Search Results for: kpn

Short cuts: EGIS, Hornbach/Praktiker, Rhoen Klinikum, KPN


This is from a broker report issued end of September by “Wood & Company”_

During the brief analysts’ conference call yesterday morning, Servier stressed two points: 1) regardless of the acceptance of the offer, Servier plans to delist the shares; and 2) Servier’s HUF 28,000/sh offer is final and will not be revised.
The minimum threshold to trigger a squeeze out under Hungarian regulations is 90%, which means that Servier needs acceptance from 79.63% of the outstanding free float, or 3.043m shares.
Regardless of the acceptance of the offer, Servier still intends to call an EGM to delist the shares from public trading, a step that requires a 75% majority of the votes cast; to block the delisting would require an absolute minimum of c.1.32m votes against, or c.35% of the free float.

Read more

Short cuts: IVG, KPN, ThyssenKrupp


Friday night or Saturday is always a good time for another “breaking” news item about the IVG restructuring. This time they came out with an outline of the restructuring plan.

As expected, equity and hybrid capital are effectively wiped out. What I found highly surprising however is this part:

Further, it is, inter alia, envisaged that SynLoan I and the convertible bond will both be transferred to the company by way of a contribution in kind with 100% of their respective face amounts (so-called debt-to-equity swap), which would lead to a quota-ratio of these two creditor groups’ share in the stated share capital of 80% (SynLoan I) to 20% (convertible bond).

This is a great surprise that although collateralized, the Syn loan I is treated “pari passu” with the convertible. I do not fully understand this, but maybe the collateralization has happened to late (and too close to potential bankruptcy) and would have been invalid in case of bankruptcy. This explains the price jump in the convertible this morning I guess.

As usual in such cases, I am surprised that the equity is still valued at 35 mn EUR.


Interesting development at KPN: After KPN decided to sell its German Eplus subsidiary, Carlos Slim canceled the “stand still” agreement and is now bidding for KPN. I think this will be interesting to watch, as KPN surely doesn’t want to be acquired. I am pretty sure, they will come up with some defences like poison pills etc. Nevertheless I clearly sold out too early . I think I underestimated the “calros Slim” angle here.


ThyssenKrupp might be an interestign “special situation in the making”. Last week, Berthold Beitz, the 99 year old industrialist who efefctively controlled ThyssenKrupp via the Krupp foundation, passed away. Rumours about an accelerated capital increase are emerging.

It is interesting to see in the shareholder structure that a lot of German inevstors got out (Deka, Union) and Anglos Saxon investors got in in the last few months. This could become really interesting.

Quick update KPN – Sold rights & stock

Today I sold, both the KPN Shares and the rights .

All in all, I got around 2,91 EUR (1.68 for the shares, 1.23 EUR for the rights) which results in a gain of ~ 11.5% before trading cost. Quite a nice outperformance against the AEX with ~ 3.5% in the same time period.

Nevertheless, this was clearly a “bumpy ride” as the chart for the rights shows:

The optimal timing would have been to buy on the second day of the trading period. I guess this was the result of the very short time period between announcement of the terms and the start of trading.

I heard that for instance US investors were completely taken by suprise and couldn’t actively trade the rights.

Main reason for selling was that I was not sure if I want to exercise the rights and I have some other, in my opinion better ideas in the pipeline. Also I am not really optimistic about KPN in the long term.

In general, those “deeply discounted rights issues” are interesting special situations for a short term trade but have to be handled with a lot of care and patience …

Someone asked me why I don’t show annualized returns for my single portfolio stocks. In my opinion, annualized returns for single stocks are pretty meaningless. The KPN Trade would have been an annualised 280% but what does such a number say ? As my investment strategy includes a lot of “sleeping” stocks, I think that showing annualized returns on single stock level do not provide any benefit at least not for me. Much more interesting than an annualized return per stock is the potential gap between the current price and intrinsic value.

Bad research KPN edition (and why my readers are a lot smarter than professional analysts)

This is “research” directly from Bloomberg:

KPN NA: 2.74 TARGET: 2.20-2.40
April 25, 2013
We recommend shorting KPN on the share issue announcement. The equilibrium price is Eur 2.04/share and the stock price should trend toward this level in the near future.
Equilibrium Price = (price pre-cap raising announcement x # shares + price cap raising x # shares) / total # shares.
The shares were trading at around 4.0 pre-announcement and there were 1.431 bn shares outs.
The company is issuing 2.84bn shares at 1.06. This works out 2.04/share. Let’s imagine that thanks to the cap raising the
fundamentals are slightly better now than they were before, and we set our target at 2.20-2.40, or 10-20% lower than the current price. The stock should be sold/shorted.

Let’s look at their “formula”:

Equilibrium Price = (price pre-cap raising announcement x # shares + price cap raising x # shares) / total # shares

“Wow, they are professionals and have a formula, this must be right” was my first thought and I briefly thought that I have made a mistake. Although I had a nagging feeling that the formula (or the application of it) was not right.

Enter readers JM and Martin in the comments of the last KPN post:

26. April 2013 um 09:57 | #8 Antwort | Zitat | Bearbeiten
ok…I join the game. When the capital increase was announced the share price was Euro 3,1…so 3,1+1,06+1,06/3 = 1,74. If the dust settles this share price is my personal target…more I do not expect .

26. April 2013 um 10:35 | #9 Antwort | Zitat | Bearbeiten
The day BEFORE the capital increase was announced, the stock price was 4.10 EUR.

26. April 2013 um 10:55 | #10 Zitat | Bearbeiten
price today 1,56
discount 24,7%
As there were cost for KPN real economic discount is somewhat lower.

Martin and JM (by the way, thank you for your many helpful comments) are using the very same formula, however with one big difference: They compare the result with the stock price AFTER the rights have been split of.

So the question is: Who is right ? The “professional” reasearch on Bloomberg or the comments on my amateur blog ?

Well, if you are a KPN shareholder before and KPN would sell the new shares directly to new shareholders at 1.03 EUR per share, then of course the old shareholders would be massively diluted.

In reality however, no one is able to by the shares directly at 1.03. You can only access those cheap new shares by buying the subscription rights which have been giving to the old shareholders as compensation for the dilution.

So the big mistake made by the “professional” analyst was that he somehow forgot to account for the subscription right. as the subscription right was worth 1 EUR pr share, suddenly an overvalued share according to the “professional” is an undervalued share.

How can a “professional” be so stupid ?

My guess is that the “analyst” mixed u a rights issue with an issue of shares without rights. Companies usually can issue a certain amount of shares (usually max. 10%) directly to new shareholders without any rights to old shareholders.

In those cases, the announcement is usually made shortly before the trading day starts and then the formula above is applied to the price the day before and the price for the new shares.

Nevertheless it is really embarrassing for any institution that such a mistake slipped through and this report gets actually published on Bloomberg

Applying the formula to a rights issue

The “formula” rests on 3 critical assumptions:

1) The price of the shares on the day before the announcement is exactly the right (and efficient) price. There was no information out there before about the capital increase

2) Nothing happened in between

3) the additional capital will not create any additional value

I think all three assumptions are quite difficult to hold for the KPN rights issue. Talk about the issue started already in September last year, so at the time of the announcement (Feb. 5th), the stock price reflected already a part of that.

Also, the time period between announcement and pricing of the issue is quite long with 6-7 weeks.


It is amazing, how bad some of the “professional” research actually is. In that case the analyst used a formula without accounting for the subscription rights. However this also shows that in those situations, the price discovery might be not fully efficient.

I wouldn’t put too much faith into the “formula”, as the application towards rights issues really stretches the implied assumptions.

KPN rights issue: Final terms

I have covered KPN as a potential “deeply discounted risghts issue” special situation in the past.

Today, KPN announced the final terms for their rights issue (bold marks mine):

2 for 1 rights issue of 2,838,732,182 new ordinary shares at an issue price of EUR 1.06 for each ordinary share
• Issue price represents a 35.1% discount to the theoretical ex-rights price, based on the closing price of KPN’s ordinary shares on NYSE Euronext in Amsterdam at 24 April 2013
AMX has committed to subscribe for the Rights pro rata to its current participation in the issued share capital (excluding treasury shares) of 29.77%
Record Date for Offering is set at 25 April 2013 at 5.40 pm CET
Exercise Period runs from 9.00 am CET on 26 April 2013 until 3.00 pm CET on 14 May 2013• Rump Offering (if any) is expected to take place on 15 May 2013

What I find very remarkable is that there is only a very short time period between announcement of the terms and the start of the trading of the rights. Basically they announced today and trading starts tomorrow.

For the portfolio, I will start with a 1% investment as a rather “short term” special situation based on current prices of around 2.61 EUR per share. Lets wait and see how that one works out.

Short updates: Rhoen, KPN, HT1 Funding

A few short updates which i think are worth mentioning in a post:

Rhoen Klinikum

One of my “special situations”. My original thesis behind this was that it is a solid company with a lot of interested suitors. Just today, the Fresenius CEO stated in WSJ Germany that they are still interested.

So this is still a solid, uncorrelated speculation that something could happen any time.

As one part of their capital raising effort, KPN issued two Hybrid bonds last week, 1.1 bn EUR at 6.125% and 400 mn GBP at 6.875%. According to Bloomberg, both bonds seem to have a “change of control” clause, meaning the bonds have to be paid back if someone becomes majority shareholder of KPN. This is quite uncommon for hybrids and looks a little bit like a “poison pill” against Carlos Slim.

Additionally, I found that rating review from Fitch (via Reuters) quite interesting.

KPN is facing some headwinds in the Netherlands. A fourth entrant plans to set up a 4G network (Tele2) and there seems to be a potential 2 bn liability from a subsidiary called Reggefiber, where KPN currently seems to have a 41% share but will soon have the majority.

Commerzbank HT1 Bond

Commerzbank just released news that they plan to increase share capital by 2.5 bn EUR and paying back their silent participations. This is not so nice for shareholders, but very good for HT1 holders as more equity is now “below” the subordinated capital, reducing downside risk.

So not surprisingly, the price of the HT1 bonds increased significantly.

Quick KPN update

Today, KPN came out with an interesting press release regarding the capital raising activities.

In my opnion, there were 2 surprises:


The capital raise to be supported by AMX will consist of a EUR 3bn rights issue and, in addition, issuance of hybrid capital instruments which are expected to receive partial equity recognition. Through this combination KPN intends to achieve the targeted EUR 4bn equity equivalent capital. The proceeds of the capital raise will be used to reduce KPN’s net debt level and to continue to invest in KPN’s operations.

In another comment I read that they are planning to issue 2 bn EUR Hybrid, bringing the total volume to 5 bn EUR. I was not sure why they were going for 4 bn before, now I am even less sure why the want to raise 5 bn. I have the feeling that I might be missing something here. The Hybrid will be much more expensive than a senior debt even at junk level.

The second surprise is the following:

AMX has committed, subject to certain conditions, to participate in the rights issue and subscribe for newly issued ordinary shares in KPN pro rata to its current participation in the total share capital of KPN. Subject to market conditions, KPN intends to issue the hybrid capital instruments during the course of 2013.

So Carlos Slim has committed to pay his share, but under some conditions. The conditions contain, among others

– 2 supervisory board seats for Carlos Slim
– a “stand still”, Slim promised not to increase his share above 30%

The second point however is then basically taken away with this point

In case of an announcement of an offer for any outstanding share capital of KPN or an offer for a material subsidiary of KPN the standstill may immediately be terminated by AMX;

So I am not sure why they negotiate a “stand still” with Slim which can be broken any second by him.

Finally the timing has shifted back into April as the extraordinary shareholder meeting has been cancelled:

The Annual General Meeting (“AGM”) has been scheduled to take place on 10 April 2013, for which a notification will follow. The matters which had been scheduled for the Extraordinary General Meeting (“EGM”) on 19 March 2013 will be included in the agenda of the AGM; the EGM scheduled for 19 March 2013 is hereby cancelled.

The market seems to have hoped that Carlos Slim would block the capital increase. This is the only explanation why the stock price fell almost 10% on this release:

Interestingly, 2 large hedgefunds (Marshall Wace, GLG) disclosed -0.6% short positions in the last few days.

So summing up:

– I even understand less why they want to raise 5 bn expensive capital
– Carlos SLim is not going away

I will stick to my initial plan and wait until the details of the rights issue are released. In between I will lean back and watch the show….

A few more thoughts on KPN (potential deeply discounted rights issue)

As discussed last week, KPN might become a potentially interesting “special situation” because of its announced massive equity raising.

In any case it makes sense to look a little bit deeper into KPN, even if it would be only a “short-term” special situation invest.

Relative valuation

let’s look at some standard valuation metrics:

Name P/B P/E Dvd Ind Yld EV/EBITDA T12M EV/MC
KONINKLIJKE KPN NV 1.88 6.47 3.81 3.80 3.79
DEUTSCHE TELEKOM AG-REG 1.46   8.04 4.28 2.22
BELGACOM SA 2.30 9.45 7.74 4.98 1.26
FRANCE TELECOM SA 0.76 5.63 17.49 3.81 2.60
BT GROUP PLC   9.78 3.26 5.02 1.41
VODAFONE GROUP PLC 1.23   5.67 8.20 1.34
TELIASONERA AB 1.72 9.51 6.56 7.28 1.35
PORTUGAL TELECOM SGPS SA-REG 1.55 17.25 15.71 5.43 3.23
SWISSCOM AG-REG 5.05 11.92 5.49 7.09 1.39
TELECOM ITALIA SPA 0.55   6.39 4.11 3.99
TELE2 AB-B SHS 2.20 13.92 6.91 5.95 1.34
TDC A/S 1.54 8.99 11.23 5.39 1.69
TELENOR ASA 2.53 41.85 4.20 5.65 1.20
TELEFONICA SA 2.19 7.37   5.29 2.41
ILIAD SA 5.04 42.03 0.27 11.09 1.14
TELEKOM AUSTRIA AG 2.53     3.75 2.39

KPN looks relatively cheap based on some metrics, especially P/E and EV/EBITDA. However we can also see that KPN is one of the TelCo companies with the highest debt loads. I used here´EV divided by market cap, but one could also use simple debt/equity ratios.

What is interesting to see is for me that despite the very weak performance of the sector, price/book is still relatively high for most of the companies. I think this is a result of the high dividends being paid by the TelCos which “eroded” book equity.

KPN history

In the case of KPN, things look a little bit different. If we look at this first set of numbers, dividends don’t’ seem to be the problem:

31.12.2002 -3.94 #N/A N/A 1.83
31.12.2003 1.11 #N/A N/A 2.90
31.12.2004 0.72 0.16 2.69
30.12.2005 0.66 0.40 2.36
29.12.2006 0.79 0.48 2.19
31.12.2007 1.42 0.52 2.51
31.12.2008 0.77 0.56 2.18
31.12.2009 1.33 0.63 2.36
31.12.2010 1.15 0.73 2.23
30.12.2011 1.06 0.81 2.05

If we exclude 2003 (which contained the losses from the 3G licence excesses), KPN paid out only ~45% of its earnings as dividends. So what happened ?

This becomes clearer if we look at the next tabel, which shows free cash flow, net debt per share and outstanding shares:

FCF p. Share Net debt per share Shares outstanding
31.12.2002 1.17 4.99 2,491
31.12.2003 1.08 3.37 2,491
31.12.2004 0.91 2.90 2,410
30.12.2005 1.16 3.82 2,151
29.12.2006 1.31 4.32 2,036
31.12.2007 1.35 5.92 1,843
31.12.2008 1.21 6.32 1,714
31.12.2009 1.23 6.56 1,629
31.12.2010 1.54 7.45 1,573
30.12.2011 1.66 8.46 1,478

So we can easily see that until recently, KPN looked like the classical “anglo saxon style” shareholders dream: Fat free casflows used together with increasing debt to repurchase around 40% of their outstanding shares since 2003.

If you would take Charlie munger by his words, KPN should have been an excellent “Cannibal company”.

Looking at the stock chart, this seemed to help KPN to outperform for instance Deutsche Telekom for a long time, but now finally they both seem to have met at the bottom again:

So one lesson one can learn here is that being a “cannibal” company does not mean automatically that this will be a good investment. Based on a rough calculation, KPN had purchased around 10 bn EUR of its own shares between 2003 and 2011, nevertheless, the market cap of the company remained more or less constant over this period in time.

So looking back, this share repurchase looks rather like a debt financed liquidation than a value enhancing share buy back.

Debt profile

Having so much debt, it makes sense to look at the maturity profile of KPN.

Payments Principal Only
Year Amt(Mln)
2013 1,085
2014 1,400
2015 1,000
2016 1,250
2017 1,000
2019 1,046
2020 1,000
2021 1,250
2022 750
2024 700
2026 473

The table shows, that KPN has quite some debt to roll. So far they still have investment grade ratings (Baa2 from Moody’s, BBB- from S&P). Moody’s has them on negative outlook, S&P on stable.

The problem seems to be S&P. Despite having a BBB- rating on long term debt, S&P has them as “A-3” short term, which is the second worst rating available in the short term rating scale. This means effectively that KPN is shut out of short term financial markets as there are only a very small number if institutions permitted to buy such low grade paper. Even Telekom Italia still has an A-2 rating.

Especially the December S&P report clearly outlines some of the most important weaknesses of KPN. An interesting aspect is that one:

That said, the group is facing intense pressures on its domestic mobile revenues in particular, owing to the cannibalization of consumer revenues by IP-based instant messaging applications.

I have read that several times, that mobile carriers made most of their money with SMS. Now however, applications like “What’s App” are eating their lunch because they just use the internet flat fee, effectively eliminating the need to send SMS. As always, the established players were much to slow to react to this threat and I guess that now it is already to late.

KPN seemed to have identified this threat quite early and according to this article tried to increase fees for those services, but this actually resulted in a backlash called “net neutrality”. So The Netherlands and Chile are now the only 2 countries with full “net neutrality” which means the following:

The new law requires companies providing access to the Internet to treat all Internet services equally. They cannot favor their own services, nor charge extra to access a competitor’s service.

I guess this is one of the reasons why they earn higher margins in Germany as number 4 than as market leader in the Netherlands.

Another interesting point here:
If one reads the S&P anaylsis carefully, their major issue seems to be the 1.5 bn spectrum purchase which they think seems to be expensive. The big question here is:

Why does KPN target 4 bn as a capital increase although the rating agency problem seems to be a lot smaller ?

In my opnion, both the amount and the way to raise capital does not make sense. Why don’t they try to to the same as Telefonica and list a minority stake of their German business on the stock exhange ? With an EBITDA of almost 1.3 bn EUR of E-Plus in Germany, a 49% stake could easily raise 2-3 bn EUR on the basis of the Telefonica Dutschland valuation. This would be more than enough to resolve the rating issue and secure roll over of debt.

After being quite shareholder friendly over the last 8 years or so, suddenly, they don’t seem to care any more for shareholders. This is something which really worries me.

One explanation could of course be that they want to annoy or shake off Carlos Slim as large shareholder. In my opnion, this looks like the most likely reason why they behave in such a way. This howver would present exactly the short term opportunity I would be looking for. Management acting irrationally could open up an interesting sitauation, once the capital increase is being executed.

The other explanation would be that management sees a lot mor bad news coming and want to build up a cushion for big future losses. This would be bad.


Honestly, I would not want to own KPN as a long term investment, however I will watch the situation carefully especially if they are going through with a deeply discounted issuance price. If the shareprice than will go down close to the discounted issuance price, there migth be a good “special situation” opportunity.

Deeply discounted rights issue watch: KPN NV (NL0000009082)

I had briefly covered deeply discounted rights issue as a potential “special situation” opportunity a couple of weeks ago.

Now, with KPN, we have an interesting non-financial candidate. This is what KPN issued today:

Dutch telecoms group KPN confirmed a €4bn rights issue to shore up its capital position after heavy expenses on bandwidth that have led to dividend cuts and lower profit margins.

The company announced the move along with its 2012 annual results, which showed a 3.5 per cent drop in revenues and a 12 per cent fall in earnings from the year before.

As one might expect, the stock tanked some 16% or so. Currently, at around 3.45 EUR per share, KPN has a market Cap of only 5 bn EUR, so raising 4 bn via a rights issue might require a large discount on potential new shares.

The “wild card” in this game will be Mexican Billionaire Carlos Slim who owns currently 27.5% of the company. If he fully participates as lead investor and even taking up more than his share, then the “forced selling” aspect might not be too relevant.

If for some reason, he would refuse to participate, the situation will become very interesting.

Just for fun, let’s look how the performance was for Unicredit. I would distinguish the following events / time periods:

– 4 weeks before announcement
– announcement day
– period between announcement and price setting (for new shares)
– price setting day
– period between price setting and start trading of subscription rights
– trading period
– 4 weeks after end of trading period

First the relevant dates:

Announcement first trade date 14.11.2011
Price setting of rights issue 04.01.2012
First trade date subscr. rights 09.01.2012
Subscription trading until 01.02.2012
Discount 43%
New share 2 new for 1 old

Now the relative performance:

Performance UCG MIB Relative
– 4 weeks before announcement -18.35% -4.98% -13.37%
– Date of announcement -6.18% -1.99% -4.19%
– announcement until price setting -14.40% 2.95% -17.35%
– day of price setting -17.27% -3.65% -13.62%
– price setting to start trading -26.46% -4.45% -22.01%
– trading period 73.75% 12.94% 60.81%
– 4 weeks after trading period 0.05% 2.82% -2.77%
– 6 months after trading period -32.25% -11.39% -20.86%
– 12 months after trading period 12.53% 9.53% 3.00%

In the Unicredit example, clearly the period where the subscription rights were traded showed the best relative performance of the shares. Interestingly, on the announcement day, the price drop was much less in percentage points than KPN. This might have to do with the short selling ban which was in place (at least to my knowledge) when Unicredit announced the rights issue.

Again for fun, a quick look at Banco Popular’s rights issue from the end of last year.

Again the dates first:

Announcement first trade date 01.10.2012
Price setting of rights issue 10.11.2012
First trade date subscr. rights 14.11.2012
Subscription trading until 28.11.2012
New share 3 new for 1 old

and then relative performance to the IBEX:

Performance POP IBEX Relative
– 4 weeks before announcement -3.95% 5.11% -9.06%
– Date of announcement -6.17% 0.98% -7.15%
– announcement until price setting -29.95% -1.71% -28.24%
– day of price setting 4.56% -0.90% 5.46%
– price setting to start trading -8.86% 1.39% -10.25%
– trading period 8.12% 2.16% 5.96%
– 4 weeks after trading period -6.71% 3.74% -10.45%

One can see a similar pattern first, with the stock losing 4 weeks before announcement, as well as on the announcement date until the final price setting. However of the date of price setting, the stock jumped, until loosing only a little bit until starting of the trading period.

Then however, the gains within this period were relatively low compared to Unicredit. Overall it looks a lot less volatile than Unicredit, so maybe less forced selling here.

Back to KPN:

Other than Unicredit and Banco Popular, KPN had outperformed the AEX almost +11% in the last 4 weeks, so today’s large drop might compensate for this (unjustified) outperformance.

If the other two stocks are any guide, one could still expect lower prices until the price for the new shares will be set.

The stock price of KPN look really really ugly long term:

But make no mistake, any company which needs to go into deeply discounted rights issues is in trouble. This is “distressed” territory.

(…to be continued….)

Deeply discounted rights issues – Serco Plc (ISIN GB0007973794)

Serco Plc, the British outsourcing company, used ro be a stock market favourite for a long time. Especially in the 2000s, Serco was able to increase its profit ~10 fold from 0,04 pence per share in 1999 to around 40 pence in 2012.

Then however, a little bit similar to Royal Imtech, problems and some scandals piled up and culminated in an accounting bloodbath for 2014. Serco showed a total loss of 2,09 pounds (!!) per share, eliminating pretty much all profits made from 1999.

After raising a smaller amount of capital last year, Serco announced a large 1:1 capital increase at a sharp discount in early March, the rights have been split of on March 31st. Serco wants to raise some 500 mn GBP with the majority being used to lower the outstanding debt (currently around 600-700 mn).

Looking at the stock chart, Serco shareholders have suffered a big loss, especially compared to competitor G4S which, despite relatively similar problems, has recovered well:

Normally, I would not look at a “turn around” case like Serco at all, but in this case it might be different. The difference is the new CEO, Ex Aggreko CEO Rupert Soames:

Soames surprised everyone in early 2014 when he left Aggreko after leading the company for 11 years and with great success. For anyone who has read an Aggreko annual report, one knows that Soames was not only a succesful CEO but also a very good communicator. I can highly recommend to read those reports as they are very interesting.

Before asking for shareholder money, he actually said that he will not take his guaranteed bonus for 2014 which I found was a very good gesture.

After enjoying the Aggreko reports I decided to look into the 2014 annual report and especially the “CEO Letter” from Soames to see what he has to say.

I was positively surprised by the openness how Serco’s problems were adressed, both from the Chairman and Soames himself. It is the classic tale of too much growth through acquisitions combined with a lack of integration and bad execution. Other than at Royal Imtech, it doesn’t involve outright accounting fraud.

One rarely gets to read such a good description of the problems of a company and the historic context (page 9 of a turnaround case. This is then followed by a clear change in strategy, namely to focus on Government services and get out of “private” contracts altogether. Overall the strategy section looked very well thought out and not unrealistic to me.

Further in the report, I found this interesting statement:

Historically, the key metrics used in forecasts were non-GAAP measures of Adjusted Revenue (adjusted to include Serco’s share of joint venture revenue) and Adjusted Operating Profit (adjusted to exclude Serco’s share of joint venture interest and tax as well as removing transaction-related costs and other material costs estimated by management that were considered to have been impacted by the UK Government reviews that followed the issues on the EM and PECS contracts). We believe that in the future the Group should report its results (and provide its future guidance) on metrics that are more closely aligned to statutory measures. Accordingly, our outlook for 2015 is now expressed in terms of Revenue and Trading Profit. The revenue measure is consistent with the IFRS definition, and therefore excludes Serco’s share of joint venture revenue. Trading Profit, which is otherwise consistent with the IFRS definition of operating profit,adjusts only to exclude amortisation and impairment of intangibles arising on acquisition, as well as exceptional items. Trading Profit is therefore lower han the previously defined Adjusted Operating Profit measure due to the inclusion of Serco’s share of joint venture interest and tax charges. We believe that reporting and forecasting using metrics that are consistent with IFRS will be simpler and more transparent, and therefore more helpful to investors.

This is something whcih I haven’t seen before that actually a company is going back from “adjusted” reporting to statutory which I find is very positive.

Another good part can be found later in the statement from the CFO (by the way another Aggreko veteran) regarding the implementation of ROIC:

A new measure of pre-tax return on invested capital (ROIC) has been introduced in 2014 to measure how efficiently the Group uses its capital in terms of the return it generates from its assets. Pre-tax ROIC is calculated as Trading Profit divided by the Invested Capital balance. Invested Capital represents the assets and liabilities considered to be deployed in delivering the trading performance of the business.

I always like to see return on capital as an important measurement for businesses and implementing this is clearly a great step forward.

Another interesting fact from the Renumeration report: Both new board members have significantly lower salaries than the old, outgoing board members. Soames has a 800 k base salary, Cockburn 500 k. both pretty reasonable numbers.

However the big problem for me is that I know next to nothing about the business of Government outsourcing. So for me it is at this time very difficult to assess how attractive the stock is and how long it will take to recover.

The current management is clearly a good one but I am not sure if the underlying business is a good one as well. Especially those long-term contracts do seem to contain significant risks. Page 50 and following pages in the report provides  a very good view in great on what can go wrong with long dated contracts. In many cases, Serco was locked into fix price contracts and costs went against them without having a chance to do anything about it.

On the other hand, the 1,5 bn write-off for sure is conservative and one could/should expect that it contains some “reserves” which might be released in coming years.

Deeply discounted rights issues in general

Another word of caution here: A couple of discounted rights issues I looked at in the past were actually not very good investments.

Severfield was a good one with around +50% outperformance against the Footsie since the rights issue in March 2013. KPN even outperformed the Dutch Index by ~+62% in the two years and Unicredit even more than 70%.

On the other hand, Monte di Pasci underperformed by -70% against the index since their rights issue  and Royal Imtech by -45%. EMAK finally performed more or less in line with the index over time after the capital increase.

So overall, the score of outperformers to underperformers would be 3,5:2,5. With Royal Imtech it was pretty easy to see that it would be difficult, as there was a significant accounting fraud involved. BMPS also looked like a big problem as the rights issue was to small and another one is in the making.

So the question is clearly: Is Serco more like Severfield/KPN or Royal Imtech ? For the time being I would rather look at Serco more positively, mostly due to management.

Not surprisingly, analysts hate Serco. the company has one of the lowest consensus ratings within the Stoxx 600. This alone is not a reason to buy, but at least might explain a potential under valuation. A final note: Soames might not be a bad choice for running a Government outsourcing company. His ancestry should ensure some viable contacts at government level:

Rupert Soames can just remember his grandfather, Sir Winston Churchill. His earliest memories are of playing cowboys and Indians with Britain’s wartime prime minister – and of not being allowed to attend his state funeral. He was six at the time and furious: “Watching it on TV was a very poor substitute,” he once said.

His family has long been part of the political establishment: his father Christopher was the last governor of southern Rhodesia, now Zimbabwe, who served in Margaret Thatcher’s cabinet and was also a European commissioner, while his brother Nicholas is a current Tory MP.


Overall, the Serco case does look interesting. A brilliant management team is trying to turn around a troubled Government contractor with a transparent and plausible strategy. On the other hand, the business is a difficult one or at least I do not have a lot of knowledge about this sector so I need to digg more into it.

So for the time being, I will watch this from the sidelines and maybe try to learn more about this sector in general.

« Older Entries