Monthly Archives: January 2013

The Herbalife “Slugfest”

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

“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…….

Investment checklist v 0.1 (beta)

One of my “secondary” goals for 2013 is trying to develop a more “formal” checklist especially for my “boring stock” strategy. As the “Boss Score” is only ment to be a starting point, I usually try to “quick check” certain points in order to find out if a deeper analysis makes sense.

One of the first thing one has to decide is: “what kind of stocks am I looking for” ? I don’t believe that a single check list for all kind of different stocks exists. So please keep in mind, the purpose of this checklist wil be to find stocks that:

– perform consistently well over time but not spectacularily so (no “wide moat” companies)
– have little fundamental downside (low debt, “hard” assets, stable sector)
– can be “left alone” if necessary for a long time because management is trustworthy (“low maintenance”)
– are nevertheless “mispriced” by the market

So far I have come up with the following list and the first 27 items (beta version):

1 . Market cap between 25-250 mn
“sweet spot”, large enough to invest, small enough to deter “large professional” investors

2. Less than 3 analysts following on Bloomberg or very bad sentiment
Unfollowed or “hated” stocks have larger potential to be mispriced

3. “low key” IR. E.g. no English annual reports, short quarterly updates etc., no share price on company homepage
Many investors skip such stocks

4. Potential special circumstances like Euro crisis, very diverse business activities, complex structure, Spin off etc.
increases chance of mispricing

5. Low historical beta /volatility
Good for my nerves, bad for any index oriented investors

6. Dividend yield > 3%
subjective criteria based on experience

7. P/E < 10
For some reasons I prefer “single digits” P/E

8. P/B < 1.2
Maybe anchoring effect, but in my opinion limtis downside risk

9. EV/EBITDA <= 6
in order to detect “special effects”

10. 10 Year mean reversion potential > 50%
Mean reversion potential based on P/E- net margin & EV/EBITDA, EBITDA margin

11. Positive 10 year FCF yield
no FCF generation normally indicates issues with capital allocation efficiency

12. Large acquisitions in the past or serial “acquirer” ?
might severly impact quality of reported numbers

13. Large share of intangible assets ?
again, quality of reported numbers

14. Significant pension liabilities, operating leases ?
Adjust for them accordingly to see if total leverage still acceptable

15. Low financial debt (net debt/equity <0.5)
again to minimize downside risk

16. Family owned / run
better chance for long term strategic management, best with founder still in charge and not too old

17. Treatment of shareholders in the past ?
Any indications of screwing shareholders in the past ?

18. Sharecount stable or decreasing ?
Does company dilute shareholders e.g. via options to management ?

19. Alignment of management and shareholders ?
Does management earn comparably much more than their shareholdings ? Outsized & unwarranted bonuses ?

20. Subjective impression of company management (pictures, speeches, comments)
Might sound stupid, but sometimes a picture says more than 500 pages …. Avoid jet set, sleazy looking guys

21. 10 Years of comparable history available ?
preferably companies with a long term track record as listed companies without major restructurings etc.

22. Industry in general decline
avoid value traps or make sure to understand whats going on

23. Positive/neutral short term (6m-1 year) price momentum ?
only catch the falling knife if you are very very sure

24. high quality investors as share holders ?
Preferable less known but good investors

25. Do I understand the business model ?
Why is the company succesful over the long run ?

26. Potential short/medium catalyst ?
i.e. sale of loss making division, change in shareholder structure etc.

27. 10 year sales growth above inflation
Don’t pay for growth, but if you get it cheap…also trade off with FCF

For each item I will give a score which is either:

+1 for a very positive answer
0 for a neutral position
-1 for a negative aspect

I will then add all the scores, the maximum is then logically the total number of checklist items. Anything which scores above 50% or more will be analysed deeper. In order to “callibrate” the list, I will also calculate scores for all my current holdings.

For a first test I calculated the “sores” for the following positions:

Installux: 18
Total Produce: 16
Hornbach: 16
Tonnelerie: 22
AS Creation: 20
Vetropack: 18
Buzzi: 10

As with any checklist or other “Model”, I don’t think one should follow this like a slave. Rather it should help to look more structured at a stock and also being able to review such a stock periodically on a structured basis.

I would be highly interested if any of the readers has comparable checklists and suggestions for the list.

Weekly links

John Hempton from Bronte is actually long Herbalife. Fascinating story.

Longtermvalue blog is unhappy with his 2012 performance. He argues that small investors must use their advantages even better.

Eddy Elfenbein has published his 2013 buy list. Great how he beats the S&P 500 year after year with a simple large cap portfolio.

Wexboy too, writes about his favourites for 2013.

Good long story about Dish Network. Being nice to employees seems not to be their main strategy. Nevertheless, the stock has risen 4-fold since 2009.

Economist story of a relatively unknown fraud 200 years ago, involving among others, bonds of a non-existent country called Poyais.

Detailed story on Nokia’s decline from Techcrunch

Listed German utility companies – part 1: Overview and E.on (ISIN DE000ENAG999)

In my small series about utility companies, it might make sense to start with those companies which are at least geographically in my “circle of competence”, Germany.

There are currently 8 listed companies which qualifiy one way or the other as “utilities” which are:

Ticker Name Mkt Cap EV/EBITDA T12M P/B P/E Dvd Yld
 
EOAN GR Equity E.ON SE 28,194 7.5 0.7   7.8
RWE GR Equity RWE AG 19,099 4.7 1.2 8.3 6.3
EBK GR Equity ENBW ENERGIE BADEN-WUERTTEMB 8,340 5.6 1.4 31.0 2.7
MVV1 GR Equity MVV ENERGIE AG 1,549 8.3 1.4 25.3 3.8
FHW GR Equity FERNHEIZWERK NEUKOELLN AG 72 6.8 2.1 15.6 4.5
MNV6 GR Equity MAINOVA AG 2,031 22.9 2.2 20.8 2.5
WWG GR Equity GELSENWASSER AG 1,887 17.8 2.3 19.3 3.2
LEC GR Equity LECHWERKE AG 2,198 20.0 2.7 22.6 3.2

Obviously, the large companies look the cheapest. Most of the smaller companies are in fact subsidiaries of the large players or owned by the Government such as:

– Lechwerke is owned ~90% by RWE
– Mainova is part of EON (91.3%)
– Gelsenwasser is owned by the government (92%)
– MVV is majority owned by the city of Mannheim (50.1%)
– EnbW is majority owned by the Government (85-90%)
– Fernheizwerk Neukölln is owned by Sweidish Vattenfall (80.1%)

RWE is de facto controlled by the regional government as well, only E.On to my knowledge does not have a controlling shareholder or significant Government influence.
A
s one could read in the press, the regulatory environment in Germany is supposed to be quite ugly, among others, the major issues are:

– unpredictable politics (close down of Nuclear power plants following Fukushima), the utilities are actually trying to sue the Governemnt for this
– heavily subsidized renewable energy (costs are added to the electricity bill for retail customers)
– relative low allowed yields on infrastructure which led the major players to shed electricity grids and gas pipelines
– heavy competition for instance for electricity. I just checked, where I am living (Munich), I got ~44 different offers for electricity

Going back to the “Buffet on utilities” approach, especially suing the Government (i.e. regulator) is maybe not a ver good long-term strategy if you then want to negotiate your next investment.

Another interesting aspect in my opinion is the fact, that especially the subsidiaries with purely local (regulated) focus show quite satisfying longterm ROEs.

10Y ROE 5Y ROE Debt/Equity
FERNHEIZWERK NEUKOELLN AG 18.6% 19.6% 0.0%
LECHWERKE AG 24.5% 13.9% 0.2%
GELSENWASSER AG 17.7% 12.5% 2.1%
MAINOVA AG 17.1% 9.1% 70.3%
ENBW ENERGIE BADEN-WUERTTEMB 21.0% 12.8% 94.1%
MVV ENERGIE AG 10.3% 11.3% 107.6%
       
 
RWE AG 17.4% 15.4% 122.4%
E.ON AG 10.2% 1.8% 79.2%

I find especially Lechwerke, Fernheizwerk and Gelsenwasser fascinating. Without any leverage they manage to produce solid double-digit ROE’s over long periods of time. So looking at this one might think that both, for RWE and EON, the German regulator is maybe not the real reason for their current problems.

Rather bad management and failed international expansion are the drivers between the rather bad performance in the last few years. Eon for instance lost lot of money with gas contracts outside Germany.

This is also the major issue I have with E.on. For some reason, they believe that they must grow outside Germany, just recently they swapped German Hydro plants with Austrian Verbund against a 50% stake in a Turkish utility group. Earlier in 2012 they teamed up with Brazil’s Eike Batista to invest in Brazil. Some people might like this exposure to “growth markets”, but personally I think this is a quite risky strategy.

Again, if we look at the comparable performance between E.on and its listed German subsidiary Mainova, we can see that at least this German business performs quite well and consistent despite E.on’s claims of bad German regulation:

Some additional thoughts about E.on based on the 2011 annual report:

– Nuclear is not coming back, that was more than 1 bn of EBIT which is missing going forward
– 60% of sales are actually energy trading revenues. The results of this “sector” look quite volatile
– they show huge swings in the net results of financial derivatives. In 2010 for instance, E.on showed a net gain of 2.5 bn against a 2011 loss of -1 bn .
– E.on has around 17 bn liabilities for nuclear waste etc. This liability is hard to analyse and could be grossly over-/understated. In the notes they state that the discount rate they use is 5.2%. I think this is a rather high rate. Combined with the long duration of those liabilities, there could lurk a potential multi billion hole there as well as in the 14 bn pension liabilities
– another “whopper” are the 325 bn EUR (yes that’s three hundred twenty five billion) of outstanding fossil fuel purchase commitments. Disclosure is rather limited here but I guess this is one of the big problem areas where they have locked in Russian NatGas purchases at too high rates

On the plus side we could add:

+ maybe earnings were understated to put pressure on regulators and trade unions
+ positive effect from future reduction in interest rates

All in all, EON in the current form looks like a big black box to me. mostly due to the large trading activities which are not transparent at all. I would be not able to value the company. I also don’t think it is particularly well-managed. As there is no dominant shareholder, the major “upside catalyst” could come from an activist investor. In contrast, I think current management will most likely waste the cash flow in stupid “growth investments”.

Another issue, and that goes for most of the German utilities is the fact, that the combination of Nuclear exit and strongly subsidised local renewal energy production might have altered the business model going forward. So betting on a “reversion to the mean” might not necessarily work here, at least not in the short run.

Last but not least, I don’t see how I could have any “edge” in valueing E.on. It is a liquid large cap stock, with plenty of analyst coverage. True, sentiment is quite bad which is maybe a chance at some point in time but as a private investor with a small portfolio, this is not the first place to look for “value”.

Yes I know, for many “value investors”, a P/B of 0.77 and dividend yield of 7.6% would already be enough and maybe yield starved investors will bid up E.On stocks for the dividend, but looking 3.5 years ahead, I don’t see a real “Margin of safety” at current prices with the current management and strategy plus taking into account the fundamental issues mentioned above.

2012 Performance review and comments

Performance

2012 was a very good year for the blog portfolio. Overall performance 2012 including dividends and interest) was 37,4% vs 26.6 % for the Benchmark (50% Eurostoxx, 30% DAX, 20% MDAX), resulting in a relative outperformance of 10.4% for the year 2012.

Further details can be found in the following table:

Bench Portfolio Perf BM Perf. Portf. Portf-BM
2010 6,394 100      
2011 5,510 95.95 -13.8% -4.1% 9.8%
           
Jan 12 5,972 99.27 8.4% 3.5% -4.9%
Feb 12 6,275 105.90 5.1% 6.7% 1.6%
Mrz 12 6,330 107.22 0.9% 1.2% 0.4%
Apr 12 6,168 108.02 0.8% -2.6% -3.3%
Mai 12 5,750 108.90 -6.8% 0.8% 7.5%
Jun 12 5,969 110.17 3.8% 1.2% -2.6%
Jul 12 6,229 112.15 4.4% 1.8% -2.6%
Aug 12 6,428 119.48 3.2% 6.5% 3.3%
Sep 12 6,510 123.48 1.3% 3.3% 2.1%
Okt 12 6,672 125.32 2.5% 1.5% -1.0%
Nov 12 6,804 127.04 2.0% 1.4% -0.6%
Dez 12 6,973 131.81 2.5% 3.8% 1.3%
           
           
YTD 12 6,973 131.81 26.6% 37.4% 10.8%
           
Since inception 6,973 131.81 9.1% 31.8% 22.7%

The December 2012 outperformance is mainly a result of some significant year-end effects in some of the stocks like Total Produce, SIAS and Buzzi to name a few.

Also many of the stocks are rather “boring” low beta stocks. Therefore the 2012 outperformance should be viewed more as lucky timing of special situations than anything else. In a normal “bull year” like 2012 the portfolio should significantly underperform. In 2012 however, some of the special situations (esp. AIRE KgAA and Draegerwerke) catalysed unexpectedly early and let to this outperformance. From an overall strategy point of view, i would assume that my portfolio outperforms in bad years and underperforms in bull years.

To be honest, I don’t think that the current portfolio has an equal upside potential like in the beginning of last year, mostly due to the lack of really interesting special situation investments. For instance, the upside of athe Draeger Genußschein was much higher when it trades at ~2.5 times the pref shares than the current 4.5 times. On the other hand, I think the portfolio is well protected to the downside which should be the major concern of any (real) value investor.

Portfolio:

The only change in the portfolio in December was the purchase of some Sol Spa shares in the last few days, taking advantage of the significantly dropping share price.

Name Weight Perf. Incl. Div
Hornbach Baumarkt 4.5% 6.9%
AS Creation Tapeten 4.1% 22.2%
BUZZI UNICEM SPA-RSP 5.5% 16.0%
WMF VZ 3.4% 42.6%
Tonnellerie Frere Paris 4.9% 31.5%
Vetropack 4.5% -2.3%
Total Produce 6.2% 53.3%
SIAS 6.3% 52.6%
Installux 2.9% -1.6%
Poujoulat 0.9% -2.8%
Dart Group 3.8% 83.7%
Cranswick 5.0% 2.7%
April SA 3.5% 33.0%
Bouygues 3.1% 15.2%
KAS Bank NV 4.7% 9.6%
Gronlandsbanken 1.2% 19.5%
SOL Spa 1.7% -0.7%
     
Drägerwerk Genüsse D 9.2% 96.5%
IVG Wandler 4.9% 11.6%
DEPFA LT2 2015 3.0% 52.6%
HT1 Funding 4.7% 38.4%
EMAK SPA 4.4% 17.6%
Rhoen Klinikum 2.4% 2.4%
     
Short: Focus Media Group -1.0% -3.7%
Short: Prada -1.2% -17.3%
     
Short Lyxor Cac40 -1.3% -5.7%
Short Ishares FTSE MIB -2.2% -7.5%
     
Terminverkauf CHF EUR 0.2% 5.0%
     
Tagesgeldkonto 2% 10.7%  
     
     
     
Value 63.4%  
Opportunity 28.6%  
Short+ Hedges -5.5%  
Cash 10.7%  
  97.2%

The cash quota of ~10% is within my usual target range.

Outlook and comments:

If I would be in the “tactical” Asset allocation business, I would expect a rather strong start into the new year.(Edit: Is started writing this 2 days ago…) So many investors have watched the stock market from the outside and momentum looks quite strong. It looks like the fear of missing out another strong year is overcoming the fear of Euro crisis, fiscal cliff etc. or to quote Howard Marks: “when greed is stronger than fear”.

On the other hand, as a bottom up value investor one should be more cautious than ever. When greed is trumping fear, naturally for a value investor times get harder as under valuations are fewer and harder to find. The temptation rises to invest in “weak” stocks or turnarounds without much downside protection.

This goes together with the behavioural bias of “overconfidence” which usually is getting stronger after good years.

So the main focus for value investors will be to “stay the course” and not get lured into more risky and only superficially “cheap” stocks despite another period of potential underperformance against major stock indices.

The “harvest” will come when everyone is “on board” in the stock market and the next (inevitable) correction or contraction will come.

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