Author Archives: memyselfandi007

Performance review August 2014 – Comment “Patient enough ?”

Posted on by 6 comments

Performance August:

In August, the Benchmark (Eurostoxx50 (Perf.Ind) (25%), Eurostoxx small 200 (25), DAX (30%), MDAX (20%)) recovered from last month’s loss to a certain extent and gained +1,1%. The portfolio could not keep up with that and was almost unchanged. YTD, the score is +7,6% for the portfolio against +0,3% for the BM.

Winners were Installux (+6,9%), Van Lanschot (+5,9%) and Cranswick (+5,1%). Losers were Admiral (-8,4%), Sistema (-8,3%) and Kas Bank (-3,2%).

Current Portfolio & transactions:

In August, I added Bouvet ASA as a new position to the portfolio and increased Gronlandsbanken to a half (2,5%) position. This reduced the outright cash level to 9,0%. Together with 3 special situations (Depfa LT2, MAN AG, Sky Deutschland) which I consider “close to cash”, the portfolio is still very conservatively positioned.

The detailed portfolio can be seen as always under the portfolio page.

Comment: “Patient enough ?”

In my blog, I have often written about the virtues of patience for an investor, for example in my January 2013 comment. This is what I wrote some 19 months ago:

However another potentially big mistake should also not be underestimated: Taking profits too early. Most investors (including myself) get nervous if their stocks climb quickly 20-30%. What you then often hear is something like “It never hurts taking a profit” or “No one ever got bankrupt by taking a profit” or something similar.

The truth is: In order to generate above average returns, taking profits too early hurts badly. Statistically, the vast majority of investment ideas will be rather average, some will be bad, but some of them and usually only a small amount will be really really succesful.

So if I look at the January 2013 portfolio, I can already identify a couple of positions which I have sold far too early, among them Total Produce, WMF, Dart Group, Bouygues which I sold far too early despite my smart talks in the comment. So obviously, I am still not patient enough, especially with my winning shares. So how can I trick myself into more patience ?

In my current portfolio overview I added a column called “Holding period”. This is simply the calculated time since I bought the first part of the position. Interestingly, both for the “core value” part as well as for the special situations, the average holding period is around 1,5-1,6 years.

Name Weight Perf. Incl. Div Holding period
CORE VALUE      
Hornbach Baumarkt 4,3% 35,7% 3,7
Miko 3,9% 10,7% 1,0
Tonnellerie Frere Paris 5,7% 117,3% 3,7
Installux 3,5% 82,1% 2,3
Poujoulat 0,8% 26,5% 2,3
Cranswick 5,8% 72,4% 2,2
Gronlandsbanken 2,5% 25,7% 1,8
G. Perrier 4,5% 102,5% 1,5
IGE & XAO 2,2% 57,3% 1,3
Thermador 3,0% 41,3% 1,2
Trilogiq 1,7% -14,5% 0,9
Van Lanschot 2,6% 9,7% 0,8
TGS Nopec 4,9% 12,3% 0,8
Koc Holding 3,6% 46,3% 0,5
Ashmore 2,9% 17,8% 0,5
Sistema 1,1% 4,4% 0,5
Sberbank 1,1% 6,7% 0,3
Admiral 2,7% 3,3% 0,2
Bouvet 2,7% -0,3% 0,0
       
OPPORTUNITY      
KAS Bank NV 4,3% 49,8% 3,7
Drägerwerk Genüsse D 4,8% 143,5% 2,9
DEPFA LT2 2015 5,0% 30,3% 3,7
HT1 Funding 4,3% 86,5% 0,8
MAN AG 2,3% 4,8% 0,5
Energiedienst 2,6% 10,6% 0,3
Depfa 0% 2022 TRY 3,0% 16,5% 0,2
NN Group 2,6% 2,5% 0,1
Sky Deutschland 2,5% -0,8% 0,0
       
Cash 9,0%    
       
Core Value 59,5%   1,6
Opportunity 31,5%   1,5
Short+ Hedges 0,0%    
Cash 9,0%    
  100,0%   100,0%

Most of my “core value” investments are usually meant to take 3-5 years in order to work out as planned. Of course, sometimes events out of my control impact the holding period such as buy- outs (EGIS, AIRE KGAA) or maturities in the case of bonds. But especially for the “core value”, the current 1,6 year holding period looks short on average. Clearly, there is some effect due to the fact that I started the blog 3,7 years ago and in my private portfolio some of the initial positions are there for a much longer time. Nevertheless, in the future I will focus more on the average holding period.

If i would invest consequently along my stated goals I would expect an average holding period of at least 2-3 years for my “core value” part. The “special situation” part is naturally a little bit shorter.

Now the good news: I don’t have to do anything to increase the holding period. I just have to sit around, wait and do nothing and the holding period will increase each day…..

I don’t want to give myself any “hard restrictions” on the average holding period as I strongly believe that most external restrictions on investment portfolios are negative for performance in the long run. One of the biggest advantages of any private investor is that he/she doesn’t need to have any restrictions. If you look at any institutional portfolio, it is crazy how many regulatory and other restrictions exist. Many portfolio managers spend most of their time steering through those restrictions instead of looking for good investments.

For that reason I will not create any artificial minimum but rather look at this as a continuous process and as a “qualitative factor”. In practice for instance I will check any new idea against the alternative to increase an existing position and report the holding period in my monthly updates. Of course this does not prevent too early selling, but I think it helps to implement more patience into my portfolio management process.

AGEAS (ISIN BE0974264930) – Potential litigation play ?

Posted on by Leave a comment

The company:

Ageas is a Belgium based insurance company and formerly known as “Fortis”, one of the biggest Eurpoean casualties of the financial crisis. Fortis, together with RBS and Santander tried to take over ABN Amro but especially Fortis then failed spectacularily and was saved by the Belgian Government and finally sliced and diced into Insurance and Banking, of which the banking part was sold to BNP Paribas.

Ageas itself is an interesting case, similar to NN Group, it is a strange collection of Belgium, UK, and Asian insurance companies plus some weird stuff at corporate level, resulting from the quite ugly split of a combined group into two separate businesses. However, a lot of the ugly stuff has already been cleared over the last few years and Ageas was looking like an almost “Normal” insurance company

The litigation

A few weeks ago, a Dutch court decided that Ageas is liable for misinforming Fortis shareholders in 2008:

The Amsterdam Appeals Court ruled that Fortis is liable for misleading investors by saying the firm was “financially stronger than ever” after a government bailout on Sept. 28, 2008, only to be replaced by a break-up plan five days later.

and further down:

Ageas should be able to meet a worst-case liability of 2.5 billion euros before taxes possibly stemming from the ruling, Matthias De Wit, a Brussels-based analyst at KBC, said in a note today. Still, potential indirect effects shouldn’t be ignored, he said.

Looking at the stockprice, we can estimate that the stock lost ~ 5 EUR per share:

With about 230 mn shares outstanding, the market seems to have implied ~ 1,1 bn EUR loss after tax. Ageas itself has provisioned around 130 mn EUR against this case.

Is this interesting ?

At the moment, it is hard to say. Ageas trades at ~0,62 times book value, which is relatively cheap. They are very active in repurchasing shares (sharecount decreased by -115 since 2011). I do like the insurance sector at the moment because its cheap and the problems (low interest rates etc.) are well known.

Insurance companies do have traditionally very good lawyers on their payroll and litigation is part of their business, so one can assume that they handle this very professionally. On the other hand, other than the CIR Spa case, there is no direct catalyst as the law suit can linger on quite some time.

Valuation wise, Ageas look similar to NN Group, actually, I could easily see those two Groups merging at some point in the future. My guess is that someone is maybe already working on the idea to form a strong Benelux players out of the available mid size companies (Delta lloyd, NN Group, Ageas, SNS).

Nevertheless, I do not think that AGEAS is a “Litigation play” at the moment, as I don’t have a good idea on the time line of the law suit. However it it looks like a pretty cheap insruance company with some upside potential, so I will keep it on my watchlist.

MIFA Bond (ISIN DE000A1X25B5) – Distressed debt & Restructuring “German Style”

Posted on by 9 comments

I had covered the case of MIFA several times in the last few months (part 1, part 2, update, update 2).

Over the week-end, finally some news emerged with details about the restructuring.

If I understood the filing correctly, the following will happen:

1. Existing shareholders will be diluted 1:100
2. Bondholders will accept a “haircut” of 60% plus the coupon will be reduced to 1% (from 7,5%) and the maturity will be extended to 2021 (from 2018)
3. Hero cycles will inject (up to) 15mn EUR via a capital increase
4. Bondholders will get 10% of the new company for the 15 mn haircut and a subscription right for additional shares

Interestingly, the advisor nominated by the bondholders also made a press release. Some additional info from this release:

– the advisor estimated a recovery rate of only 15% for bondholders in the case of bankruptcy
– technically, bondholders will own 91% of MIFA equity before Hero cycle invests
– bondholders get subscriptions right and could, if they want to invest new money, own up to 30% of MIFA including those shares they get via the debt equity swap

As some details are still missing (price of new shares) etc., it is hard to correctly say how much the bonds are worth and if bondholders were treated fairly compared to Hero. However current prices at ~38% seem to imply most of the upside.

My 5 cents on this

For me, the following aspects of this whole episode are interesting:

– How can be the recovery rate of bond issued twelve months ago only be 15% ? Where did the 21,5 mn EUR disappear ? In my opinion, MIFA was a fraudulent company for quite some time and was already insolvent when they issued the bonds.

– Will there be any law suits by bondholders ? Why did Hero take the risk and didn’t wait for insolvency ? Are there any special provisions for Hero to back out if law suits come up ?

– “Senior bonds” under German law should not be treated and priced as senior bonds. As this example shows, one can “haircut” bond holders under German law (“Schuldverschreibungsgesetz”) without even going into bankruptcy procedures. German Bonds are much more similar to potentially perpetual, deeply subordinated bonds or “Genußschein” than a senior bond under international law. Any covenants written into the prospectus are worth nothing as it is so simple to just restructure the bonds.

– such a restructuring can be decided with only a small percentage of the bondholders. Only 28% of the MIFA bondholders were present when the advisor, who can commit to binding changes, was elected. So in theory, 14% of the bondholders can decide what happens to the remaining 86% of the bondholders with very little chance for any “hold outs”. Maybe Greece and Argentina should issue their future bonds simply under German law. Tha would make life much easier for them.

. why does the MIFA share (1% of the future company) trade at 80 cents or 6 mn EUR market cap ? Do shareholders think that the company is worth 600 mn EUR ? This is a clear “short zo zero” situation if one could actually borrow the shares

– one could argue that the restructuring makes sense because MIFA will be able to continue to operate and now jobs are lost. However I think it would be naive to believe that Hero will operate MIFA they way they worked before. Hero wants the brands and the distribution, not the production. I am pretty sure that they will not guarantee a lot of jobs.

– but at least, the order that existing equity gets wiped out before the senior bonds still holds, even under German law. I had some serious doubts about this.

The most important lesson: As I have written before, new corporate bonds under German law should be avoided at all cost. Especially the “Mittelstandsanleihen” are in principal similar 20 EUR bills issued at 100 EUR with a tiny little option to receive 100 EUR. The “lipstick on this pig” is the high coupon. But German investors seem to buy anything with a high coupon these days anyway. No surprise maybe if you have to pay for holding 2 year treasuries at the time of writing.

Short cuts: Installux, Gronlandsbanken, Admiral

Posted on by 9 comments

Installux

Compared to Poujoulat and other French company, Installux released almost sensationally good 6M results. Sales went up +3% which is quite impressive for a domestic, France focused company and net result went up almost +14%.

According to the half year report, cash is now around ~86 EUR per share. Only with the 15,80 EUR 6M Earnings per share, Installux would trade at a single digit p/E ex cash even if they make no profit at all in the second 6 months. With a realistic 25-30 EUR per share for the whole year, we are at an cash adjusted P/E of somewhere between 5-6. In my opinion, despite the illiquidity, Installux still offers a great return/risk profile.

Gronlandsbanken

Grondlandsbanken delivered very strong 6 month numbers. 6 month profits of 30 DKK per share were almost 20% higher than in 2013, althhough there were significant positive one time effects included (valuation and disposal gains). Nevertheless, operating results also increased yoy despite overall still muted economic activity. What I found most interesting in the report was this statement from the outlook:

After a weak socio-economic growth and negative GDP in 2012 and 2013, no or a weak growth in the Greenland economy is expected in 2014, however, still with much uncertainty. In the expectation that the prices and
quantities of fish hold steady, that no raw material projects are initiated, but that large construction activities will start in the second half of 2014, the bank expects an increase in activity in 2014. It is, however, si gnificant that the activity in Nuuk remains low, while there is in creased activity in a number of coastal towns. A noticeable activity increase is thus essentially not expected until 2015.

So it seems to be that finally the big projects will be realized with a delay. As Gronlandsbanken has shown that they can increase earnings even without economic growth, I think the stock is “worth” to be upgraded to a “half position”. I will therefore increase the position from 1,9% to around 2,5% at current prices.

Admiral

Already a few days ago, Admiral released H1 2014 numbers. Looking at the stock price, many investors seem to have been dissapointed:

Analysts have mostly lowered their ratings and/or price targets:

Firm Analyst Recommendation Tgt Px Date↑ 1 Yr Rtn BARR Rank
Credit Suisse Chris Esson neutral 1350 08/18/14
Canaccord Genuity Corp Ben Cohen sell 1220 08/15/14 4th
Berenberg Sami Taipalus sell 1168 08/14/14
Nomura Fahad Changazi buy 1493 08/14/14 10.64% 4th 5th
Exane BNP Paribas Andy Hughes underperform 1070 08/14/14
Deutsche Bank Oliver Steel hold 1260 08/13/14 2nd
Keefe, Bruyette & Woods Greig N Paterson market perform 1227 08/13/14
Oriel Securities Ltd Marcus Barnard sell 900 08/13/14 6th
Numis Securities Ltd Nicholas Johnson add 1720 08/12/14 10.97% 3rd
Barclays Andrew Broadfield equalweight 1428 08/12/14 3rd

Tha analyst “consensus” rating in Blommberg is 2,57 which is pretty bad and one of the worst for all European insurers.

Actually, Admiral posted higher profits than the comparable 6 months in 2013, however the released above average reserves. On the other hand, they still invest a lot, especially in US price comparison and the international business. For me, the results were pretty inline with what management has been saying all along. UK car insurance is in a tough spot and will remain so for some time. Interestingly, the all important “auxiliary” income remained constant despite lower premiums which in my opinion is a very good sign.

International premium has increased by 10%, however the loss has increased as well. Allthough I usually don’t like investor presentations that much, but the Admiral presentation is extremely good. There is also a lot to learn about insurance in general, such as the claim inflation example on page 20 or the detailed reinsurance terms on page 48. Also their view on the US market is quite interesting, especially slide 35 with the acquisition cost per insurance contract. For me, this is showing that the Admiral guys know what they are doing which is unfortunately not the general rule in insurance.

The only disappointing part in my opinion is the Italian subsidiary. Admiral says that they didn’t undwrite more as prices were un attractive. Other than that the international business seems to expand nicely.

Reader Musti forwarded me a link why Morgan Stanley sold out Admiral in one of their funds.

The team became more wary of Admiral (LSE:ADM) after the 2011 turbulence in the stock price, after a scare about the potential for large personal injury claims. While the 2011 claims ratio eventually turned out to be fine, it caused a revision in our view of the quality of the name. The combination of the stock’s recovery, and long-term concerns about the effect of autonomous driving on the motor insurance industry, caused us to reduce and then exit the position.

I think this is quite interesting and revealing. They became nervous because the stock price was volatile and that caused a revision of the “qualitiy of the name”. Self driving cars is definitely something to look at but I think no one can say now how quickly this will come and what impact this will have. A self driving car will still need insurance, so much should be clear.

Overall, for me nothing has changed with regard to Admiral. If you want to see smoothly increasing earnings then you have to go somewhere else. If you want a truly great business at a fair price then you should hold or buy more which I might do if the price falls further. I plan to make this a “full” position until the end of the year.

Bouvet ASA (NO0010360266) – 40%+ ROE micro cap from Norway

Posted on by 19 comments

DISCLAIMER: The stock which is discussed in this post is an illiquid micro cap stock. The author will most certainly have bought it before writing the post and will not necessarily tell you when he sells. This is not an investment advice. Please do your own research and never rely on stock tips without carefully scrutinizing th motivation and assumptions behind them.

The company

Bouvet ASA is a small Norwegian IT consulting company operating almost exclusively in Norway.

The company is the result of a merger of several smaller Norwegian IT consulting companies and, after a management buyout went public in 2007 on the Oslo stock exchange. Current market cap is around 850 mn NOKs or ~ 100 mn EUR, so it is really small.

Valuation wise, the traditional metrics are OK but not spectacular (at 83 NOks):

P/E: 11,8
P/B: 4,8
P/S: 0,7
Dividend yield 7,2%
EV/EBIT: 8,1
EV/EBITDA: 7,3

No debt, the company has net cash of ~15 NOK per share.

Clearly the dividend yield looks attractive but P/B for instance looks quite expensive, so it’s definitely not a Graham cigar butt.


The business

Consulting business itself is a relatively straight forward business. You hire bright young motivated people and “sell them” on a daily basis to companies at a higher price. In between you have to train and motivate them. This business requires very little capital, mostly it is the receivables from clients and some office supply in a small company office. You don’t need big offices anyway as the consultants are usually at the client’s site.

In my opinion, barriers to entry and therefore competitive advantages in consulting can be achieved via:

1) “Brand name”

The brand name is important for two purposes:

a) For clients: Hiring a “famous” consultant is more expensive but also lowers the “reputational risk” for a project sponsor. If “xyz consulting” is screwing up a project, then the project sponsor has a problem because he hired and unknown consultant. If McKinsey screws up, than it’s not his fault. Achieving a brand is not that easy, so entering the market on the “High end” is not that easy either. It needs time to build up the reputation, although in IT consulting the brand name is a little less relevant than in typical management consulting.

b) For employees: In order to get the best employees, you must have a good reputation with Students, MBAs etc. Without good people you cannot charge high prices, so this is a self-reinforcing cycle once you are on the list of the “High potentials”. High potentials these days have many options, consulting companies, start-ups, investment banks, Google, brand companies etc.

2) Existing client list

It is always easier to pitch “from the inside” than from the outside. Once you are inside a company as consultant, you have access to decision makers which is essential to sell new projects. If you do a good job, many managers will think twice to go through an official bidding process and give the follow-up work to the consultant who is already there. Even for projects with a competitive bidding, it is always better to have some “Inside” knowledge, especially about the client company culture etc. The bigger the client company, the better the chances to get additional projects. Large companies have a surprisingly large “thirst” for consultants.

3) Network effect of “old” consultants with important function

Consulting is not a job to get old. Most young employees will switch to a “normal” job at some point in time. If you treat your employees well, they will be proud of having worked there. Often consultants switch to relatively senior jobs or get hired straight way by clients. If they then search for consultants, they will often give the first shot to their former colleagues (and friends…). This is even more important in management consulting but also important for IT consultants. Good consulting companies “groom” their network of ex colleagues via regular “off site” meetings in nice location.

So how does Bouvet score on these 3 categories ? From my armchair perspective, it is clearly difficult to judge. With regard to attractiveness to employees; Bouvet seems to do some things right, as they are regularily among the “top places to work” both in Norway and Europe. Employee reviews are generally good, although I found one comment that the atmosphere might be a little bit “too relaxed”.

I cannot judge how good their network is, but at least the “Brand” seems to be good in Norway. The client list seems to be as good as it gets in Norway, with Statoil being a big client as well as the Norwegian Government.

Additionally to their consulting (or as a result of it), they also seem to develop some specializes software, for instance this one which measures electricity consumption of trains.

Financial track record

The easiest way to look how Bouvet is doing is of course to look at their financials

EPS ROE NI margin Div Payout ratio
2006 3,04 53,6% 7,7%    
2007 3,96 39,3% 8,3% 3,70 121,8%
2008 5,51 42,3% 9,8% 4,00 100,9%
2009 4,21 34,3% 7,2% 3,75 68,0%
2010 4,78 40,1% 6,8% 4,10 97,3%
2011 6,13 50,0% 7,0% 5,00 104,6%
2012 5,41 40,2% 5,4% 5,00 81,6%
2013 6,75 46,2% 6,2% 5,00 92,4%
2014       6,00 88,9%
           
CAGR/avg 10,5% 43,2% 7,3%   99,4%

Them most remarkable part is clearly that they managed to grow EPS by 10,5% p.a. and distribute 100% of their profit as dividend. This shows that consulting can be really good business if done right and Bouvet at least in the past seems to have done a lot of things right.

Let’s look at a quick peer group comparison:

EPS Growth NI margin ROE Payout ratio EV/EBIT
Accenture 14,3% 7,5% 64,4% 146,0% 12,0
Cap Gemini 3,0% 3,9% 8,8% 103,0% 8,8
Atos 5,6% 1,7% 5,7% 109,0% 9,3
Bechtle 10,2% 2,8% 13,6% 100,0% 12,1
Reply 16,2% 5,4% 16,4% 100,0% 8,8
Tieto -3,6% 3,90% 12,3% 89,0% 17,0
           
Bouvet 10,5% 7,3% 43,2% 99,3% 8,1

Interestingly, payout ratios are in all cases around 100%. However margins and especially return on equity are very different. Clearly US behemoth Accenture shows outstanding ratios in any category, but the stock is also priced a lot higher than the competitors. The comparison in my opinion shows that Bouvet is cheap compared to how good the business look. Bouvet has at least double the profit margins and multiple time ROE compared to those peers and still trades as the cheapest stock in this group.

Other considerations

Management / compensation

This is CEO Sverre Hurum, who owns 4,9% of the Bouvet SA:

He earned around 330k EUR total comp in 2013. This is actually slightly less than what he earned as dividend on his ~5% stake. So at first sight, comp seems to be reasonable and aligned with shareholders. One has to mention that he seems to have sold 1,4% some years ago, he used to own 6,3%.

Other than for instance the Akka CEO, he is not into motor racing but seems to enjoy cross-country skiing. The CFO Erik Stuboe owns another 2,35% in the company.

Analyst coverage /shareholders

Only 2 analysts are covering the stock according to Bloomberg and only one analysis is actually from 2014 (ABG, price target 110 NOK).

Other shareholders:

No dominating shareholders, mostly Nordic pension funds and asset managers. The biggest shareholder is Varner Kapital, the investment arm of a rich Norwegian textile family, followed by Stenshagen, another Norwegian investor with 8%, Interestingly, none of the big international investment companies is invested, this seems to be a “Local” stock.

Stock price & performance

Shareholders who bought Bouvet at the IPO and held the stock, will be very happy. They made 21,9% p.a. or 320% in total compared to only 3,9% p.a. for the Norwegian Stock index.

Despite the stock price increase, the valuation of Bouvet stayed mostly in the 11-13 P/E range as profits rose proportionally to the stock price. The stock has a very low beta to the stock market (0,38). That is not terribly important but good for my nerves especially in volatile markets….

“Flying under the radar” or why is the stock cheap ?

Bouvet is a micro cap stock. Most of the stock is held by pension funds etc, so although free float is theoretically there, trading volume is very low, around 60k EUR per day. So for many small cap funds, this is not interesting as they want to be able to move in and out of a stock relatively quickly. On the other side, this is also a potential “double upside” for investors who are able to invest “under the radar screen”. If the company continues to grow, at some point in time the market cap, free float and trading volume get so big that smaller funds become interested. In such a case, multiple expansion is often very likely. So as an investor, investing in a small, unknown grwoth stock the upside is much better than compared to an “established” stock with a relatively big free float


Negatives:

– expansion outside Norway difficult. Norway is a high cost country, exporting Norwegian consultants to other countries will most likely not work that well
– CEO is 57, how long will he continue ?
– cost structure most likely not as flexible as in an US style company
– consulting is to a certain extent personalized business. If employees are unhappy they can leave the firm but keep the client

Valuation / return expectation

Instead of coming up with a valuation, this time I make an even simpler case. I want to earn 15% on this investment p.a. With the 7,2% dividend yield, I am almost half way there. In order to earn another 8% p.a. over 3-5 years I need either:

– a multiple expansion. Based on the current cash adjusted multiple of ~10xP/E, it is not unreasonable to expect a 12-13 multiple at some point in the future
– or, based on the same multiple ~7% p.a. which is slightly below the CAGR since IPO (around 8% pa.a.)

I am willing to “bet” that it ois likely that one of those 2 scenarios will happen. If both happen, then my upside would be much higher.

Summary:

Bouvet in my opinion is the perfect “boring” small cap company I am looking for. Although it is neither terribly cheap nor having a big moat, it is a very good business at a reasonable price. It is pretty much neglected from analysts and the shareholders seem to be “strong hands”. The company is very shareholder friendly and has good growth potential in a normal environment. There is no “catalyst” event around the corner, but I still think that it is a very good complimentary position to my current portfolio, adding some Norwegian exposure along my mostly continental Europe /UK stocks.

I will therefore establish a “half position” (2,5%) at current prices of ~85 NOK per share. My target would be a 50-75% gain within 3-5 years including dividends.

Alstom SA (ISIN FR0010220475) – an interesting potential “sum of parts” play after the GE deal ?

Posted on by 6 comments

Profitlich & Schmidlin (“P&S”) had a post a week ago (in German) on how they view the current situation at Alstom.

A short refresher: Both, General Electric and Siemens wanted to take over Alstom and/or parts of it. At the end, GE prevailed, however they failed to take over Alstom completely. Instead, they purchase the Grid, Renewables and Power businesses, leaving the Transport business at Alstom.

In order to make it more “interesting” and to please the French Government, GE and Alstom will form 3 Joint Ventures of which Alstom will buy a 50% share each. Plus Alstom will buy a transport related business from GE for 600 mn EUR. Additionally, Alstom seems to have a put option for these JV back to General Electric with a floor of 2,5 bn EUR.

So in theory, one could now use the information given for instance in the GE press release and calculate a prospective “sum of the parts” valuation for Alstom after the deal and this is how P&S have done it:

No op Assets  
Net cash 4.122
London Metro loan 364
Transmash 700
Pension, others -620
Total 4.566
Per share 14,78

On top of those ~15 EUR per share “extra assets” they add the 2,5 bn EUR for the JVs, which results in around 22,87 EUR per share for all those non-transport assets. With a “fair value” of the transport business of ~11 EUR per share they come up with their target value of 34 EUR per share, which would mean a nice +30% upside potential based on the current share price of 26 EUR.

My 5 cents on this

First of all I find it great that P&S share their investment case via their blog. This is definitely a good thing. And clearly, as with everything, it is their opinion and not everyone will agree with this. My opinion differs from theirs, but that does not mean that they are wrong or vice versa.

Before jumping into the details, I would just want to refer back to some earlier stuff I have written about holding companies. The question is: will investors really apply a “full valuation” to the operating business plus all the “extra assets” or will they discount the extra assets, especially the JVs and the other non-consolidated assets. I think it is more prudent to apply a discount to the extra assets. Unless there is clear evidence that those assets get liquidated, I think it is too optimistic to assign full value to those assets.

A second big issue is that at the moment no one knows exactly how much of the liabilities will get transferred to GE. Especially with regard to operating leases (nominal ~830 mn EUR), litigation liabilities (528 mn EUR) and pension liabilites (gross 5,2 bn) there is no definitive answer how much will be transferred to GE and what remains at Alstom. In a sum of part calculation, any of those remaining liabilities will have to be deducted from the extra assets as they are economically equivalent to debt.

Net cash position

Let’s start with that one. In their annual report, Alstom provides us with EUR -3.041 as net cash at March 31st 2014. GE stated that the whole transaction will generate a 7,3 bn net cash outflow for them which is an equivalent inflow for Alstom.

So theoretically we could calculate -3.041 + 7.300 = 4259 mn EUR net cash for Alstom. However there are several caveats to this:

– transaction costs: A transaction like this easily swallows up a large amount of costs for lawyers, consultants bankers etc. I would assume between 100-300 mn cash costs for Alstom before closing, with an expected value of -200
– mark to market debt: Although any financial assets under IFRS are marked-to-market, debt is still accounted for at cost. If Alstom would really want to buy back their bonds to shorten the balance sheet, they would have to pay market value which is ~350 mn higher than book value. So net debt has to be adjusted for this.

So for my calculation, net cash would be 4.259-200-350 = 3.709 mn net cash after closing of the deal

Transmashholding

Transmashholding is a 25% stake alstom holds in a Russian transport equipment manufacturer. P&S value this company 10x average 2012/2013 earnings at 700 mn EUR which is around 90% higher than book value. I would value this asset significantly lower because

– according to Bloomberg, the majority of the profit is “extraordinary profit”
– if we value them based on operating income (EBIT) with the same averaging, we would get on average 2800 mn Rubels EBIT p.a. (which is around 60 mn EUR p.a.) and assuming 10 times EV/EBIT we get 600 mn EUR EV. Minus ~10 bn RUB or 200 mn debt, the equity would be worth 400 mn, 25% of Alstom then would be 100 mn EUR.

Other liabilities

As I said before, we how much of the liabilities go to GE. My own assumption would be that all the critical ones (Litigation, Pension deficit, operating leases) are divided proportionally to the total amount of liabilities for the transport segment. According to the segment report in the annual report, transport had ~28% of all liabilities of Alstom. My default assumption therefore is that 28% of all “debt like” liabilities remain at Alstom as part of the transport business

Discount to extra assets

Finally, I would argue that especially as this complicated deal will only close in mid 2015, it would be quite optimistic to assume zero discount on the future cash inflow, JV assets etc etc. So I would actually discount those assets to be on the safe side with between 10-20% at the current status, as a compromise I will use 15% both, for net cash and the JVs. Just as a reminder: I am not sure if anyone remembers the planned GE – Honeywell merger in 2001. This looked like a done deal for a long time before the deal actually fell through. The deal might be very likely but there is always the risk of a deal stopper and one has to adjust for this in my opinion.

Bringing it all together & Summary:

So this would be my version of the “extra asset” calculation:

MMI
Net cash 03/2014 -3.041
+ Cash proceeds GE 7.300
– mtm bonds -350
– deal cost -200
   
Net cash adj 3.709
+ London Metro 364
+ Transmash 100
+ JVs 2.500
   
Total “extra assets” 6.673
– 15% discount JV&Cash -931
Discounted extra assets 5.742
   
– “pension others” from P&S -620
– 28% of Litigation liab -148
– 28% of operating leases -210
– 28% of pension underfunding -217
   
Adjusted “extra” assets 4.547
per share 14,71

With my rather cautious approach, i would value the potential extra assets after the deal ~ 8 EUR per share lower as P&S. Together with their valuation of the Transport business od ~11-12 EUR, the current Alstom price at 26 EUR looks fair with no big upside.

Clearly, any of my assumptions could (and should) be challenged as well. Transmash could be worth a lot more and maybe all the liabilities go to GE. On the other hand, one should not forget that the deal is not done yet. I am for instance not sure how happy the potential clients are and if I read correctly, they need approval of 32 national regulators for this deal. Plus, the French Government will be heavily involved in Alstom going forward which might lower the prospects of aggressive share repurchases and increase the risk for “strategic” acquisitions.

Alstom has proposed more detailed information in November before an extraordinary shareholder meeting. For me, at the moment Alstom is not a buy. This might change especially if most of the liabilities would be assumed by GE, then the Alstom “stub” could be really interesting. In the mean time, the stock however is “watch only”.

Bilfinger SE (DEDE0005909006) – Opportunity or Falling knife to be avoided ?

Posted on by 8 comments

Background:

Bilfinger is a traditional German and international construction company with a history going back to 1880. As many of its peers, it tried to diversify away from the risky large-scale construction business into concessions and services. 3 years ago, Bilfinger surprised many by naming the the former German politician Roland Koch as new CEO. In 2011, Swedisch activist fund Cevian disclosed a 10% position and has increased this to 20% making them Bilfinger’s largest shareholders. Under Koch many of the traditional construction subsidiaries were sold and many new services companies were acquired. I counted 13 acquisitions in 2012 and 2013.

Up until early 2014, the strategy seemed to have worked well, margins and ROE/ROIC increased and the stock price hit an all time high of 93 EUR in April 2014.

Current situation

However since then, it seems that the “wheels went off”. Koch had to lower the guidance for 2014 2 times with quite significant impact on the share price as we can see in the chart:

Quite surprisingly for a traditional German company, he left the office on the very same day with his predecessor becoming his successor. There is some speculation in the press why this happened so fast but I think that activist investor Cevian was most likely also involved in this decision. Interestingly, Koch was buying shares for his personal account in July, so even he seems to have been surprised to a certain extent.

Falling knife vs. opportunity

I am a big fan of the saying “never catch a falling knife”. In the Bilfinger case we have a lot of risks:

– some of the many acquisitions could lead to further write downs, especially if a new CEO comes in and goes for the “kitchen sink” approach
– especially the energy business has some structural problems
– fundamentally the company is cheap but not super cheap
– often, when the bad news start to hit, the really bad news only comes out later like for instance Royal Imtech, which was in a very similar business. I don’t think that we will see actual fraud issues at Bilfinger, but who knows ?

On the plus side however we do have also a couple of arguments:

+ Bilfinger still has only a low amount of debt outstanding, so I don’t thin we will see a “Royal Imtech scenario”
+ Cevian will not sit back and watch. They have board members and a proven track record. They are usually in for the long-term but act quickly if things go wrong
+ Bilfinger does not have a majority owner and could be an M&A target
+ Bilfinger is a traditionally well-managed company
+ Analyst sentiment is already pretty bad (lowest quarter of the HDAX)

Especially the Cevian involvement looks interesting. The final target is pretty clear: By shifting the business mix more into engineering/service, they want to realise higher multiples than what traditionally is associated with “real” construction companies. Especially companies like Arcadis or Atkins trade at EV/EBITDA multiples of 8x-10. Bilfinger currently trades at around 6x EV/EBITDA, 10x EV/EBIT and 11 times earnings based on the reduced 2014 estimates. So there is clearly some potential here if they manage to stabilize the company.

On the other hand, Cevian clearly didn’t see that coming either. They actually increased their position in May when the stock traded north of 85 EUR. I would estimate that they paid around 70 EUR per share for their whole position.

Also, when we look at other comparable situations for instance Suedzucker, we can clearly see that the “knife can fall” a very long way down:

Clearly Suedzucker is not comparable to Bilfinger but it shows that one can easily lose 2/3 or more within a relatively short period of time if things og bad.

So what to do ?

Despite the lure of a “bargain” I will not invest now. For now I will stick to my principles and not catch a falling knife

What could make me change my mind ? For instance a new CEO who does not need to start with an accounting bloodbath……

Lancashire Group (ISIN BMG5361W1047) – The UK equivalent of Buffett’s National Indemnity ?

Posted on by 10 comments

While I was writing this post which I do normally over 1-2 weeks, the excellent WertArt Capital blog has released a very good post on Lancashire a few days ago. I higly recommend to read the post as it contains a lot of usefull information.

This saves me a lot of time and I only need to summarize the highlights:

– Lancashire is a specialist insurance company which insures mostly short tail “Excess loss” type of risks. It was founded by Richard Brindle, an experienced underwriter

– Since founding & IPO in 2009, the company has shown an amazing track record. No loss year, 59% average combined ratio and 19,5% ROE is simply fantastic.
– the company has a very disciplined underwriting focused business model, investment returns are negligible
– focus in on capital allocation and efficiency. If rates are not good, Lancashire returns capital to shareholders
– good alignment of management and shareholders (majority of bonus depends if ROE hurdle of 13% + risk free is hit)
– The company looks cheap at ~8,5x P/E and 1,3 x P/B

For non-insurance experts a few quick explanations of insurance terms:

“Short tail” insurance business:

“Short tail” means that one is only insuring stuff where you pretty quickly see if there is a loss or not. For instance a “plane crash” insurance will be good for 1 year and if a plane crashes, the insurer will pay. After that 1 year there are no obligations for the insurer.

“Long tail” in contrast is an insurance policy which again covers a calendar year but where the damage can come up much later. A good example is D&O (director and officers) insurance. Often, when a big company goes bankrupt, some fraud etc. was involved at management level. Until a jury finally makes a verdict, many years can pass by but still the insurance company which has underwritten the policy remains liable. A good example is for instance the recent Deutsch Bank /Kirch trial where insurers will have to pay 500 mn EUR for something that happened 12 years ago.

Long tail has the advantage that the “float” can be invested long-term and illiquid, on the other hand the risk if a significant miss-pricing is much higher.

Excess Loss contracts

Excess loss contracts are contracts where the insurer only pays above a normally quite high threshold. This means that in normal cases, one does not need to pay but as a result premiums are lower than with normal contracts or “lower attachment points”. These kind of contracts are also often called “catastrophe risk” or “Cat Risk”. If such an event hits, then the hit will be big. Lancashire initially expected to make a loss 1 out of 5 years but up to now they had no loosing year. A company which has many excess loss contracts will report very good results in some years but very very bad in others.

What is the connection to Warren Buffett ?

Lancashire and Co. are relatively similar to Buffet’s National Indemnity Insurance, maybe the most overlooked part of his insurance empire after GEICO and Berkshire/General Re. Buffet has commented several times on National Indemnity and the competitive advantages of this company. The major competitive advantage of this business according to him was the ability NOT to write business if premiums are too low. The problem with this approach is of course that if you write less business, cost will be higher and the all important “Combined Ratio” (costs+claims divided by premium) will go up and investors will get nervous.

I wrote down this quote from last’s year Berkshire AGM from Buffett:

“I prefer the underwriters playing golf all day instead of underwriting risks at the wrong price. I don’t care of combined ratios grow well above 100% in such years.” For normal Insurance companies this is almost impossible to achieve as investors want to see increasing sales and profits any year and so most Insurance companies will underwrite no matter what the price is just to maintain the premium.

On the web I found similar quotes from him on the National Indemnity (NICO) which the bought in the 80ties:

Nevertheless, for almost all of the past 38 years, NICO has been a star performer. Indeed, had we not made this acquisition, Berkshire would be lucky to be worth half of what it is today.

What we’ve had going for us is a managerial mindset that most insurers find impossible to replicate.

and:

Most American businesses harbor an “institutional imperative” that rejects extended decreases in volume. What CEO wants to report to his shareholders that not only did business contract last year but that it will continue to drop? In insurance, the urge to keep writing business is also intensified because the consequences of foolishly-priced policies may not become apparent for some time. If an insurer is optimistic in its reserving, reported earnings will be overstated, and years may pass before true loss costs are revealed (a form of self-deception that nearly destroyed GEICO in the early 1970s).

Additionally, Buffett is already participating in the London/Lloyd’s market via another structure. Last year, he underwrote a socalled “side car” deal with Aon. The deal is still controversial but indicates a change of how things are being done at Lloyds. Funnily enough, Lancashire CEO Richard Brindle called the Buffet/Aon deal “foolish” in an interview last year.

Why is the company cheap ?

1. In general, all the socalled “London market” insurers are cheap. Let’s look at the “London” peer group:

Name Est Price/Book Current Yr P/E P/E FY1 Current Div. Yld (%)
         
LANCASHIRE HOLDINGS LTD 1,24 8,76 8,77 8,26
HISCOX LTD 1,62 10,47 13,48 8,21
BRIT PLC 1,23 #N/A N/A 8,59 #N/A N/A
BEAZLEY PLC 1,55 8,11 9,55 10,00
AMLIN PLC 1,36 7,94 11,13 6,07

Compared to those London players, all European P&C Insurance peers trade on average at~ 2,2 x book and 12 x earnings. So why are the London insurers so cheap ? In my opinion, the answer lies in the cyclicality of the business similar to Admiral. The “London market” is even more cyclical as it is primarily an institutional price driven market. The London market specialises in large and complex risks with “natural catastrophe” exposure. Despite the headline news, in the last years there were very few NatCat events which really led to large insured losses. In those times, profit margin increase and there is big pressure to lower premium. As companies accumulate capital, the appetite for risk increases, which further lowers premiums. This works as long as either a large NatCat event happens or capital markets crash and the insurers then have to raise premiums in order to restore their capital levels.

2. Management and strategy change

Lancashire so far has shown excellent underwriting discipline and outstanding an outstanding ability to allocate capital. However in the last few months a couple of things have changed:

a) The founder & CEO has “retired” in April at an age of 54. I haven’t found out why. Since 2005 I would guess that he has earned 50+ mn GBP, maybe he thought that this is enough ? At least he got an extra 10 mn package according to this article. He has been selling shares before his retirement.

b) In a change of strategy, Lancashire bought at the end of 2013 a Lloyd’s syndicate called Cathedral for ~200 mn GBP. Although the Lloyd’s business is not necessarily bad business, it is clearly a change. Lloyd’s underwriting is often reinsurance in contrast to Lancashire’s direct insurance. In their previous reports they claimed that their strategy of insuring directly was a competitive advantage. The Lloyd’s market on the other side is mostly reinsurance and more vulnerable.

c) Finally, after having been invested in short-term no-risk bonds since their IPO, they suddenly disclosed beginning at year-end 2013 that they now invest also into stocks and “Low volatility” hedge funds. Most likely not a good idea at this point.

For me, the cyclicality of the business itself would be no problem. But the combination of Management change and strategy change is very hard to swallow. I would happily invest if there would be EITHER a management change OR a strategy change but not both.

Summary:

To quote Donald Rumsfeld, those two changes lead Lancashire into the “unknown unknowns” territory. Sure, the new CEO is at Lancashire since 2007 and an underwriter, but overall I am not sure if the superior capabilities of the forme CEO have been “institutionalized” in the 8+ years of company history. Having three platforms instead of one sounds great, but it can also mean a loss of focus. So at the moment, Lancashire for me is not a “buy” as I do not have a clear idea how and if they can replicate their past results. T

However in general, the business model is attractive and the “London Insurers” could become interesting, especially if the market softens further so I will try to look into the others at some point in time.

Edit: I have just seen via the “Corner of Berkshire and Fairfax” board a link to an “Insurance Insider” article which states that the former CEO has completely sold out and is expected to launch a new company. A reason more not to rely on past results as this business is very dependent on the persons and the old CEO wil be a pretty tough competitor if he starts over again.

« Older Entries Recent Entries »