Monthly Archives: January 2014

Random thoughts on Emerging Markets, Contrarian investing and Circle of competence

Since I have started the blog, I have been actively avoiding (or even shorting) anything which has significant Emerging markets exposure. This was quite a controversial strategy as for the last few years, investing in Emerging markets or companies with high Emerging market exposure was considered to be one of “THE” no-brainers in investing, along with commodities and residential real estate. Who doesn’t remember the famous “cleanest dirty shirt” slogan from Pimco’s El Erian ?

The momentum of Emerging markets carried them over the Eurozone crisis up until the end of 2012. Interestingly, even after first warning signs emerged like falling commodity prices, free-falling orders for companies like Caterpilar, the Batista bankruptcy etc. last year, the story of the “Emerging market consumer” and the swift transformation from investment led economies into happy consumer countries seemed to be still alive.

Now however, at least in the public perception, people are surprised that the infamous “decoupling” of the BRICs & Co was (as always) more wishful thinking than anything else. Interestingly again, the mood quickly turns from “no brainer” to “full panic”. On the other hand, European stocks, which 2 years ago were seen as total disaster, are touted as the most promising asset class despite being now much more expensive than 2 years ago.

As a contrarian investor, this is the time when one should pay attention and prepare oneself. On the one side, current sentiment tells me that I should become more careful with my high percentage of European stocks, on the other hand, I think it will be a good time trying to expand my circle of competence and start to look more into stocks with Emerging Markets exposure.

However, as a contrarian investor, one should be aware that one is always too early, both in the way in and the way out. This is basically the opposite side of the momentum investor. Psychologically, in my experience, most stock investors seek “instant” gratification. If you buy a new stock, you want the stock go up directly in order to have positive feedback on your thesis. Very few people can stomach declining share prices especially for new investments. In institutional environments there is a very high implicit pressure to invest into stocks with positive momentum as this increases the likelihood to look good in the short-term and this is all that counts, even in many so-called “value investing” outfits.

Back to Emerging markets: The truth is, I know very little about Emerging markets. I have documented one attempt with Pharmstandard as a special situation, where I was clearly luck to get out in time. So one clearly needs to have some sort of strategy.

In principal, there are various ways to gain exposure to Emerging markets:

1. diversified funds/ETFs of Emerging market stocks
2. single emerging markets stocks which are traded on accessible stock exchanges
3. Companies in developed markets with significant EM exposure

Personally, I think it makes most sense to extend the circle of competence in little steps. So investing in a company based for instance in China, where I have no clue how the market works and which is active in an industry where I don not have a lot of experience might be a very bad idea or the equivalent of pure gambling. One should also avoid obvious “compromised” sectors like German listed Chinese companies as the likelihood of systematic fraud is too high in my opinion.

The diversified approach has also big problems. In many markets, for instance Turkey, banks have a huge weight in the indices. As banks are the most vulnerable companies in a real crisis, index investing often turns out to be a suboptimal approach.

This leaves in my opinion two alternatives:

A) Invest in EM companies where I know the sector / business very well
B) Invest in developed market companies with significant EM exposure

Strategy B) in the current stage is relatively difficult, as especially in the consumer and automobile sector, people seem not to believe in any crisis or downturn. Yes, companies like Adidas, Yum or Volkswagen have underperformed the DAX this year, but they are not cheap.

Strategy A) has the drawback that often only a few companies are easily available to invest. In Turkey for instance, there is only a handful companies traded outside Turkey and one might not easily find traded ones in the prefered sectors.

One important caveat: In my experience, both booms and busts take longer to play out as everyone thinks. So there is absolutely no hurry to fully jump into EM stocks now. On the other hand it is very unrealistic to actually identify the low point. So once a certain investment is identified which is attractive, one should buy without trying to time the market.

In any case, for the rest 2014 I will try to look at the one or another company with significant EM exposure instead of chasing the few remaining undervalued European or American stocks. I might even start positions in some and prepare for a lot of pain, both for missing a continuing rally in Europe and for losses in new investments. But that is what contrarian investing is all about.

How to value IFRS 19 Pension liabilities – Part 2: Inflation

AFter the introduction and some technical aspects in the first part, let’s look at how inflation is impacting pension liabilities. Inflation in my experience is something which is widely misunderstood when it comes to pension plans.

In many countries, especially Germany and UK, defined benefit pension plans work in general the following way:

Accumulation/active phase:
For active employees, each year the work for the company, they get promised a pension in relation to their current salary. So the longer they work and the more they earn, the higher the future pension promise. Companies have to disclose the assumption for the increase in salaries. Salary increases are a function of inflation and promotion. People who work a long time in companies and get promoted, usually increase their salary much more than inflation. Nevertheless it is fair to assume that in many cases, inflation will be reflected in salary increases.

Payout phase
Once an employee has retired, his pension payments are often linked to an inflation rate. In Germany for instance, those payments are linked to the German CPI (consumer price inflation) but with a minimum increase of 1% in any case.

Inflation Compounding
What many people don’t realize is that a permanent increase in the inflation level has a compounding effect, the adverse effect of course with decreasing inflation level. Roughly, an increase in inflation by a certain percentage has the same “sensitivity” as the discount rate.

Example Thyssen:

Thyssen Krupp for instance uses in their annual report 2012/2013 the following assumptions (Germany):

– Inflation rate for pension payments 1.5%
– Wage increases 2.5%

They show that a 1% change in the discount rate will change the pension liability by around 920 mn EUR. With a current net pension liability of 6.2 bn we can “reverse engineer” the duration of the liability simply by dividing 20/6.2 bn ~ 15 years.

This duration can be used both, as a simplified multiplier for changes tinterest rates and changes in assumed inflation rates. For instance if one assumes 2% instead of 1.5% as future inflation, the pension liability would be 15×0.5%=7.5% higher than it is shown on the balance sheet.

Inflation expectation vs. break even inflation rates

Many people especially here in Germany do think that we will see higher inflation going forward. I would not base my inflation expectations on subjective opinions but on observable market prices. Luckily we do have observable market prices for inflation: So called “inflation break even rates“, i.e the yield differences between nominal bonds and inflation linked bonds of the same issuer with the same maturity.

In order to adjust for inflation, one should always use those break even rates, as they are the best (and actually traded) proxies for inflation. Let’s look quickly at German Break even rates:

DEGGBE10 Index (Germany Breakeve 2014-01-27 11-34-09

So we can see that currently, the break even rate is very close to the actual assumed inflation rates for Thyssenkrupp and we do not need to adjust for this. However, when inflation rates would go up, we would need to adjust and the impact can be huge. For further information about inflation linked bonds, there is a lot of stuff available, for instance here.

Deflation put

There is however one “small” problem with the approach above: The price difference between inflation linked bonds and nominal bonds includes the scenario of deflation. Normal, EUR based inflation linked bonds will have a floor at 0% inflation, i.e. they don’t loose nominal value in a deflation scenario. German pension plans however have a floor at +1% inflation. If I would compare a German Inflation linked bond with a floor at 0% and one with a floor at 1%, the one with the 1% floor is clearly more valuable, which means that this put granted to the retirees is definitely worth something. Modelling inflation linked options is quite complex, so as a proxy I would use maybe a 2-3% top up for German pension plans in order to reflect this 1% “floor” granted to the retirees.

Common myth: Inflation component is not important as profits of the company and or nominal interest rates will increase with inflation

This is an argument I often hear: You don’t need to care about the inflation in pension liabilities, as the profit of the company will increase with inflation. A second argument is that if inlfation increases, interest rates will automatically go up and thus, offsetting the increase. Let’s tackle the issues one after another:

Company profits and inflation
Honestly, I think not many of us do really know how a period of increasing inflation looks like. In Germany for instance, the inflation rate was between 0-2% p.a. for the last 20 years, a real increase in inflation was experienced the last time around the date of the reunification in the late 80ties and early 90ties as this chart shows:

It should be clear from the past that not all company can simply pass inflation to customers and maintain (or even grow) profits. In my opinion, especially those companies with large pension liabilities have vulnerable business models, especially capital-intensive companies like Thyssen and Lufthansa. Software Companies like SAP for instance will be able to pass most of their cost increases to customers, but they don’t have an issue with pension liabilities anyway. Especially vulnerable in my opinion are utilities, where power prices in inflationary periods are often capped by regulators, whereas input costs often rise quickly

Inflation and interest rates

In the past, high inflation risks often went along with high interest rates, especially in the 70ties and 80ties. The relationship was mostly: Inflation spiked and central banks then had to increase interest rates in order to reduce economic activity and get inflation under control. This time however it might be different. Central banks all over the world have made it clear that the want higher inflation AND low interest rates in order to lower Sovereign debt burdens. It is not clear if they do achieve this, but I think it is also optimistic to assume automatically higher interest rates in the future if inflation picks up.

Quantifying inflation risk pragmatically:

If we look at all the points above, it should be clear that having a liability which will increase with increasing inflation is worse than having for instance a senior bond liability with fixed payments. Even if we use and adjust for current break even rates, there is always the risk that inflation increases above that, especially now, with the Central banks clearly targeting higher levels. As we have seen above, companies with a very strong competitive position and low capital intensity, we can assume that they will be able to earn their margins even under increased inflation. A company which is very asset intensive (i.e. depreciation will be too low in an inflationary scenario), will however get a “double whammy” via increasing pension liabilities.

My proposal to quantify inflation risk would be the following:

– company where inflation has no impact (or even positive) on profit: No adjustment necessary
– company where inflation impact is unclear: 5%-10% “risk adjustment”
– company where inflation impacts business negatively: 10%-20% “risk adjustment”

Those adjustments are very rough proxies for the amounts which would be calculated by a fully fledged risk model but I think as a rough indication this is better than nothing.


So summing it up: In order to reflect inflation risks in a typical inflation linked DBO pension plan correctly, one should make the following adjustments for a prudent valuation:

1. Check if assumed inflation rate is close to relevant “Break even” inflation rates implied in traded inflation linked bonds. If not adjust with the difference multiplied with duration.
2. If there is a minimum inflation “guarantee”, further adjust with a 2-3% upwards adjustment for the liability
3. Determine if the underlying business is negatively effected from inflation. In doubt, use a 5%-10% mark up, if there is a clear negative relationship, use a 10%-20% mark up to reflect the uncertainty compared to a fixed liability

Again, I know that this are very rough proxies and you don’t need to do that. But for a prudent valuation, especially for companies with large pension liabilities, it would be very optimistic not to make adjustemnts for inflation risk.

Some links

Steve Romick’s FPA Q4 comment including some very good remarks about the overall valuation levels

Rare interview with Paul Singer (Elliott Capital) on EM and other global topics

Interesting article about someof the “secret sauce” of US retailer Costco

Jim Chanos is shorting companies which buy back stocks

Companies going to the WEF in Davos are loosers

Finally, Prokon, the issuer of the Genußscheine I looked at 2 years ago went bankrupt. Not really a surprise, it is always the same sad story.

Celesio Merger arbitrage “Post mortem”

So roughly 10 days after the first failed attempt, Haniel today announced that they have an agreement with both, McKesson and Elliott and that Haniel will sell for 23,50 EUR per share to McKesson.

What happened in between ? Elliott, after the failed attempt further increased its stake to 32% (including convertibles).

In a second step, Elliott sold its stake for an undisclosed price to Haniel, which then in turn sold the 75% plus stake to McKesson at the initial 23,50 EUR.

This structure achieved the following goals:

– Elliott got more than 23,50 EUR
– McKesson does not have to pay more than 23,50 EUR

The “Looser” is clearly Haniel, which will have proceeds lower than 23,50 EUR per share. A friend of mine argued that most likely Haniel paid 24,50 EUR which would roughly equal the initial 23 EUR per share. If this is that case, then we would have the paradox outcome, that the majority owner got the lowest price, the minority a little bit more and the Hedgefund the most.

This is something to keep in mind for potential future merger arbitrage deals: The minority shareholders might not get the same deal as the activist shareholder, at least in the cases where a majority shareholder is selling. In this case, the minority holders got a 50 cent better price than the initial bid, but I could imagine scenarios where there is also the risk of a lower bid.

Interestingly, the stocks jumped today over 25 EUR, I guess some people are already speculating on a compensation payment following the Profit & loss transfer agreement which is the logical next step after the purchase.

Personally, I don’t think that there is a lot of upside, but who knows ? In any case, I think Elliott played that one pretty well for themselves. In any case, this is a hard blow to JP Morgan as M&A advisor to Haniel.

There could be open questions if the whole deal could be interpreted as “acting in concert” between Elliott, Haniel and McKesson. In this case, the bid for all shareholders would need to be increased to the price paid from Haniel to Elliott. I have no idea how likely that is and would not bet on this either.

Compagnie Du Bois Sauvage (BE0005576476])- See’s Candy in a Belgian wrapper ?

While researching Ackermans & Van Haaren, I stumbled over another smaller diversified Belgian holding company called Compagnie Du Bois Sauvage (CBS).

The company doesn’t look too exciting with the following “standard” metrics:

P/B 0.92
P/E 16.6 (mostly meaningless for Holdcos)
Div. Yield 3.3%
Market Cap 340 mn EUR

The company presents itself as a holding company, active in Real estate and strategic participation plus a so-called “treasury” division.

The strange name of the company (wild forest) is explained on the website as well as the origins.

However it is much more interesting what they are doing now, especially the strategic holdings. The company divides the participations into the following pillars:



This segment consists only out of 2 investments:

1) A 26.41 stake in a tiny Belgian Credit insurance company and

2) much more interesting a 12% stake in one of Germany’s oldest and most succesful private banks, Berenberg .

According to the CBS report, Berenberg has around 300 mn EUR equity and earned on average around 20% return on equity over the last 3 years, which is very very good. They seemed to have bought the stake in 2002 from an US shareholder.

I tried to reconcile the numbers in CBS annual report with the official annual report of Berenberg but it did not match. I think Berenberg reports only their bank, not the complete Group

Nevertheless a very interesting and high quality asset


CBS discloses the following stakes:

– a 1.56% stake in listed Belgian metal group Umicore

– a 29% stake in listed Belgian automotive supplier Recticel

– 29% in an unlisted US plastics company called Noel

Nothing special here, very diversified but in my opinion without a clear focus or strategy.

Food – Neuhaus Chocolate & Pralines

This is in my opinion the “highlight” . The main company in this segment is Neuhaus, a famous Belgian chocolate manufacturer where CBS owns 100% of the company . According to Wikpedia, Neuhaus has actually invented the “praliné” as we know it.

Neuhaus was actually a separate listed company until 2006 and then taken private by CBS.

Out of curiosity, I did not follow my normal “Armchair investing” approach but did some real research. Neuhaus positions itself at the very high end of Chocolate and praline manufacturers. When i went into one of the biggest downtown department store in Munich, i was surprised that they actually charge 5 EUR for a 100 g chocolate bar and up to 75 EUR for a 1 Kilo representative praline selection. I bought myself a 250 gram pack for 17 EUR which looked like this:

I am not an expert chocolate, but someone else is, Warren Buffet. That is what he said about See’s Candy: (from 1998):

It is a good business. Think about it a little. Most people do not buy boxed chocolate to consume themselves, they buy them as gifts— somebody’s birthday or more likely it is a holiday. Valentine’s Day is the single biggest day of the year. Christmas is the biggest season by far. Women buy for Christmas and they plan ahead and buy over a two or three week period. Men buy on Valentine’s Day. They are driving home; we run ads on the Radio. Guilt, guilt, guilt—guys are veering off the highway right and left. They won’t dare go home without a box of Chocolates by the time we get through with them on our radio ads. So that Valentine’s Day is the biggest day.

Can you imagine going home on Valentine’s Day—our See’s Candy is now $11 a pound thanks to my brilliance. And let’s say there is candy available at $6 a pound. Do you really want to walk in on Valentine’s Day and hand—she has all these positive images of See’s Candy over the years—and say, “Honey, this year I took the low bid.” And hand her a box of candy. It just isn’t going to work. So in a sense, there is untapped pricing power—it is not price dependent.

Neuhaus is doing pretty much the same but with a twist: Their increase in sales seems to come to a large extent from Airport duty free stores. So instead of the Californian car driver you have the European business man or tourist but the principle is the same.

The biggest difference in my opinion is only the price. While See’s currently charges 18 USD per pound, Neuhaus actually gets away charging more than twice with 33 EUR (~40 USD).

It seems to be that for one, “Belgian Chocolate” allows them to charge premium prices. On a recent inland flight I quickly checked an Airport store in Munich, and indeed, Neuhaus together with Lindt was sold at very high prices at a premium location. The third brand was Feodora, the premium brand from Hachez, a privately owned German chocolate manufacturer.

Out of fun, I created a table of the developement of Neuhaus from the CBS annual report. The turn around and growth since acquisition is impressive:

Neuhaus 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Sales   64.52 70.88 83.9 96.25 102.25 105.7 119.9 133.47 149.27
Net   0.505 1.34 3.33 6.95 8.94 10.31 10.95 11.63 12.02
Equity   25.98 26.5 29.55 36.37 45.18 50.89 57.6 53.24 58.79
Net margin   0.78% 1.89% 3.97% 7.22% 8.74% 9.75% 9.13% 8.71% 8.05%
ROE     5.1% 11.9% 21.1% 21.9% 21.5% 20.2% 21.0% 21.5%
CAGR Sales     9.9% 18.4% 14.7% 6.2% 3.4% 13.4% 11.3% 11.8%
CAGR Earnings     165.3% 148.5% 108.7% 28.6% 15.3% 6.2% 6.2% 3.4%

Not only did they achieve a great turnaround, but Sales doubled and ROEs have been constantly at 21-22% p.a.since 2007. This resulted in a 10 times increase in earnings over this period.

If we look for instance to market leader Lindt from Switzerland, we can see that Lindt has a slight advantage in margins, but Neuhaus in growing more and has a better (and more stable) ROEs .

Lindt 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Sales p.s.   9,151 10,255 11,721 13,210 11,389 11,126 11,309 10,944 11,765
Net incom p.s.   684 788 947 1,123 1,158 851 1,061 1,084 1,198
Equity   3,638 4,421 5,224 6,195 6,519 7,168 7,410 7,095 7,695
Net margin   7.47% 7.69% 8.08% 8.50% 10.16% 7.65% 9.38% 9.91% 10.19%
ROE     19.6% 19.6% 19.7% 18.2% 12.4% 14.6% 14.9% 16.2%
CAGR Sales     12.1% 14.3% 12.7% -13.8% -2.3% 1.6% -3.2% 7.5%
CAGR Earnings     15.3% 20.2% 18.6% 3.1% -26.5% 24.6% 2.2% 10.5%

Don’t forget that the market is valuing Lindt at a 30x P/E, I think a 25x P/E for Neuhaus would not be unrealistic, as the business looks like a nice high ROE compounder.

In a M&A transaction, I could imagine even a higher multiple for such a premium brand from a strategic buyer.


Interestingly, CBS discloses NAVs on bi-annual basis, the last value being 270 EUR per share at June 30th 2013.

So we can easily use the template from the annual report and plug in own values:

What about a Holding Discount ?

I have written about how I look at Holding Comanies. In CBS case, I am neutral. I like that they are able to strike really good deals (Neuhaus, Behrenberg) and hold them for the long term. On the other hand, some of the activities look like trying to kill time. Positive: transparent and conservative NAV calculation. Overall I would not necessarily require a big discount here, maybe 10-15% or so.

Compared to GBL/Pargesa for instance we do not have a double holding structure and the main assets cannot be invested directly. So definitely a lower discount here. Compared to CIR, there is also only little leverage in the company.

SO let’s look at the sum of part valuation now:

% Value Comment
Neuhaus Chocolate 100.00% 300.00 PE 25(2012)
Behrenberg 12.00% 54.00 at 1.5 times book
Umicore 1.56% 60.53 At market
Recticel 28.89% 47.67 at market
Noel Group 29.37% 4.64 PE 10
Other   20.00 as disclosed
Codic Real Estate 23.81% 24.52 at book
other reals estate   60 as disclosed
cash etc.   20  
Sum   591.36  
Net debt   -80  
NAV   511.36  
shares our   1.6  
NAV per share   319.60  
Holding Discount   271.66 -15%
Upside   25.19% at EUR 217

What we see is that before applying the holding discount, the stock would have an upside of around 50% which would be OK for me. After applying the discount, the potential upside shrinks to 25%.

Other Info:

The guy behind CBS is Guy Paquot, a well-known Belgian investor. He owns close ~47% of the company.

According to this article, he comes from a rich family and was knighted in 2000 by the Belgian King. He stepped down in 2010 and is no official director anymore, but I guess he still influences the company to a large extent as the dominating shareholder

The Fortis situation

There is one dark chapter in CBOs history: As part of their activities they also invest into Belgian stocks. In 2008 however, they seemed to have received insider information about the upcoming nationalization of Fortis and were able to sell the stock before.

Because of this episode, the CEO actually was imprisoned for a few days and Guy Paquot came back from “retirement”.

It seems to be that one member of the supervisory board of CBS was also in the supervisory board of Fortis and passed the information. In 2008, it was speculated that the fine might be 40 mn or more.

The company settled the dispute finally in last November for a 8.5 mn EUR payment without committing to any wrong doing.

Stock price

Interestingly, the November settlement seems to have been some sort of catalyst, as the stock gained almost 30% in the aftermath.

The stock seems to have bounced off from the 2011 level of 230 EUR but overall I would say the chart looks ok.


Compagnie du Bois Sauvage is an quite unusual stock. Among a strange combination of businesses, there is a prime asset hidden which I think is comparable to Buffet’s famous “See’s Candy” which accounts currently for 60% of the value of the company under my assumptions. If Neuhaus keeps growing at this pace for 2-3 more years, the percentage of Neuhaus could be even bigger.

My own valuation shows an upside of around 25% from current prices after a 15% holding discount which is too low for me to buy . So although I like the company and the two great assets (Neuhaus, Behrenberg), the current price is not attractive enough for me +. For me, A stock price of 185 UR would be required or maybe profits (and valuations) of the two prime assets increase enough to justify an investment.

P.S: I started looking at the company and writing this post already in November 2013, when the stock was around 190 EUR. This is the reason why the post is so long despite the missing upside.

How to value IFRS 19 pension liabilities – Part 1: Introduction & Discount Rates

I have written already a few times about pension liabilities,for instance here and here.

With IFRS 1, pension liabilities have become a bigger topic, as now pension liabilities are “on balance sheet” and changes are recorded in the comprehensive income statement. As I have already written, for some companies this had quite drastic effects, like Lufthansa and ThyssenKrupp which saw large parts of their equity disappear.

As I had a lot discussions about pension liabilities lately, I think it is a good idea trying to summarize some important issues for analyzing pension liabilities.

However one cautious remark: I am not a pension actuary. There might be incorrect or too simplified statements later on and I will not dive into the details of pension modelling. I will try to come up with simplified approaches in order to better understand and value pension liabilities.

How are these pension liabilities created ?

Most companies have some sort of pension program for their employees. Fundamentally, there are 2 different ways to offer pension benefits:

1) Defined contribution plans
Here, the company only promises to invest (directly or indirectly) a certain amount on behalf of the employee on a regular basis. The employee retains the risk of the investment outcome. In those cases, there is no pension liability recorded.

2) Defined benefit plans / obligations (DBO)
In these cases, the employer promises the employee a certain payment per month after he has retired, depending on certain factors such as length of employment, salary, inflation etc. The risk of not being able to pay this is retained by the employer, the company has therefore to book a liability for the estimated (and discounted) potential cash outflows in the future. One might ask, why any employer is choosing this model anyway. There are two reasons. First, for instance in Germany, only DBO plans are tax-deductible. Secondly, DBO plan allows the company two retain the money in the company. Defined contribution plans have to be invested into “external” assets.

Funded vs. unfunded DBOs

In many jurisdictions, the employer can either set up a dedicated fund and invest into financial assets which hopefully cover future obligations, or he can keep the money in the company and fund operational assets.

Accounting wise, the liabilities are in both cases the same, but for funded plans, only the net amount (liabilities – fair value of assets) has to be shown on the balance sheet. Fro more “gory” accounting details, KPMG has a comprehensive guide here.

What are pensions liabilities economically ?

I have written about that before: Pension liabilities are economically senior debt. Why ? Not paying out due amounts for pensions will cause a bankruptcy filing in many jurisdiction. There is no legal way to delay or lower payments, a lesson which was learned the hard way for instance at General Motors. In many jurisdictions, unfunded pension liabilities do not have priority on assets, so one should assume that they are “pari passu” to senior debt, adding them to Enterprise Value.

In jurisdictions like the UK, where pension trustees can claim payments if there is a deficit, one could argue that pension liabilities are “more senior” than senior debt which is quite important as we see later.

So where is the problem ?

If a company issues a senior bond, we know exactly how much money the company has to pay both, in interest and principal. With pension, it is very different. We can only estimate future payments, as the amount paid out depends on a couple of assumptions such as:

– how will salaries develop for active employees (pension contributions are usually a percentage of monthly salaries)
– how long will active employees work for the company ?
– how long will pensioners actually live ?
– what inflation will we experience (in most plans, payouts are linked to inflation) ?

So in a first step, a clever actuary has to estimate those parameters and then, in a second step he/she will generate a future cashflow pattern. Finally, in a third step, the actuary or accountant will then discount those payments using a certain rate to come up with the net present value which is the required value.

Despite that there is no clear rule how to set many of the parameters, there is one big issue with those liabilities: The are really long term. Depending on the plan and the participants, payments will have to be made 50 years or more into the future. So slight changes in parameters, especially for inflation and discount rates will have a large effect on the value of the liability.

Discount rates – technical aspects & Yield curves

IFRS requires to discount the projected outflows with a single “high-grade corporate bond rate”. In practice, most companies use the yields of available, long term AA rated corporate bonds.

Discounting with a single yield however is only a proxy and works best for “bullet maturity” cash flows. Pension liabilities do not have a bullet maturity, but look much more like an amortizing loan. For such cash flows, the correct way is to use appropriate zero yields from a full yield curve. In practice one would bootstrap zero yields from the yield curve on an annual basis and the discount the annual cash flows with the respective rate.

If the interest rate curve is flat, there is not a big difference in this approach. If the yield curve however is steep, there can be a BIG DIFFERENCE.

Lets look at the following example, extracted from the 2012/2103 ThyssenKrupp annual report. I took the projected cash outflows of Thyssenkrupp for the first 10 years and discounted them with both, the official discount rate and an assumed zero curve (year 5-10 were anonly given as a total):

Cashout IFRS rate Zero rates AA NPV stated NPV zero
2013/2014 -546 3.5% 0.25% -527.54 -544.64
2014/2015 -526 3.5% 0.45% -491.03 -521.30
2015/2016 -528 3.5% 0.69% -476.23 -517.22
2016/2017 -520 3.5% 1.03% -453.15 -499.12
2017/2018 -517 3.5% 1.24% -435.30 -486.10
2018/2019 -498 3.5% 1.6% -405.45 -453.12
2019/2020 -498 3.5% 1.8% -391.74 -439.89
2020/2021 -498 3.5% 2.01% -378.49 -425.05
2022/2023 -498 3.5% 2.21% -365.69 -409.39
2023/2024 -498 3.5% 2.43% -353.33 -392.02
Total -5129     -4,278 -4,688
Difference:         -409.91
in%         9.58%

So for those first 10 years, the NPV based on the simple approach is -9.5% lower (and the liability underestimated) than using the correct approach with zero yields. This is clearly a necessary adjustment to be made. The adjustment is of course subject to yield curve steepness and cash flow profile, but as a rule of thumb, a general 10% upwards adjustment might not be unreasonable in any case.

Key take away: If the yield curve is steep as it is now, with a 0% floor on the short end, one should adjust pension liabilities upward no matter what one assumes as the final discount rate. Currently, a 10% general upwards adjustment for the yield curve effect looks like an appropriate adjustment. If interest rise on the long end but stay at 0% in the short, even larger adjustments are justified.

In the next post I will take a deeper look on which discount rates to use anyway and inflation.

Some links

Must read: Howard Marks on skill, luck and inefficient markets

Deep value investing: Buying a house in Detrait for 500 USD

Great interview on Japanese economic myths

Technical but interesting story, how a 95% market share software program (Quark XPress) was killed by the competing product.

Interestingly, packaging seems to be as important as branding. Another argument that Brand does not equal Moat.

Finally a new and promising value investment blog: Odd lot Investing. Great post about compound and decay rates for instance.

Celesio – why merger arbitrage is hard business

Let’s start with a few quotes from yesterday’s post:

a) It is almost 100% assured that the bid goes through, there is now a “floor” under the stock price at 23,50 EUR


I have written above that this was a “Low risk” bet. In reality, I do not know if it was high risk and I was very very lucky or if it was indeed low risk. In statistics, one would call this a “beta error”, assuming that one was right but in reality the probabilities were very different. For me the best way to handle this is to do only small “bets”, keep track of assumptions and outcomes. Systematic “beta errors” in investing in my opinion are very dangerous as this will inevitable lead to some disastrous outcomes in the long run (Bill Miller).

Very rarely, one gets such a direct feedback from the market. McKesson said yesterday around 7 pm that they did not reach the 75% threshold and dropped the bid.

So this was clearly no a low risk M&A arbitrage situation but a high risk one and I was very very lucky to exit just in time.

McKesson themselves seems to be surprised as well:

“This is fresh news to us. We obviously had the support of the management team, we had the support of the family, which obviously was a significant holder, we had the support of Elliott, which was one of the vocal players in this process,” he said. “The best I can speculate is that people either forgot the tender date or they somehow believed that there is more on the other side of this.”

Let’s quickly check the facts:

In their 9th notification, dated January 9th, 2 pm, McKesson reported the following:

As of the Notification Reference Date, based on the regular conversion price, the aggregate number of Celesio-Shares held by the Bidder and/or persons acting jointly with it plus the number of Celesio-Shares for which the Takeover Offer has been accepted plus the number of voting Celesio-Shares which can be acquired through instruments pursuant to section 25a WpHG amounts to 106,213,544 Celesio-Shares; this corresponds to approximately 62.44% of the currently issued share capital and the currently existing voting rights in Celesio. In relation to the acceptance threshold in section 13.1 of the offer document the aggregate number amounts to 107,617,021 Celesio-Shares, which corresponds to approximately 52.94% of the share capital and the voting rights in Celesio on a fully diluted basis.

This was a significant increase against the 44,88% (fully diluted) a day before.

How much did Elliott own ?

This is from their official “recection” notice as of December 23rd:

Elliott Associates, L.P. and Elliott International, L.P. together with affiliated entities (“Elliott”), which own or have an interest economically equivalent to over 25% of Celesio AG (1)
(1) Calculated in accordance with Section 25a of the German Securities Trading Act (Wertpapierhandelsgesetz/WpHG), in connection with Sections 21, 22 and 25 WpHG

Elliott did report surpassing the 25% threshold in late November 2013.

If I read this correctly, they owned 25.1% on a non-diluted basis.

So let’s do quickly the math with what we have available:

  Undiluted Diluted
McK 107,617,021 62.44% 52.94%
Elliott 42,803,603 25.16% 21.06%
Total   87.60% 74.00%
Shares undiluted 170,100,000    
Shares diluted 203,281,113  

So this is interesting: Even with Elliott tendering its full stake, McK was still short 1% to their threshold on a diluted basis.

Could it be that this whole thing was just an accident ? No super-clever play by Elliott but rather a stuoid one ? Were other people assuming like myself that the offer period would be extended ? I don’t know, but I think it would have been better if MCK had said something about the offer period.

Looking back at the Rhoen chart after the first bid failed, one can expect the stock price to be very very volatile:

Anyway, I will watch this from the side line and will be extra carefull with the next M&A arbitrage situation….

Celesio Merger Arbitrage – follow up (and exit)

On Thursday, acquirer McKesson and Elliott agreed on a slightly increased offer 23.50 EUR (vs. 23 EUR) per share which Elliottt promptly accepted.

Interestingly,the stock trades now higher than the offer:

Apparently, during Wednesday some people already anticipated the increased offer. Technically, the acceptance period has not been extended and closed on Friday, January 9th according to the official statement. Honestly, I do not understand this. If I read §21 of the German take over law correctly, any late change in the offer automatically extends the offer period by 2 more weeks. I will need to double-check this.

The offer for the 2018 bond was also increased to 123.4 according to the amended bond offering document.

So what to do now with the price of he shares trading above the 23,50 EUR offer ?

Going back to the initial post, that’s how I valued the shares back then:

Now if we want to speculate on a top up, we have to make two assumptions: How likely is a top up and how large will it be ? In order to keep it simple, I would assume a 50/50 chance for a top up and as I like “round” numbers, I assume 5 EUR per share or a final offer at 28.

This leads us to the following expected value under those assumptions:

Exp. value Celesio share = (3.4% x 17) + (48.3% *23) + (48.3%*28)= 24.25 EUR or around 10.6% higher than the current share price.

So if we leave aside the rather bad mistake in calculating the upside potential, the price is now where I saw the “fair value” before, although I was totally wrong about the size of the “top up”. The reason that I still can make some money was that I bought below the initial bid price and the stock price did overshoot the offer.

Now we do have a very different situation compared to some weeks ago:

a) It is almost 100% assured that the bid goes through, there is now a “floor” under the stock price at 23,50 EUR
b) on the other hand it is a lot less likely that the bid will be further increased.

I can think of two reasons why the stock is currently trading above 23,50 EUR:

1) People are hoping that Elliott might have one last trick up in its sleeve to increase the offer within a relatively short time
2) Speculation that McK wants to quickly achieve a squeeze out and will buy more shares and/or have to pay some compensation for implementing the profit and loss transfer agreement (similar to MAN).

Overall, the “new” situation for me is harder to grasp and the time frame is more difficult to estimate. One should also expect, that Celesio will show most likely a lot of extra charges etc. in the next few quarters in order to both, build some buffer for Mckesson in the future and to discourage shareholders bidding up the remaining shares.

So for the portfolio, I will exit the position at current prices with a modest gain of around 6.5% for the shares and a little less for the bonds. Not spectacular but also not bad for a 4 week and relatively low risk investment.

One final remark on such M&A Arbitrage situations:

I have written above that this was a “Low risk” bet. In reality, I do not know if it was high risk and I was very very lucky or if it was indeed low risk. In statistics, one would call this a “beta error”, assuming that one was right but in reality the probabilities were very different. For me the best way to handle this is to do only small “bets”, keep track of assumptions and outcomes. Systematic “beta errors” in investing in my opinion are very dangerous as this will inevitable lead to some disastrous outcomes in the long run (Bill Miller).

Ackermans & Van Haaren – Mini Berkshire from Belgium ?

Ackerman’s and Van Haaren is a diversified Belgian company which was on my research pile for quite some time. Bloomberg describes the company as follows:

Ackermans & van Haaren NV is an industrial holding company. The Company’s holdings are in the contracting-dredging environmental services, financial services, staffing services, and private equity investing.

Looking onto their participations overview on the (very informative) homepage, one can easily see that this is a quite diversified company. From oil palms in Asia (SIPEF) to old age homes, port service companies, real estate investments and an Indian cement company are among the 30 or more participations.

The largest investments are however a 78.75% Stakes in Delen Investments and Private Bank J. van Breda and a 50% stake in DEME, a marine engineering Group.

The DEME stake itself shows that Ackermans is rather an active holding company. This year they surprised everyone by striking a deal with Vinci and traded their 50% stake in DEME (valued at 550 mn EUR) with a 60% stake in CFE, the listed Belgian company which owns the other 50% of DEME.

The stock itself is not really cheap:

P/B ~ 1.3
P/E 2013 ~15
Market cap: 2.8 bn

The stock gained nicely in 2013 and is trading at an ATH:

Why did I call them a potential “Mini Berkshire” in the beginning ? Well, that’s what they are showing in their latest Q3 presentation:

avh cagr

14.4% CAGR of book value is not bad over the last 10 years. Just for fun, I calculated Berkshires 10 Year CAGR from 2003-2012 based on the disclosure in the latest letter to shareholders:

2003 21%
2004 10.5%
2005 6.4%
2006 18.4%
2007 11%
2008 -9.6%
2009 19.8%
2010 13%
2011 4.6%
2012 14.4%
10 year CAGR 10.60%

So at least for the last 10 years, AvH has clearly outperformed Buffet by almost 4% p.a. which is really a lot.

Step 1: “Quick and Dirty” sum of parts

When I look at a company like AvH, i generally try to do a quick and dirty “sum of part” analysis first. AvH makes it quite simple by providing a net cash figure at holding level which is required as the consolidated accounts include non-recourse debt as well.

The only thing I was not sure was the fact that the holding segment borrowed money from the private equity part in an amount of 120 mn EUR. I decided to play it save and deduct it from the private equity NAV.

So this is the “quick and dirty” result:

Value Method
DEME 550 Implicit valuation takeover
Van Laere 26 0.75 book
rent-a-port 5 at book
Maatschappi 20 At book
Sipef 130 market cap 482
Delen 522 1.5 book
van Breda 336 1.2 book
Extensa 80 0.8 book
Leaseinvest 108 Traded
Financiere duval 40 at book
AnimaCare 40 2x book
MAx Green 70 10x Earnings
Telemanod 30 10x Earnings
Sofinim 255 75% of NAV minus cash to holding
Net cash holding 148 Q3
Total 2,361

The result of this exercise is higher than stated book equity of around 2.05 bn EUR, but on the other hand, significantly lower than the 2.8 bn market value.

If I haven’t made a big mistake, then even if some of the holdings like Delen are worth more than I assumed, AvH looks as it is trading at a premium. Although I think the company is a good one and can create value, I would not want to pay a premium, so one can stop at this point and move on.


Ackermans & Van Haaren seems to be an interesting company with diverse holdings and a good culture and some very good and interesting businesses. The track record over the last 10 Years looks impressive and is better than Berkshire. Nevertheless, the stock looks overvalued from a sum of parts point of view, offering no margin of safety.

« Older Entries