INVESTSMART GROUP LIMITED — AGM Information 2012

Nov 21, 2012

CHAIRMAN’S ADDRESS TO ANNUAL GENERAL MEETING OF MERRICKS CAPITAL SPECIAL OPPORTUNITY FUND

22 NOVEMBER 2012

I think everyone here is well aware that the past year – specifically the last six months – has not been a propitious one for your Company or the value of your shareholding in MEF. NTA per share has declined from $1.03 at 31 October 2011 to the last published level of $0.61 at 31 October 2012; rather more starkly, the NTA at end April 2012 was $1.07, at which time the shares of the largest investment within MEF, Straits Resources Limited, were trading at $0.78; they are now approximately $0.09.

In tandem with this decline in net asset value, shares in MEF trade at a marginally higher discount to their NTA – 30% or so versus about 25% this time last year.

I think you all are fully aware of the reasons behind this situation. Hence, whilst I don’t want to gloss over the poor performance of MEF, the main aim of looking backwards is to address some misnomers about the investments in Straits and IEF Real Estate Entertainment Fund. Adrian will speak about the current situation with Straits and IEF in his post meeting presentation.

In respect of Straits, the investment has been dismissed by some as “highly speculative”. At the time the significant investment was made Straits was working down a path of corrective action to reduce the cost base at Tritton, which remember is a 25,000 tonnes per annum copper producer, exit the onerous treatment cost contract and ramp up the Mt. Muro gold/silver mine to a production level of 100,000 ounces per annum. In addition, various non-core assets were slated to be sold.

Straits was – and is – a company with real production assets, not a speculative exploration play. The problem with Straits was not the assets underlying the investment, rather the execution by the company of the various operational improvements and ramp-ups. The quantum of cash consumption surprised everyone outside of Straits itself. In many respects, this is no different to an ‘industrial” company failing to divest non-core assets and being unable to ramp up a new division in an effective manner. Straits has not been hamstrung by low commodity prices over this period of change.

Adrian Redlich has recently joined the Straits board. This will mean that we will be constrained from adding to or reducing our position in Straits for large periods of the year; however, the significant trade–off is having direct input to the Straits strategy which has been aided by new investment banking and strategic shareholder relationships.

In the case of IEF, Adrian has enunciated the investment case in the 2012 Annual Report as part of the Manager’s Letter. With 82% of IEF’s units held by five shareholders, these securities are not extensively followed by wider market participants resulting in the nature of the inherent asset value contained therein being widely misunderstood. It is accepted that the turnaround in IEF has taken longer than expected due to the complexity of the structure and the elongated tenure of ING as the RE and manager. However, IEF is now in an exceptional position to move forward under vastly improved micro-management of the tenants, and it is noteworthy that Directors have been significant recent purchasers of the stapled entity.

So where does MEF go in the future? In correspondence from shareholders, the general themes have revolved around:

• Winding up MEF;

• Having some form of cash distribution to pay out shareholders who wish to exit at NTA; or

• Replacing the Investment Manager.

As at 31 October 2012, the Company held 110.4million IEF shares valued at $6.3million; 57.1million Straits shares valued at about $5.7million plus cash and smaller investments with a value on the day of about $4.7million. All up, that’s about $16.7million of investments and cash, with an on balance sheet tax asset of about $680,000 to make up the 61cents per share of stated NTA.

However, we have two significant off-balance sheet assets:

• $3.5million of tax benefits arising from unrealised losses, which would shield $11.7million of appropriate income; and

• $1.7million of tax paid franking credits, equivalent to 14.1cents per MEF share on a distributable basis.

At the current time, the franking credits cannot be appropriately used since there is now a deficit balance of MEF’s retained earnings and the company has incurred an accounting loss for the 2013 financial year to date – I would remind you that Straits shares were trading around $0.36 on 30 June 2012. As a result of the 11 July 2012 Class Ruling 2012/5 by the Australian Taxation Office, these franking credits are effectively “locked up” until MEF can generate a current year profit.

I think this description clearly illustrates that a winding up of MEF is nonsensical. These offbalance sheet assets would be wasted, and in the opinion of the Investment Manager, MEF would be selling its two key investment assets at a sub-optimal time. That’s why the Board of Directors has discounted this option.

We have also discounted a use of the Company’s cash to effect a buyout option at NTA, as it is unlikely to be particularly productive, since:

• It would require a general meeting to be called for approval, at significant expense;

• It is a reasonable assumption to make that most shareholders would wish to sell back to the Company at NTA and so significant scale backs would occur;

• It would further increase the effective management expense ratio of the smaller company by forcing amortisation of fixed overheads (audit, Directors fees, insurance, registry etc) across a smaller company – as a guide, these fixed fees are in the vicinity of $300,000 per annum in a normal year; and

• It would potentially taint some of the taxation benefits that MEF currently possesses.

Finally, the non-Merricks related Directors have been asked why they have not replaced the Investment Manager in the wake of 2012’s performance. As is the case with most externally managed listed investment companies, there is virtually no scope to terminate the management

contract of the external manager before its expiry unless there has been some form of uncorrected abrogation of the contract or mandate by the manager. This has not occurred with respect to Merricks Capital and MEF.

MEF is (I believe) unique within the Australian market, in that it does have a clause which enables the termination of the Manager for non-performance. In broad terms, this clause becomes potentially operative if the Manager has underperformed the S&P/ASX 300 Accumulation index by 15% over a three year period. I say potentially operative, because it is a right of the Company, not an obligation.

To fully effect the non-performance termination option, requires shareholders of MEF to pass a Special Resolution to terminate the Manager (i.e. 75% of all votes cast). It should be noted that the Manager and related parties are able to vote any MEF shares they hold. As the non-Manager related Directors, and after taking appropriate advice, John Reynolds and I believe that such a motion has virtually no chance of success given the shareholding of the Manager and its related parties and would be a relatively costly exercise.

Taking all of the above into account, the board believes the status-quo is by far the best option for the time being. We have the option of small on-market buybacks of securities, hope to see some forward progress with both Straits and particularly IEF over the 2013 financial year from their current share price levels. We do acknowledge, that MEF is small and that the fixed cost base is a significant impost, and that it would be preferable, from this perspective, if the Company were larger.

Credit providers are exceptionally cautious at present reflecting their past losses and need to work off underperforming loans; skittish financial markets have blocked the IPO pipeline and restricted access to equity capital. For these reasons, the Manager is seeing a significantly enhanced pipeline of very attractive mezzanine and capital standby opportunities. The ability to take advantage of these types of transactions is not a widely held attribute, but it is one which the Manager, and hence, MEF assuredly has. This was perfectly illustrated in the Digital Harbour Holdings transaction which yielded around 17% per annum across its sixteen month life. MEF was the sole vehicle through which ordinary investors could access such a transaction.

The prevailing environment, the value of $16million of permanent capital and the availability of differentiated transactions to the Manager vindicates the type of mandate being operated within MEF, and suggests that the future of the Company is rather brighter than many might suppose, and why we hope the balance of the 2013 financial year will see improvement in the value of the portfolio and your, and our, shareholding.