Author Archives: memyselfandi007

Short cuts: KAS Bank, April SA, Draegerwwerke GS

KAS Bank

When I invested into KAS Bank, the Dutch, the main motivation was the cheap valuation and the stable core business (custody). One add-on was that they wanted to extend their retail business together with dwp bank from Germany.

For some reason, dwp decided not to go ahead with this cooperation and cancelled it in June 2014. Kas Bank will be compensated for this according to the press release:

As a compensation for the loss of the anticipated annual saving that KAS BANK would have realised from 2016 onwards, dwp bank will pay KAS BANK a lump sum at the end of June which, after deducting the costs in 2014, amounts to approximately € 20 million. KAS BANK will use this one-off compensation to invest in further improving its efficiency and its services to institutional investors. dwp bank will focus its future investments on improving the quality and standards of its operations and IT.

20 mn compensation for a 160 mn Market company is a lot, but it seems that this contract would have been quite good for KAS Bank going forward. Maybe it was so good that dwp bank only recognized it after signing ? I don’t know. In any case, I think the “Value case” for KAS Bank is still intact. Book value should still be achievable, which would mean the stock has still 50% upside let, despite the quite satisfactory performance of +58% (incl. dividends) since I bought the stock 2 years ago.

April SA

A few weeks ago, I finally sold the rest of my April SA position. I never really explained this in more detail. When I first looked at April SA, I didn’t buy it because the stock was not cheap enough (part 1, part 2, follow up, follow up).

I only established a position when the stock got hammered during the EUR crisis, as they were then trading in single digit P/E territory and implcitly I asumed at least constant earnings going forward. Fast forward 2 years. EPS developed negatively, both in 2012 and 2013:

EPS
31.12.2010 1,96
30.12.2011 1,37
31.12.2012 1,32
31.12.2013 1,26

Nevertheless, the new-found enthusiasm for European and especially French stocks led to a significant multiple expansion from around 8xP/E to ~ 14xP/E in June. Although I still think that April is not a bad company, I had to admit that the ~63% return I made on the stock was much more luck than anything else as I don’t think that multiple expansion like this (even considering shrinking EPS) could be forecasted. Additionally, I found much more interesting alternatives in the insurance sector (Admiral, NN Group), so I decided to sell although the two years holding period were shorter than I would normally target.

Draegerwerke GS

A few days ago, Draeger revised their guidance for 2014 significantly downwards. The stock got hammered significantly, the Genußscheine lost some value as well but less than the shares.

For me, Draeger was always a relative bet, assuming that the intrinsic value of the Genußscheine (10 times the Vorzuege) would at sometime close. I never believed that Draeger itself was a “great” company. Looking at the developement of the ratio (price Genußschein / Price Vorzuege) we can clearly see that currently we are in a territory which we haven’t seen for the last 15 years:

draeger upd 2014

At almost 6 times the Pref shares, the relative risk/return ratio is not as good as it was before. With almost 7%, the Draeger Genußschein is still with a margin my largest position. In order to reflect the somehow lower relative potential of this position, I will cut the position to a 5% stake going forward.

Some links

GMO’s very interesting Q2 letter. Their speculation about a massive M&A boom is quite realistic

Wexboy’s 6 month performance review

A list of 5 unknown but interesting books about investing

A great profile of Hedge Fund honcho Leon Cooperman

An interesting but very exotic stock analysis from WertArt (UK listed Indian private equity…..)

Finally, in German, the second quarter report of ProfitlichSchmidlin Fonds. Especially the bond section is worth reading with a lot of interesting ideas.

Book review: “The Go Go years” – John Brooks

“The Go Go years” was how the late 1960ties were called at Wall Street. Although covering a time almost 50 years ago and written in the early 1970ties, this book is still a very good read as a lot of things that happened and a lot of things invented in the 1960ties still influence capital markets.

Among the innovations of the 1960ties were Mutual funds, conglomerates, earnings per share games via acquisitions, financial “innovation” like convertibles, letter stocks etc. etc. Especially the interaction between the new and red-hot Mutual funds and the acquisition hungry conglomerates pushed up stock market levels significantly over the 60ties.

The book gives a very good account especially how stocks were actually traded back then. Paper certificates had to e moved from seller to buyer and due to the increasing trading levels, a lot of transactions wer not correctly settled. Also woman were rarely seen in “real” finance jobs and were denied entry to most of the restaurants around Wall street.

The book contains also some amusing side stories about the beginning the Hippy movement, for instance that many of the back office guys were pretty much on drugs all the time which further added to the back office problems.

There is also good coverage on some of the most “notorious” conglomerates and early “Raiders” like Saul Steinberg, who, finally unsuccessfully tried to take over one of the biggest banks back then, Chemical Bank.

Although this isn’t mentioned in the book we all know that Warren Buffett closed his partnership in 1969 because he didn’t find anything interesting to invest in, but he was definitely not a houshold name back then. Funnily enough, Buffet’s Berkshire itself became the most succesful conglomerate ever over the next 50 years, although with a clearly more conserative structure then the “Go go” guys.

The whole story culminates in the “almost fail”of two of the biggest brokerage houses at that time, Goodbody and Du Pont in the early 1970ties. Du Pont was actually rescued by Ross Perot, founder of EDS and future billionaire presidential candidate.

This part of story almost reads like a 1:1 copy to Bear Stearns and Lehman Brothers 40 years later. Too much leverage, aggressive deals etc. Interestingly, the partnership structures did not prevent those problems as “partners” could take out their capital with a 30 day notice. of course those institutions “had to be saved”, a 1970ties version of to big to fail. Goodbody by the way was “saved” by Merril Lynch, which as we all know now had to be saved 40 years later by Bank of America. Other than now, no tax payer money was involved though.

There is a pretty good Wikipedia entry about the author John Brooks, a “New Yorker” staff writer who has written a couple of other interesting sounding books.

Overall I found this a very very good book and a “must read” for anyone interested in the history of Wall Street and the stock markets in general.

Some lessons to be learned are from my point of view:

1. On Wall Street and in finance generally, “innovation” very often means gains for the guys who run them and big risks and big pain in the long-term for investors

2. Brokerage houses and banks are naturally unstable institutions. Even the best regulation will not make them stable businesses

3. Investors forget quickly, only 10-15 years after that episode, the junk bond mania broke out. After 10-15 years it seems one can run the same schemes again. The current startup, social media etc “craze” is taking place 15 years after the first dot.com boom

4. Whenever the “plumbing” of the market is not working, it gets dangerous. Something similar was happening in 2007/2008 with unsettled CDS contracts

5. Business stratgies relying on ongoing and ever biiger acquisitions are risky and most often do not end well (Valleant anyone ?)

The author closes the book with the expectation that Wall Street will never be the same. To a certain extent he was right as future events were not “The same” but the basic patterns were very similar. Boom bust, speculation, greed, fraud belong to Wall Street, only their appearance changes slightly.

P.S.: The “go go” years were called so because quite often, people would stand before stock tickers in brokerage offices and shouting “Stock x – go go go stock x”….

Fiat Merger Cash Exit rights – Short term “high yield deposit” ?

Thanks to the reader who sent me this idea. Althought the stock price has risen in between, I still think it is interesting to look at this country specific “special situation”.

The Italian stock market is always worth a look as things are definitely different south of the Alps. I have documented a couple of cass where minority shareholders were the victims, but sometimes, Italian stockmarket laws actually seem to protect minority shareholders.

The FIAT merger

FIAT Spa is currently in the process to merge its Italian operations with a Dutch Holding company which holds Fiat’s interest in Chrysler.

In order to do so, FIAT is holding an Extraordinary shareholder meeting on August 1th. Now comes the interesting part: Under Italian law, any FIAT shareholder can vote against the merger (or not vote for it) and is then entitled for a so called “cash exit right”, which gives him the right to sell the shares back to the company. Normally, this compensation is a 6 month average, but in Fiat’s case the cash compensation has been fixed at 7.727 EUR per share.

Details about the cash exit rights can be found in the official prospectus.

Q: Are Fiat shareholders entitled to exercise dissenters’, appraisal, cash exit or similar rights?
A: Under Italian law, Fiat shareholders are entitled to cash exit rights because, as a result of the Merger, the
registered office of the surviving company in the Merger, FCA, will be outside of Italy, Fiat ordinary shares will
be delisted from the MTA, and FCA will be governed by the laws of a country other than Italy. Cash exit rights
may be exercised by Fiat shareholders that did not concur in the approval of the merger plan at the extraordinary
general meeting. The exercise of such cash exit rights will be effective subject to completion of the Merger. A
Fiat shareholder that has voted shares in favor of the Merger may not exercise any cash exit right in relation to
those shares. A Fiat shareholder that properly exercises cash exit rights will be entitled to receive an amount of
cash equal to the average closing price per Fiat ordinary share for the six-month period prior to the publication of
the notice of call of the extraordinary general meeting which is equal to €7.727 per share. If the aggregate
amount of cash to be paid to Fiat shareholders in connection with the exercise by such shareholders of cash exit
rights under Italian law and to creditors pursuant to creditor opposition rights proceedings under Italian law and
Dutch law, respectively, exceeds €500 million, a condition to closing of the Merger will not be satisfied.

Exercise period Timeline:

This is from the prospectus:

In accordance with Article 2437-bis of the ICC, Qualifying Shareholders may exercise their cash exit rights, in relation to some or all of their shares, by sending notice via registered mail to the registered offices of FIAT no later than 15 days following registration with the Companies’ Register of Turin of the minutes of the FIAT Extraordinary Meeting of Shareholders. Notice of the registration will be published in the daily newspaper La Stampa and on the FIAT corporate website.

If I read this correctly, this will at the earliest start with the day of the annual shareholder’s meeting, if they manage to register on the very same day. I asume that it is then 15 calender days. The money will be received on the “effective date of the merger” (A-15), which after reading the

The 500 mn EUR threshold

If more than 500 mn EUR “cash exit rights” are exercised, the merger will not take place and the cash exit rights are not valid. How big is the risk ? Fiat did the same structure with Fiat International and there, only 25 mn EUR rights were exerecised. In my opinion, FIAT will want to make this merger happen IN ANY CASE so I consider this as a very remote risk.

Stock chart

Last week, when I first looked at this, Fiat was still trading at around 7,35 EUR which would have meant a 5% upside (or 10% annualised) for this relatively riskless trade. At the current price of almost 7,60 EUR and considering transaction costs, it looks less compelling.

Nevertheless it is worth watching the FIAT stock in the next few days i there is a potential entry point if we see weakness in the overall market.

Summary:

Although at the moment, the Fiat Merger Cash Exit Rights do not look that interesting, in general this looks like an interesting short term “high yield” opportunity. I could imagine that also other Italian companies are trying this sort of cross border merger to escape onerous Italian provisions so it will be worth keeping an eye on similar situations.

7 things to learn from the Football Word Championhip for investments

First of all congratulations to our German team. I think they’ve earned it, especially considering the setbacks (many injured players, many critical voices etc.).

Clearly, football cannot directly be compared with investing, but among sports, football is pretty unique as luck plays a much bigger role than in other sports. Compared to basketball for instance, in football for a single match luck (or better randomness) is much more important as the number of goals is usually pretty low. The same goes for investing, where over a single period of time the results are also pretty close to random and only over longer periods of time (and on a compounded basis) skill emerges.

Following are 7 very subjective things to learn and the post is clearly written under “the influence” of yesterday’s victory:

1. Keep your eyes on the ball

Although Lionel Messi did not win the cup, there was one situation where one could learn a lot from him: The penalty shoot-out with the Netherlands. The Netherlands won the previous shoot out against Costa Rica because the Dutch Goalie influenced the Costa Rican players so much with his clownery. Against Argentina, the other Dutch keeper tried to do the same and made some crazy moves against Messi who was the first to shoot. If you watched Messsi, I had the impression that Messi didn’t even notice the goal keeper. He kept his eyes on the ball for the whole time until the ball was in the net. Here the picture how he shot:

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Lesson for any investors: Don’t listen to or watch the “crazy” guys who jump around in front of you” and tell you the world will go up in flames or that everyone will get rich. Keep your eyes on the ball, i.e. concentrate on finding good investments and avoid bad ones.

2. The best team wins, not a single super-star

If you look at the outstanding single players in the tournament, only maybe Thomas Mueller would be considered as a “Superstar” from the German team. My internal ranking would put him behind Messi, Neimar, Robben and Rodriguez (Colombia). In the final, Germany played against Argentina, with Messi, who potentially is the best player on an individual basis that football has ever seen. Nevertheless Germany won because they simply had the better team.

In investing, the same lesson is often learned hard by investors. Many investors are searching for the next Apple or Tesla, the super-star stock which will make them rich in short time. For long term success however the likelihood of winning is much better with a good portfolio of good companies at reasonable prices than a collection of overpriced potential super-star stocks. Often, it turns out that especially the good company at a reasonable price turns out a super-star at some point in time as Mario Goetze did.

Plus, sometimes much underappreciated players turn out to be great value, like Benjamin Höwedes. A lot of people criticized Löw for nominating him at all. Technically, he was clearly not on a level with the rest of the team but he showed fantastic fighting spirit and played all 7 games and almost scored a goal in the final. In investment terms he would have been the typical “deep value investment”, bought cheap and then tripling in value.

3. Each time is different – don’t rely on statistics alone

If a guy like John Hussmann would be a football analyst, he would have told anyone that Germany would have no chance in the final because statistically never ever did a European win the world cup in “America”. The last 6 times the world cup was played there, always a Latin American team took the title. As in investing, the problem with backward looking statistics is that although this is a very important aspect, there is no “causal” link for this. In 1950 in Brazil after World War II for instance only 13 teams competed and 7 of them were “American”, the same in 1930. In the early world cups, often many very good teams were missing for some reason or the other, so constructing any “laws” out of such long gone and irrelevant past events is not always useful.

So yes, it is interesting and entertaining to look at statistics but often they are not very useful for predicting singular events.

4. Leave out (too many) emotions

Although a certain passion for football and investing is certainly a help, too much passion or emotions are often not good. I have rarely seen so many men crying as during and after Brazilian matches. Coach Scolari seems to have “motivated” his team in a way that they felt responsible for the future of their whole country. It was also a strange sight when they held up the Neymar jersey before the match against Germany. Of course, everyone is smarter after the match, but maybe it was not such a good idea to mourn about something you cannot change before the match.

In investing you should also be careful with too many emotions. You should never love or hate a stock but try to see it through a neutral “risk/return” perspective. Otherwise you will run the danger of losing focus and get caught up with a lot of behavioral biases like loss aversion etc. etc. Also politics and investing don’t mix well as Charlie Munger has remarked several times.

5. Defense is important, but don’t forget the offense

The final 4 of the world cup included 3 teams with a really good defense (Netherlands, Argentina, Germany). “Defense wins championships” is basically equivalent to the famous Warren Buffett quote “Rule No.1 is never lose money. Rule No.2 is never forget rule number one”. However, ONLY defense does not win championships as especially the Dutch players had to experience. For me a similar mistake in investing would be to just to sit only on cash and wait for a potential crash. This strategy can work but has some risks. For me the better strategy is like the German team to build on a strong defense but also take some measured risks in order to “create opportunities” in the offense. Yes, you will increase the risks for counter attacks / investment losses, but if you manage to create an overall positive expected value you will win in the long run.

6. Sometimes things do change fundamentally

When I grew up, Germany always had strong national teams, however their main strength was their will to win and their physical power. German players were, with some exceptions technically inferior to most other nation’s especially southern European teams and Latin American ones. There were many theories why, but in general it was just considered a natural fact that especially Brazilians are the better individual football players.

Fast forward to 2014: Not only did Germany win the world cup but also they were considered to be the technically best playing football team. Brazil had Neymar, but the other players were technically rather inferior compared to for instance also Dutch players and to German players like Özil, Goetze, Khedira, Schweinsteiger etc. In Germany, there seems to have been a systematic approach to promote technically gifted players much more than in the past. Also, referees today (with some exceptions) protect technically good players much more than they did in the past by more quickly giving yellow and red cards to unfair players.

Although it is still the same ball, field, goal and 22 players, there seemed to be a fundamental shift how football is played and not all nations seem to have made the necessary adjustments.

For me something similar can be seen in economic life. Currently, many industries undergo very deep changes be it because of the internet, mobile phones, emerging markets or renewable energy. On an individual company basis, assuming a “mean reversion” is very dangerous in such times and I am also not sure if the overall market level “mean reversion” camp might be missing something. I don’t want to justify current market levels either, but I think it is important to understand that calculating (more or less sophisticated) historical averages does not explain fully what is going on in the world.

7. Don’t take things too seriously all the time

I don’t know the details of the other teams so well, but for me one of the very interesting aspects of the German team was that they genuinely seemed to have a really good time over those 8 weeks before and during the World Cup. Although they were hundred percent focused during the matches, there seemed to be a lot of humor before and after matches. Even right before the final when the cameras showed the teams in the hallways leading to the Maracana stadium, Mueller was making jokes with Lahm while they were waiting. Before the tournament, many people criticized that the German team is “too nice” and that they will not stand a chance against their mostly gangster style tattooed international opponents.

But in the end I think it is important to step back somehow and even be able to laugh about own mistakes as Thomas Mueller did when he did his “slapstick” free kick approach:

Often, taking a break, cracking a joke or two gives you the chance to regain your strength at and away some of the pressure. If you are a reader of Warren Buffett’s annual shareholder letters, you will notice this pattern as well….Should we call now Warren Buffett the “Thomas Mueller of Investing” or the other way round ?

Final Disclaimer:

As always, never take anything on this blog as investment advice, especially not this post created less than 24 hours of the historic German victory…..

R. Stahl (ISIN DE000A1PHBB5) – Another “failed take-over” special situation ?

Usually, I try to stay away from a “true” Merger Arbitrage as this is mostly a typical “shark tank” situation where as a small investor, the chances are pretty high to end up as shark food. However the situation when a first attempt fails and the price pulls back, it could be more interesting. In cases such as Rhoen Klinikum ,the interesting aspect is that suddenly the “true” value or “control price” of a business is revealed when a bid is made. With this information, one can more easily calculate the odds and expected returns.

The attempted take-over of R. Stahl by closely held German company Weidmüller was a special case anyway. In April 2014, German company Weidmüller made an “unfriendly” offer to all R. Stahl shareholders offering 47,50 EUR under the condition that 50% of shareholders accept the offer. Later, they increased the offer to 50 EUR, which was significantly higher than the “undisturbed” price of around 34 EUR.

The strange thing about the offer was the fact, that 51% of the company is held by the heirs of the founding family and further 10% is held by R. Stahl themselves. The families directly commented that they won’t sell and of course R. Stahl’s management was also not a big fan of this transaction, so the Treasury shares were out of question as well.

Not surprisingly, on July 4th, Weidmueller released that the offer has expired as only ~17% of shareholders have tendered their shares.

R. Stahl as a company

Let’s take a step back and look at R. Stahl as a company. In my opinion, R. Stahl is one of the typical “hidden Champions” of the German “Mittelstand”. They specialize in electrical installations within potential explosive environmenta (chemical plants, gas/oil etc.). The company is financed “rock solid” and has shown good growth in its core business for quite some time althoughresults did not fully trail rising sales.

I actually owned R. Stahl back in 2003 when it was a turn around case. I do have prove for this as I opened a discussion thread at “wallstret:online” back in 2003 when the stockprice was around 5 EUR per share and which is still active. I sold at 17 EUR and thought I was a genius and missing the next 100% in 2 years…

R Stahl does not look too expensive. Although P/E is around 19, EV/EBIT and EV/EBITDA look pretty cheap. EV/EBIT of 7,3 for instance is pretty cheap and is not even adjusted for the 10% treasury shares which should be deducted from EV. The latest quarter didn’t look that good as R. Stahl suffers to a certain extent from the lower Capex of its mein customers, oil and natural gas companies.

R. Stahl was actually on my watch list after the fell in the beginning of 2014 however the Weidmueller offer came before I could look more closely into the accounts.

Back to the failed Weidmueller offer

So the question is: Why did Weidmüller make this offer anyway? To be honest, I don’t know. I researched a little bit and it seems, according to some newspaper articles (for instance here), that Weidmüller had contacts to the family before and that maybe the families are not such a “solid block” at all. In this other article there is an interesting comment that chances were not so bad after all as family controlled companies are more open to sell to other family companies like Weidmüller. They also mention “Phoenix Contact” as another potential buyer.

The combination of Weidmueller and R. Stahl seems to make some sense as this interview with the Weidmüller CFO clearly shows. It was clearly not a cost cutting project but a growth project.

Interestingly, the stock price did not retreat to the “undisturbed” level, but is hovering around 41 EUR, clearly above the level before the offer.

Q1 numbers which were issued after the first Weidmüller offer did not look so good, so this is not an explanation for the still elevated stock price.

Is this interesting ?

A very simple way to look at this is making the following assumptions:

- something is happening within 1 year, either deal or ultimately no deal
- the “undisturbed” price is EUR 34.
- the control price is 50 EUR per share
- I want to make an expected return of 15% p.a.

Then I can solve for the implict required probability of a 50 EUR deal happening within 1 year:

41*1.15 = (Prob*50) + (1-Prob)*34 or (41*1.15-34)/16 = Prob

Based on those assumption, I would need to apply a 82% probability in order to have a 15% expected return on investment. I think this is much too high for my taste.

At the moment, I would assume that there is a 50/50 chance. With this assumption, I can calculate my required price level where the stock gets interesting.

This would be then the follwoing calculation:

0,5*34 + 0,5*50 = Price *1.15 = 36,52 EUR. So at 36,52 EUR per share I could get an expected return of 15% with odds at 50/50.

Now we can make another assumption: Let’s assume we are still at 50/50, but we assume that any acquirer has to pay more than 50 as the 50 were clearly not enough. So lets say 55 EUR. Then my target price would be around 38,69 EUR per share where I would be prepared to buy.

In reality, of course the outcome will not be so binary, but I think this framework is a good way to get a feeling for an intersting entry point. For me, the current price level of 41 EUR is a little bit to high, but I think this could be interesting around 38,50 EUR as a special “failed M&A” situation.

Activist angle

There is a further interesting angle. A smaller, but in expert circles well known investor (Scherzer) has released an “open letter” to the management and board during the offer period. There they critize that from the beginning Management and board were against the offer despite the fact that they are obliged to work for the benefit of all shareholders and not only the founding family. The letter contains some other interesting info, such as that the Head of the supervisory board had actually sold shares in the market before etc. etc.

The target of this letter is clearly to put pressure on the family in order to “Motivate” them making an offer to minority shareholders at the “eidmueller” price. I am not sure how the chances of success are here, but this could increase the odds towards an “event” as described above. I am not a lawyer, so I cannot fully judge if the potential legal issues mentioned in the letter with refusing the offer are enough to build a case against them but it clearly increases the leverage.

The question for me is: Does this move the “needle” far enough t justify an investment at the current price of 41 EUR ?

Summary:

Although the failed R. Stahl offer is clearly different from my succesful Rhoen investment, the situation itself is interesting. However for my taste, the current price of 41 EUR is a little bit to high compared to the undisturbed price of around 34 EUR in order to justify an investment. For me, this would get very interesting at a price of around 38-39 EUR at the curent stage. I will watch this one closely…..

Portugal Telecom follow up – SELL

In April, I invested ~1% of my portfolio into Portugal Telecom because I found the merger situation with Brazilian Telco OI very intersting.

In the last few days, the stock price dropped like a stone because they disclosed a 900 mn “investment” into the troubled Portuguese “Espirito Santo” Group

Reader benny_m post a very good comment on the old post, asking where to find in the balance sheet those 900 mn EUR.

Looking into the 2013 annual report and the Q1 2014 report, there are only 2 possibilites:

1. Cash and Cash equivalents
2. Short term financial investments

Those are the respective amounts:

Q1 2014 2013
Cash 1.276 1.659
ST investments 1.071 914

So theoretically, the could be within either category. However two important caveats from my side:

- if they would book this under Cash and Cash equivalents, this would be scandalous and reminds me very much about the Royal Imtech fraud
- in the annual report, the comment to short term investments reads as follows:

24. SHORT – TERM INVESTMENTS
This caption consists of short-term financial applications which have terms and conditions previously agreed with financial institutions.

They disclose 750 mn of “debt securities” which are described as follows:

(i) This caption includes primarily debt securities issued by PT Finance and Portugal Telecom that had an average maturity of approximately 2 months and were settled in 2014 at nominal value plus accrued interest.

This makes no sense. “Issuing” a security means actually receiving money. They cannot own their own issued securities as those would have to be consolidated out. Also the second part of the sentence makes no sense at all. Those amounts were not “settled” as the total amount even increased in Q1 2014.

To add insult to injury, Portugal Telecom actually discloses “related party transactions” with Banco Espirito Santo (BES) on page 219 of its annual report as they are a significant shereholder, but there is no word of the loans to “Rioforte” another Espirito Santo group company.

Let’s look back at the “official” press release of PTC:

PT subscribed, through its former subsidiaries PT International Finance BV and PT Portugal SGPS, a total of Euro 897 million in commercial paper of Rioforte with an average annual remuneration of 3.6%. All treasury applications in commercial paper of Rioforte will mature on 15 and 17 July 2014 (Euro 847 million and Euro 50 million, respectively). Treasury operations are carried out in the context of analysis of various short-term investment options available in the market and taking into account the attractiveness of the remuneration offered and are monitored and approved by the Executive Committee.

Additionally, it is thus important to note that the subscription of commercial paper of Rioforte is based on the 14-year long adequate experience in treasury applications of Banco Espírito Santo (“BES”) and GES entities, in the context of the strategic partnership signed in April 2000 between both parties. This strategic partnership contemplated the cross shareholding between both entities as well as the designation of PT as a preferred supplier of telecommunications to BES Group and the designation of BES as preferred provider of financial services to PT.

Both sentences are in my opinion a clear prove of dishonesty of PTC management. No, lending 900 mn EUR to a troubled financial institution IS NOT part of normal treasury operations. And second, if you have a “strategic partnership” then you shoul disclose this under the relvant section in your annual report instead ogf hiding it behind nonsensical comments.

I have actually send some simple questions to PTC IR (where did they book it etc.) but received no answer.

Summary:

At this stage, I cannot say for sure if this is “only” dishonesty on part of PTCs management or if there is even fraudulent activity involved. In any case this looks really bad and as a result I will sell my PTC shares at current prices (2,18 EUR) and take the loss (~-27%. This is a company where you can’t trust management and even less their accounts/disclosures and this is an absolute “no go” for me.

Performance review June 2014

Performance June

In June, the portfolio gained 0,9% against -1,2% for the Benchmark (Eurostoxx50 (Perf.Ind) (25%), Eurostoxx small 200 (25%), DAX (30%), MDAX (20%)) an outperformance of +2,1%. YTD, the score is +10,2% against 4,1% for the Benchmark.

For June, positive contributers were IGE+XAO (+13,2%), Sistema (+7,5%), Admiral (+6,2%). Main loosers were Van Lanschott (-4,2%), KAS Bank (-4%,0%) and Energiedienst (-2,5%).

Interestingly enough, June was the fourth month in 2014 with negative BM performance and significant outperformance of the portfolio. This is how 2014 looks on a monthly basis:

Bench Portfolio Perf BM Perf. Portf. Portf-BM
Jan 14 8.849,21 181,48 -1,9% 3,7% 5,5%
Feb 14 9.306,80 186,34 5,2% 2,7% -2,5%
Mrz 14 9.228,53 187,18 -0,8% 0,5% 1,3%
Apr 14 9.203,99 189,76 -0,3% 1,4% 1,6%
Mai 14 9.499,94 191,22 3,2% 0,8% -2,4%
Jun 14 9.387,95 192,98 -1,2% 0,9% 2,1%

So whenever the market performs strongly, the portfolio underperforms significantly and when the market retreats it more then compensates. There is certainly some time lag involved here but I cannot completely explain what is happening here. At least it doesn’t look like a lot of beta ;-)

Portfolio transactions

June was a very quiet month, the only transaction was to sell the remaining April SA stake. Although I introduced Admiral in June, I had invested already in April. The current portfolio as always can be seen here.

Including all the earned dividends, cash is now at ~11,8% plus the 5% in the Depfa LT2 which I consider very close to cash.

Currently, Portugal Telecom is “under review”. I bought a small position in order to keep my interest in the PTC/OI merger, the recent news about the undisclosed Rioforte investment caught me by surprise. I have sent an Email to PTC IR in order to clarify the accounting, but overall I think this is not a comapny to invest in after this incident.

As I have already written, in early July I already invested another 2,5% of the portfolio into NN Group, the Dutch IPO and insurance subsidiary of ING.

NN Group NV – “Hands off” IPO or interesting special situation ?

NN Group is the name of the soon to be just IPOed Insurance subsidiary of Dutch ING Group. NN Group sounds a little bit strange but is the “traditional” name of the Dutch Insurance company, “Nationale Nederlanden”.

As a value investor, normally, IPOs are an absolute “No go”. Benjamin Graham famously said that one should never touch an IPO because almost always, the stock price is overhyped and the risk return relationship is not good. Especially now with the market reaching new highs, buying IPOs doesn’t seem a good idea.

So why could this IPO be different ? In my opinion there are some good reasons:

1. ING is obliged to sell.

ING had to be rescued in 2008 by the Dutch Government under the condition that they dispose their full insurance activities. They cannot simply spin off the business because they need the money to pay back the Dutch Government and shore up the bank balance sheet.

This is form a recent Bloomberg article what they have done so far and what they committed to:

ING, the recipient of a 10 billion-euro bailout from the Netherlands in 2008, agreed with EU regulators to complete its disposal program by the end of 2016 and to sell more than half of NN by the end of next year. ING also still owns about 43 percent of Voya and a stake of about 10 percent in Sul America SA (SULA11) in Brazil.

The company is open to selling the Sul America stake, worth about 566 million reais ($253 million) based on the Rio de Janeiro-based insurer’s market value, in a block trade, Chief Executive Officer Ralph Hamers said in an interview in Sao Paulo yesterday.

2. The company is an “ugly duck” at first sight

The remaining insurance compqny is a strange combination of Netherlands, Eastern Europe and Japan with some Investment Management thrown in. In German, one would call the business mix a “Resterampe”, so the remains of what could not be sold directly. The majority of the business is Life insurance, which itself is clearly suffering from low interest rates.

The company shows more or less zero profits for 2013, however a couple of items could be considered true “One offs” in order to look better in the future, for instance the large charge against the closed Japanese VA business. Also Q1 2014 showed a loss, this time because of a charge in relation to pensions.

So now one can accuse ING of “dressing up the bride”, rather the opposite.

3. European Insurance is one of the sectors with the lowest valuations anyhow

The Stoxx 600 has currently a P/E of 24,8 and a P/B of 1,9. Compared to this, the Insurance sector trades at a trailing p/E of 12,4 and P/B of 1,21. This is even cheaper than banks and utilities. Within the insurance sector again, the Life Insurance sector is even cheaper. There are clearly many reasons for those low valuations, especially that interest rates are so low which makes it hard for life insurers to earn their guarantees and a spread on top if this.

4. The IPO valuation looks cheap compared to the sector.

The company comes to the market at around 50% of book value. Considering that they don’t have a lot of Goodwill, this looks cheap even compared to the generally low valuations for life insurance companies. Dutch competitors Aegon and Delta Llyod trade at P/Bs of 0,7 and 1,3, the average for European Life insurers is ~1.4 including UK, and around 1 excluding UK.

5. The company looks like a target

Looking at this IPO, there seems to be a big sign on the company saying “split me up”. This strange combination of businesses is clearly not value enhancing. Splitting the company up for instance into a Dutch entity and selling down the rest could be a pretty easy exercise for an activist Hedge fund. I could also imagine that some Asian financial companies would be interested in acquiring a solid Dutch “brand”-.

6. The company is relatively solid

If one looks at the “usual suspects”, like Goodwill, pensions etc. there is not much to be found. The company had 6 bn of defined benifit liabilities in 2013 but actually got completely rid of them in early 2014 against an extra charge. I consider this as very positive and a good sign that they really cleaned up a lot of stuff befor doing this IPO. Additionally, another insurance specialty, so-called “DACs”, which are capitalized distribution costs only play a very minor role at NN compeared to other life players like AXA.

They do have some leverage but overall I would rate the balance sheet quality as “above average” for the sector.

7. The US IPO went relatively similar

There is a blue print for this transaction: Voya, the former ING US IPO. The US business was also supposed to be pretty ugly, so ING placed the first tranche very very cheap at below 0,4 times book value. Since then however the valuation seems to slowly approach those of other US life insurers and the stock almost doubled since IPO:

Other thoughts:

Management incentives
What I didn’t find out in the annual report or in the IPO prospectus was how the NN Group management is aligned with shareholders going forward.

In situations like this, a lot depends on Management, especially if they want to actually increase sahreholder value or if they want to maximise salaries which is easier in a bigger company and which would make reasonable spin-offs and disposals unlikely. So this is something to be watched.

Management has committed to a quite aggressive dividend payout ratio of 40-50%, starting with a large payout already this year in autumn. I am not a dividend investor, but this greatly reduces the risk of stupid acquisitions.

Distribution agreements with ING Bank

Life Insurance is mainly distributed via banks these days (often along with a mortgage loan). NN has an exclusive agreement with ING Bank according to the IPO porspectus until 2022. Although this is a limited time frame, this is very valuable as banks now charge high upfront fees in order to access their distribution channel.

Summary:

In my opinion this “IPO” of NN Group is much more similar to the classic “spin-off” than a “real” IPO. ING has to sell, the underlying business looks ugly at first sight and there is a lot of overall negative headline news for the sector and the specific business fields. As a result, other than with a normal IPO, the valuation is very cheap.

As I feel comfortable with the headline risks at this price level, I will invest a “half position” (2,5%) of the portfolio into NN Group at current prices (21,70 EUR). The short form investment thesis is that one gets an above average quality insurance business for a below average price.

Again, this is clearly not a “no brainer” and will need (lots of) patience, but over 2-3 years, the price of the shares could be easily 50% higher (including dividend distributions) if they reach average valuation ratios and the one-offs turn out to be real one-offs.

Book review: “Dream Big” (The 3G story) – Christiane Correa

To be honest, when Waren Buffet last year announced his intention to team up with the Private Equity company 3G in order to buy Heinz, I didn’t know anything about those Brazlian guys behind that company. Especially, the “Mastermind” Jorge Paolo Lemann who is now the 28th richest guy in the world with a net worth of around 25 bn USD was amlmost completely unknown to me.

During the Berkshire AGM, someone (I don’t know who it was, maybe Buffet ?) mentioned that they are selling 250 hard copies of the book which describes how those Brazilian guys got so succesful. However when I went to the bookstore, the copies were already sold out.

So as a kind of additional research when I looked at GP Investments, I downloaded the available Kindle verison of the book.

Jorge Paolo Lemann started his business carreer as a classical banker/trader. Relatively soon, he was able to buy a small brokerage which he renamed to “Garantia”. Over 20 years or so, Garantia was one of the most succesful investment banks in Brazil. The book lacks a little bit in detailed description what they actually did at Garantia, however it seemed to have been a mixture of investment bank and hedge fund, generating huge profits especially in those times when the Brazilian currency was in trouble.

One of Lemann’s key strategies was that he tried to hire “hungry” people and motivated them via huge bonuses which were distributed based on actual results and not, as with many other Brazilian companies based on seniority etc. So to a certain extent, Garantia seemed to have been not unsimilar to a typical “wolf of Wallstreet” boiler room where young and aggressive traders could get rich very quickly.

However the main differentiator of Garantia was the fact that Lemann didn’t pay out the bonuses but required his employees to use the bonus in order to buy shares in Garantia from the founders. So the most susccesful employees also became very quickly major shareholders and partners. In theory and practice, this aligned the interests very well. Lemann is cited several times that he wanted his employees to remain “cash hungry” which doesn’t work well when you pay high cash bonuses.

Relatively early, he also became interested in investing in “real” companies. The first succesful attempt was the Brazilian Retailer Lojas Amricanas. Especially when more and more cash piled up at Garantia, he didn’t want to pay out huge dividends, but used the cash to buy the then struggling Brazilian brewer Brahma for an amount of 60 mn USD. The story about that transaction sounds quite funny. The didn’t do a real due dilligence and only found out afterwards that the company had a 250 mn USD pension hole. Without knowing anything about breweries, they managed to turn around the company pretty quickly.

While being occupied with Brahma, Lemann seemed to have lost interest in banking. While he was still on the board, Garantia almost went belly up and was finally sold for 675 mn USD to Credit Suisse, however the Brahma shares were spinned off before that to the partners. In the book, at thwo instances he seems to have complained about his younger partners that they paid out themselves too much cash instead of adhering to his beloved partnership model.

Going forward, Brahma managed to acquire their biggest rival in Brazil, Antarctica. Further “rolling up” the beer industry, they “merged” with Belgian Interbrew and then finally, in 2008 made the all debt financed acquisition of Anheuser Bush for a whopping 50 bn USD, creating the largest brewing group in the world.

Overall, by only reading the book, it was hard for me to understand if Lemann and his close associates (Telles, Sicupira) are really genius and visionary business men and investors or if they are just aggresive “financiers” who got lucky.

In the time when they build up Garantia for instance, a lot of financial institutions in Brazil prospered, sometimes through questionable ways of information gathering. Also the essential Brahma and Antarctica merger, creating a dominating Brewery in Brazil with 70% market share would have not worked that well in a country with a tougher anti-monopoly regulation.

At least they were more cautious than another former Brazilian superstar, Eike Batista, who stayed in Brazil with his investments and almost lost it all in the last 2 years or so.

For me, the most crucial part of the “Lemann” story is his view on how to align Management and owners. Its seems that in the long term, the owner/manager model where managery invest their salaries back into the company is able to generate exceptional value compared to a “cash bonus/option” model for management.

Interestingly, there was a story earlier this year the Brito, the Brazilian AB Imbev CEO seems to have “gamed” his targets in order to earn a massive bonus. This would not be in line with Lemann’s philosophy. Still it doesn’t seem to have impacted the stock price of AB Inbev which has trippled over the last 5 years.

Overall, the book is written OK, not exceptional like Michael Lewis but still interesting to read. I think it is worth a read especially if one is interested in the Brazilian market and its history and in the alignment of management and shareholders. It is clearly not an “how to invest” book.

Other sources:
Bloomberg story on Lemann & 3G

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