Category Archives: Opportunities

Short cuts: Sky Deutschland, Rhoen Klinikum, Bilfinger, Vossloh

Sky Deutschland

A short quiz: Can you spot the day when the 6,75 EUR offer expired ?

My initial strategy obviously didn’t work out. Now however I am wondering why I didn’t short Sky Deutschland instead before the offer expired. It seems to be clear now that the price didn’t move above 6,75 EUR during the offer period, because most people attach a fundamental value of less than 6,75 EUR to the shares. That would have been second level thinking, but I missed it.

I read somewhere that you should only sell a stock from a portfolio if you are ready to short it. That would have been the best approach here.

Rhoen Klinikum

Looking at the chart, my decision to take a profit at 23,15 EUR looks stupid:

The mechanics of the current “listed transferable tender rights” are the following: The less people who want to actually sell there shares, the lower the price of the tender rights and the higher the share price. As for now, it seems that not so many people want to sell. I have to confess that I got nervous when the price of Rhoen dropped after I bought on the first day ex rights.

In the future, I think it makes sense to wait longer and see how these special situation plays out. I think I waisted some “intrinsic optionality” by taking the small profit much too early.

Bilfinger

In August I looked at Bilfinger for the first time. My arguments against an investment back then were the following:

– some of the many acquisitions could lead to further write downs, especially if a new CEO comes in and goes for the “kitchen sink” approach
– especially the energy business has some structural problems
– fundamentally the company is cheap but not super cheap
– often, when the bad news start to hit, the really bad news only comes out later like for instance Royal Imtech, which was in a very similar business. I don’t think that we will see actual fraud issues at Bilfinger, but who knows ?

Yesterday, Bilfinger released Q3 numbers.

For me, it was therefore no big surprise that they had to write down in total of ~230 mn EUR. The market however seems to have been expecting other things as the extreme drop in the share price shows:

I think Bilfinger is now approaching the “very cheap” area and I will look at them a little closer in the next weeks.

Vossloh

Vossloh, another potential “turn around” story also released Q3 numbers a few days ago. Similar to Bilfinger, investors seemed to have been spooked by the numbers.

In my opinion, two issues might have irritated investors:

- new orders in Q3 were very weak (new orders in the first 6 months were very strong)
– management basically said that a “full” recovery can only be expected for 2017

Interestingly, the whole press release had a very negative tone, they make no attempt to strip out the one offs etc. etc. Maybe it is coincidence, but if I would want to talk the stock down in order to maybe buy the company cheaply, I would do it exactly that way…..

This is what I said in September:

Looking at the chart, this might not be unrealistic as the stock price is still in free fall and any “technical” support levels would be somewhere around 39 EUR per share if one would be into chart analysis. In any of those “falling knife” cases, patience is essential anyway.

Vossloh will therefore be “only” on my watch list with a limit of 42 EUR where I would start to buy if no adverse developments arise.

So we are now very close to my potential entry point. I will watch this as closely as Bilfinger. Both for Bilfinger and Vossloh, Iit will be interesting to see if there will be some year end tax loss selling.

Special situation: Citizens Financial Group (CFG) – Another interesting “forced IPO” ?

Summary:
The recently IPOed US bank Citizens Financial Group looks like a typical “forced IPO” from a troubled regulated financial conglomerate, similar to Voya & NN Group /ING. The current valuation shortly after the IPO would imply a decent upside (~50%) even if Citizens only manages to become an “average” US regional bank.

Citizen Financial Group went public on September 24th . The story of the US-based lender is similar to the NN Group IPO in which I have already invested.

In this case, parent company Royal Bank of Scotland (RBS), which has been bailed out by the UK government following the financial crisis, is forced to concentrate on its UK business. RBS then decided to ged rid of its US business via an IPO instead of a direct sale to another buyer. It seems to be that there were quite some interested buyers.

Very similar to ING and NN Group, RBS has time until 2016 to sell down the whole stake. That this is not easy was clearly shown as RBS had to price the IPO at 21,50 USD per share, below the inital range of 23-25 USD.

Compared to other regional US banks, the valuation based on book value (and tangible book value) looks attractive:

Name Price/ Book Price/ Tangible Book ROE Current
CITIZENS FINANCIAL GROUP 0,65 1,00 -15,82
REGIONS FINANCIAL CORP 0,79 1,14 7,19
ZIONS BANCORPORATION 0,87 1,05 5,66
SUNTRUST BANKS INC 0,91 1,41 6,38
HUDSON CITY BANCORP INC 0,98 1,01 3,92
KEYCORP 1,07 1,21 8,87
COMERICA INC 1,08 1,19 7,56
FIFTH THIRD BANCORP 1,12 1,35 13,39
NEW YORK COMMUNITY BANCORP 1,17 2,02 8,35
BB&T CORP 1,20 1,82 8,00
HUNTINGTON BANCSHARES INC 1,29 1,44 10,92
M & T BANK CORP 1,37 2,02 10,76
FIRST REPUBLIC BANK/CA 1,73 1,84 13,66
CULLEN/FROST BANKERS INC 1,82 2,43 9,66
SVB FINANCIAL GROUP 1,98 1,98 11,37
SIGNATURE BANK 2,43 2,43 13,26
Average 1,28 1,58 7,70

If we just assume an average multiple, there would be a 50% upside based on tangible book and a 100% upside based on total book value. The problem is of course: in order to reach this multiple you have to earn the average return on equity.

Looking into the IPO filings, we can clearly see that things didn’t work that well in the past. “Normalized” earnings were around 650 mn USD in the past or ~2-3% ROE which clearly would not justify a valuation at book value. Due to the low-interest rate environment, revenues decreased and in 2013, most likely to prepare the IPO, they made a massive goodwill impairment of around 4 bn USD in 2013.

Banks as investments

As there is no shortage of material against banking and the associated risks and evil spirit, I want to outline instead what I do like about banking and this situation:

- Traditional banking in my opinion is a solid and good business if run conservatively and responsibly. Many value investors would never invest in a bank, but I have no problem with this (Mr. Buffet neither as we all know)
– Traditional banking (and Citizens is a traditional bank) profits from higher interest rates. It is easier to put margins on the loan if the nominal rate is higher. So owning a bank is quite a good interest rate hedge
– mid size banks used to have a disadvantage over the large banks, especially with regard to funding. With all the new regulation aimed at the mega banks, I think there is a much better “equal level” playing field. I like good & cheap mid-sized banks.
– I could imagine that being on its own feet, Citizen’s management can react better to local challenges and develop its business than being part of a nationalized UK banking group under constant pressure. The “spin-off effect” could be at work here. Many of the directors have purchased shares directly after the IPO. The CEO owns shares in the amount of 6 mn USD.
– Citizen does have scale on a regional level which in my opinion is quite important (see page 152 of the S1 document) in order to achieve good ROEs
– the region where they are active (North east, New England) had less issues with the housing bubble, so theoretically loan quality should be OK. Most of their business is by the way in so called “recourse states” which adds to the incentive of actually paying back personal loans

Stock overhang

RBS still owns ~66% after the IPO and a subsequent share repurchase. 2016 is not that far in the future and placing another 10 bn of shares will not be a walk in the park, but on the other hand a lot of this could be reflected already in the share price. For me it is always interesting to see when typically sell-side analysts apply a discount due to “stock overhang”. As an “intrinsic” value investor, those situations are one of the clearest situations for market inefficiencies as the intrinsic value of a company does not change because of this.

Similar to ING, I think RBS did sell the first part cheaply in order to then (hopefully) sell into positive momentum. ING for instance managed to sell Voya down from over 60% to now 32% within 1 year and the stock still outperformed the indices.

My assumption is that RBS will not sell below tangible book value which is around the current stock price. If they sell below, they will lose available capital at RBS and therefore weaken their capital base and ratios. So a scenario where RBS sells down to very low levels far below the IPO price is in my opinion not realistic.

Valuation

I am clearly not in the position to judge if CFG is an “above average” bank. However, I think one can attach a high probability to the outcome that CFG will be an average bank. The nice thing about this is that there is significant upside already to the “average case”.

Therefore I would make the following, simplified case:

I assume that there is a 50% probability that within 3 years, CFG will be an “average” bank and trade at an average valuation. Conservatively I ignore goodwill and assume a target price of 1,6x current tangible book value in 3 years which would be ~ 40 USD per share.

To keep things simple, I further assume that there is a 25% chance that they will do really well and a 25% chance that they screw up. In the downside case, I will assume a 50% loss, in the upside case I will assume a valuation at 2x tangible book or around 50 USD.

So my “expected” value in 3 years time would be (0,5*40)+(0,25*11,5)+(0,25*50)= 35,4 USD. Based on the current price of around 22,80 USD, this gives me a potential annual return of ~15,4% which looks attractive to me for such a “special situation” investment.

Summary:

Citizens Financial “forced IPO” looks very similar to ING’s NN Group and Voya IPOs. I think this could be very attractive as even the assumption of Citizens becoming an “average ROE US regional bank” has significant upside. Despite or because of the assumed “stock overhang”, the mid-term risk/relationship looks attractive although, but similar to NN Group, one should not expect a quick win here.

I will therefore invest 2,5% of the portfolio into Citizens at current prices of around 22,80 USD.

P.S.: This will be my first US stock since a long time. I don’t have anything against US stocks, but often I do not find any kind of “edge”. In this case, I do have the feeling that banks are still highly unpopular as investments in general and that there is a good chance for some market inefficiency, even in the highly efficient US market.

Special situation quick check: Rhoen Klinikum (ISIN DE0007042301) – “Listed transferable tender rights”

Yesterday, Rhoen Klinikum released the details how they will buy back shares following the sale of most of their business to Fresenius (Rhoen was a very successful “busted M&A” special situation, previous posts can be found here)

They way they do it looks interesting and seems to be like a “reverse rights issue”. The instrument is called “Listed transferable tender right” and seems to work as follows:

- as of tomorrow, October 16th, each shareholder gets automatically one “tender right” per share
– those “tender rights” are traded separately at the stock exchange
– you need to have 21 tender rights in order to sell 10 shares
– the tender price is 25,18 per share
– the exercise period runs until November 12th, until then, the tender rights are traded
– already tendered shares will trade under a separate ISIN until November 14th
– the cash for tendered shares will be paid out on November 19th

As of today, the shares are trading at around 23,85 EUR. Following the logic of the subscription rights, one right should be worth

Edit: in the first version, I had the wrong formula. Thanks to a friendly reader, this is the correct formula:

(25,18-23,85)/((21/10)-1)= 1,21 EUR.

So tomorrow, the Rhoen shares should open (all other things equal) -1,21 EUR lower and the rights should trade at 1,21 EUR. Let’s see if there is a chance to find a little arbitrage here and there.

One strategy could be to buy the stock at the open, hoping that the “discount” will be eliminated quickly. A second one could be an arbitrage between the rights and the stocks. Finally, it could be worthwhile to look at the tendered shares as well.

Don’t ask me why they are doing it that way. I think it most likely optimizes the tax position of the large shareholders, especially for the founder Eugen Muench, who wanted to cash in his remaining 10%.

A final comment for clarification: No, this does not mean that Rhoen shares should trade at 25,18. The price chosen by Rhoen is relatively “arbitrary”, they could have used any other price as well.

Vossloh (DE0007667107) – another potentially interesting “Fallen Angel” with an activist angle ?

Vossloh AG is a mid-sized German company and calls itself “a leader in the rail infrastructure and rail technology”.

Looking at the stock chart we can clearly see that not everything is going well there:

Vossloh lost almost 50% from their peak 3 years ago. If we look at some profitability measures of the past 10 years we see an interesting pattern:

EPS Profit Margin ROE
30.12.2004 3,91 6,2% 18,5%
30.12.2005 3,08 4,8% 13,3%
29.12.2006 2,98 2,0% 5,7%
28.12.2007 4,26 7,0% 18,2%
30.12.2008 6,30 11,5% 31,1%
30.12.2009 6,57 7,5% 18,5%
30.12.2010 7,32 7,2% 19,0%
30.12.2011 4,32 4,7% 11,0%
28.12.2012 4,15 4,8% 12,4%
30.12.2013 1,00 1,1% 3,1%

Vossloh showed only little impact during the financial crisis but then results deteriorated. They showed a small profit for 2013, but for the first half-year 2014, they shocked everyone with an “Accounting Bloodbath”, showing a loss of ~12,20 EUR per share, wiping out all profits for the last 3 years and some more.

So what happened ?

This is a quote from the CEO letter of the 2010 annual report:

For the years ahead, we intend to accelerate our growth while sustaining the rate of profitability. It is especially in the international markets that we will be amplifying our presence and we will be scoring in particular with the new products. For 2011, we are targeting group sales of €1.4 billion and an EBIT above €160 million.

This is from the 2011 CEO letter, where profits already declined:

Dear Stockholders:
Following a series of very successful fiscal years marked by above-average growth rates Vossloh suffered setbacks in 2011. Contrary to our expectations, Group sales and earnings declined. The chief influencing factors were the slowdown in the progress of Chinese rail projects, which only became evident as the year proceeded, the suspension of shipments for a major project in Libya and, from the summer onward, weak demand in key European rail markets. Under these circumstances, the Rail Infrastructure division’s sales, which at around 65 percent of the Group’s continued to contribute the lion’s share of revenue, dropped for the first time in years, by some 13 percent. The sales shortfall at Vossloh Fastening Systems was especially severe at the Chinese location and could not be offset by business elsewhere. The Switch Systems unit also performed below expectations due to the military conflict in Libya, which prevented the planned extensive shipments to that country in 2011. In addition, in several European countries demand slackened and price pressure stepped up.

In 2012, the outlook for 2013 was not that good but still “solid”:

However again, they disappointed, as stated in the 2013 annual report:

There were two significant reasons for the downward development in 2013: For one, we were confronted with extensive non-recurring charges that were due to expenses for the final out-of-court settlement of a dispute in the Transportation division in an amount and extent that was not to be expected. For another, there were additional expenses in this division in connection with the processing of several projects, which entailed additional and unexpected losses of earnings. In contrast, the Rail Infrastructure division performed significantly better than expected, and revenues as well as the result increased significantly. The Fastening Systems business unit primarily contributed to this positive development.

Not too surprisingly, both, the CEO and COO stepped down in February making way for a new management. Normally, CEO hate to step down even after management disasters so what happened ?

The activist angle:

Vossloh had been more or less controlled by the founding Vossloh family for more than 100 years although they only owned around 34%. Since 2011 though, another strong shareholder emerged: Hermann Thiele, the owner of German unlisted company Knorr Bremse who had built up a stake of close to 30 % from 2011 to 2013.

Although Thiele is not widely known and keeps a low profile, he is one of the most succesful German entrepreneurs of the last 30 years. He bought Knorr Bremse in 1985 as one would call it a “leveraged management buyout” and then grew the company by a factor of 15-20 times over the last 30 years. Despite being a non-listed company, Knorr Bremse issues a relatively good annual report where onr can see that the company is spectacularly profitable. Net margins of 8-9% and cash adjusted ROICs of more than 30% are clearly an indicator that this guy seems to know what he is doing. Besides that, depending on how you value Knorr Bremse, he is also one of the richest persons in Germany.

A little side story: World famous BMW AG once was the engine subdivision of Knorr Bremse until 1922 when it was sold to an investor as they didn’t find the engine business interesting enough……

In 2013, he finally succeeded in being elected as boss of the supervisory board against the explicit wish of the founding family. The founding family finally sold most of their shares in late 2013. It was him who kicked out the old management and brought in 2 new guys, among them the new CEO Hans Schabert who used to run the rail operations of Siemens.

In one of Thiele’s rare interviews in 2013 he stated that Vossloh is his private investment. Although he likes the business, he doesn’t want to take full control and leave Vossloh listed.

As a supplier to the rail industry, he knows the sector pretty well. I could imagine that long-term this might help Vossloh to get back on track. However I do not believe that he will remain a minority shareholder for ever. I do think that sooner or later he will try to take control. There would be clearly synergies between Knorr Bremse and Vossloh as both have the same clients and Knorr is even a supplier to Vossloh’s locomotive unit.

The 6 months 2014 “accounting massacre”

If you ever want to see a “how book as many losses as possible” financial report then look at the recent 6 month report from Vossloh. The new management wasted no time and did not even wait until year-end in order to write down everything they could.

Even in the investor presentation, they don’t make the slightest attempt to normalize the result.

Digging deeper into the report, you will find among others:

- goodwill write offs
– inventory write downs
– extra provisions against “risks”
– and even a charge because they did an early retirement of a higher coupon debt facility, which is clearly earnings accretive in the future.

In their outlook the state that one can expect some more losses in 2014 but from 2015 on Vossloh will be profitable again. But they did not specifc how profitable. Operationally they made already some significant changes. So overall this looks a little bit similar to the Van Lanschot story. The new CEO (with the support of the Supervisory Board) has written off whatever he could in order to show increasing profits going forward.

However there could also be a problem here. At some point in time, Thiele could decide that he doesn’t want to share the upside of a turn-around with the other shareholders and try to take Vossloh private as cheaply as possible. Other than Cevian at Bilfinger, Thiel has no track record with capital markets and many “old school” German business tycoons do not care very much about minority shareholders. This is clearly a risk to be considered

What could be a “turned around” Vossloh be worth ?

This is an overview of average margins (10/15 Years) of Vossloh and its 3 listed European “pure play” competitors:

Avg NI Margin  
  10 Y 15 Y
Vossloh 5,67% 5,19%
CAF 5,40% 6,46%
Faiveley 6,50% 5,00%
Ansaldo 5,98% n.a.

Overall, I would say a 5,5% net profit margin on average is not unrealistic. Based on 2013 1.325 mn sales and assuming no growth, this could mean that Vossloh at some point in the future makes ~ 73 mn EUR profit or ~5,5 EUR per share If we assume a 12-15 P/E range, this would mean that a target share price of 66-82 EUR would be realistic.

Based on today’s price of ~49 EUR this would mean a potential upside of 35-68%. However one should assume that this turn-around needs at least 3 years. For a turn around, I personally would require a higher return than for a normal “boring” value stock as there is clearly a risk that the turnaround does not work out as planned.

If I assume a target return of 20% p.a., i would need to be sure that the price of Vossloh is in 3 years at around 85 EUR. This is clearly at the very upper end of my target range. So I would either need to have more aggressive assumptions or I would need a lower entry price. As a value investor, I would not want to bet on growth or on a shorter time frame for the turn around, so the only alternative is to wait for a lower entry price.

Taking the midpoint of my range from above at 74, I would be a buyer at ~42 EUR per share but not before.

How does this compare to the Bilfinger case ?

A few weeks ago, I was looking at a similar case, Bilfinger. Similar to Vossloh, an activist investor (Cevian) managed to get rid of the CEO and tries to turn around the company after mutliple earnings disappointments.

At a high level comparison I like Vossloh’s underlying business better. Bilfinger clearly has some structural issues especially with its power business where the underlying market (electrictiy) is undergoing a big fundamental change whereas the railway business to me seems fundamentally intact. On the other hand, Cevian as “activist” has a very good reputation and is easier to “handicap”. They will most likely treat minority shareholders fairly and do some kind of spin off etc. So the risk of getting screwed by the activist is lower.

In a dirct comparison however I would prefer the “activist risk” at Vossloh against the fundamental issues at Bilfinger. Additionally, the real “accounting bloodbath” at Bilfinger hasn’t happened yet.

Summary:

In general I think Vossloh could be an interesting turn around story, especially considering the involvement of German self-made billionaire Hermann Thiele. I do like the industry better than for instance Bilfinger. It is clearly cyclical but I don’t see any structural issues. On the other hand, the current price is too high with regard what I would expect for such a relatively high risk “turn around” investment. The “Mean reversion potential” at the current price is not high enough, I would need a ~20% lower share price to justify an investment.

Looking at the chart, this might not be unrealistic as the stock price is still in free fall and any “technical” support levels would be somewhere around 39 EUR per share if one would be into chart analysis. In any of those “falling knife” cases, patience is essential anyway.

Vossloh will therefore be “only” on my watch list with a limit of 42 EUR where I would start to buy if no adverse developments arise. Additionally I will need to check Vossloh against Alstom once

AGEAS (ISIN BE0974264930) – Potential litigation play ?

The company:

Ageas is a Belgium based insurance company and formerly known as “Fortis”, one of the biggest Eurpoean casualties of the financial crisis. Fortis, together with RBS and Santander tried to take over ABN Amro but especially Fortis then failed spectacularily and was saved by the Belgian Government and finally sliced and diced into Insurance and Banking, of which the banking part was sold to BNP Paribas.

Ageas itself is an interesting case, similar to NN Group, it is a strange collection of Belgium, UK, and Asian insurance companies plus some weird stuff at corporate level, resulting from the quite ugly split of a combined group into two separate businesses. However, a lot of the ugly stuff has already been cleared over the last few years and Ageas was looking like an almost “Normal” insurance company

The litigation

A few weeks ago, a Dutch court decided that Ageas is liable for misinforming Fortis shareholders in 2008:

The Amsterdam Appeals Court ruled that Fortis is liable for misleading investors by saying the firm was “financially stronger than ever” after a government bailout on Sept. 28, 2008, only to be replaced by a break-up plan five days later.

and further down:

Ageas should be able to meet a worst-case liability of 2.5 billion euros before taxes possibly stemming from the ruling, Matthias De Wit, a Brussels-based analyst at KBC, said in a note today. Still, potential indirect effects shouldn’t be ignored, he said.

Looking at the stockprice, we can estimate that the stock lost ~ 5 EUR per share:

With about 230 mn shares outstanding, the market seems to have implied ~ 1,1 bn EUR loss after tax. Ageas itself has provisioned around 130 mn EUR against this case.

Is this interesting ?

At the moment, it is hard to say. Ageas trades at ~0,62 times book value, which is relatively cheap. They are very active in repurchasing shares (sharecount decreased by -115 since 2011). I do like the insurance sector at the moment because its cheap and the problems (low interest rates etc.) are well known.

Insurance companies do have traditionally very good lawyers on their payroll and litigation is part of their business, so one can assume that they handle this very professionally. On the other hand, other than the CIR Spa case, there is no direct catalyst as the law suit can linger on quite some time.

Valuation wise, Ageas look similar to NN Group, actually, I could easily see those two Groups merging at some point in the future. My guess is that someone is maybe already working on the idea to form a strong Benelux players out of the available mid size companies (Delta lloyd, NN Group, Ageas, SNS).

Nevertheless, I do not think that AGEAS is a “Litigation play” at the moment, as I don’t have a good idea on the time line of the law suit. However it it looks like a pretty cheap insruance company with some upside potential, so I will keep it on my watchlist.

Alstom SA (ISIN FR0010220475) – an interesting potential “sum of parts” play after the GE deal ?

Profitlich & Schmidlin (“P&S”) had a post a week ago (in German) on how they view the current situation at Alstom.

A short refresher: Both, General Electric and Siemens wanted to take over Alstom and/or parts of it. At the end, GE prevailed, however they failed to take over Alstom completely. Instead, they purchase the Grid, Renewables and Power businesses, leaving the Transport business at Alstom.

In order to make it more “interesting” and to please the French Government, GE and Alstom will form 3 Joint Ventures of which Alstom will buy a 50% share each. Plus Alstom will buy a transport related business from GE for 600 mn EUR. Additionally, Alstom seems to have a put option for these JV back to General Electric with a floor of 2,5 bn EUR.

So in theory, one could now use the information given for instance in the GE press release and calculate a prospective “sum of the parts” valuation for Alstom after the deal and this is how P&S have done it:

No op Assets  
Net cash 4.122
London Metro loan 364
Transmash 700
Pension, others -620
Total 4.566
Per share 14,78

On top of those ~15 EUR per share “extra assets” they add the 2,5 bn EUR for the JVs, which results in around 22,87 EUR per share for all those non-transport assets. With a “fair value” of the transport business of ~11 EUR per share they come up with their target value of 34 EUR per share, which would mean a nice +30% upside potential based on the current share price of 26 EUR.

My 5 cents on this

First of all I find it great that P&S share their investment case via their blog. This is definitely a good thing. And clearly, as with everything, it is their opinion and not everyone will agree with this. My opinion differs from theirs, but that does not mean that they are wrong or vice versa.

Before jumping into the details, I would just want to refer back to some earlier stuff I have written about holding companies. The question is: will investors really apply a “full valuation” to the operating business plus all the “extra assets” or will they discount the extra assets, especially the JVs and the other non-consolidated assets. I think it is more prudent to apply a discount to the extra assets. Unless there is clear evidence that those assets get liquidated, I think it is too optimistic to assign full value to those assets.

A second big issue is that at the moment no one knows exactly how much of the liabilities will get transferred to GE. Especially with regard to operating leases (nominal ~830 mn EUR), litigation liabilities (528 mn EUR) and pension liabilites (gross 5,2 bn) there is no definitive answer how much will be transferred to GE and what remains at Alstom. In a sum of part calculation, any of those remaining liabilities will have to be deducted from the extra assets as they are economically equivalent to debt.

Net cash position

Let’s start with that one. In their annual report, Alstom provides us with EUR -3.041 as net cash at March 31st 2014. GE stated that the whole transaction will generate a 7,3 bn net cash outflow for them which is an equivalent inflow for Alstom.

So theoretically we could calculate -3.041 + 7.300 = 4259 mn EUR net cash for Alstom. However there are several caveats to this:

- transaction costs: A transaction like this easily swallows up a large amount of costs for lawyers, consultants bankers etc. I would assume between 100-300 mn cash costs for Alstom before closing, with an expected value of -200
- mark to market debt: Although any financial assets under IFRS are marked-to-market, debt is still accounted for at cost. If Alstom would really want to buy back their bonds to shorten the balance sheet, they would have to pay market value which is ~350 mn higher than book value. So net debt has to be adjusted for this.

So for my calculation, net cash would be 4.259-200-350 = 3.709 mn net cash after closing of the deal

Transmashholding

Transmashholding is a 25% stake alstom holds in a Russian transport equipment manufacturer. P&S value this company 10x average 2012/2013 earnings at 700 mn EUR which is around 90% higher than book value. I would value this asset significantly lower because

- according to Bloomberg, the majority of the profit is “extraordinary profit”
– if we value them based on operating income (EBIT) with the same averaging, we would get on average 2800 mn Rubels EBIT p.a. (which is around 60 mn EUR p.a.) and assuming 10 times EV/EBIT we get 600 mn EUR EV. Minus ~10 bn RUB or 200 mn debt, the equity would be worth 400 mn, 25% of Alstom then would be 100 mn EUR.

Other liabilities

As I said before, we how much of the liabilities go to GE. My own assumption would be that all the critical ones (Litigation, Pension deficit, operating leases) are divided proportionally to the total amount of liabilities for the transport segment. According to the segment report in the annual report, transport had ~28% of all liabilities of Alstom. My default assumption therefore is that 28% of all “debt like” liabilities remain at Alstom as part of the transport business

Discount to extra assets

Finally, I would argue that especially as this complicated deal will only close in mid 2015, it would be quite optimistic to assume zero discount on the future cash inflow, JV assets etc etc. So I would actually discount those assets to be on the safe side with between 10-20% at the current status, as a compromise I will use 15% both, for net cash and the JVs. Just as a reminder: I am not sure if anyone remembers the planned GE – Honeywell merger in 2001. This looked like a done deal for a long time before the deal actually fell through. The deal might be very likely but there is always the risk of a deal stopper and one has to adjust for this in my opinion.

Bringing it all together & Summary:

So this would be my version of the “extra asset” calculation:

MMI
Net cash 03/2014 -3.041
+ Cash proceeds GE 7.300
– mtm bonds -350
– deal cost -200
   
Net cash adj 3.709
+ London Metro 364
+ Transmash 100
+ JVs 2.500
   
Total “extra assets” 6.673
– 15% discount JV&Cash -931
Discounted extra assets 5.742
   
– “pension others” from P&S -620
– 28% of Litigation liab -148
– 28% of operating leases -210
– 28% of pension underfunding -217
   
Adjusted “extra” assets 4.547
per share 14,71

With my rather cautious approach, i would value the potential extra assets after the deal ~ 8 EUR per share lower as P&S. Together with their valuation of the Transport business od ~11-12 EUR, the current Alstom price at 26 EUR looks fair with no big upside.

Clearly, any of my assumptions could (and should) be challenged as well. Transmash could be worth a lot more and maybe all the liabilities go to GE. On the other hand, one should not forget that the deal is not done yet. I am for instance not sure how happy the potential clients are and if I read correctly, they need approval of 32 national regulators for this deal. Plus, the French Government will be heavily involved in Alstom going forward which might lower the prospects of aggressive share repurchases and increase the risk for “strategic” acquisitions.

Alstom has proposed more detailed information in November before an extraordinary shareholder meeting. For me, at the moment Alstom is not a buy. This might change especially if most of the liabilities would be assumed by GE, then the Alstom “stub” could be really interesting. In the mean time, the stock however is “watch only”.

Bilfinger SE (DEDE0005909006) – Opportunity or Falling knife to be avoided ?

Background:

Bilfinger is a traditional German and international construction company with a history going back to 1880. As many of its peers, it tried to diversify away from the risky large-scale construction business into concessions and services. 3 years ago, Bilfinger surprised many by naming the the former German politician Roland Koch as new CEO. In 2011, Swedisch activist fund Cevian disclosed a 10% position and has increased this to 20% making them Bilfinger’s largest shareholders. Under Koch many of the traditional construction subsidiaries were sold and many new services companies were acquired. I counted 13 acquisitions in 2012 and 2013.

Up until early 2014, the strategy seemed to have worked well, margins and ROE/ROIC increased and the stock price hit an all time high of 93 EUR in April 2014.

Current situation

However since then, it seems that the “wheels went off”. Koch had to lower the guidance for 2014 2 times with quite significant impact on the share price as we can see in the chart:

Quite surprisingly for a traditional German company, he left the office on the very same day with his predecessor becoming his successor. There is some speculation in the press why this happened so fast but I think that activist investor Cevian was most likely also involved in this decision. Interestingly, Koch was buying shares for his personal account in July, so even he seems to have been surprised to a certain extent.

Falling knife vs. opportunity

I am a big fan of the saying “never catch a falling knife”. In the Bilfinger case we have a lot of risks:

- some of the many acquisitions could lead to further write downs, especially if a new CEO comes in and goes for the “kitchen sink” approach
– especially the energy business has some structural problems
– fundamentally the company is cheap but not super cheap
– often, when the bad news start to hit, the really bad news only comes out later like for instance Royal Imtech, which was in a very similar business. I don’t think that we will see actual fraud issues at Bilfinger, but who knows ?

On the plus side however we do have also a couple of arguments:

+ Bilfinger still has only a low amount of debt outstanding, so I don’t thin we will see a “Royal Imtech scenario”
+ Cevian will not sit back and watch. They have board members and a proven track record. They are usually in for the long-term but act quickly if things go wrong
+ Bilfinger does not have a majority owner and could be an M&A target
+ Bilfinger is a traditionally well-managed company
+ Analyst sentiment is already pretty bad (lowest quarter of the HDAX)

Especially the Cevian involvement looks interesting. The final target is pretty clear: By shifting the business mix more into engineering/service, they want to realise higher multiples than what traditionally is associated with “real” construction companies. Especially companies like Arcadis or Atkins trade at EV/EBITDA multiples of 8×-10. Bilfinger currently trades at around 6x EV/EBITDA, 10x EV/EBIT and 11 times earnings based on the reduced 2014 estimates. So there is clearly some potential here if they manage to stabilize the company.

On the other hand, Cevian clearly didn’t see that coming either. They actually increased their position in May when the stock traded north of 85 EUR. I would estimate that they paid around 70 EUR per share for their whole position.

Also, when we look at other comparable situations for instance Suedzucker, we can clearly see that the “knife can fall” a very long way down:

Clearly Suedzucker is not comparable to Bilfinger but it shows that one can easily lose 2/3 or more within a relatively short period of time if things og bad.

So what to do ?

Despite the lure of a “bargain” I will not invest now. For now I will stick to my principles and not catch a falling knife

What could make me change my mind ? For instance a new CEO who does not need to start with an accounting bloodbath……

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