Electrica SA Update – Annual Report 2014 & Q1 2015 and AGM

Time to update on my Electrica case which I have presented in December last year.

Let’s start with some bad news:

I had mentioned two potential “upside options”, which could drive the value of Electrica even higher than in my simple base case:

1. Potential M&A opportunities with regard to ENEL’S Romanian assets
2. Clean up of 22% minority holdings in all major subsidiaries

Both options, for the time being did not materialize. Already in February, ENEL said that they will not sell their Romanian subsidiaries. Additionally, Electrica could not agree with Fondul Proprietatea on the price. The differences in valuation were still significant:

Fondul Proprietatea holds stakes of about 22% in each of these companies, which are valued at EUR 173 million in its portfolio. Electrica, which is 49% controlled by the state, was looking to pay a price closer to EUR 100 million, according to sources familiar with the negotiations.

So none of those two options seem to be realistic for now, but on the other hand I haven’t priced them in anyway.

So now let’s look at the good stuff, starting with the 2014 annual report:

Profit AT, before minorities has been 401 mn RON for 2014, which translates into 288 mn RON after minorities, that is around +15% against what I had projected for 2014. However Electrica stresses that this is due to a one-time effect in the supply segment where they were able to by electricity cheaply during the year. In contrast to many other companies, I can gladly live with positive one time effects…

Operating cash flow was very strong, especially they seem to be able to reduce their outstanding receivables significantly which in my opinion is VERY positive. Payroll costs decreased significantly, it seems to be that privatization is clearly motivator for more efficiency.

They also now show the regulated assets as a separate balance sheet line. They are however lower than I had initially assumed but more on that later.

Q1 2015

According to the Q1 report, the year started quite well. Profit increased by around 25%, Profit after minority increased by almost 50%. Again there is a positive one-time effect, in this case it is the de-consolidation of one the 100% owned but loss making service operations which had negative equity. Without this effect, earnings would have increased only slightly, maybe between 5-10%.

I think these 100% service subsidiaries and this effect is also the reason why one reader could not reconcile 2014 results and the 2015 plan from the operating entities which all have 22% minority interests.

All in all I would say a very solid first quarter.

Shareholder meeting & Investment budget

A reader already pointed out the following: In the April shareholder meeting something interesting happened: Shareholders rejected the presented investment plan of Electrica for 2015. Honestly I did not look at the investment plan before but the issue seems to be the following according to this article:

The Energy Ministry rejected electricity distributor Electrica’s investment plan for 2015, in the general shareholders meeting on Tuesday, April 28.

The ministry is Electrica’s biggest shareholder as it owns almost 49% of its shares. The remaining 51% are held by local and international investors who bought shares in the company’s initial public offering (IPO), in June last year, and afterwards, from the Bucharest Stock Exchange and London Stock Exchange. EBRD has an 8.6% stake.

Electrica’s total investment budget for 2015 was about EUR 151 million, EUR 135 million of which was for revamping the group’s electricity distribution network, according to the report the group presented to investors.

The state’s representatives have asked Electrica to correlate the investment plan for 2015 with that it had in the listing prospectus. According to the prospectus, Electrica should invest some EUR 317 million this year.

I have double checked the IPO prospectus and indeed on page 166 we can find the 1,4 bn RON (~400 mn) investment budget and thereof 3/4 for regulated assets. So the Government shareholder clearly has a point here. Honestly, I have no idea why Electrica presented now a much smaller budget. I only can speculate that they maybe want to make a point to the government because of the unexpected reduction on guaranteed returns after the IPO. For my investment case it would be important that they actually do grow their regulated asset base, so this is something to watch.

Another interesting aspect of this episode for me is the fact that shareholders do have pretty much to say in Romania. In any other country, an investment budegt for the next year would not be subject to a vote. The reason for this is most likely that trust is still very low in Romanian society when it comes to large organizations.

So how will this be resolved ? Romanian companies do have quite frequently extraordinary shareholder meetings. So I guess they willhold one pretty soon and present a different investment budget. Maybe not the initial 2015 number but maybe something in between.


Overall, I do think the investment case for Electrica has not changed. Some frictions with the Government and possible delays in the build up of the regulated asset base are countered with unexpected positive effects and a good operational development. It remains to e seen how quickly Electrica and the Government will align themselves, but overall I still think that over 3-5years this wilbe a VERY GOOD investment.

Updates: Admiral CEO, Lloyds Banking, Cranswick + Editorial (Comments)

Editorial stuff:

While I was away (without access to my account) some people complained that their comments were not shown while other comments went through. The reason is the WordPress commenting system. If you comment for the first time, I need to manually approve this first comment. Once you are approved, further comments appear automatically if you login and comment the same way than you had done for the first time. So for anyone who commented for the fist time in the last 2 weeks, the comments were still in the “to be approved queue”.

Admiral Plc

Last week, Henry Engelhardt the founder CEO and largest shareholder of Admiral announced that he will step down in one year and co-founder and current COO David Stevens will take over from then on.

This was clearly a surprise as with currently 57 years, one could have expected him to stay on for quite some couple of years more. Losing a highly succesful charismatic CEO is of course bad news.

On the other hand, one rarely has the situation that there is a co-founder available to run the company who also owns a significant company, is younger (currently 51) and clearly knows how Admiral works. It remains to be seen if the former number 2 will be a good number 1. He clearly isn’t as charismatic as Engelhardt, on the other hand I do think that he exactly knows what he is doing and that there is little risk that he doesn’t obtain the same level of authority as the old CEO.

So all in all, for me for  the time being the investment case doesn’t change. Oh, and by the way watch the official video until the very end. then you know why Admiral is different and hopefully remains so ;-

Lloyds Banking

The timing of my Lloyds investment was indeed lucky. The stock got a second boost after the election as Cameron seems to be the better choice for bank investors than his opponents.

The conservative government reiterated their plan to sell the whole stake in the next 12 months. In the meantime, the percentage has fallen below 20% already last week, and the sale of TSB to Sabadell has been approved by European authorities last week as well.

All in all good news for the stock.


Cranswick was my biggest holding until January this year when I sold because I expected lowerresults going forward and found the stock as too expensive.

Last week, Cranswick came out with preliminary annuals for 2014/2015 (FY March to March). On the first look everything went up and the stock market seemed to like it and the stock was up almost 10% over the last few days:

At a second glance, things do not look so god however. Profits only went up on an “adjusted” basis, unadjusted, profit fell by -6% and without acquisitions, sales would have been lower as well. The core business, fresh pork was down by a hefty -10%.

ROE decreased further to 12,9%. Still OK but in my opinion this does not justify a P/E of almost 19. However so far, the market does not seem to be concerned and is granting Cranswick a further multiple expansion.

Double Book review: Tim Clissold “Mr. China” & “Chinese Rules: Mao’s Dog, Deng’s Cat, and Five Timeless Lessons from the Front Lines in China”

Tim Clissold is an English guy who happened to go to China just when China was opening up to the Western world in the early 1990s. His first book “Mr. China” tells the story how he tried to set up and invest a 400 mn USD private equity fund in China together with an US Wall Street veteran.

This was clearly not an easy task. When, after visiting 100 or more companies, he finally found some to invest in, the real problems only began. Ownership rights in China are quite flexible and in his book there are a couple of in-detail stories what can go wrong in China. As a short summary I would say that actually almost everything can go wrong in China for a foreign investor. Contracts are worth nothing and more than once a manager disappeared with most of the money. In other cases, the old owner just built a new factory next to the old one and all the workers left for the new factory and so on and so on. An interesting details was the importance of company seals (“chops”). Those company seals are much more important than anything and the one who has those seals in possession can do anything.

It might be a severe case of confirmation bias but after reading this book I felt fully vindicated for not even considering to invest in any German or US listed Chinese companies (and yes, this includes Alibaba, Baidu etc.). If you can’t even control what’s happening when you are in the country how should you have any chance if you are only invested via several questionable legal constructs.

Clissold makes it especially clear that Chinese thinking is entirely different from western thinking when it comes to business and rules that we take for granted just do not apply or even exist in China.

The second book is a more focused story on his second attempt in China, where he was called in to solve a difficult situation with regard to a big Carbon credit project and then started out to set up his own Carbon Credit investment fund in the mid 2000s. Of course he encountered the same problems as in the first try but he tried to counter them with more typical Chinese tactics which seemed to have worked better. In the end this project didn’t work either as the price of Carbon credits collapsed during and after the financial crisis.

The second book also includes more historical and philosophical background on China which makes it a “deeper” read than the first one.

Overall I can recommend both books to anyone who is interested in China in general and investing or working in China specifically. Although they are a lot of “How China thinks” books out there, this is one of the few with really first hand experience. And the books are quite well written, too.

Book review: “King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone”

The title of the book is actually a little bit misleading. Yes, Blackstone and Steve Schwarzman play a large role in the book, but the book also covers the story of the whole private equity industry pretty well.

After working for DLJ and Lehman, Schwarzman started Blackstone as a 2 person M&A advisory boutique in the 1980ties. As the M&A advisory business was somehow limited, Schwarzmann and his partner decided trying to get into the then fledgling private equity business. Just before they were out of money, they got their first investor money and then became on of the most succesful Private Equity players.

What I liked the book ist that it looks not only at Blackstone but at the development of Private Equity since the 1980ties in general. There is also a lot of interesting detail to be found on specific deals which I found very interesting. For instance how Blackstone failed in Germany in the Cable sector and many more deals. Blackstone in contrast to some other players invests often in cyclical companies where timing is quite important.

Most recently they also branched out big time into Real Estate. A funny side story is the fact, that Larry Fink started Blackrock as a division of Blackstone and relatively early bough the company out for a couple of hundred million USD. Blackrock is now a 65 bn USD market cap company, almost 20 bn more than Blackstone, its former parent.

The author hinself seems to be relatively neutral or even slightly positiv on the general role of private equity and collects some good arguments.

Overall, private equity investors like Blackstone are very close to what I would call “value investors”. Clearly, sometimes they extract that value petty quickly but many times they also create and grow companies like Blackrock. Overall those guys clearly have longer time horizons than most equity fund managers and one of their strengths is that they are not meassured against benchmarks on a monthly or quarterly basis. I guess that is the main reason why they can act very countercyclical.

However, Private Equity is not a one-way street to success a s the side story of Forstmann-Little shows. In the 1990s, they were the predominant player but than went all in into telecom and technology and finally did not survive. Blackstone did some Telco deals as well but nothing which would harm them big time.

As a summary, I can highly recommend this book who has a some interest on how Private Equity works and how those guys think.

New position: Lloyd’s Banking Group (GBGB0008706128) as special situation investment

Interestingly, while looking at AerCap, I always almost automatically compared them to Llyods Banking Group. In the old days I might have bought both shares but as I limit myself to 1 new position (or one complete sale) per month I had to make a decision and it went to Lloyds. My previous analyses can be found here: part 1 & part 2

Just to summarize my view on Lloyd’s and why I bought now:

1. I do think UK retail banking is a structurally good business in the mid- to long term
2. Lloyds does have a certain “franchise” and good management
3. I like buying into uncertainty (UK election). Most investors hate uncertainty and often political uncertainty provides interesting entry points
4. Continued heavy selling by UK Government has a direct impact on the price. This is from a few days ago:

Lloyds Says U.K. Treasury’s Stake In Bank Falls Below 21%
By Keith Campbell
(Bloomberg) — Govt now holds 14,955m shares, down from 15,697m Govt had cut stake to 22% as of March 25

Within 4 weeks,the UK Government sold almost 750 mn shares. Total trading volume according to Bloomebrg was ~2,6 bn shares, so the selling program accounts for ~29% of the total traded volume. Normally, 10-15% of daily volume is already critical, but dumping almost 30% of daily trading clearly must have an impact on the price.

I am not sure why the Government is still “dribbling” out (at this pace it is rather “pumping out” shares) instead of placing the whole amount but I guess that has to be with political tactics, i.e. not leaving this around for the next government

5. Lloyd’s is taking market share from competition (via Halifax):

Lloyds Banking Group Plc’s Halifax unit gained the most customers from its rivals of any U.K. lender in the third quarter as probes by the competition watchdog and financial incentives resulted in more Britons switching banks. Royal Bank of Scotland Group Plc and Barclays Plc lost the most U.K. checking accounts in the period, the most recent data published by Britain’s Payments Council on Thursday show.

6. HSBC is doing everything to destroy its reputation on UK’s high street by threatening to leave the UK. Also the other big players (Barclay’s, RBOS) have other problems
7. Compared to AerCap, increasing interest rates should be overall positive for banks
8. the major risk for the LLoyd’s investment case is relatively independent to overall markets (UK regulation, PPI, election)
9. results and dividends will improve more or less automatically over the next 2-3 years even under relatively adverse developments
10. I said this a couple of times, but for me a regulated retail bank like Lloyd’s is less risky than a “shadow bank” financing company like AerCap. If there is a next finanical crisis, in my opinion traditional banks will be less effected than “non traditional” players

Similar thoughts to my own can be found at teh UK version of Motley Fool just a few days ago.

There is clearly also a potential downside:

– there are no prominent investors like Einhorn and Jana on board and no direct “catalyst”, so stock price could remain “range bound” for some time
– clear tail risk with regard to UK election outcomes, “Brexit”, bank levy etc.
– Q1 could again look not very nice (TSB charges, bond repurchase)
– if interest rates in the UK go “European”, profitability could suffer in the long term
– Lloyds has pretty low beta and will underperform in a “Good market” for some time

Anyway, to me Lloyd’s banking Group looks like an interesting special situation at this time. The share overhang and selling should clear at some time, profits will most likely increase. Over 3-4 years I look for an upside of around 50% plus dividends or ~15% p.a. if my assumptions turn out to be correct.

I therefore established a 2,5% for the portfolio at around 0,77 GBP per share for my “special situation” bucket.

If because of the election or a share placement the price will go to around 70 pence I would increase the position. A reason for selling would be for instance the departure of the CEO.

Disclaimer: Please note that this is not meant as investment advise. Never trust stock tipps anyway. DO YOUR OWN RESEARCH and in most cases index funds are the best investment alternative anyway

Edit: This was clearly pure luck that the day after I bought, Lloyds jumped already almost +7%. As I had expected, net income was lower compared to Q1 2014 but operating profit was up significantly and investors seem to have been positively surprised.

AerCap Holdings N.V. part 2 – Less tangible at a second glance

So after my first look into David Einhorn’s long pick AerCap last week, I want to follow up with some more detailed analyis in a second step.

By the way, a big “thank you” for all the qualified comments and Emails I got already after the first post, that’s the best return on investment on a blog post I can get !!!

The book value story growth

This was for me one of the core slides of Einhorn’s deck:


I mean you don’t have to be a genius to understand this: A company which trades near book value and compounds 20% p.a. is pretty much a no brainer. However, if I look at the developement of book values for financial companies, I always look at both, stated and tangible book value per share.

In AerCap’s case, the comparison looks interesting:

BV per share TBV share
2006 8,83 8,3493
2007 11,18 10,6041
2008 13,04 12,4083
2009 14,79 14,3448
2010 14,82 14,3798
2011 15,26 15,0608
2012 18,72 18,5592
2013 21,32 21,2334
2014 37,04 16,174
CAGR 19,6% 8,6%
CAGR 2006-2013 13,4% 14,3%

This table shows two things: Before the ILFC transaction, stated book values and tangible book values were pretty much the same and compounding around 13% p.a. Still pretty good but clearly not 20%. In 2014 however, with the ILFC deal something interesting happened: The book value per share doubled but tangible book value dropped.

The ILFC deal

So this is the right time to look into the ILFC deal. The two main questions for me are:

a) why did the book value per share increase so much ?
b) why did tangible book value per share actually decrease ?

This is how AerCap presents what and how they paid for ILFC:


So AerCap paid the majority of the purchase with own shares, 97,56 mn shares valued at 46,49 USD. Issuing new shares always has an impact on book value per share if the issue price is different from the book value. Let’s look at an example:

We have a company which has issued 100 Shares at 50 EUR book value per share and 100 EUR market value (P/B =2). So the total market value is 10.000, total book value is 5000. If the company now issues another 100 Shares at 100 EUR market value, we have 200 shares outstanding and 5000+10000 = 15.000 EUR total book value. Divided by 200 stocks we now have 75 EUR book value per share or a 50% increase in book value per share for the old shareholders. So issuing shares above book value increases book value per share automatically.

In AerCap’s case, it worked more or less the same way: AerCap had ~113 mn shares outstanding with a book value of around 21,30 USD per share. So issuing 97,56 mn share at a steep premium at 46,49 of course increased book value per share dramatically. The transaction alone would have increased the book value to ((113*21,30)+(97,56*46,49))/(113+97,56)= 32,97 USD per share or an increase of ~50%.

So how is this to be interpreted ? Well, clearly it was a smart move from AerCaps management to pay with its owns shares at such a nice price. On the other hand, one should clearly not mistake this a a recurring kind of thing. I would not use the historic 20% p.a. increase in ROE as expectation for the future but rather something like 13% or so in the past.


After looking into how much and in what form AerCap was paying, let’s look now what they actually got:


Yes, they got a lot of planes and debt. Interestingly they assumed more debt than book value of the planes. Altogether they did get a lot of intangible assets. All in, AerCap bought 4,6 bn intangibles which is around 80 mn more than equity created through the new shares. So at the end of the day, one could argue that the new shares have been exchanged more or less 1:1 against intangible assets.

The largest part of this is a 4 bn USD position called “Maintenance rights intangible” which for me is something new. This is what they say in their 20-F filing:

Maintenance rights intangible and lease premium, net
The maintenance rights intangible asset arose from the application of the acquisition method of accounting to aircraft and leases which were acquired in the ILFC Transaction, and represented the fair value of our contractual aircraft return rights under our leases at the Closing Date. The maintenance rights intangible asset represents the fair value of our contractual aircraft return right under our leases to receive the aircraft in a specified maintenance condition at the end of the lease (EOL contracts) or our right to an aircraft in better maintenance condition by virtue of our obligation to contribute towards the cost of the
maintenance events performed by the lessee either through reimbursement of maintenance deposit rents held (MR contracts), or through a lessor contribution to the lessee. The maintenance rights intangible arose from the application of the acquisition method of accounting to aircraft and leases which were acquired in the ILFC Transaction, and represented the fair value of our contractual aircraft return rights under our leases at the Closing Date. The maintenance rights represented the difference between the specified maintenance return condition in our leases and the actual physical condition of our aircraft at the Closing Date.

For EOL contracts, maintenance rights expense is recognized upon lease termination, to the extent the lease end cash compensation paid to us is less than the maintenance rights intangible asset. Maintenance rights expense is included in Leasing expenses in our Consolidated Income Statement. To the extent the lease end cash compensation paid to us is more than the maintenance rights intangible asset, revenue is recognized in Lease revenue in our Consolidated Income Statement, upon lease termination. For MR contracts, maintenance rights expense is recognized at the time the lessee provides us with an invoice for reimbursement relating to the cost of a qualifying maintenance event that relates to pre-acquisition usage.

The lease premium represents the value of an acquired lease where the contractual rent payments are above the market rate. We amortize the lease premium on a straight-line bases over the term of the lease as a reduction of Lease revenue.

This sounds quite complicated and for some reason part of the sentences seem to have been duplicated. If I understand correctly, they assume that the underlying value of the aircraft is higher than the book value of the acquired planes. To be honest: I do not have any clue if this is justified or not.

However, as those intangibles are significant (more than 50% of book value), the case gets a lot less interesting for me. Intangibles created via M&A activity are in my experience always difficult, especially if it is esoteric stuff like this. It’s also a big change to the past of AerCap. Historically, they were carrying very little intangibles.

Funding cost & ROE

This was Einhorn’s prospective ROE calculation:

aercap roe

One of the key assumptions is a 3% funding cost. So let’s do a reality check and look at the expected pricing of AerCaps new bond issue. This is from Bloomberg:

Aercap $750m TLB Talk L+275, 99.75, 0.75%; Due April 30
By Krista Giovacco
(Bloomberg) — Commits due April 30 by 12pm ET.
Borrower: Flying Fortress Holdings LLC, a subsidiary of AerCap Holdings and International Lease Finance Corp., largest independent aircraft lessor
$750m TLB due 2020 (5 yr extended)
Price Talk: L+275
OID: 99.75
Libor Floor: 0.75%
Call: 101 SC (6 mos)
Fin. Covenants: Max LTV test
Existing Ratings: Ba2/BB+ (corp.); Ba1/BBB-, RR2 (TLB)

So AerCap is funding at a spread of 2,75% vs. LIBOR. With the 10 year USD LIBOR at 2,00%, funding would be way more expensive than the 3% assumed by Einhorn. Maybe the fund floating rate, but then the whole company would rather be a bet against rising interest rates than anything else. On a “like for like” basis without structural interest rate risk, I don’t think AerCap will generate a double-digit ROE at current spreads.

Business case & competitive environment

Within the comments of the first post, some people argued that the company is not a financing company but that the access to Aircraft is the value driver. Buying cheap aircraft from manufacturers and then selling (or leasing) them with a mark-up to clients then looks like some kind of Aircraft trading business.

For me however there is one big problem with such a business model. Retailing or wholesaling any merchandise is then most attractive as a business when 3 criteria are met:

– there are a lot of suppliers
– there are a lot of clients
– you can create a competitive advantage via physical distribution networks

In AerCap’s case, the biggest problem is clearly that there are not that many suppliers but only 2, Boeing and Airbus. Both don’t have much incentive to let any intermediary become too large so they will most likely encourage competition between Aircraft buyers.

Secondly, as far as I understand, there is no physical distribution network etc. behind AerCap’s business. So entering the market and competing with AerCap in the future doesn’t look so difficult for anyone with access to cheap capital.

Clearly, as in any opaque trading business, an extremely smart trader can always make money but it is important to understand that at least in my understanding there are no LONG TERM competitive advantages besides the purchase order flow from ILFC.

That the barrier to entry the business is not that high is proven by no other than Steven Udvar-Hazy the initial founder of ILFC and his new company Air Lease.

IPO’ed in 2010 and now the company is already a 4 bn USD market company 5 years later. Interestingly, AIG sued Air Lease in 2012 because they

were able “to effectively steal a business,” and reap a windfall at the expense of ILFC, the world’s second-largest aircraft lessor by fleet size. It described how some employees, while still working at ILFC, downloaded confidential files and allegedly diverted deals with certain ILFC customers to Air Lease, before leaving to join that firm. The companies are in the business of buying aircraft and leasing them to commercial airlines all over the world.

So to me it’s not clear what AerCap actually bought. It seems the “secret sauce” of ILFC seems to have been transferred to competitor Air Lease already. Interestingly, the lawsuit was settled a few days ago at a sum of 72 mn USD. I found that quote from Udvar-Hazy interesting:

“I want to make it clear that there is no secret sauce in the aircraft leasing business,” Hazy told analysts on a conference call. “ALC’s success is a result of a strong management team with extensive experience and solid industry relationships.”


My problem with AerCap is the following: The financial part of the company, which I feel that I can judge to a certain extent, does not look attractive but rather risky to me. The Aircraft “buying and trading” segment on the other hand seems to be the more attractive part but for me too hard to judge in a reasonable way.

So for the time being, this is clearly not an investment for me. To look further into AerCap, two things need to happen: First they need to regain their investment grade rating and funding cost will need to drop to the 3% that Einhorn is assuming and secondly, there should be a clear impact on the share price from a potential sale from AIG.

In the current market environment clearly anything can happen and a multiple expansion could bring nice profits but personally, in a direct comparison I prefer the LLoyd’s case.

« Older Entries