Category Archives: Investment-Gurus

Buffett & Munger on Cost of Capital: Don’t listen to what they say but look at what they do

After bashing David Einhorn for his Consol Energy WACC assumption last week, by chance I read at the very good 25iq blog an article on how Buffett and Munger publicly speak about those things.

Indirectly, this is clearly a slap in my face because even the headline already says it all:


Why and how do Munger and Buffett “discount the future cash flows” at the 30-year U.S. Treasury Rate?

The post summarizes what Charlie and Warren have said over the years with regard to cost of capital and discounting. I try to summarize it as follows:

  • They seem to use the same discount rate for every investment, the 30 year Treasury rate
  • in a second step they then require a “margin of safety” against the price at offer
  • they estimate cash flows conservatively
  • Somehow Buffet seems to have a 10% hurdle nevertheless
  • Buffett compares potential new investment for instance with adding more to Wells Fargo

So if Buffett doesn’t use more elaborated methods why should any one else ? Was I wrong to beat up David Einhorn because he used a pretty low rate for Consol Energy ? Add to this Mungers famous quote “I’ve never heard an intelligent cost of capital discussion” and we seem to waste a lot of time here, right ?

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Dear David Einhorn: Why are your interns doing all the cost of capital estimates (Consol Energy) ?

Just to be clear: I have nothing personally against David Einhorn. I am just wondering how he comes up with his underlying valuation assumptions these days.

I already had issues with funding cost assumptions at AerCap as well as his return assumptions for SunEdison.

Now I came across his latest pitch for Consol Energy this week. This is the slide which explains the value of the coal business:

Without going into the other details, the question here is of course: How the hell did he come up with a WACC (Weighted Average Cost of Capital) of 8,4% ?

The WACC is supposed to be the blended total cost of capital of a company, including both, debt and equity. For Consol Energy however the obvious problem is the following: Their bonds are trading at a level of 12-15% p.a. Even if we us an after-tax figure of maybe 8-10%, even the after-tax cost of debt is higher than the assumed WACC.

As the cost of equity has to be higher than senior debt (it is more risky), there is no way in ending up with a WACC of 8,4%. Maybe some of my readers can help me out if I am missing here something, but I am pretty sure that 8,4% is not the right number for Consol’s cost of capital. He uses the same WACC later for the shale gas part of the company, so it is certainly not a typo:

On his website he then explains how they (or his intern) came up with the WACC (slide “A-1”):

consol wacc

The real joke however is to be found a little bit below:

consol 2

Edit: Now that I know that it was meant as a joke it reads somehow different ;-)


So he somehow believes that his WACC is actually conservative.

Let’s look at some “real world” data. This is the overview of Consol’s currently outstanding bonds:

consol bon ex

The average yield based on outstanding amount of Consol’s bonds is 14,5%, a full 11% (or 1.100 basis points) higher than in Einhorn’s calculation. As I have said above, the cost of equity has to be higher than the cost of debt as thee is no protection to the downside. So if we use Einhorn’s quity risk premium of around 6%, we would get cost of equity of around 20,5%.

Based on Einhorn’s weighting, we would get a WACC of (20,5%*0,75) + (15,5%*0,65*0,25)= 17,73%, roughly speaking double the charge that Einhorn uses. You might say this is conservative but in effect it is just realistic and based on current market prices.

Even at issuance, Consol’s cheapest bond had a 5,875% coupon, far above the assumed 3,5%, so it is not even a question of current market dislocation.

Either Einhorn assumes implicitly that cost of capital goes down dramatically or he has some “secret” that I don’t know. If I look at Einhorn’s last pitches, especially AerCap, SunEdison and Consol, there seems to be a common theme: He is always pitching capital-intensive companies with significant debt where he assumes pretty low cost of capital in order to show upside.

So what he seems to do these days is effectively betting on low funding costs which, at least for SunEdison and Consol didn’t work out at all.

In my opinion, this has nothing to do with value investing. Value investing requires to make really conservative assumptions to make sure that the downside is well protected as first priority. For those leveraged, capital-intensive businesses however, the risk that you will get seriously diluted as shareholder in those cases is significant, there is no margin of safety. On the other hand I somehow admire his Chupza. Standing in front of a lot of people who paid significant fees to hear the “Hedge Fund honchos” speak and pitching such a weak case with unrealistic assumptions is brave.

Of course a stock like Consol can always go up significantly after dropping -75% year to date, but the underlying analysis is really flawed. I would actually like to ask him if he really believes in those assumptions or if he just didn’t pay any attention to the details. This would be really interesting.

Maybe a final word on this: I am always criticising David Einhorn on his assumptions. Which is easy because he actually is very transparent about them. Many other Hedge Fund managers just tell nice stories. I am pretty sure that in many cases the assumptions behind those cases are not much better.

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.

AerCap Holdings NV (ISIN NL0000687663) – How good is Einhorn’s new favourite ?

A friend forwarded me the latest presentation from “guru” David Einhorn where his main long pick was AerCap, an Airplane leasing company.

To shortly summarize the “Long case”:

– AerCap is cheap (P/E 9)
– they made a great deal taking over IFLC, the airplane leasing division of AIG which is several times AerCap’s original size
– they have great management which is incentivized along shareholders
– The business is a simple and secure “spread business”
– major risks are according to Einhorn mostly the credit risk of the airlines and residual value risk of the planes

There are also quite obvious reasons why Aercap is cheap and trades at lower multiples than its peers:

– share overhang: AIG accepted new AerCap shares as part of the purchase price and owns 45,6%. They want to sell and the lock up is expiring
– following the IFLC/AIG transaction, the company was downgraded to “Non-investment grade” or “junk” and has therefore relatively high funding costs compared for instance to GE as main competitor

What kind of business are we talking about?

Well, Airplane leasing is essentially a “special purpose lending business” without an official bank license, one could also say it is a “shadow bank”. What Aercap essentially does is to loan an airplane to an airline.

In order to make any money at all, they have to be cheaper than the simple alternative which would be the airline gets a loan from a bank and buys the airplane directly. As Airlines are notoriously unprofitable and often thinly capitalized, they often need to pay pretty high spreads even if they borrow money on a collateralized basis.

As any lessor funds the plane mostly with debt, the cost of debt is one important factor to make money compared to competitors. It is therefore no big surprise that GE with its AA+ Rating is the biggest Airplane leasing company in the world and that ILFC thrived while AIG was still AAA and had comparably low funding cost.

Airplane buying is tricky business

A second aspect is also clearly buying power. Planes have to be ordered many years in advance and the two big manufacturers want to be sure that they are getting paid. I assume a reliable bulk buyer gets better access to the most sought after planes and maybe even better prices. Prices for planes at least in my experience are notoriously intransparent. Nobody pays the official list prices anyway. I found this interesting article in the WSJ from 2012.

When Airbus and Boeing Co. announce orders at the Farnborough International Airshow this week, they will value the deals based on the planes’ catalog prices—which no one pays. Airline executives, when pressed for details, will probably say they got “a great deal.” But actual terms will remain guarded like nuclear launch codes.
The aviation industry’s code of silence on pricing is notable in this era of information overload. Thousands of people world-wide are involved in airplane purchases, yet few numbers spill out. That yields much mystery and speculation.

Discounts are large:

But there are ways to estimate the range of discounts. An analysis of public data by The Wall Street Journal and interviews with numerous industry officials yielded this: Discounts seem to vary between roughly 20% and 60%, with an average around 45%. Savvy buyers don’t pay more than half the sticker price, industry veterans say. But deal specifics differ greatly.

But no one wants to talk about it:

One reason for the secrecy surrounding all this, say industry officials, is psychology: Less-experienced plane buyers like to think they got a bargain and don’t want to be embarrassed if they overpaid. The safest approach then is silence. More-seasoned plane buyers also know that bragging about discount specifics would anger Airbus, Boeing or other producers and hurt the chances of striking a sweetheart deal again.

Clearly, as a large “quasi broker”, Airline leasing companies seem wo have a chance to make some money in such a intransparent market. But it is really hard to pin down real numbers. It reminds me a little bit about how you buy kitchens in Germany where the system is pretty much the same. Everyone gets a discount, but no one knows what the “true” price looks like.

But this also leads to a problem:

With the current funding costs, AerCap would not be competitive in the long run. Let’s take as a proxy the 10 year CDS spread as a proxy for funding costs and compare them across airlines and competitors (more than 50% of AerCaps outstanding debt is unsecured):

10 year senior CDS Rating
AerCap 215 BB+
Air France 96  
Singapore Airlines 105 A+
Southwest 109  
Lufthansa 195 BBB-
Thai Airways 240  
Delta 256 BB
Emirates 257  
Jet Blue 362 B
GE Capital 72 AA+
Air Lease 175 BBB-
ICBC 194 A
CIT 229 BB-

So purely from the funding cost perspective, AerCap at the moment has a problem. Someone like Air France could easily fund a loan for an airplane cheaper than AerCap, so cutting out the middle man is basically a no brainer and even the smaller competitors could easily under price AerCap when they bid for leasing deals. On top of that, a lot of non-traditional players like pension funds and insurance companies want some piece of the action, as the return on investments on those leases are significantly higher than anything comparable. Even Asset managers have entered this market and have created specific funds for instance Investec.

AerCap does have a positive rating outlook, so there is a perspective for lower funding costs. Just to give an indication of how important this rating upgrade is: On average, 10 year BB financial isuers pay 2,4% p.a. more than BBB financial issuers at the moment. The jump from BB+ to BBB- will not be that big but it would increase the investor universe a lot for AerCaps bonds.

The biggest risk for AerCap

So although I am clearly no match for David Einhorn (*), I would argue that the biggest risk for AerCap is not the residual value of the planes or the credit quality of the Airlines but quite simply the refinancing risk. AerCap has to fund a significant amount going forward and if for some reasons, spreads move against them, they will be screwed. Just a quick reminder what happened to ILFC in 2011:

Credit-default swaps on the company climbed this month as global stocks tumbled and speculative-grade debt issuance all but evaporated. The cost reached as high as 663 basis points on Aug. 11, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The contracts have held at prices that imply ILFC’s debt should be rated B2, according to Moody’s Corp.’s capital markets group.

However if they manage to to get an investment grade rating and lower their funding cost, then it could be an interesting investment as funding is cheap and they do have access to a lot of new and sought after aircraft. Again, borrowing from Warren Buffett, with any leveraged company, management is extremely important.

And one should clearly compare AerCaps valuation and risk/return to banks and not to the currently much higher valued corporates. AerCap is much more similar to a bank than anything else. This general valuation disconnect seems to be also one of major reason why GE announced the massive reorganization just 2 weeks ago. However, as far as I understood tehy will keep the leasing business as this is unregulated.


Although I slightly disagree with the risk assessment of Einhorn’s case, I still think AerCap could be an interesting case and is worth to dig deeper. I don not have a problem investing into financial companies and I do like those “share overhang” situations. However, I will need to dig deeper and especially try to figure out how good AerCap’s management really is.

(*) I did disagree with David Einhorn already once with Dutch Insurer Delta LLyod which was Einhorn’s long pick of the year 2011. Overall in this case I would put the score of MMI vs. Einhorn at 1:0 as Delta LLoyd did not outperform.

Why on earth is Seth Klarman investing 1,7 bn USD in Cheniere Energy (LNG) at 7x P/B ?

In my book review “The Frackers”, I mentioned one of the stories in the book was about Cheniere Energy:

Finally, there is a fascinating side story about the guy who is running Cheniere Energy, Charif Souki. His great idea was to import natural gas into the US and he raised several billion USD to build a huge gasification plant on the gulf coast. He clearly did not see fracking coming and his investment was worthless. Nevertheless, he was able to raise another few billion bucks and retool the facility in order to export natural gas.

This “double or nothing” gamble seems to have paid off. Seth Klarmann by the way, has just doubled its stake in Cheniere, making it their biggest public listed position at around 1,7 bn USD.

Seth Klarman

Seth Klarman is a famous value investor running Baupost Group a 25bn USD hedge fund. In contrast to Buffett, Klarman very seldom gives interviews and his fund commentaries are hard to get. Hi is considered to be the “heir” of Benjamin Graham and still sticking to the “cigar butt” approach of deep value investing. Two years ago in a Charlie Rose interview, Klarman made the following comment:

Baupost’s leading man says that he buys “cigar butts” at cheap prices. Warren Buffett used to also do this. The difference between the two legends is that Klarman stayed focused on cigar butts while Buffett’s process morphed into buying great companies at great prices and then into paying so-so prices for great companies.

Klarman does many things ordinary investors can’t do, like buying defaulted Lehman stuff etc. Not many of his investments are public and not all of his public investments are successes. Nevertheless it is clearly interesting to look more deeply into his biggest public position, Cheniere Energy.

Cheniere Energy

Cheniere’s stock chart shows the “unusual” history of the company:

Just as a side remark, somehow this chart reminds me of this funny animal:

Looking at Cheniere’s latest quarterly report, we can clearly see that Seth Klarman’s days as Graham style “net-net” investor seem to be over. Cheniere has currently around 7,5 bn net debt and 2,3 bn equity. Based on a market cap of around 17 bn USD, this is a P/B of roughly 7 times so hardly a bargain investment based on this metrics.

On top of that, the company never made a profit in its life as this table with EPS since 2004 clearly shows:

02/21/2014 FY 13 12/13   -2,2
02/22/2013 FY 12 12/12   -1,6
02/24/2012 FY 11 12/11   -2,6
03/03/2011 FY 10 12/10   -2,3
02/26/2010 FY 09 12/09   -3,8
02/27/2009 FY 08 12/08   -6,0
02/27/2008 FY 07 12/07   -3,6
02/27/2007 FY 06 12/06   -1,5
03/13/2006 FY 05 12/05   -0,9
03/10/2005 FY 04 12/04   -0,6
N.A. FY 03 12/03   -0,4

So the question is clearly: What does Seth Klarman see to make this his biggest publicly disclosed investment ?

The best analysis I found was the one at Value Investor’s Club (accessible with guest login) from 2013, where the stock was trading at a third of the current price (Klarman bought between 60-70 USD). There is also a good article in Forbes from 2013 about the story behind Cheniere from 2013.

I try to summarize the case in a few bullet points:

– natural gas is very cheap in the US due to fracking and multiple times more expensive especially in Asia
– despite high costs, it is a pretty good business to liquify natural gas in the US and ship it to Asia in order to earn the spread
– Cheniere is in the process of finishing its first gasification plant by the end of the year 2015 and will then start to produce reliable cash flows as it has already contracted out its full production capacity for 20 years to major energy companies

The most important point is however the following quote from Forbes:

Cheniere’s Sabine Pass facility got its approval from the Department of Energy to export to any country in the world two years ago. It is so far the only facility to be cleared to export to countries that do not have a Free Trade Agreement with the U.S. And getting a non-FTA permit is a make-it-or-break-it approval for these projects, because there’s only one big gas-importing country (South Korea) with a free trade deal with the U.S. Unless a facility can export to the likes of Japan, China and India, the economics likely won’t support a multibillion-dollar build-out.

Cheniere had the luck to be the first to get this license. Later on, mostly due to the pressure of US based energy users, the US Government declined to issue further LNG “non FTA” export licenses for some time. According to Cheniere’s latest investor relation presentation, in 2014 two more “non FTA” licenses have been granted but Cheniere clearly has a head start.

Many more export facilities in the US would lead to higher prices in the US and to lower spreads compared to Asia, but for the time being, Cheniere’s primary LNG facility could be viewed as the typical “toll bridge” for US natural gas on its way to off shore destination as the other two licensed projects are still to be completed in several years time.

Cheniere itself is trying to further expand its current facility by 50% and they are projecting another site, but both projects have not yet received their license.


Replacement value

Despite buying at 7 times book, the question is: Could it be that Klarman is buying below replacement value ? I think it is unlikely. EV is around 25bn, stated book value of the assets is around 8 bn. Liquification facilities are not that hard to construct. all you have to do is to call someone like Bechtel and sign a turn-key project. Ok, you need the land and the permission, but overall this seems to be manageable in the US. So without going into more detail, we can assume that the current valuation of Cheniere is clearly above replacement value.

Valuation based on future cash flows

The VIC author estimates around 4-6 USD per share distributions for Cheniere’s shareholders going forward based on the first 4 trains of the initial liquification project. I have not double checked this but I will assume this number of being correct.

Reading through the roughly 15 pages of risk factors in Cheniere’s 2013 report, I would not call this a risk free business.There are still a lot of moving parts and operational risks even if the whole facility is up and running. Cheniere’s public bonds in the operational subsidiary trade at around 5,5% yield p.a. So discounting equity cash flows at the HoldCo level should be higher than that.

A) Existing facility and licence & contracted cash flows only

Cheniere has fixed contracts for 20 years. In the following table I have calculated NPS for the above mentioned EPS range and different discount rates, based on the assumption that one gets those earnings for 20 years and after that nothing (for instance any future earnings have to be applied to retire the debt):

eps/discount rate 4 5 6
6,50% 44,07 55,09 66,11
7,50% 40,78 50,69 60,83
8,50% 37,85 46,73 56,08
9,50% 35,25 43,17 51,81
10,50% 32,92 39,96 47,95
11,50% 30,84 37,05 44,46

We can clearly see, that the contracted amounts at the existing facility will not be enough to justify the current valuation of around 70 USD.

B) Existing facility, indefinite cashflows

This is the table with an indefinite stream of earnings at various discount rates:

eps 4 5 6
6,50% 61,54 76,92 92,31
7,50% 53,33 66,67 80,00
8,50% 47,06 58,82 70,59
9,50% 42,11 52,63 63,16
10,50% 38,10 47,62 57,14
11,50% 34,78 43,48 52,17

Even with an indefinite time horizon, Cheniere does not look like a “bargain stock”.

C) Existing facility + 50% capacity increase, contracted cash flows only

eps/discount rate 4 5 6
6,50% 66,11 82,64 99,17
7,50% 61,17 76,03 91,24
8,50% 56,78 70,10 84,12
9,50% 52,87 64,76 77,71
10,50% 49,39 59,93 71,92
11,50% 46,26 55,57 66,69

D) Existing facility +50% capacity increase, indefinite cash flows

eps 6 7,5 9
6,50% 92,31 115,38 138,46
7,50% 80,00 100,00 120,00
8,50% 70,59 88,24 105,88
9,50% 63,16 78,95 94,74
10,50% 57,14 71,43 85,71
11,50% 52,17 65,22 78,26

The 4 scenarios show relatively clearly that only with including future non-contracted cashflows and additional, not yet approved capacity, the stock looks interesting. In order to satisfy the return expectations of Klarman, which should be 15-20% p.a.based on his track record, he must assume further cash flows for instance from the second site Cheniere wants to contruct at some point in the future in Corpus Christi. Plus, there should be no dilution etc. from raising the rquired gigantic amounts of capital.

Maybe he is betting that the stock will trade like a bond if the company starts paing dividends ? Or is he leveraging the investment with addtional debt ?

In any case, he seems to be paying a lot for future, uncertain cash flows, which contradicts his “we still do cigar butts” statement. This is not that different from what Buffett is doing when he is paying rather expensive prices for great companies. At least for a guy with a portfolio size like Seth Klarman, the time of “cigar butt” investing seems to be over. Even he must feel th pressure that you cannot charge 2/20 for holding cash.

So to answer the question from the beginning:

Why on earth is Seth Klarman investing 1,7 bn USD in Cheniere Energy (LNG) at 7x P/B ?

I have no real idea but it might be the case that Klarman somehow need to put money at work and he expects this investment to be uncorrelated to general market as he has been quite pessimistic on equities for some time.


For me, Cheniere at current prices is clearly one for the “too hard” pile. Klarman of course can spend a lot of money and time to fully analyze the energy markets etc. although as we know now, most energy experts have a hard time to make meaningful forcasts. But still it doesn’t look like a bargain and clearly no “cigar butt” or “net-net” kind of investment.

Funnily enough, analyzing Cheniere makes me much more confident in my Electrica investment. At least to me, the risk/return relationship there is some magnitudes better than for Cheniere. I think I will upgrade this to a full position over the next few days.


Some other stories I found about Cheniere

Harvesting the archives (1): AS Creation, Medtronic, Netflix


Keeping track of all the companies one has ever looked at is pretty hard. It is pretty easy to update the companies which are in the current portfolio, but in my case, I often forget about the companies which I have looked a couple of years ago but didn’t buy for one reason or another or sold them. One of the great things of blogging is that you can easily look at everything you have ever written. Especially in the current environment, where good value investing ideas are pretty hard to find, it might make sense to look back at companies one has researched sometimes ago and either sold or not bought. Maybe they have become interesting again ? For me it is a lot easier to update myself on a stock I have looked 3-4 years ago compared to looking (and digging) into a completely new stock.

So in this new series, I will look into stocks I have written about and either sold or rejected and try to find out if something has changed or if some lessons could be learned.

AS Creation

AS Creation was the first detailed stock analysis on the blog in December 2010 (in German). The company back then looked cheap: Single Digit P/E, historically a single digit p.a. grower, 30% market share in Germany and the potential upside of a Russian JV (Russia was supposed to be a growth market back then). After some quite significant ups and downs, the stock was sold in August 2013 because the margins didn’t mean revert and the Russian JV was already in some trouble under “non crisis” conditions.

Looking back, the decision to sell in June 2013 at ~34 EUR looks smart if we consider the chart although in between the stock went up to 40 EUR again:

Operationally, AS Creation was hit by several negative events: First, the bankruptcy of Praktiker impacted them in the German core business, secondly, their French subsidiaries suffered and finally, the Russian JV which had to suffer from delays has been clearly hit by by the current crisis. With regard to the German business I have the impression that they never really rebounded to their historical average, maybe they did profit from some kind of anticompetition arrangements, for which they were fined. An interesting detail: They were convicted to pay 10,5 mn EUR in 2014, but they seem to have appealed the decision. To my knowledge, no appeal was ever succesful.

In any case, I don’t think AS Creation is interesting at the current level of 30 EUR. At a 2014 P/E of 15-20 (before any extra write-offs on Russia) there seems to be quite some turn around fantasy being priced in.

From my side there were 2 important lessons:
1. Mean reversion on single stock basis is nit guaranteed
2. If you buy cheap enough, you don’t lose much if things go wrong.


Medtronic was introduced (in German) on December 31st 2010 and then kicked out in August 2011 because I didn’t feel comfortable with a large cap US stock.

Looking back, this clearly doesn’t look like the smartest decision I ever made. Back then, I sold Medtronic at a loss of around -19%. Since then, the stock showed a total return of 167% in EUR. One of the interesting things about Medtronic is that a lot of the performance came from multiple expansion.

When I sold the stock at around 32 USD, the stock was trading around 10 times trailing earnings (3,27 USD per share 2010). 4 years later, reported earnings 2013/2014 have been ~20% higher per share at 3,80 USD, but Medtronic is now trading at around 18,5 times trailing earnings.

What is even more interesting than that is the fact that in absolute terms, 2013/14 earnings are at exactly the same levels as 2010/2011. Profit margins are even lower than back then. What happened ? Well, as in many cases for US stocks, the company bought back shares aggressively. Still, both ROE and ROIC declined but shareholders don’t seem to bother.

So despite the big run up of the share price, I don’t think that selling the shares has been a mistake. From a fundamental view the company looks worse than back then, however investors seem to be so happy about buyback driven EPS gains that they are willing to pay a pretty high valuation for this.

You could have speculated on such an outcome but as a fundamental investor, this would not have been in line with my investment philosophy. And clearly, You cannot increase the value of the company forever just by reducing the share count.

Stand-alone I would argue that Medtronic is clearly overvalued, based on the stagnating profit and deteriorating profitability. However with the current Healthcare “merger mania” I would not want to short the stock either.


I briefly considered to skip the whole Netflix episode but then decided against it. Looking back, this clearly shows that one can do stupid things and still make money….

I shorted Netflix in January 2011 after a short thesis from Whitney Tilson. Luckily I was able to cover the short with a gain in September 2011.

Looking at the chart, we can see that despite extreme volatility, Netflix is now trading 3 times higher than when I covered the position:

The lessons here were pretty simple:

1. Don’t short “hot stocks” based on fundamentals. It is too volatile and just not worth it-
2. Stay away from whatever Whitney Tilson is recommending

Fundamentally, Netflix is on my “too hard” pile. I do think streaming is a big thing and will be even bigger in the future. However I have no idea how much money Netflix will actually be able to make.

Lancashire Group (ISIN BMG5361W1047) – The UK equivalent of Buffett’s National Indemnity ?

While I was writing this post which I do normally over 1-2 weeks, the excellent WertArt Capital blog has released a very good post on Lancashire a few days ago. I higly recommend to read the post as it contains a lot of usefull information.

This saves me a lot of time and I only need to summarize the highlights:

– Lancashire is a specialist insurance company which insures mostly short tail “Excess loss” type of risks. It was founded by Richard Brindle, an experienced underwriter

– Since founding & IPO in 2009, the company has shown an amazing track record. No loss year, 59% average combined ratio and 19,5% ROE is simply fantastic.
– the company has a very disciplined underwriting focused business model, investment returns are negligible
– focus in on capital allocation and efficiency. If rates are not good, Lancashire returns capital to shareholders
good alignment of management and shareholders (majority of bonus depends if ROE hurdle of 13% + risk free is hit)
– The company looks cheap at ~8,5x P/E and 1,3 x P/B

For non-insurance experts a few quick explanations of insurance terms:

“Short tail” insurance business:

“Short tail” means that one is only insuring stuff where you pretty quickly see if there is a loss or not. For instance a “plane crash” insurance will be good for 1 year and if a plane crashes, the insurer will pay. After that 1 year there are no obligations for the insurer.

“Long tail” in contrast is an insurance policy which again covers a calendar year but where the damage can come up much later. A good example is D&O (director and officers) insurance. Often, when a big company goes bankrupt, some fraud etc. was involved at management level. Until a jury finally makes a verdict, many years can pass by but still the insurance company which has underwritten the policy remains liable. A good example is for instance the recent Deutsch Bank /Kirch trial where insurers will have to pay 500 mn EUR for something that happened 12 years ago.

Long tail has the advantage that the “float” can be invested long-term and illiquid, on the other hand the risk if a significant miss-pricing is much higher.

Excess Loss contracts

Excess loss contracts are contracts where the insurer only pays above a normally quite high threshold. This means that in normal cases, one does not need to pay but as a result premiums are lower than with normal contracts or “lower attachment points”. These kind of contracts are also often called “catastrophe risk” or “Cat Risk”. If such an event hits, then the hit will be big. Lancashire initially expected to make a loss 1 out of 5 years but up to now they had no loosing year. A company which has many excess loss contracts will report very good results in some years but very very bad in others.

What is the connection to Warren Buffett ?

Lancashire and Co. are relatively similar to Buffet’s National Indemnity Insurance, maybe the most overlooked part of his insurance empire after GEICO and Berkshire/General Re. Buffet has commented several times on National Indemnity and the competitive advantages of this company. The major competitive advantage of this business according to him was the ability NOT to write business if premiums are too low. The problem with this approach is of course that if you write less business, cost will be higher and the all important “Combined Ratio” (costs+claims divided by premium) will go up and investors will get nervous.

I wrote down this quote from last’s year Berkshire AGM from Buffett:

“I prefer the underwriters playing golf all day instead of underwriting risks at the wrong price. I don’t care of combined ratios grow well above 100% in such years.” For normal Insurance companies this is almost impossible to achieve as investors want to see increasing sales and profits any year and so most Insurance companies will underwrite no matter what the price is just to maintain the premium.

On the web I found similar quotes from him on the National Indemnity (NICO) which the bought in the 80ties:

Nevertheless, for almost all of the past 38 years, NICO has been a star performer. Indeed, had we not made this acquisition, Berkshire would be lucky to be worth half of what it is today.

What we’ve had going for us is a managerial mindset that most insurers find impossible to replicate.


Most American businesses harbor an “institutional imperative” that rejects extended decreases in volume. What CEO wants to report to his shareholders that not only did business contract last year but that it will continue to drop? In insurance, the urge to keep writing business is also intensified because the consequences of foolishly-priced policies may not become apparent for some time. If an insurer is optimistic in its reserving, reported earnings will be overstated, and years may pass before true loss costs are revealed (a form of self-deception that nearly destroyed GEICO in the early 1970s).

Additionally, Buffett is already participating in the London/Lloyd’s market via another structure. Last year, he underwrote a socalled “side car” deal with Aon. The deal is still controversial but indicates a change of how things are being done at Lloyds. Funnily enough, Lancashire CEO Richard Brindle called the Buffet/Aon deal “foolish” in an interview last year.

Why is the company cheap ?

1. In general, all the socalled “London market” insurers are cheap. Let’s look at the “London” peer group:

Name Est Price/Book Current Yr P/E P/E FY1 Current Div. Yld (%)
LANCASHIRE HOLDINGS LTD 1,24 8,76 8,77 8,26
HISCOX LTD 1,62 10,47 13,48 8,21
BRIT PLC 1,23 #N/A N/A 8,59 #N/A N/A
BEAZLEY PLC 1,55 8,11 9,55 10,00
AMLIN PLC 1,36 7,94 11,13 6,07

Compared to those London players, all European P&C Insurance peers trade on average at~ 2,2 x book and 12 x earnings. So why are the London insurers so cheap ? In my opinion, the answer lies in the cyclicality of the business similar to Admiral. The “London market” is even more cyclical as it is primarily an institutional price driven market. The London market specialises in large and complex risks with “natural catastrophe” exposure. Despite the headline news, in the last years there were very few NatCat events which really led to large insured losses. In those times, profit margin increase and there is big pressure to lower premium. As companies accumulate capital, the appetite for risk increases, which further lowers premiums. This works as long as either a large NatCat event happens or capital markets crash and the insurers then have to raise premiums in order to restore their capital levels.

2. Management and strategy change

Lancashire so far has shown excellent underwriting discipline and outstanding an outstanding ability to allocate capital. However in the last few months a couple of things have changed:

a) The founder & CEO has “retired” in April at an age of 54. I haven’t found out why. Since 2005 I would guess that he has earned 50+ mn GBP, maybe he thought that this is enough ? At least he got an extra 10 mn package according to this article. He has been selling shares before his retirement.

b) In a change of strategy, Lancashire bought at the end of 2013 a Lloyd’s syndicate called Cathedral for ~200 mn GBP. Although the Lloyd’s business is not necessarily bad business, it is clearly a change. Lloyd’s underwriting is often reinsurance in contrast to Lancashire’s direct insurance. In their previous reports they claimed that their strategy of insuring directly was a competitive advantage. The Lloyd’s market on the other side is mostly reinsurance and more vulnerable.

c) Finally, after having been invested in short-term no-risk bonds since their IPO, they suddenly disclosed beginning at year-end 2013 that they now invest also into stocks and “Low volatility” hedge funds. Most likely not a good idea at this point.

For me, the cyclicality of the business itself would be no problem. But the combination of Management change and strategy change is very hard to swallow. I would happily invest if there would be EITHER a management change OR a strategy change but not both.


To quote Donald Rumsfeld, those two changes lead Lancashire into the “unknown unknowns” territory. Sure, the new CEO is at Lancashire since 2007 and an underwriter, but overall I am not sure if the superior capabilities of the forme CEO have been “institutionalized” in the 8+ years of company history. Having three platforms instead of one sounds great, but it can also mean a loss of focus. So at the moment, Lancashire for me is not a “buy” as I do not have a clear idea how and if they can replicate their past results. T

However in general, the business model is attractive and the “London Insurers” could become interesting, especially if the market softens further so I will try to look into the others at some point in time.

Edit: I have just seen via the “Corner of Berkshire and Fairfax” board a link to an “Insurance Insider” article which states that the former CEO has completely sold out and is expected to launch a new company. A reason more not to rely on past results as this business is very dependent on the persons and the old CEO wil be a pretty tough competitor if he starts over again.

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