Monthly Archives: April 2014

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.

Performance review March 2014 – Comment “P/E is not equal P/E”

Performance March

Performance in March was +0,5%, slightly better than the -0,8% for the Benchmark (Dax 30%, MDAX 20%, Eurostoxx 50 30%, Eurostoxx small 20%). YTD the Portfolio is up +6,9% against +2,4%. Interestingly, the driver for the BM return ist the Eurostoxx small index with a +7,9% performance YTD whereas the MDAX, one of the best performing indices in the world for the last few years is actually slightly negative.

In the portfolio, positive contributors were primarily Thermador (+9,2%), SIAS (+6,9%) and TGS Nopec (+3,9%). Additionally, I was very lucky with my short-term EM timing. KOC is up +14,2%, Sistema +7,9% and Ashmore +5%. However I expect that those positions will be very volatile so nothing to celebrate here. The biggest looser was Vetropack with -6,5%.

In general, the portfolio clearly profits from the current big hype on European small caps. I think in many cases, valuations imply already a fair amount of recovery in the Euro zone which might happen or not. On the other hand, the fundamental upside in many cases seems to be somehow exhausted, so I will remain on the selling side in some cases such as the reminder of SIAS. For my “French” bucket I am still comfortable as fundamentals for “my” stocks are keeping pace with stock price increases.

Portfolio activity

In March, Portfolio activity went back to “normal” pace, with one new position, Sistema (1%) and the sale of a half position of SIAS. Cash level is now ~15%. The current portfolio can be seen here as always.

Comment – “P/E is not P/E”

Quite a number of very clever investors are very negative on the stock market and expect a “real crash” rather sooner than later. This starts with famous guy like Seth Klarman, John Hussman over to a lot of very clever people I know personally.I am not a big fan of trying to read the “sentiment” of the market, as this turns into second guessing and I prefer to do “primary” research.

The idea of trying to get out before the crash, wait for the bottom and then invest cheap sounds pretty logical. Avoiding the crashes would have generated significant alpha over the last years. “Buy low, sell high” sounds like the most easiest thing in the world. So why are “we” investors not all rich and living on our private Islands in the Caribbean Sea ?

In my experience, there are several problems with this approach, one of the simplest is the following:

Many pundits look at past P/Es and try to “datamine” a strategy like: Sell if P/E is above 30, buy if P/E is below 8. It is no problem to come up with an algorithm, which, based on past data will show you a bullet proof strategy. But, surprise surprise, more often than not, this will not work.

A simple example why such data mining exercises often result in “spurious correlation”: P/Es are not absolutely “fixed” numbers. As everything in life, P/Es have to be seen in relation to other things.

I would assume that many people agree that the “intrinsic value” of any financial asset is the sum of the future cashflows discounted by the appropriate discount rate. Clearly prices can fluctuate around that value widely, but over the long-term, prices more often than not follow value.

The “appropriate discount rate” again, is the sum of the risk free rate (as a proxy the 10Y treasury yield is often used) and the stock specific equity premium.

The arithmetic relationship between discount rate and “intrinsic” value is relatively easy: All other things equal, the lower the discount rate, the higher the intrinsic value. It doesn’t matter if the risk free rate goes down or the stock specific equity premium, a lower discount rate means higher intrinsic value. Full stop.

So as a fun exercise, let’s look at a virtual company which generates 10 mn EUR profits per year with an assumed growth of 4% until eternity. Let’s further assume the correct equity premium for this company is 6% and does not change over time.

So now let’s look at 3 data points for the “risk free rate”, the historical 10 year USD Treasury rate:

30.09.1987: 9,587%
31.12.2000: 5,112%
31.12.2013: 3,012%

The “intrinsic” value of our virtual company at those 3 points in time would be:

30.09.1987: 10/(9,587%+6%-4%) = 86,3 or a P/E of 86/10= 8,6
31.12.2000: 10/(5,112%+6%-4%) = 140,6 or a P/E of 141/10= 14,1
31.12.2013: 10/(3,012%+6%-4%) = 199,5 or a P/E of 195,5/10= 19,6

SO if at all those 3 points in time, the company would trade at a P/E of 20, in the first case the company would be overvalued based on intrinsic value more than 2 times, in the second case by 37% and in the last case this virtual company would be fairly valued at a P/E of 20.

Clearly, my virtual company is unrealistic as growth rates change, equity premiums are not constant etc. etc. But I think the point is clear: No matter what, arithmetically, the “fair” P/E is higher when interest rates are lower. So a P/E of 20 from 1987 with interest rates at close to 10% is NOT EQUAL to a P/E of 20 in the current interest rate environment. All the P/E “mean reversion” analysis in my opinion is pretty meaningless if it doesn’t take into account interest rate levels.

Although many people don’t like it, but this simple aspect is covered nicely by the so-called “Fed model” which basically calculates the “P/E for bonds” and compares it with the P/E for stocks.

One could now start a discussion that interest rates are artificially low and have to go up and therefore P/Es will come down. But then we are already at a much better level of understanding tahn simply stating “PEs are too high and they have to come down”.

So to summarize this quickly: Looking at historical P/Es without taking into account then prevailing interest rates is pretty useless. Even more useless is the attempt to create “timing” models based on stand alone “P/E mean reversion” models. They might look good on paper but will most likely not work in reality. Although it makes nice headlines and blog posts.

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