Monthly Archives: February 2015

Book review: “Good to Great to Gone: The 60 Year Rise and Fall of Circuit City” – Alan Wurtzel

Circuit City was the largest consumer electronics retail chain in the US in the 1990s and 2000s. The stock was a super star performer and the company even made it into Jim Collin’s book “Good to Great” as one of the best companies in the US.

In 2009, Circuit City filed bankruptcy. The book now describes the full story from the founding in the 1960s to the fall in 2009. The book is written by Alan Wurtzel, the son of the founder Sam Wurtzel, who also served 13 years as CEO from 1973 to 1986 and as a board member for couple of more years until 2001.

So clearly his story about the company is not as neutral as a “normal” author might have written it but he states that at the very beginning of the book.

Pretty early in corporate life, around the 1970s, Circuit City (then called Wards) had already an existential crisis as their previous business model (mostly selling to “department like” stores in larger stores) stopped to work. They then completely changed strategy. In the 1970s to the 1990s they perfectly rode the wave of consumer electronics with their “super stores” which relied on sales via dedicated sales professionals working on a commission.

Then, starting in the mid 2000s, Circuit City lost track, especially against Best Buy and had finally to file for bankruptcy in 2009. Funnily enough, Best Buy had its own crises but somehow recovered.

Wurtzel is very critical on his successors, especially that they never really used the cashflow for improving stores but rather did share buy backs and acquisitions.

The unique aspect of the book in my opinion is that the author very much focuses on strategic planning and the interaction between Management and the Board. He describes in very good detail what kind of strategical mistakes were made by the management and how the board failed in challenging and correcting the flawed strategy. There was a lot to learn for me and I think it would be interesting for people who regularly speak to management. Just asking how they handle strategy might get some surprising results. Wurtzel for instance is of the opinion that an annual strategy process tends to become “mechanical” and inefficient and that strategy should only updated on a 2 year basis.

The book is also a reminder that retail is a very difficult industry. Retailers can grow very quickly and profitable, but if something changes profoundly in the competitive landscape, turning around businesses becomes difficult. In Circuit City’s case, the larger self-service Best Buy stores seem to have been the nail in the coffin. Circuit City never got up to really take a big investment and completely remodel the stores. Instead, in order to keep investor happy, they used the cash to buy back stocks. Wurtzel correctly points out that stock buy-backs make only sense if you have “truly” free cash flow. If you just avoid or shift necessary Capex, then buying back shares is not a good idea.

Circuit City also had a very strong corporate culture, especially with regard to its sales personal. The problem with that culture was that it also seemed to prevent the shift to a non-commission, self-service structure like Best Buy. So yes, strong culture is a competitive advantage, unless it prevents a necessary change in the business model. Interestingly, Circuit City started a used-car dealership called CarMax based on the same prinicpals which was spun off from Circuit City and still is doing well (14 bn USD market cap).

The Circuit City story reminds me a little bit about Tesco. Tesco also tinkered around little by little in its stores in the UK while they didn’t fully realize the threat of the discounters. Let’s wait and see how they will do.

In any case, I can highly recommend this book to anyone who is interested in the retail industry and/or company strategy.

P.S.: There is even a documentary on the rise and fall of Circuit City called “The tale of two cities”. Some clips of that movie can be viewed on Youtube here.

Svenska Handelsbanken vs. Deutsche Bank – what to look for when investing in banks

Many value investors are of the opinion that banks are not investable. Either because they say the business is too complex or because they think banks are doomed anyway. Maybe due to the overall low valuations of banks, I get regularly requests on writing about how to value bank,s so at least some people seem to be interested. The greatest value investor of all obviously has no problems with investing into banks. Wells Fargo is the biggest position of Buffett at around 26 bn USD and he holds various other bank assets like the Bank of America Warrants.

A few days ago, a good friend recommended me to look at Handelsbanken from Sweden as an example how a well run bank should look like.
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Update Gronlandsbanken – result and annual report 2014 & Danish interest rates


Gronlandsbanken has just released 2014 numbers and its 2014 annual report. 2014 results look solid: ~50 DKK profit per share, roughly 6% more than in 2013. The dividend remains at DKK 55 (dividend is paid out of pretax income). ROE has remained high at 16,3%. The result would have been even better if Gronlandsbanken would have not increased reserves. This is the quote from the annual report:

The result before value adjustments and write downs of DKK 148,6 million is the Bank’s best basis result so far. This is of course satisfactory. It is at the same time above the last announced results expectation of a result before value adjustments and write downs in the upper end of the range DKK 125 – 145 million. The result before tax returns 16.3% on year start equity after dividend.

This was achieved against a slight drop in Greenland’s GDP which I find quite remarkable. The stock market seemed to have “anticipated” those results to a certain extend as the stock price shows:

The balance sheet is still super rock solid with an equity ratio of 19% (of total balance sheet, not risk weighted assets or some similar shenanigans).

My initial investment thesis 2 years ago was the following:

– as it is the only bank in Greenland, its margins are around twice as high as the best global banks and the balance sheet is rock solid. One could call this a natural moat
– even based on the current state, current valuation implies significant upside to fair value
– the Greenland resource story could add significant growth going forward, even with maybe other banks entering Greenland
– finally, Management has started to buy shares after surprisingly good Q3 numbers
– although there is no direct catalyst, an indirect catalyst could be if some of the projects proceed well and Greenland will move into the spotlight. Gronlandsbanken is the easiest (and only) way to invest into Greenland without project specific risk

One of the issues of course is that most of the natural resources projects look a lot less likely to happen than 2,5 years ago.The annual report is as always a great resource to see what is going on in Greenland. Most projects seem to be on hold or cancelled, the only remaining interest is from China:

Among the larger projects, it has become obvious that virtually only Chinese investors continue to show a certain interest. The BANK of Greenland considers it likely and quite naturally, that the funding can come from China. Chinese enterprises are often the leaders in processing for further use in either Chinese, American, or European industry.

Especially the oil sector has been hit hard:

The prospects of the oil area are more dismal than of the mineral area. After Cairns test drilling in 2010 and 2011, oil exploration in Greenland is now greatly reduced, see Figure 8. The stagnation of the exploration in both the oil and the mineral area is expected to continue over the next few years, even though new licenses have been issued and the preparatory work is continuing in 2014 as well.
The declining interest in oil exploration is a.o. due to large oil and gas discoveries in other places, and the fall in the oil price . Of importance can possibly also be the administration and regulation of the area so far have not been regarded as sufficient by several persons in the industry.

So the bad news is that within my initial time frame of 3-5 years, I will not see any large mining or oil projects in Greenland. The upside might be that the incentive for other banks to enter Greenland will be most likely quite low.

Interest rates

However, another thing happened which was not on my radar screen: Denmark went from having low-interest rates to negative interest rates. This is how 3 month local swap rates developed:

dkk ir

Just as a reminder: Swap rates are “unfunded”, that means based on contracts where no principal changes hands. If we look at “funded” rates, so how much money Danish banks pay for actual deposits, the situation is much more dramatic:

dkk fund

So just to put this in context: If you want to deposit money for 3 months at a Danish bank for 3 months in DKK, they charge you -1,6% p.a. for this “service” !!!!

Impact on Gronlandsbanken:

One thing about Gronlandsbanken which I liked initially but what could be a problem going forward is the following: Gronlandsbanken has a significantly higher deposit base than loans outstanding. While this is good from a liquidity and risk point of view, it is bad because those excess funds have to be invested somewhere and in local currency.

I am not sure if Gronlandsbanken could actually charge for deposits locally, so the risk is there that they get squeezed on the amounts not loaned out to customers. They seem to have anticipated this and increased their bond holdings, but still, at year end 2014, roughly 20% of the balance sheet is potentially exposed to this potential “Negative carry” problem.

On the other hand, as a EUR investor being invested into a DKK security exposes me to a “positive Black Swan” similar to the CHF/EUR move in January. If something goes horribly wrong in the EUR zone, there might be some upside in holding DKK denominated securities.

Addtitionally, any Danish pension fund and Insurance company will struggle to find income producing assets in DKK. With a dividend yield of (gross) of around 8%, Grondlandsbanken should be not unattractive and therefore support the share price in the short term.


The underlying business of Gronlandsbanken has done surprisingly well in 2014 despite a lackluster economy. Due to the carnage in natural resource prices, the implied “resource option” has been postponed some years into the future, making the investment case less attractive compared to 2,5 years ago.

Ultra low and negative interest rates could make it more difficult for deposit-rich banks like Gronlandsbanken to maintain their interest margins. As there are not that many alternatives at the moment I will continue to hold the stock for the time being, as it also functions as a kind of “Euro Black Swan” hedge. If I find other interesting finaincial service stocks, Gronlandsbanken would be the first one to be replaced as I think that my other financial holdings (Kasbank, Van Lanschot, NN, Admiral) have a better risk/return ratio.

I will also monitor closely if and how the negative rates will feed through Grondlandsbanken’s Q1 results.

Why on earth is Seth Klarman investing 1,7 bn USD in Cheniere Energy (LNG) at 7x P/B ?

In my book review “The Frackers”, I mentioned one of the stories in the book was about Cheniere Energy:

Finally, there is a fascinating side story about the guy who is running Cheniere Energy, Charif Souki. His great idea was to import natural gas into the US and he raised several billion USD to build a huge gasification plant on the gulf coast. He clearly did not see fracking coming and his investment was worthless. Nevertheless, he was able to raise another few billion bucks and retool the facility in order to export natural gas.

This “double or nothing” gamble seems to have paid off. Seth Klarmann by the way, has just doubled its stake in Cheniere, making it their biggest public listed position at around 1,7 bn USD.

Seth Klarman

Seth Klarman is a famous value investor running Baupost Group a 25bn USD hedge fund. In contrast to Buffett, Klarman very seldom gives interviews and his fund commentaries are hard to get. Hi is considered to be the “heir” of Benjamin Graham and still sticking to the “cigar butt” approach of deep value investing. Two years ago in a Charlie Rose interview, Klarman made the following comment:

Baupost’s leading man says that he buys “cigar butts” at cheap prices. Warren Buffett used to also do this. The difference between the two legends is that Klarman stayed focused on cigar butts while Buffett’s process morphed into buying great companies at great prices and then into paying so-so prices for great companies.

Klarman does many things ordinary investors can’t do, like buying defaulted Lehman stuff etc. Not many of his investments are public and not all of his public investments are successes. Nevertheless it is clearly interesting to look more deeply into his biggest public position, Cheniere Energy.

Cheniere Energy

Cheniere’s stock chart shows the “unusual” history of the company:

Just as a side remark, somehow this chart reminds me of this funny animal:

Looking at Cheniere’s latest quarterly report, we can clearly see that Seth Klarman’s days as Graham style “net-net” investor seem to be over. Cheniere has currently around 7,5 bn net debt and 2,3 bn equity. Based on a market cap of around 17 bn USD, this is a P/B of roughly 7 times so hardly a bargain investment based on this metrics.

On top of that, the company never made a profit in its life as this table with EPS since 2004 clearly shows:

02/21/2014 FY 13 12/13   -2,2
02/22/2013 FY 12 12/12   -1,6
02/24/2012 FY 11 12/11   -2,6
03/03/2011 FY 10 12/10   -2,3
02/26/2010 FY 09 12/09   -3,8
02/27/2009 FY 08 12/08   -6,0
02/27/2008 FY 07 12/07   -3,6
02/27/2007 FY 06 12/06   -1,5
03/13/2006 FY 05 12/05   -0,9
03/10/2005 FY 04 12/04   -0,6
N.A. FY 03 12/03   -0,4

So the question is clearly: What does Seth Klarman see to make this his biggest publicly disclosed investment ?

The best analysis I found was the one at Value Investor’s Club (accessible with guest login) from 2013, where the stock was trading at a third of the current price (Klarman bought between 60-70 USD). There is also a good article in Forbes from 2013 about the story behind Cheniere from 2013.

I try to summarize the case in a few bullet points:

– natural gas is very cheap in the US due to fracking and multiple times more expensive especially in Asia
– despite high costs, it is a pretty good business to liquify natural gas in the US and ship it to Asia in order to earn the spread
– Cheniere is in the process of finishing its first gasification plant by the end of the year 2015 and will then start to produce reliable cash flows as it has already contracted out its full production capacity for 20 years to major energy companies

The most important point is however the following quote from Forbes:

Cheniere’s Sabine Pass facility got its approval from the Department of Energy to export to any country in the world two years ago. It is so far the only facility to be cleared to export to countries that do not have a Free Trade Agreement with the U.S. And getting a non-FTA permit is a make-it-or-break-it approval for these projects, because there’s only one big gas-importing country (South Korea) with a free trade deal with the U.S. Unless a facility can export to the likes of Japan, China and India, the economics likely won’t support a multibillion-dollar build-out.

Cheniere had the luck to be the first to get this license. Later on, mostly due to the pressure of US based energy users, the US Government declined to issue further LNG “non FTA” export licenses for some time. According to Cheniere’s latest investor relation presentation, in 2014 two more “non FTA” licenses have been granted but Cheniere clearly has a head start.

Many more export facilities in the US would lead to higher prices in the US and to lower spreads compared to Asia, but for the time being, Cheniere’s primary LNG facility could be viewed as the typical “toll bridge” for US natural gas on its way to off shore destination as the other two licensed projects are still to be completed in several years time.

Cheniere itself is trying to further expand its current facility by 50% and they are projecting another site, but both projects have not yet received their license.


Replacement value

Despite buying at 7 times book, the question is: Could it be that Klarman is buying below replacement value ? I think it is unlikely. EV is around 25bn, stated book value of the assets is around 8 bn. Liquification facilities are not that hard to construct. all you have to do is to call someone like Bechtel and sign a turn-key project. Ok, you need the land and the permission, but overall this seems to be manageable in the US. So without going into more detail, we can assume that the current valuation of Cheniere is clearly above replacement value.

Valuation based on future cash flows

The VIC author estimates around 4-6 USD per share distributions for Cheniere’s shareholders going forward based on the first 4 trains of the initial liquification project. I have not double checked this but I will assume this number of being correct.

Reading through the roughly 15 pages of risk factors in Cheniere’s 2013 report, I would not call this a risk free business.There are still a lot of moving parts and operational risks even if the whole facility is up and running. Cheniere’s public bonds in the operational subsidiary trade at around 5,5% yield p.a. So discounting equity cash flows at the HoldCo level should be higher than that.

A) Existing facility and licence & contracted cash flows only

Cheniere has fixed contracts for 20 years. In the following table I have calculated NPS for the above mentioned EPS range and different discount rates, based on the assumption that one gets those earnings for 20 years and after that nothing (for instance any future earnings have to be applied to retire the debt):

eps/discount rate 4 5 6
6,50% 44,07 55,09 66,11
7,50% 40,78 50,69 60,83
8,50% 37,85 46,73 56,08
9,50% 35,25 43,17 51,81
10,50% 32,92 39,96 47,95
11,50% 30,84 37,05 44,46

We can clearly see, that the contracted amounts at the existing facility will not be enough to justify the current valuation of around 70 USD.

B) Existing facility, indefinite cashflows

This is the table with an indefinite stream of earnings at various discount rates:

eps 4 5 6
6,50% 61,54 76,92 92,31
7,50% 53,33 66,67 80,00
8,50% 47,06 58,82 70,59
9,50% 42,11 52,63 63,16
10,50% 38,10 47,62 57,14
11,50% 34,78 43,48 52,17

Even with an indefinite time horizon, Cheniere does not look like a “bargain stock”.

C) Existing facility + 50% capacity increase, contracted cash flows only

eps/discount rate 4 5 6
6,50% 66,11 82,64 99,17
7,50% 61,17 76,03 91,24
8,50% 56,78 70,10 84,12
9,50% 52,87 64,76 77,71
10,50% 49,39 59,93 71,92
11,50% 46,26 55,57 66,69

D) Existing facility +50% capacity increase, indefinite cash flows

eps 6 7,5 9
6,50% 92,31 115,38 138,46
7,50% 80,00 100,00 120,00
8,50% 70,59 88,24 105,88
9,50% 63,16 78,95 94,74
10,50% 57,14 71,43 85,71
11,50% 52,17 65,22 78,26

The 4 scenarios show relatively clearly that only with including future non-contracted cashflows and additional, not yet approved capacity, the stock looks interesting. In order to satisfy the return expectations of Klarman, which should be 15-20% p.a.based on his track record, he must assume further cash flows for instance from the second site Cheniere wants to contruct at some point in the future in Corpus Christi. Plus, there should be no dilution etc. from raising the rquired gigantic amounts of capital.

Maybe he is betting that the stock will trade like a bond if the company starts paing dividends ? Or is he leveraging the investment with addtional debt ?

In any case, he seems to be paying a lot for future, uncertain cash flows, which contradicts his “we still do cigar butts” statement. This is not that different from what Buffett is doing when he is paying rather expensive prices for great companies. At least for a guy with a portfolio size like Seth Klarman, the time of “cigar butt” investing seems to be over. Even he must feel th pressure that you cannot charge 2/20 for holding cash.

So to answer the question from the beginning:

Why on earth is Seth Klarman investing 1,7 bn USD in Cheniere Energy (LNG) at 7x P/B ?

I have no real idea but it might be the case that Klarman somehow need to put money at work and he expects this investment to be uncorrelated to general market as he has been quite pessimistic on equities for some time.


For me, Cheniere at current prices is clearly one for the “too hard” pile. Klarman of course can spend a lot of money and time to fully analyze the energy markets etc. although as we know now, most energy experts have a hard time to make meaningful forcasts. But still it doesn’t look like a bargain and clearly no “cigar butt” or “net-net” kind of investment.

Funnily enough, analyzing Cheniere makes me much more confident in my Electrica investment. At least to me, the risk/return relationship there is some magnitudes better than for Cheniere. I think I will upgrade this to a full position over the next few days.


Some other stories I found about Cheniere

Some links

Arte documentation (German) how Amazon disrupts publishing (h/t Blicklog). wants to attack Amazon. The founder has sold to Amazon and worked for 2 years “inside”.

Tesla seems to be ready to produce batteries which will power your home

Pat Dorsey abandons somehow moats and is betting on managers instead. With his new German investment Aurelius AG, he might be betting on the wrong guy….(MS Deutschland bond scandal).

Highly recommended: Damodaran on the mess that is Petrobras

Ed Morse, one of the very few who predicted the drop in oil prices, expects much lower prices in the next few months

And finally, based on the “overwhelming demand”, a few pictures from a recent skiing trip (Austria, Warth/Lech):


IMG-20150212-00160 (1)

“Quick and dirty” portfolio risk management

In my January performance review, I made the following comment:

Overall, if you don’t have an active opinion on interest rates (which in my opinion you shouldn’t), one should make sure that the overall exposure of the portfolio is as neutral as possible with regard to interest rates. This sounds easier than it actually is. For some companies (insurers) it is relatively easy to see how their exposure is to interest rates. For others, it is much harder. But in my opinion, just checking business models against the influence of interest rates is a very worthwhile and value creating exercise.

Checking a portfolio against interest exposure (or any other exposure) involves 2 basic steps:

1) You have to make a judgement how businesses are effected by the exposure (positive, negative, neutral)
2) You have to aggregate those exposures over your portfolio

Complex or keep it simple ?

In institutional environments, risk management departments are usually staffed by legions of math or physics Phd’s which employ very complex modelling tools in order to both, come up with exposures and aggregate them. There are a myriad sophisticated risk management techniques available. Monte Carlo analysis, correlation modelling etc. etc. can be combined to come up with great looking distribution charts showing portfolio exposures against a multitude of factors.

The problem with such sophisticated models is that the outcomes are often not stable and outcomes change a lot if some inputs are changed only slightly. In many cases those models develop into your typical “black box” where people do not understand any more of what is going on and how the results are actually creates and no one dares to ask.

This is the reason why I personally think that one should prefer simple and easy to understand models even if they lack most sophisticated tools. Maybe the results are not 100% accurate but at least one can understand them.

A very simple way to analyze and aggregate interest rate exposure

For step 1), I use a very simple heuristic based on capital intensity and sector:

– banks and insurance companies a clearly negatively effected, the more traditional the business model, the more negative the impact
– capital-intensive business or real estate related stuff usually profits most from low-interest rates
– capital light businesses are relatively neutral
– any longer term fixed income investments will do very well

For step 2), I then attach a score ranging from +1 (low-interest rates are very positive) to -1 (very negative) to each position and multiply it with the percentage of the portfolio.

This is how this would look for my current portfolio:

Name Weight Impact low interest rates Weigt
Hornbach Baumarkt 4.3% 0.5 0.02
Miko 4.3% 0 0.00
Tonnellerie Frere Paris 6.1% 0.5 0.03
Installux 3.6% 0 0.00
Cranswick 3.0% 0 0.00
Gronlandsbanken 2.5% -0.75 -0.02
G. Perrier 4.5% 0 0.00
IGE & XAO 2.1% 0 0.00
Thermador 2.6% 0 0.00
Trilogiq 1.5% 0 0.00
Van Lanschot 2.4% -1 -0.02
TGS Nopec 4.7% 0 0.00
Admiral 4.6% -0.5 -0.02
Bouvet 2.4% 0 0.00
KAS Bank NV 4.5% -0.75 -0.03
Emerging Market     0.00
Koc Holding 1.2% 0.5 0.01
Ashmore 4.2% -0.25 -0.01
Depfa 0% 2022 TRY 3.0% 1 0.03
Romgaz 2.5% 0.5 0.01
Electrica 2.6% 0.5 0.01
Drägerwerk Genüsse D 4.9% 0.5 0.02
DEPFA LT2 2015 5.1% 0 0.00
HT1 Funding 4.2% 0.5 0.02
MAN AG 2.4% 0.5 0.01
NN Group 2.8% -1 -0.03
Citizen Financial 2.8% -0.75 -0.02
Cash 11.3% 0 0.00
Overall IR exposure     1.2%

The resulting score will be between -1 (totally negative) to +1 (in aggregate positive).

Overall, based on my initial judgements, my portfolio looks pretty neutral vs. low interest rates. Clearly this is no scientific approach and I would not get any academic grades for this, but still, just doing the exercise in my opinion makes a lot of sense and makes you think about your overall portfolio exposures.

Once you have created this spreadsheet, it can be used with additional columns also to look at exposures like Oil prices or EUR crisis scenarios.

Some links

Always a good read: Rob Vinall’s (RV Capital) annual letter featuring US based Credit Acceptance Corp. as major new investment

Don’t miss the new issue of Graham and Doddsville featuring among others Bill Ackman and Corsair Capital

Very good (long form) post on the future of television networks vs. Netflix, Amazon & Co

GMO’s Q4 letter contains an intersting part on oil, fracking etc. from Jeremy Grantham. He references this NYT article on oil by Daniel Yergin which is also a good read.

Some (Australian) perspectice on iron ore and China

AlphaVulture has a very unique perspective on Amaya, the new online poker power house. It could actually be a rather interesting short opportunity.

WertArt has discovered closed end Italian Real estate funds. Something to look at more closely…..

Performance review January 2015 – Comment: “Life in zero gravity”


In January, the portfolio gained +3,38%. That looks good stand-alone but pretty weak against the +8,1% of my Benchmark (Eurostoxx50 (25%), Eurostoxx small 200 (25%), DAX (30%),MDAX (20%)) for January.

[EDIT: the first version of the post stated +4,14%, that was a mistake as well as the 3,54% from the second version. Somehow my spreadsheet got screwed up]

Looking at all 5 Januaries since I run the portfolio, one can see that a 4% performance difference in January rather seems the rule than the exception:
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