Monthly Archives: October 2012

Weekly links

Charlie Munger transcript from 2010

Great final post from Wexboy about investment catalysts with “case studies”

UK Blogger Paul Scott has launched a UK small cap website based on s proprietary “PAS” system. Maybe I should challenge him with my boss score ?

Great documentary (German) about the end of one of the shittiest German banks ever, WestLB.

Very interesting Asset Allocation blog called GestaltU. Among others they recommend cash in order to protect against inflation…..

ExpectingValue, a great UK blog has reviewed his Portfolio. Good place to start if one is interested in UK small caps.

How to screw your clients – Deutsche Bank “Aktienanleihe” edition (WKN DX2UZZ)

From time to time I use the blog to look at some “grey market” stuff, usually from obscure issuers with a very bad risk/return relationship. Examples were Prokon, WGF or Solar Millenium.

However, one should not forget that the established financial institutions are also “capable” to screw their clients over and over.

Let’s, for example, look at a currently marketed “Aktienanleihe” from Deutsch Bank with the WKN DX2UZZ.

The paper flyer comes with the slogan “Sichern Sie sich einen attraktiven Zinssatz” (meaning: secure your attractive yield right now) and a big 7% sticker.

On the second page you see “7 % interest p.a and repayment at 23.10.2012”. Then in fine print on the left side you see something like “In times of low interest rates, “Aktienanleihen” (direct translation “Stockbonds”) offer an interesting alternative with an attractive coupon but higher risk bla bla bla…”

So this is clearly a case where the bank tries to sell a quite risky investment based on a coupon which looks attractive on a nominal basis.

So let’s look at what this particular “investment” is about:

An “Aktienanleihe” is a structured bond which has the following features:

– you get a fixed coupon
– the repayment depends on the value of an underlying share
– in this case, the underlying share is interestingly the Deutsche Bank share itself
– if, at maturity, the share is below a certain level (here only a range is indicated from 60%-70%), you don’t get your money back, but you will receive the shares at the lower value

In sales speak this is sold as “Your coupon is secure plus you have a (30-40%) buffer before you loose money”.

Where is the problem ?

I do not know where the Deutsche Bank share price will be in one year’s time, but other than the Prokon and WGF securities, here the underlying is a traded security which means that the structured security can be modeled and valued.

Analytically, in a first step one has to slice the security into the funded part, a 1 year Deutsch bank unsecured senior bond and the “structure”.

We can easily find on Bloomberg the “fair price” for a 1 year Deutsche Bank Senior bond: Thats 0.65% for the Euribor plus 0.45% 1 year senior Deutsche spread. So a plain vanilla 1 year Deutsche Bond would yield 1,1%.

Now comes the tricky part: How to value the structure ? Without going into option pricing theory, I can tell you that the structure is basically the following “exotic option” of the following type:

“Short put with terminal knock-in feature”, meaning you, as buyer of the security are selling Deutsche Bank a put option on their own share.

Luckily, if you have a Bloomberg, you can very easily price this “beauty” with their standard option valuation tool. Please see the screenshot (i used 70%) :

What we see is that the standard valuation tool says you should receive 10% (of nominal) if you are selling such an option. Add on the 1.1% for the “plain vanilla” bond, then the “fair” value of the coupon would be 11.1% not 7%.

Why bother might some people say, 7% is better than 1% and the probability of the Deutsche Bank share going down so much is probably not so big. The problem is: Deutsch eBank takes out almost 40% of the “Fair value”. No one knows the probability, but there is a market for this kind of risk.

Deutsch Bank can easily hedge their part and directly pocket the 4% at the moment when they sell this “beauty” to the German retail investor. Although they have to share their “harvest” with the distribution partners.

For the “little investor” this is bad, because a large share of his “expected” return is taken out by the bank, which means simply on average he will loose money with this if he invests in such products.

I don’t even want to mention all the other issues like “asynchron information” if the issuer of the security is also the issuer of the underlying. There are a couple of more possibilities to screw the investor because off this.


This Deutsche bank “security” in my opinion represents everything which is wrong with the financial system. The banks still try to sell complicated stuff to investors who don’t understand it and cut out fat fees in order to make sure the little guy looses over time.

In my opnion, the banks should have to disclose at least the “fair value” of such securiteis based on available standard models so that teh invetsor knows what amount Deutsche is earning upfront. The current disclosure would indicate that they only charge 1% addional issuing fee.

However I guess I will not see in my lifetime that banks will offer “fair products” to little investors unless they are forced too. Maybe the little guys do have to share the blame by being too greedy (or desperate), but Deutsche Bank knows exactly what they are doing.

Boss Score harvest: Morgan Sindall Plc (UK GB0008085614) – negative invested capital

Morgan Sindall ist one of the best scoring UK companies in my Boss Score screener, so I thought I might have a closer look into it.

Company description per Bloomberg:

Morgan Sindall Group PLC operates a specialist construction group. The Group’s activities include office design, fitting out, refurbishment, building contracting, property investment, and related specialist services. Morgan Sindall operates in the United Kingdom and the Channel Islands.

Traditional metrics look Ok, no “deep value” but “cheap”:

Market Cap 293.5 mn GBP
P/E 8.7
P/B 1.2
P/S 0.1
Dividend yield 6.9%

Other quick check Items:

+ company has no financial debt (GOOD)
+ management holds significant shares (GOOD)
+ however no majority shareholder (GOOD)
+ constant and high ROE/ROE/ROIC (GOOD)
+ long established operating history (GOOD)
+ relatively low beta against Footsie of 0.66 (GOOD)
+ almost no pension liabilities (GOOD, important for UK companies)
large intangible assets (TO BE CHECKED)
– low but stable margins (TO BE CHECKED)
UK only construction company (TO BE CHECKED)
– volatile free cashflows (TO BE CHECKED)
– increasing share count over the last decade (TO BE CHECKED)

So the big question one has to solve with Morgan SIndal is: How do they manage to have such stable margins although they are so razor-thin ? “Classical” competitive theory would suggest that a company with 1-2% margins is in a very difficult situation from a competitive point of view. Morgan Sindal howver seems to be able to constantly earn those razor-thin margins and turns them into great ROEs with efficient capital management.

Prof. Margin ROE ROA
31.12.1998 1.8% 48.4% 34.7%
31.12.1999 1.6% 30.7% 26.9%
29.12.2000 1.7% 29.7% 27.5%
31.12.2001 1.6% 27.4% 26.1%
31.12.2002 1.0% 15.9% 16.0%
31.12.2003 1.3% 20.0% 21.4%
31.12.2004 2.0% 27.0% 28.1%
30.12.2005 2.3% 27.5% 28.1%
29.12.2006 2.2% 25.4% 26.0%
31.12.2007 1.9% 25.6% 26.8%
31.12.2008 1.8% 25.0% 26.1%
31.12.2009 1.5% 16.4% 16.5%
31.12.2010 1.4% 13.9% 14.2%
30.12.2011 1.5% 14.4% 14.8%
Avg 1.7% 24.8% 23.8%

The table clearly shows the discrepancy between “moat like” returns on assets and “distressed” profit margins.

Interestingly, Morgan Sindall is also an extremely good long term performer. The longe term chart does only show this to a certain extent:

Over the last 20 years, Morgan Sindall was under the Top 20 performers of the UK small cap index, with an incredible performance of 15.4% p.a. vs. 4.6% for the UK all share index.

I guess the low margins are also one of the reasons, why Morgan Sindall is not the darling of UK stock bloggers.

Paul Scott for instance writes:

Construction company Morgan Sindall (MGNS) report a “satisfactory first half”. It seems to consistently throw out about 75p EPS each year, and pays 42p in divis. So at 615p it looks fair value. I don’t like this type of company with huge turnover £2.2bn p.a., and wafer thin profit of around £40m p.a., as they are only one problem contract away from a profits warning & potentially insolvency.

John Mc Elliot covered it a little in his Valueinquisition blog, but I think he didn’t buy and his blog is not very active anymore.

There is also a rather shallow article on Motley Fool Uk.

Sell side wise, the stock is covered from 8 analysts, 5 buys, 3 holds, the more recent recommendations were buys. So not a totally uncovered stock but definitely not in the spotlight.

Business model

The company is first and foremost a construction company. Additionally the provide “fit out” services for offices and “affordable housing” projects. A new business field is called urban regeneration.

A quick look into the balance sheet quickly shows where the capital efficiency comes from: Negative working capital

Let’s quickly look at 2010/2011 net working capital:

2010 2011
Inventories 146.0 141.1
Amounts due from constr. Cust 228.6 178.4
receivables 186.5 229.2
cash 108.9 148.6
  670.0 697.3
Trade payables -620.9 -667.2
amounts due construction contr. -78.8 -70.7
others -14.1 -39.4
  -713.8 -777.3
Net -43.8 -80.0
Net ex cash -152.7 -228.6

Nice business if you can get it, at least from a Working capital perspective. Where does that come from ?

A quote from the notes of the 2011 annual report:

The average credit period on revenue is 15 days (2010: 23 days). No interest is charged on the trade receivables outstanding balance. Trade receivables overdue are provided for based on estimated irrecoverable amounts.


The directors consider that the carrying amount of trade payables approximates to their fair value. The average credit period taken for trade purchases is 28 days (2010: 25 days). No interest was incurred on outstanding balances.

So a “Quick and dirt” calculation tells us: Morgan Sindall gets paid 15-28 = -13 days earlier than they pay their bill. 13/365*2 bn = 80 mn EUR on average “net negative working capital”, so the year-end numbers above are somewhat higher than average.

What I find even more amazing is the fact that property, plant and equipment is a mere 21 mn GBPs, the rest of the long term assets are Intangibles and special investments. Only 6 mn in property (freehold, financial lease) and 15 mn EUR in equipment.

They only have around 24 mn operating leases for buildings outstanding, so no big issues. So the Negative working capital is additionally funding all the fixed assets (excluding goodwill) and some more

So my stupid question is: Where do they get all the machinery etc. from ? The answer seems to be simple. Outsorcing. For example to Speedy Hire Plc as this web site shows.

Speedy Hire’s balance sheet is like the (bad) mirror image of Morgan Sindall: Lots of fixed assets, positive net working capital. Higher gross margins but very volatile. Operating cashflow looks better, mostly because of depreciation of the fixed assets.

Howver if we look at Speedy’s historical numbers we see that despite the higher net margins, the business model of Speedy Hire is much more volatile and returns less on capital:

NI Margin ROE
31.12.1998 4.0% 19.8%
31.12.1999 15.5% 26.9%
29.12.2000 -12.0% -17.4%
31.12.2001 2.1% 4.0%
31.12.2002 9.2% 17.9%
31.12.2003 10.3% 20.4%
31.12.2004 8.8% 18.0%
30.12.2005 8.7% 17.7%
29.12.2006 7.9% 17.1%
31.12.2007 5.0% 11.4%
31.12.2008 -11.4% -27.1%
31.12.2009 -5.2% -8.8%
31.12.2010 -5.4% -8.1%
30.12.2011 0.5% 0.7%
Avg 2.7% 6.6%

To me it seems that Morgan Sindall managed to pass on a lot of capital requirements and volatility onto its “partners” like Speedy hire.


Despite being an UK construction company working on very thin margins, Morgan Sindall seems to have a very interesting business model. They run the firm as a whole on negative invested capital requirement (ex Goodwill) which is quite an achievement and seem to have outsourced a lot of volatility.

Together with the other positive aspects mentioned above, this definitely is worth a deeper look into it and the UK construction sector. The main question is if the comapny is cheap enough to offer a “margin of safety”.

To be continued……


Bouygues again: How deep does one have to dig into Telco, sell side analysts & comparable Eiffage SA

So to conclude my “Bouygues week”, a final post about the company.

In my recent post about Bouygues, a commentator said if I can’t correctly project future profitability levels for the French mobile phone market, then investing into Bouygues is not a good idea.

As I call myself a fundamental investor, I have to admit that I do not have any extra knowledge about the french mobile market at the moment.

Read more

A few more thoughts on Bouygues (Telecom) – O2 IPO

Recent news
After my buy decision two days ago, the share price jumped immeadiately 3%, but this was not the result of my blog but of some interesting news from the French Government, which was interpreted as positive for Bouygues Telecom.

The French Government seemed to have clarified that Illiad SA wil not be able to rely on cheap roaming contracts forever, but has to build out their own network rather sooner than later.


Another, in my opinion even more interesting story is the currently planned IPO of Telefonica’s German mobile business O2. According to the FTD (German), Telefonica is looking for an EV/EBITDA multiple of 6.5-7.

One has to keep in mind that this is only the number 4 operator in Germany and they are offering a minority stake only.

So I would say my 6.5x EV/EBITDA for Bouygues is not that far off from reality.

What I found even more interesting is the fact that at least in the second quarter, O2 managed to earn 333 mn EBITDA based on 789 mn EUR sales. This is an EBITDA margin of 42% against ~20% for Bouygues. This is really interestign becaues for me it shows the potentail for Bouygues if O2 manages to earn such margins in such a tough market as Germany which has already 4 carriers.

I will have to reread Bruce Greenwalds “Competition demystified”, but I am pretty sure that if at some point in time Iliad has etsablished itself, there is a good chance that margins might “mean revert”.

In any case, if the IPO goes through, O2 will be a very good comparable for Bouygues, much better than Vodafone or France Telecom.

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