Quick check: Grindeks AS (ISIN LV0000100659) – P/E 4.9, P/B 0.6 Baltic value or “red flag” alert ?
Via my “home forum”, someone brought up the Latvian Pharma company Grindeks AS. The company looks similar form the business model to Hungarian company EGIS and Croatian Krka which I covered some months ago
Valuation wise, the stock looks like a clear “no brainer”:
Market cap: 62 mn EUR (at ~7 EUR per share)
P/E trailing 4.9
ROIC, ROE, net margins all solid “double digit” numbers. My own, mechanical “Boss Score” would indictae a fair value of at least 3 times the current market cap.
The only issue coming up is the fact that the company never paid a dividend.
There is also a quite obvious reason why the stock is cheap: The majority of sales goes to neighbouring Russia, which clearly is not very popular with investors these days. As I do not have an issue with this “Headline risk” as long as I get compensated accordingly, I looked into the annual report 2013 in order to find out more.
As with Australian Vintage, I scan the report for unusual or problematic things first.
In Grindeks case, I was puzzled by a quite unusual balance sheet position called “Advance payments for financial investments “ something which I haven’t seen before. The explanation in the notes says the following:
In 2012 the Company has signed purchase agreement with Dashdirect Limited regarding purchase of the controlling interest in the equity of HBM Pharma (Slovakia). As of the date of signing these financial statements the agreement is partly completed. The main activity of the HBM Pharma is production of the medical substances. As of December 31, 2013 the Company’s and Group statement of financial position contains advance payments related to the before mentioned purchase agreement in the amount of EUR 11,670,000. The Group management is certain that this deal is going to be finalized during 2014.
In my experience, it is not uncommon to take over M&A targets in several steps, but it is quite uncommon to pay money first and get nothing in return. A few days ago, Grindeks issued another news item which covered this strange transaction.
The numbers look OK, Grineks seem to pay only 6 times P/E of the target company. However another sentence looked strange:
Orders of JSC «Grindeks» make up about 30% of the total “HBM Pharma” s.r.o. turnover
So they are buying a company where they are the biggest customer anyway, also strange. So I decided to google a little bit and found this:
On July 8, 2010 Lithuanian-domiciled Central and Eastern European (CEE) specialty pharmaceutical company Sanitas, AB sold its 100% shareholding in subsidiary HBM Pharma s.r.o in Slovakia to Latvian company Liplats 2000, SIA. HBM Pharma was primarily engaged in toll manufacturing activities and the entity has been sold with all of its existing toll manufacturing contracts. As previously announced, sales, marketing and regulatory divisions in Slovakia and the Czech Republic were separated from HBM Pharma and retained in Sanitas Group prior to the divestment.
Sanitas acquired HBM Pharma (previously named Hoechst Biotika) from Sanofi Aventis in July 2005.
So a Latvian company called Liplats 2000 bought HBM in 2010. Googling further, I found this document on HBM’s website, describing a cross border merger between Liplats 2000 and HBM. The most interesting part of this document ist the last line in the final page: From Liplats side, a guy called Kirovs Lipman signed.
Now Kirovs Lipmans happens to be the majority shareholder of Grindeks. So effectively, Grindeks is buying this M&A target from theit majority shareholder (and former CEO). This is from Grindeks annual report:
Kirovs Lipmans – Chairman of the Council Born in 1940. Kirovs Lipmans has been the Chairman of the Council of “Grindeks” since 2003. Simultaneously K.Lipmans is also the President of the Latvian Hockey Fede
ration, the Member of the Executive Committee of the Latvian Olympic Committee, the Chairman of the Board of “Liplats 2000” Ltd. and JSC “Grindeks” Foundation „For the Support of Science and Education”, the Chairman of the Council of JSC “Kalceks” and JSC “Tallinn pharmaceutical plant”, also the Member of the Council of JSC “Liepajas Metalurgs”. Graduated from the Leningrad Institute of Railway and Transport
So to summarize it at this point: Grindeks never paid any dividends but makes a major acquisition and pays money upfront to a company controlled by the majority shareholder, without any disclosure of this potential conflict of interest.
Of course, theoretically, this could have been an “arm’s length” deal with no disadvantages for Grindeks, but the probability that something is “fishy” is quite high, combined with the fact that they never paid dividends.
Maybe I am too cautious here, but an undisclosed significant “related party” transaction is a big red flag for me.
Coincidentally, Grindeks also issued Q1 numbers a few days ago which didn’t look good. Sales in Russia tumbled. This seems to be a very Grindeks specific problem, as for instance Krka showed strong Russian sales in Q1 despite the “Russian crisis”.
Just to be clear: A “red flag” doesn’t need to be the ultimate “value driver”. Reply SpA is a good example. Since my “red flag” alert, the stock made a whopping 276% return.
For me, Grindeks is, depsite the attractive valuation, an absolute no -go. Undisclosed related party transactions combined with a lack of dividend makes this a speculation rather than a value investment. I don’t know if there are Corporate activists in the baltics, but this would be a good target. Additionally, they seem to have some specific operating issues as well, so no buy, watch only.