This is an idea a reader mailed me some time ago and originated in the Value Investor Club. The idea is freely available following this link.
A quick summary of the stock & the case:
Market Cap: 573 mn EUR
P/E 12.4
Div. Yield 5.97%
P/B 1.8
EV/EBITDA 3.7
Several readers already mentioned KHD Humboldt Wedag as a potential “special situation” investment, so it might make sense to quickly check it out.
KHD Humboldt Wedag
KHD is planning and constructing cement plants world wide. The company has a quite interesting past. It used to be part of the big “Deutz” Group of companies but was sold.
In the meantime, the company has been taken over and then spun off again in some sort of form. The mastermind behing those transactions is financier Michael J. Smith. This guy himself seems to be a very interesting investor himself as this Seekingalpha post shows.
There is a very good Thread on Wallstreet Online covering the history of the company for the last 7 years or so.
The business itself is highly cyclical. If I look at how cement companies themselves are struggeling to even earn a small profit because of a large over capacity in the indutry, I am not sure how many new cement plants will be actually built in the coming years. Sales dropped 50% from 2009 to 2011. One could describe this as “extremely late cyclical”.
KHD is since a long time a favourit among “net net “investors as they carry a large cash balance on their balance sheet. However, cashflows are extremely volatile.In 2011, operating cashflow was around -80 mn EUR.
Again in Q1 2012 the comapny showed shrinking sales and a large net cash outflow of around -20 mn EUR reulting in a loss for the first quarter, although the orderbook seems to have improved. I have however no idea how the orderbook actually transforms into sales and profits.
In early 2011, KHD executed a capital increase for around 20% of the company to bring on board a Chinese company. At least for me it was not clear why they did it. Officially they said to increase their “footprint” in China. if one looks at the order intake in 2011, this cooperation didn’t really show any results, at least not in the line for China.
Some weeks, Paul Desmarais, the guy behind the “Canandian Berkshire” Power Cooperation has revealed a 3% position. Another activist investor, Sterling Strategic Value is on board with 12%.
In the invitation to the annual shareholders meeting, Michael J Smith was proposed to enter the supervisory board as the boss. Although the first news seems to be interesting, the second part, MJS returning might not be the best news for the uninformed minority investor.
Just a few day’s ago, the annual shareholder’s meeting was postponed due to “technical reasons”, although some investoirs seem to have received a surprise dividend therafter.
For me, KHD at the moment is something I would not invest into due to the following reason:
– I have no idea about the goals of the parties involved (MJS, Chinese guys).
– the business is extremely cyclical and at the moment fully depending on Emerging markets
– I have no idea how much of the cash is really “free” and what is needed to finance new projects
– I would rather prefer to buy cheap cement companies, because they will proft earlier from a revival in cement sales
– I do not have any (good) experience with activist campaigns, I am not sure that I have the nerves for that
Overall, I do not think that I can gain any “edge” in this situation and it is clearly outside my core competencies. In such cases I will rather pass however it might be a good learning experience following the further “proceedings” from the outside.
For the record, some special situations which I try to avoid:
– merger arbitrage (to many pros)
– distressed debt (complex, dirty stuff going on)
– activist campaigns (insider)
As many may know, German drug store retailer Schlecker went bankrupt a few weeks ago. Schlecker was not listed and didn’t have any bonds outstanding, but I found nevertheless this article quite interesting:
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One of the “ineffecient” corners of the stock markets are definitely penny stocks, in particular stocks of bankrupt companies.
A very good example is currently Solon SE, the once highflying German solar panel manufacturer.
Solon became bankrupt in mid December 2011. The stock dropped already a lot before:
However, after the news that an Indian company might be interested in some of the assets, the share price went up from around 0,23 EUR to 0,30 EUR, giving the shares a market cap of around 5 mn EUR.
Before going into the liquidation value anaylsis, we should look at the debt structure. Solon has created a lot of debt in the last years, in total around 400 mn in loans and bonds. Solon has one listed bond outstanding, a Convertible Bond from 2007 which would have matured end of 2012. Total outstanding amount is 132 mn EUR.
This bond is trading at 4% (!!! not 40%) of nominal value.
So in order for the shareholders to see a single cent of any liquidation proceeds, the bondholders will have to be paid in full. The likelyhood for this happening seems to be extremely low according to the bond price. The reason for this is that most of the asstes have been pledged for the bank loans after a debt restructuring in 2010.
One could now anaylse if the bond is correctly valued, but after any metric, the recovery rate for the bond will be significantly below 100%, which means the shareholders will get nothing.
So why on earth is someone willing to pay 30 cents for something thatr is worth nothing ? There are some theories about option value, but in my opinion the reason is most likely ignorance and “animal” spirits.
Fundemantally, Solon SE is a stock one can safely short down to zero, provided one can stand the volatility. For the portfolio I will initiate a short position of max. 2% from today, again following the 20% VWAP rule.
Edit: I have looked at the funding structure and my conclusion is that also the bond is a ZERO, but I would not want to bet on it. The safe bet is the stock.
Following part 1 and part 2 about my thoughts on a potential Hyundai Motors capital structure arbitrage deal, I wanted to summarize my thoughts and come to a conclusion.
In between, some new information came up:
a) it is possible to trade single stock futures in Korea thorugh Interactive Brokers
b) the mentioned US ADRs are actually ADRs on Hyundai Motor pref shares, so no “cheap” short potential
c) a contact told me that stock borrowing costs for Hyundai Motors common shares in Korea would be about 3-4%
Based on this new information, the relative value trade (short common shares, long pref shares) looks less attractive.
Traditional long-short
In the traditional short with a long position in the pref shares and a short position in the common, the “carry” would be calculated as follows:
Yield long position (3.77%) minus yield short position (0,80%) minus cost stock borrowing (3-4%).
So we would end up in the best case with 0% carry, in the worst case with -1 % carry for the long short position. Negative carry trades are much less attractive because you actually loose if nothing happens. A good carry trades gives you something in case nothing happens (“positive cary”) plus upside to compensate against the potential unlimited risk from the short position.
Long pref / short future
The problem with the long pref and short future strategy is that one has to fully fund the long position as the short future does not provide funding. So the overall potential return on investment is much lower than a fully funded long short trade. Only if you believe that the pref shares could close the valuation gap dramatically you would get an interesting return out of this strategy. However I do not have any view on this.
So to summarize this: based on current dividend yields and and stock borrowing costs, the long-short trade does not look too attractive as it doesn’t provide a positive carry. The long pref / short future trade might not be worth the effort too implement it as the upside potential is relatively limited and now real catalyst is on the horizon.
value and opportunity 