Monthly Archives: February 2013

Royal Imtech update: Higher loss & Rights issue

After last qeek’s first look at Royal Imtech, Imtech came out today with a press release:

The highlights were as follows:

Rights issue will be completely used for debt reduction
Measures to make financial structure more robust
Write-off of 150 million euro for Polish projects
Write-off of 150 million euro for German projects

So this means that the write offs are a lot higher than initially communciated. Back then, they only said “100 mn EUR in Poland”, now we are at 300 mn EUR in Poland and Germany.

In parallel they also reported a change in the CEO positon:

Gouda, the Netherlands – The Supervisory Board of Royal Imtech N.V. (IM-AE, technical services provision within and outside Europe) confirms that in good consultation and in line with the original plan, René van der Bruggen (65) has decided to retire as of 3 April 2013. He will remain a member of the Board of Management until 3 April. He will hand over as Chairman with immediate effect. Gerard van de Aast (55), who is already a member of the Board of Management, is as of now appointed CEO of Royal Imtech and Chairman of the Board of Management

So this could be an interesiting situation. The new CEO will most likely go for a “kitchen sink” approach and write off as much as possible in order to have some “cushion” in the future.

Another aspect is what they say in the first press release:

Royal Imtech N.V. (IM-AE, technical services provider in and outside Europe) announces that the company will strengthen its equity through a rights issue of 500 million euro. The proceeds of the rights issue will be completely used for debt reduction. As a result of this the balance sheet of Imtech will be reinforced

This looks like that the banks have Imtech “by the balls” and could push through the rights issue in their interest. So it is not really a surprise that the share price of Imtech dropped to a new low:

Again, as in the KPN case I would wait until the details of the rights issue are known. With a current market cap of 800 mn EUR, a 500 mn EUR rights issue will require a significant discount.

Operating Cash Flow and interest expenses – (ThyssenKrupp vs. Kabel Deutschland, IFRS vs. US GAAP)

In my recent post to Kabel Deutschland, I made the following remark:

Interestingly, the “operating cashflow” does not include interest charges. In my opinion, interest charges are operating, as they have to be paid regularly and there is no discretion like dividends. So in my view Kabel Deutschland currently runs free cashflow negative and dividends are paid out from the increase in debt.

After some discussions, I was less sure about this myself so I thought it might be a good thing to look at this more closely.

Before jumping into “definitions” of how to calculate and report different cash flow definitions, one should take one step back and ask oneself:

What is “free Cash Flow” supposed to mean anyway ?

The current mantra for most “sophisticated” investors is that you should more or less forget earnings and concentrate on “free Cash flow” as this is the most important metric for determining the value of any (non financial) company.

“Free Cash Flow” in plain English should quantify the amount of money which is generated by a company over a certain period of time (usually 1 year) which can be used in a discretionary fashion to either grow the company, pay dividends, buy back shares etc.

In order to calculate this number, you normally start with operating cash flow, which in theory should contain all cashflows to operate the business on a going concern basis and then deduct cash out for normal Capex, i.e. investments required to ensure the “status quo” of the company.

Further one has to distinguish between two perspectives when deciding how to calculate Free Cash flow:

Free Cash flow to the firm vs. Free cashflow to equity

The single most difference between Firm/equity perspective is that in the “firm perspective” one assumes that the financing structure is discretionary. One wants to evaluate the whole value of the firm based on the firm wide discretionary cashflow.

However, with free cash flow to equity, I have to take the current financing structure as given and one has to calculate how much of discretionary cash flow is left for the shareholder. This of course implies, that interest charges are not discretionary for a shareholder but have to be subtracted from Free cash flow to equity.

This is especially important for highly leveraged companies where interest expenses can “eat away” a lot of discretionary cashflow.

The problem:

So far so good, where is the problem ? The problem is that different companies report cashflow differently.

Let’s look at Thyssenkrupp for instance:

thyssenkrupp opcf

They start with Net income and adjust for depreciation etc. but not for interest expense. Interest expense ist therefore shown within Operating Cashflow (net finance expense was 168mn, maybe they didn’t bother with -1.3 bn operating cashflow.

Now let’s look at the 9M Kabel Deutschland Cashflow report:

kabel op cf

We can see that other than Thyssen Krupp, Kabel Deutschland adds back interest expense to Operating CF.

Later on, we can see interest expense under Financing Cashflow:

kabel financing cf

Accounting view

Under US GAAP it is clear: Interest expense belongs to the Operating cashflow statement. Under IFRS however a company can can choose between Operating and Investing Cashflow (see here, 7.15)

So we can see, there is nothing explictly wrong with Kabel Deutschland from a reporting point of view, they just have chosen to report interest expenses under Financing cashflow.

There is an interesting paper to be found here which makes the following observations:

We find that firms with greater likelihood of financial distress and a greater probability of default make OCF-increasing classification choices. We further show that firms accessing equity markets more frequently and those with greater contracting concerns are also more likely to make OCF-increasing classification choices. Firms with negative OCF are less likely to make OCF-increasing classification choices.

So that is no surprise that a PE “boot strapped” company like Kabel wants to show higher OCF and FCF and opts for Financing Cashflow.

What to do & Summary?

In my opinion, you have to make sure first that you compare apples to apples if you look at two different companies and compare free cashflows. Make sure that you treat this consistently. I am not sure if all the US investors which hold the largest stakes in Kabel know about this small but important reporting difference.

Secondly, I personally think that interest expenses always should be deducted from Operating Expenses and therefore Free Cash Flow in any equity valuation exercise.

Imagine for instance a company which rents its building against a company which takes out a loan to buy the exact same building. In the first building, you would subtract the rent clearly from operating profit, so why would you not subtract the interest on the mortgage for the second company ?

Kabel Deutschland (DE000KD88880) – Short again !!

Kabel Deutschland is a stock which I have written about quite often. I was short the stock but closed out with a quite significant loss (-53% to be exact).

I am still following the stock out of interest because I think it is a prime example of a modern day high quality “stock promotion”.

Clearly, the performance of the stock since its IPO is outstanding. Without many setbacks, the stock has tripled since its MArch 2010 IPO, making it one of the most succesful German stocks in that time period:

Also the advantages of Kabel Deutschlands business model are clear:

– the business seems to be a “natural moat” business. Effectively, Kabel Deutschland makes contracts with the administers of multi family homes, so all those people become automatically clients of Kabel Deutschland and have to pay a base fee via their monthly rent bill. With this guaranteed inflow, Kabel Deutschland is then able to sell aggressively phone services, internet etc. to those clients

As a result, Kabel Deutschland is supposed to be a free cash flow machine with still significant growth potential, the rare exception in the European TelCo market. So it doesn’t matter that Kabel Deutschland has negative equity and the debt is mostly covered by goodwill and intangible assets.

Markets are clearly paying a premium for that. With a trailing EV/EBITDA of 11.4, Kabel Deutschland is ~30% more expensive than even the comparable cable operators in Europe and the US.

Recent developements

Telecolumbus acquisition

Kable Deutschland was on track to take over Telecolumbus, another regional cable operator. Taking over other regional cable operators is of course a no brainer for any aspiring cable company. Economics of scale is what counts in cable. However 3 days ago, the german antitrust office finally rejected the request from Kabel Deutschland due to anti trust concerns.

So this significantly reduces growth opportunities for Kabel Deutschland. Yes, they might be able to sell more internet etc. to existing clients but I am not sure if this really warrants the extra price paid for Kabel Deutschland

9m results

The official release came out with an encouraging dividend increase from 1.50 EUR to 2.50 EUR per share. Also all their self defined funky KPIs look fantastic.

However if you really look into the cash flow statement, one can see that 9 months free cashflow is only ~50 mn EUR, to significantly increased investments. The company even announced an “accelerated network investment” plan:

In order to enable accelerated growth, the Company intends to pull forward network investments of €300 million to be spent over the course of the next two fiscal years in addition to the Company’s existing investment plans.

Interestingly, the “operating cashflow” does not include interest charges. In my opinion, interest charges are operating, as they have to be paid regularly and there is no discretion like dividends. So in my view Kabel Deutschland currently runs free cashflow negative and dividends are paid out from the increase in debt.

All in all, one might think that those two issues might lead to a decrease of the valuation premium for Kabel Deutschland. Fat chance, because just by pure coincidence, the following story appeared in the Newspapers last week (before the other two events mentioned bacame public):

According to “insiders”, Vodafone is contemplating to take over Kabel Deutschland.

The reason seems logical: Vodafone needs to offer “quad play” services (Televison, Internet, fix line phone, mobile phones) and has already purchased in a similar fashion Cable and Wireless UK fixed line operations in 2012. So a clear no brainer.

Kabel Deutschland directly jumped more than 20% and the following bad news (Telecolumbus, 9 months earnings) were mostly ignored.

Vodafone Cable and Wireless UK acquisition

It is absolutely correct, that Vodafone acquired Cable and Wireless UK operations last year. However, what many “analysts” did not mention was the fact that Vodafone was very disciplined here.

When Cable and wireless split in two companies in 2011, there was always the rumour that Vodafone would be interested. However the waited a long time until the price was right before they came out with an announcement in April last year.

According to Bloomberg, Vodafone finally paid the following multiples:

P/S 0.3

So Vodafone actually bought here at “rock bottom prices”. In my opinion, the days are over when Vodafone would move in and pay any price for Cable Deutschland.

In my opinion, there are also no other natural buyers for Kabel Deutschland. Liberty has already bought Kabel BW and will not be allowed to buy Kabel Deutschland. The big Telcos have enough problems already and for a PE buyer, Kabel Deutschland is already too “bootstrapped” to be interesting.

I am pretty sure that Vodafone knows that and will not rush into a Kabel Deutschland deal, if at all.


In my opinion, the “Vodafone Insider story” was a prime example of stock promotion, making the stock jump with a somehow plausible story and making people forget about the rather sobering underlying picture.

I am therefore once again, going to establish a short position in Kabel Deutschland, betting against a take over by Vodafone at a premium. As always with shorts, I will start with a 1% position.

At current prcies, I believe the risk/return ratio is quite good, as I don’t believe that Vodafone will buy at current prices (or even pay a premium) and there is a good chance that Kabel Deutschland’s valuation will approach average levels at some point in time.

In my “home forum” benny_m posted a interesting link regarding potential cable regulation in Germany:

That might be a game changer…….

Quick KPN update

Today, KPN came out with an interesting press release regarding the capital raising activities.

In my opnion, there were 2 surprises:


The capital raise to be supported by AMX will consist of a EUR 3bn rights issue and, in addition, issuance of hybrid capital instruments which are expected to receive partial equity recognition. Through this combination KPN intends to achieve the targeted EUR 4bn equity equivalent capital. The proceeds of the capital raise will be used to reduce KPN’s net debt level and to continue to invest in KPN’s operations.

In another comment I read that they are planning to issue 2 bn EUR Hybrid, bringing the total volume to 5 bn EUR. I was not sure why they were going for 4 bn before, now I am even less sure why the want to raise 5 bn. I have the feeling that I might be missing something here. The Hybrid will be much more expensive than a senior debt even at junk level.

The second surprise is the following:

AMX has committed, subject to certain conditions, to participate in the rights issue and subscribe for newly issued ordinary shares in KPN pro rata to its current participation in the total share capital of KPN. Subject to market conditions, KPN intends to issue the hybrid capital instruments during the course of 2013.

So Carlos Slim has committed to pay his share, but under some conditions. The conditions contain, among others

– 2 supervisory board seats for Carlos Slim
– a “stand still”, Slim promised not to increase his share above 30%

The second point however is then basically taken away with this point

In case of an announcement of an offer for any outstanding share capital of KPN or an offer for a material subsidiary of KPN the standstill may immediately be terminated by AMX;

So I am not sure why they negotiate a “stand still” with Slim which can be broken any second by him.

Finally the timing has shifted back into April as the extraordinary shareholder meeting has been cancelled:

The Annual General Meeting (“AGM”) has been scheduled to take place on 10 April 2013, for which a notification will follow. The matters which had been scheduled for the Extraordinary General Meeting (“EGM”) on 19 March 2013 will be included in the agenda of the AGM; the EGM scheduled for 19 March 2013 is hereby cancelled.

The market seems to have hoped that Carlos Slim would block the capital increase. This is the only explanation why the stock price fell almost 10% on this release:

Interestingly, 2 large hedgefunds (Marshall Wace, GLG) disclosed -0.6% short positions in the last few days.

So summing up:

– I even understand less why they want to raise 5 bn expensive capital
– Carlos SLim is not going away

I will stick to my initial plan and wait until the details of the rights issue are released. In between I will lean back and watch the show….

Imploding Dutch stock of the week: Royal Imtech (ISIN NL0006055329)

After KPN and TNT Express, we highly welcome another Dutch company with an imploding stock price, Royal Imtech.

The company:

Royal Imtech seems to be active mostly in everything which on can install into buildings, such as heating, securities, electrical equipments etc. although the company profile on its website sounds like a perfect score at “bullshit bingo”:

Imtech offers added value with integrated and multidisciplinary total solutions that lead to better business processes and more efficiency for customers and the customers they, in their turn, serve. Imtech also offers solutions that contribute towards a sustainable society – for example, in the areas of energy, the environment, water and traffic.

Nevertheless, until recently (November 2011) Imtech was highly coveted by analysts as “clean tech” super star , with a 100% buy rating and price targets of 30 EUR per share and more.

The problem

In beginning of February, Imtech came out with a “bombshell” press release.

Not only did they have to postpone their earnings release, but they also indicated that they have a loss of min. 100 mn EUR in their fast growing Polish business. The press release contains this “gem” of potential accounting fraud:

The Board of Management has also determined that a promissory note and pledged accounts related to the Adventure World Warsaw project – amounting to around 200 million euro – that had been recognised in the half-yearly 2012 financial statements under cash and cash equivalents must, according to IFRS, be reclassified under current financial assets. Most of this amount was recognised as an advance payment under work in progress for the four projects concerned. This advance payment was considerably higher than the incurred costs. As stated above, the advance payments have not become available to Imtech. The effect of this is incorporated in the expected write-off of at least 100 million euro

This potential fraud leads to another problem: As net cash is part of their loan covenants, the company already indicates that all of a sudden, they are now in breach with their loan covenants:

The consequence of the expected write-off will be that, when its 2012 financial statements are drawn-up, Imtech will no longer fulfil its covenants with lenders – average ratios of 3.0 maximum for net debt/EBITDA and 4.0 minimum for interest coverage. As a result Imtech will begin consultations with its lenders. Imtech has retained Rabobank as its financial advisor for these consultations.

The share price fell of course like a stone following this announcements:

One interesting aspect about Imtech is the fact that some rumours about aggressive accounting were circulating already late last year. Of course management denied all allegations at that time.

Interestingly, Imtech had already a quite high short interest at that time, almost 10% of the market cap was short at the end of the year. Thanks to the new regulations about short disclosure one could see that the “smart money” like Dan Loeb’s Third Point is short the share.

Why bother at all ?

One of the reasons I looked at Imtech is that based on many metrics, Imtech looked like a great stock and even more now at the current price levels. I am sure, Imtech will show up now on many “value screens”. Even in my BOSS model, Imtech looks quite compelling.

If we look at some measures, Imtech really looks like a great company:

31.12.2002 0.61 0.42 17.4% 21.9%
31.12.2003 0.57 0.36 14.5% 41.7%
31.12.2004 0.58 0.36 12.5% 17.1%
30.12.2005 0.69 0.36 18.4% 18.6%
29.12.2006 0.86 0.36 21.9% 19.5%
31.12.2007 1.17 0.36 26.4% 21.4%
31.12.2008 1.46 0.47 29.7% 18.3%
31.12.2009 1.62 0.59 28.2% 16.3%
31.12.2010 1.70 0.64 21.4% #WERT!
30.12.2011 1.72 0.65 17.3% 11.4%

One can see growing earnings, growing dividends, nice free cashflow and double digit ROIC and ROEs. So what is not to like ?

The big question

So the question is: Is Imtech a great company which has just facing a bump on its road to further success or is there a real problem with the company ?

There are some examples of great companies with similar problems, for instance Hugo Boss AG, the German luxury Group. In 2002, they detected fraud in their US subsidiary (“channel stuffing”) and had to restate their 2001 balance sheet significantly. I just found this research note from Commerzbank in 2002 where they downgraded the stock from 16 to 9 EUR per share. Looking back, this would have been the perfect entry point for Hugo Boss. The stock since then performed ~30 p.a. until now (a 15-bagger so to say) against 7.7% of the CDAX.

However with Imtech, I have some doubts due to the following reasons:

Imtech more or less looks like a typical “roll up”. On the “acquisitions” page of their homepage one can see that they have done like 10–15 acquisitions per year. With roll ups, it is very difficult to asses the reported numbers of such a company because of the large leeway available for accounting for acquisition. Even cash flows can be “massaged” quite significantly as we have seen many times before.
As a result, Imtech carries significant goodwill. This in itself is not necessarily a problem, but together with significant accounting problems, this might become a problem quite soon.

Type of fraud
As mentioned above, this fraud was not “only” about faking sales but also about faking on-balance sheet cash. As we know now, Imtech has quite tight credit covenants. So in my opinion this implies that the fraud has some connection to the whole group and is not only a result of some renegade employees in a subsidiary. Imtech seemed to have general problems with cash and fulfilling its covenants before.


In theory, Imtech could be a great company which had bad luck with management in a subsidiary. This would be a good entry point to buy a great business at rock bottom prices.

However, at least in my opinion, the history of the company as a “roll up” as well as the type of fraud makes me cautious. So for the time being this will be just sit back and watch what is going to happen (and trying to learn more…).

Maybe if they really go the way of a big rights issue as indicated in this Bloomberg story might be an interesting entry point, but only if the issues regarding the fraud have been clarified in the meantime and the business is viable. Otherwise, the good parts of the business will most likely go to the creditors and the shareholders might get nothing (but the blues).

Weekly links

Kid Dynamite with a very good update on the Icahn/Ackman Herbalife situation

Citron Research with a short thesis about “bubble stock” 3D printing

Great analysis of Oaktree Capital from the Brooklyn Investor

Some interesting but diverging views on Buffet’s Heinz deal: Felix Salmon thinks it is clever from the Brazilian perspective, Eddy Elfenbein thinks it is too expensive, Katsenelson thinks it is still cheap.

The other side of Buffet’s business: Few talk about it because few really understand it. Aleph blog however does.

Great interview with Clayton Christensen (Innovator’s dilemma)

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