Monthly Archives: April 2012

Quick check: Vivendi SA – Seth Klarman “Cigar butt”

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I hate to admit it, but I am somehow a Seth Klarman “groupie” after reading his “margin of Safety” a couple of years ago.

So when ever Baupost reveals a new position, I stop everything else and try to find out why they did it (see my Microsoft analysis).

So I was quite surprised that Klarman now invested in Vivendi, the French media company.

In the hedge fund’s 2011 annual letter, they disclosed buys in private companies and mentioned recent purchases in Europe, without giving any names. The letter mentioned an expansion of the London office, as the hedge fund has been finding value due to large selling in Europe.

However, we have just discovered that Baupost’s largest disclosed equity holding (at least at the time of the purchase) was Vivendi SA (EPA:VIV) (VIV FP). The purchase was recently disclosed in Vivendi’s 2011 annual report.

Baupost owned 25.5 million shares as of February 29th, 2012; then worth close to $530 million using a ratio of 1.3:1 for euros to dollars. The $550million figure comes from looking at where Vivendi’s shares traded in 2011 and early 2012.

In the back of my mind I have always booked Vivendi as just another shitty media stock who spends all the money on stuopid acquisitions, however Klarman sticks to his strategy of buying cheap and struggling companies instead of “beautiful expensive” companies.

One of the reasons why they bought Vivendi are relatively clear: Vivendi generated a ton of free cashflow over the last few years. Some of this cashflow made it as dividend to investors, but most of this (plus some) went into acquisitions.

Lets look at some historical data:

EPS BV BV tang. FCF/Share Dvd net Debt/share
2002 -21.43 13.09 -19.68 0.49 1.15 11.55
2003 -1.07 11.13 -16.47 2.18 1.15 10.55
2004 2.57 14.40 -2.16 2.92 0.00 4.55
2005 2.66 16.27 0.50 2.14 0.60 3.25
2006 3.50 17.23 2.13 2.43 1.00 3.53
2007 2.26 17.47 -0.84 2.81 1.20 4.41
2008 2.23 19.34 -6.73 2.81 1.30 7.00
2009 0.69 17.92 -8.17 3.53 1.40 7.69
2010 1.78 19.44 -6.85 2.46 1.40 6.52
2011 2.16 15.61 -9.95 2.43 1.40 9.57
             
Sum/Delta       24.20 10.60 -1.98

From a free cashflow perspective, Vivendi generated an impressive 2,40 EUR free cashflow per year. Howver, less than half of it was distributed as dividend and a small amoutn was used to reduce debt.

Tangible book as one could expect for a media company is negative, but for a media company I would accept it to a certain extent. Debt is relatively high, but even including the debt load, the total valuation is quite low at 3.7 EV/EBITDA.

The share price looks really really ugly:

So based on yesterday’s post about momentum, this would be a clear “no” or better “non”.

Some more interesting points:

1. Vivendi does not have a majority owner

2. A couple of their subsidiaries are listed. That makes an interesting “sum of parts”:
– 61% in Activision are worth around 6.5 bn
– 53% of Maroc Telecom are worth around 5 bn EUR
A very simplistic comparison with Vivendi’s total marekt cap of 14 bn shows a maybe interesting situation.

3. Acquisitions:
– Vivdendi paid almost 8 bn EUR in 2011 for the 40% they did not own in its French Telecom subsidiary. However, after Iliad SA launched its aggressive enntrance into the French mobile market this amount was most likely much to high.

– in parallel, Vivendi is bidding for EMI and has bought several other companies, like a tv station for 350 mn EUR last year.

One has also to keep in mind that Klarman is managing around 25 bn USD, so the Vivendi position is for him a 2% postion, similar to News Corp, HP and BP. And not all of his invetsments are winners, despite the “Margin of Safety”.

I am howver not sure if the Iliad scenario was included in his “Margin of Safety” considerations.

Nevertheless it is very interesting situation as this is basically his first major contintental European Investment (despite a 5 mn EUR stake in a samll fFrench company named Chargeurs SA).

For the time being I nevertheless prefer to watch this from the outside as for me Vivendi is still a company which generates a lot of free cashflow but spends most of it for stupid acquisitions.

Trying to understand momentum from a value perspective

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Momentum is one the concepts I really have some difficulties with. As a traditional value investor, one would basically ignore market movements and invest purely based on intrinsic value.

However if one looks at different reasearch papers, “momentum” seems to be an important indicator. For instance Tim du Toits latest research, momentum combined with value metrics created some astonishing results for the 1999-2011 period.

Also for example this article shows based on a back test that pure momentum trading strategies can produce theoretically 10 % p.a. outperformance.

Interestingly, the mentioned AQR US momentum fund isn’t really outperforming the indeces in real life. Bloomberg shows an underperformance of this momnetaum fund against all major US indices since inception in mid 2009.

Definition & application of momentum for grwoth stocks

I have been looking around a little bit, but there seem to be different definitions for “momentum”.

The more simple approaches seem to look at a trailing time period (1M, 6M, 1Y) and define momentum either as the best performance within a certain group of stocks (i.e. low P/B) or in general relative performance agains an index.

I have found this site where they give the following advice for “momentum growth stocks”:

One of the things to spot momentum stocks is the relative strength of the stock compared to the overall market over a specific timeframe. Most momentum investors seek at a stock which has outperformed at least 90% of all stocks over the past 12 months. When major indices declines, a great momentum stock exhibit strength by holding or even exceeding their highs. When the major indices rally, momentum stocks typically lead the rally and make new highs outpacing the market.

Potential momentum stocks should show in their balance sheet that they are growing at an accelerated rate.

Another factor is the Earnings per Share growth. At least a 15% year-over-year earnings per share growth is needed to qualify a momentum stock. Stocks with accelerating rates of EPS growth over previous quarters are also considered.

In addition, a positive forecast by at least some analysts regarding the Company’s earnings in necessary for identifying momentum stocks. Further, momentum investors also looks at whether the reported earnings exceeded the analysts forecasts compared to the last quarter.

A company can’t grow its earnings faster than its Return on Equity, which is the Company’s net income divided by the number of shares held by investors, without raising cash by borrowing or selling more shares. Many companies raise cash by issuing stock or borrowing, but both alternatives reduce earnings-per-share growth. For momentum investors, a potential stock should show an ROE of 17% or better.

This simple strategy at the moment is quite succesfull. If we look at two typical “MoMo” stocks Chipotle and LuluLemon we can see this in action. The “fundamental requirements” are clearly in place like this table shows:

EPS Growth   ROE  
  Chipotle Lululemon Chipotle Lululemon
2007 67% 292% 14% 41%
2008 11% 30% 13% 29%
2009 61% 34% 19% 30%
2010 42% 109% 24% 39%
2011 19% 49% 23% 37%

As one could expect, analysts go wild for both stocks and as for any respectable US comapny, earnings are ALWAYS above (carefully guided) expectations and of copurse both shares are in the top 10% performers.

And both stocks are still in their “parabolic” phase:

However, as my two “MoMo” short positions, Netflix and Green Mountain showed, once “Momentum” dissapears, those stocks can loose 50-80% of their value in the matter of a few days or weeks:

“Fundamentally”, momentum is usually explained the following way:

The capital market is not really efficient, so positive and negative information does not transform directly into securitiy prices but this takes some time.

However, in my opnion, there is also a “psychological” component for momentum:

Many investors prefer to see an immeadiate positive feedback on an investment decision. Even for myself, I tend to look more closely to daily or even intraday price movements when I just have bought a stock. With a “positive” momentum stock, there is a very high probability that the stock continuos to climb and you see direct positive feedback (and feel like an investing genius),

With a declining stock, on a short time horizon it is very likely to see a loss directly after buying the stock (and feel like an idiot for not waiting longer).

As an “intrinsic value” investor one should not care about the short term direction of stock prices, but never the less it still takes a lot of conviction to buy into a falling or underperforming stock.

The big question for me would be: Can momentum add value to an investment process based on intrinsic value ?

Intuitively I would say that extremely negative momentum could be a warning sign for a “value trap”. On the other hand, I can also see the argument for stocks where after a long decline some fundamental changes are occuring.

One of the stocks I have been tracking for a long time is Sto AG. Sto in the 90ties was one of the typical construction related stocks. After the reunification, prices of construction and construction related stocks exploded. However in the mid 90ties the boom went bust and construction stocks suffered. In the 2000s, then Sto could participate in the boom for energy saving, multiplying its earnings sevral times.

I did a very crude check on Sto with regard to relative performance: I compared annual returns with the dax since 1992 ( I diddn’t get earlier numbers). The result is quite surprising:

P/E EPS Last price 12m change DAX 12m Change Delta
1992 11.9 1.51 17.985      
1993 20.7 1.47 30.523 69.7% 46.7% 23.0%
1994 13.2 2.58 33.901 11.1% -7.1% 18.1%
1995 12.8 2.51 32.098 -5.3% 7.3% -12.6%
1996 18.0 1.83 32.915 2.5% 27.8% -25.2%
1997 14.1 2.12 29.927 -9.1% 47.1% -56.2%
1998 16.8 1.11 18.618 -37.8% 17.7% -55.5%
1999 12.0 1.69 20.32 9.1% 39.1% -30.0%
2000 13.2 1.39 18.342 -9.7% -7.5% -2.2%
2001 13.1 1.17 15.285 -16.7% -19.8% 3.1%
2002 7.6 1.27 9.71 -36.5% -43.9% 7.5%
2003 15.0 0.96 14.386 48.2% 37.1% 11.1%
2004 10.3 1.46 14.97 4.1% 7.3% -3.3%
2005 8.3 2.41 20.05 33.9% 27.1% 6.9%
2006 3.9 7.35 28.591 42.6% 22.0% 20.6%
2007 6.7 7.29 48.855 70.9% 22.3% 48.6%
2008 5.3 8.05 42.794 -12.4% -40.4% 28.0%
2009 7.1 8.60 61.057 42.7% 23.8% 18.8%
2010 10.3 8.98 92.17 51.0% 16.1% 34.9%

One can clearly see that once “negative momentum” occured in 1995, four subsequent years with strong underperformance followed. Sto shareholders basically missed the whole 90ties boom.

Then again the same happened in 2006: Once Sto really started to outperform, 4 more years of outperformance followed.

Another example: KSB

When we look at the same type of crude analysis, we see a less clear picture at KSB:

P/E EPS Last price 12m change DAX 12m Change Delta
1992 10.2 19.32 196.847      
1993 40.1 5.74 230.081 16.9% 46.7% -29.8%
1994 41.8 4.59 191.734 -16.7% -7.1% -9.6%
1995 #N/A N/A -18.82 121.687 -36.5% 7.3% -43.8%
1996 #N/A N/A -5.71 123.733 1.7% 27.8% -26.1%
1997 18.2 11.35 206.562 66.9% 47.1% 19.8%
1998 9.5 17.82 169.238 -18.1% 17.7% -35.8%
1999 18.9 5.92 112 -33.8% 39.1% -72.9%
2000 14.2 5.8354 82.98 -25.9% -7.5% -18.4%
2001 15.0 5.32 80 -3.6% -19.8% 16.2%
2002 8.4 8.65 73.09 -8.6% -43.9% 35.3%
2003 19.4 7 136 86.1% 37.1% 49.0%
2004 27.1 4.67 126.5 -7.0% 7.3% -14.3%
2005 25.9 5.85 151.43 19.7% 27.1% -7.4%
2006 13.4 27.99 375 147.6% 22.0% 125.7%
2007 10.3 43.86 450.06 20.0% 22.3% -2.3%
2008 5.1 70.17 360 -20.0% -40.4% 20.4%
2009 6.7 61.32 409 13.6% 23.8% -10.2%
2010 14.0 44.09 618 51.1% 16.1% 35.0%
2011 11.0623 40.95 453 -26.7% -14.7% -12.0%

For the first 4 years, momentum would have worked but in 1997, momentum would have failed us. However in the subsequent years momentum might have worked OK, although one would have missed the big jump in 2006.

Let’s finally look at one of the “true hidden champions”, Fuchs Petrolub which I regret deeply not to have bought in the past:

P/E EPS Last price 12m change DAX 12m Change Delta
1992 23.0 0.10 2.414      
1993 27.3 0.13 3.46 43.3% 46.7% -3.4%
1994 23.3 0.17 3.848 11.2% -7.1% 18.3%
1995 34.2 0.08 2.869 -25.4% 7.3% -32.8%
1996 21.6 0.14 3.123 8.9% 27.8% -18.9%
1997 13.0 0.27 3.544 13.5% 47.1% -33.6%
1998 44.6 0.07 2.92 -17.6% 17.7% -35.3%
1999 9.2 0.22 2.03 -30.5% 39.1% -69.6%
2000 8.4 0.234 1.964 -3.3% -7.5% 4.3%
2001 19.9 0.1089 2.162 10.1% -19.8% 29.9%
2002 7.3 0.3207 2.327 7.6% -43.9% 51.6%
2003 11.6 0.4152 4.816 107.0% 37.1% 69.9%
2004 17.4 0.4919 8.564 77.8% 7.3% 70.5%
2005 11.3 0.9394 10.57 23.4% 27.1% -3.6%
2006 13.8 1.2413 17.163 62.4% 22.0% 40.4%
2007 13.5 1.5517 20.983 22.3% 22.3% 0.0%
2008 8.7 1.4867 12.943 -38.3% -40.4% 2.1%
2009 11.9 1.70 20.217 56.2% 23.8% 32.4%
2010 13.7 2.39 32.9 62.7% 16.1% 46.7%
2011 11.7637 2.56 30.115 -8.5% -14.7% 6.2%

Again we can see here longer stretches of under- and outperformance which clearly seem to imply some kind of momentum, persisting at least for some 4-5 years in this example.

Summary: Momentum is something which is is usually not connected to intrinsic value investing but with growth investing. However, some recent studies show that momentum also seems to be a factor in “value” stocks. A crude test with three examples from my long term “circle of comeptence” shows some anecdotical evidence for momentum in stock prices of “normal” companies and even “value companies”.

So this is definitely something to include in the investment process as additional aspect.

Edit: There is acutally a new Dilbert out referring to “momentum”:

Quick updates: Praktiker, Buzzi, Aire

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Praktiker

Unfortunately, theb ond already went above my limit of 41%. So I was only able to purchase a 1.4% position for the protfolio under my usual restrictions (max 25% of daily volume). I will not increase the limit for the time being.

One additional remark: I got access to the document showing all bond holders which took part in the first round of the vote. I saw no “suspicious” hedge fund participation. It will be interesting to see if they now go into a second round. According to this note of the notary, only 19% of the bondholders participated in the first round

Buzzi

After the encouraging results of Dyckerhoff, Buzzi reported total 2011 results .

The home market Italy decreased significantly, Dyckerhoff reported a total profit of ~60 mn EUR for 2011, Buzzi in total only 26 mn EUR. So net income for Buzzi ex Dyckerhoff was negative.

However, net debt has been reduced almost by the same amount as for Dyckerhoff. For 2012 they were very cautious:

Based on the above considerations, which show emerging economies well set to achieve a further progress in profitability, a stable situation in Central Europe, some opportunities for an earlier recovery in the United States and on-going difficulties in Italy, we can state that at consolidated level the next financial year should close with operating results similar to those of 2011.

It seems that the market had expected a better outlook, from my side however this is a 3-5 year “reversion to the mean” bet and we are only in year 2 now.

AIRE KgAA

For some reason, AIRE jumped significantly in the last few days.

However, I didn’t find any news and volume was relatively small. As I don’t have that many alternative “special situations”, I will keep the shares despite the price slowly approaching fair value.

Follow up April SA – No investment

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End of last year, I looked at April SA, the French Insurance broker (part 1 and part 2).

In March, April pre released 2011 numbers which were quite dissapointing.

EPS per share in 2011 were only 1.37 EUR per share, a drop of -30% vs. the 1.97 EUR in 2010. They also released a regulatory required detailed report in French here.

The problem is that one cannot really understand where the drop in profit comes from.

Sales were more or less constant, however personel expenses increased by almost 10%. Also a 6 mn profit in non op income turned into a -4 mn loss in 2011.

Although claims paymants and therefore technicla results from insurance have increased significantly, lower interest rates increased general costs and an increase in commissions paid more than off set this positive developement.

Deeply hidden in the document (page 145) one can find that also brokerage commission income only stayed flat. Based on what the company communicated, I had assumed that they wanted to increase this part and reduce insurance premium but that didn’t seem to have happened.

On the plus side one can see that free cashflow on the non regulated holding level recovered nicely and amounted to around 65 mn EUR before acquisitions. Also free cash on holding level increased by 40 mn EUR to 80 mn EUR.

Summary:
Despite good cash flow on holding level, the underlying business especially the flat brokerage commissions are disappointing and not coherent with the communicated startegy change. At current prices (EUR 14,60 per share) and based on the underlying business developement, the risk/return profiel is not attractive enough.

The Italian temptation – Autostrada / SIAS – revisited

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In my previous posts I have always concentrated on Autostarda as a way to invest at a discount into SIAS, the operating company whioch owns all the Italian concessions.

However, after the IGLI deal and the drop in Autostrada’s share price, SIAS itself became cheaper.

Based on year end numbers, SIAS is valued as follows:

P/E 8.2
P/B 0.9
EV/EBITDA 5.6
Dividend 9,1%

Market Cap: 1.2 bn
Debt : 1,9 bn
EV 3.1 bn

Relatively cheap, but as I mentioned before, SIAS basically had a “catalyst” event, the sale of its Chilean minority particpation. here is the section from the investor presentation:

• Sale agreement to transfer 45.8% stake in Chilean assets to Autostrade per l’Italia for €565mln cash consideration along with a discharge of debt guarantees of about €180mln. Sale price in line with the preliminary IPO evaluation of Sale of Chilean assets
• Unlock significant value from an investment asset, well above book value
• The transaction gives rise to a capital gain of €382mln (overall price of €565mln vs. a book value of €183mln)
• Sale will be finalized by 30 June 2012. €100mln advance cash payment have already been collected on 8 March 2012
• Cash proceeds from the sale of Chilean assets to be used for:
Potential use of proceeds
• Call option on 99.98% of Autostrada Torino – Savona” (valued at 223mln) expiring on September 2012
• Extraordinary dividend (increased pay-out for 5yrs)
• Additional resources for “green field” projects / other strategic uses
• Minorities acquisition of existing concessionaries

So what does that mean ? For sure we know now, that dividends will most likely increase, i.e. a dividend over 10% for the next 5 years is likely

From a valuation point of view, if we assume the purchase of the “Torino Savona” motorway goes through, we can assume the follwoing effects:

1. EV decreases by (745-223)= 522 mn EUR
2. EBITDA will increase by 32 mn EUR

So we will have an EV of ~2.6 bn and an EBITDA of around 588+32 = 620 mn. So EV/EBITDA will be reduced to 4.2 all other things equal because the minority share did not contribute to EBITDA.

If we look at other motorway operators, we see the following EV/EBITDAs:

Brisa 11.2
Abertis 10.1
Atlantia 7.6
Soc. Paris 8.7

So we can see that the cheapest comparable company in the universe is valued at least 50% higher than SIAS. Interestingly, the most expensive comapny, Brisa from Portugal actually received a takeover offer at the current 11x EV/EBITDA valuation.

A few more remarks:SIAS Bonds:

SIAS has a senior bond outstanding with maturity 2020 (XS0552569005). Interestingly this bond performed really strong after the announcement of the sale of the Chilean minority stake.

Corporate Governance:

This is something to explore further, but in my opinion SIAS as the holder of concessions is regulated to a certain extent. That is also the reason why the Gavio family seems to use Autostrada as vehicle for its transactions instead of SIAS.

Normally it would have been much easier to just use the sale proceeds at SIAS to purchase the IGLI stake but it seems that they cannot access it directly but have to upstream this via dividends.

So as a minority shareholder, interests are better aligned at the OpCo than at HoldCo (Autostarda).

Summary: SIAS really looks attractive right now, so I will start to establish a half position (2.5%) for the portfolio. 50% of this I will hedge with the FTSE MIB ETF short position

Quick news : Piquadro SpA – Tumi IPO coming soon

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I have mentioned Tumi several times as one of the major competitors of Piquadro in my small “series” about Piquadro.

Now it looks like that the Tumi IPO is finally happening . According to Bloomberg, they want to IPO on April 19th, with a quite optimistic valuation:

Demand for luxury goods is helping Doughty Hanson reduce its stake in Tumi, which it bought for $276 million eight years ago, longer than buyout firms typically hold investments. Tumi, whose backpacks retail for up to $595, is seeking a valuation of as much as 3.5 times 2011 sales, compared with the median of 0.6 times for a basket of peers, according to data compiled by Bloomberg.

I guess they are using P/S as a benchmark, because profits seem to be quite slim:

The luggage maker’s sales increased 31 percent to $330 million last year, while net income surged to $16.6 million from $104,000 in the same period, according to today’s filing. The company turned a profit for the first time in 2010 since at least 2007, the filing shows.

It is still amazing how the “pump and dump” strategy of those PE houses still work.

If we compare this to Piquadro, with multiples of 1.2 P/S and a P/E of 10, one can clearly see the impact of Anglo Saxon “financial magic”.

Piquadro itself seems to be reaching my threshold of 1.50 EUR again:

Below 1.50 EUR I will increase Piquadro to a half position (2.5%) of the portfolio, however in parallel I will increase the FTSE MIB hedge accordingly to hedge out my increasing Italian exposure.

Gruppo Sol Spa part 3: No decision yet –> Watchlist

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In part 1 and part 2 I have analyzed Sol SpA from a variety of perspectives.

However, we still have the open question: Buy or don’t buy ?

To a large extent, I share JanHendriks comment that below book or at a single digit P/E the company would be an outright buy.

At the current 4 EUR per share, the company trades at 1.06 x book and 11.4 trailing P/E, the stock is neither really cheap nor expensive.

Additionally, I would still like to understand better the 2011 result with regard to the two segments, industrial gases and homecare.

For the time being, I will not buy the shares but put it onto my watchlist.

I will buy the shares if one of the two following conditions will be fullfilled:

1) either, the price goes down to somewhere below EUR 3.50 per share
2) we see a still strong profit growth and stable margins in the homecare segment in the upcoming annual report.

Praktiker Bond (ISIN DE000A1H3JZ8) – Scenario analysis & crazy hedging idea

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I already wrote a lot of posts about Praktiker in the past.

My previous summary was something like this : I don’t understand the motivation behind the recent events especially asking senior bond holders for a cut first before shareholders contribute , why they didn’t do any capital increase when the stock price was higher etc. etc.

After thinking about this the most likely possibility in my opinion is the following thesis:

Current Management doesn’t work in the interest of the current shareholders and bondholders but in the interest of potential future investors.

The result of this is relatively clear: It would be suicide to invest into the shares, as you can take a massive dilution at some point in time for granted. However, a new investor might prefer a “non-bancrupt” company, so for the bond things might look better from a risk/return perspective.

With this in mind, I think one can now try to analyse the different possible scenarios for bondholders, which in my opinion are

1) No bankruptcy – (unrealistic) best case: Take over within 1-2 year and early full pay out of bond
2) No bankruptcy – normal case: Bond pays out as scheduled
3) No bankruptcy – bad case: coupon gets reduced in second round of bondholders vote
4) bancruptcy – normal case: bond gets “fair” share of liquidation value 40% in 2016
5) bancruptcy – bad case: “DIP” financing reduces liquidation value significantly , value 10% in 201

Then we have to do 4 more steps:

First, assign probabilities to each scenario and the second, “model” cashflows.In a third steps we then can calculate “weighted” total cashflow and then calculate an internal rate of return based on current market prices.

In the following table, I have made a first try:

Bankrupt Prob. in % 2013 2014 2015 2016
Best Case No 5.00% 5.88 105.88 0.00 0.00
Normal Case No 60.00% 5.88 5.88 5.88 105.88
bad case No 10.00% 1.00 1.00 1.00 101.00
Normal Case Yes 12.50% 0.00 0.00 0.00 40.00
bad case Yes 12.50% 0.00 0.00 0.00 10.00
             
Weighted CF   100% 3.91875 8.91875 3.625 79.875

This scenario would give the bond at the current price of 40% an implicit IRR of 28%, which would be attractive. If we would change for instance the “normal non bancruptcy” probability to 35% and increase the two bancrupty scenarios to 25% each, we would end upwith a 17.6% IRR.

Bankrupt Prob. in % 2013 2014 2015 2016
Best Case No 5.00% 5.88 105.88 0.00 0.00
Normal Case No 35.00% 5.88 5.88 5.88 105.88
bad case No 10.00% 1.00 1.00 1.00 101.00
Normal Case Yes 25.00% 0.00 0.00 0.00 40.00
bad case Yes 25.00% 0.00 0.00 0.00 10.00
             
Weighted CF   100% 2.45 7.45 2.16 59.66

An analysis like this can help to understand better the sensitivities of such a rather complicated special situation investment.

Of coure, the probability of bankruptcy is the single most important driver, so let’s discuss this shortly:

On the positive side we have the fact that Praktiker survived the year end and the restocking of inventory for the spring 2012 season. Further, I think at the moment no one has a real advantage if Praktiker goes bankrupt. The biggest problem, the leases for the real estate, could be better reduced if Praktiker would be bancrupt but on the other hand they might have much more problems getting merchandise delivered even if bankruptcy would only be short term.

Additionally, I think the “year end accounting blood bath” makes more sense on a going concern basis than if one would prepare a “prepackaged” bancruptcy.

Potential Catalyst:

In my opinion, something with regard to financing has to happen this year. So there might be a good chance that the bond reacts positively within a limited time frame if the refinancing package is hopefully finalized.

Stand alone risk / return and portfolio view

If I compare Praktiker with the sucessful WestLB Genußschein investment, the Praktiker bond looks more risky, both from the potential downside and time horizon. However, also the potential upside is a lot higher at current levels.

However, on a portfolio level, things look differently. With special situations, I try to make “bets” as long as they are company specific and not directly correlate with each other or “normal” portfolio companies.

With Praktiker, we have the interesting situation that the bond ecoonomically is even negatively correlated with one of my core holdings, Hornbach.

This is something we can clearly see in current company news. In 2011, the German DIY segment showed around 3% growth, Praktiker lost almost 10% in slaes whereas Hornbach and OBI gained significantly above the market growth with 5-6% growth each.

If Praktiker really goes bancrupt, Hornbach among other will profit even more, either through taking over some of the better locations or just gaining more customers. On the other hand, if Praktiker manages the turn around or even gets a startegic shareholder, they might win back a lot of customers from the competition and hurt them significantly.

So one could argue (and I know this sounds a little crazy) that the Praktiker bond combined with the Hornbach shares creates a kind of “hedged” position.

Just for fun I loked at correlations between the Praktiker share, the Praktiker bond and the Hornbach Baumarkt Aktie. And, surprisingly we see the following based on 12 months and daily observations:

Over the last 12 months, the Praktiker share was slightly positively correlated with the Hornbach share (+0.03) whereas the bond was slightly negatively correlated with -.002. Not much but. nevertheless interesting. Again, for instance the last 4 months shows a small positive correlation between the shares (0.05) and a slightly negative correlation (-0.02) between Bond and Hornbach. So maybe not that crazy after all….

Summary:

On a stand alone basis, at current level, the Praktiker Bond is no “sure thing”, but a relatively risky speculation however with a relatively attractive risk/return ratio. In combination with the Hornbach share in my opinion, the combined position has a very intersting risk/return relationship which can greatly increase the expected return of the portfolio by actually reducing risk on an overall level.

I will therefore add a half position (2.5%) of Praktiker 2016 bonds to the portfolio at current prices (limit 41% of nominal value).

Book review: Dark Genius of Wallstreet

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Easter time is a good time for a “historical” book review:

The book is about the life of Jay Gould, one of the most notorious “Robber barrons” in the 19th Century in the US.

The so called “robber barons” were a group of several “arch capitalists” who made their money in the 19th century through means which nowerdays would be punished with prison.

However in those days, there was no such things as “insider training”, people were even considered stupid if they traded stocks without insider information.

The first part of the book covers Jay Gould’s childhood which I found personally a little bit boring. It gets more interesting around page 50 or so when Jay Gould’s first real business venture, leather manufacturing is described where he starts as a junior partner.

It is fascinating to see how quickly he realizes that the production part of the value chain is the most capital consuming and risky part wheras the traders need a lot less capital and make more or less the same amount of profit. Naturally he started to speculate early in leather futures.

The “spirit” of those times is already clearly shown in the fight over a leather production site with the heirs of his former partners. “Unfriendly takeovers” in those times were a lot more unfriendly than today, not only involving lawyers but also armed men and gun fights.

Some how naturally he finds his way to Wall Street, where he starts as a so called “curb trader”, traders who literally stood outside the stock exchange and making bets because they had no license to trade directly.

After trading a lot, Gould started pretty early to actually taking over a small railroad company a and operate it on a day today basis. To day one would call this a public-to-private equit deal. This lead directly to the famous battle for Erie Railroad between Gould, Vanderbild, Drew and Fisk one of the most intensively fought battles in corporate history. Anfd fighting again in those times meant armed men etc etc

More or less in parallel, Jay Gould tried with James Fisk tried to corner the Gold market, resulting in the “Black friday” of 1869.

At the peak of his career, he even managed to control Western Union additionally to a combination of several important railroad lines.

Summary:

I think it is a great read for everyone interested in the history of capital markets. The book also shows that nothing is really new in capital markets, neither market volatility nor crashes etc. It is also interesting to gain some insight into those “dark ages” of insider based capital markets, maybe a good training if someone wants to invest in China or India…..

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