Monthly Archives: April 2014

Another pilgrimage & Portfolio transactions & Slow posting ahead

Another pilgrimage

Last year was the first time that I went to the “Woodstock for capitalists“, i.e. the annual shareholder Meeting of Berkshire Hathaway. As I mentioned last year, the annual meeting itself would not be a reason for me to (spend all the money and) go there, but the possibility to join a 2 day conference and talk to other Value Investors is definitely worth the trip.

Who knows how many more annual meetings with Buffett and Munger will be taking place and if there will be the same kind of atmosphere in the future once Warren and Charly are gone ?

I will definitely try to buy some of those great souvenirs, they make great presents for fellow value investors:

Portfolio transactions

In April so far, I have fully sold my SIAS Spa position. I further sold down April SA to 2,5% portfolio weight. The reason for this is that I have actually bought a new “half” position in the same sector, but I did not finish my write up yet. Other than that no actions.

As there will be no April monthly report, a very quick preliminary look at April: So far it looks like a relatively strong month, with the portfolio up +1,6% against -0,8% for the benchmark. Major contributors were KAS Bank (+6,2%) and the EM positions (Sistema, Ashmore, Koc) with +4 to +6%.

Slow posting ahead

The next 2-3 weeks, there will be slow or more likely no posting. Instead, I will try to support the economy of an ailing “PIIGS” country as good as I can 😉


Update: Portugal Telecom & Oi Merger & Oi capital increase

DISCLAIMER: The stock discussed is again very risky and not a typical “value stock”. Please do your own homework and never commit large amounts of your capital to such investments. The author might buy or sell the shares without giving advance notice. Do your wn homework !!

Last year I had a mini series (part 1, part 2, part 3) about the merger between Portugal Telecom and the Brazilian Oi. My initial idea was a long PTC / short OI deal as the mechanics of the merger seemed to imply a signifcant dilution for OI shareholders.

Interestingly, since I wrote the first post in October 2013, both shares lost siginficantly, however Oi with around -37% more than double than PTC with -15%.

Oi is now in the process of preparing the planned capital increase and it looks that they did push through the share offering though there have been some hickups along the way.

Just as a quick reminder:

Oi was supposed to do a big capital increase first before then the company gets merged with PTC.

Oi seems to have priced the new shares aggresively at the bottom of the expected range:

Grupo Oi SA, Brazil’s largest fixed-line telephone carrier, priced an offering of preferred shares at 2 reais each, at the bottom of the indicative range set by bankers, sources said on Monday.

So at current prices with PTC at ~3 EUR and OI common shares at 2,50 Reais (or ~0,81 EUR) PTC sharesholders will receive “new shares” of OI at the value of 2,2911 Euros plus 0,6330 “CorpCo” shares which should equal common shares. So at 3 EUR there seems to be a small discount but I think this is hardly exploitable as an arbitrage situation.

For me, the current situation is an interesting combination of a special situation (capital increase regardless of price) and Emerging Markets exposure.

However, much more interesting for me is that aspect:

It is pretty clear that Oi wanted to raise a defined amount without really caring about the share price. This looks similar to EMAK and Unicredit in Italy 2 years ago. This is one of the rare cases where we clearly have a seller who does not care about the price but just wants to raise a fixed amount of money.

The “special-special” aspect of this one are the following feature:

1. We do not have subscription rights despite the massive amount of new shares
2. We have the additional complexity of the subsequent PTC merger

In such a situation, it is extremely hard to come up with a solid valuation of the business. Both, OI and PTC look very cheap on a trailing EV/EBITDA basis but honestly, i did not try to figure out how the combined entity will look like. Oi minorities clealry got screwed by this transaction whereas PTC shareholders had been protected to a certain extent.

The good part of the this capital raising is that the entity will have some fresh cash which will allow them to operate for some time. Although there is clearly the risk of further dilutions if they want to bid for instance for additional businesses in Brazil.


For me, the Oi capital increase looks very similar to situations like EMAK and Unicredit, where the companies issued new shares regardless of price. This increases the possibility that the price has been pushed significantly below fair value. Buying PTC now looks like an interesting way to get exposure to the merged entity at a depressed price. I will therefore invest a 1% position into PTC at current prices (3 EUR) for my “special situation” bucket.

Some links

Bob Robotti presentation on Subsea 7, a Norwegian Oils service company

How to start an ETF by Meb Faber

A pretty good 90 item investment check list (via Aleph blog)

A deep look into the current status of the Spanish economy. My take: Don’t bet on tising interest rates in the Euro zone…….

Nate from Oddball on the virtues of attending shareholder meetings from small companies

The book “Sustainable Energy” looks like it is worth reading

And a very interesting reading list from the Bull, Bear & Value blog

Emerging Markets: Sberbank ADRs (ISIN US80585Y3080)- Buying Russia in one stock

Warning: The stock discussed is very risky and the risk of a complete loss is high. In any case this should be seen at best as a very small part of a diversified Emerging Markets portfolio and in no case as a concentrated “bet”.

After a short visit in Hongkong, back to Russia, the currently cheapest Emerging market.

Sberbank is the largest publicly listed bank in Russia, with a market cap of around 32 bn EUR. As many Russian stocks, the stock price has suffered severely, especially if you look at the EUR price including the Rubel devaluation:

The current valuation looks attractive as with most Russian stocks:

P/E 4.2
P/B 0.8
Dividend yield 4,5%

Clearly, there are a lot of banks which have lower P/B Ratios, but Sberbank has, despite some volatility, shown ROEs of ~25% on average over the last 11 years (low: 3% in 2009, high 44% in 2001) combined with remarkable growth (in Ruble, EPS increased from 1 RUB in 2004 to 17, CAGR of 132%). This supports my thesis that banking in high interest rate countries is much more interesting than in low-interest rate environments.

What about current situation Russia ?

Standard and Poors just downgraded Russia from BBB to BBB-. This forced the Russian central bank to increase short-term rates from 7 to 7,5% after increasing it from 5% to 7% in March. Clearly, this will not support the currently weak economy in Russia.

And there is certainly a big risk that the situation in Russia and Ukraine gets worse. As with Sistema, the argument that it can get much worse before it gets better is clearly valid. Nevertheless, I think it will be difficult to really hit the bottom and as Mark Moebius has said “If you see the end of the tunnel it is already too late to invest”, I think investing when everyone expects worse to come is usually the better strategy with Emerging Markets.

What many people forget: Despite the big headline issues, from a financial point of view Russia looks very solid. Super low government debt (~15% of GDP), low consumer debt etc. Russia is a pretty “underleveraged” country, so the impact of devaluation, higher interest rates etc. on the economy are less significant than for instance in highly leveraged countries. Although certain Oligarchs may disagree for their personal portfolios….

Why a bank ?

Well, first of all, Sberbank is not a bank in Russia but the biggest bank of Russia. 52% of the voting rights are held by the Russian Central bank, so it is effectively Government controlled.

Investing into a bank is clearly a leveraged bet on the whole economy. If the economy tanks and debtors default, banks are getting hit hard. If the economy recovers, banks often profit strongly.

In Sberbanks case, I assume due to the ownership stake of the Russian Central bank that they will not have any funding problems in local currency. Clearly, getting dollars might be a little bit trickier, but Russia as a whole as Oil and commodity exporter should be USD positive.

Why Sberbank

Sberbank has quite good reporting in place including a brand new investor presentation. Interestingly, even in a 0% GDP growth scenario, they still project double-digit growth in loans.

The highlights of Sberbanks market position are:

+ 11x the number of branches of the next competitor
+ ~30-40% market share in all areas
+ one of the most profitable banks globally (ROA)

Clearly, there are also a lot of issues. Corporate Loan defaults could easily double or triple in a worst case scenario. Nevertheless, if they manage only a part of their ambitious goal (doubling their profit until 2018), the potential upside could be significant.

Other considerations

When looking at Russian companies, fraud, missing property rights etc. are always an issue. You can bet that in such a large organization like Sberbank a lot of fraudulent stuff is going on. On the other hand, es we have seen in 2008/2009 this is a general issue with banks in all jurisdictions. Sberbank has a history of fruads like this one or that one. Although if we compare that for instance with the two massive frauds at Citigroup’s Mexican subsidiaries it doesn’t look that spectacular.

Subjectively I would say that Sberbank is quite transparent compared to other Russian companies and that there were no obvious attempts to screw shareholders in the last few years.

One thing needs to be mentioned here: The Sberbank shares traded outside Russia are “ADRs”, American Deposit Receipts. I have no idea if somehow US authorities could seize those ADRs or do anything else to cause problems for ADR holders. I assume not as this would kill the ADR business but you never know.


Sberbank is stand alone not a “value investment” as there is clearly a risk of permanent loss in a very adverse scenario. However as a small part of an Emerging markets portfolio, I think it could be an interesting play on a normalization in Russia.

I will therefore invest a 1% portfolio position at around 5,80 EUR into Sberbank ADRs as part of my Emerging market basket (currently Sistema 1%, Koc 2,5%, Ashmore 2,5%).

Emerging markets: China & Hong Kong stocks

On my trip into the Emerging Markets space, I tend to favour the most “countercyclical” countries and markets. When I was looking for my next “target”, I was thinking: Ok, which country and which sector have the worst reputation right now (of cours after Russia/Ukraine and Turkey) ? The answer was pretty easy: Chinese companies. Consensus seems to be now that China is crashing rather sooner than later, so that might be a natural place to start (slowly) looking for opportunities.

China & Chinese companies

In general, I have been sceptical or “bearish” about China since around 2008/2009. So far, Chine has kept up better and longer than I have expected, at least based on the official growth figures etc.

A quick look a the chart shows that the Hang Seng Index is only at 50% of the peak valuation compared to 2007, so the “official” growth rates did not translate into rising share prices at all:

Mainland Chinese companies are even more “depressed” based on the chart as the mainland based, Shanghai composite index clearly shows:

Valuation wise, the markets look cheap but not dirt cheap:

Hang Seng:
P/E 10,4
P/B 1.4
Dividend Yield 3,47%

Shanghai Comp
P/E 10,2
P/B 1,3
Dividend Yield 2,95%

I have written in the blog a couple of times about Chinese companies listed in Germany which in my opinion are to a very large extent promoted frauds, for instance Powerland (2011) and the Asian Bamboo series. I have also written why I would never invest in Chinese companies , so did anything change ?

Just to be clear: I would still not invest into a German-Chinese company or a US listed Chinese company. Also I would have reservations about China ;Mainland companies, as I don’t think that mainland standards are comparable to anything I have experienced yet.

Why not just ignore China ?

Some people might argue that “staying in the circle of competence” would be the better and safer option. However, if you look at the German Mittelstand for instance, most of the growth comes from business in China and/or Southeast Asia. Ignoring China is in my opinion a big risk for any investor as the impact on almost any company is growing day by day.

Looking directly at Chinese or Asian companies in my opinion will add an important perspective for any investor in order to be able to analyse Asian operations of non-Asian companies as well.

Where to look then in China ?

From my current status of knowledge, I would make one exception to my “Anti China” bias: I do think that “traditional” Hong kong listed companies could qualify as an investment.

As some might remember, Hong kong belonged to the UK until 1997, when the control then was ceded to China. What is interesting in my opinion is the fact, that the legal system in Hong Kong is still British or very close to British. This is a quote form Wikipedia:

The Hong Kong judiciary has had a long reputation for its fairness and was recently rated as the best judicial system in Asia by a North Carolina think tank.[2]

Although Hong Kong had its waves of fraudulent “Mainland” Chinese companies , I do think that “traditional” Hong listed AND Hong Kong registered companies are “investable”. A funny quote from the linked article above shows the issues with Chinese mainland companies:

There is no extradition treaty between Hong Kong and the mainland making it hard to take criminal action for fraud.

So even the Hong Kong regulators cannot get their hand on mainland fraudster, so good luck to German investors in Kinghero, Ming Le sports etc. ……

A good history of Hong Kong company registration and listings can be found here: including the short histories of many of Hong Kong’s most famous companies. So a lot of Hong Kong companies have a long history against one can check how they treated their shareholders etc. which is lacking for many mainland companies.

Despite the British heritage, Hong Kong is clearly an Asian market with a lot of pitfalls, specialties etc. Many companies are run by “Tycoons” or “Tai Pans”, strong patriarchical characters with many links and connections between large Groups, listed and non-listed comapneis etc. To get a “flavour” of some of the more common issues in Asia, one can read for instance this document from 2009 called “Guide on Fighting Abusive Related Party transactions in Asia”. A little Gem out of this report: There are no insider trading charges in Indonesia…..

What I do like about major Hong Kong companies is the relatively high standard of reporting. I looked at some annual reports and many of them were very well written and informative.

Hong Kong specialities

Traditionally, the big Hong Kong conglomerates are mostly active in some kind of transportation, real estate or both and have branched out into many other areas.

The Hang Seng index company is actually calculating a special index for “Non China” Hang Seng companies called the Hang Seng HK35 index. The constituents are the following stocks which I think are a good start to analyze further:


Code Constituent Name
1 Cheung Kong
2 CLP Hldgs
3 HK & China Gas
4 Wharf (Hldgs)
5 HSBC Hldgs
6 Power Assets
11 Hang Seng Bank
12 Henderson Land
13 Hutchison
14 Hysan Dev
16 SHK Prop
17 New World Dev
19 Swire Pacific ‘A’
20 Wheelock
23 Bank of E Asia
27 Galaxy Ent
66 MTR Corporation
83 Sino Land
101 Hang Lung Prop
142 First Pacific
93 Cathay Pac Air
303 VTech Hldgs
330 Esprit Hldgs
388 HKEx
494 Li & Fung
522 ASM Pacific
551 Yue Yuen Ind
880 SJM Hldgs
1038 CKI Hldgs
1128 Wynn Macau
1299 AIA
1928 Sands China
1972 Swire Properties
2282 MGM China
2388 BOC Hong Kong

As many companies invest to a certain extent in real estate, one should now that most HK companies revalue their proporties through the P&L. So low P/Es are often a result of large property valuation gains which might not be sustainable. This is the first thing to check with any HK company.

What to look for in general

For further excursions into Hong kong, I will try to concentrate on companies which will (among others) have the following characteristics:

– transparent reporting & good track record with regard to shareholder orientation (e.g. dividends, share buy backs etc.)
– conglomerates with the majority of listed subsidiaries (sum of parts)
– no pure real estate companies
– significantly cheaper valuation than comparable US/European companies or clear discount to sum of part
– it would not hurt if some well known value investors would be among the shareholders

Two reading tips:

At the end of this first Hong Kong post, 2 reading recommendations. The first is from Mark Moebius and called “Passport for profits”:

This is basically the extended version of the “Little book of Emerging markets” which I reviewed a few weeks ago. Mobius started his career in Hong Kong and has some interesting Hong Kong stories in the book.

A second, more unconventional tip is the novel “Noble House” from James Clavell:

This massive 1.200 pages book written in the 1960ies covers the story of a CEO or “Tai Pan” of a big Hong Kong Trading house and his fight against another big trading house. The author lived in Hong Kong for a couple of years and the story seems to be based on two “real life” Asian companies, Jardine Matheson (now headquartered in Singapore) and Swire. Along a spy story, various murders etc., the book contains detailed descriptions of bank runs, bear raids, insider stock trading, non existent trading rules etc. Although the names were changed, many of the events in the book actually happened, for instance a bank run in 1965.

A good long read for a summer (beach) vacation.

To be continued…..

There is always something “on sale”

When I go home from work, it is usually quite late and I don’t have a lot of time for shopping, as shops close at 8 pm sharp.

The next store for me is actually a “Karstadt” branch, which has a nice but VERY expensive grocery department. The interior looks like this:

The stuff they are offereing is good quality but it is in general very expensive (like 2 times the price compared to a normal REWE), but they do always have some items on sale. In the sausage department for instance, they will have really good Parma ham at a good price one week, Serano ham the next week and “Südtiroler Speck” the next week. So if you are flexible, you can make a “good value” purchase despite the fact that the store on average is really expensive. The interesting thing about being flexible is that if you always go for the “on sale” item, which I do for instance also for cheese, you sometimes discover interesting new things. One of my favourite cheeses (goat cheese with cranberries) for instance is one which I would never had thought of buying before. But as it was on sale, I bought it and really liked it.

The big trick is not to buy (too much) of the expensive stuff. Sometimes you can’t avoid it, but if you have a plan and stick to it, my overall bill is relatively similar to a “normal” Supermarket and I often end up with new and interesting items.

If I would always buy the same item, for example Parma ham, my favourite ham, I would end up paying on average far too much or, if I would use a hard cap on price I would end up hungry on many days. In my case, buying nothing and being hungry often ends in eating really unhealthy stuff like chips and chocolate, so this is a rather “high risk” strategy.

So why am I writing about my shopping habits ? Did I run out of investment ideas or what

Well, I do think that the current stock market is, to a large extent similar to my Karstadt grocery department. There is no doubt that on average stock prices look very expensive. Especially my favourite “hunting ground”, quality small caps are on average really expensive, same as US blue chips etc etc.

On the other hand, if you look around a little bit further and allow some flexibility like in my Karstadt grocery store, there is almost always something on sale in the stock market. For instance in 2011/2012 when German small caps already looked very rich, I decided to look into Italian and French stocks (which I had never done before) and I was genuinely surprised how many “good value” stocks existed outside my native environment. Clearly, not every new item will be of good “Taste” as some of my early experiments with Greek and Italian stocks showed. But the gain of the positive surprises more than made up the items which were not to my liking.

Although it is much early to tell, my trip further away into markets like Russia and Turkey seem to confirm my theory. Those markets are clearly on sale, but at a first glance, it is an unusual taste. On a second glance, one is often surprised how good those companies are.

Here are, in no particular order, some areas where I think “on sale items” can be found:

– Emerging markets stocks (Russia, Turkey etc.)
– Eastern European stocks
– European utility stocks
– European financials (banks, insurance)
– Oil majors, oil service
– Dutch real estate companies
– “traditional” Hong Kong companies
– UK grocery companies
– shipping

Clearly, not everything on this list will turn out as “good value” and some of them might even be far over the “consume until” date. And none of them will most likely prvide you with a “quick double”. But medium term, 3-5 years, many of those areas will contain stocks who will provide more than ufficent return compared to their risk.

Coming back to my grocery example: Many of those “sale items” aren’t even in the sausage and cheese department, they might be in the fish or salad area or even at the vegetable stand. But if you are flexible enough to go home and eat a delicious “oriental bulgur salad” instead of cheese or Parma ham, you will not only make a good deal but gain an interesting perspective.

One advice however: if you try something new and exotic, don’t go all in and buy 3 kilo for the next two weeks. Just buy a small amount and look if it is your taste. At Karstadt for instance i ended up once with a pink fish egg paste which I really didn’t like at all. But as I had bought only a small portion, I just threw it away with no loss.

Back to the stock market: What I see at the moment is that many good stock pickers are going into cash because their favourite area has become to expensive. They “slavishly” follow Buffett’s advice to buy only what they know and wait for a crash in order to buy back their favourite shares at low prices. For me however this strategy resembles a little bit this well-known strategy:

Additionally, many investors seem to be influenced by guys like John Hussmann who claim to have statistical proof that nothing can be earned on average at the current valuation levels. Ignoring the fact that Hussmann’s performance numbers short, mid and longterm totally suck, I think the problem with all those “backtesting” gurus is that their market timing asset allocation look great on paper and charts but rarely work in practice.

I personally think that “contrarian, value based” stock picking without active market timing will beat any “asset allocation backtest” strategy over the long run. Especially for smaller investors, the coming years might be very very good years for stock pickers if one stays away from the beaten paths despite most likely weak returns for the overall market.

As a stock picker, I think times likes these are a great opportunity to expand one’s circle of competence and look for bargains outside your favourite areas as there might seem to be plenty available. As I said in the headline: There is always something on sale.

Quick MIFA update – How to “play” covenants

Disclosure: No position, for educational purposes only.

2 weeks ago I had a quick look at the troubles at MIFA, the German bicycle manufacturer.

The official version was that they had a short term problem with their accounting but no liquidity issues. This was the last paragraph of their press release in MArch:

MIFA expects to break even at the after-tax level in the first quarter of 2014. It will not be possible for the company to issue a reliable guidance concerning the full 2014 financial year until the preparation of the annual financial statements has been completed. The company has sufficient liquidity for its operating business.

So it was quite surprising that the company today, MIFA announced the following:

– The CEO is now gone forever
– they did a “sale-lease back” of their real estate to the local Government, raising 5,7 mn EUR

So to a certain extent they do seem to have liquidity issues, otherwise they would not sell their “last shirt” for cash. The more interesting part for me is the fact that “sale-lease back” is economically nothing else than a “secured loan” on the real estate.

Looking into the bond prospectus, the outstanding bond includes a so-called “Negative Pledge” covenant:

Der Emittent verpflichtet sich, solange Schuldverschreibungen ausstehen, jedoch nur bis zu dem Zeitpunkt, an dem alle Beträge an Kapital und Zinsen, die gemäß den Schuldverschreibungen
zu zahlen sind, der Zahlstelle zur Verfügung gestellt worden sind, keine Grundpfandrechte, Pfandrechte oder sonstige dingliche Sicherungsrechte (jedes solches Sicherungsrecht ein “Sicherungsrecht”) in Bezug auf ihren gesamten Geschäftsbetrieb oder ihr gesamtes Vermögen oder ihre Einkünfte, jeweils gegenwärtig oder zukünftig, oder Teile davon zur Sicherung von anderen Kapitalmarktverbindlichkeiten oder zur Sicherung einer vom Emittenten oder einer seiner Tochterunternehmen gewährten Garantie oder Freistellung bezüglich einer Kapitalmarktverbindlichkeit einer anderen Person zu bestellen, ohne gleichzeitig für alle unter den Schuldverschreibungen zahlbaren Beträge dasselbe Sicherungsrecht zu bestellen oder für alle unter den Schuldverschreibungen zahlbaren Beträge solch ein anderes Sicherungsrecht zu bestellen, das von einer unabhängigen, international anerkannten Wirtschaftsprüfungsgesellschaft als gleichwertig anerkannt wird. Dies gilt vorbehaltlich bestimmter Ausnahmen.
“Kapitalmarktverbindlichkeit” bezeichnet jede Verbindlichkeit aus Schuldverschreibungen oder ähnliche verbriefte Schuldtitel oder aus Schuldscheindarlehen oder aus dafür übernommenen Garantien und/oder Gewährleistungen.

The covenants do actually prevent them to take out a typical German “Schuldscheindarlehen” against their real estate. Interestingly, an economically equivalent sale-lease back (which will be booked as financial liability) doesn’t seem to violate this covenant.

Should for some reason, MIFA go bankrupt, the recovery for the bondholders will be significantly lower than before as the real estate now belongs to someone else and will not be part of any liquidation proceeds.

I find it interesting how easy it is to circumvent such covenants with economically equivalent transaction. A reason more to stay as far away as possible from German corporate bonds in general and the so-called “Mittelstandsanleihen”. There is no “seniority” of those senior bonds, those instruments are clearly “junior” capital for German corporates. Nevertheless, bondholders seemed to like it:

It will be interesting to see if today’s bounce in the bond price is similar to what happened at Praktiker when they announced their first “rescue” and the bond price doubled from 40% to 80% before then collapsing to close to zero. Or maybe the Indians are already on their way with big suitcases full of frsh money. Who knows ? But a lot to learn for bond investors.

Exotic Securities: Piraeus Bank Warrants (ISIN GRR000000044)


First of all a hat tip to Profitlich & Schmidtlin which had mentioned this idea in their first quarterly letter.

Piraeus Bank is one of the “survivors” of the Greek Banking sector. As with other Greek banks, the bank was “rescued” by the Government via a dilutive capital increase, with the Greek Government as a majority shareholder. Those private investor who participated in the capital increase got as a kind of “compensation” (and exit vehicle) some Warrants “for free” which allows them to buy back the shares until 2018 from the Greek Government. Those Warrant are traded quite actively on the Athens Stock Exchange.

Maybe in order to make it more fun, the Greek Government spiced up the Warrants with some extra features which are ( a kind of term sheet can be found here)

one Warrant gives the right to purchase 4,476 shares from the Hellenic Stability Fund (so its non dilutive”)
– the final maturity is 02.01.2018, however there seems to be a kind of “forced” exchange possibility on 02.07.2016
– the Warrants can be exercised every 6 months, so its technically a “Bermudan option”
– the strike price increases every 6 months after a predetermined formula

At a first glance, this “thing” seems to be really hard to value. Bloomberg for instance does not offer to value “Bermudan Equity options” in its standard option valuation tool (OVME).

Bermudan Option

Let’s take a step back and look at principal option types. The two classical types are:

European Option: This option can only be exercised at the final maturity date
American Option: This option can be exercised on every day during the term of the option

Nevertheless, there is normally very little difference in the value of an European option and American one if all other things are equal. The main reason for this is that in normal cases, the “time value” of an option is usually positive until the very last day. Exercising an American option early and “throwing away” the time value normally doesn’t make sense. For “normal” stock options, the only reason to exercise early would be a large dividend payment before maturity which will reduce the value of a (long Call) option, but in most cases one can ignore the valuation difference between an European and American option.

On the other hand, the increasing strike price of the Piraeus Warrant is economically equal to a dividend, so we cannot just ignore this feature and value it as a European Option.

This is the call schedule and the corresponding strike prices for the Warrant:

Call Date Strike Delta
02.01.2014 1,734  
02.07.2014 1,768 0,034
02.01.2015 1,811 0,043
02.07.2015 1,853 0,043
02.01.2016 1,904 0,051
02.07.2016 1,955 0,051
02.01.2017 2,015 0,059
02.07.2017 2,074 0,059
02.01.2018 2,142 0,068

From what I know, Piraeus Bank is not supposed to pay out any dividends in the foreseeable future. So in order to replicate the increasing strike, we could assume that the increasing strike is similar to a dividend assumption and we model this as an option with a strike of 1,734 EUR and dividends as shown in the column “Delta”.

Using the Bloomberg Option Valuation tool “OVME”, the same volatility and the assumption of a July 2016 maturity, the value difference between an European and American Option would be almost 20%, i.e. the American Option with the possibility to exercise at any day is 20% more valuable than the European one. This is due to the fact that I can basically wait until the last day before the synthetical dividend is paid an exercise then. So I don’t lose any time value and save myself the full dividend compared to an European exercise.

In our case however, I have to exercise 6 months earlier. With the OVME tool, I can for instance also calculate the value of an American vs. European Option for 6 months, “simulating” the time between for instance 03.07.2014 and 02.01.2015. For those 6 months, the valuation difference between an American and an European Option is only ~ 10%. Again, the “Bermudan” option is worth less than an American.

If I am actually in the last 6 months of the warrant maturity, the day after the last exercise possibility, the option will be exactly worth the value of a European Option. The day before it will be worth slightly less.

Anyway, as a very simple working assumption, I will assume that the “Bermudan” feature overall is worth 5% more than a European option.

Valuation of Piraeus Warrant

In order to value the Pireaus Warrant, we will have to make one further assumption: What is the final maturity ? If I understand correctly, the Greek Government has the possibility, to sell the shares after July 2016 without compensation to the Warrant holders if the Warrant holders do not convert. So as a realistic assumption one should use July 2016 as final maturity and not January 2018.

By the way, this “mechanic” of selling the shares without compnesation is a very strange featre for a Warrant.

In the following exercise I will use as the share price for Pireaus the level of 1.73 EUR, for the warrant 0.94 EUR (price at the time of writing)

As the first valuation steps, we can now do the following:

1) calculate the price of the warrant per share which equals the current traded warrant divided by 4,475. This would be 0.94/4,475= 0,21 EUR per share
2) “plug in” the price into the option calculator and solve for implied volatility (based on the current strike of 1.734 EUR and the “synthetic” dividends)

As a result we get an implied volatility of ~31.3% for the European Option, 26.2% for the American . This is rather at the low side for Piraeus. It is always a big question which volatilities to use, short-term (10 day) or longer term. Only 10 day historical volatility would justify such levels, trailing 305,50 and 100 day volatility is more in the 40-50% range.

We can now do a third step and

3) plug in for instance 45% as volatility and add 5% premium on the price of the European option to get to our value estimate. In this case this would result in a fair value of 0.33*1.05= 0.35 EUR per share or ~1.56 EUR for the Warrant. Compared to the 0,94 EUR per share, this would mean that the warrants trade at around 40% discount to their “fair value” which is quite significant.

So should one now run out and buy this undervalued security ? I would say: Not so fast, we need to consider at least one other factor

Potential shortening of maturity

The Greek Government as counterpart has quite a bad reputation for sticking to its terms. By googling a little bit, i found this quite revealing story from Reuters.

Two quotes here:

Some of Greece’s biggest banks and their advisors are starting to press the country’s banking rescue fund to look at ways to speed up their return to wider private ownership, banking sources say.

“They recognize that there are arguments to support the early retirement of the warrants,” he said, adding that the proposals would be favorable for the HFSF because it would no longer face a ‘cliff’ of all the warrants being exercised together.

However, any changes would have to be approved by the troika of European Commission, European Central Bank and IMF officials overseeing Greece’s bailout, who would be keen to make sure any changes did not disadvantage the HFSF or gift overly generous terms to the private investors.

In my opinion, this should make any holder of the Warrants really nervous. Currently, the Piraus Warrants do not have any intrinsic value, as the price of the share is below the strike. So all value is time value. With the option valuation tool we can play around a little bit with the maturity. Shortening the maturity (all other things equal) by 6 months for instance reduces the value of the Warrant by -10%, shortening it to July 2015 would reduce the value by more than -20%. The “break even” based on a 45% volatility would be some kind of “forced exercise” at the end of October 2014.

I do not know under which law the warrant has been issued, but if it’s under Greek law, then anything could be possible.

Valuation of Piraeus Bank

Finally a quick glance at the valuation of Piraeus Bank itself. Piraeus is currently valued at around 1,2 times book value. This is on a level with banks like Standard Chartered or Banco Santander, high quality diversified banks. However this is much higher than other domestic or regional players like for instance Unicredit (0.74) , Intesa (0,84), Credit Agricole (0,64) or even HSBC (1.05).

So without going into much detail, Piraeus bank looks rather expensive and a lot of recovery expectations seem to be priced in already.


At a first glance and under some critical assumptions, the Piraeus Warrants do look undervalued by around 40% based on historical volatilities and the price of the Piraeus share. However there seems to be significant risks, that the terms of the Warrant could be subject to change with a negative impact on the warrant. ALso the valuation level of Piraeus bank itself looks rather optimistic.

I would not want to own the Warrants “outright”. For someone who is ale to short the shares, a delta hedged position could be interesting in order to “harvest” to low implied volatility, although there would still be the risk of the change in Warrant terms.

I haven’t looked at the other Greek banks where similar warrants have been issued.

Some Links

Highly recommended: First Quarterly report of the new “Profitlich-Schmidlin” fund with short summaries of all positions (in German). Interesting portfolio and interesting strategy. Good luck !!

Short write up on Aggreko, an interesting UK company

Great story how stock picking legend Julian Robertson seemed to have lost it in 1996

Old School Value with a short thesis on Weight Watchers, a favourite among many value blogger. For a long thesis for instance look here.

Mebane Faber has developed a new ETF which invests into the 10 cheapest countries globally

Conference notes from the 2014 Value Investing congress in Las Vegas can be found here. As always, Zeke Ashton’s case looks interesting, although his BMW pitch looks pretty similar to that one from RV Capital a few months ago.

For all those who are desperately waiting for the next crash: A short overview of 240 years of financial crisis

Book review: “Flash Boys” – Michael Lewis

Following the current hype, I read over the weekend the new book “Flash boys” from Micheal Lewis.

Michael Lewis is most likely the best “writer” of finance books and the new book is now exception. As in most of his books, he focuses on specific person who are usually some kind of outsiders.

In this book, the focus is mostly on an equity trader named Brad Katsuyama who stumbles over the fact that he is not able to make a profit any more in equity block trading at his old job at Royal Bank of Canada (RBC).

Step by step he discovers more and more details how so-called “High Frequency traders” (HFT) are able to exploit tiny timing advantages to squeeze out riskless profits from big orders. This goes as far as HFT companies paying loads of money for direct fiber connections and for the privilege to put their machines directly next to the stock exchange computers in order to get any “micro second” advantage they can get.

In HFT, suddenly knowledge about how computer signals are being transmitted are becoming more important than any kind of fundamental knowledge about stocks, so he assembles a team of TelCo and computer experts in order to understand what is going on.

AFter Katsuyama discovers that the markets are pretty unfair, he decides to quit RBC and starts to build a new, slower and fairer stock exchange called IEX which does not allow HFT to conduct their strategies.

Lewis weaves in 2 other stories, one from an entrepreneur who digs out a fiber optic line between Chicago and the east cost and the other, which Lewis had already published separately in 2013 about Serge Aleinikov, the Russian born Goldman Sachs programer who got tracked down and arrested for stealing computer code.

In my opinion, the book is written very well and despite being an easy read, is pretty helpful to understand what is going on in the HFT area.

Lewis covers specifically the time difference arbitrage between the fragmented US exchanges, which interestingly became only possible because of regulation which was targeted to prevent abuse but backfired.

To a lesser extend, he also touches the issue that at US exchanges, professional players can use hundreds of different order types which gives them a big advantage. SOme f them seem to work that they seem to offer a certain price but when you want to buy, they suddenly disappear and/or get more expensive. Finally, he also looks at the so-called “dark pools” of the banks where a lot of trades are made without any transparency for clients.

Personally, I do think that HFT creates certain issues as seen in the Flash Crash some years ago. But overall, I do not have the feeling that HFT is the only reason why the market is “rigged” as Lewis implies in many parts of the book.

For instance, algorithmic or program trading is much older than high frequency trading. People atbank equity desks like Katsuyama used those algos to trade their large orders before. Those programs created nice profits for the banks without much risk. Usually, a client would give a “VWAP” order to the broker, who then would bill the client the VWAP, but would execute the trade via an intelligent algo who would make sure that the bank would make a profit. I actually met I guy once who had programmed such an algo for Lehman in the 90ties. The profits from this algos and the resulting bonuses for him allowed him to retire in his 40ties.

What those HFT shops seem to do is to “sniff out” the algos of the banks and then trade against them with lightning speed and exploit their weaknesses. In my opinion this is also one of the reasons why the banks created their “dark pools”.

As a little guy, I do not care that much of an extra penny or so per trade.I pay substantial fees in any case and trade once or twice a month. A flash crash for me is a non-event as I just sit it out. For me, “market rigging” comes much more in the form of things like low ball take-overs from Private Equity shops with CEO consenting and getting big bonuses, unfair minority shareholder provisions, stock lending fees in ETFs with an unfair fee split, classic insider trading, “adjusted” earnings etc.etc.

So as a summary I would say: It is a very entertaining book and HFT is clearly an issue. However for the “small guy” which gets referred to quite often in the book, there are a lot more other issues in the market. HFT for me seems to be rather an issue for banks and institutional investors than for a little guy with a “slow trading” stock portfolio.

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