Monthly Archives: November 2011

Magic Sixes – “New entries”

    At the moment. there are some interesting “new entries” in my Europe based “Magic Sixes” Screen.
    New entries (non financials) at which I will have a look in the next days are:

    ESSO S.A.F (French Exxon subsidiary)
    Stora Enso (another paper company)
    Deutsche Lufthansa– CSP International (Italian underwear, firewall blocks website ;-))
    Screen Service (Italian manufactorer of television broadcasting equipment)
    Isagro SpA (Italian producer of herbicides)
    Mondadori (Italian publisher, majority owned by Berlusconi)

    It looks like an interesting time for contrarian investors…..

    Additionally i run a “magic sixes light screen” with slightly relaxed rulse (P/b 0.7, P/E 7, Div. yield 5%)

    Some interesting companies there:

    ICT Automatisering (Durch softwar company)
    Huntsworth PLC (UK PR company)
    BWG Homes (norwegian residentail house builder)

Lesenswertes – Wochenrückblick

Toller langer Artikel über die Übernahme und Pleite der LA Times durch Sam Zell (via Simoleon Sense)

Graham & Doddsville Herbstausgabe Marty Whitman.

Fairholme Präsentation zu Bankof America. Motto: “Ignore the crowds….”

Bronte zu Olympus, MF Global und US Kongress Insidertrading

Audio Interview mit Kyle Bass

Interview mit Gordon Chang, der den baldigen Kollaps von China prognostiziert

Hartes Jahr für Whitney Tilson

Sehr interessanter Post zum Thema Schiffebroker

AIRE KGaA – Q3 Bericht 2011

Ein kurzer Blick auf den Quartalsbericht:

Nach dem Verkauf der Bratislava Immobilie sieht die Bilanz deutlich einfacher aus:

Man hält jetzt folgende Investments:

+ Fonds 37,3 Mio
+ US Direktinvestitionen 34,6 Mio.
+ Cash 20 Mio EUR
-2 Mio EUR Verbindlichkeiten
= 90 Mio NAV oder 21 EUR pro Aktie (4,22 Mio Aktien)

Demgegenüber stehen Investitionsverpflichtungen von:

CUR in CUR EUR k X-Rate
AIG Europe I EUR 1,459 1,459 1
AIG US Res USD 811 601 1.35
Neptune USD 4,114 3,047 1.35
Trivest USD 3,362 2,490 1.35
Invesco Jap II JPY 570 5,429 105
Marina V USD 998 739 1.35
Invesco Jap III JPY 628 5,981 105
AIG Mex USD 6,565 4,863 1.35
Station USD 138 102 1.35
One world USD 11 8 1.35
Pleasanton USD 2,079 1,540 1.35
Millenium USD 1 1 1.35
Invesco Asia JPY 3,675 35,000 105
AIG India USD 3,314 2,455 1.35
Summe     63,715

Man sieht deutlich, dass dies die “Achillessehne” ist.

Im Bericht steht dazu noch, dass das Management davon ausgeht, dass nicht alle Zusagen in Anspruch genommen werden.

Was jetzt eigentlich fehlt is eine Art Cashflowplanung:

Wieviel Erlöse kommen aus den bestehenden Investments zurück und wieviel Geld muss wann noch ausgezahlt werden ?

M.E. ist die Chance, dass von den 20 Mio Cash ein größerer Teil sofort an die Aktionäre fliesst, relativ gering. Es bleibt eine “Geduldsprobe”.

UPM Kymmene part 3: Qualitative aspects, Value Trap check and conclusion

So after the quick check, the Replacement Value analysis and the calculation of the EPV we have the following result:

Replacement Value ~ 14 EUR
EPV between 9.2 and 13.5 EUR depending on the assumption for future Capex.

Reader Weljo grouv however made a very good comment: The lower Capex seems to be an industry wide developement, so actually projecting the currently low capex expenditures into the future might be aggressive.

If we then just try to explain, why a conservative EPV is so much lower (maybe ~10 EUR) than the replacement value, the simple answer could be that I falsely took all the machinery at book value instead of applying a discount.

At this point in time it makes also sense to check for characteristics of a value trap. I posted already the great presentation from Jim Chanos and like to use now as a exercise.

I will start with the first mentioned characteristic:

Cyclical and/or Single Product
• Cycles sometimes become secular (Steel, Autos)
• Fad does not equal sustainable value (Coleco,Salton, Renewable Energy)
• Illegal does not equal value (Online Poker)

The first point is really the key: Will demand for paper (especially magazine paper where UPM is market leader) really recover ? Or will the Ipad take over. I am not an expert in this, but this is definitely a “red light”.

Hindsight Drives Perceived Value
• Technological obsolescence (Minicomputers,Eastman Kodak, Video Rental)
• Rapid prior growth – “Law of Large Numbers”(Telecom Build-Out)

This is also an interesting point. Although UPM is not a technology company, its major product magazine paper could be a victim of technolgy change. Let’s call this an “yellow light”.

Marquis Management and/or Famous Investor(s)
• New CEO as a savior – ignoring Buffett’s maxim(Conseco)
• The “Smart Guy Syndrome” (Take your pick!)

No problem here, “green light”.

Cheap on Management’s Metric
• EBITDA…Arrgh! (Cable TV, Blockbuster)
• Ignore restructuring charges at your own peril(Eastman Kodak)
• ‘Free’ cash flow…? (Tyco)

This could be a problem. Management stresses “free cashflow” based on current low Capex. We don’t know how sustainable that is. “yellow light”.

Accounting Issues
• Confusing disclosure (Bally Total Fitness)
• Nonsensical GAAP (Subprime lenders)
• Growth by acquisition (Tyco, Roll-ups)
• Fair value (Level 3 assets)

“Green Light” here I would say.

So all in all, that makes 2 green lights, two yellow one red.

So basically we can stop at this point. Especially based on the EPV analysis, UPM doesn’t really offer a “hard” Margin of Safety. It also shows several characteristics of potential value traps. The relativley high free cashflow could be at least partly more a liquidation than a going concern.

Despite some very positive characteristics like

– transparent use of free cash flow
– strong market position
– some upside due to consolidation (recent takeover of smaller competitor)
– vertical integration
– some “extra assets”

the risk of ending up with a value trap in a secular declining industry is not offset by the margin of safety.

As a result, I will still follow UPM and maybe look at other paper companies (SCA is maybe a better choice), but for the time being I will not buy any shares of UPM at the current price.

Portfolio transaction update – Einhell & AIRE KGaA


As anounced a couple of days ago, I have been reducing the Einhell position since then.

Due to the low volume of trading and my restriction not to simulate trades greater than 20% of daily volumes, I was only able to sell roughly 2/5 of the position at the VWAP of 34.03 EUR per share. Einhell is now doww to ~1% of the portfolio and will be reduced to 0% going forward.


In parallel, as mentioned here, I continued to build up the AIRE KgAA Position into a “full” position , which means a 5% portfolio share.

Total trading volume since then (20.10.) has been 79.139 shares at a VWAP of 8.17 EUR per share. 20% of that volume results in a purchase of 15.827 shares at 8.17 EUR, increasing the weight of AIRE to 4,6% at a cost of 8,75 EUR per share.

After these transaction, the cash percentage dropped below 10% (9,9%), so going forward I will only increase the AIRE position to the extend Einhell shares can be sold at the same time.

UPM Kymmene Part 2: Earnings Power Value (EPV)

After the replacement value analysis for UPM in part 1, let’s move to an EV analysis based on free cash flows:

Interestingly, UPM’s standard cashflow reporting makes life relatively easy for my free cashflow analysis.

I will start with a rather big table and then explain

Starting with the operating Cashflow as stated, one can quickly see that working capital is relatively volatile, however over 7 years the effect was more or less neutral.

Next, the capex line is really interesting (Capex ex M&A and sale of assets). We can clearly see that UPM drastically reduced capex from 2009 on. UPM’ paper mills seem to be relatively new and don’t require a lot of maintenance cost in the foreseeable future.

Also interesting is the fact that although UPM is still relatively “asset rich” and despite having invested more than 500 mn EUR into the Uruguyan pulp mill in 2008, over the last 7 years ~ 1.8 bn EUR of net assets have been sold.

So in total, UPM generated ~ 4.9 bn cash, thereof 3.1 bn free Cash flow plus 1.8 bn assset sales over the last seven years. More than half of this has been used to pay dividends and buy back stock, the rest has been used to pay down net debt.

This corresponds nicely ith the communicated goals of the company:

UPM intends to pay as an annual dividend at least one third of net cash flow from operating activities less operational capital expenditure. To promote stability in dividends, net cash flow will be calculated as an average over a three-year period.
Remaining funds are to be allocated between growth capital expenditure and debt reduction. The net cash flow from operating activities for 2010 was EUR 982 million and operational capital expenditure EUR 186 million.

So how does this translate into EPV ? Based on the 7 year average free cashflow of 0.92 EUR and a standard discount rate of 10%, this would only result in an EPV of 9,2 EUR or roughly 10% undervaluation.

Now the big question is: are those 7 years really “average” years or has something changed? In particular it is crucial to understand if capex will go up again in the future or remain at the current low level.

A quick glance into the Q3 report shows that “normal” capex has remained at a relatively low level, at a run rate of around 300 mn EUR for 2011.

If we assume this as a representative Capex going forward, UPM could deliver under a “no growth” scenario around 1 bn of operating cash minus 300 mn for Capex which would result in a recurring free cash flow of 700 mn EUR or ~ 1.35 EUR per share p.a., which would give us an EPV of around 13.5 EUR, relatively close to the Replacement Value of 14.26 EUR.

So summarizing this I would state the following:

– UPM seems to have greatly reduced Capex over the last 2 years
– if those reductions are to a large extent permanent, a “fair” EPV could be around 13.5 EUR per share (no growth), if not, the stock would be only slightly undervalued
– management clearly communicates and delivers on the use of free cash flow (very positive in my opinion)

In the upcoming final post for UPM I will focus on the qualitative aspects and the business itself

Book Review: The Match King

Those who read my blog more often know that I like to read “historical” Finance books especially when there is high volitility in the markets. For me this is maybe some sort of “therapy” in order to control my “Buy and sell” finger better…..

Anyway, when I read my last historical book, the “Lords of finance”, a historical financier named Ivar Kreuger popped up a couple of times.

Coincidently, I found out there is a recent book avaliable from the author Frank Partnoy who also wrote “FIASCO”, a wall street classic.

Back to “the Match King”:

It is the story of Ivan Kreuger, a self-made Swede who made his first money in construction and then moved on and tried to monopolise the international match production in the 1920ies and early 30ies.

He soon became one of the most famous business men in the world, having shares of his companies listed on the New York stock exchange and dining with US President Hoover and other head of states. He was a master in taking advantage of the problems after WWI by offering loans to Governments in return for monopolies for match production and imports.

As some side activities, he also owned Ericsson, the Swedish telephone company as well as gold mines and other assets.

However from his early beginnings he was an absolute master in 2 disciplins: issueing complicated securities including many “derivatives” and creative accounting and transactions between his numerous official and unofficial companies.

After the big crash of 1929 he had to do more and more aggresive transactions in order to stabilize his empire before he was finally caught out and shot himself in Paris in 1932.

Besides being a really good read, the book clearly shows that nothing is really new in finance. One could even think that the CFOs of companies like Enron or several Chinese Reverse Mergers have used the “Match empire” as a case study.

The story of a brilliant guy, impressing everyone but doing one deal too many seems to be one of the constant themes of financial history. Indirectly it is also a lesson not to believe too much in Management, no matter how brilliant it seems, but stick to the hard numbers and facts (Groupon anyone ?).

I really liked the book and can recommend it to anyone who is interested in historical finance and large financial scandals.

UPM Kymmene – Relacement Value analysis

Based on the positive results from the “quick check”, I will follow up with the first step of my standard analysis process, the so called “Replacement Value” analysis.

As a starting point, I will use the Net Equity position from the 2010 Annual report of UPM.

Then as a standard I would normally subtract the following entries from the Net Equity:

– minority interests (small, only -16 mn EUR)
– Goodwill (-1.022)

However, if we look at the goodwill breakdown in the annual report, we see the following:

Goodwill by reporting segment
As at 31 December
EURm 2010 2009
Pulp 202 197
Forest and Timber 1 1
Paper 799 799
Label 7 7
Plywood 13 13
Total 1,022 1,017

If we look at the segment numbers of the pulp business on page 90 of the report, we can easily see that the pulp business (basically the pulp mill acquired in Urugay in 2007) was extremely profitable in 2010, providing a significant share of UPM’s profit. So in this case I would consider the goodwill of the acquisition not as worthless, but include it into the replacement value. (remark: It looks like that the investment into the Uruguayan pulp mill was really perfectly timed, UPM got back most of its investment already after one year !!!)

Next in line are the “other intangible assets”, worth 424 mn EUR. The largest portion of this position are “intangible rights”, with ” water rights” (189 mn EUR) having the largest share.

These water rights are explained as follows:

Intangible rights include EUR 189 million (189 million) in respect of the water rights of hydropower plants belonging to the Energy segment. The water rights of power plants are deemed to have an indefinite useful life as the company has a contractual right to exploit water resources in the energy production of power plants. The values of water rights are tested annually for impairment based on expected future cash flows of each separate hydropower plant.

Any other company which would like to start a similar Hydro Power project would have to buy those rights as well, so we can assume that this part of the “Intangible Assets” has value. The rest of the intangibles seem to be software licences and carbon rights, so in the absence of fancy stuff I would not make any further deductions.

This results in the following adjusted value for equity after minorities, Goodwill and intangibles:

FY 2010 mn EUR per share
Equity 7,109 13.67
-minorities -16 -0.03
-goodwill -1,022 -1.97
+ goodwill pulp 202 0.39
-intangibles 0 0.00
adj. Equity 6,273 12.06

Next are “special” balance sheet items such as pensions, land and buildings etc.

Pensions:UPM has 424 mn EUR pension liabilities on-balance sheet. According to the notes, the total pension liabilities including funded schemes are around 1 bn EUR.

The underlying assumptions (~ 4.4% discount rates, 6.5% assumed yield on plan assets) seem to be OK, however the large percentage of stocks in the pension funds (60%) results in a certain risk to the sponsor of those plans. So as a conservative approach, I will deduct 100 mn EUR (or 10% of gross pension liabilities) from UPM’s net equity as “buffer” for pension plan asset risk.

Other than for example a REIT, a company like UPM which owns most of their buildings outright has to write them down to zero over the term of their “economical life”. As everyone knows this appoach is quite conservative, as even 25 or 40 year old building keep some of their value if they are properly maintained.

If one looks at private equity buyouts, own real estate is often one of the “quick wins” for LBO investors if they sell and lease back the written down real estate at a large profit.

So as a rule of thumb I usually add back 50% of the cumulative depriciation on buildings. UPM has 1.505 mn EUR of buildings on its balance sheet, with an original cost of 3.207 mn EUR. So 50% of 1.702 mn EUR is 851 mn EUR which I add back to the equity value of UPM.

Biological Assets:
As UPM owns ~ 1 mn hectares of timber land, we see ~ 1.4 bn of biological assets. As the discount rates (7.5% for Finland, 10% for Urugay) seem to look OK, I don’t adjust this position. However this is something worth to be monitored closely.

“Extra Assets”:

UPM shows 573 mn of investments in “associated” companies. The largest by far with around 540 mn EUR is the participation of 43% in a company named “Pohjolan Voima Oy, FI”.

The homepage of the company states the following:

Pohjolan Voima produces energy at cost for its owners and manages the entire lifespan of power plants reliably, cost-effectively and in an environmentally friendly manner.

In another section of the homepage, the business model is explained as follows:

Pohjolan Voima supplies electricity and heat to its shareholders at cost, and the shareholders cover the costs of the operations – this operating model is also called the “Mankala principle”. The name is derived from a ruling issued by the Supreme Administrative Court in the 1960s, constituting a precedent. In this ruling, the shareholders of a company called Oy Mankala Ab were found not to have received taxable income when Mankala generated and supplied them with electricity at a price lower than the market price and the shareholders covered the company’s costs on the basis of its Articles of Association.

So this is really interesting. UPM carries the participation “at Equity”, but what would be a fair price ? Any new competitor would have to purchase electricity at market prices. One easy answer would be to look at Fortum. The big Finish utility with approx. the same mix of energy assets (nuclear/hydro) trades around 1.8 times book value. If we apply a more conservative multiple of 1.5 book value, we should add 270 nn EUR to UPM’s replacement value in order to reflect the value of the Pohjolan Voima participation.

R&D + Marketing / Branding

Last but not least we have to look at R&D and marketing expenses, if there is some “hidden” replacement value in the form of brand value or “off balance know how”. For acompanylike UPM,the value of the brand is moreor less neglectible, however we can attach some value to R&D.

UPM spends 40-50 mn EUR peryear on R&D. If we use as a rule of thumb 50% of the R&D expenses of the last 5 years as additional “replacement value”, we should add (5x45x0.5) = 112.5 mn to UPM’s replacment value.

So bringing all this together we get the folowing replacemnt value for UPM:

FY 2010 mn EUR per share
Equity 7,109 13.67
-minorities -16 -0.03
-goodwill -1,022 -1.97
+ goodwill pulp 202 0.39
-intangibles 0 0.00
adj. Equity 6,273 12.06
-pensions -100 -0.19
+ real estate 851 1.64
+ at Equ.part 270 0.52
+ R&D 122 0.23
Repl.Value 7,416 14.26

Summary: UPM is a very asset rich company. A relatively conservative approach results in an replacement value of ~ 14.26 EUR per share, mostly the result of undervalued real estate and at-equity participations. This alone would be an interesting investment case, as based on a current share price of 8,25 EUR, this equals a discount of 42% to replacement value or an upside of 72%.

In the following days I will take a closer look at free cash flows and “Earnings Power Value”.

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