Quick check: CIR Spa (ISIN IT0000080447) – HoldCo sum of part play with “special situation” catalyst ?

This is an idea I read recently on the beyondproxy blog/site.

As my first attempt at this post somehow disappeared, I will now just copy the introduction from the beyond proxy post:

CIR Group is a company whose story is an intricate all-Italian tale of family ownership, corruption and dirty politics. This unique combination of factors seems to be frightening investors away from the company thereby causing its shares to become substantially undervalued. Within the next two quarters however, the Italian courts will decide on a legal dispute that will put an end to the tale and, most likely, a higher valuation on the stock.

CIR is structured as a holding company. It owns controlling interest in four businesses (Sorgenia, Espresso, Sogefi and KOS) and has substantial investments in alternative assets such as hedge funds and other financial instruments. Its liabilities consist mainly of €300mm of publicly traded bonds and €564 million of legal reserves.

and this is the “kicker”:

CIR carries a €564 million liability that has been booked as “Borrowings”. In reality, this is not borrowed money – it is a legal reserve for an infamous legal proceeding that has been making headlines in Italy for the past twenty years: the so-called ‘Lodo Mondadori’.

The author (a Italian grad student by the way) then values the company with a simple sum of part model, using share prices for the listed subsidiaries (Espresso, SOGEFI) and NAVs (P/B=1) for the unlisted shares (utility Sorgenia, hospital KOS). As a result, the author sees an upside of at least 20% in any case or up to 135% in case of a positive outcome of the “Berlusconi situation”

I think this is a good starting point, but I would adjust the approach slightly:

1. add control premiums to the participations
2. adjust NAVs for unlisted participations if appropriate (and comparables are available)
3. deduct finally a control premium for the CIR share

One could ask: Why add control premiums and then deduct them again ? Well, clearly, being a minority shareholder in the middle of an Italian shareholding chain is not the best position to be in. The main effect of this approach is to deduct a control premium from the expected Berlusconi settlement. This should be done as one does not know what happens with the money. I assume it will not be paid out as a dividend.

Assumptions:

1. For a control premiums in both cases I assume 30%
2. For the unlisted utility, I will use a P/B valuation not at nAV but at 0.5 times NAV. This is in line with similar Italian utilities like Iren (0.58) and Enel (0.6). I use 0.5 because the others are even profitable, Sorgenia is not.

First step: Sum of parts ex “Berlusconi”

CIR Spa 12/2012          
 
Assets          
    mn EUR MTM Control premium MTM + prem
Participations 1,192        
– Sorgenia   197.7 186 30% 241.8
– Espresso   341.7 178 30% 231.6
– Sogefi   106.9 172 30% 223.7
– KOS   99.2 99.2   69
– CIR Investimenti   421 421   421
– others   25.5 25.5   25.5
           
Receivables (group) 320   320   320
Cash, securities 291   291   291
other 67   67   67
Total 1,870   1,760   1,891
           
Liabilities          
LT debt -299   -299   -299
“Berlusconi liability” -564   -564   -564
Other -68   -68   -68
Total -931   -931   -931
           
NAV 939   829   960
shares 793.3   793.3   793.3
NAV per share 1.18   1.05   1.21

This rather simple table shows how i moved from the current “carrying values” in the HoldCo balance sheet of CIR Spa Holding to my mark-to-market valuation BEFORE applying the overall control discount. Remark: Using consolidated numbers for a company consisting of mostly 50% participations does not make a lot of sense.

Step 2: Berlusconi scenarios and control discount

before tax After Tax Per sh NAV Upside -30% control Upside
               
Base case       1.21 27% 0.85 -11%
Berlusconi min 150.0 97.5 0.12 1.33 40% 0.93 -2%
berlusconi max 564.0 366.6 0.46 1.67 76% 1.17 23%
Belusconi Mid 357.0 232.1 0.29 1.50 58% 1.05 11%
last news -15% 479.4 311.6 0.39 1.60 69% 1.12 18%

Here you can see the base case (as is) and 4 potential scenarios for the payment, assuming that 150 mn before tax is the minimum. The upside is calculated based on a current share price of 0.95 EUR per CIR SpA share

We can see that after applying the -30% control discount on the sum of part, without the Berlsuconi settlement, the shares look rather expensive. The max. upside with around +28% is rather limited at this price.

So it looks like that some of the expected Berlusconi payments are already priced in. At that price, I don’t think CIR SpA is attractive if one applies a 30% control discount.

Legal disputes /court cases as special situationss

In general, legal disputes are often quite interesting special situations. This is a quote from the 1951 edition of Ben Graham’s 1951 edition of “security analysis” (via CS Investing):

Class D Litigated Matters.

There are fairly numerous cases in which the value of a security depends largely on the outcome of litigation. This may involve a damage or subordination suit (e.g., International Hydro Electric, Inland Gas Co.); disputed income tax liability (e.g., Gold and Stock Telegraph, Pittsburgh Incline Plane); an appeal from a reorganization plan wiping out stock issues (e.g., St Louis Southwestern Ry., New Haven R.R.). In general, the market undervalues a litigated claim as an asset and overvalues it as a liability. Hence the students of these situations often have an opportunity to buy into them at less than their true value, to realize attractive profits—on the average—when the litigation is disposed of.

What kind of holding company is CIR SpA ?

A few months ago, I had a post about how I distinguish Holding companies:

For myself, I distinguish between 3 forms of holding companies:

A) Value adding HoldCos
B) Value neutral HoldCos
C) Value destroying HoldCos

Back then, we saw that even for a “value neutral” holding like Pargesa, a 30% discount applied. So implicitly I assume CIR SpA is value neutral as well. At least the reporting is quite transparent. In the past, CIR was involved in many typical Italian Feuds like Olivetti and Mondadori, but I haven’t read anything that they try to screw minority shareholders of their own group.

Although Benedetti Junior looks a little bit like someone who enjoys doing shady deals 😉

According to the last annual report, Benedetti Senior has ceded control of CIR SpA to his sons.

Summary:

Although I like the unique aspect of this special situation, the potential upside is NOT attractive enough to justify an investment at current prices.

I will keep this on the radar but I would not invest above ~0.70 EUR. I would need 50% upside in order to justify the risk of the underlying companies which are clearly struggling.

13 comments

  • Well done Gianluca! CIR won the case, price is 1.24, I made 28% in 2 months following your thesis, a truly assymetric bet you identified there. Grazie maestro!

  • Gianluca Ferrari

    FYI, this is worth watching http://youtu.be/yYITJD41Y2A

  • Gianluca Ferrari

    Very interesting and good response.

    Perhaps you are right about Espresso. Given the underlying value, there should be a control premium and a subsequent discount given that the de Benedettis are very unlikely to monetize that asset. Either way, I like to believe that that ‘control’ value is an extra margin of safety on CIR’s price.

    Nonetheless, I don’t see how anymore value could be added by having control of Sorgenia, Sofefi and KOS, nor do I believe that any value is being destroyed, so I stand by my idea that no control premium/discount should be applied to those three companies.

    In regards to the €300mm in debt, Espresso has about €130m in excess cash on its balance sheet, so the amount that CIR would potentially be required to finance Espresso with would be about €170 minus any free cash that they generate. That leaves quite a bit of cash free for distribution.

    Other than that, I agree with everything you say – there isn’t really much for me to add.

  • Gianluca Ferrari

    Hello. A friend told me that somebody was digging into my thesis so I couldn’t help but come and read your observations. First of all, thanks for taking the time to challenge my ideas. It is always a pleasure to receive value-adding criticism.

    So, to get down to the point. There are a few observations that I would like to make on the issue of control: the value of control (positive or negative) is equal to the value that control would bring to the company. Let me make an example: if the liquidation value of a stock is $10 per share and it is trading at $6, the value of control is $4 per share. Control is economically worthless unless it can create value. Accordingly, control does not destroy value either (unless the controlling shareholders are destroying value of course). For this reason I disagree with your 30% control premium on the subsidiaries and the the subsequent discount.

    You were the one to say that CIR’s management is value-neutral in the sense that they aren’t exceptional value creators nor are they destroying value. Plus, considering that interests are aligned, I really don’t agree that from an economic standpoint, any premium/discount should be applied. (I will discuss its effects on the price in a second)

    Now, if you really want to apply a discount, I believe that the appropriate amount to subtract from NAV are holdco operating costs. I capitalize them at 5x, so assuming €20mm in costs, you can subtract €100m from NAV.

    As of the effect that control has on price, one may argue that a discount should be applied for uncertainty regarding the future, but what kind of discount should one apply? 5%? 10%? I personally do not know how to calculate it so I just value it at NAV, but I think that anything over 10% is excessive. (rule of thumb)

    So having said that, using your valuation, CIR’s value (ex Lodo) would be €730mm, which is more or less the current price. You would therefore be getting a free call option on the outcome of the Lodo.

    However, I do not fully agree with your valuations. Agreed that perhaps Sorgenia may be worth a bit less than what I said in my report (I still stand by my valuation), Espresso, for example, would be worth more than its market price. In Italy, there are only four or five main national newspapers, and La Repubblica is one of them. The political value of that newspaper alone is incalculable, so just by breaking up Espresso and selling it off in pieces, it would be worth much more than it is trading for.

    Either way, however you look at it, it looks attractive to me.

    Also, there were already two news reports here in Italy that CIR may pay out the settlement of the Lodo in dividends. Who knows!

    Also, as an update, the court must decide within the 29th of July otherwise it must request an extension, which I doubt it will because it is not deciding whether CIR or Fininvest is right, but only on the settlement amount.

    I look forward to hearing your response. Again, great analysis and it is a pleasure to exchange ideas with you.

    -Gianluca

    • Hi Gianluca,

      thank you very much for your comment. I liked your thesis by the way a lot, I just have a different opinion.

      With regard to control premiums:

      You are contradicting yourself a little bit here.

      On the one hand you say the following:

      Control is economically worthless unless it can create value. Accordingly, control does not destroy value either (unless the controlling shareholders are destroying value of course). For this reason I disagree with your 30% control premium on the subsidiaries and the the subsequent discount.

      Further down you state the following:

      Espresso, for example, would be worth more than its market price. In Italy, there are only four or five main national newspapers, and La Repubblica is one of them. The political value of that newspaper alone is incalculable, so just by breaking up Espresso and selling it off in pieces, it would be worth much more than it is trading for.

      So for Espresso, gaining control and breaking it up would generate value. But CIR does not do that. So in this case, applying a control premium to Espresso is the only logical result, isn’t it ? If someone would break up CIR and break up Espresso, he could create additional value. But as a minority shareholder, you can’t.

      The same goes in my opnion for CIR. CIR is not fully transparent. To me, it is also not clear how good Benedetti junior really can manage the company. The problem with a conglomerate like CIR is that investors usually prefer exposure to “pure play” company. So if someone thinks Sorgenia is a great company, he might not want to invest in SOGEFI or Espresso.

      All thse factors in my opinion justify a clear discount. If this is 10,20 or 30%, one can argue. However as a fact, even extremely transparent holdcos like Pargesa trade at 20-30% discount.

      mmi

      Edit: I am clearly far away from Italy so I don’t know any rumours. But highly doubt that they distribute the money right away. Espresso for instance has a (300 mn ?) bond maturity in 2014 and I am not ure if they can easily roll that bond. Also Sorgenia might need some “back up” liquidity. I think CIR will keep the majority of the funds.

  • Fine, you are looking to italy as well. I suppose the italian stock marked has to offer some nice pearls, seeing that FTSE MIB is today at the same level as nearly 20 years ago: http://upload.wikimedia.org/wikipedia/commons/thumb/f/f7/FTSE_MIB.png/800px-FTSE_MIB.png

    Have you ever boss-checked Astaldi?
    Its an italian contruction company I actually really like.
    P/E12=7; P/E13e=6,1;
    average yearly growth in last 10 years: 12%
    ROI12=13,3%, average ROI in last 10 years: 12,6%
    Every of the last 10 years with posivite earnings, margin between 2,4 and 3,1%.
    Growing internationality (actually 50% Italy, 50% abroad)
    And, last but not least: Good IR-repoting in English: http://www.astaldi.com/investor_relations

    I really like the data and still don’t know if I missed a foul fruit or the share is that cheap.
    I suppose it was stuck with all italian stocks in the last two years.

    • I looked at them superficially. Didn’t like the debt load though

      • I am long astaldi, too.
        As of 2013Q1: “The debt/equity ratio stood at 1.4x. At the same date, the corporate debt/equity ratio, which excludes the share of debt related to concessions insofar as without recourse or self-liquidating, totalled 0.9x.”
        Some debt is non-recourse and share of concession business is increasing. Would also like lower debt.

  • Hi, thanks for the write-up. I wonder if you aren’t a bit too conservative with Sorgenia’s and Kos’s valuations. In a private transaction Sorgenia would certainly fetch more than half the book value. Current negative numbers are influenced by cyclically low electricity demand, last year’s impairment charges (question of course is whether they are one-off), high gas prices from long term delivery contracts (which are currently being renegotiated), and competition of renewables at peak hours. On the gas prices, they already got a temporary relief last September and will get a permanent relief this September if gas market doesn’t change for the better. This was already visible in margins during Q4 and Q1. Competition from renewables might also ease as government recently announced subsidy cuts to renewables. Also, if you look at what Verbund was willing to pay last November for an additional 0.75% stake it would value CIR’s part at 670m (not to mention how much they valued Sorgenia in 2008 when Verbund did a one-sided capital increase – well this were different times). Since it is a viable asset in a viable industry for which there has already been interest from abroad I believe one can at least get close to reproduction value which is certainly higher than half book value. Another issue is KOS where Axa Private Equity Partners was just recently (2010) willing to pay 150m for a 46.7% stake, valuing CIR’s stake at 160m – and the business has done very well since then, Plus the growth perspective are wonderful given the roll-up of potential within this very fragmented market. Cash strapped local authorities are actually wiling to pay for KOS to take over some of the facilities which they lost money on. Anyway, I believe you discount those private assets by too much, even though I agree that Sorgenia is certainly challenged at this point. A stabilization in the Italian economy, which is quite likely over the next 2-3 years, might certainly help. Sorry for the rather long comment. Really like your blog. Best regards, Robert

    • robert, thank you very much for your long comment. As you might have read, I have assumed a 30% control premium for both stakes.

      NeverthelessI try to err on the conservative side if possible. For me, it is not clear why I should value Sorgenia higher than Iren or ENEL or RWE or Eon.

      MMI

  • Thank you for this quick-check. It would be interesting to see if Mediaset Spa (Berlusconi) trades at a discount reflecting the other end of the potential settlement. The Mediaset share-price has gone up significantly (doubled since March), so I assume, that at an official EV/EBITDA of around 17 (2013) and 11 (2014) this Company is not particularly cheap either.

    Makes me wonder more and more about the broad evaluation of the stock market… .

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