Category Archives: Accounting Tricks

SunEdison (SUNE) – Deja vu all over again

SunEdison, a US based renewable energy company popped up 2 times on my radar screen. Once a year ago as one of David Einhorn’s top picks and last week as one of the very few published long investments of John Hempton at Bronte.

I try to sum up Einhorn’s 2014 thesis in four bullet points:

– Solar energy is competetive, strong growth almost guaranteed
– SUNE has a moat and will grow strongly by maintaining its margins
– extra value is created via the “YieldCo” subsidiary
– investors don’t understand the company especially the fact that most of the debt is “non-recourse”

The “Moat”

From Einhorn’s slide deck:

As an experienced project developer, SUNE’s financial, legal, and due diligence expertise gives it a competitive moat. It has opened offices in the most attractive international markets several years before anyone else, giving it a first mover edge and unique geographic diversity in an industry that faces capricious governments, currency fluctuations, sovereign risk and competition.

Well, now it is pretty easy to point out that this thesis might have some flaws after the stock cratered in the last weeks:

Let’ just look at the annual report where SUNE reports on competition:

Competition. The solar power market in general competes with conventional fossil fuels supplied by utilities and other sources of renewable energy such as wind, hydro, biomass, concentrated solar power and emerging distributed generation technologies such as micro-turbines and fuel cells. Furthermore, the market for solar electric power technologies is competitive and continually evolving. We believe our major competitors in the renewable energy services provider market include E.On, Enel, NextEra, NRG, SunPower Corporation, First Solar, Inc., JUWI Solar Gmbh and Solar City. We may also face competition from polysilicon solar wafer and module suppliers, who may develop solar energy system projects internally that compete with our product and service offerings, or who may enter into strategic relationships with or acquire other existing solar power system providers.
We also compete to obtain limited government funding, subsidies or credits. In the large-scale on-grid solar power systems market, we face direct competition from a number of companies, including some utilities and construction companies that have expanded into the renewable sector. In addition, we will occasionally compete with distributed generation equipment suppliers.
We generally compete on the basis of the price of electricity we can offer to our customers; our experience in installing high quality solar energy systems that are generally free from system interruption and that preserve the integrity of our customers’ properties; our continuing long-term solar services (operations and maintenance services) and the scope of our system monitoring and control services; quality and reliability; and our ability to serve customers in multiple jurisdictions.

If you compete mainly on price, then there is obviously not much of a moat. There are no network effects, they don’t have any patents and clients don’t care about the brand of a solar project company. In contrast, a strongly growing markets attracts many new entrants which will drive down margins especially if it is relatively easy to enter the market. or even if there would be an “econimies of scale advantage”, in a strongly growing market this is not worth much

Germany is here maybe already some years further in the experience curve and one learning here was that there wasn’t any first mover advantage. In contrast, many of the first movers made some real mistakes like contracting solar modules for fixed prices and were then wiped off by the followers who bought cheaper.

Success metrics

If you look at SunEdisons investor presentation, you don’t see any GAAP numbers, only adjusted EBITDAs and self created metrics like MW and GW delivered etc. The reason is clear: GAAP numbers look awfull, both earnings and cashflows at all levels. The company is using boatloads of money under GAAP reporting.

Overall, the accounts are pretty much incomprehensible not only on the financing side but also cash flow wise. So non-recourse debt sounds great but without earnings it will be a quite difficult investment case.

The YieldCo – TerraForm Power

TerraForm Power is a consolidated subsidiary of SUNE but has a stock listing and minority shareholders. The sole function of TerraFrom power is to buy the projects from SUNE, leverage them up ~4:1 or 5:1, hold them and pay out dividends. The stock price got hit hard along SUNE as this chart shows:

However according to Einhorn the participation is extremely valuable due to 2 reasons:

1. A Yieldco structure is value enhancing per se as Yieldco investor require much lower returns on investment as stock investors
2. Terraform and SUNE have a structure in place where SUNE retains much of the upside of the YieldCo, so the worth to SUNE is much higher than the market value of the shares

Einhorn makes some remarkable comments in his presentation, but I was struck mostly by this one:

In the recent sell‐off, Terraform’s shares declined with the oil and gas MLPs. Because most MLPs pay out cash flows from depleting oil and gas reserves that need to be replaced with new wells, these companies need continued access to cheap capital just to sustain their dividends. Terraform doesn’t face that risk because solar assets don’t deplete. So Terraform will only raise capital for growth.

Well, this is clearly wrong. Of course do Solar panels deplete. They seem to deplete clearly slower than oilwells but the problem is that there are not that many old solar panel installed to actually get statistical relevant numbers. Some studies show that there is a relatively high loss of power in the beginning (~5%) and then a depletion of capacity of around 1% per year. Additionally, most of the funding and the electricity take-off agreements have to be renewed at some point in time which includes some significant “roll over” risk ithin the YieldCos.

Another thing that struck me is the fact that both, SUNE and Einhorn assume ~8,5% p.a. unlevered return on their renewable assets going forward which then can be levered up nicely even if you have to pay 6% interest on your bonds. I don’t really know the US market, but assuming such a yield in Europe would be completely unrealistic. Unlevered yields for renewable energy projects are at 4-6% p.a. max and you can only lever them up with “low cost” leverage for instance pension or insurance liabilities, it doesn’t really work with long term more expensive “subordinated” capital as many companies have found out the hard way.

Maybe the US market is less competitive to allow such returns ? I find that hard to believe. Just by chance I have been involved in some uS wind projects and the returns are nowhere near 8% unlevered but rather similar to European yields.

Another thing which is different to European projects: In Europe, you don’t have specific credit risk in the projects as the electricity has to be taken off from the grid, which means that basically all grid user guarantee your return. SunEdison’sproject contain undisclosed credit risks because if the client default there will be no backstop.

That leads to the question: Who on earth is actually buying into those YieldCos ? In TerraForm’s case any upside is capped and equity holders are fully exposed to any problems that could show up like increasing interest rates, defaults of off-takers, debt roll risk etc. So who is prepared to take equity like risk but accepting bond like returns ? I do know but my guess is that many yield starved private investors will most likely not care about the risks as long as they get a “juicy” dividend. In Germany something similar but on a lower scale happened. a lot of the renewable companies financed themselves with “participation rights” and promises of high dividends but most big cases ended in spectacular failures. I covered some here for instance

To shorten this: Yes, at the moment the Yieldco structure could actually generate some value because for the time being there seem to be enough stupid investors out there who buy something with equity risk in exchange for bond like returns. But this could go away quickly especially if some of them blow up spectacularily. It’s the same old reason why people on Wallstreet earn so much: Pretending that repackaging an asset increases its value.

Financing structure

Although the complicated financing structure attracted me to the stock in the first place, based on what I have written above I don’t think it’s worth the time to dig deeper. One thing that John Hemption seems to have missed in his post is the fact SUNE has implemented a margin loan with TerraForm Power shares as collateral. Such a strcuture alone for me already indicats that either those guys don’t know what the are doing or that they are really desperate.

In such a case the only “safe place” in the capital structure is within the senior secured paper, everything else in my opinion is more a gamble than a value investment.


At the first glance Sun Edison looks interesting. You can buy into a (still) strongly growing company at around 1/3 of the price David Einhorn paid a year ago. From my point of view however the business relies on two fundamental assumptions to perform as planned:

– the ability to continously source renewable energy projects with really high yields (“risk free” plus 6% or so)
– enough stupid investors who buy into YieldCos with equity like risks and bond like returns to subsidize the development company

If Germany as one of the renewable power pioneer markets is any indication, both assumptions will not hold for very long. In Germany’s case, the yield for the projects went down very quickly especially after government subsidies were reduced and the “yield investors” got fleeced massively as a consequence.

Clearly, in the short run SUNE and TERP could make massive jumps up and down in price but mid- to long term I don’t think that they will be great investments.

P.S.: It might look like I want to bash David Einhorn, as this is already the third time that I strongly disaggree with him after Delta Lloyd and Aercap. But on the contrary, i do still think that he s one of the best investors in the hedge fund area, he just had some bad luck and a lot of money to manage which makes things difficult.

Management / shareholder disconnect- E.ON SE edition

Normally, I don’t care that much about quarterly results, but in the case of German utilities I sometimes make an exception simply because often they are too entertaining to miss.

Yesterday, for instance E.ON the German utility company reported Q3 figures. The press release reads pretty “upbeat”:

E.ON affirms 2014 forecast
11/12/14 | Posted in: Finance
Adjusted for portfolio and currency-translation effects, EDITDA above prior-year level
Renewables’ share of earnings rises to 17 percent
Economic net debt reduced by €1.2 billion
E.ON today reported nine-month earnings that were in line with its expectations. It therefore continues to anticipate full-year 2014 EBITDA of €8 to 8.6 billion and underlying net income of €1.5 to €1.9 billion. Nine-month EBITDA declined by seven percent year on year to €6.6 billion. The absence of earnings streams from divested companies and adverse currency-translation effects were the main factors. On a like-for-like basis—that is, adjusted for portfolio changes and currency-translation effects—E.ON’s EBITDA was above the prior-year level.

I would call this kind of disclosure “Level 1”: How the company wants to be seen

So with “adjustments” things look better than last year. However this time even a relatively “mainstream” German magazine remarked that the earnings disclosure of EON is relatively difficult to understand.

Level 2: P&L – Some kind of truth

In their quarterly report, EON has to use Accounting standards at some point. After 15 pages of useless “Management report” the first “real” accounting number shows up on page 16.

In fat type you can see the following:
Net income 255
for YTD 2014, which is around 90% lower than 2014. Then in small print they show the following:

Attributable to shareholders of E.ON SE -14
Attributable to non-controlling interests 269

So under IFRS, EON actually lost 14 mn EUR in the first 9 months.But anyone who is reading this blog regularily knows that this is still only “half of the truth”:

Level 3: What really happened – Comprehensive income

Only on page 25 we see the comprehensive income statement of EON for the first 9 months. And this looks really ugly.

-1,7 bn losses from the increase in pension liability
-0,6 bn FX and hedging losses

then lead to a total loss of 2,2 bn EUR or -1,1 EUR per share for E.ON’s shareholders for the first 9 months.

If we look at the stock price, we see that the positive “spin” only lasted for around 20 minutes before the stock price started to drop.

Why are they doing this ?

Well, this is pretty easy and straight forward: This allows the Management to award them nice bonuses independent of what the total result for the shareholder looks like.

Total comp in 2013 according to the annual report for management was 18,5 mn, thereof around 13 mn “bonus”. And this in a year where the were only able to generate a comprehensive income o ~600 mn EUR or 2% ROE.

EON’s target achievement is measured the following way according to the annual report:

As under the old plan, the metric used for the operating-
earnings target is EBITDA. The EBITDA target for a particular
financial year is the plan figure approved by the Supervisory
Board. If E.ON’s actual EBITDA is equal to the EBITDA target,
this constitutes 100 percent attainment. If it is 30 percentage
points or more below the target, this constitutes zero percent
achievement. If it is 30 percentage points or more above the
target, this constitutes 200 percent attainment. Linear inter-
polation is used to translate intermediate EBITDA figures
into percentage

For a capital-intensive business like a utility, EBITDA in absolute is pretty useless. However it is pretty easy to achieve or beat for Management. As a shareholder you can be sure that your interests are not aligned well with those of the management. In my opinion, that whole mess at EON has a lot to do with this pretty obvious “detachment” between management and shareholders and only to a smaller extent with German energy policy.

Finally some other stuff

The most interesting item in the whole Q3 report for me was the fact that Electrical Power generation was actually 50% better (EBITDA) than in 2013 and more than 100% better on EBIT basis. The biggest drop yoy actually came from the natural gas business.


EON’s Q3 report for me is a prime example for a badly managed company. The disconnect between management incentives and shareholders leads to nonsense reporting, mostly in order to avoid the hard truth of losses to shareholders. For instance anyone who wondered why they bought crappy assets in Brazil and Turkey instead of paying back debt should understand that this actually increased the bonuses of management irrespective of FX losses, write-offs etc. As an investor, one should stay as far away as possible from such companies, no matter how cheap they are because at some point in the future they will “hit the brick wall”.

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.

Some fun with Enterprise Value – E.ON AG Decommissioning Liabilities

This is a follow-up to both, my recent post about EV/EBIT & Co as well as a discussion in a forum about how cheap German utility stocks really are.

German utility stocks are clearly in many lists for cheap stocks. Here is for instance a list of large utilities in Europe sorted by EV/EBIT:

Name Mkt Cap Curr EV/T12M EBITDA EV/T12M EBIT
ENDESA SA 23038.45 4.43 7.17
RWE AG 16827.67 3.06 7.27
E.ON SE 27849.92 4.89 7.64
PGE SA 8340.95 4.55 7.74
GDF SUEZ 41669.47 5.31 10.04
VERBUND AG 5739.31 4.93 10.07
EDF 49364.74 5.83 11.08
GAS NATURAL SDG SA 18052.44 6.91 11.26
DRAX GROUP PLC 3286.74 9.41 12.12
NATIONAL GRID PLC 34397.63 10.20 14.02
ENEL SPA 30805.4 6.22 14.94
A2A SPA 2562.72 7.52 15.16
SSE PLC 15811.63 12.01 18.76
IBERDROLA SA 29309.16 9.92 21.69
PUBLIC POWER CORP 2343.2 6.87 21.72

Apart from Endesa, EON and RWE really look like bargains. Even most “club Med” Italian utilities are trading at twice the EV/EBIT or Ev/EBITD levels than RWE and EON. A “mechanical” investor will say: I don’t care if they have issues, I will buy them because they are cheap.

However, there is a small problem: As many people know, following the Fukushima incident, the German Government decided in 2011 to speed up the exit from nuclear power and switch off the last nuclear power plant in 2011. Funnily enough, only in 2009, they decided to extend the licenses significantly.

Anyway, just switching of a nuclear power plant is not enough. Especially in a densely populated country like Germany, you don’t want to have those nuclear ruins everywhere. So the utilites are required to fully “decommission” the reactors and also all the nuclear waste. Decommissioning is expensive, for instance it is estimated for instance at currently 70 bn GBP for all UK nuclear power plant.

In order to avoid that utilities just go broke before they close their nuclear power plants, the are required to build up reserve accounts in their balance sheet. Let’s take a look into their 2012 annual report page 159:

eon nuclear

EON has 16 bn EUR of reserves on its balance sheet for the decommissioning of nuclear power plants. Those 16 bn are clearly already reserved in the balance sheet, but as they will be due in cash rather sooner than later, they should be clearly treated as debt and added to Enterprise value.

However, there is a second issue with them: For some reasons, they are allowed to discount those amounts with 5% p.a. This is around 2% higher than for pension liabilities which in my opinion is already quite “optimistic”. They do not offer any hint about the duration of those liabilities, but if we assume something like 10-15, just adjusting the discount rate to pension levels would increase those reserves by 3-5 bn and reduce book value by the same amount.

So all in all, net financial debt for EON more than doubles if we take into account a realistic value for the nuclear waste removal obligations.

Interestingly enough, E.on presents its own “economic financial debt” calculation on page 45 of the annual report, including pensions etc.:

EON net debt

If we adjust the nuclear liabilities for the unrealistical discount rate, we get around 40 bn “economic” finanicial debt. So let’s look how EV/EBIT and EV/EBITDA change if we use those debt figures:

Before adjustment:

Enterprise Value of 48 bn (28 bn Equity, 3 bn minorities, 23.5 bn debt minus 6.8 bn cash)
EBITDA ~ 9.8 bn
EBIT ~6.3 bn

Adjusting for economic debt, we get an EV of 71 bn and the ratios change as follows

EV/EBITDA adj = 7.2 v. 4.9 unadj.
EV/EBIT adj = 11.3 vs. 7.6 unadj.

So adjusting for economical debt already eliminates most of the “undervaluation” compared to the peers. All things equal, a Verbund for instance which only produces “clean” power at the same valuation seems to be a much much safer bet than EON.


Even quite useful metrics like EV/EBIT and EV/EBITDA can be misleading if a company has large other liabilities which turn out to be very similar to debt. If a company looks cheap under EV/EBITDA, always check if there are pensions, operating leases or in the case of utilities Decommissioning liabilities which are not captured by the standard formula.

In this case, the company evene presents its “true” debt, but it is still not adequately reflected in almost every investment database.

Finally a quick word on “mechanical” investment strategies: I cannot prove it, but I am pretty sure that a mechanical strategy based on EV which adjusts for “obvious” shortcomings like operating leases should perform even better than the published results from O’s et al. However It is almost impossible to backtest this.

Quick check: Astaldi SpA (ISIN IT0003261069)

Astaldi SPA was now mentioned by at least 2 commentators as an interesting stock, so let’s look at this Italian stock.

Looking at the “Normal” fundamentals, it seems clear why:

P/E 7.1 (2012)
P/B 1.0
P/S 0.2
dvd. yield 3.1%

So at the first look, a single digit P/E and P/B of 1.0 look attractive.

On top of that, Astaldi has increased earnings each year in the last 10 years at an impressive rate:

31.12.2003 0.23 0.05 10.0%
31.12.2004 0.27 0.07 12.1%
30.12.2005 0.28 0.08 13.1%
29.12.2006 0.31 0.09 11.2%
31.12.2007 0.39 0.09 12.9%
31.12.2008 0.43 0.10 13.2%
31.12.2009 0.57 0.10 16.0%
31.12.2010 0.64 0.13 15.8%
30.12.2011 0.73 0.15 16.0%
31.12.2012 0.76 0.17 15.2%

Well, what is not to like ? Even my Boss Score says that they are attractive, indicating ~100% upside.

First, Astaldi is primarily a construction company. As a construction company, a large part of the balance sheet is either “work in progress” or “receivables”. The problem with that is that you never really know how at what stage profit will booked and if this is really earned or if there is some nasty surprise at the end. To illustrate this point, look at this table from page 179 of the 2012 annual report:

2012 2011 Change 2012 2011 2011+2012 In % of sales
– Revenue from sales and services 879,025.00 292,875.00 1,171,900.00 26%
– Plant maintenance services 12,544.00   12,544.00 0%
– Concessions construction and management phase 95,740.00 91,186.00 186,926.00 4%
– Changes in contract work in progress 1,330,781.00 1,881,223.00 3,212,004.00 70%
– Final inventories of assets and plant under construction 7,209.00 0.00 7,209.00 0%
Total 2,325,299.00 2,265,284.00 4,590,583.00

So this table shows that around 70% of Astaldi’s sales were unfinished projects accounted for as “percentage of completion”. This is the respective passage of their accounting principles (page 285):

Long-term contracts
Contract work in progress is recognised in accordance with the percentage of completion method, calculated by applying the cost to cost criterion.
285. This measurement reflects the best estimate of works performed at the reporting date. Assumptions, underlying measurements, are periodically updated. Any income statement effects deriving therefrom are accounted for in the year in which such update is made.

This is a big problem for me. I don’t know if their “best estimate” is cautious or aggressive. I have no evidence that they are doing anything wrong, but for my personal investment style, I do not like companies with a large share of “percentage of completion” business because that introduces a lot of uncertainty into the stated results.

The second problem I see here is the high amount of (gross) debt funding. Astaldi had around 1.25 bn EUR gross financial debt at the end of 2012. For construction companies, a combination of external debt with long term projects can be quite dangerous. Normally, one would expect that most of the projects would be funded via prepayments but Astaldi only manages to get around 400 mn EUR in prepayments.

The big risk here is that one big busted project or problems with one subsidiary can trigger loan covenants and then there is “game over” or at least a large dilutive capital increase.

Loan covenants:

Let’s look shortly at their loan covenants (page 223):

Covenants and negative pledges
The levels of financial covenants operating on all the committed loans the Group has taken out with banks are listed below:
(The present document is a translation from the Italian original, which remains the definitive version)
– Ratio between net financial position and equity attributable to owners of the parent: less than or equal to 1.60x at year end and 1.75x at half year end;
– Ratio between net financial position and gross operating profit: less than or equal to 3.50x at year end and 3.75x at half year end.

Lets do a quick calculation of the ratios in 2012 (based on their own “net financial debt calculations on page 32):

YE 2012: Net financial deb 812 mn, Equity 468 mn –> this would be already 1.73 times, so clearly above the threshold. Only if they include some “non current financial receivables” in an amount of 186 mn, the come down to 622/486 = 1.27 times.

In my opnion, their financial position looks clearly stretched. Maybe this is the reason why they had to issue a quite expensive 100 mn EUR convertible bond early this year. Issuing convertible bonds is ALWAYS a big warning sign that a company cannot fund its operations with “normal” debt.

For me, this is already a BIG RED FLAG. In my opinion, there is no margin of safety in a company with such a high debt load and such tight situation in terms of covenants.

Other more superficial observations after reading thorough the last annual report:

. unfocused concession portfolio (car parks, motorway, airports, hydroelectric plant, hospitals)
– comprehensive income in the last 4 years was always lower than stated eps

SIAS in comparison, my Italian “infrastructure” stock is a much easier story. Less debt, no “percentage of completion”, clear focus on motorway concessions.


Despite the nominally cheap valuation, I don’t really like Astaldi. The high amount of “percentage of completion” assets combined with a rather large debt load make the stock quite risky in my eyes. If things work out well, there is clearly upside, however if one project goes wrong, the company will be in big trouble. So no real “Margin of safety” here in my opinion.

And no, I don’t think that concession business has a bright future. As an Italian company one has a clear competitive disadvantage with higher funding costs and in my opinion it is impossible to run so many different types of concessions in different countries really effectively. I am afraid that they will overpay and/or get the stuff the specialists don’t want.

IFRS 19 pensions “Voodoo accounting” – ThyssenKrupp edition

ThyssenKrupp issued their quarterly earnings today. Together with Lufthansa, Thyssen has one of the largest “pension holes” in the DAX index.

As we all know, from 2013, IFRS 19 requires to fully reflect pension liabilities “on balance”. Interestingly, in their Investor presentation, IFRS equity is not mentioned at all.

So one really has to go into the interim report to look what happened.

And again, at a first glance it doesn’t look so spectacular:

Shareholders Equity end of March is around 2.8 bn EUR, 0.77 bn less than stated for September 2012, in line with the losses. However when we look into the developement of the equity position of page 32 of the report, we can see that closing shareholders equity has actually been 7.6 bn in September 2012.

In contrast to Lufthansa, they hide their restatement in an “insignificant drop” of retained earning from March 2012 to September 2012 in an amount of ~4.2 bn EUR. Lufthansa had spread their restatement over 2 years. So there seems to be quite some leeway how to do this.

So to sum it up: Thyssen Krupp has lost ~ 4.8 bn of equity or -63% and management doesn’t even bother to disclose this to shareholders in their presentation. Well, who cares about equity anyway ?

One final remark: Thyssenkrupp uses 3,6% to discount the liabilities, which is quite high. Many other companies use 3.2% for EUR or less. As a proxy, one would multiply the difference times 15-20 in order to see what to add in percentage points to the pension liabilities.

So to scale this, we would for instance multiply 0.4%*15= 6%. With total pension liabilities of 8 bn EUR, we would need to deduct a further 500 mn EUR from equity in order to compare them with more conservative companies.

In any case, I think Thyssen will need to raise some equity capital pretty soon.

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