Monthly Archives: June 2014

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
P/B 0,59
P/S 0,6

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.

Performance review May 2014 – Comment “Leave the driver in the bag”

Performance May

May was a strong month for the Benchmark (Eurostoxx50 (Perf.Ind) (25%), Eurostoxx small 200 (25%), DAX (30%), MDAX (20%)) with a gain of 3,2%. The Portfolio made 0,8%, an underperformance of -2.4% in May. YTD, the portfolio is up 9,2% against 5,3% for the benchmark. Interestingly, the portfolio was up every single month this year whereas the benchmark only was positive in February and May.

Best performer in May were the 2 Russian stocks (Sberbank +21,2%, Sistem +20,4%), Koc Holding (+8,6%) and Cranswick (+5,6%), loosers were Portugal Telecom (-12% without dividend), IGE & XAO (-5,4%) and TGS Nopec (-5%).

Portfolio transactions May

Major transactions in May were:

– Sale of second half of the Sias Position at 8,75 EUR (and missing the 5% rally in the last 2 days…..)
– Purchase of TRY 2020 Depfa Zerobond
– Increase of LT2 Depfa 2015

Cash is now at ~10% plus the 5% in the LT2 Depfa 2015 which I consider “cash equivalent”. The portfolio as of May 31st can be seen as always under the “Current Portfolio” page.

Comment: “Leave the driver in the bag”

Anyone who plays golf (yes, I play as well but badly….) likes to swing with the biggest club, the driver. If you hit the ball right, you hear a satisfying sound like “Ziiiinggg” and the ball goes really far. The problem ist the following: For most golfers it is quite difficult to control the direction. On the other hand, especially for players with high (bad..) Handicaps, you need the distance in order to have a fair chance for a good score.

More often than not, especially if you play on older golf courses, you are faced with a similar view from the tee-off:

Trees to the left, trees to the right and only a very narrow fairway and you cannot see the flag. If you hit the ball into the trees, you might not be able to find it and you get a penalty, destroying your chances on a decent score. Or you find the ball, but you need several strokes to get out of the trees again.

The much more reasonable strategy for an average golf player is to use a shorter club where the distance is much shorter but you have better control on the direction. Yes, if you hit the driver straight, you will be much better off than with the iron, but ane iron gives you a much higher probability to stay on the fairway. For professional players, this is a quite common problem. Especially if you play tournaments over 4 days where every stroke counts, one bad hole (out of 72) can kill the whole tournament. So professional golf players have to be pretty good in probablilities. They have to assess constantly what club gives them the overalll probability to get the best total score from any situation.

So why do I tell this “golf stories” ? The answer is easy, an investor is facing the almost same problems than a professional golf players. You can make really risky investments, like for instance a concentrated position in an expensive growth stock which would be the stock equivalent of a driver. Or a super cheap “deep value stock” with management problems and a high debtload. Great upside potential but also big risk the end up in the “trees”. As in golf, the investment environment plays a big role in deciding what amount of risk to take. When markets are cheap in general, then taking risk makes more sense as you are facing a nice and wide fairway.

If valuations are high and a lot of strange things are going on, you might want to leave your driver in the bag and use the investment equivalents of short woods or irons, like smaller positions and more defensive stocks.

The current market environment, especially in the “developed” markets with low yields to me looks very similar to the narrow fairway from above. Relatively high valuations, experiments from central bankers etc etc. in my opinion is faced best with a more “controlled” game, like smaller position more diversification, a prudent cash position and uncorrelated risks. Otherwise the risk of permanent loss of capital and missing the “Cut” is real.

What we actually see in the markets is currently the opposite. Especially pension funds, insurance companies and sovereign wealth funds are “taking out the big clubs” by increasing the risk of their portfolios to compensate for low yields. Suddenly real estate, private equity, high yield corporate bonds and illiquid infrastructure loans are considered perfect investments for conservative pension funds and life insurance companies. Those investors are betting fully on being able to “Control the driver” whereas in reality they might not even had a practice swing before. In my opinion there is a high risk that many or most of those investors will find themselves “in the trees” at some point in the future and cursing themselves for not being prudent before.

So my advice for anyone would be: Now is not the time to “swing for the fences”. Try to stay in the middle of the investment fairway with controlled (and known) risk taking. Don’t take badly priced illiquidity risk and/or credit risk. Don’t buy badly managed companies or troubled business models with concentrated position. On the other hand, don’t stop “the game” completely but play patiently and wait for the “wide fairways” i.e. low valuation environments in order to bring out the driver again.

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