There is always something “on sale”

When I go home from work, it is usually quite late and I don’t have a lot of time for shopping, as shops close at 8 pm sharp.

The next store for me is actually a “Karstadt” branch, which has a nice but VERY expensive grocery department. The interior looks like this:

The stuff they are offereing is good quality but it is in general very expensive (like 2 times the price compared to a normal REWE), but they do always have some items on sale. In the sausage department for instance, they will have really good Parma ham at a good price one week, Serano ham the next week and “Südtiroler Speck” the next week. So if you are flexible, you can make a “good value” purchase despite the fact that the store on average is really expensive. The interesting thing about being flexible is that if you always go for the “on sale” item, which I do for instance also for cheese, you sometimes discover interesting new things. One of my favourite cheeses (goat cheese with cranberries) for instance is one which I would never had thought of buying before. But as it was on sale, I bought it and really liked it.

The big trick is not to buy (too much) of the expensive stuff. Sometimes you can’t avoid it, but if you have a plan and stick to it, my overall bill is relatively similar to a “normal” Supermarket and I often end up with new and interesting items.

If I would always buy the same item, for example Parma ham, my favourite ham, I would end up paying on average far too much or, if I would use a hard cap on price I would end up hungry on many days. In my case, buying nothing and being hungry often ends in eating really unhealthy stuff like chips and chocolate, so this is a rather “high risk” strategy.

So why am I writing about my shopping habits ? Did I run out of investment ideas or what

Well, I do think that the current stock market is, to a large extent similar to my Karstadt grocery department. There is no doubt that on average stock prices look very expensive. Especially my favourite “hunting ground”, quality small caps are on average really expensive, same as US blue chips etc etc.

On the other hand, if you look around a little bit further and allow some flexibility like in my Karstadt grocery store, there is almost always something on sale in the stock market. For instance in 2011/2012 when German small caps already looked very rich, I decided to look into Italian and French stocks (which I had never done before) and I was genuinely surprised how many “good value” stocks existed outside my native environment. Clearly, not every new item will be of good “Taste” as some of my early experiments with Greek and Italian stocks showed. But the gain of the positive surprises more than made up the items which were not to my liking.

Although it is much early to tell, my trip further away into markets like Russia and Turkey seem to confirm my theory. Those markets are clearly on sale, but at a first glance, it is an unusual taste. On a second glance, one is often surprised how good those companies are.

Here are, in no particular order, some areas where I think “on sale items” can be found:

- Emerging markets stocks (Russia, Turkey etc.)
- Eastern European stocks
- European utility stocks
- European financials (banks, insurance)
- Oil majors, oil service
- Dutch real estate companies
- “traditional” Hong Kong companies
- UK grocery companies
- shipping

Clearly, not everything on this list will turn out as “good value” and some of them might even be far over the “consume until” date. And none of them will most likely prvide you with a “quick double”. But medium term, 3-5 years, many of those areas will contain stocks who will provide more than ufficent return compared to their risk.

Coming back to my grocery example: Many of those “sale items” aren’t even in the sausage and cheese department, they might be in the fish or salad area or even at the vegetable stand. But if you are flexible enough to go home and eat a delicious “oriental bulgur salad” instead of cheese or Parma ham, you will not only make a good deal but gain an interesting perspective.

One advice however: if you try something new and exotic, don’t go all in and buy 3 kilo for the next two weeks. Just buy a small amount and look if it is your taste. At Karstadt for instance i ended up once with a pink fish egg paste which I really didn’t like at all. But as I had bought only a small portion, I just threw it away with no loss.

Back to the stock market: What I see at the moment is that many good stock pickers are going into cash because their favourite area has become to expensive. They “slavishly” follow Buffett’s advice to buy only what they know and wait for a crash in order to buy back their favourite shares at low prices. For me however this strategy resembles a little bit this well-known strategy:

Additionally, many investors seem to be influenced by guys like John Hussmann who claim to have statistical proof that nothing can be earned on average at the current valuation levels. Ignoring the fact that Hussmann’s performance numbers short, mid and longterm totally suck, I think the problem with all those “backtesting” gurus is that their market timing asset allocation look great on paper and charts but rarely work in practice.

I personally think that “contrarian, value based” stock picking without active market timing will beat any “asset allocation backtest” strategy over the long run. Especially for smaller investors, the coming years might be very very good years for stock pickers if one stays away from the beaten paths despite most likely weak returns for the overall market.

As a stock picker, I think times likes these are a great opportunity to expand one’s circle of competence and look for bargains outside your favourite areas as there might seem to be plenty available. As I said in the headline: There is always something on sale.

Quick MIFA update – How to “play” covenants

Disclosure: No position, for educational purposes only.

2 weeks ago I had a quick look at the troubles at MIFA, the German bicycle manufacturer.

The official version was that they had a short term problem with their accounting but no liquidity issues. This was the last paragraph of their press release in MArch:

MIFA expects to break even at the after-tax level in the first quarter of 2014. It will not be possible for the company to issue a reliable guidance concerning the full 2014 financial year until the preparation of the annual financial statements has been completed. The company has sufficient liquidity for its operating business.

So it was quite surprising that the company today, MIFA announced the following:

- The CEO is now gone forever
- they did a “sale-lease back” of their real estate to the local Government, raising 5,7 mn EUR

So to a certain extent they do seem to have liquidity issues, otherwise they would not sell their “last shirt” for cash. The more interesting part for me is the fact that “sale-lease back” is economically nothing else than a “secured loan” on the real estate.

Looking into the bond prospectus, the outstanding bond includes a so-called “Negative Pledge” covenant:

Der Emittent verpflichtet sich, solange Schuldverschreibungen ausstehen, jedoch nur bis zu dem Zeitpunkt, an dem alle Beträge an Kapital und Zinsen, die gemäß den Schuldverschreibungen
zu zahlen sind, der Zahlstelle zur Verfügung gestellt worden sind, keine Grundpfandrechte, Pfandrechte oder sonstige dingliche Sicherungsrechte (jedes solches Sicherungsrecht ein “Sicherungsrecht”) in Bezug auf ihren gesamten Geschäftsbetrieb oder ihr gesamtes Vermögen oder ihre Einkünfte, jeweils gegenwärtig oder zukünftig, oder Teile davon zur Sicherung von anderen Kapitalmarktverbindlichkeiten oder zur Sicherung einer vom Emittenten oder einer seiner Tochterunternehmen gewährten Garantie oder Freistellung bezüglich einer Kapitalmarktverbindlichkeit einer anderen Person zu bestellen, ohne gleichzeitig für alle unter den Schuldverschreibungen zahlbaren Beträge dasselbe Sicherungsrecht zu bestellen oder für alle unter den Schuldverschreibungen zahlbaren Beträge solch ein anderes Sicherungsrecht zu bestellen, das von einer unabhängigen, international anerkannten Wirtschaftsprüfungsgesellschaft als gleichwertig anerkannt wird. Dies gilt vorbehaltlich bestimmter Ausnahmen.
“Kapitalmarktverbindlichkeit” bezeichnet jede Verbindlichkeit aus Schuldverschreibungen oder ähnliche verbriefte Schuldtitel oder aus Schuldscheindarlehen oder aus dafür übernommenen Garantien und/oder Gewährleistungen.

The covenants do actually prevent them to take out a typical German “Schuldscheindarlehen” against their real estate. Interestingly, an economically equivalent sale-lease back (which will be booked as financial liability) doesn’t seem to violate this covenant.

Should for some reason, MIFA go bankrupt, the recovery for the bondholders will be significantly lower than before as the real estate now belongs to someone else and will not be part of any liquidation proceeds.

I find it interesting how easy it is to circumvent such covenants with economically equivalent transaction. A reason more to stay as far away as possible from German corporate bonds in general and the so-called “Mittelstandsanleihen”. There is no “seniority” of those senior bonds, those instruments are clearly “junior” capital for German corporates. Nevertheless, bondholders seemed to like it:

It will be interesting to see if today’s bounce in the bond price is similar to what happened at Praktiker when they announced their first “rescue” and the bond price doubled from 40% to 80% before then collapsing to close to zero. Or maybe the Indians are already on their way with big suitcases full of frsh money. Who knows ? But a lot to learn for bond investors.

Exotic Securities: Piraeus Bank Warrants (ISIN GRR000000044)


First of all a hat tip to Profitlich & Schmidtlin which had mentioned this idea in their first quarterly letter.

Piraeus Bank is one of the “survivors” of the Greek Banking sector. As with other Greek banks, the bank was “rescued” by the Government via a dilutive capital increase, with the Greek Government as a majority shareholder. Those private investor who participated in the capital increase got as a kind of “compensation” (and exit vehicle) some Warrants “for free” which allows them to buy back the shares until 2018 from the Greek Government. Those Warrant are traded quite actively on the Athens Stock Exchange.

Maybe in order to make it more fun, the Greek Government spiced up the Warrants with some extra features which are ( a kind of term sheet can be found here)

- one Warrant gives the right to purchase 4,476 shares from the Hellenic Stability Fund (so its non dilutive”)
- the final maturity is 02.01.2018, however there seems to be a kind of “forced” exchange possibility on 02.07.2016
- the Warrants can be exercised every 6 months, so its technically a “Bermudan option”
- the strike price increases every 6 months after a predetermined formula

At a first glance, this “thing” seems to be really hard to value. Bloomberg for instance does not offer to value “Bermudan Equity options” in its standard option valuation tool (OVME).

Bermudan Option

Let’s take a step back and look at principal option types. The two classical types are:

- European Option: This option can only be exercised at the final maturity date
- American Option: This option can be exercised on every day during the term of the option

Nevertheless, there is normally very little difference in the value of an European option and American one if all other things are equal. The main reason for this is that in normal cases, the “time value” of an option is usually positive until the very last day. Exercising an American option early and “throwing away” the time value normally doesn’t make sense. For “normal” stock options, the only reason to exercise early would be a large dividend payment before maturity which will reduce the value of a (long Call) option, but in most cases one can ignore the valuation difference between an European and American option.

On the other hand, the increasing strike price of the Piraeus Warrant is economically equal to a dividend, so we cannot just ignore this feature and value it as a European Option.

This is the call schedule and the corresponding strike prices for the Warrant:

Call Date Strike Delta
02.01.2014 1,734  
02.07.2014 1,768 0,034
02.01.2015 1,811 0,043
02.07.2015 1,853 0,043
02.01.2016 1,904 0,051
02.07.2016 1,955 0,051
02.01.2017 2,015 0,059
02.07.2017 2,074 0,059
02.01.2018 2,142 0,068

From what I know, Piraeus Bank is not supposed to pay out any dividends in the foreseeable future. So in order to replicate the increasing strike, we could assume that the increasing strike is similar to a dividend assumption and we model this as an option with a strike of 1,734 EUR and dividends as shown in the column “Delta”.

Using the Bloomberg Option Valuation tool “OVME”, the same volatility and the assumption of a July 2016 maturity, the value difference between an European and American Option would be almost 20%, i.e. the American Option with the possibility to exercise at any day is 20% more valuable than the European one. This is due to the fact that I can basically wait until the last day before the synthetical dividend is paid an exercise then. So I don’t lose any time value and save myself the full dividend compared to an European exercise.

In our case however, I have to exercise 6 months earlier. With the OVME tool, I can for instance also calculate the value of an American vs. European Option for 6 months, “simulating” the time between for instance 03.07.2014 and 02.01.2015. For those 6 months, the valuation difference between an American and an European Option is only ~ 10%. Again, the “Bermudan” option is worth less than an American.

If I am actually in the last 6 months of the warrant maturity, the day after the last exercise possibility, the option will be exactly worth the value of a European Option. The day before it will be worth slightly less.

Anyway, as a very simple working assumption, I will assume that the “Bermudan” feature overall is worth 5% more than a European option.

Valuation of Piraeus Warrant

In order to value the Pireaus Warrant, we will have to make one further assumption: What is the final maturity ? If I understand correctly, the Greek Government has the possibility, to sell the shares after July 2016 without compensation to the Warrant holders if the Warrant holders do not convert. So as a realistic assumption one should use July 2016 as final maturity and not January 2018.

By the way, this “mechanic” of selling the shares without compnesation is a very strange featre for a Warrant.

In the following exercise I will use as the share price for Pireaus the level of 1.73 EUR, for the warrant 0.94 EUR (price at the time of writing)

As the first valuation steps, we can now do the following:

1) calculate the price of the warrant per share which equals the current traded warrant divided by 4,475. This would be 0.94/4,475= 0,21 EUR per share
2) “plug in” the price into the option calculator and solve for implied volatility (based on the current strike of 1.734 EUR and the “synthetic” dividends)

As a result we get an implied volatility of ~31.3% for the European Option, 26.2% for the American . This is rather at the low side for Piraeus. It is always a big question which volatilities to use, short-term (10 day) or longer term. Only 10 day historical volatility would justify such levels, trailing 305,50 and 100 day volatility is more in the 40-50% range.

We can now do a third step and

3) plug in for instance 45% as volatility and add 5% premium on the price of the European option to get to our value estimate. In this case this would result in a fair value of 0.33*1.05= 0.35 EUR per share or ~1.56 EUR for the Warrant. Compared to the 0,94 EUR per share, this would mean that the warrants trade at around 40% discount to their “fair value” which is quite significant.

So should one now run out and buy this undervalued security ? I would say: Not so fast, we need to consider at least one other factor

Potential shortening of maturity

The Greek Government as counterpart has quite a bad reputation for sticking to its terms. By googling a little bit, i found this quite revealing story from Reuters.

Two quotes here:

Some of Greece’s biggest banks and their advisors are starting to press the country’s banking rescue fund to look at ways to speed up their return to wider private ownership, banking sources say.

“They recognize that there are arguments to support the early retirement of the warrants,” he said, adding that the proposals would be favorable for the HFSF because it would no longer face a ‘cliff’ of all the warrants being exercised together.

However, any changes would have to be approved by the troika of European Commission, European Central Bank and IMF officials overseeing Greece’s bailout, who would be keen to make sure any changes did not disadvantage the HFSF or gift overly generous terms to the private investors.

In my opinion, this should make any holder of the Warrants really nervous. Currently, the Piraus Warrants do not have any intrinsic value, as the price of the share is below the strike. So all value is time value. With the option valuation tool we can play around a little bit with the maturity. Shortening the maturity (all other things equal) by 6 months for instance reduces the value of the Warrant by -10%, shortening it to July 2015 would reduce the value by more than -20%. The “break even” based on a 45% volatility would be some kind of “forced exercise” at the end of October 2014.

I do not know under which law the warrant has been issued, but if it’s under Greek law, then anything could be possible.

Valuation of Piraeus Bank

Finally a quick glance at the valuation of Piraeus Bank itself. Piraeus is currently valued at around 1,2 times book value. This is on a level with banks like Standard Chartered or Banco Santander, high quality diversified banks. However this is much higher than other domestic or regional players like for instance Unicredit (0.74) , Intesa (0,84), Credit Agricole (0,64) or even HSBC (1.05).

So without going into much detail, Piraeus bank looks rather expensive and a lot of recovery expectations seem to be priced in already.


At a first glance and under some critical assumptions, the Piraeus Warrants do look undervalued by around 40% based on historical volatilities and the price of the Piraeus share. However there seems to be significant risks, that the terms of the Warrant could be subject to change with a negative impact on the warrant. ALso the valuation level of Piraeus bank itself looks rather optimistic.

I would not want to own the Warrants “outright”. For someone who is ale to short the shares, a delta hedged position could be interesting in order to “harvest” to low implied volatility, although there would still be the risk of the change in Warrant terms.

I haven’t looked at the other Greek banks where similar warrants have been issued.

Some Links

Highly recommended: First Quarterly report of the new “Profitlich-Schmidlin” fund with short summaries of all positions (in German). Interesting portfolio and interesting strategy. Good luck !!

Short write up on Aggreko, an interesting UK company

Great story how stock picking legend Julian Robertson seemed to have lost it in 1996

Old School Value with a short thesis on Weight Watchers, a favourite among many value blogger. For a long thesis for instance look here.

Mebane Faber has developed a new ETF which invests into the 10 cheapest countries globally

Conference notes from the 2014 Value Investing congress in Las Vegas can be found here. As always, Zeke Ashton’s case looks interesting, although his BMW pitch looks pretty similar to that one from RV Capital a few months ago.

For all those who are desperately waiting for the next crash: A short overview of 240 years of financial crisis

Book review: “Flash Boys” – Michael Lewis

Following the current hype, I read over the weekend the new book “Flash boys” from Micheal Lewis.

Michael Lewis is most likely the best “writer” of finance books and the new book is now exception. As in most of his books, he focuses on specific person who are usually some kind of outsiders.

In this book, the focus is mostly on an equity trader named Brad Katsuyama who stumbles over the fact that he is not able to make a profit any more in equity block trading at his old job at Royal Bank of Canada (RBC).

Step by step he discovers more and more details how so-called “High Frequency traders” (HFT) are able to exploit tiny timing advantages to squeeze out riskless profits from big orders. This goes as far as HFT companies paying loads of money for direct fiber connections and for the privilege to put their machines directly next to the stock exchange computers in order to get any “micro second” advantage they can get.

In HFT, suddenly knowledge about how computer signals are being transmitted are becoming more important than any kind of fundamental knowledge about stocks, so he assembles a team of TelCo and computer experts in order to understand what is going on.

AFter Katsuyama discovers that the markets are pretty unfair, he decides to quit RBC and starts to build a new, slower and fairer stock exchange called IEX which does not allow HFT to conduct their strategies.

Lewis weaves in 2 other stories, one from an entrepreneur who digs out a fiber optic line between Chicago and the east cost and the other, which Lewis had already published separately in 2013 about Serge Aleinikov, the Russian born Goldman Sachs programer who got tracked down and arrested for stealing computer code.

In my opinion, the book is written very well and despite being an easy read, is pretty helpful to understand what is going on in the HFT area.

Lewis covers specifically the time difference arbitrage between the fragmented US exchanges, which interestingly became only possible because of regulation which was targeted to prevent abuse but backfired.

To a lesser extend, he also touches the issue that at US exchanges, professional players can use hundreds of different order types which gives them a big advantage. SOme f them seem to work that they seem to offer a certain price but when you want to buy, they suddenly disappear and/or get more expensive. Finally, he also looks at the so-called “dark pools” of the banks where a lot of trades are made without any transparency for clients.

Personally, I do think that HFT creates certain issues as seen in the Flash Crash some years ago. But overall, I do not have the feeling that HFT is the only reason why the market is “rigged” as Lewis implies in many parts of the book.

For instance, algorithmic or program trading is much older than high frequency trading. People atbank equity desks like Katsuyama used those algos to trade their large orders before. Those programs created nice profits for the banks without much risk. Usually, a client would give a “VWAP” order to the broker, who then would bill the client the VWAP, but would execute the trade via an intelligent algo who would make sure that the bank would make a profit. I actually met I guy once who had programmed such an algo for Lehman in the 90ties. The profits from this algos and the resulting bonuses for him allowed him to retire in his 40ties.

What those HFT shops seem to do is to “sniff out” the algos of the banks and then trade against them with lightning speed and exploit their weaknesses. In my opinion this is also one of the reasons why the banks created their “dark pools”.

As a little guy, I do not care that much of an extra penny or so per trade.I pay substantial fees in any case and trade once or twice a month. A flash crash for me is a non-event as I just sit it out. For me, “market rigging” comes much more in the form of things like low ball take-overs from Private Equity shops with CEO consenting and getting big bonuses, unfair minority shareholder provisions, stock lending fees in ETFs with an unfair fee split, classic insider trading, “adjusted” earnings etc.etc.

So as a summary I would say: It is a very entertaining book and HFT is clearly an issue. However for the “small guy” which gets referred to quite often in the book, there are a lot more other issues in the market. HFT for me seems to be rather an issue for banks and institutional investors than for a little guy with a “slow trading” stock portfolio.

Performance review March 2014 – Comment “P/E is not equal P/E”

Performance March

Performance in March was +0,5%, slightly better than the -0,8% for the Benchmark (Dax 30%, MDAX 20%, Eurostoxx 50 30%, Eurostoxx small 20%). YTD the Portfolio is up +6,9% against +2,4%. Interestingly, the driver for the BM return ist the Eurostoxx small index with a +7,9% performance YTD whereas the MDAX, one of the best performing indices in the world for the last few years is actually slightly negative.

In the portfolio, positive contributors were primarily Thermador (+9,2%), SIAS (+6,9%) and TGS Nopec (+3,9%). Additionally, I was very lucky with my short-term EM timing. KOC is up +14,2%, Sistema +7,9% and Ashmore +5%. However I expect that those positions will be very volatile so nothing to celebrate here. The biggest looser was Vetropack with -6,5%.

In general, the portfolio clearly profits from the current big hype on European small caps. I think in many cases, valuations imply already a fair amount of recovery in the Euro zone which might happen or not. On the other hand, the fundamental upside in many cases seems to be somehow exhausted, so I will remain on the selling side in some cases such as the reminder of SIAS. For my “French” bucket I am still comfortable as fundamentals for “my” stocks are keeping pace with stock price increases.

Portfolio activity

In March, Portfolio activity went back to “normal” pace, with one new position, Sistema (1%) and the sale of a half position of SIAS. Cash level is now ~15%. The current portfolio can be seen here as always.

Comment – “P/E is not P/E”

Quite a number of very clever investors are very negative on the stock market and expect a “real crash” rather sooner than later. This starts with famous guy like Seth Klarman, John Hussman over to a lot of very clever people I know personally.I am not a big fan of trying to read the “sentiment” of the market, as this turns into second guessing and I prefer to do “primary” research.

The idea of trying to get out before the crash, wait for the bottom and then invest cheap sounds pretty logical. Avoiding the crashes would have generated significant alpha over the last years. “Buy low, sell high” sounds like the most easiest thing in the world. So why are “we” investors not all rich and living on our private Islands in the Caribbean Sea ?

In my experience, there are several problems with this approach, one of the simplest is the following:

Many pundits look at past P/Es and try to “datamine” a strategy like: Sell if P/E is above 30, buy if P/E is below 8. It is no problem to come up with an algorithm, which, based on past data will show you a bullet proof strategy. But, surprise surprise, more often than not, this will not work.

A simple example why such data mining exercises often result in “spurious correlation”: P/Es are not absolutely “fixed” numbers. As everything in life, P/Es have to be seen in relation to other things.

I would assume that many people agree that the “intrinsic value” of any financial asset is the sum of the future cashflows discounted by the appropriate discount rate. Clearly prices can fluctuate around that value widely, but over the long-term, prices more often than not follow value.

The “appropriate discount rate” again, is the sum of the risk free rate (as a proxy the 10Y treasury yield is often used) and the stock specific equity premium.

The arithmetic relationship between discount rate and “intrinsic” value is relatively easy: All other things equal, the lower the discount rate, the higher the intrinsic value. It doesn’t matter if the risk free rate goes down or the stock specific equity premium, a lower discount rate means higher intrinsic value. Full stop.

So as a fun exercise, let’s look at a virtual company which generates 10 mn EUR profits per year with an assumed growth of 4% until eternity. Let’s further assume the correct equity premium for this company is 6% and does not change over time.

So now let’s look at 3 data points for the “risk free rate”, the historical 10 year USD Treasury rate:

30.09.1987: 9,587%
31.12.2000: 5,112%
31.12.2013: 3,012%

The “intrinsic” value of our virtual company at those 3 points in time would be:

30.09.1987: 10/(9,587%+6%-4%) = 86,3 or a P/E of 86/10= 8,6
31.12.2000: 10/(5,112%+6%-4%) = 140,6 or a P/E of 141/10= 14,1
31.12.2013: 10/(3,012%+6%-4%) = 199,5 or a P/E of 195,5/10= 19,6

SO if at all those 3 points in time, the company would trade at a P/E of 20, in the first case the company would be overvalued based on intrinsic value more than 2 times, in the second case by 37% and in the last case this virtual company would be fairly valued at a P/E of 20.

Clearly, my virtual company is unrealistic as growth rates change, equity premiums are not constant etc. etc. But I think the point is clear: No matter what, arithmetically, the “fair” P/E is higher when interest rates are lower. So a P/E of 20 from 1987 with interest rates at close to 10% is NOT EQUAL to a P/E of 20 in the current interest rate environment. All the P/E “mean reversion” analysis in my opinion is pretty meaningless if it doesn’t take into account interest rate levels.

Although many people don’t like it, but this simple aspect is covered nicely by the so-called “Fed model” which basically calculates the “P/E for bonds” and compares it with the P/E for stocks.

One could now start a discussion that interest rates are artificially low and have to go up and therefore P/Es will come down. But then we are already at a much better level of understanding tahn simply stating “PEs are too high and they have to come down”.

So to summarize this quickly: Looking at historical P/Es without taking into account then prevailing interest rates is pretty useless. Even more useless is the attempt to create “timing” models based on stand alone “P/E mean reversion” models. They might look good on paper but will most likely not work in reality. Although it makes nice headlines and blog posts.

MIFA AG (ISIN DE000A0B95Y8) – all that inventory and the supposedly largest bicycle company of the world

Disclosure: I do not have any interest in MIFA shares or bonds and I do not plan to invest, neither long nor short. This is a “for education purposes” analysis only..


MIFA is a German based manufacturer of bicycles. I had actually included them into the peer group when I looked at Accell, the Dutch bicycle company some time ago. The company went public in 2004. Its largest shareholders are the CEO (24%) and Carsten Maschmeyer, the billionaire former CEO of the controversial financial services company AWD.

A few days ago, they shocked their shareholders by sending out a press release which in my opinion is among the “all time greatest” press releases ever.


The headline was thee following:

DGAP-News: MIFA expands Management Board and announces prospective net loss for 2013

That doesn’t sound good but the highlights are within the release:

- Preliminary FY 2013 net loss of EUR 15 million

To put this in perspective, those are the accumulated earnings of MIFA since 2004:

MIFA Net income
2004 1,8
2005 1,7
2006 0,5
2007 -2,0
2008 1,2
2009 1,7
2010 0,4
2011 2,0
2012 -1,0
Total 6,3

So the loss is around 2,5 times their accumulated profits of their prior 9 years of operation. Not bad and shareholders didn’t seem to like that one:

Where it gets really interesting, is the explanation for the loss which really caught my interest:

 This net loss for the year is mainly attributable to a failure to meet sales revenue expectations during the 2013 financial year. Inventory positions were incorrectly booked in connection with the launch of a new accounting system in the second quarter 2013. The cost of materials was understated accordingly in the quarterly financial statements for the second and third quarters of 2013. As MIFA does not conduct inventory-taking during the course of the year, the company failed to identify the erroneous bookings until the preparation of the annual financial statements.

So what they are saying is: Sorry, we launched a new accounting system in Q2 2013 and screwed up our accounting for those last few quarters. This sounds unprofessional but rather innocent.

A quick attempt at some “forensic” accounting analysis:

Well, let’s have a quick look how this looks based on their own published numbers. If the cost of materials was the problem, we should easily see this in the share of material cost divided by sales. This is a table I have prepared over the last 15 quarters:


Cost of material against average Q
Q1 2010 71,3% -0,2%
Q2 2010 67,1% 1,5%
Q3 2010 63,6% -1,1%
Q4 2010 65,8% 6,1%
Q1 2011 74,3% 2,8%
Q2 2011 60,5% -5,1%
Q3 2011 69,8% 5,1%
Q4 2011 55,3% -4,4%
Q1 2012 71,3% 0,2%
Q2 2012 66,3% -0,7%
Q3 2012 68,3% -3,6%
Q4 2012 58,1% 1,7%
Q1 2013 69,0% -2,4%
Q2 2013 68,6% 2,9%
Q3 2013 57,2% -7,5%
avg Q1 71,5%  
avg Q2 65,6%  
avg Q3 64,7%  
avg Q4 59,7%

What I did is the following: I calculated the share of materials per quarter and then, as the bicycle business is cyclical, calculated averages per quarter. Then in a final step I subtracted the averages from the actual numbers to see the variation.

The table shows clearly, that variations of +/- 5% are not unusual. Indeed, Q3 2013 looks strange as the cost of material seems to be too low. But on the other hand, Q2 looks normal (material cost above average). So the “accounting software problem” seems to have kicked in only in Q3. However the impact of that problem is far from 15 mn EUR.

MIFA had around 20 mn “gross” sales. So if we assume that material costs would be average for Q3 at around 65%, then the impact of the new accounting system would have been around -1,5 mn EUR (pre tax). This is somehow less than the 15 mn loss (post tax) MIFA indicated.

So we can quickly summarize at this point: The new accounting system only explains around 1,5 mn EUR loss, not 15 mn.

Digging deeper: Inventory levels

So the question is: Where did the other 13,5 mn EUR loss come from ? Let’s have a quick look at their inventory levels.

Inventory/12 m sales vs 12 m ago
Q1 2010 43,7%  
Q2 2010 42,6%  
Q3 2010 40,9%  
Q4 2010 50,4%  
Q1 2011 56,4% 12,7%
Q2 2011 43,0% 0,4%
Q3 2011 39,1% -1,8%
Q4 2011 40,4% -10,0%
Q1 2012 57,8% 1,4%
Q2 2012 48,1% 5,1%
Q3 2012 53,4% 14,3%
Q4 2012 61,0% 20,6%
Q1 2013 77,7% 20,0%
Q2 2013 59,0% 10,9%
Q3 2013 64,2% 10,8%

This table shows per quarter the inventory level divided by 12 months trailing sales. Then in a second step, in order to eliminate the seasonal effect, I calculate the change per quarter from a year ago. As one can easily see, something seems to have changed in the second quarter 2012. Inventory levels went up and never came down. And just for reference: Accell manages to work with inventory levels of around 30% per year-end, half of what MIFA is showing.

What also seems to be a strange coincidence is the fact, that MIFA stopped to break down inventory in their 2013 quarterly reports. Before, they would split it out in finished but not sold products etc, whereas from Q1 2013 we only get one line for total inventory. A large inventory in my opinion is a big problem for a bicycle companies. Mostly, they renew their models annually. Full prices are only paid by customer in spring time, the later in the year the higher the discounts.Especially with Ebikes and their components, which improve a lot over the annual cycle, old stuff will require large discounts to sell them.

Finally a last look on the relationship actual sales vs. produced but not sold. Normally, due to the seasonality, MIFA would build up inventory (i.e. produce more than they sell) in Q4 and Q1 and then sell more than they produce in spring/summer (Q2 and Q3).

Total production Sales Unsold products
Q4 2011 11.435 7172 4.263
Q1 2012 40.731 38.297 2.434
Q2 2012 41.758 41.668 90
Q3 2012 17.426 17.463 -37
Q4 2012 13.782 13.836 -54
Q1 2013 43.025 35.954 7.071
Q2 2013 44.535 46.653 -2.118
Q3 2013 20.167 15.079 5.088

This table shows us that they had the usual inventory build up in Q4 2011 and Q1 2012 but that they failed to sell this in 2012. We then see a huge inventory build up again in Q1 2013 (on top of the large base). Then there was some selling again in Q2 2013, but the really strange thing is the inventory build up in Q3 2013.

So again, this underlines the impression that the problems started already in 2012 and that most likely the inventory is much to high.

Other stuff

When I quoted the press release above, I left out a few passages.

Mr. Wicht is currently unavailable to the company due to illness.

Mr. Wicht was the long time CEo and 24% owner. That he just dissapeared is not a good sign.

As far as the corporate bond that was issued in 2013 and existing bank credit facilities are concerned, it cannot be excluded that one or several of the financial covenants included
in the bond and credit facility terms cannot be complied with in the 2013 financial year. This might result in a special right of cancellation for the respective investors. If this were to occur, the company plans to convene a bondholders’ meeting to coordinate a corresponding amendment to the bond terms. The company would also examine other refinancing options in such an instance.

Oh oh, covenant breach, this does not sound very promising. I am pretty sure, bondholders and banks will not consent to anything, unless additional (dilutive) equity wil be injected.

And finally the “carrot on a stick”:

MIFA has made significant progress with its planned strategic partnership with Indian company HERO Cycles Ltd. (“HERO”). MIFA has signed a letter of intent with HERO that comprises a EUR 15 million investment by HERO. Further details relating to the transaction are subject to final due diligence, and to agreements where the parties are in advanced negotiations. Besides an equity investment, the strategic partnership includes an extensive cooperation venture between MIFA and HERO in the purchasing and product purchasing areas, especially in the case of electric bikes and motors. Legally-binding agreements with HERO are expected within the next few weeks. In terms of revenue, HERO is the world’s largest bicycle manufacturer.

Two comments here:

1. In technical terms, a letter of intent has no legal implications. Hero Cycle can walk away at any time if they don’t like the terms.

2. According to this report, Hery Cycles had sales of 1.450 “Crores” Indian rupees. One crore is 10 million so we are talking abot 14.5 bn Indian rupees of sales. Sounds like a lot, but with a 60:1 INR/USD exchange rate, we are talking only about 240 mn USD annual sales. So in terms of revenue, Hero Cycles is only around 60% the size of Accell. And the largest bicycle manufacturer in the world by sales is Giant from Taiwan with 1.8 bn sales or 7,5 times the sales of Hero cycles.

So the claim that Hero is the largest bicycle manufacturer is clearly wrong and in my opinion could be interpreted as misleading investors believing that there is a “deep pocket” Indian investor, whereas in reality, Hery cycles is only a relatively small company selling lots of ultracheap bicycles. If I calculated correctly, they are selling ~5 mn bicycles in India per year which results in an average selling price 44 USD per bicycle. I just found this link with the 2014 line up of Hero. Most of the models indeed are in the 40-50 USD per bicycle range. And by the way, the bicycle business in India doesn’t seem to be so great either at the moment.

And for the avoidance of doubt: Hery Cycles IS NOT part of the much bigger Hero Motor group. They do have the same founder but split up a few years ago.


I do not claim to really understand what MIFA was doing and I have no idea if they will survive or not. However, just by looking at their historical material costs and inventory level, it seems unlikely that the newly introduced accounting system could be responsible for a 15 mn loss. For me it is much more likely that the inventory build up at least since mid 2012 lead to overstated results over a longer period of time. The 15 mn loss announced seems to contain a significant write down on inventory as well. I could imagine that they might have to restate older financial statements as well.

For someone analyzing MIFA in detail, it would not have been that hard to see that something was going really wrong. Drastically increasing inventory levels in a seasonal business are always a really bad sign, at least as bad as increasing receivables.

For the shareholders and bond holders, there is still the hope that Hero Cycles from India might be the much needed saviour, although the false claims made in the press release should make one suspicious and I highly doubt that those guys have such “deep pockets”.

Let’s wait and see but this will not be easy for MIFA.

Update: Vetropack (CH0006227612)

Vetropack just released 2013 numbers and the annual report yesterday.

All in all, things don’t look so great. Sales increased 2%, however EBIT margins declined and net income declined significantly as the one-off gain from a property sale in 2012 could not be repeated. EPS (undiluted) was 137 CHF per share.

A quick reminder here: Vetropack reports in CHF but the majority of sales are non-CHF. In 2013, the Swiss frank depreciated against the EUR, so all things equal, even with constant EUR sales, Vetropack would show increasing CHF sales.

The stock market seems to have been expecting more, the share has dropped significantly over the last few week:

The biggest problem for Vetropack is clearly Ukraine, where they had ~15% of sales in 2013. They do not provide profits for their subsidiaries, so we do not know which margins come from what country. But clearly, with the currency devaluation (~-50% since the beginning of the year), in the best case, sales from Ukraine (and profits) will be -50% lower in 2014 than in 2013 just from the currency effect.

Looking into the 2013 annual report, we can see that most other subsidiaries are stagnating or only growing very slowly. interestingly, if we compare 2013 with the 2008 report, we can see that especially Switzerland has disappointed, with sales now -20% lower in 2013 than in 2008. Somehow, the increase int he Swiss franc seems to have been a big problem.

All in all, things don’t look very good. This is reflected also in the current valuation. At the current share price of ~1570 CHF, P/B is almost exactly 1, trailing P/E 11,4 and the dividend ~2,4%.

The only bright side was that cashflow looked rather OK in 2013. Operating CF of around 100 mn CHF minus Capex of 50 mn is ~50 mn free cash flow which has been distributed to shareholder to a large extent via divdends and teh stock repurchase last year. Net cash went down but this seems to be the result of a “Non core” purchase of a real estate company which came with some real estate loans (note 26 annual report). I would therefore exclude the 20 mn real estate debt from EV as the acquired assets are “extra assets”, not required to run the business.

Valuation & Competitors

That’s what i wrote back in “the old days”:

We can clearly see that for a margin of safety of 50% I would need to assume for instance a discount rate of 8% and a growth rate of 3%.

If history is any guide, Vetropack should be easily able to grow by 3%, having achieved much much mor in the past. Additionally, a 8% discount rate for a non-cyclical consumer product related company with net cash and an extreme conservative balance sheet should be reasonable.

This was based on 150 CHF free cash flow per share. 2013 FCF per share was around 122 CHF per share. So first mistake: Free cash flow did not increase by 3% from 150 CHF but did actually contract. Secondly, I used 8% as discount rate. As we see now, Vetropack’s regional exposure does not really warrant a lower discount rate than my simple 10%. So second mistake: The 8% discount rate was much too optimistic for a company with signficant “emerging markets” exposure.

If we look at the peers, both Zignano and Vidrala have been doing much better, at least over the last 2 years:

Both trade at siginficant higher valuations. Zignago at 20x trailing p/E, 8,5 EV EBITDA and 4,6x book, Vidrala at 18xP/E, 3x book and 7,8 x EV/EBITDA. MArgins are not that much higher for Zignago and Vidrala, but Return on invested capital (including debt) looks better. ROE anyway as both competitors use leverage. Both peer companies, despite being based in “PIIGS” countries managed to grow their top line better than Vetropack. Vidrala has grown sales by ~25% since 2008, Zignago by around 20%. Vetropack in comparison has grown sales (in EUR) since 2008 only by 15%, net income went down -10% vs. 2008.

But: Also for Zignago, net income went down -20% since 2008, only Vidrala could actually increase net income (after a small dip in 2011 and 2012). Although they seem to do almost all of their business in crisis ridden Spain, Portugal and Italy. So Vidrala clearly shows that you can do a solid job in this business even under adverse circumstances. Although valuations look stretched for both competitors.

Back to Vetropack: Starting with the current variables (1.575 CHF per share, 125 CHF FCF), I would need at a 10% discount rate ~4,5% FCF growth per annum to give me a 50% upside. This is clearly not going to happen soon. On the plus side, the downside is well protected via the (conservative) tangible book value which will most likely grow by mid single digits going forward.

So at the moment, I do not see a big upside or under valuation for stock, taking into account the higher risk profile of the stock.

The upside could come back, if Ukraine gets solved quickly and a lower discount rate could be justified. Another positive could be somehow lower costs but I would not rely on this. Finally, if they continue to buy back shares, then we could also see improving metrics per share but they didn’t announce anything yet.

What to do now ?

I am a little bit uncertain at the. I think I made a mistake in the beginning by using a discount rate which was too low and did not reflect the geopolitical risk profile of their subsidiaries. Now however, the Ukrainian risk seems to be priced in already to a large extent. As I am somehow more sympathetic to Emerging Markets in their currently depressed state, I am tending to keep Vetropack as a partial “Emerging markets / Ukraine bet” for the time being.

However, if I would find more and better EM bets, I might sacrifice Vetropack at some point in time.

Potential AirBerlin Delisting – Bad news for German stocks and its shareholders

Late last week, AirBerlin announced (more or less directly), among other stuff, that they plan to completely delist and transform themselves into a non traded “limited liability” company.

AirBerlin is a struggling regional German Airline, where Etihad, the Arabian airline has currently a 29% stake. Ethihad seems to be eager to increase their share to slightly below 50%, above that Airberlin would be at risk to lose valuable Airport slots etc. as they would not be considered a German/European airline anymore.

Normally, if you cross the threshold of 30%, you have to make a bid to all shareholders, usually related to an average price over the last 30 (or 0 ?) days or so.

In this case, the plan seems to be different. Ethihad and the management seem to want to take Airberlin private. In this case the tactic seem to be to scare investors away by delisting the shares and transform then into non-tradable stakes first, and then most likely come with a lowball bid for the remaining shareholders.

Looking at the stock chart, we can see that Air Berlins stock has been struggling anyway for a long time:

Funnily, the stock chart jumped shortly when the news came out but then went back down again rather quickly.

Why is this possible and where is the problem ?

Why did I say in the headline that this is bad news for stocks and ist shareholders ? Well, first of all, delisting a stock is definitely not a good thing for shareholders, all other things equal. Not being able to trade via an exchange means very limited liquidity. Limited liquidity or no liquidity means that holders either will require a higher discount to fair value or, as many funds etc. are not even be allowed to hold the stock and are forced to sell.

While this is a bad thing for existing shareholders, it is of course a good thing for a strategic investor, who does not need any liquidity in his position and wants to buy cheap. So “conspiring” with management in order to delist a company and drive down the acquisition price would be a very obvious strategy to take over companies cheaply.

In order to avoid this and protect especially small shareholders, there are usually regulations to prevent this. One case where I was directly involved last year for instance was EGIS, the Hungarian pharmaceutical company. There, the majority owner also threatened to take the company private in order to “motivate” small shareholders. But in Hungary, he would have needed at least 90% of the shareholder vote in order to do so. So he had to make a somehow fair offer at first before then being able to add his “going private” thread. This makes a huge difference.

So why the hell is this so easy in Germany ?

My guess is that this is a first test balloon, following to court decisions in Germany.

First, in 2012, the highest German court, the “Bundesverfassungsgericht” said that the listing of a share is not explicitly protected by the German constitution. As a result of this, late last year, the highest Civil court then decided in October 2013, a delisting can be decided without asking shareholders by the management of the company alone.

Until now, based on the so-called “Macrotron case”, companies had to offer a fair-value based cash compensation if the wanted to delist from the stock exchange.

I am not a lawyer, but in general this decision has clearly negatively impacted the right of minority shareholders. I do not know which are the possibilities to fight against those delistings, but it seems that it has become much harder and more difficult. So going back to the EGIS example: Minority shareholders in Hungary are much better protected against this as German shareholders.

Of course this is great news for M&A advisors, private equity funds or dominant shareholders etc., because it makes it easier to buy companies and kick out small shareholders at a low price.

On the other hand, in the long run, valuation levels for markets almost always reflect the rights of shareholders, especially minorities. If there are no rights (see Russia) than stocks will trade at a discount.

For me, this is a reason more to stay away from the rather expensive German stocks, especially if they have dominant shareholders who want to have the whole company cheaply.

If the AirBerlin case would be the blueprint for similar deals to come, this would be very negative for the valuations of similar German companies. One might even think about developing a short strategy for likely candidates. And yes, squeeze out speculations do not look so attractive anymore.

Book review: “The little book of Emerging Markets” – Mark Mobius

After starting to look into Emerging Market companies, I thought it might be a good idea to beef up my library with some books on that topic.

Mark Mobius, the author of the book is one of the most well-known EM investors of all time (although he looks a little bit like the bad guy from a James Bond movie):

Nevertheless, I bought the “Little book” as they are usually compact and easy to read.

The book starts with the general investment principles of Mobius, which are clearly derived from value investing “Graham-style” following his mentor John Templeton. He stresses low valuations, especially with regard to tangible book and wants companies to pay out dividends.

Similar to Howard Marks he deeply believes in the cyclicality of markets.

Within the book there are several stories about specific markets such as Czech Republic, Kazakhstan, China, Thailand and Russia, but most of this are anecdotes, entertaining but not very instructive. He mentions some specific investments (Siam Cement, China Telecom) but overall he remains mre on the general level.

The best part in the book are the last chapters where he provides some general advice how to invest in Emerging Markets. For him, investing in Emerging Markets is Contrarian Investing.

My highlight quote from the book is the following:

“If you see the light at the and of the tunnel, it might be already too late to invest”.

Other good quotes are:

“When everything else is dying to get in, get out. When everyone else is screaming to get out, get in”.

“When everyone else is getting all pessimistic, that’s usually when it is tim to turn optimistic”

“You’ve sometimes got to take pain in the short-term in order to outperform in the future”

“The first country to get hit , and hit hard, is typically the first one to recover”

Overall I liked the book as it is easy to read, although it doesn’t offer a lot of “depth” which, on the other hand, is not the goal of the “little book” series.

Maybe it is a kind of “confirmation bias” from my side, but somehow the book confirmed my view that it is now a good time to dig deeper into Emerging Markets.

A final warning at the end: Just for fun I looked up the long term performance of the Templeton Emerging MArkets Fund. Despite being hailed as a guru, the long term performance of Mark Mobius doens’t look very good:

Interestingly, the last 5 years or so the fund looks like a simple MSCI EM tracker fund (minus fees):

I have to verify this but in fund management, legends are often overrated…….