value and opportunity

Several readers already mentioned KHD Humboldt Wedag as a potential “special situation” investment, so it might make sense to quickly check it out.

KHD Humboldt Wedag

KHD is planning and constructing cement plants world wide. The company has a quite interesting past. It used to be part of the big “Deutz” Group of companies but was sold.

In the meantime, the company has been taken over and then spun off again in some sort of form. The mastermind behing those transactions is financier Michael J. Smith. This guy himself seems to be a very interesting investor himself as this Seekingalpha post shows.

There is a very good Thread on Wallstreet Online covering the history of the company for the last 7 years or so.

The business itself is highly cyclical. If I look at how cement companies themselves are struggeling to even earn a small profit because of a large over capacity in the indutry, I am not sure how many new cement plants will be actually built in the coming years. Sales dropped 50% from 2009 to 2011. One could describe this as “extremely late cyclical”.

KHD is since a long time a favourit among “net net “investors as they carry a large cash balance on their balance sheet. However, cashflows are extremely volatile.In 2011, operating cashflow was around -80 mn EUR.

Again in Q1 2012 the comapny showed shrinking sales and a large net cash outflow of around -20 mn EUR reulting in a loss for the first quarter, although the orderbook seems to have improved. I have however no idea how the orderbook actually transforms into sales and profits.

In early 2011, KHD executed a capital increase for around 20% of the company to bring on board a Chinese company. At least for me it was not clear why they did it. Officially they said to increase their “footprint” in China. if one looks at the order intake in 2011, this cooperation didn’t really show any results, at least not in the line for China.

Some weeks, Paul Desmarais, the guy behind the “Canandian Berkshire” Power Cooperation has revealed a 3% position. Another activist investor, Sterling Strategic Value is on board with 12%.

In the invitation to the annual shareholders meeting, Michael J Smith was proposed to enter the supervisory board as the boss. Although the first news seems to be interesting, the second part, MJS returning might not be the best news for the uninformed minority investor.

Just a few day’s ago, the annual shareholder’s meeting was postponed due to “technical reasons”, although some investoirs seem to have received a surprise dividend therafter.

For me, KHD at the moment is something I would not invest into due to the following reason:
– I have no idea about the goals of the parties involved (MJS, Chinese guys).
– the business is extremely cyclical and at the moment fully depending on Emerging markets
– I have no idea how much of the cash is really “free” and what is needed to finance new projects
– I would rather prefer to buy cheap cement companies, because they will proft earlier from a revival in cement sales
– I do not have any (good) experience with activist campaigns, I am not sure that I have the nerves for that

Overall, I do not think that I can gain any “edge” in this situation and it is clearly outside my core competencies. In such cases I will rather pass however it might be a good learning experience following the further “proceedings” from the outside.

For the record, some special situations which I try to avoid:

– merger arbitrage (to many pros)
– distressed debt (complex, dirty stuff going on)
– activist campaigns (insider)