value and opportunity

Uniper /E.On Spin-off

In David Einhorn’s latest letter to investors he mentions the following:

We purchased E.ON (Germany: EOAN) in the fourth quarter of 2015. When EOAN spun out Uniper (Germany: UN01) in September, we kept the UN01 shares we received at €10.02 in thetransaction and sold the balance of our EOAN stake at a modest loss to redeploy that capital into additional UN01 shares. We believe the market does not appreciate the earnings stability o fUN01’s power generation and natural gas logistics assets. Further, the incoming management team is incentivized and has committed to cost-cutting, which will create a powerful cash flow profile. We own the company at 6x our 2017 earnings estimate.

So looking back this was a smart move. Although Uniper’s stock price came back a little bit, Einhorn is still up like 35% and has done clearly better than holding on E.On:

Looking back, I clearly did make a mistake not buying the stock after the spin-off. This was what I wrote back then:

But it could be an interesting short-term special situation, similar to Osram. If they start trading significantly below my fair value estimate (<15 EUR per share) I will allocate 1-2% as a special situation depending on the price.

but then this:

UPDATE (9.9.2016)

After a lot of input via the comments & Email, I also lower my buying threshold for Monday. The fair value range seems to be rather in the 9-12 EUR range. So buying prices would be rather in the single digit range like 7-8 EUR. Let’s wait and see, this will be VERY interesting.

In this case I was really not strong enough to follow through on the idea. For spin-offs the general rule really seems to be if everyone hates it, then there is a very high probability that the stock price might be undervalued in the beginning. The same lesson could be observed with Osram.

So memo to myself: Succesful Spin-off investing has nothing to do with finding “great companies” but potential mispricing. 

So in my internal sparring match against David Einhorn, I would say that this is clearly one point for him .It is however interesting to mention that his initial thesis (E.on will go up if nuclear decommissioning gets resolved) did not play out.

Upcoming Metro AG / “Ceconomy” Spin-off

Metro AG, the German Cash & Carry company has also decided to split into 2. If everything goes according to plan. the company plans to split into 2 companies after its annual shareholder meeting on February 6th.

Looking at the stock chart we can see that Metro didn’t create a lot of shareholder value over the last 20 years.

The company will split into the (more attractive) “new Metro” which will comprise the Cash & Carry markets and the super market chain Real. Those two businesses account for more than 2/3 of Metro’s earnings. The old Metro will rename itself into “Ceconomy” and represent the consumer electronics retailers Mediamarkt & Saturn.

The ugly duck: Ceconomy

In this case it clearly looks like that “Ceconomy” not only is burdened with an idiotic name but also with a business which is not an easy one in the age of Amazon.

The reason for the spin-off is most likely the result of long struggle with the founder of Mediamarkt, Erich Kellerhals. Kellerhals still owns around 22% of Media Saturn and had a public dispute with Metro over many years how to run Mediamarkt/Saturn.

In my opinion, the spin-off is now the only way how Metro can get rid of Kellerhals. It will be interesting to see how long the big shareholders of Metro (Haniel) will keep the “Ceconomy” shares and if Kellerhals, a billionaire will try to get more control of Ceconomy.

Clearly Ceconomy is the ugly duck in this Spin-off situation. The cash and carry business has roughly twice the EBIT margins of Mediamarkt/saturn and is still growing whereas the Consumer Electronics business has been stagnating over the years.

The only advantage of the Ceconomy business is that they seem to have a better “ROCE” than the Cash & Carry business, but the ROCE declined quite significantly last year (page 36 in the annual report) and I am not sure how to define it

More details about Ceconomy can be found in the “Demerger” documentation.

Main points of interest from my side:

1. Trailing EPS for the Ceconomy share will be only 0,14 EUR/share (page 164), but htere seem to be significant one-offs, especially with regard to tax assets
2. EBIT for 100% of the business was 312 mn EUR, however they claim that there were 150 mn EUR “one-off items”
3. They expect additional costs for the stand-alone company of at least 20 mn EUR per year
4. Ceconomy will inherit around 800 mn (IFRS) pension liabilities, but no net debt if I read it correctly
5. Ceconomy will own ~10% of the new Cash and Carry business as “extra” asset. I am not sure why but this could relate to property transfer taxes
6. There is not really good material available for investors. Only a short text describing the transactionshort text describing the transaction but nothing more.

Ceconomy Quick and Dirty valuation:

As a peer group, I think Best Buy in the US and Dixon’s Carphone might be the closest peers. Without deeper research I would use BBY’s EV/EBIT of 6 and Dixon’s EV/EBIT of 11 as a valuation range (Metro currently trades at 7,8 x EV/EBIT unadjusted)

Assuming 400 mn EBIT for 100% of the underlying Mediamarkt business, the lower bound for a valuation would be an EV of  (6×400*0,8)= 1,92 bn.

If we deduct pension liabilities with a market value of ~1 bn, this would leave us 1 bn equity value for the business +10% of the value of the cash and Carry business. If the C&C will be worth 9,5 bn (current MEtro market cap is 10,5 bn), this would add another 1 bn to Ceconomy’s equity value.

With 327 mn shares outstanding, this would translate into ~6,20 EUR per share as a lower bound value for Ceconomy under my (very rtough assumptions).

It think at or below this price, Ceconomy could be an interesting “Ugly duck” spin-off investment.

Preference shares

Metro has a pretty small number of preference sharers outstanding (2,7 mn) compared with 324 mn ordinary shares. The preference shares trade at ~15% discount. If I understood everything correctly, the new Metro will also have ordinary and preference shares, so one preference share of the old Metro will turn into one preference share of Ceconomy and one preference share of Ceconomy.

It will be interesting to see how the discount will behave after the spin-off. Maybe there is an opportunity to buy into one of the parts at an interesting discount via the less liquid preference shares.

Summary:

There is clearly more work to do, but to some extent, the Metro Spin-off and especially Ceconomy looks similar to Uniper. A really ugly duck which, at the right price could represent an interesting special situation investment.