Category Archives: Opportunities

IVG again (and again and again)

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disclaimer: The discussed investment is very risky and not recommended for any investor. There are strong hints of insider trading and permanent loss of capital and permanent loss of principal is quite likely. The author owns the investment and is clearly biased towards a positive outcome

Thanks to a reader, I received some “research” about IVG directly out of London, HF and “predator” capital (highlights are mine):

IVG – Further Thoughts

I had the opportunity to talk to the company late on Friday. I remain public on the name and have not received private information…

As one would expect, the company would not give any details of proposals being discussed with stakeholders; however, the company admitted that it had considered a number of options for repaying the convertible and deleveraging the company (which became necessary when the synloan holders indicated they wouldn’t be able to refi in September 2014)… including a rights issue which wouldn’t work due to the size required and the status of the hybrid and a quickie disposal of the SQUAIRE which would have seen a very significant discount to book.

A couple of things became clear:

· The company views the equitisation of the convertible and the hybrid as being the necessary first step in a restructuring process
· The haircut may also have to apply to the syndicated loans – especially SynLoan 1 which is under-collateralised
· The company’s fervent hope is to avoid any type of insolvency through a consensual agreement. Any type of restructuring under insolvency is currently considered a distant ‘Plan B’
· The company believes that significant value could be generated for equity investors through the continued management of the SQUAIRE and in the unencumbered caverns currently due to be delivered to Cavern Fund II in c. four years
· The company’s major shareholders are supporting the restructuring proposals – at least from their position on the Supervisory Board; that doesn’t mean that they will vote for restructuring at the AGM…
· Any new capital would require 75% approval at the new AGM
· The convertible bonds will require 100% vote of those attending a general meeting (quorum 50%); but that could be lowered to 75% under a new German Scheme
· It looks like Plan B may well be the more realistic proposition…

The German market is relatively short of ‘prime’ office space… prime would mean significant property located in the centre of major cities like Berlin, Frankfurt, Hamburg and Munich. IVG categorises most of its property as located in these cities. However, more properly it should be described as near one of these cities and very little of the investment portfolio could be described as prime… Prime properties still command premium rentals, non-prime properties face significant competition and rents are likely to fall on the renewal of tenancy agreements. The company states that €2.25bn is core/core+, €690mn is value add (needs work or on short tenancy) and €250mn is workout… in an insolvency the core/core+ valuations would come under pressure; the latter two categories may well be reflective of a going concern but I believe could well be significantly haircut in an insolvency… Furthermore I place little value in the €264mn ‘future caverns’ given the lack of interest from utilities; the fund valuations could come under pressure if EuroSelect 14 does indeed default; and tax assets are hard to transfer.

The company confirmed that:

· The debt on the SQUAIRE represent c. 60% LTV; the rental currently covers interest and the cover will improve. The company expects this debt to roll when it falls due at the end of the year
· The company also has a Core Financing: currently €570mn vs. assets valued at €800mn
· The Pegasus loan is currently €140mn and is secured on a variety of properties situated all over Germany and valued at €300mn
· SynLoan 1 is under-collateralised; I got the impression that less than 75% of the loan had collateral
· SynLoan 2 is over-collateralised but I have the impression that not by much… c. 90% LTV; obviously it benefits from the caverns disposals which should generate €300mn by the end of 2014

It would seem that it would be in the best interests of all of the stakeholders to keep the company a going concern, otherwise one can make a case that even the collateralised parts of the syndicated loans could be haircut.

Andrew Carrie ** 22nd April 2013 ** acarrie@knight.com ** +44 20 7997 2066

In my opinion only 2 parts of that “research” is interesting:

Number 1:

The company views the equitisation of the convertible and the hybrid as being the necessary first step in a restructuring process

This is the same kind of b…s… I have heard in the first few Praktiker calls. The answer is simple: Nope. The first step is that equity gets wiped out, then Hybrid then senior. However it clearly shows that will go down the same path as Praktiker tried and ask the bondholders for deferral.

If for some reason, they would succeed, this would in my opinion kill the complete (high yield) corporate bond market. If it is suddenly possible to change the sequence in teh capital structure, why should then be corporate spreads where they are at the moment ?

Number 2:

This is the really interesting part:

SynLoan 1 is under-collateralised; I got the impression that less than 75% of the loan had collateral

In some boards people were arguing: If a collateralized loan is sold at 85%, this is the proof that the senior is worthless, as even the collateral for the first priority loans is not sufficient. To be honest, I was struggling with that one most.

Well, this argument now doesn’t hold anymore. If in reality, the Synloan is only collaterallized at 75%, then a price of ~85% is in line with the current pricing of the convertible.

The uncollateralized part of the Synloan is “pari passu” with the convertible. So in case of the bankruptcy, synloan holders would get full repayment on the collateralized part (75%) plus pro rata repayment with the convertible which trades around 55%. The “fair value” of such a Synloan would therefore be 75% + (25%*0.55)= 87.5% and therefore absolutely consistent with current convertible prices.

If we assume that the buyers have quite high return requirements, then I think the fear of a zero recovery for the convertible gets even more unrealistic.

Summary:

If only for this one piece of information, the “research” as superficial as it is has greatly increased my confidence in the IVG convertible, because suddenly the prices paid for the more senior but partly uncolateralised loans makes sense.

One should still expect a very bumpy ride with “Praktiker style” attempts to bail in the convertible holders before anyone else, but at current prices, the risk/return relationship looks very good to me.

Again a disclaimer: “Don’t do this at home” and I might be subject to confirmation bias.

IVG Convertible and distressed debt in general: Beware the “predators” – but don’t panic either…

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It is quite interesting to read the comments to my latest IVG post and elsewhere. The overall sentiment seems to be quite negative. I think this is also partly due to some recent bankruptcies in Germany’s fledgling “Mittelstand” corporate bond market, where a couple of companies with really bad balance sheets issued bonds and defaulted quite soon afterwords. Very often, recovery rates were low double digits or even single digits.

Investing and evaluating bankruptcy situations is very complex. You have to figure out two things in order to come up with a value:

1. The probability of the company going bankrupt
2. The recovery in case of bancruptcy

The valuation of the bond is then pretty straight forward. However, before going there, maybe we should take step back and

Why do companies go bankrupt ?

In general, companies do not go bankrupt voluntarily because first and foremost the equity holders and owners will object strongly. Once a company is in bankruptcy, the game is over for equity owners, however as long as the company “lives” there is always a chance (or technically the option) that things turn around. So an equity holder will always try to stay in business.

Also management usually has not a lot to gain from bankruptcy and will try to hang on as long as they can to their posts and receive salaries. This is also one of the reasons why in many jurisdictions, not filing for bankruptcy although you are in a unsolvable position is considered a crime. In German, this for instance would be called “Insolvenzverschleppung”.

Usually, it is creditors who “pull the plug”, either by not rolling debt or by enforcing covenants which usually are part of standard bank loans. “Normal creditors” like banks and normal bond holders also don’t really like bankruptcies, they prefer their bonds being paid or rolled over. For a normal bank for instance, there is no upside to simply enforce a loan covenant if there is still a high chance that the company can survive. Enforcing a covenant for a normal bank usually means that they have to swap their loan into an asset with a much higher capital requirement.

So what banks normally do is that they will press for more equity and/or a higher coupon but normally they prefer the company to stay in business because seizing the assets does not provide a lot of upside, as the bank at max gets its notional back.

However “normal” creditors get nervous if a debtor is loosing money and the underlying assets pool is shrinking fast. If a bankruptcy is more or less unavoidable and the asset pool is shrinking, than the logical way is to press for bankruptcy as fast as possible in order to protect the downside.

Introducing the “predators”

However there is also another group of creditors: So called “vulture funds”. Those guy usually come in if a company is in some kind of trouble, but there is still enough collateral.

Their strategy is quite simple: They try to enter the capital structure at the most senior level at a discount. Those discounts often appear, if for example a bad bank is set up and people want to dispose legacy assets as soon as possible.

Example:

Assume, secured loans of a troubled company with a maturity of 5 years are sold to a “distressed debt” fund at 60% of nominal. The interest rate is 5%. By holding it until maturity, the fund will earn 13.7% p.a. if everything goes OK. This is nice, however distressed debt claims to earn as their Private equity investors more like 20-30% ROEs.

So how can they increase their annual returns ? The answer is simple: Try to enforce bankruptcy as quickly as possible and sell the collateral. So for the example from above I made two further scenarios: either bankruptcy after one year or direct bankruptcy.

Period 0 1 2 3 4 5
HTM -70 5 5 5 5 105
IRR 13.7%          
Bankruptcy after 1 year -70 5 0 100    
IRR 15.1%          
Direct bankruptcy -70 0 100      
IRR 19.5%        

So in this simple example, the principle is quite easy to see: For a “distressed secured” buyer, the earlier the bankruptcy, the higher the returns.

How can a predator enforce bankruptcy ?

The usual way to do this is to enforce “broken” loan covenants. Normal bank loans contain certain minimum thresholds, often with regard to debt/equity or debt/asset ratios as well as interest/income. If those thresholds are not met anymore, usually the debtor has a certain “cure period” to fix things. Otherwise, the loans will become “due”. In normal cases, banks will not have an incentive to enforce the covenant. So they will renegotiate the covenants but demand extra collateral and/or a higher coupon.

A “predator” however, wil try to enforce the covenant in order to get his hands on the collateral.

In general, syndicated loans (i.e. a big loan which has been split up between a group of banks) will require a majority vote to actually renegotiate loan covenants. And that is where it gets interesting.

“Distressed debt” funds normally apply 2 strategies to accelerate their returns:

1) Enforcing bankruptcy
2) Blackmailing the loan syndicate

The second strategy is basically a game theory thing. If you have enough share of a syndicate to block decisions, sometimes those creditors who cannot afford a bankruptcy process will buy off th “predators”. This is often even better than going through the liquidation process.

Back to IVG: What does it mean here ?

Well, that’s easy: Look out for the predators !!!

As those guys smell the blood quite early, they have of course already arrived, at least according to this interesting piece of news from Reuters:

German property company IVG Immobilien is attracting attention from distressed debt investors as some lenders seek to cut their exposure to avoid potential heavy losses in a restructuring of its 4 billion euro ($5.3 billion) debts.

Between 400 million euros and 500 million in loans have been sold in three trades recently by banks looking to reduce or exit their positions in IVG and more trades are expected to occur in the coming weeks, bankers said on Friday.

And even more interesting:

IVG was not immediately available to comment.

The loans were sold to investors at around mid-80 percent of face value, a level considered to be distressed in Europe’s secondary loan market, bankers added.

IVG had outstanding debt of almost 4 billion euros at the end of 2012, comprising mostly bank loans, 3.16 billion euros of which are due to be refinanced by the end of 2014. IVG is close to breaching covenants on its debts.

So the predators are there, time to panic and sell the convertible ?

Not so fast. In my opinion there are 4 reasons why one should not panic:

1. The covenants are not broken yet, so there is no way to enforce the covenant here and now.
2. The price levels mentioned here does not justify a liquidation in my opinion. If you buy at 85% and you liquidate, then you will get money only within 2-3 years. This would be a single digit return at this levels
3. The amount traded does not provide a majority in any of the loan tranches.
4. There is a lot of money in the market chasing “high yield” paper, therefore improving IVG’s chance for refinancing

So for me it looks at the moment rather like a blackmailing strategy as discussed above, where the syndicate banks shall be forced to buy out the predators. Even if the predators go for liquidation, the question is how quickly they will be able to enforce the covenants.

Sometimes, “predators” run even more sophisticated schemes errrh strategies. One strategy for example would be Blackmailing as described above plus then investing in other parts of the capital structure at even more distressed prices. So the funds mentioned above could threaten the company and hold up the negotiation process only to purchase for instance the convertible at a very low price. At the last moment, they could then agree to a restructuring (or sell to the other banks) and harvesting the upside on the convertible.

Summary:

With the arrival of the “predators”, renegotiation for IVG will become more difficult. For the time being, it rather looks like a typical distressed debt “blackmailing” strategy, aimed at the other consortium banks. However this could change.

On the other hand, at current levels (66%-67%), a lot of bad news seems to be priced in, giving convertible holders an upside of > 50% in less than a year if the convertible gets paid in full.

Even in a liquidation scenario, I do not believe that we see such low recoveries as in other German cases in the recent past.

So for the time being, I am considering if I add carefully to my position if the (expected) bad news arrives. I am pretty sure the next call with management will be a disaster, so this could be a good entry point.

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.

Quick updates: Installux, EMAK, SIAS & ATSM

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As I am not doing this fulltime, I sometimes miss if companies publish their results. In principle, for my “Value companies” I don’t think that one time period makes a big change in the overall investment case. However it definitely makes sense to look at existing companies at least once a year.

Installux

As reader Caque commented, Installux reported prelimary earnings a few days ago.

With 6.67 mn EUR or around 22 EUR per share, earnings were surprisingly good. Net cash is now at 18.8 mn EUR or 62 EUR per share. So trailing EPS ex cash is around (100/22) ~4.9 times, quite low for a company which earns around 15-20% ROCE.

2013 will clearly be a challenge for them, according to the last sentence of the statement:

L’environnement général incite Installux à la prudence quant à ses perspectives 2013. Le groupe anticipe un repli d’environ -8%. “Cette tendance se confirme malheureusement en terme de volume d’activité sur le 1er trimestre (-13%),

-13% in sales in the 1 quarter is quite substantial. On the other side, this might open up some interesting entry points during the year. Nevertheless it should be clear that France in general is going through a quite difficult year. As ussual, the stock price doesn’t do much and volume remains low:

One remark from my side: France and the Netherlands are Germany’s major trading partners. I cannot understand how people can be so positive about German companies and negative about Netherlands and France in particular.

EMAK

EMAK came out with a investor relation presentation including preliminary annual figures already a few weeks ago.

Interestingly, the “old” EMAK business is doing quite poorly, profit is down 50% or so. The “new” businesses acquired from the main shareholder were holding up much better. So looking back, the dilution is not that big.

EPS was ~5 cent per share so we have a trailing P/E of around 10. If they really make good on their ambition level (38-40 mn EBITDA), the stock would be quite cheap. Let’s wait and see, no need to do something at the moment. This has 2-3 years more to play out.

The stock price at the moment seems to “lazily” trail the FTSE MIB to a certain extent:

SIAS SpA

SIAS came out with preliminary 2012 numbers already 4 weeks ago.

What was clearly an issue is the fact, that traffic declined significantly in 2012, much more than expected. So despite a overall tariff increase, revenues stayed flat.

The good news: On April 15th, they are expected to pay the special dividend of 90 cent per share , distributing what is left from the sale of the Chilean asset sale and the purchase of the concession.

Operationally, there seems to be additional preassure from the regulatory side, as agreed tarrif increases have been suspended by the regulator.

After the special dividend, a large part of the “special situation” aspect (extra asset) has now played out. Howver, the fundamental part looks not as good as I have though initially. I will need to decide if I hold on to SIAS as a “Normal” value investmetn or sell it at some point in the near future. Fundamentally, the company does a lot worse than I had exepected. Thankfully, the entry price was low enough and investors seem to liek special dividends.

The stock price has outperformed the FTSE MIB in the last 12 month by a margin of more than 30%. Quite significant for a purely domestic business:

Even more interesting:

Autostrada (“ATSM”) now caught up with SIAS ver 2 years as it turned out that the “Italian Job”, the Purchase of Impregilo,turned out to be a great special situation investment, netting Autostrada a nice profit.

http://chart.finance.yahoo.com/z?s=SIS.MI&t=1y&q=l&l=on&z=l&c=FTSEMIB.MI&a=v&p=s&lang=de-DE&region=DE

Maybe time to switch back into the “Cheapie” ? Let’s wait and see. Definitely worth to check the Autostrada annual report this year.

IVG – Now what ?

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IVG is one of my special situation investments, I had detailed posts about them here:

Introduction (German)
“Good news” (German)
Capital Increase
Capital Structure considerations
Balance sheet analysis

My overall thesis could be summarised as follows:

IVG is clearly in troubled water, so the shares and the Hybrid bonds are extremely risky, however the senior convertible which has a put in early 2014 has a good chance of being repaid. My main argument was and is that IVG is quite big and an outright default would have too bad consequences for the banks and hedge funds wer not yet involved. Even in the downside case, I would still come up with a recovery for the Hybrid in the 90ties due to the amount of underlying equity and hybrid debt.

Last week however, IVG came out with another worse than expected annual result for 2012.

The “bomb” however was this statement:

As the company would like to explain the financing concept being developed to the shareholders and to allow them to decide on specific measures, where appropriate, the 2013 Annual General Meeting will be postponed from 16 May 2013 to presumably the end of July 2013.

Well, clearly postponing the Annual Meeting is ALWAYS a bad sign. So all the listed IVG securities got of course hammered:

The stock lost around 2/3 of its value:

as well as the Hybrid bond:

The convertible lost almost half of its value before rebounding, resulting in a loss of 1/3:

So to look at the only positive aspect. At least the Senior bond outperformed against the subordinated capital tranches as one would expect in such cases. As reader JM commented, the activity in the convertible prior to the announcement looks very very suspicious and smells of insider trading.

Updated liquidation analysis

First of all, let’s update the liquidation analysis from 2012:

Summary valuation of Assets

In the first step, I think it makes sense to use the same assumptions as last time, to make the numbers comparable. In the following table we see the asset “model” updated based on the 2012 report.

2011 Adj. Val 2012 Adj.Val Comment
Intangibles 251 0 253 0 100% write off
Inv. Property 3,964 3,398 3,654 2,920 scaled to 7% yield
PPE 157 118 190 143 25% discount
Financial Assets 189 142 174 131 25% discount
equity part 95 71 84 63 25% discount
DTA 404 0 336 0 100% write off
Receivables 60 45     25% discount
   
Inventory 1,025 513 996 498 50% discount
Receivables 179 134 190 143 25% discount
Cash 238 238 142 142 0% discount
   
AFS 341 256 58 44 25% discount
Asset Management 275   318 1.5% of AUM
Marekt value caverns 163   140 50% of disclosed adj.
         
Total 6,903 5,351   4,540

In second step we can then determine, how much assets are available for which debtor class. In the case of an insolvency, collateralized lenders get paid first, then senior lenders then hybrid and then equity.

Based on the 2012 numbers, i would calculate the following liquidation values:

  2012
Adjusted NAV   4540
-Bank loans   -3837
Remaining   703
Other senior liabilities    
  -Derivatives -84
  – Tax -77
  – pension -34
  – other financial -17
  – other liabilities -218
  – Convertible -400
  Total senior unsecured -830
     
  Coverage 84.70%

So this means that senior creditors would get under my assumptions still around 85% of nominal. This is slightly worse than last year but still quite positive and should limit the downside.

Of course, I did not consider additional costs of winding such a company up, on the other hand I didn’t put for instance a business value on the cavern business. However it is also clear that in a liquidation, both Hybrid and shareholders get a big fat “donut” as recovery.

What next ?

In such situations, it usually makes sense to listen to the analyst call in order to see what Management is actually saying. Fortunately, the call is easily accessible via their website. By the way: The used app for the audio file is really shitty…..

The most interesting section of the management comments is the fact that the 0.7 bn EUR 2013 maturity doesn’t seem to be a problem at all, as this is a 50% LTV loan.

From the Q&A, I found the following points most interesting:

– Squaire: Relative slow increase in occupancy. They need 90% occupancy to really exit which seems to need time, at least until 2014
– Caverns: Demand from utility side has shrinked, “NAV adjustment” at risk
– IFRS 13: There seem to be some issues in order to reflect transactional costs in the current valuations. They mentioned 100 mn EUR as potential (negative) impact.
– LTV target: They mentioned 55% as a goal, from around 71% today, with the intermediate step of 60-65% (my remark: with ~4 bn Bank, 5% LTV is 200 mn EUR.)
– no plan to sell fund management (would have been one option to generate equity)
– no mention of hedge funds as holders of the bank debt
– the “gherkin fund” has an indirect 44 mn EUR risk for IVG

In general, they were very vague about refinancing. They mentioned Rothshild being an advisor which is not the best news for existing investors. The whole call was with that respect a deja vue similar to the Praktiker call almost 2 years ago.

My expectation is the following:

Current equity holders will suffer one way or the other. My guess is that a new convertible will be part of any refinancing package. I could easily imagine somthing like pledging the fund business to a new investor, similar to the “Max Bahr” pledge at Praktiker.

In the process, they will come up with some “voluntary” contribution of Hybrid and Convertible holders which in my opinion will not work. I still belive that the Convertible will be paid in full in 2014, but the next few months can be very volatile.

Lessons learned:

I think I made one real mistake here: When I researched utilities earlier this year, especially Energiedienst, it should have been clear that the gas cavern business will not be so good going forward as in the past. As my thesis on the IVG bond implied a stable gas cavern business, I should have reviewed the case back then.

On the other hand it is interesting to see that a very broad research focus could yield quite interesting “cross results”.

Summery:

I think there is no urgent need to sell as Convertible holder. The asset base is still high enough to support a relatively high worst case recovery for the senior unsecured creditors.

Nevertheless, one should prepare oneself for a quite bumpy rest of the year with some “Praktiker style” attempts t bail in bond holders. All in all I still expect full repayment in MArch 2014 with a high probability. However, because of the problems in the utility sector, the stabilizing effect of the cavern business has weakened significantly and the investment is riskier than before.

For the portfolio, I will hold the bonds for the time being.

DISCLAIMER: As always, DO YOUR OWN RESEARCH !!!! This is by no means an investment recommendation for anyone. Don’t trust anyone with tipps etc.

Short updates: Rhoen, KPN, HT1 Funding

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

Rhoen Klinikum

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

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

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

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

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

Commerzbank HT1 Bond

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

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

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.

A few more thoughts on TNT Express – Implied probability of deal happening is only 19%

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Yesterday’s post was of course only a first step towards a potential “special situation” investment.

In order to decide if this is actually an interesting investment, one would need to come up with

A) some more considerations with regard to timing
B) at least a rough idea about intrinsic value

With regard to timing, I think it makes sense to look at Rhoen Klinikum, where there was a similar situation:

On April 26th, Fresenius offered 22,50 EUR per share from an “undisturbed” level of 14.76 EUR the day before. Then, when doubts came up, the stock went down to around 16 EUR before once again climbing to around 20 EUR, before then the deal fell apart. Interestingly, the current share price seems to have a floor at the previous undisturbed level.

For TNT Express, the truly “undisturbed” price the day before the offer was 6,34 EUR, so the current price is around 10% higher than that level.

Just as a side remark:

There were a couple of articles which said that there is now a 50/50 chance of the deal happening, like here.

However at current prices(6.95 EUR) we can relatively easily calculate the implied probability of the deal happening:

Undisturbed price: 6.34 EUR
Current prcie: 6.95 EUR
Offer price: 9,50 EUR

So the implied probabality of the deal happening can be calculated the following way:

(6.95-6.34) / (9.50-6.34) = 19.3%.

Anyone who thinks that there is really a 50/50 chance of the deal happening should buy now as the expected share price under this assumption should be 7.92 EUR (6.34 + (9.5-6.34)/2).

Going back to timing: What we haven’t seen here is a upmove of the stock like we have seen with Rhoen. So far we only saw the price going doen and the implied probability of the deal happening decreasing.

B) intrinsic value

This is somwhow difficult. The 9,50 EUR is a “private market” value, maybe including a premium for synergies.

TNT Express since its spin off has yet to prove that they can achieve margins like their competitors. Based on Q3 numbers, they are curently heading to something like 220 mn “operating income” or EBITDA for 2012 which equals an “operating margin” of only 3%.

UPS for example has an operating margin of 11.4%, FedEx of 7.8%. Deutsche Post has an ~9% EBIT Margin in the Express segment. So TNT has definitely some room to improve.

If we assume 8% operating margin, TNT would show ~600 mn EBITDA. Current EV is 3.5 bn, potential EV/EBITDA ~6.

This is much lower than UPS (10x EV/EBITDA) but higher than Fedex (4.9x). Deutsche Post is at 5 times EV/EBITDA.

So at current prices and assuming quite a turn around, TNT Express is not really cheap. So any investment would be a pure “Merger arbitrage” or “control premium” inevstment which might or not work out.

No action yet.

Edit: During writing this post, the share price jumped some 3.5% compared to yesterday, is this the first leg of the rebound ?…..

Gronlandsbanken AB (ISIN DK0010230630) – Sleepy eskimo bank or moat company with natural resource option ?

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Sometimes the only reason why I research a stock is because I find it interesting for some reason, not because it will be a good investment or so.

Gronlandsbanken AB is such a stock. Although it showed up in my Top 25 Scandinavian stocks, normally I would discard that because it is a bank. With Gronlandbanken however, the fact that this is the only listed stock of a company from Greenland got me interested.

Before looking into the bank, a few facts about Greenland from Wikipedia:

– Greenland has arond 60 tsd inhabitants spread over 2 mn square kilometers, however only 400 k square kilomoters are not permanent ice (Germany has ~350 k Square kilometers)

– politically, Greenland is mostly independent since 1979, however strong ties to its former “Colonial master” Denmark remain, among others the offical currency which is the Danish Krone
– total GDP is estimated to be around ~2 bn USD
– However, basically 50% of the countries GDP are transfer payments from Denmark
– Greenland left the EU in the 80ties but still enjoys free trade and other preferred treatments via Denmark
– most people basically work for the Government, the second largest sector is fishing
– Last but not least, Greenland could become one of the prime beneficiaries of climate change, as its vast natural resources could become much easier to access

The Bank:

Grondlandsbanken has been founded in 1967. In 1997 it merged with the only other bank in Greenland, Nuna Bank and is therefore the only bank based in Greenland. However it doesn’t seem to be the only bank with branches in Greenland as this post shows:

Banking
There are 2 banks in Nuuk, Greenland Bank and BankNordik. However, the latter has no cash function. There are ATMs in both banks in Nuuk, and cash in advance and Visa Card can be used in all stores and the like.

Anyway, it looks like competition is currently quite limited in Greenland in the banking sector.

Gronlandsbanken valuation looks Ok, but not very exciting:

Market cap: 830 mn DKK (~110 mn EUR)
P/E Trailing ~14
P/B 1.0
Dividend yield 6.5%

Around 65% of the shares are held by large shareholders, among them with 14% the Government of Greenland. So “free float” is around 30-35% or 35-40 mn EUR only.

Interestingly, value shop Sparinvest has a 0.44% stake . Another value fund which I didn’t encounter yet, Nielsen Global Value holds 5% as well. For them it seems to be a quite significant position with 5% portfolio weight according to the latest fact sheet.

Thankfully, no sell-side analyst has discovered the stock yet.

The stock is up 56% YTD, however this is still less then 50% of the peak price back in 2007:

Not surprisingly, the stock has a very low beta of ~0.55 vs. the Danish stock index.

But why buy a bank at book value if you can get banks for 0.3 times book ?

Well, there are a few things which are “not normal”:

– Gronlandsbanken has an equity ratio of 17.3% (that’s right, not Tier 1 ratio or such crap)

– their net interest margin is around 4%-5%, Return on assets is around 1.7% If we compare this to the most profitable banks like HSBC (1.9% – 0.6% and Standard Chartered (2.4% and 0.9%) or DNB (1.4% -0.6%), we can see that Gronlandsbanken is at least twice as profitable as the most profitable European bank.

Due to the high ratio of equity, ROEs do not look spectacular, but still my model calculates ~15-16% total ROE with a relatively low volatility. According to my model, the fair value for such a company should be around 1.3 times higher than the current market price.

Especially interesting for me was the 2011 annual report from Gronlandsbanken.

The pages 8-16 are definitely the best summary of the economic situation in Greenland I have been able to find. Most interesting was the following passage:

Greenland at a Cross-Road
Looking forward the economy of Greenland will come to a cross-road because most likely the economy will follow one of the following paths:
1. If one or more of the major projects are built, enormous pressure will be exerted on the economy of Greenland with concurrent high rates of growth and pressure on inflation. Based on current analyses, a great deal of the required labour force will be from abroad.
2. If none of these major projects is built, the major challenge in Greenland will be to create jobs and to ensure economic growth.
Within a few years, we can be expecting either very high rates of growth or zero-growth, or perhaps even negative growth. On the other hand, it is harder to imagine a middle-of-the-road scenario with reasonable and sustainable rates of growth since there are few growth-drivers in the economy (except for metals and minerals).

So this is fundamentally a very interesting “Binary” situation with a clear “trigger”.

Some of those “projects” mentioned are relatively interesting as well:

– Oil: Uk Cairn Plc seems to have drilled for oil but has found nothing yet
– a public listed company called London Mining Plc is trying to develop a large iron ore mine
– ALCOA seems to be interested in building a large Aluminium plant
– there seems to be a “rare earth” project buy an Australian listed company called “Greenland Mineral and Energy”, the so called Kvanefjield deposit.

Additional interesting articles form the Web about the natural resources developement in Greenland

Natural resources and Oil in Greenland
Cairn’s drilling results in Greenland
Chinese interest in Greenland
Chinese workers to be “Imported” ?

So it seems to be that the Government in Greenland seems to “warm up” to the natural resources projects. Maybe this is the reason why Management is buying shares since end of October. The amounts are not huge but every other day one can see purchases.

Summary:

Although I wish I had discovered Gronlandsbanken some months ago, I still think it is a really interesting stock:

– as it is the only bank in Greenland, its margins are around twice as high as the best global banks and the balance sheet is rock solid. One could call this a natural moat
– even based on the current state, current valuation implies significant upside to fair value
– the Greenland resource story could add significant growth going forward, even with maybe other banks entering Greenland
– finally, Management has started to buy shares after surprisingly good Q3 numbers
– although there is no direct catalyst, an indirect catalyst could be if some of the projects proceed well and Greenland will move inte the spotlight. Gronlandsbanken is the easiest (and only) way to invest into Greenland without project specific risk

As a result, I will start with a 1% position in order to further track this interesting “opportunity” stock.

Rhoen-Klinikum (DE0007042301) – or why merger arbitrage is a really hard business

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The Story of the takleover fight for German hospital operator Rhoen Klinikum has been in the news quite often lately.

I try to summarize it in a few short sentences:

– Fresenius AG the big German healthcare group launched a bid at 22.50 EUR contingent on getting 90%
– in the meantime, some of the German competitors bought large stakes (Asklepios, Braun) of 5% to block the deal
– additionally some M&A arbitrage specialists (John Paulson) took stakes as well, hoping for a higher bid
– on the weekend, Fresenius then declared that they will not pursue the offer and the stock price drops almost 30%

Rhoen is now back or even below the level before the offer:

This shows that merger arbitrage is not an easy business. I have to confess that i was tempted to speculate on the Fresenies offer as well, but thanks to not having time to write a blog post, I didn’t jump into it as I would have done before I started the blog.

Fresenius is a big player and I would have thought that they might make at least one more attempt to gain 90%, which under German law would give them the right to squeeze out monrity shareholders.

However, now it is a different situation.

Rhoen is a well managed company and scores quite well in my Boss model. On top, we know that the private market value of the company is 22,50 EUR and one could theoretically buy it at a nice discount. Rhoen is one of the few German companies which do not have a majority shareholder although the fuender with his 13% holding still has a big influence but obviously not enough.

However, Rhoen is now clearly “in play”. I am considering really hard, if I should not open a half position for my “special situation” bucket.

Any opinions on that one ?

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