Category Archives: Anlage Philosophie

“The death of value investing”

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There was a quite provocative article with the same headline “The death of value investing” on Business Insider a few days ago.

Why should one take such a Business Insider article serious at all ?

Well, at first, this was not written by some lowly paid BI staff but from Marc Andreesen and Ben Horowitz, two venture capital legends with currently 3 bn under management. Andreesen by the way was one of the creators of MOsaic, the first web browser and founded Netscape.

Let’s look at their article:

Most of the best investors in the world are considered value investors. Well, times are changing — the destructive power of technology is starting to break down companies faster than ever.
Value investing is an investment philosophy that evolved based on the ideas that Ben Graham and David Dodd started teaching at Columbia Business School in 1928. Since I started my career as an investor, value investing was the holy grail of investing.

Hmm, I am not sure about that one. I always thought that value investing is rather a minority strategy…but ok.

There are many interpretations of what value investing is, but the basic concept is as follows: essentially you want to buy stocks at a discount to their intrinsic value. Intrinsic value is calculated by taking a discount to future cash flows. If the stock price of a company is lower than the intrinsic value by a “margin of safety” (normally ~30% of intrinsic value), then the company is undervalued and worth investing in.

That part is OK although I am not sure where have the 30% “margin of safety”. But then it gets interesting:

Generally, value stocks are companies that are in decline but the market has overreacted to their situation and the stock is trading lower than their intrinsic value.

Hmm, that is in my opinion only true for the original Graham “Cigar Butts”, but lets move on:

The classic case is Research in Motion (RIM). In January 2007, RIM was trading at a high 55x PE multiple. Over in Cupertino, a computer company called Apple had reinvented itself as an MP3 player company and was now unveiling a new phone set to launch in the summer. By the end of December 2009, market share for Apple’s iPhone iOS as a percentage of US smartphone OS was 25% while RIM had increased from 28% to 41% in that same period. Though RIM had grown market share, fears of iOS growth had toppled the PE multiple to ~17x.

Many traditional, value investors sat back and thought, “Well, RIM is holding up pretty well compared to the iPhone, yet their PE multiple is getting destroyed.” It’s trading at near the historical average S&P 500 PE multiple of 15x. Apple hasn’t historically been strong in the enterprise, so maybe iPhone will just be a consumer phenomenon that doesn’t break through to business users. Android is irrelevant with 5% market share. The smartphone market is growing rapidly and RIM is the clear leader. RIM is still growing north of 35% and generating nearly $2.5B in net income. I think RIM looks cheap!
Two years later, RIM was trading at a 3.5x PE multiple and topline growth had screeched to a halt. Market share for RIM had contracted to 16% while iOS and Android combined for 77% market share. In fact, in 2012, RIM posted a net income loss of $847mm. Investors lost a ton of cash and were left scratching their heads.
How did this happen so quickly? Why did net income fall off a cliff? Why now?

They then go on to explain that technology changes faster and faster, mostly because of

1. Technology adoption accelerating
2. Internet way of life
and what they call: 3. Software Eating the World

Their final verdict is clear:

With technology upending markets, remaining a value investor is a death sentence. In the case of RIM, the company thought that their scale was defensible and stopped innovating on the operating system, favoring battery life instead. Apple’s iPhone operating system and associated software was an order of magnitude better than RIM and attracted consumers. Interestingly enough, Apple is dangerously close to losing their own software battle to Google with mobile versions of Google Maps, Gmail and Google voice being far better than their iOS counterparts.

While there may still be opportunities for value investing, you need to be cautious of businesses that appear to be on a slow decline. With the rate of technology adoption accelerating, Internet being a way of life and software consuming the world, businesses who refuse to embrace or adapt don’t just slowly decline; they fall off a cliff and take their cash flows with them.

The final statement in my opinion is both, partly wrong and partly very important for value investors.

What A&H describe is what is known to value investors as a Value Trap. A superficially cheap stock, which however for different reasons is in terminal decline. This is clearly not restricted to technology stocks, although there it is quite obvious.

Even the most famous value investors are not immune against this, as Seth Klarmann’s unsuccessful investment in Hewlett Packard showed.

Interestingly, short seller Jim Chanos (who I consider to be one of the best value investors ever) basically says the same thing:

You have to be very careful, because we looked at our returns over the past 10 years, and, particularly since the advent of the digital age, some of our very best shorts have been so-called value stocks. One of the differences in the value game now versus, say, 15 or 20 years ago, is that declining businesses, while they often throw off cash early in their decline, find that cash flow actually reaches a tipping point and goes negative much faster than it used to.

I think this is a very important point here: Low valuation (low P/E, low P/B) and/or high FCF yields based on past data are by no means a guarantee for superior investment returns. He directly confirms A&H in this paragraph:

The advent of digitization in lots of businesses also means that the timing gets compressed, meaning that you need to move quickly or you are roadkill on the digital highway. That’s true whether you look at companies like Eastman Kodak, or Blockbuster, or the newspapers. Value investors have been drawn to these companies like moths to the flame, only to find out that the business has declined a lot faster than they thought and that the valuation cushion proved to be anything but.

I think this is also one of the reasons, why many of the older “Quantitative Value strategies”, such as Dreman’s or O’Shaugnessey don’t work so well any more.

To summarize it bluntly up to this point: If you think value investing is only about buying low P/E and/or low P/B or low P/FCF stocks, then you will most likely be in for a quite nasty surprise, especially if you invest in anything that is subject to the technological changes as described above. Many of thse companies will drop off much more quickly than in the past and reversion to the mean will not happen.

On the other hand, I don’t think that value investing is dead, but it has rather evolved. If you look at Warren Bufft (and Todd Combs and Ted Weschler of course), Buffet style value investing looks of course very different. He invests at much higher P/Es and P/B, however still with a lot of margin of safety as he is able to factor in the value of potential “moats”.

Other value investors like Seth Klarmann for instance go into other asset classes or “special situation” investing where “margins of safety” are created via forced selling of market participants.

Funnily enough, when I was googling “The death of value investing”, an article with exactly the same title popped up from 2008, written by the quite famous author Edward Chancelor.

He refers to mistakes made by some “value investors” at that time:

The housing bubble, however, changed many facts. But some of the world’s leading investors appeared not to have noticed. First, several prominent names piled into housing stocks when they were selling at around book value. This proved a disastrous move as falling land prices and slowing sales generated massive losses for homebuilders. Then, some of the same investors charged into banks, figuring they were cheap. That also turned out to be a poor idea.

As we know now, Value investing made it at least another 5 years and 2008 and 2009 provided the best opportunities for open minded value investors in a generation.

Summary:

Clearly, Value Investing is not dead. It was not dead in 2008 and it is not dead now. But as the A&H well describe, “simple value” investing, i.e. just buying low P/E and P/B stocks is much more dangerous now that it was in the past.

For the “Normal” value investor, this means to put more effort in to identifying potential value traps. There is strong support to the thesis that declining companies, especially those subject to technological change, will “drop over the cliff” much faster than ever. So buying HP/Apple/ Micrososft/Intel/Solar/Media because it is so cheap at single digit trailing P/E minus cash should not considered to be a value investment unless you are really sure that sales and profits will not drop off similar to Nokia and RIM.

Value investing willneed to further evolve, but buying investments at a discount to a (carefully) determined intrinsic value will always be a good investment startegy.

Sourcing ideas: Quick Scan Evermore Global portfolio

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In the weekly links, I had linked to the Evermore portfolio. On reader commented that the fund performed badly, so why bother ?

Well, I do not know if they perform better in the future, but their philosophy which the lined out in the report looks quite OK and if they follow that then in the long run they should do OK. It is also rare that you have a “mutual fund wrapper” for a special situation fund. There are many funds where you can see the “usual” value stuff. As sourcing special situation ideas is not as easy (there is no real “screener”), having such funds and looking for ideas is quite helpful.

So as I use the blog also as my personal notepad, I wanted to quickly put down some points about their positions in order not to forget them:

Frontline Convertible
Far out of the money convertible, maturity April 2015. Currently trades at around ~50%. Situation similar to IVG. Could be interesting.

Ei Towers
Italia based operator of broadcasting “infrastructure”. At a first glance not as cheap as SIAS but more shareholder oriented.

Constantin/Highlight
Many years ago I had saved Constantin as “uninvestible”, however I do not remember why. Time to look at them again ?

AIG/Genworth
No interest here. I guess many people underestimate how catastrophic the combination of low interest rates and potentially higher inflation is for insurance companies (yes I know, Baupost owns them both, but why does Buffet not write Life Insurance policies ?)

Vivendi
Also a Baupost stock. I still believe Bougyues is the better company.

Bolore
I personally view Bolore more like a financial “juggler”. There is much cheaper stuff in France in the small cap sector

ADT
Spin-off / split off from Tyco. US company, not my cup of tea

Moduslink Global
This seems to be some sort of Asset play. Unprofitable US small cap (market cap ~140 mn USD), however half of market cap in cash.

Impregilo
Smart move, although I looked at them during my Autostrada/SIAS analysis, I didn’t figure out the stake in the Brazilian company. I don’t know when they bought but this was a very good one. The Sicilian guy Salini made a tender for 4 EUR per share and Autostrada seems to accept it at 4 EUR per share.

Exor SpA
The HoldCo of the Agnielli family for FIAT. I saw them in some other portfolios (Longleaf, Southeastern) but never had the time to look at them.

Sevan Drilling Norway
Stock price looks distressed (P/B ~0.3). However I have no knowledge about deep sea drilling. MAybe a good stock to start ?

Sky Deutschland
Nothing for my portfolio.

Ackermans & Van Haaren
Diversified Belgium company. Looks more like a potentially “boring compounder” than special situation but interesting.

Guoco Group
Hongkong based group, bid from a Malaysian company. First Eagle and Third Avenue are shareholders as well

Pulse Seismic
Seismic data licensing company. Never heard before. business model itself quite interesting

Lonrho Plc
(in)famous UK conglomerate, now seems to be reinvent itself as an African-Agricultural company. Anyone remembers Tiny Rowland ?

Summary:

I think their portfolio is quite interesting, despite the yet lackluster performance. I will keep them on my list for possibly “Stealing” some ideas. Currently, I think Ei Towers, Sevan, Pulse and Ackermans look the most interesting to me.

Value Investor or Value Pretender ?

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There was a very nice post over at beyondproxy about the varieties of value investors.

The top 10 characteristics to spot the so called “Value Pretenders” from beyondproxy were the following:

Reason #10: You invest based on chart patterns,
Reason #9: You assume multiple expansion in your investment theses
Reason #8: You try to figure out how a company will do vis-à-vis quarterly EPS estimates
Reason #7: You base your decisions on analyst recommendations
Reason #6: You use P/E to Growth (PEG) as a key valuation metric
Reason #5: You use EBITDA as a measure of cash flow
Reason #4: You would worry about your portfolio if the market closed for a year.
Reason #3: You make investment decisions based on the activity or tips of others
Reason #2: Your investment process centers on the market opportunity.
Reason #1: Your investment theses do not reference the stock price

David Merkel at the Aleph blog has (as always) a very good reply to all the 10 points which I strongly support.

As I think this topic is quite interesting and funny, I tried to come up with some of my own characteristics which, in my opinion, could help to detect “Value Pretenders”:

My Top 10 list for detecting value pretenders would be the following:

10. Portfolio turnaround of 50% or more p.a.
“True value investments” are almost never short term bets. Sometimes if you are lucky, value gets realised more quickly but on average those ideas need at least 3-5 years for full potential.

9. Buy and sell decisions because of macro events or macro expectations
As a value investor, you have to be a fundamental investor and analyse on a company level. Macro expectations play a certain role but should never ever be the basis of a buy and sell decision as no one is able to really and consistently to predict them. In contrary, negative macro events are .sometimes very fertile hunting grounds for fundamental investors

8. Investment process does not include reading several annual reports per company in detail
As a fundamental investor, there is no replacement for reading the “original” source of information.

7. Investments in companies with questionable / aggressive accounting
As a value investor, you first thought should be: Can I lose money with this. Whenever a company looks cheap but accounting is questionable, there is no real margin of safety. Conservative accounting and integrity of the persons involved is key.

6. Investor does not discuss risks and weaknesses in detail
Again, the main point in value investing is not loosing. There is never a sure thing, every investment can go belly up. But as a value investor you should be able to identify and price in at least all the obvious risks. And communicate them.

5. Investor does not have a (to a certain extent) structured investment process or a very complicated one
A structured investment process is no guarantee for success, most asset managers pretend to have one. However, if the process is to complicated, with lots of committees and stuff, it is not a positive sign as responsibilities get diluted. No real proces at all is also a waring sign, although for the rare genius (WB) this might work. For pure mortals no process means the big risk of being vulnerable to all kind of behavioural biases.

4. Performance record consistently shows higher draw downs in negative periods than the market
Clearly, even the best value portfolio can underperform in a bad market. However if one sees this more than once, the portfolio is most likely not a “value portfolio” but a high beta portfolio of low quality stocks.

3. Investor offers you redemption on a daily basis
One of the big issues with investors is the tendency to second guess the investment manager. A value investor should “protect” his investors from their animal instincts and align their expectations with his investment style. Joel Greenblatt had a great article on this as he showed how individuals underperformed the Magic Formula by a wide margin because of jumping in and out of the strategy. For me, offering a daily redeemable investment vehicle (mutual fund) and claiming to be a value investor does not go well together.

2. Investor can tell you a great “story” for every stock he owns
On the one hand, any value investor should be able to lay out his investment thesis in a few simple sentences. Anything which is too complicated to explain is most likely not a good investment. On the other hand, “story stocks”, especially those touting some new invention or change in business strategy etc. are mostly never good investments. Good investments often don’t have “catchy” stories but rather are simply good and reliable businesses.

1. Investor uses only last year’s earnings / book value / cashflow plus projections as basis for an investment
This is one of the worst mistakes one can make. One year numbers are to a certain extent more or less meaningless. This is also one of the main reasons why I am very sceptical of “statistical value” strategies where people try to “data mine” investments. Clearly one can use this as a starting point for further analysis, but every company is the sum of its past and looking only at one year is like judging a book purely by its cover.

Finally a few words in general: there is clearly more than one way to success in investing and also more than one way to do “value” investing”. But at the core of value investing are in my opinion:

A) detailed fundamental analysis
B) protection of the downside
C) long time horizon
D) patience

Quick updates: G. Perrier, Maisons France Confort, April

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Some quick updates on French stocks:

G. Perrier

Already some days ago, G. Perrier announced preliminary 2012 numbers.

Highlights:

– Sales up 7% (+4% without acquisitions)
– Profit up 13.2% to 7.94 mn or 4.02 EUR per share

In my opinion, this is an absolut outstanding result if one considers that G. Perrier is more or less a purely domestic French company and clearly shows the quality of the company and their business model. I am not sure when the annual report is out, but as discussed perviously, I will increase the position further, target is now a full position.

Maisons France Confort

Also already a few days ago, Maisons France Confort issued annual numbers including the annual report. As some readers might remeber, i had two posts about them (part 1 & part 2), but didn’t include them in the portfolio yet.

Looking at the stock price action, it seems to be that market participants had expected better numbers or a better outlooK:

Final numbers were 2.70 EUR EPS for 2012. With around 7 EUR net cash per share, this translates into a trailing P/E of ~5.9. Of course, 2013 will not be easy for them, i guess the late spring in Europe will not improve things and the business model of MFC has much more exposure to the weak French economy. Nevertheless it looks like a potentially interesting cyclical entry point into a real good business. I will have to follow up on that one.

April SA

Quite similar to MFC, April came out with its 2012 numbers and the stock got hammered quite significantly.

The company earned 1.31 EUR per share, additionally there were some positive effects in the other comprehensive income. April clearly has the same problem as any financial services company which is very low interest rates. Nevertheless it is not clear to me, why the share price has now decoupeled from peer company AXA.

I will clearly have to look at the annual report, but so far I don’t see any reasons to sell.

Cyprus bank deposit guarantee scheme – fact checking

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Yesterday and today, the press and most of the blogs I follow are full of comments on the Cyprus Deal.

Some examples:

Pragmatic Capitalism, Naked capitalsim, self evident

The summary is clear:

“Insured” bank deposits are going to be confiscated because of the evil (Germans/IMF/ECB). This is a catastrophe because no one will believe in bank deposit insurance any more.

Fact checking:

What I find extremely interesting is the fact that no one actually bothered to really look at the so-called “bank deposit insurance” in Cyprus. The Central Bank of Cyprus has an English language description of the scheme on their homepage.

In the beginning it sounds like a “normal” deposit guarantee:

Deposit Protection Scheme (DPS) was established in September 2000, and operates since then, in accordance with Article 34 of the Banking Law of 1997 as subsequently amended, and the Establishment and Operation of the Deposit Protection Scheme Regulations of 2000 to 2009. In accordance with these Regulations, a Deposit Protection Fund has also been established which operates as a separate legal entity administered by a Management Committee.

The purpose of the DPS is to provide protection to deposits and compensate depositors in the event that a member bank is unable to repay its deposits. The DPS covers deposits denominated in all currencies.

But then this:

The maximum level of compensation, per depositor, per bank, is €100.000. This limit applies to the aggregate deposits held with a particular bank. When calculating the amount of compensation payable to a depositor, any loans or other credit facilities granted by the depositor’s bank are set-off against the deposits. Any counterclaims that the bank concerned may have against the depositor in respect of which a right of set-off exists, can also be set-off.

I have to admit that I didn’t check all European deposit guarantee schemes but setting of loans against your deposit first looks unique to me. So in practice this means if you have a 300 k mortgage from your bank and for some reason a deposit of 100k at the same bank, your guarantee is worth nothing/nada/niente/nichts.

So the proposed deal of getting a 6.75% haircut on deposits irrespective of outstanding loans will be a much better deal for many people than being the “beneficiary” of this so-called “deposit guarantee”. Maybe that is one of the reasons they did this ?

It also seems to be that the word “guarantee” means something different in Cyprus than in the rest of the (finance) world.

Berkshire Hathaway 2012 listed stocks performance

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I hope everyone has now read the 2012 annual Berkshire Letter which came out last week.

Among other stufff, Warren Buffet complained a little bit that he didn’t beat the S&P 500 based on the increase in Book Value at Berkshire.

Just for fun, I hacked in Berkshire portfolio.

In a first step I looked at all the disclosed positions above 1 bn USD.

2012 perfomance P/E P/B EV/EBIT EV/EBITDA Beta Volume
American Express 23.57% 14.7 3.8 16.1 8.9 1.05 8,715
Coca Cola 6.51% 19.6 5.3 16.6 14.0 0.72 14,500
Conoco Philips 9.20% 9.5 1.5 6.5 4.4 0.98 1,399
Direct TV 17.31% 10.8 #N/A N/A 9.0 6.2 0.89 1,154
IBM 4.17% 13.7 12.4 11.6 9.4 0.91 13,048
Moody’s 51.86% 16.6 29.1 10.3 9.5 1.31 1,430
Munich Re 54.71% 8.1 1.0 #N/A N/A #N/A N/A 0.94 3,599
Philips 66 50.41% #N/A N/A 2.0 10.8 8.5 1.16 1,097
POSCO 1.19% 8.3 0.7 9.0 6.4 1.01 1,295
Procter & Gamble 5.18% 19.4 3.2 14.4 11.9 0.64 3,563
Sanofi 34.20% 20.0 1.7 13.2 6.9 0.76 2,438
Tesco -8.20% 10.8 1.7 10.4 7.2 0.72 2,268
US Bancorp 20.96% 11.9 1.9 #N/A N/A #N/A N/A 1.09 2,493
Walmart 16.97% 14.6 3.2 10.3 7.9 0.59 3,741
Wells Fargo 27.37% 10.7 1.3 #N/A N/A #N/A N/A 1.15 15,592
 
Total / Avg 17.56% 14.27 5.0 13.4 10.1 0.92 76,332

To add some value, I have added some valuation metrics and aggregated the performance based on year end values. Although this is not the 100% correct way to do this, we can see that the listed stock portfolio outperformed the S&P Total return index (+14.1%) by a margin of almost 3.5%. A very respectable outperformance for a 75 bn USD portfolio. One can also see that the Beta of the portfolio is clearly below 1, so the outperformance really looks like alpha. (EDIT: I do not know which Index Buffet used for his 16%, I took S&P 500 total return performance from Bloomberg).

From simple valuation metrics, the portfolio of course looks quite expensive. P/E of 14.4 is in line with the S&P 500, but it looks like that Berkshire doesn’t consider P/B as a meaningful metric for listed stocks anymore. Also, the average EV/EBIT of 13 and EV/EBITDA of 10 is far above I would be prepared to pay.

In a second step, I added all the stock positions which were disclosed by Berkshire plus anything available on Bloomberg with a value of more than 200 mn USD.

2012 perfomance P/E P/B EV/EBIT EV/EBITDA Beta Volume
American Express 23.57% 14.7 3.78 16.05 8.88 1.05 8,715
Coca Cola 6.51% 19.6 5.33 16.55 13.98 0.72 14,500
Conoco Philips 9.20% 9.5 1.47 6.54 4.38 0.98 1,399
Direct TV 17.31% 10.8 #N/A N/A 9.03 6.16 0.89 1,154
IBM 4.17% 13.7 12.41 11.56 9.41 0.91 13,048
Moody’s 51.86% 16.6 29.11 10.29 9.48 1.31 1,430
Munich Re 54.71% 8.1 0.96 #N/A N/A #N/A N/A 0.94 3,599
Philips 66 50.41% #N/A N/A 1.98 10.82 8.52 1.16 1,097
POSCO 1.19% 8.3 0.70 8.96 6.36 1.01 1,295
Procter & Gamble 5.18% 19.4 3.21 14.44 11.88 0.64 3,563
Sanofi 34.20% 20.0 1.74 13.22 6.88 0.76 2,438
Tesco -8.20% 10.8 1.74 10.40 7.15 0.72 2,268
US Bancorp 20.96% 11.9 1.86 #N/A N/A #N/A N/A 1.09 2,493
Walmart 16.97% 14.6 3.21 10.27 7.86 0.59 3,741
Wells Fargo 27.37% 10.7 1.33 #N/A N/A #N/A N/A 1.15 15,592
               
Davita 45.80% 19.4 3.33 14.95 11.94 0.80 1,830
Swiss Re 49.31% 6.8 0.92 #N/A N/A #N/A N/A 1.15 909
Washington Post 1.20% 17.6 1.16 9.27 4.52 0.81 704
General Motors 37.40% 9.3 1.47 #N/A N/A 1.31 1.19 697
M&T Bank 31.99% 13.7 1.43 #N/A N/A #N/A N/A 1.07 558
BonY Mellon 30.69% 12.2 0.92 #N/A N/A #N/A N/A 1.28 544
Costco 26.15% 24.8 3.50 13.49 10.21 0.75 444
USG 166.24% #N/A N/A 502.76 48.17 18.47 2.14 472
Viacom 16.92% 14.5 4.21 9.25 8.70 1.16 459
Precision Castparts 12.83% 20.3 2.92 15.23 13.93 0.92 374
Mondelez 6.24% 12.7 1.58 9.46 7.81 0.62 366
National Oilwell -0.76% 11.5 1.43 8.19 6.96 1.51 357
Deere 11.80% 11.2 4.67 8.22 6.75 1.14 355
Wabco 43.46% 14.4 6.48 12.46 10.07 1.72 281
General Dynamics 6.04% 10.6 2.10 30.15 17.28 0.97 262
Visa 47.56% 24.6 4.68 18.01 17.09 0.98 250
Torchmark 18.82% 11.2 1.25 #N/A N/A #N/A N/A 0.97 245
Mastercard 29.89% 23.9 9.38 14.04 13.27 1.00 214
               
               
               
 
Total / Avg 19.57% 14.4 7.6 13.6 10.1 0.94 85,653

A few observations here:

I do not understand, why DaVita was not included in the shareholder’s letter with a market value of 1.8 bn. Maybe they have forgotten this position ?

Secondly, including those additional ~10 bn of stocks increases the total performance of the total portfolio by an incredible 2%.

In a third step, I calculated the performance of what I would call the “Non Buffet” Portfolio, taking Direct TV from the annual letter and eliminating Swiss Re and Washington Post from the < 1bn list.

2012 perfomance P/E P/B EV/EBIT EV/EBITDA Beta Volume
               
Direct TV 17.31% 10.8 #N/A N/A 9.03 6.16 0.89 1,154
Davita 45.80% 19.4 3.33 14.95 11.94 0.80 1,830
General Motors 37.40% 9.3 1.47 #N/A N/A 1.31 1.19 697
M&T Bank 31.99% 13.7 1.43 #N/A N/A #N/A N/A 1.07 558
BonY Mellon 30.69% 12.2 0.92 #N/A N/A #N/A N/A 1.28 544
Costco 26.15% 24.8 3.50 13.49 10.21 0.75 444
USG 166.24% #N/A N/A 502.76 48.17 18.47 2.14 472
Viacom 16.92% 14.5 4.21 9.25 8.70 1.16 459
Precision Castparts 12.83% 20.3 2.92 15.23 13.93 0.92 374
Mondelez 6.24% 12.7 1.58 9.46 7.81 0.62 366
National Oilwell -0.76% 11.5 1.43 8.19 6.96 1.51 357
Deere 11.80% 11.2 4.67 8.22 6.75 1.14 355
Wabco 43.46% 14.4 6.48 12.46 10.07 1.72 281
General Dynamics 6.04% 10.6 2.10 30.15 17.28 0.97 262
Visa 47.56% 24.6 4.68 18.01 17.09 0.98 250
Torchmark 18.82% 11.2 1.25 #N/A N/A #N/A N/A 0.97 245
Mastercard 29.89% 23.9 9.38 14.04 13.27 1.00 214
               
               
Total / Avg 34.97% 15.2 33.6 15.3 9.9 1.07 8,862

And here we can see that Weschler and Combs really “shot out the lights”. 35% performance for 2012 is a fxxxing fantastic result. Ok, Beta is slightly above 1 but at least for 2012 the did a outstanding job. No wonder Buffet said that in his annual letter:

Todd Combs and Ted Weschler, our new investment managers, have proved to be smart, models of integrity, helpful to Berkshire in many ways beyond portfolio management, and a perfect cultural fit. We hit the jackpot with these two. In 2012 each outperformed the S&P 500 by double-digit margins. They left me in the dust as well.

So even if some of the smaller stocks are “Warren & Charlie” stocks as well, Weschler and Combs showed them how its done at least with a smaller portfolio. Maybe the smaller size of the portfolio is the reason ?

Summary:

Once again, the portfolio of listed stocks of Berkshire outperformed the S&P 500 by a nice margin. However it seems to be that Buffet’s “elephants” don’t have a chance against the smaller holdings of Weschler and Combs. Nevertheless, for the “lazy” value investor, copying the Berkshire portfolio looks still like a winning strategy.

Copying the “small” Berkshire stocks however looks like the absolute killer strategy.

Royal Imtech update: Higher loss & Rights issue

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After last qeek’s first look at Royal Imtech, Imtech came out today with a press release:

The highlights were as follows:

Rights issue will be completely used for debt reduction
Measures to make financial structure more robust
Write-off of 150 million euro for Polish projects
Write-off of 150 million euro for German projects

So this means that the write offs are a lot higher than initially communciated. Back then, they only said “100 mn EUR in Poland”, now we are at 300 mn EUR in Poland and Germany.

In parallel they also reported a change in the CEO positon:

Gouda, the Netherlands – The Supervisory Board of Royal Imtech N.V. (IM-AE, technical services provision within and outside Europe) confirms that in good consultation and in line with the original plan, René van der Bruggen (65) has decided to retire as of 3 April 2013. He will remain a member of the Board of Management until 3 April. He will hand over as Chairman with immediate effect. Gerard van de Aast (55), who is already a member of the Board of Management, is as of now appointed CEO of Royal Imtech and Chairman of the Board of Management

So this could be an interesiting situation. The new CEO will most likely go for a “kitchen sink” approach and write off as much as possible in order to have some “cushion” in the future.

Another aspect is what they say in the first press release:

Royal Imtech N.V. (IM-AE, technical services provider in and outside Europe) announces that the company will strengthen its equity through a rights issue of 500 million euro. The proceeds of the rights issue will be completely used for debt reduction. As a result of this the balance sheet of Imtech will be reinforced

This looks like that the banks have Imtech “by the balls” and could push through the rights issue in their interest. So it is not really a surprise that the share price of Imtech dropped to a new low:

Again, as in the KPN case I would wait until the details of the rights issue are known. With a current market cap of 800 mn EUR, a 500 mn EUR rights issue will require a significant discount.

Quick KPN update

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

In my opnion, there were 2 surprises:

Size

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

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

The second surprise is the following:

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

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

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

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

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

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

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

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

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

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

So summing up:

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

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

Imploding Dutch stock of the week: Royal Imtech (ISIN NL0006055329)

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After KPN and TNT Express, we highly welcome another Dutch company with an imploding stock price, Royal Imtech.

The company:

Royal Imtech seems to be active mostly in everything which on can install into buildings, such as heating, securities, electrical equipments etc. although the company profile on its website sounds like a perfect score at “bullshit bingo”:

Imtech offers added value with integrated and multidisciplinary total solutions that lead to better business processes and more efficiency for customers and the customers they, in their turn, serve. Imtech also offers solutions that contribute towards a sustainable society – for example, in the areas of energy, the environment, water and traffic.

Nevertheless, until recently (November 2011) Imtech was highly coveted by analysts as “clean tech” super star , with a 100% buy rating and price targets of 30 EUR per share and more.

The problem

In beginning of February, Imtech came out with a “bombshell” press release.

Not only did they have to postpone their earnings release, but they also indicated that they have a loss of min. 100 mn EUR in their fast growing Polish business. The press release contains this “gem” of potential accounting fraud:

The Board of Management has also determined that a promissory note and pledged accounts related to the Adventure World Warsaw project – amounting to around 200 million euro – that had been recognised in the half-yearly 2012 financial statements under cash and cash equivalents must, according to IFRS, be reclassified under current financial assets. Most of this amount was recognised as an advance payment under work in progress for the four projects concerned. This advance payment was considerably higher than the incurred costs. As stated above, the advance payments have not become available to Imtech. The effect of this is incorporated in the expected write-off of at least 100 million euro

This potential fraud leads to another problem: As net cash is part of their loan covenants, the company already indicates that all of a sudden, they are now in breach with their loan covenants:

The consequence of the expected write-off will be that, when its 2012 financial statements are drawn-up, Imtech will no longer fulfil its covenants with lenders – average ratios of 3.0 maximum for net debt/EBITDA and 4.0 minimum for interest coverage. As a result Imtech will begin consultations with its lenders. Imtech has retained Rabobank as its financial advisor for these consultations.

The share price fell of course like a stone following this announcements:

One interesting aspect about Imtech is the fact that some rumours about aggressive accounting were circulating already late last year. Of course management denied all allegations at that time.

Interestingly, Imtech had already a quite high short interest at that time, almost 10% of the market cap was short at the end of the year. Thanks to the new regulations about short disclosure one could see that the “smart money” like Dan Loeb’s Third Point is short the share.

Why bother at all ?

One of the reasons I looked at Imtech is that based on many metrics, Imtech looked like a great stock and even more now at the current price levels. I am sure, Imtech will show up now on many “value screens”. Even in my BOSS model, Imtech looks quite compelling.

If we look at some measures, Imtech really looks like a great company:

EPS DIV ROE ROIC
31.12.2002 0.61 0.42 17.4% 21.9%
31.12.2003 0.57 0.36 14.5% 41.7%
31.12.2004 0.58 0.36 12.5% 17.1%
30.12.2005 0.69 0.36 18.4% 18.6%
29.12.2006 0.86 0.36 21.9% 19.5%
31.12.2007 1.17 0.36 26.4% 21.4%
31.12.2008 1.46 0.47 29.7% 18.3%
31.12.2009 1.62 0.59 28.2% 16.3%
31.12.2010 1.70 0.64 21.4% #WERT!
30.12.2011 1.72 0.65 17.3% 11.4%

One can see growing earnings, growing dividends, nice free cashflow and double digit ROIC and ROEs. So what is not to like ?

The big question

So the question is: Is Imtech a great company which has just facing a bump on its road to further success or is there a real problem with the company ?

There are some examples of great companies with similar problems, for instance Hugo Boss AG, the German luxury Group. In 2002, they detected fraud in their US subsidiary (“channel stuffing”) and had to restate their 2001 balance sheet significantly. I just found this research note from Commerzbank in 2002 where they downgraded the stock from 16 to 9 EUR per share. Looking back, this would have been the perfect entry point for Hugo Boss. The stock since then performed ~30 p.a. until now (a 15-bagger so to say) against 7.7% of the CDAX.

However with Imtech, I have some doubts due to the following reasons:

Acquisitions:
Imtech more or less looks like a typical “roll up”. On the “acquisitions” page of their homepage one can see that they have done like 10–15 acquisitions per year. With roll ups, it is very difficult to asses the reported numbers of such a company because of the large leeway available for accounting for acquisition. Even cash flows can be “massaged” quite significantly as we have seen many times before.
As a result, Imtech carries significant goodwill. This in itself is not necessarily a problem, but together with significant accounting problems, this might become a problem quite soon.

Type of fraud
As mentioned above, this fraud was not “only” about faking sales but also about faking on-balance sheet cash. As we know now, Imtech has quite tight credit covenants. So in my opinion this implies that the fraud has some connection to the whole group and is not only a result of some renegade employees in a subsidiary. Imtech seemed to have general problems with cash and fulfilling its covenants before.

Summary:

In theory, Imtech could be a great company which had bad luck with management in a subsidiary. This would be a good entry point to buy a great business at rock bottom prices.

However, at least in my opinion, the history of the company as a “roll up” as well as the type of fraud makes me cautious. So for the time being this will be just sit back and watch what is going to happen (and trying to learn more…).

Maybe if they really go the way of a big rights issue as indicated in this Bloomberg story might be an interesting entry point, but only if the issues regarding the fraud have been clarified in the meantime and the business is viable. Otherwise, the good parts of the business will most likely go to the creditors and the shareholders might get nothing (but the blues).

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

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

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

Relative valuation

let’s look at some standard valuation metrics:

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

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

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

KPN history

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

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

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

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

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

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

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

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

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

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

Debt profile

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Summary:

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

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