Agcapita Update May 23, 2012

Agcapita Update

INVESTMENT THEMES - RISK, RETURN AND VALUE IN WESTERN CANADA The challenge current investors face is that sovereign debt default via inflation/currency debasement obviously doesnt create any new wealth but it certainly reallocates it amongst economic participants, and it is a process that takes place largely unnoticed until it is too late for most. Sadly, that is the entire point of the ongoing zero-interest rate policies - to quietly expropriate as much scarce capital as possible for the benefit of bankrupt but politically influential sectors of the economy - particularly in finance and real estate. Where do you invest in such a world - a world of negative real interest rates, bloated central bank balance sheets and solvency challenged governments? I do not intend this letter to be a definitive answer to that question by any means, rather a quick overview of some ideas which we believe are worth consideration. There are still pockets of good risk-adjusted returns to be found in the developed world despite the relentless overall deterioration in western growth fundamentals - or perhaps due to the dogmatically Keynesian mindset of our monetary and fiscal authorities, because of them. I hope it does not come as a surprise that for the diligent researcher there are ways outside of gold to go long monetary malfeasance while obtaining some growth exposure and perhaps a margin of safety as well. Consider the value of commodity-linked returns in a politically stable part of the world - western Canada. Commodity production assets, or more generally commodity linked cash flows, have interesting inflation hedging

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characteristics, can be useful tail risk hedging tools (farmland) and when located in Canada provide linkage to emerging market growth and tight supply dynamics without emerging market risk. In addition, agriculture and energy have another useful quality in volatile times - highly inelastic demand curves. For those unfamiliar with western Canadas commodity endowment, it is a region with less than 10 million inhabitants but is the epicenter of one of the worlds most impressive concentrations of real assets. Its approximate global reserve rankings (or production rankings in the case of beef, timber and wheat) are as follows: Potash - 1 Oil - 2 Uranium - 3 Timber - 5 Wheat -6 Gold - 7 Beef - 10 Natural Gas - 20 The advantage of producing the commodities that the emerging economies need and importing the manufactured goods they make is significant western Canadian growth rates have averaged twice those of central Canada over the last decade. So for investors looking for commodity linked returns with political safety - western Canada is a good choice. Why the reference to political risk? When seeking to generate commodity linked returns political risk can

never be ignored, as I believe it is a key differentiator of returns. Just ask investors in Sino-Forest or YPF to name just two recent demonstrations of this principle. Private Equity (PE): Canada has some of the best PE returns globally (particularly smaller transactions): 10 years Canadian PE US PE <250mm TSX 14.2% 3.4% 3.9% 5 years 16.8% 4.2% 4.1% 3 years 7.2% 0.1% -2.5%

At the most basic level western Canadian PE returns are linked to commodity prices and the consistently higher and more stable rates of growth that have been occurring in this market. However, there are some additional factors driving returns as well: Firstly, there is a strong supply of small & medium enterprise deal-flow in western Canada due to high levels of entrepreneurship (roughly speaking a SME is a business with less than 100 employees or an enterprise value of less than $10 million). SME penetration in the west is almost 30% higher than the Canadian per capita average. per 1,000 pop Canada Saskatchewan Alberta BC Ontario 70 91 92 81 68

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Secondly, the number of Canadian baby boomer retirees has been increasing rapidly and is projected reach more than 40% of the working age population by the late 2010s. It is no secret that baby-boomers continue to be an influential cohort and in retirement will have a significant effect on the pricing of assets, just as they did during their key investment years, except now they are entering liquidation mode. The effect on the private equity market is simple - retiring baby boomer entrepreneurs must sell their numerous SME businesses which should create both deal flow and downward pressure on cash multiples. Phrased another way, PE returns should improve. Saskatchewan Farmland: Since the beginning of 2007 Saskatchewan farmland has appreciated at a rate of over 12% per year due to increasing agricultural commodity prices but much more because of a large price discount to fundamentally identical land in the neighboring province of Alberta. In fact, the differential between the rate of appreciation of similar land in Alberta and Saskatchewan is over 50% with Saskatchewan farmland generating substantial margin of safety returns as the long-term price parity with its neighbour is restored. On a fundamental price per bushel of yield basis Saskatchewan stills trades at a material discount to global averages, a diminishing legacy of regulatory barriers to capital that have disappeared for domestic investors. Conventional Heavy Oil: When investing in conventional heavy oil in western Canada, you are

subject to two discounts: 1) the discount of heavy to WTI prices and 2) the discount of WTI to global prices. Conventional heavy oil represents a relatively inexpensive oil BTU and we believe spreads will compress over time, enhancing returns to heavy oil production assets. In addition, we are experiencing historically low natural gas (NG) prices. The perverse effect of low NG prices is to force operators with high levels of NG in their production mix to sell oil production assets to raise capital. This in turn tends to creates oil production deal flow - even though oil cash flows are robust. Natural Gas: For the extreme value oriented investor with a long-term horizon, NG assets with large reserves and low production levels necessary to maintain leases represent a low cost-of-carry long position. Our analysis leads us to believe that for this purpose such a position has distinct cost, volatility and return advantages over traditional long NG futures exposures or investments into operating companies. Assuming that the market will find a way to exploit one of the most inexpensive BTUs in world (North American NG) then we should expect prices to recover over the medium to long term as these BTUs are eventually pulled into other markets - perhaps in the form of feed stocks (ethylene & propylene), finished goods (fertilizers) or LNG. Obviously this is not an investment with a view to an immediate return but for value investors who believe in the long-term strength of the energy markets surely something worth considering.

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