Monthly Archives: January 2013

Following up an Maisons France Confort (ISIN FR0004159473) – Business model & Capital management

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Last week, I ran Maisons France Confort through my checklist and found it quite interesting.

If we simply look at very basic profitability numbers, we can see that the numbers look almost too good to be true:

ROE NI margin Net debt per share
31.12.2002 27.1% 2.8% -1.46
31.12.2003 28.5% 3.1% -2.28
31.12.2004 34.5% 4.0% -4.74
30.12.2005 38.0% 4.6% -5.92
29.12.2006 39.1% 4.8% -7.33
31.12.2007 35.3% 4.8% -4.09
31.12.2008 24.3% 3.8% -4.44
31.12.2009 13.3% 2.9% -5.15
31.12.2010 16.7% 3.6% -6.98
30.12.2011 21.2% 3.9% -10.39
       
avg 27.8% 3.8%

The 10 years from 2002-2011 is a full cycle with boom and bust years, so achieving on average an ROE of 28% with a financially unlevered balance sheet is outstanding.

How do they do it ? The answer is (of course) effective capital management. I have used Bloomberg data for this but if we look at the last 6 years we can see that their capital management is really outstanding:

FY 2011 FY 2010 FY 2009 FY 2008 FY 2007 FY 2006
Goodwill 45.34 40.75 36.6 37.11 33.64 17.31
PPE 17.8 16.39 13.96 14.39 12.02 9.59
 
Inventory 21.74 20.8 24.23 24.14 21.17 7.95
Receivables 82.11 74.41 57 80.9 91.2 82.5
Prepayed expense 27.06 25.37 23.36 24.85 23.24 44.49
 
Accounts payable 96.9 81.88 70.95 93.26 92.58 80.06
Net Working capital 34.01 38.7 33.64 36.63 43.03 54.88
 
Revenue 583.91 443.06 395.84 499.62 482.97 424.98
Net income 22.68 15.83 11.51 18.9 23.19 20.2
 
PPE in % of sales 3.0% 3.7% 3.5% 2.9% 2.5% 2.3%
Net Working capital in % of sales 5.8% 8.7% 8.5% 7.3% 8.9% 12.9%
PPE+Net WC in % of sales 8.9% 12.4% 12.0% 10.2% 11.4% 15.2%

Running a business with only ~9% of “operating” net assets compared to sales is something you don’t see very often.

Let’s have a quick look at Kaufman & Broad, another French listed home and appartment builder:

FY 2011 FY 2010 FY 2009 FY 2008 FY 2007 FY 2006
Goodwill + int 151.52 150.82 150.5 149.71 149.81 69.96
PPE 5.88 5.99 5.93 7.27 9.47 8.87
 
Inventory 235.56 246.15 295.74 519.52 595.46 513.2
Receivables 305.67 203.33 203.77 296.26 405.7 309.13
Prepayed expense 141.26 159.48 139.43 158.64 147.39 122.14
 
Accounts payable 409.67 377.29 398.79 552.65 620.98 535.91
Net Working capital 272.82 231.67 240.15 421.77 527.57 408.56
 
Revenue 1,044.26 935.70 934.91 1,165.11 1,382.57 1,282.83
Net income 0 0 0 0 0 0
 
PPE in % of sales 0.6% 0.6% 0.6% 0.6% 0.7% 0.7%
Net Working capital in % of sales 26.1% 24.8% 25.7% 36.2% 38.2% 31.8%
PPE+Net WC in % of sales 26.7% 25.4% 26.3% 36.8% 38.8% 32.5%

Interestingly, Kaufman & Broad improved their capital management as well but they still need 3 times the operating net assets to generate roughly the same returns.

This of course shows in Profitability:

ROE NI margin Net debt per share
31.12.2002 21.4% 4.4% 5.90
31.12.2003 20.8% 4.5% 2.55
31.12.2004 20.1% 4.7% 3.46
30.12.2005 28.7% 5.9% 3.79
29.12.2006 33.5% 6.6% 4.64
31.12.2007 31.8% 6.1% 16.74
31.12.2008 4.6% 0.7% 19.90
31.12.2009 -31.1% -3.2% 12.46
31.12.2010 19.4% 1.9% 9.92
30.12.2011 37.7% 4.5% 7.69
       
avg 18.7% 3.6%

Despite a significant leverage, ROE are lower on average and due to the leverage much more volatile.

Maybe this is one of the reasons why Maisons has outperformed larger Kaufman by a wide margin over the last 10 years.

Just for fun, let’s also look at Helma AG, a small homebuilder in the currently booming German market:

FY 2011 FY 2010 FY 2009 FY 2008 FY 2007
Goodwill + int 2.21 2.19 1.85 1.63 1.51
PPE 16.31 14.57 14.89 15.48 13.79
           
Inventory 19.83 8.63 5.61 5.8 6.67
Receivables 10.59 6.33 4.27 3.47 2.92
Prepayed expense 8.85 5.76 3.11 2.98 2.72
           
Accounts payable 5.85 5.02 0.76 0.79 4.72
Net Working capital 33.42 15.7 12.23 11.46 7.59
           
Revenue 139.50 118.50 106.68 103.59 74.54
Net income 5.2 3.4 2.36 2.31 1.3
           
PPE in % of sales 11.7% 12.3% 14.0% 14.9% 18.5%
Net Working capital in % of sales 24.0% 13.2% 11.5% 11.1% 10.2%
PPE+Net WC in % of sales 35.6% 25.5% 25.4% 26.0% 28.7%

Interestingly, the operate roughly at the level at Kaufmann & Broad but nowhere near MFC’s level. Helma by the way actually seems to have jumped into property developement which might explain the increase in operating assets.

So compared to two other homebuilders, the business model of Maisons France looks extremely “lean” from a capital management point of view. The big question of course is why are they so much better ?

I think the big “trick” was already mentioned in the Ennismore summary from last week’s post:

Unlike many other markets, in France there is virtually no development risk for the company because land is purchased separately by the customer and the house will only be built once it is fully financed.

In their annual report, there is a hint how they operate:

Under Note 4.8 (receivables) we find the interesting information, that the receivables amount on their balance sheet is a net amount. So the roughly 80 mn receivables translate into 320 mn gross receivables against which they show something like 250 mn prepayments.

Those prepayments, which they seem able to get are basically an interest free float which explains in my opinion the superior ROE and ROIC metrics compared to the other builders.

Summary:

From a pure capital management perspective, Maisons France Confort seems to have a very good business model. they seem to generate a lot of interest rate free “float” which greatly reduces the required amount of net operating assets.

I am not sure if currently is the right time to invest as the stock has run up quite fast and french housing might be slow this year, but is definitely a very interesting company.

The big quesiton is: Is such a business sustainable without an obvious “moat” ? In my opinon yes, because creating such a business model is not something you can do from scratch. 3-5% margins are not overly attractive for many competitors. Howevr, in any case some deeper research into to this will be necessary anyway before a final investment.

Is France like Germany 10-15 years ago ?

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The weekend is always a good time to step away from the “micro level” i.e. single stocks to more general considerations.

More recently, if find myself more and more analysing French stockss, as they seem to be technically still quite cheap. In my portfolio, the weight of my French stocks Bouygues, Tonnelerie, Installux, April, Poujoulat is around 15% and growing.

On the other hand if you read especially “Anglo Saxon” media, it seems to be clear that France is in deep trouble.

Perma Bear Mish for instance a month ago saw problems everywhere and as always a quite immediate chance of collapse.

Before that, the (UK based) Economist titled France as the “time-bomb” of Europe with a quite funny cover in on of its November issues:

Germany, in contrast, is considered to be the growth engine of Europe despite a recent slow down.

Let’t go back a couple of years:

In the year 2000, Ireland was the Celtic Tiger as reflected in this famous speech of Mary Harney and a year before that, again the Economist branded germany as the “sick man of Europe”.

The economist article greatly summarizes the overall view on the German economy of that time:

But it is now coming under pressure as never before. As economic growth stalls yet again, the country is being branded the sick man (or even the Japan) of Europe.

The reason was clear: A socialist Government and suspicious company bosses:

The red-green coalition government led by Gerhard Schröder since last October has “encouraged the suspicions of a corporate sector predisposed to fear the worst,” says Alison Cottrell, chief international economist at PaineWebber in London. The dark picture painted by Hans Eichel, Mr Lafontaine’s replacement, to justify fiscal belt-tightening has further unsettled industrial bosses. And a lack of corporate confidence has been one of the main factors that has kept unemployment so high.

The 1999 article mentions all the “standard” prerequisites for a better future like lowering corporate taxes, increasing flexibility but finishes with a quite bleak outlook:

It is, perhaps, not surprising that market-friendly politicians, including one or two in the government, now complain of Germany being a blockierte Gesellschaft (blocked society). Unblocking it will take determination. Without that, Germany is unlikely soon to shed its title as the sick man of Europe.

So what happened in between, how did the sick man of Europe become the (temporary) growth engine ?

Let’s look at Corporate taxes for instance:

It is interesting to see that the biggest drop in corporate tax rates actually happened in the 1998-2005 period where Gerhard Schroeder led a Social Democratic/Green government.

In my personal opinion, a combination of several factors has at least contributed to the change in fortune of Germany at least so far:

– lower tax rates on corporation which stimulated investment in Germany
– Hartz IV which “motivated” people to go back to work quicker when they lost a job
– increased labour flexibility (“Kurzarbeit”, etc.
– a generally cooperative climate between trade unions and employers with modest salary increases and more one time awards
– privatisation of major Government companies such as Deutsche Post, Deutsche Telekom etc.

A second set of developments which in my opinion is not so prominent but were nevertheless equally important:

The end of the “Deutschland AG” which was the description for the fact that almost all German companies were owned locally and/or by each other. Management of German companies did not have a lot of pressure because each manager sat on the board of several other companies. In the center of The Deutschland AG were the big financial institutions such as Deutsch Bank, Muenchener Rück, Commerzbank and Allianz.

The end of the “Deutschland AG” was driven in my opinion by 3 major developments:

– the removal of taxes on investment gains for corporations in 2002
– the problems of the large German financial institutions after the 2002/2003 crash which forced them to sell their shareholdings
– finally the Euro. Before the Euro, German Insurers for instance had to invest 95% of their investments in Deutschmark. So basically if they had to invest in German shares because there was no alternative. After that, the 5% restriction changed to “non Euro”, so suddenly german insurers could diversify their portfolios into the Eurozone.

Although there will always be a special relationship between companies in one country, one can say that the old “Deutschland AG” does not exist any more. One of the big examples for instance was the take over of Hochtief, the German construction company by ACS from Spain. 15 years ago, something like this would never had happened. Deutsch Bank or someone else would have organized a defense.

In my opinion, the end of the Deutschland AG contributed a lot to the positive developement of big German companies like BASF etc. because it put a lot more pressure on management. Ironically as a result, many of the benefits of the German renaissance went to foreign shareholders.

Back to France:

From the German example we know now that a title story in the economist might not be the best indicator for the future of a country. In the cae of France is see a few similarities to Germany in the end of the 90ties:

– everyone is complaining about the socialist president
– the press is full about the “millionaire tax” and guys like Gerard Depardieu and Aranult leaving the country

Without being an expert in French politics, however from my outside view this looks like a brilliant political move from Hollande. He gives his leftwing voters something directly and spectacular to calm them down. I would assume that a guy like Bernard arnault is not paying that much taxes in France anyway, so it doesn’t really hurt seeing him leaving.

On the other hand, Hollande seems to now the German play book quite well and is on the way trying to improve labour flexibility in France. Interestingly, Sarkozy made a similar last minute attempt almost exactly a year ago.

But as history shows, at least in continental Europe, real labour reforms are mostly implemented by Socialist Governments, liberal or conservative ones. As always, the comment says that this is not enough:

Still, this is no Reagan (or even Schröder) Revolution. The unions will preserve counterproductive worker protections and welfare guarantees. The deal includes expanded privileges for union reps within companies and more reserved seats on company boards.

However, you have to start somewhere and together with his “U turn” in corporate taxation, this is a significant green shoot in my humble opinion.

Last but not least I see two other interesting factors at work which might point to a better future for France:

Demographics:

France’s demographic development is much much better than Germany’s as one can read for instance here.

From a demographic standpoint, France and Germany are thus in radically different situations. While France has maintained a satisfactory fertility rate, almost sufficient to ensure the long-term stability of the population, Germany’s low birth rate will lead to a substantial and rapid decline in the total population and to much more pronounced ageing than in France (Figures 3 and 4).

At some not so very distant point in the future, there will be more Frenchies than Germans:

So yes, France has definitely a problem with youth unemployment, but part of the problem is that they actually do have a lot of young people which Germany does not have any more.

Africa

I am not able to comment on Mali or any other political issue here. But if at some point in time Africa will catch up with the rest of the world, French companies will benefit most due to their historical relationship etc.

Summary:

It is clear that France at the moment does not look like the future growth machine of Europe but neither was germany end of the 90ties. However I see a good chance that France finally gets it act together and implements the required reforms. If that happens, France could experience a somehow similar trajectory like germany over the last 10-15 years.

From an investment point of view, this might be one of the most interesting “secular” opportunities going forward despite (or because of) the very negative headline news. From a micro level, I find a lot more well managed, unlevered companies in France than in all the PIIGS countires combined.

From a portfolio point of view, I will accept a quite significant weighting of French stocks if I find additional interesting french companies. I could imagine having up to 30-50% of french stocks in my portfolio going forward.

But make no mistake, this will be a long journey and superior investment returns on French stocks might require more then 1 or 2 years to materialise.

And finally to make this a little bit funnier, the Monty Python take on the epic battle between the English and the French:

Rallye SA (ISIN FR0000060618) – another Holding company at a discount ?

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Rallye SA, France is the holding company for 49.97% of Casino Guichard, one of the big French retail chains.

In their annual report they present the company as follows:

Their major assets are:

– 49.93% of Casino Guichard Perrachon SA (ISIN FR0000125585)shares (61.24% of voting rights)
– 72.86% of Groupe Go Sport SA (ISIN FR0000072456)(78.73% of voting rights), another small listed French company
– “investment portfolio”.

There is some qualitative description of the “investment portfolio” on page 19 of the report, it seems to be a quite divers collection of participations and real estate.

Rallye’s investment portfolio was valued at €365 million as of December 31, 2011, compared to €435 million as of December 31,
2010. At the end of 2011, the portfolio consisted of financial investments with a market value(1) of €272 million (vs. €295 million
at end-2010) and real estate developments measured at historical cost(2) of €93 million (vs. €140 million at the end of 2010).

Net external debt stands at 3 bn as of year end 2011. Other than that i did not see major positions.

The trickiest part of Rallye’s balance sheet is the 2.5 bn EUR receivables position the show in their single entity balance sheet.^2.3 bn of that seem to be receivables against Group companies:

The current account advances made by Rallye to its subsidiaries are part of the Group’s centralized cash management system. They are
due within one year.

The point I am struggling with most is the following:

If those receivables are against Casino, then one would add those assets for the Rallye evaluation. If those receivables are against their various subholdings which also hold Casino shares, then one would need to fully eliminate them.

I have quickly checked the 2011 Casino annual report, but didn’t find any liability against Rally SA. So we should assume that those internal Rallye receivables are a technical position which is financing the Casino stack and should therefore not be counted extra. Only the “external” part (~200 mn) should be used).

So with that assumption we can now calculate the “sum of part” or intrinsic value of the Rallye SA share:

EUR mn
Casino Guichard (50%) 4,112.3
Group Go 34.8
Investment Portfolio 365.0
Receivables, other assets 220.0
Sum assets 4,732.1
   
Debt -3,000.0
Other liabilites -110.0
Net Assets at market 1,622.1
   
 
Number of shares 47.2
Value per share 34.37
 
Current market price: 25.80
“Discount” 24.9%

Overall, a 25% “discount” seems to be quite normal for such a slightly in transparent structure including extra financial debt. However if one thinks Casino is a great investment, then investing through Rallye might be a good idea:

Casino Guichard itself is not uninteresting. Although it is not cheap, they are growing pretty strongly. Especially interesting is the fact that 60% or more of their sales are now in LatAm (Brazil and Colombia), two markets which seem to be the most interesting retail markets at the moment.

On the other hand, I am not a big expert on retail chains, so from that point of view I will not analyze Rally/Casino further.

Summary:

If my assumptions are correct, the current “discount” of Rallye vs. its sum-of-parts as a holding of 50% Casino Guichard is only 25%. Considering the extra leverage and the lack of visibility, it does not look greatly undervalued.

Hess AG (DEDE000A0N3EJ6) busted German IPO stock – Could the fraud have been easily detected ?

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Just yesterday, Hess AG, a company which IPOed on the German stock exchange on October 25th 2012, announced that they fired both, their CEO and CFO because of alleged balance sheet manipulations.

The stock price directly crashed some 60% to 6 EUR (IPO price 15,50 EUR):

In some follow up news, the company reported that sales might have been inflated and the financial position might not be as good as stated in the IPO prospectus.

As a value investor, one wouldn’t invest in IPOs anyway.

The Hess AG IPO was priced at levels which one could only assume as “optimistic”, with a trailing P/E ratio of ~50. The price was justified with the supposed “growth” the company was showing in the past and the “story” of the “LED” based business model.

As usual, all parties involved in the IPO (Banks: Landesbank BaWü, Kempen, MM Warburg) will claim that they knew nothing and that you cannot protect against fraudulent management.

The auditors of course will claim the same, in the IPO prospectus they stated explicitly (in German) the follow:

Nicht Gegenstand unseres Auftrags ist die Pr¨ufung der Ausgangszahlen, einschließlich ihrer Anpassung an die Rechnungslegungsgrunds¨atze, Ausweis-,
Bilanzierungs- und Bewertungsmethoden der Gesellschaft sowie der in den Pro-Forma-Erl¨auterungen dargestellten Pro-Forma-Annahmen.

This says they explicitly didn’t check the underlying figures.

The big question of course is: Were there any red flags in the presented numbers ?

How do you “fake” sales anyway ? Well, this is quite simple. You have to organize some kind of “strawman” first, then sell the stuff to him/her and book the proceeds against receivebales. So whenever one sees a large increase in receivables, one should be extremely cautious.

In the case of Hess AG, one does not need to be a Rocket scientist to “smell the rat”. I have extracted the following working capital items from the balance sheet (page 64):

6M 2012 2011 2010 2009
 
Inventories 17.3 14.8 11.7 9.6
receivables 24.1 22 11.5 8.5
 
Payables 9.8 4 2.2 1.3
Net Working cap   32.8 21 16.8
         
“Sales”   68.3 55.7 52.4
 
Inv/sales   21.7% 21.0% 18.3%
Rec/Sales   32.2% 20.6% 16.2%
Payables/Sales   5.9% 3.9% 2.5%
 
NetWC/Sales   48.0% 37.7% 32.1%

So it is pretty easy to see, that receivables compared to sales almost doubled over 2 years. The increase in receivables almost exactly mirrors the actual increase in sales. It looks like that almost all the sales increase were actually generated by sales against receivables.

The next item to check is of course the cash flow statement. Here however we see something strange:

6M 2012 2011 2010 2009 Total
 
Op CF 3.4 -4.6 -1.4 3.6 1.0
inv CF -7.3 -7.9 -1.5 -6.9 -23.6
Fin CF 6.2 14.2 2.3 2.6 25.3

At first it looks that in total, operating CF over the last 3 1/2 years was positive and the company did just invest a lot. But how did they manage the Turnaround ?

In the IPO prospectus they say the following (page 89) about the operating cashflow:

Operativer Cashflow
Vergleich der Halbjahre endend zum 30. Juni 2012 und 2011
Der operative Cashflow erh¨ohte sich von TEUR -3.133 im ersten Halbjahr 2011 um TEUR 6.494 auf TEUR 3.361 im ersten Halbjahr 2012. Wesentliche den operativen Cashflow bestimmende Faktoren waren ein erheblicher Mittelzufluss aus der Position „Veränderungen der Forderungen aus Lieferungen und Leistungen und sonstigen Forderungen und Vermögenswerte’’ in Höhe von TEUR 8.130 gegenüber einem Mittelabfluss im ersten Halbjahr 2011 in Höhe von TEUR 638, der Rückgang des Mittelabflusses aus der Veränderung der Vorräte in Höhe von nur TEUR -652 gegen¨uber TEUR -3.043 im ersten Halbjahr 2011 sowie eine deutliche Erhöhung der Position Abschreibungen in Höhe von TEUR 2.086 gegen¨uber TEUR 1.255 im ersten Halbjahr 2011. Gegenl¨aufig verhielt sich die die Position „Veränderungen der Verbindlichkeiten aus Lieferungen und Leistungen und sonstiger Verbindlichkeiten’’, die zu einem deutlich erh¨ohten Mittelabfluss in Höhe von TEUR -7.976 im ersten Halbjahr 2012 gegen¨uber TEUR -1.719 im ersten Halbjahr 2011 f¨uhrte.

This statement clearly shows that there is something very fishy going on. In the table I extracted above, we can clearly see that there was a NEGATIVE effect from receivables and inventories in the first half year and an unexplained very POSITIVE effect from payable. So why do they state the exact OPPOSITE in their explanation of the cash flow statement ?

Explanation 1: They just mixed up the vocabulary (which would be already a reason to fire the CFO)

Explanation 2: They included other balance sheet item here in order to obscure the fact that they have inflated sales.

Explanation 3: The 6m 2012 cashflow statement is just fabricated and does not fit together with the (fabricated balance sheet)

Just for fun, let’s compare the balance sheet positions with the entries in the operating cashflow statement:

OP CF statement Balance sheet   calculated Op CF Delta stated
  6 M 2012 30.06.2012 31.12.2011    
           
Change in inventory -0.7 17.3 14.8 -2.5 -1.8
Change in receivables 8.1 24.1 22 -2.1 -10.2
Change in short term payables -8.0 9.8 4 5.8 13.8

We can clearly see that the 6m “flow” numbers have absolutely nothing to do with the delta of the respective balance sheet numbers.

At that point in time one could already stop and conclude that there is either total incompetency or already fraud. Even taking into account all the other short term balance sheet figures, one never gets to the stated cash flow numbers.

In my experience, strongly rising receivables combined with an incomprehensible or even wrong operating cashflow calculation are a very reliable “red flag”.

Summary:

Although it sounds like “Monday morning quarterbacking”, a relatively superficial analysis of HEss AG’s IPO prospectus would have discovered some serious issues with receivables and operating cash flows. Whe someone starts to doctor around with fake sales, one usually gets negative operating cashflows. If the cashflow statement then looks incomprehensible or wrong, actual fraud is quite likely.

In cases like Hess, “red flags” in that magnitude could even be a very good indicator for an interesting short opportunity. In cases like Reply, where the inconsistencies are on a smaller scale, it is rather a hint to stay away from investing.

Edit: If someone thinks that Hess is now a good investment, because it is so “cheap”, then forget it. Eevn if there is some “sound” business left in the company, first of all there is no proof that they ever earned money and secondly I will assume that there will be quite some legal action on that one.

TNT Express (NL0009739424) – “post mortem”

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As it is commonly known, free lunches are few and rare in the stock market.

Another proof for this was last week’s termination of the TNT Express takeover by UPS.

I was quite lucky that I didn’t join in the “trade“, despite considering it quite seriously. My final decision was based on the believe that in such a “crowded” market like merger arbitrage, if a situation looks too good to be true, most likely it isn’t true.

Interestingly enough, a lot of “players” must still have believed in the deal. Looking at the chart, we can see that TNT is now trading relatively close to the lower bound of the “undisturbed” price before UPS came up with the bid:

As discussed in the previous post, at the current level, TNT Express is still not cheap, for instance compared to FedEx.

On the other hand, UPS seems to have been better off without TNT Express if we believe in “Mr. Market” as they have outperfomed the Dow Jones by almost 10%:

To me, this looks like that the offered price of 9,50 EUR was way too high and UPS realized this at some point in time and did not really try hard to get the deal through. For a company like UPS, blaming it to the EC is always a “face-saving” possibility.

However that also means that the price tag of UPS might never be reached again, even if FedEx would show up as potential buyer. On the other hand, TNT Express might still benefit by being spun off from POstNL which is crippled by pension liabilities and the terminally declining mail business.

PostNL Was even hit harder, dropping to a new all time low:

This might have to do also with Moody’s recent downgrade.

At the moment, both, PostNl and TNT Express are too much “hot potato” type investments, but it is definitely something for my “special situation” watch list. I think it will be especially interesting to see if TNT Express is able to turn around the business on a standalone basis.

Alsi for the future, I think it is the safest to keep away from Merger Arbitrage situations for my special situation “bucket”, as this requires very special skills which I do not have.

Edit:
It seems that French activist investor Lutetia is trying to start a campaign for PostNL. This could bcaome interesting at some point. Lutetia also showed up (quite succesful so far) in the SIAS Spa case.

Weekly links

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Good example why “ordinary investors can’t copy what Seth Klarman is doing: Earning money with Madoff claims

Herbalife: John Hempton visits a Herbalife Nutrition club and some interesting comments from the “Waren Buffet for shorties”, Jim Chanos on “mulit level marketing” and Herbalife.

Plus the full 30 minutes interview with Jim Chanos.

Great post at Oddball why sometimes less information about a companymight be a good thing

Monish Papray on checklists for investments

Checking the checklist: Maison France Confort (ISIN FR0004159473)

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Looking at other good investors is one of the simplest way to generate investment ideas. I had linked to Ennismore already, which is a very interesting European small cap manager.

In their monthly updates, they always feature one stock. In the most recent December Newsletter, they write about Maisons France Confort (highlights are mine):

Maison France Confort – French housebuilder (1.2% NAV)
Maison France Confort (MFC) is a construction company that designs and builds family homes in France. Unlike many other markets, in France there is virtually no development risk for the company because land is purchased separately by the customer and the house will only be built once it is fully financed. MFC’s model is to provide a service designing the building and sub-contracting its construction. This ties up little capital and has allowed them to generate post-tax returns on net operating assets of 30% over the last 10 years. The company was founded by the Vandromme family five generations ago and they still own over 30%. It is run by brothers Philippe and Patrick Vandromme who have built MFC into the largest player in what remains a very fragmented market, with a 6.6% share of the self-build market in the regions that it operates in (4.0% for France as a whole). MFC has consistently taken share over the last 15 years through organic growth and acquisitions, a trend we expect to continue. MFC benefits from its greater scale: its large number of architects give it a more extensive range of houses (particularly energy efficient homes), it has a more professional and bigger sales force, a strong brand name, greater capabilities to deal with regulations and bargaining power with subcontractors and raw materials suppliers. As a result, revenue grew at a compound annual rate of 15% from 2000 to 2011, of which over half was organic, while the market for single homes was broadly flat in volume terms.

MFC primarily serves the lower end of the market, particularly first time buyers, with the average house costing EUR 100,000 to build (excluding VAT). With general economic weakness in France, tighter lending conditions and uncertainty around the new government’s incentives for homebuyers, housing starts are down 14% year on year for the nine months to September 2012 and MFC’s order book is down a similar percentage on a like for like basis. However the cost base is highly flexible, we estimate around 90% is variable with demand, and this allowed the company to remain profitable even in very weak markets from 2007 to 2010 (we also like the fact that Philippe and Patrick waived their bonuses in each of these years). With net cash of EUR 59m (equivalent to a third of its EUR 174m market cap) MFC is in a good position to take advantage of the weak market and has a proven record of strong capital allocation, buying back shares at depressed levels and making small bolt-on acquisitions that typically have a 3-4 year payback. At the current share price of EUR 25.10 the historic dividend yield is more than 5% and MFC has an enterprise value that is 3.2 times its operating profit over the last year and only six times the trough profit achieved in 2009. This is far too low for a business that has consistently generated a high return on capital and we think the shares have at least 80% upside.

As I am considering France one of the most attractive stock markets (for small caps) anyway, and the write-up is really interesting, lets test my new checklist for Maison France Confort:

1. Market cap between 25-250 mn
market cap 175.7 mn –> Score +1

2. less than 3 analysts following on Bloomberg or very bad sentiment
no, 7 analysts follow, mostly positive outlook, however only small cos. –> Score 0

3. No English annual reports, short quarterly updates etc., no share price on company homepage
I didn’t find recent English reports, only relatively slim intra year updates –> Score +1

4 . Potential special circumstances like Euro crisis, very diverse business activities, complex structure, Spin off etc.
Not really, although “france bashing” seems to increase –> Score 0

5 . Low historical beta /volatility
Beta of 1.0 –> Score 0

6. Dividend yield > 3%
Div. Yield 5.13% –> Score +1

7. P/E < 10
Trailing P/E of 8.7 –> Score +1

8. P/B < 1.2
P/B 1.5 –> neutral

9. EV/EBITDA <= 6
EV/EBITDA = 2.2 !!! –> Score +1

10. 10 Year mean reversion potential > 50%
Yes, Based on EV/EBITDA, mean reversion potential would be 200%

11. Positive 10 year FCF yield
Very solid FCF generation (~10% p.a.) –> Score +1

12. Large acquisitions in the past ?
neutral, no big acquisitions, but series of small ones –> score 0

13. Large share Intangible assets ?
40% of book value intangible —-> Score 0

14. Pension liabilities, operating lease ?
Nothing discovered at first glance —> Score +1

15. Low debt (net debt/equity <0.5)
Significant net cash —> Score +1

16. Family owned / run
Yes, 5th generation —> Score +1

17. Treatment of shareholders in the past ?
looks fair, share buy backs —> Score +1

18. Sharecount stable or decreasing ?
Decreasing —> Score +1

19. Alignment of management and shareholders
Good, CEOs skipped bonuses etc. —> Score +1

20. Insider Share purchases/sales last 12 months ?
No —> Score 0

21. Subjective impression of company management (pictures, speeches, comments)
Good —> Score +1

22. 10 Years of history available ?
Yes, Score +1

23. Industry attractiveness
neutral (“discretionary consumer”) —> Score 0

24. Positive/neutral price momentum ?
positive —-> Score +1

25. high quality investors as share holders ?
Yes, Ennismore, Amiral —> Score +1

26. Do I understand the business model ? Is it attractive
looks like a very capital efficient, attractive business model —> Score +1

27. Potential short/medium catalyst ?
Not really —> Score 0

28. 10 year sales growth above inflation ?
Yes, 10 year growth 11.8% p.a –> Score +1

All in all, this results in a quite good score of 19 (out of 28), which compared to my other stocks looks quite good. So this is definitely a stock to follow up more closely.

I am still considering if I might implement either a higher range (like -3 to +3) or decimals to further differentiate. Like for instance at the moment I would give a +1 score to an entity with 30% debt as well as to one with net cash etc. However I am not sure if this makes the “first step check” to complicated.

Summary:
Based on my checklist, Maison France Confort looks very interesting and definitely a stock to follow up. Cheap on many metrics combined with a very capital efficient business model makes it interesting. Only drawback is the focus on the currently dwindling domestic French housing market, where the portfolio is already exposed to via Poujoulat (chimneys), Installux and even Bouygues.

The Herbalife “Slugfest”

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In my opinion, the most interesting (and entertaining) story in equity markets is the current Herbalife story.

Herbalife is a US based producer and distributor of diet shakes, vitamin pills etc.

Looking at the chart, one can see that until early 2012, Herbalife was one of the “hottest” stocks out there:

Herbalife went public in December 2004 at a price of 14 USD per share. Including a stock split, the stock returned a phenomenal return of ~ 30% p.a. until the end of 2011.

Earnings per share rose more than 10-fold from 0.47 USD per share to more than 4.80 USD in 2011. During the “financial crisis”, the stock suffered but then quickly went back into outperformance mode.

The first “crack” in the success story appeared, when David Einhorn personally dialed into the conference call on May 1st 2012 for the first quarter and started to ask some weird questions.

Two weeks later, when Einhorn spoke at the annual Ira Son conference, the stock bounced back 20% because Einhorn didn’t mention Herbalife. So far I didn’t find out if Einhorn is still short.

The next step in the story is well known, the epic presentation of Bill Ackman why Herbalife is a Pyramid scheme. To reinforce his point, he even set up a dedicated website about his Herbalife short thesis. For Ackman, this is not his first short battle. There is even a book (by the way highly recommended) about his several year long fight against the US mortgage insurers, called “The confidence game”:

However, pretty soon after his presentation, some quite savvy investors and bloggers pointed out some weaknesses in Ackman’s presentation, especially the claim that the Herbalife “scheme” is illegal and the US regulators will have to shut the company down.

One of the first was blogger Kid Dynamite and one of my personal favouritesm, blogger and hedge fund manager John Hempton.

Like sharks smelling blood, some other “famous” hedgefund managers joined the party, most notably Dan Loeb’s Third point which actually took a massive 8% long position in the company. Yesterday, even “activist” legend Carl Icahn came out swinging against Ackman, disclosing a long position in Herbalife.

So this is quite an interesting situation:

On the one side, we have some of the brightest “new generation” HF managers David Einhorn and Bill Ackman against well respected “activists” like Dan Loeb and Carl Icahn as well as extremely clever bloggers like Kid Dynamite and John Hempton.

Last Thursday, Herbalife held an investor day, trying to take on Ackman’s acusations. I found the Herbalife presentation rather unconvincing.

My advice on this:

If you are not a famous investor who can move markets with a presentation, STAY OUT OF THIS !!!!!

Otherwise you will end up like this poor guy, who “joined” Bill Ackman just at the wrong point in time:

The Herbalife story is the proverbial “hot potato” investment one should just enjoy and watch (and learn) instead of joining.

Personally, I think that Loeb and Icahn are only in for the quick rebound and long term Ackman will most likely come out with a nice profit, but I wouldn’t really bet on this, as you might be killed (or squeezed) in the meantime.

So get your popcorn, lean back and enjoy !!!

P.S.: For anyone more deeply interested in “multilevel marketingg companies”, there is a very good detailed post at Seeking Alpha.

Book review: Cable Cowboy: John Malone and the Rise of the Modern Cable Business

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“Inspired” by Gannon’s post about the book and indirectly Whopper, I read the book, partly also to understand why I got the Kabel Deutschland short wrong.

The book is sketching John Malone’s business history from the early 70ties, when he joined the almost bankrupt regional cable company TCI until the early 2000s when he already was a billionaire.

For me, especially the following points stood out:

Malone as CEO/cable operator
+ Malone is rather a “financier” and deal maker than an operator, although he certainly knows his stuff about cable and media

+ very early, even at university he already developed the concept to use maximal leverage for regulated “quasi monopoly” businesses

+ at his time at TCI, he perfected this business model even further. He used depreciation/amortization aggressively in order to be able to “compound” cable assets without paying a single cent of taxes

+ he was one of the first CEOs to convince investors to disregard earnings and focus on cashflow

+ in his first 15-20 years at TCI, he managed to increase the share price by several thousand percent without ever showing a single cent of profit

+ he perfectly understood competitive behaviour, effectively running a “cable cartel” for many years and extracting the maximal gain for shareholders (would be maybe a very good study for the Bruce Greenwald book..)

Malone as an investor

+ as an investor he is being quoted rather as an “asset collector”

+ this implies that he has extremely long time horizon’s, sometimes 20 years and more and no hurry to cash out

+ his “exits” were usually tax optimised stock swaps into more liquid shares of acquirers

+ his first “genius” stroke was the early spin-off of Liberty media which made him rich. This is also one of the very prominent spin offs Joel Greenblatt wrote in his “You can be a stock market genius” about. I think it also explains a lot why such a special spin off worked so well. Malone structured the spin off in a way that people were not really interested in the spun off shares. With a loan of his employer, he then bought up as many shares as he could.

+ some investments he made were either genius or sometimes monopolistic, for instance buying a struggling network and then allowing it to be distributed over his cable systems. One example was the “BET” network, were he invested 500 tsd USD in the early 80ties as the founder was struggling, distributed it via his cable network and then sold the stake for close to 1 bn USD to viacom in 2003. This shows his patience with such investments and might be one of the best “angel investments” in history.

Although the book clearly has some lengths, I found the book very interesting and highly recommendable from many perspectives. It offers good insights into the cable business as well as into “cutting edge” corporate finance and long term investment thinking.

John Malone is also someone you definitely you want to follow. So if John Malone aggressively buys into German cable, it is maybe not the best timing to short Kabel Deutschland at the same time.

I wish I had read this book much much earlier…….

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