Author Archives: memyselfandi007

Banca Monte dei Paschi Siena (BMPS)- Another deeply discounted rights issue “Italo style”

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Capital Raising in Italy is always worth looking into. Not always as an investment, but almost always in order to see interesting and unusal things. I didn’t have BMPS on my active radar screen, but reader Benny_m pointed out this interesting situation.

Banca Monte dei Paschi Siena, the over 600 year old Italian bank has been in trouble for quite some time. After receiving a government bailout, they were forced to do a large capital increase which they priced in the beginning of last week.

The big problem was that they have to issue 5 bn EUR based on a market cap of around 2,9 bn.

After a reverse 1:10 share split in April, BMPS shares traded at around 25 EUR before the announcement. In true “Italian job” style, BMPS did a subscription rights issue with 214 new shares per 5 old shares at 1 EUR per share, in theory a discount of more than 95%.

The intention here was relatively clear: The large discount should lead to a “valuable” subscription right which should prevent the market from just letting the subscription right expire. What one often sees, such as in the Unicredit case is the following:

– the old investors sell partly already before the capital increase in order to raise some cash for the new shares
– within the subscription right trading period, there will be pressure on the subscription right price as many investors will try to do a “operation blanche”, meaning seling enough subscription rights to fund the exercise of the remaininng rights. This often results in a certain discount for the subscription rights

In BMPS’s case, the first strange thing ist the price of the underlying stock:

BMPS IM Equity (Banca Monte dei 2014-06-16 13-51-34

Adjusted for the subscription right, the stock gained more than 20% since the start of the subscription right trading period and it didn’t drop before, quite in contrast, the stock is up ~80% YTD. As a result of course, the subscription right should increase in value. But this is how the subscription rights have performed since they started trading:

MPSAXA IM Equity (Banca Monte de 2014-06-16 13-59-10

It is not unusual that the subscription rights trade at a certain discount, as the “arbitrage deal”, shorting stocks and going long the subscription right is not always easy to implement.

At the current price however, the discount is enormous::

At 1,95 EUR per share, the subscription right should be worth (214/5)* (1,95-1,00)= 40,66 EUR against the current price of 18 EUR, a discount of more than 50%. The most I have seen so far was 10-15%. So is this the best arbitrage situation of the century ?

Not so fast.

First, it seems not to be possible to short the shares, at least not for retail investors. Secondly, different to other subscription right situations, the subscription right are trading extremely liquid. Since the start of trading on June 9th, around 560 mn EUR in subscription rights have been traded, roughly twice the value of the ordinary shares. The trading in the ordinary shares themselves however is also intersting, trading volume since June 9th has been higher than the market cap.

Thirdly, for a retail investors, the banks ususally require a very early notice of exercise. So one cannot wait until the trading period and decide if to exercise or not, some banks require 1 week advance notice or more. My own bank, Consors told me that I would need to advice them until June 19th 10 AM, which is pretty OK but prevents me from buying on the last day.

In general, in such a situation like this the question would be: What is the mispriced asset, the subscription right or the shares themselves ? Coming from the subscription right perspective, the implicit share price would be 1+ (18/((214/5)*1,95-1)))= 1,44 EUR. This is roughly where BMPS traded a week before the capital increase.

For me it is pretty hard to say which is now the “fair” price, the traded stock price at 1,95, the implict price from the rights at 1,44 or somewhere in between. As the rights almost always trade at a discount, even in non-Italian cases, one could argue that there might be some 10-15% upside in buying the shares via the rights. On the other hand, I find the Italian stock market rather overheated at the moment and the outstanding BMPS shares are quite easy to manipulate higher due to the low market cap of the “rump shares” at around 200-250 mn EUR.

The “sure thing” would be to short the Stock at 1,96 EUR, but that doens’t seem to be possible.

Summary:

Again, this “Italian right” capital raising creates a unique situation, this time with a price for the subscription right totally disconnected from the share price.

Nevertheless I am not quite sure at the moment what to to with this. One strategy would be to buy the subscription right now and then sell the new shares as quickly as possible, but it looks like that this is exactly what the “masterminds” behind this deal have actually want investors to do. They don’t care about the share price, they just want to bring in 5 bn EUR in fresh money and an ultra cheap subscription right is the best way to ensure an exercise. In this case we should expect a significant drop in the share price once the new shares become tradable. So for the time being am sitting on the sidelines and watch this with (great) interest as it is hard for me to “handicap” this special situation at the moment.

The German Dax at 10.000 – looking back

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Following Mr. Draghi’s speach on Thursday, the German Stock Index DAX hit the 10.000 mark for the first time in history soon thereafter. Many major publications directly came out with headlines along the line “DAX 10000 – what’s next” and speculated where the DAX might go.

In contrast to that and only for reasons of personal entertainment, I want to take a look back into the DAX history. The DAX was introduced 26 years ago in July 1988 by the German Stock Exchange in order to introduce a modern, performance based stock index. The linked Wikipedia site gives a great overview on the history of the DAX and the change in constituents. Mathematically, the DAX times series was based on 31.12.1987 with a starting value of 1.000 although there exist some “Virtual” time series going back much further.

Just a few interesting facts about the DAX:

– only 15 of the original constituents are still in the DAX
– 3 (or 10% of the original 30) actually went bankrupt
– the best years since 1987 have been 1993 with +46,71% and 1997 with +47,11%
– the worst year were 2002 with -43,94% and 2008 with -40,37%
– the biggest cummulative loss was the 2001-2003 period with a cumulative loss -58,9%
– the Dax rarely ends up pruducing single digit returns over a full calender year. Only 5 out of the last 26 years produced “single digit” returns. So yes, long term stock returns might be single digits but short term single digit returns are an exception

Neverthess, the 10.000 level represents an annual return of ~9,02% over 26,5 years (from December 1987 until May 2014). This compares with around 10,1% for the S&P 500 (in EUR).

For me personally, the implementation of the Dax coincidently equals almost exactly when I bought my first stock. The first Stock I bought was a company called Hoesch in September 1987. I remember this so well because just a few weeks later, the “Black october of 1987” hit me with full force. I had used half of my earnings from a vacation job. As I wanted to increase my position after the crash, the people at the bank refused to take my order because they said that stocks are only for gamblers. As I was not yet of legal age back then, I had to come again with written permission of my parents to buy stocks.

This leads to another question:

Was this huge 26 year rally predictable or not ?

3 years ago I had reviewed the original “Market Wizards” from Jack Schwager which contains interviews with many then famous traders and hedge fund managers. Overall, one year after th 1987 crash, the sentiment was very very negative.

As I did not find historical P/Es for the Dax in 1987/1988, let’s look at this table of historic P/Es for the S&P 500:

P/E
31.12.1973 12,3
31.12.1974 7,3
31.12.1975 11,7
31.12.1976 11,0
30.12.1977 8,8
29.12.1978 8,3
31.12.1979 7,4
31.12.1980 9,1
31.12.1981 8,1
31.12.1982 10,2
30.12.1983 12,4
31.12.1984 9,9
31.12.1985 13,5
31.12.1986 16,3
31.12.1987 15,6
avg 10,8

Someone like John Hussmann might have said that stocks have nowhere to go as the P/E even after the 1987 crash was ~50% higher than the preceeding 15 year average. At the and of 1987, 10 30 year US Treasuries were yielding around 9%, another argument why stocks didn’t look that “apetizing” at that point in time. Why bother with stocks if you can earn double digits with corporate bonds any time ?

What followed

Looking back, it is easy to point out some of the events which led to this remarkable run especially for the DAX over the last 26 years:

– Communism broke down (“Peace dividend”)
– the Eurozone was created, stimulating cross border trading, increasing competition
– technology change (PC, Internet, Mobile)
– Corporate taxes in Germany went down form >50% to ~30%
– interest rates declined for now 25 years in a row
– old crossholding structure (“Deutschland AG”) dissolved, more professional management, foreign investors
– the BRIC story unfolded, further possibilities to export “core competency” goods like machinery and cars

In 1987/1988, few market pundits did even predict a single one of those factors. That’s why I think that just looking into the rearview (valuation) mirror should not be the only tool in the investing toolbox. Past P/Es will not predict future seismic shifts. On the other hand, one should not rely on such evcents happening over and over again and boosting share prices further. Clearly, interest rates and taxes will not fall that much lower and the effect of the end of Communism will not repeat itself.

For me the major conclusion is the following: Do not rely on any one system which tries to predict the future and/or future returns. Keep an open eye on everything, from valuations to macro economic factors and political shifts. Be prepared for surprises. Inthe long term, many surprises turned out to be positive for the economy and stock return.

Some musings on the Dax constituents

Just for fun, I created a table with the long term performance of the 15 “surviving” Dax constituents. Unfortunately I only got performance numbers back to 1992, but the p.a. Performance of the DAX was quite similar. lets look at those 15:

1987 Still in DAX Comment LT Perf (08/1992) p.a.
DAX     545,14% 8,95%
Allianz * 1   177,55% 4,80%
BASF * 1   3650,23% 18,12%
Bayer * 1   1598,15% 13,90%
BMW * 1   1723,82% 14,28%
Commerzbank * 1   -70,14% -5,40%
Continental 1   1962,28% 14,92%
Daimler-Benz (*) 1   90,50% 4,22%
Deutsche Bank * 1   89,57% 2,98%
Deutsche Lufthansa * 1   615,84% 9,47%
Henkel * 1   1200,08% 12,51%
Linde * 1   699,66% 10,03%
RWE * 1   308,71% 6,68%
Siemens * 1   742,92% 10,29%
Thyssen (*) 1   89,98% 4,32%
Volkswagen * 1   1690,10% 14,18%

Not surprisingly, financial stocks do not look good here. Overall, companies which are considered “well managed” did quite well such as Henkel, Bayer, BMW, Linde. Surprising for me is the fact that Lufthansa actually outperformed the DAX as well as Siemens.

Now let’s take a quick look at the new stocks. If I didn’t have returns from 1992, I made a comment:

    Total p.a. Perf. Since
Adidas 1   896,84% 13,23% 1995
Beiersdorf 1   1658,99% 14,09%  
Deutsche Börse 1   335,79% 11,74% 2001
Deutsche Post 1   103,80% 5,41% 2000
Deutsche Telekom 1   62,22% 2,80% 1996
EON 1   485,63% 8,46%  
Fresenius 1   4651,42% 19,42%  
Fresenius Medical Care 1   174,05% 5,90% 1996
HeidelCement 1   242,80% 5,83%  
Infineon 1   -80,66% -10,95% 2000
K&S 1   3084,30% 17,24%  
Lanxess 1   302,98% 16,11%  
Merck 1   555,53% 10,64% 1995
Munich Re 1   300,42% 7,24% 1994
SAP 1   3502,32% 19,98%

Not surprisingly, the best “newcomers” also lead the total Dax performance. Smaller companies which grow big are always the best investments, although it is often hard to identify them before.

Finally one other table. Let’s look at some of the best performers and their historical P/Es:

FRE SAP HEN3 BEI BAS
31.12.1992 28,6 24,4 19,6 18,9 11,4
31.12.1993 35,2 25,8 25,7 22,8 28,0
30.12.1994 19,4 36,7 15,0 20,6 14,6
29.12.1995 33,0 55,2 18,4 18,9 7,8
31.12.1996 64,4 52,1 25,9 28,7 14,4
30.12.1997 49,2 61,1 29,5 46,8 12,0
30.12.1998 30,8 71,5 32,8 30,4 11,8
30.12.1999 27,1 83,7 26,2 32,5 25,3
29.12.2000 37,7 60,0 21,7 41,9 23,6
28.12.2001 183,3 78,5 18,3 38,1 20,7
30.12.2002 10,8 46,3 20,0 31,3 13,9
30.12.2003 23,0 38,1 17,1 27,3 27,5
30.12.2004 18,2 30,9 5,3 21,9 14,5
30.12.2005 20,1 31,5 16,2 23,7 11,3
29.12.2006 23,5 26,2 18,9 16,7 11,6
28.12.2007 21,5 22,3 18,1 27,2 12,1
30.12.2008 21,2 15,5 54,7 16,8 8,9
30.12.2009 14,2 22,3 26,4 27,8 28,2
30.12.2010 16,3 24,9 18,1 29,7 12,0
30.12.2011 16,9 14,0 16,7 39,8 8,0
28.12.2012 16,3 25,8 18,3 31,6 13,6
30.12.2013 19,7 22,3 23,1 31,3 14,7

We can easily see that quality and growth NEVER is cheap. I am not sure if that Henkel 2004 P/E of 5 is incorrect data, but the solid “quality stocks” always traded “richly” and nevertheless delivered outstanding long term performance. Only BASF, as a “quality cyclical” company has been available at single digit P/Es at some years.

So after all, this is wat Warren B. likes to tell us: In the long term, quality does seem to beat anything else, especially if you factor in taxes, trading costs etc.

Summary:

So what does this all tell us ? I am afraid that I cannot come up with some “Magic Formula” to identify future winners. Nevertheless, I think the look back emphasizes three of Warren Buffet’s main points:

1) over the long term, stocks have been a unbeatable compounding machine. A return 10 times the original inevstment in 26 years despite several devasting crashes speaks for itself

2) over such a long time horizon, it seems that “quality buy and hold” seems to be at an advantage at least for large caps. Yes, introducing a backtested system (market timing, EV/anything) could generate fantastic returns as well, but just buying and holding well managed companies did produce spectacular returns

3) Just buying the index and sitting on one’s ass would have beaten almost all active strategies. To be fair although, the first DAX index funds were available mid/end 90ties…..

P.S.: To finish the story: What happend to my first stock, Hoesch AG ? Hoesch was taken over by steel company Krupp which itself merged with Thyssen. If I would held it all the time, it would have been a pretty weak investment……

Some links

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Great WSJ interview with Ray Dalio (google headline to read article)

Interesting post on the upcoming Samsung restructuring and pitfalls of Korean “Chaebols” (via Beyondproxy).

Profitlich & Schmidlin with a (German language) case study on Hypo Alpe Adria Bonds.

“The red corner” looks at a Chinese company called “Texhong Textile Group”

Nothing really new there but still worth a read: Aleph blog about Value Traps. For a good example, look no further than Set-top boxes.

A very comprehensive paper on dividends and share buy backs from Credit Suisse

And finally a non-financial link: I had the chance to see a live concert of Charles Bradley, a great “Old school” soul singe. The guy was only “discovered” at the Age of 63, a great example that is never too late for anything:

Quick check: Grindeks AS (ISIN LV0000100659) – P/E 4.9, P/B 0.6 Baltic value or “red flag” alert ?

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Introduction:

Via my “home forum”, someone brought up the Latvian Pharma company Grindeks AS. The company looks similar form the business model to Hungarian company EGIS and Croatian Krka which I covered some months ago

Valuation wise, the stock looks like a clear “no brainer”:

Market cap: 62 mn EUR (at ~7 EUR per share)
P/E trailing 4.9
P/B 0,59
P/S 0,6

ROIC, ROE, net margins all solid “double digit” numbers. My own, mechanical “Boss Score” would indictae a fair value of at least 3 times the current market cap.
The only issue coming up is the fact that the company never paid a dividend.

There is also a quite obvious reason why the stock is cheap: The majority of sales goes to neighbouring Russia, which clearly is not very popular with investors these days. As I do not have an issue with this “Headline risk” as long as I get compensated accordingly, I looked into the annual report 2013 in order to find out more.

As with Australian Vintage, I scan the report for unusual or problematic things first.

In Grindeks case, I was puzzled by a quite unusual balance sheet position called “Advance payments for financial investments “ something which I haven’t seen before. The explanation in the notes says the following:

In 2012 the Company has signed purchase agreement with Dashdirect Limited regarding purchase of the controlling interest in the equity of HBM Pharma (Slovakia). As of the date of signing these financial statements the agreement is partly completed. The main activity of the HBM Pharma is production of the medical substances. As of December 31, 2013 the Company’s and Group statement of financial position contains advance payments related to the before mentioned purchase agreement in the amount of EUR 11,670,000. The Group management is certain that this deal is going to be finalized during 2014.

In my experience, it is not uncommon to take over M&A targets in several steps, but it is quite uncommon to pay money first and get nothing in return. A few days ago, Grindeks issued another news item which covered this strange transaction.

The numbers look OK, Grineks seem to pay only 6 times P/E of the target company. However another sentence looked strange:

Orders of JSC «Grindeks» make up about 30% of the total “HBM Pharma” s.r.o. turnover

So they are buying a company where they are the biggest customer anyway, also strange. So I decided to google a little bit and found this:

On July 8, 2010 Lithuanian-domiciled Central and Eastern European (CEE) specialty pharmaceutical company Sanitas, AB sold its 100% shareholding in subsidiary HBM Pharma s.r.o in Slovakia to Latvian company Liplats 2000, SIA. HBM Pharma was primarily engaged in toll manufacturing activities and the entity has been sold with all of its existing toll manufacturing contracts. As previously announced, sales, marketing and regulatory divisions in Slovakia and the Czech Republic were separated from HBM Pharma and retained in Sanitas Group prior to the divestment.
Sanitas acquired HBM Pharma (previously named Hoechst Biotika) from Sanofi Aventis in July 2005.

So a Latvian company called Liplats 2000 bought HBM in 2010. Googling further, I found this document on HBM’s website, describing a cross border merger between Liplats 2000 and HBM. The most interesting part of this document ist the last line in the final page: From Liplats side, a guy called Kirovs Lipman signed.

Now Kirovs Lipmans happens to be the majority shareholder of Grindeks. So effectively, Grindeks is buying this M&A target from theit majority shareholder (and former CEO). This is from Grindeks annual report:

Kirovs Lipmans – Chairman of the Council Born in 1940. Kirovs Lipmans has been the Chairman of the Council of “Grindeks” since 2003. Simultaneously K.Lipmans is also the President of the Latvian Hockey Fede
ration, the Member of the Executive Committee of the Latvian Olympic Committee, the Chairman of the Board of “Liplats 2000” Ltd. and JSC “Grindeks” Foundation „For the Support of Science and Education”, the Chairman of the Council of JSC “Kalceks” and JSC “Tallinn pharmaceutical plant”, also the Member of the Council of JSC “Liepajas Metalurgs”. Graduated from the Leningrad Institute of Railway and Transport

So to summarize it at this point: Grindeks never paid any dividends but makes a major acquisition and pays money upfront to a company controlled by the majority shareholder, without any disclosure of this potential conflict of interest.

Of course, theoretically, this could have been an “arm’s length” deal with no disadvantages for Grindeks, but the probability that something is “fishy” is quite high, combined with the fact that they never paid dividends.

Maybe I am too cautious here, but an undisclosed significant “related party” transaction is a big red flag for me.

Coincidentally, Grindeks also issued Q1 numbers a few days ago which didn’t look good. Sales in Russia tumbled. This seems to be a very Grindeks specific problem, as for instance Krka showed strong Russian sales in Q1 despite the “Russian crisis”.

Just to be clear: A “red flag” doesn’t need to be the ultimate “value driver”. Reply SpA is a good example. Since my “red flag” alert, the stock made a whopping 276% return.

Summary:
For me, Grindeks is, depsite the attractive valuation, an absolute no -go. Undisclosed related party transactions combined with a lack of dividend makes this a speculation rather than a value investment. I don’t know if there are Corporate activists in the baltics, but this would be a good target. Additionally, they seem to have some specific operating issues as well, so no buy, watch only.

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

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Performance May

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

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

Portfolio transactions May

Major transactions in May were:

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

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

Comment: “Leave the driver in the bag”

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

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

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

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

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

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

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

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

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

Quick check: Australian Vintage Ltd. (ISIN AU000000AVG6) – Deep Value Pearl or risky turn around Gamble ?

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A very persistent commentator asked me about my opinion on Australian Vintage, an Australian Wine producer. In between, Nate from Oddball covered the stock and seemed to like it as an asset play .

Optically, the company looks dirt cheap (Bloomberg):

P/E 7
P/B 0,3
P/S 0,3
Dividend yield 10,5%

When I look at such “cheap” companies, I start reading the only annual report and concentrate only on problems. I tend to avoid company presentations as they usually only show the positive stuff. A 30 minutes “speed” read of the 2013 annual report shows already some issues:

– goodwill, brand values and DTAs make up ~100 mn AUD of the book value plus another 50 mn AUD or so for biological assets and water rights
– the 2013 profit includes a significant “one-off” reserve release. without that, 2013 profit would have been some 40% lower or the P/E well into “double digits”
– the company carries significant debt and lease obligations, overall around 240 mn AUD in the 2013 annual report
– the directors salary is at ~ 3 mn AUD a significant portion of the profit
– on the other hand, directors own only insignificant amounts of shares (AUD amount of shares ~20% of total annual salary)
– operating cashflow has been negative in 2013, so the dividend has not been “earned”
– Depreciation is around 7 mn AUD per year, investments only 4-5 mn in 2012, 2013. This looks like “underinvestment”.
– most “hard” assets (inventory, property etc.) are pledged for the loans
– all subsidiaries are explicitly guaranteed by the Holdco, so all loans are fully recourse against any asset
– bank loan covenants exist, but are not clearly reported:

The Group is also subject to bank covenants with its primary financier as follows:
– Equity must be above $210 million.
– Gross profit and earnings before interest and tax must exceed pre-defined levels

– the bank loan facilites mature in 2015 and will have to be renegotiated
– there are “related party dealings” with companies of the CEO (purchase of grapes etc.)

In October / November 2013, they did a massive capital increase (42 mn AUD) in order to pay back debt. Some might argue this is a good thing, but paying large dividends and in parallel doing large capital increases is a very bad sign and very bad capital management (among others, they had to pay around 5% fees on the raised capital).

One observation with regard to the capital increase proespectus: On page 35 they show that the capital increase will increase earnings per share due to lower interest rate expenses. However they use a pretty obvious “trick” here: they use an “average amount” of outstanding shares, not the relevant final amount of shares. With the full amount of shares (232 mn) instead of the “average”, the capital increase would of course be “dilutive”.

The first 6 months of fiscal 2014 looked better on the bottom line, but again includes a big reserve release. Operationally, the first 6 months of 2014 were a lot worse than the year before, especially the US turned from an operating profit to a loss.

Some additional thoughts:

– As an Australian asset play, the Australian Dollar plays a big role. As a non Australian investor, I might have a operational upside if the AUD goes lower, but asset value as a EUR investor will be lower as well
– the UK supermarkets who are the major non Australian clients, are under a lot of preassure themselves. They will squeeze their suppliers as hard as they can and will demand lower prices if the AUD becomes weaker
– return on assets is very low. If the 10 Year treasuries yield 3.7% and Return on assets is far below that than the value of the assets ist most likely overstated by a large margin
– moving “upscale” is not easy. This needs even more capital (oak barrels, longer ageing = higher inventory etc.) and time.
– from the main brand “McGuigan”, you can buy in Germany only the Shiraz which is currently on sale (4,95 EUR vs. 5,99 EUR) and a “Sparkling Shiraz” at 12,95 EUR. To upgrade from that level will be hard…..
– finally, the Australian wine industry seems to be one of the clearest victims of climate change. Water will become much more expensive and many grapes might not grow so well in the future. This could for instance seveely reduce the value both, of the land and teh biological assets. This study for instance shows that Australie is hit hardest globally. If this will realize, everything, land, machinery and “Biological assets” would loose most of their value.

Overall I think the main issue is that the interests of the Management and shareholders are not really aligned in this case. Especially the CEO, whose max target bonus has by the way doubled for next year, seems to be far more interested in his salary than the shares and it looks like that the majority of his own investments seem to be outside the listed companies. Combined with the relatively risky financial profile, this is clearly a “deep value” case with a significant risk especially close to the 2015 maturity of the loans.

Opposite to Nate, I can see a lot of things that could go wrong here and either trigger another massive capital increase or even a bankruptcy. As I do not know a lot about the Australian Wine industry either, I think I would pass on this investment as it is extremely difficult for me to handicap the probabilities and would therefore be a quite “risky turn around gamble”. As I don’t have any experience with Australian liquidation rules, I would also be really careful to expect meaningful recovery rates for shareholders in case of a bankruptcy / restructuring. If for instance the loans would get into the hand of aggressive “vultures” like Oaktree, I would bet that stated book values would not be worth a lot.

However for “deep value” specialists, this could be interesting if they are able to estimate the “survival probability” to a certain extent.

A side note: “Moving up the value chain” in wine usually means oak barrels. So despite the much higher valuation, I still think that Tonnelerie Francois Freres is the better (and safer) long term investment in the wine industry.

Depfa: No sale, LT2 and the “Kebab Zerobond” (ISIN XS0221762932)

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Warning: The securities discussed are illiquid and/or risky and the author might have bought them already before publishing the posts. Please do your own research and if you decide to invest nevertheless, use apropriate limits !!!

Background:

For readers of my blog, Depfa is no stranger. I did buy a 2015 floating tier 2 subordinated bond in 2011 and this has been a very good investment so far.

To summarize the story of Depfa for “new” readers quickly: Depfa was initially a “full service” German mortgage bank which then split up into a German mortgage bank (Aareal) and an Ireland based “public funding” bank (Depfa Plc). Shortly before the Lehman crisis, Depfa got bought by another German mortage bank, HypoRealestate (itself a spin-off from Hypovereinbsank). The rest is history: Depfa/Hyporeal Estate was the first bank to go belly up and needed to be rescued by the German Government.

After beeing rescued, the startegy was to concentrate on German Mortgage banking and to sell the old Depfa part (which has been “cleansed” from PIIGS exposure via a bad bank). The sale process seemed to have been already quite far advanced, with Leucadia as favourite, before very surprisingly the German Government pulled the sale in the last minute before closing.

Germany has intervened to prevent bailed-out bank Depfa from falling into US hands just hours before a deal was about to be struck.

The government’s financial market stabilisation fund, known as Soffin, said on Tuesday evening that Depfa should be wound down by the German authorities rather than sold for what would have been €320m to US investor Leucadia, according to people familiar with the deal.

What does that mean for Depfa bonds in general ?

Tier 1 bonds of Depfa got hit quite hard, although one must say that they enjoyed a great run up until then as this chart shows:

The reason here is I think the expectation that the FMS, which will have the task to run down Depfa, will not do anything actively with the subordinated bonds, whereas any private buyer would have tried to get the subs out as soon as possible under par in order to realize value more quickly.

Although it is not clear, how Depfa will be passed over to FMS (most likely a sale at book in my opinion, in order to facility a Hypo Real Estate sale in 2015), I think it is fair to asume that sooner or later FMS will be the owner of all assets and liabilites.

FMS itself is a Government owned “bad bank”. As bad banks need constant refinancing, FMS issues new bonds on a regular basis like this one. FMS is owned by SOFFIN, the German “bank rescue” vehicle, which itself carries an explicit Government guarantee. A good description of the FMS can be found here (in German, page 108 ff).

So once, Depfa has been transferred to FMS, in principle the liabilites should be considered FMS liabilities which again carry a AAA rating and trade more or less at levels similar to KfW.

Impact on subordinated bonds

The bloomberg article above mentioned that Depfa subordinated investors were afraid of the following:

“The main risks facing creditors now are the risk of burden-sharing as well as an indefinite coupon ban,” the analysts wrote in a note to clients on May 14. “It’s difficult to see clear upside from current levels and further volatility is likely.”

I share the opinion that it is very unlikely that coupons on Tier 1 bonds will be paid in the near future, although, at some point in time FMS might want to buy out the Tier 1 investors as well. But at current levels (50% of nominal), this is not a very attractive speculation.

However for the Tier 2 bond I own, the transfer of Depfa to the FMS is actually good news. I cannot think of any realistic scenario which would lead to a loss for the Tier 2 until maturity in 2015. If they would like to screw those bond holders, I am pretty sure they will have issues refinancing and this is the last thing they want. The LT2 bond priced consequently barely moved as we can see in the Chart:

So far, the LT2 has been a very good investment. Around 30% annualised return with, in my opinion, very little risk. If one has cash to park, I think the bond is even now a very interesting investment. You get around 5% annualized return until maturity December 2015 which is effectively Governemnt guaranteed.

I will therefore increase the position from a “half position” to a full 5% as I have plenty of liquidity in the portfolio to park.

The Depfa 2020 TRY “Kebab Zerobond” (ISIN XS0221762932)

When I started to look at Emerging markets earlier this year, especially when I looked at Koc Holding, I was surpried that Depfa had Turish Lira bonds outstanding.

When you search in Bondboard.de for TRY bonds which are traded in Germany it is even interesting to see that the 2020 Depfa TRY Zero bond is the highest yielding TRY bond available.

At a current yield of ~13% p.a., the bond trades around 4% p.a. wider than a 2 year longer EIB Zero bond and around 3% wider than similar Turkish Government (coupon) bonds.

Why does the bond look cheap ?

1. First of all, I think the problem is that the “official” rating of Depfa is BBB. Many investors will simply compare the bond with other financial BBB issues and apply respective spreads. As many of the Italian and Spanish banks are BBB as well, BBB financial spreads are high.

2. The bond is relatively small (425 mn TRY) and illiquid as the 100 K TRY denomination will deter many smaller investors (at ~47%, you need to pay around minimum 17k EUR to buy one bond). I think also, many investors prefer coupon paying bonds to zero bonds, for most investors “zero” bonds are an exotic security

3. Finally, I think not many people did like the combination of the Depfa structural risk and the TRY currency risk. Either you like Emerging markets and TRY or you want to play the Depfa capital structure, but usually not both.

However for me, the bond is the ideal combination: I do like the Depfa risk as I think that any Senior Depfa bond will be a AAA equivalent bond after the transfer to the FMS. Additionally I do also like the TRY risk. Clearly, there is downside potential and he TRY/EUR is still volatile as the chart shows:

As an investor you can gain (or loose) money with this bond based on 3 risk faktors:

A) TRY/EUR exchange rate. Based on the current interest rate differential, the market assumes that the TRY will devalue vy ~8% p.a. against the EUR.Perosnally, I see a good chance that the devaluation could be less than that. Under many metrics (PPP, BigMac index etc.) the TRY is fundamentally cheap compared to EUR and USD although there is clearly political and econimical riskimplied. The currency factor is clearly no “free lunch”.

B) Turkish interest rates. As a zerobond, the bond has a duration of ~6,5 years, i.e. if interest rates go up or down 1% the bond price will move +/-6,5%. Currently the yield curve in Turkey is flat or even inverse, with the short end slightly higher. even if long term rates stay constantand only short terms go down, one can expect some “extra juice” from the potential roll down of the bond.

C) Depfa Spread. Compared to an EIB Bond, the implicit credit spread is around 3-4% p.a. although in my eyes the credit risk is similar to an IB or german Government bond. I think there is also a good chance that this could normalize over 2-3 years. If there is some rating action following the transfer, this could even happen quicker.

All in all, I find the TRY Depfa bond very attractive and will by a half position for the portfolio. As the risk is predominantly TRY, I will allocate it to the Emerging Markets bucket.

My expectation is that I can make ~50%-60% in local currency within 3 years, if the yield curve normalizes and the Depfa Spread tightens including the normal “carry” of 13%. If half of that shows up in EUR, I will be already very happy 😉

Hedge fund edition

For a smart (hedge) fund with good access to securities lending, a long (Depfa)-short (TRY EIB 0% 2022) trade could be interesting. Despite the slight duration mismatch, this could be an interesting way to speculate on the relative spread tightening between Depfa/FMS and the EIB bonds with an interesting implicit positive carry, although I am not sure how easy it is to borrow the EB bonds.

Summary:

In my opinion, the planned transfer of the old Depfa to the FMS is good news for LT2 and Senior bonds of Depfa, as the bonds become effectively German Government equivalent. I will therefore increase my existing lT2 position up to 5% and invest a half position (2,5%) into the Depfa 2020 TRY bond as Emerging Market investment.

P.S.:Why did I call this the “Depfa Kebab bond” ?

Doner Kebab is the most popular German fast food.

Based on Turkish ingredients, the current form (with salad etc.) is supposed to be a Turkish-German invention and in my opinion a good omen that a Turkish-German combination can be really delicious…..

Some links

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“Kojak” Mark Mobius on Emerging Marktes and FPA’s Steven Romick likes Russia

Frenzel and Herzing with a nice write up on Banque Priveé Rothschild

Prosperity capital, a Russian focused und has an interesting “Russian company of the month” website

Damodaran tries to value Yahoo

The Wertart Blog likes Austrian Lenzing

VERY interesting paper on Momentum from Cliff Assness (AQR)

And instead of writing a summary of Berkies annual meeting, just read this post from Jeff Mathews. The only point to disagree: The movie was really crap.

They day on which George Soros broke the Pound 22 years ago.

Celesio Merger Arbitrage update: A new shark wants a bite

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Late last year, I joined the merger “arbitrage” play when US based McKesson wanted to take over Celesio. I did exit the position with a small profit soon therafter, as I was not really sure what was going on.

This deal was clearly “shark infested” with Elliott, the smart and aggressive US Hedgefund on the one side, Goldman as advisor of McK on the other. Nevertheless it looked very strange that Elliott seemed to have went away with only 50 cents more than the initial offer of 23,50.

Interestingly, the stock price went up above the offer price afterwards as we can see in the chart and I was wondering why:

Yesterday, this WSJ article then was very surpising:

Another big shark has joined the scene: Magnetar, one of the most (in)famous US Hedge Funds (“Big Short”). They seemed to have looked into McKessons disclosures and found this:

Magnetar accuses McKesson of offering a higher price to one large Celesio shareholder, Elliott Management Corp.

Later in the article, more details are given:

To win Elliott’s consent, McKesson paid it nearly €31 for each convertible bond, the lawsuit claims.

Documents published by McKesson indicate it did pay the equivalent of €31 a share for Elliott’s convertible bonds. Other convertible bondholders received the equivalent of €23.50 a share.

“We believe McKesson’s actions were specifically aimed at evading the minimum price rule in German takeover law, and resulted in offering only €23.50 per Celesio share to minority shareholders, whilst paying a look-through price of up to €30.95 per Celesio share through the acquisition of convertible bonds,” Magnetar said

In my post back then I had written that the 2018 convertible bond had the highest annoyance factor in the capital structure:

In total, the 2018 convertible will be exchangeable into 19 mn shares, more than 10% of total outstanding shares at any time after the take over happens. However, this could turn out to be a big problem for McK. Any company doing such a takeover wants to get rid of minorities as quickly as possible and is therefore trying hard to squeeze out shareholders and delist the company.

With the 2018 convertible, this could be very difficult. Even if McK owns more than 95% of the shares, convertible holders could suddenly convert bonds into shares and then make a squeeze out impossible. The 2018 convertible therefore has a quite high “annoyance factor” for McK. In general, when a company has a more complicated capital structure, an “annoying” security can be a very good security to own.

So Elliott seems to have cashed in the “annoyance factor in a private deal and McKesson agreed because they thought that the German take over rules (same price for everyone) does not apply to convertible bonds.

Magnetar, which seems to have held convertibles as well has obviously a different opinion and is now sueing McKesson. Elliott looks safe, but the maybe Magnetar gets another bite out of the “big whale” MCKesson. If this would be the case, this would be a further embarresment for Goldman who were Mcks advisor.

Honestly, I although I thought through many scenarios in this , I did not have this scenario on my radar screen, otherwise I wouldn’t have sold the convertibles but tendered them into the offer.

Nevertheless a very interesting story and a great learning experience. If guys like Elliott or Magnetar turn up, you should definitely be sure not to end up as shark food.

I still don’t understand why the stock currently trades at 25,80 EUR or so but this is another story.

MIFA Update (2) – And why I would prefer Russian shares to German Bonds

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The story around the German bicylce producer MIFA seems to get more and more interesting. Yesterday I posted the update on the (not so surprising) losses detected now from previuos years of dubious inventory accounting.

A few minutes after I published the post, MIFA came out with another “breaking news” which starts the following way:

MIFA: Investment agreement with Indian bike manufacturer HERO concluded,
equity investment pursuant to capital increases from authorised capital

– Investment agreement with OPM Global B.V., a subsidiary of Hero Cycles
Ltd., about an equity capital investment in the amount of EUR 15
million concluded

– FERI EuroRating Services AG reduced issue rating of corporate bond

– Annual General Meeting expected for third quarter of 2014

From the headline one would conclude that the rich Indian “uncle” finally will save the company. Handelsblatt for instance translated this into a headline which one could translate into “MIFA secures investor”.

For the real “juice” of this announcement, you have to read down a little bit towards the end of the annoncement:

The investment commitment by OPM Global B.V. entails significant financial contributions of MIFA’s financing partners and is subject to various conditions precedent, especially to the condition of a haircut in the amount of EUR 15-20 million of the bondholders as well as an exemption from the German Financial Supervisory Authority (BaFin) from the obligation to make a public takeover offer under the The German Securities Acquisition and Takeover Act.

So to understand this again, the facts:

– The 2013 issued MIFA bond has a total volume of 25 mn EUR
– most likely, the covenants of the bonds are breached, so MIFA would have to pay back the bond on short notice
– the “Indian uncle” will only invest, if bond holders accept a haircut of 60-80%

Normally, if a company cannot pay back a bond, the company will go into default. the shareholders will be wiped out and the company then changes ownership from the shareholders to creditors i.e. bondholders for instance via a debt/equity swap.

at MIFA, they try to reverse the order. Let’s look at another part of the announcement: Hero is commiting to pay 15mn for the following shares:

The cash capital increases shall comprise a 10% capital increase with subscription rights being excluded and a subsequent rights issue with a total number of 4.9 million new shares to be issued. OPM Global B.V. has undertaken to subscribe all such shares which together with additional existing shares to be transferred from
certain existing shareholders would result in an overall participation of the investor of up to 47 %.

With currently 9,8 mn shares, only (0,98 +4.9) = 5.88 mn new shares will be issued. With a total new sharecount of 15,68 mn shares, the old shareholders would keep economically (9,8/15,68) =62,5% of the company while senior bondholders would keep only 20-40% of their bond prinicpal. In my opinion it should be the other way round.

It will be interesting to see if bondholders are accepting this pretty obvious blackmailing. The argument will most likely be that if they don’t accept, they will end up with nothing. Praktiker by the way tried a similar tactic, going to bondholders first . In Praktiker’s case, both shareholders and bondholders ended with nothing.

That the proposed transaction would be better for shareholders than for bond holders shows clearly in the price action this morning. While the bond lost further from around 33% to around 27% (or -20% in relative terms), the shares are up more than +20% at the time of writing.

Coming back to my headline: When i bought my first two small Russian share positions (Sberbank, Sistema) many people commented that they would never buy Russian shares because property rights are not respected in Russia. This might be even correct, but you get very cheap valuations and if they do respect property rights, tzhe potential upside is high.

In German bond markets however, property rights are even worse in my opinion once a company is in trouble. As we learned at IVG, subordinated bond holders can be wiped out without blinking an eye and looking at the last few cases, senior bond holders are now expected to rescue the company before shareholders commit a single cent. Under German insolvency proceedings, often the old management carries on (WGF) and wipes out bondholders as they wish. However, other than in Russia, there is no upside to this if you buy a newly issued German bond at par. So for me, if I would need to choose between a newly issued German Corporate bond and a Russian stock, the choice is clear….

The sad part of this story is that this event along with many other similar event will hurt corporate bond issuance in Germany in the long run, especially for smaller companies. With the banks continuing to shrink, this is not good news for those German Mittelstand companies who need debt funding.

I am somehow tempted to become a “bond activist” here….Let’s see how this continues….

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