the remaining business is taken into account.

The situation is best for smaller Spectrum shareholders who own fewer than 1,000 shares. The $0.65 in cash per share they will receive from the reverse split brings the current share price to $1.95, which values A-Mark Precious Metals at only 4.6x trailing earnings. Holders of more than 1,000 shares face the conundrum of projecting the value of the remaining collectibles business, since their shares will not be cashed out in the reverse split. Conservatively valuing those shares at 30 cents each, less than half of the reverse split valuation, Spectrum's current share price values A-Mark at 5.5x trailing earnings. Disregarding the value of the collectibles business altogether still values A-Mark at only 6.2x trailing earnings.

The tables below show the current value of Spectrum's shares at various A-Mark P/E ratios for both large and small shareholders.

At a very reasonable 8.0x multiple of A-Mark's trailing earnings, Spectrum's current value per share is $4.01 for small shareholders and $3.66 per share for larger shareholders. Either of these prices represents a large premium over today's price of around $2.60. Purchasers at the current price have a good chance of realizing appreciation once Spectrum's losing collectibles business is separated and A-Mark's earnings power becomes apparent.

Alluvial Capital Managment, LLC holds shares of Spectrum Group International for client accounts.

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