value and opportunity

A couple of weeks ago, when I analysed EGIS and other Eastern European Genric drug companies, I mentioned Pharmstandard OJSC as one of the big players in the interesting Russian Generics market.

A kept an eye on them mainly in order to gain a little bit more insight into the Russian market. But the story which developed over the last week is definitely woth sharing it.

Up until early July, everything looked great. Pharmstandard aggresively bought back shares in an amount of roughly 10% of their market cap. They communicated that they might use those shares to finance M&A transactions.

Then, in the beginning of July some strange news emerged (official press releases can be found here):

– first they stated that they want to do a spin-off of their OTC drug business
– then, on they same day they announced that they are in advanced talks on a potential M& A transaction
– then, still on the same day they announce that they will buy a company called “Bever Pharmaceutical” for 630 mn USD without describing the company at all.
– the bought company then again, will be included in the spin-off
– it is not clear if the spin-off would be listed or not or if GDR holders can legally get those spin-off shares
– then it came out, that one of Pharmstandard’s supervisory board members, Dr. Alexander Shuster is actually the owner of Bever and will become the second largest Pharmstandard shareholder via this transaction
– Nevertheless, a few days ago, a shareholder meeting approved the acquisition with the votes of the majority shareholders
– the next special shareholder meeting will be in September to decide on the spin off

Clearly, this story did not go well with investors. Both, the London listed GDRs as well as the Russian listed stocks got punished hard:

In my opinion, this clearly is not very shareholder friendly, but on the other hand, compared with what I have experienced in Italy (EMAK, Autostrada), this rather looks like an OK transaction at least with regard to the M&A transaction:

– they paid minority shareholders in cash via an open market share buy back
– they used pre “price drop” levels to determine the purchase price consideration

And, at least in Italy, buying into a stock AFTER such an event occured was usually an interesting entry point.

The special situation aspect: Potential buy back offer before spin off at 16.50 USD

Now it gets interesting. In their spin off presentation, they mention that there will be a buy back offer to shareholders before the spin off actually happens. In several articles (I did not found this on their website), a price of 16.50 USD per GDR was mentioned. According to the timeline, this should happen in November if everything works out.

So let’s do some quick math (EDIT: I wrote this yesterday…., today’s price is a lot higher):

If I buy today at 14.65 and get 16.50 in November, that’s a 12.7% return for 3 months. Not too bad. Clearly there is some downside, if the offer will not come and they spin offf without compensation for GDR holders. On the other hand, if the spin offf works out well, there could be significant upside on top of the 16,50 USD offer.

On top of that, I like the underlying business and I think the stock is cheap and undervalued (excluding the Corp Governance issues).

According to my model, the current Pharmstandard is worth far more. The company achieved on average over the last 6 years 20% net margins and 30% ROIC at a current valuation of PE/6, P/B 1.6 and EV/EBITDA at 5.5

Update: I started writing this post yesterday, when the stockprice was at 14.65 USD, today, it jumped already significantly to 15.39. For the time being I will remain on the sideline and watch.

Maybe there will be a opportunity for a odd-lot tender like Norislk 2 years ago. I would also consider adding a small stake if the price is at a ~10% discount to the offer prcie, so below 15 USD (up to 1% of the portfolio). So I will put in a limti order at 15 USD and wait how this interesting story developes.

Some 15 months ago, I had a post about stocks I had either sold or not bought after analyzing them.

This time I want to update that list plus provide some “theoretical” background why I think this is an important part of any investment process.

Types of investment mistakes

Of course there are many mistakes to be made in investing. Nevertheless, for this exercise I would categorize “investment mistakes” into 3 general categories along the typical process of most “stock pickers”. The process normally looks something like this

A) Stock screening & quick analysis
B) Deeper Analysis
C) Buy decision (or not buy)
D) Sell at some point in time

At all stages, mistakes are easy to be made. Nevertheless I would argue that most analysis goes into what I would call Level I mistakes:

Level 1 mistake: Buying a stock which performs badly.

This is quite easy to identify, because if one looks at most investment reports, one will see the performance of the current portfolio with the bad performers “jumping out of the report”. I guess most of the efforts in many investment firms goes into finding out the reasons for those underperformers and then trying to improve.

A lot less effort usually goes in what I would call “level II” mistakes:

Level 2 mistake: Selling a stock which outperforms strongly after selling.

This is a little bit more tricky. There is a lot less literature of “when to sell” compared to “when to buy”. Once you have bought a stock, there should be already a fair amount of time and effort been made to analyse the stock. So in my opinion it makes a lot of sense to keep stocks on one’s radar screen even after selling. Nevertheless it is of course much more fun to look at new stocks and forgetting about the old stuff. Especially if sold stocks systematically outperform, one should check if one is not a prisoner to some well known investment biases

In my opinion, it also makes a lot of sense to systematically track the performance of sold stocks in order to find out if one could (and should) improve the investment process

Finally, there is a third systematic family of mistakes:

Level 3 mistake: Stocks analysed intensively but not bought

This is one of the advantages of blogging: Whenever I write a longer post, I already have invested quite some time on the specific stock. So it is quite easy for me to track those posts where I did for any reason not buy such a stock.

Again, I think one should look at this closely in order to identify potential biases etc. in one’s investment process.

From theory to practice: The last 17 months

So let’s look first at all the stocks I sold since the March 2012 post:

Stock	Reason sold /not bought	Date	Perf	Perf BM	Delta
KPN	Special situation expired	10.05.13	34.2%	3.3%	-31.0%
IVG Conv	ESUG	21.05.13	16.1%	1.1%	-15.0%
Bouygues	Portf. Mgt.	28.06.13	21.7%	7.1%	-14.6%
Total Prod	dissapointing CI	08.03.13	21.3%	7.1%	-14.2%
Mapfre	Autumn cleaning	31.10.12	30.1%	19.9%	-10.2%
Dart	Too expensive	18.07.13	7.1%	2.7%	-4.3%
Total Prod	dissapointing CI	10.04.13	12.1%	9.0%	-3.2%
OMV	Autumn cleaning	30.10.12	22.6%	19.5%	-3.0%
Dart	Too expensive	26.07.13	4.5%	2.8%	-1.7%
Buzzi	business model problems	23.05.13	2.8%	2.7%	-0.1%
WMF	too expensive	11.04.13	5.0%	8.1%	3.1%
Fortum	Autumn cleaning	30.10.12	6.4%	19.5%	13.2%
Piquadro	Sold because of business problems	08.08.12	2.7%	24.5%	21.8%
Nestle	Sold because of Pfizer acquisition	23.04.12	11.8%	35.0%	23.3%
EVN	Autumn cleaning	31.10.12	-9.9%	19.9%	29.8%
Praktiker	Sold because of Anchorage	04.07.12	-81.3%	30.6%	111.9%
				avg	6.6%

Explanation: a negative number means that the stock has outperformed my BM since I sold it, a positive number means the Benchmark outperformed vs. the stock.

On (unweighted) average, the stocks I sold underperformed the benchmark, so this looks OK. This is clearly driven by the Praktiker bonds, where I am very happy that I sold them. On the other hand, I missed out some nice gains as well. With KPN for instance, I think I was a little bit too quick with the trigger finger. My “autumn cleaning” exercise was on average also positive. So this is a good encouragement to follow-up on this exercise.

Next come all the stocks I have analysed but not bought in the same format:

Stock	Reason sold /not bought	Date	Perf	Perf BM	Delta
Reply	Cashflow red flag	31.08.2012	140.6%	24.5%	-116.1%
Banknordik	forgot to follow up	26.11.2012	70.1%	19.5%	-50.5%
Curanum	not really interested	05.09.2012	66.7%	25.0%	-41.7%
Severfield	Too expensive stand alone	21.03.2013	47.7%	7.9%	-39.8%
Walgreen	M&A	04.07.2012	62.7%	30.6%	-32.1%
Osram	Target of 23 EUR not hit	08.07.2013	35.7%	6.1%	-29.7%
M6	only short analysis, issue with CI	26.11.2012	43.0%	19.5%	-23.5%
Cairo	undecided	27.06.2012	58.1%	38.9%	-19.2%
Halfords	Negative momentum	06.06.2012	55.1%	40.5%	-14.6%
Hankook	could not buy privately	29.10.2012	31.0%	21.0%	-10.0%
Astaldi	too much debt	23.07.2013	11.2%	3.0%	-8.2%
Porsche	still don’t like them	29.11.2012	24.3%	17.7%	-6.6%
CIR	no margin of safety	17.07.2013	7.3%	4.0%	-3.3%
EAC	Watch only	29.07.2013	2.8%	2.6%	-0.2%
Canal+	no real upside	19.09.2012	19.1%	19.6%	0.5%
Rallye	leverage	25.01.2013	8.4%	9.3%	0.9%
Bongrain	Doesn’t earn coc	26.11.2012	17.0%	19.5%	2.5%
Greek GDP linker		10.06.2013	-2.6%	3.7%	6.3%
Accell	low FCF, insider selling	26.10.2012	12.3%	20.5%	8.1%
Solvac	not cheap enough	13.12.2012	4.4%	14.9%	10.4%
Mr. Bricolage	Too much debt	13.09.2012	9.4%	20.9%	11.5%
Viel	Underlying busienss	18.12.2012	2.4%	14.0%	11.6%
Morgan Sindall	no mean reversion potential	23.10.2012	1.0%	21.6%	20.6%
WSU	because of US problems, not cheap	19.04.2012	10.6%	31.9%	21.2%
Maisons France	Cycle	29.01.2013	-12.5%	9.4%	21.9%
Energiedienst	Business model	04.02.2013	-12.3%	12.5%	24.8%
TNT Express	Too expensive stand alone	21.11.2012	-5.2%	20.8%	26.0%
KHD	insiders	30.07.2012	-0.7%	27.7%	28.4%
Fabasoft	track record	25.06.2012	-2.7%	40.3%	43.0%
				avg	-5.4%

Here unfortunately, the average doesn’t look so good. On average, the stocks I analysed but did not buy outperformed the BM as well. The most obvious miss is Reply SpA. However here, I still think that in the long run it pays to avoid companies with questionable accounting. In this case, clearly at least for now I was wrong to discard it.

A little bit more bothers me that 2 of my potential special situations, Osram and Severfield outperformed. Both were pretty clear-cut cases (Osram, classical spin-off, Severfield classical rights issue), but somehow I was lacking conviction to follow through on the idea. I think I have to be more careful to separate my careful market view and focus on quality from the special situation area.

Summary:

Looking at sold stocks and stocks rejected lat e in the investment process makes a lot of sense. In my case, I think selling looks OK, whereas I will have to work on my “special situation” investments.

In my MIKO BV post a few days ago, Winter commented correctly, that the plastics division of MIKO looks similar to what a French company called Groupe Guillin SA is doing.

At a first glance, Group Guillin looks even more interesting with the following valuation metrics (in brackets MIKO):

P/B 1.0 [1.24]
P/E 6.8 [11.8]
P/S 0.3 [0.5]
EV/EBITDA 3.6 [5.5]

So Guillin does almost the same but is much cheaper. Cheaper is always better for value investors, isn’t it ?

Guillin looks also quite OK in my Boss model and even shows better free cashflow so what is not to like ? ROEs look Ok as well as this table shows:

	ROE	ROIC
31.12.2001	19.3%	9.6%
31.12.2002	27.0%	14.0%
31.12.2003	17.6%	12.6%
31.12.2004	12.0%	11.0%
30.12.2005	15.2%	10.0%
29.12.2006	10.4%	7.3%
31.12.2007	11.5%	8.4%
31.12.2008	7.0%	6.0%
31.12.2009	13.7%	10.4%
31.12.2010	13.4%	7.6%
30.12.2011	7.3%	5.3%
31.12.2012	13.4%	na.

However, ROICs don’t look so great as Guillin especially since 2006, when they grew quite quickly after 3-4 years without growth but ROIC suffered significantly

Lets compare this with MIKO’s plastic segment numbers:

MIKO plastics
	Assets	Libailities	Net invested assets	NI	ROIC/ROE
2007	29.3	5.6	23.7	2.40	10.1%
2008	35.1	4.5	30.6	2.16	7.1%
2009	32.4	4.35	28.05	5.17	18.4%
2010	39.4	6.1	33.3	4.55	13.7%
2011	42.9	5.7	37.2	4.04	10.9%
2012	46.7	6.7	40	4.12	10.3%

So we can clearly see that MIKO consistently generates significantly higher ROICs than Guillin (in some years 5-6% more) than Guillin. Guillin uses leverage to achieve OK ROEs, while Miko doesn’t use leverage. Also net margins are on average 2-4% higher for MIKO plastics than for Guillin.

So in my view, the MIKO plastics business looks much better quality than Guillin, despite the fact that the MIKO plastics division is only 15% of Guillins sales. So scale doesn’t seem to be the deciding factor, it looks like that MIKO has found a more profitable niche than the larger Groupe Guillin. As far as I understand, Guillin sells direct to supermarkets while MIKO’s clients in the plastics division are consumer product manufacturers.

I have been looking at Groupe Guillin actually quite often, but the low return on invested capital kept me away. Although one has to say that the stock performed quite well over the past years, also compared to MIKO:

So Guillin is clealry not a bad company, but in direct comparison I think MIKO has greater potential (and a better downside protection) than Guillin.

The future of Utilities is very uncertain says a CEO of an US utility company

Great stock analysis about Melco, a HK listed company from Sahara blog

Expecting value looks at Albermarle

Indonesia is struggling too…

Must read: The traditional free summer issue of Grant’s oberver

Punchcard looks at Weight Watchers

I bet that many people could not point out on a map where Slovenia actually is located. Many people also don’t really know the difference to Slovakia.

So lets look at Wikipedia:

Slovenia is a small part of Ex-Yugoslavia. It has a population of around 2 mn and covers 20 thsd square kilometer. The history can be read extensively via Wikipedia. Most importantly, Slovenia was the first part of Yugoslavia which became independent. The next few years, Slovenia was seen as one of the big success stories in Europe, which resulted in Slovenia joining the EU and adopting the Euro already in 2007.

Last year however, Slovenia joined the European countries hit hard by the recession. The prior EUR fueled construction boom resulted in shaky loans, declining GDP, Rating agency downgrades, increase in interest rates etc. Starting last year, there was big fear that Slovenia was headed towards a “Greek style” restructuring.

Lately however, things look better. SLovenia has presented a restructuring plan which among others, includes the sale of a couple of state-owned companies. One should also note, that debt to GDP looks rather manageable:

On top of that, Slovenia’s economy is good at exports, but still, they are struggling in 2013. Nevertheless, Slovenia got 2 years “probation” in order to fix their problems, which they hopefully use.

The latest export vs. import data looks OK, nevertheless, 2013 will show a deficit of around -8% for the Government including bail out costs.

Slovenian stock market

From Bloomberg, one gets ~45 stocks from Slovenia with a market cap larger than 1 mn EUR, and 24 with a market cap bigger than 10 mn EUR. The major Slovenian stock market index only consist out of 7 stocks which are the following:

Ticker	Name	% Index Weight	EV/EBITDA T12M	P/B	P/E
SBITOP Index
KRKG SV Equity	Krka dd Novo mesto	29.7	6.311327	1.32	10.39
PETG SV Equity	Petrol DD Ljubljana	21.4	8.988676	0.98	8.35
TLSG SV Equity	Telekom Slovenije DD	19.7	4.734508	0.89	16.89
MELR SV Equity	Mercator Poslovni Sistem	13.5	N.A.	0.60	N.A.
ZVTG SV Equity	Zavarovalnica Triglav DD	11.8	N.A.	0.76	5.96
GRVG SV Equity	Gorenje dd	2.9	5.500231	0.18	15.94
KBMR SV Equity	Nova Kreditna Banka Maribor dd	0.9	N.A.	0.08	N.A.

Quick check of the companies:

Krka

I have written about Krka already, a generic drug company similar to EGIS. I think this is a very interesting company,. Minimal home country exposure, consistently profitable. Not “extremely cheap” but good value for money. I would buy this company directly (if I could).

Petrol Ljublijana

This is the national refinery plus gas stations owner. Also active in Croatia and Bosnia. High “mean reversion” potential in my model.

Telekom Slovenije

Local telephone company. P/E 15 looks expensive, but company pays 15% dividend and has a 20% FCF yield. Significant debt reduction

Mercator

Supermarkets, Shopping centers. High debt load, large loss in 2012. However major shareholders sold out to Croatian company Agrokor in June.

Zavarovalnica Triglav

Major Slovenian insurance company, interesting, as valuation is really low for an insurer. 10.5% dividend yield. I would buy this stock if I could.

Gorenje

Household appliances. Has made losses but very cheap (P/B 0.2).

Nova Kreditna

One of the 3 problem banks, the only listed one. Most likely insolvent without Government support

The problem:

There is almost no way to directly buy Slovenian stocks. Only Krka and Nova Kreditna have secondary listings in Poland, but even there it is difficult to trade them. I asked several retail brokers in Germany and only SBroker (where I don’t have an account) told me I could trade the 2 stocks in Poland.

The alternative:

Although I usually do not like certificates issued by banks, in this case this would be the only alternative. I found several of them:

1. RCB7J9 / AT0000A038L9 from Raiffeisen International
2. AA0DMM / NL0000762557 from RBS
3. HV2AXY / DE000HV2AXY3 from Unicredit

The RBS paper seems to have the lowest bid/ask spread. As far as I have seen, they are all without maturity and track the SBI.

The opportunity /upside

For me the Slovenian index is quite interesting due to the following points:

+ there is almost no banking exposure left in the index. the only remaining financial is a cheap insurance company which i would buy outright
+ the Government has to sell some of their stakes, including among others the Telephone company. I am pretty sure that for the time being they will do nothing to punish the TelCo in order to get a price as high as possible
+ the largest stock in the index is Krka with ~30% which I want to buy anyway
+ once the Euro recovery story gets played more seriously (Goldman is already starting to “promote” European stocks), markets like Slovenia will follow with a certain delay.
+ Slovenia did never piss off other countries like Cyprus which supported tax dodging or Hungary which runs on a political amok course. In my opinion, they will be “well” treated by the ECB, EU and IMF.

Nevertheless for the time being I will not invest but look a little bit more into the other large index constituents, especially the TelCo and Oil company.

During a short holiday break I read that book. It is written by Charlie Gasparino, a quite famous Wall Street reporter.

The book is about the recently uncovered insider trading activity including among others, the infamous Galleon founder Raj Rajaratnam and many people connected with Steve Cohen’s SAC capital.

Those insider cases have been the biggest since Ivan Boesky in the 80ties and many people went to jail. Some trades were “simple” insider tips, others were conducted much more clever via so-called “expert networks”.

The book itself is strong on details about the lw enforcement process. It reads rather like a crime investigation story than a finance book. The author also shows a little bit the history of insider trading which was not illegal until the great depression.

The author several times calls insider trading the “victimless crime”and one does get the impression that he doesn’t consider it such a serious crime. He also stresses that the strict enforcement in these cases might have something to do with both, the financial crisis and the Bernie Madoff crime and the desire to please the public with some high-profile arrests.

Although I agree that a lot of criminal transaction before or during the financial crisis have not been really prosecuted (John Corzine, Dick Fuld etc.), I do not think that insider trading is a victimless crime. Victims are clearly many retail investors esp. mutual fund investors. Although insider trading might nt explain everything, a part of the fact that so many mutual funds underperform might lie in the lack of insider trading compared to unregulated hedge funds.

As a summary I would say the book is not bad but not half as well written as for instance a Michael Lewis book. If you are really interested in how the SEC examines insider trading, you might buy it, otherwise save the money for the next Michael Lewis book.

Red has some very good comments on Dart Group.

Must read: Michael Pettis on China

Punchcardblog is writing a fictitious letter to Jeff Bezos about the newspaper business

Expecting value looks at pawn broker H&T Group

Wilbur Ross is looking at Spanish and European banks.

Interesting table: Cable TV vs internet

Interesting study: Defined benefit pension plans (DBO) seem to perform siginficantly better than defined contribution plans

David Einhorn’s Q2 letter. Interestingly he partcipated in the recap of some Greek banks.

Good Howard Marks Interview

Michael J. Mauboussin’s updated “meassuring the moat” paper (via CSinvesting)

A kind of “small cap manifesto” from Nate at Oddball

Did value investing work during the long Japanese depression ?

Another Caterpillar short thesis

Due to the nice weather, I cannot guarantee weekly links at the moment…..

The interesting case of EBIX, a US software company with potential fraud allegations

One of the early Chinese reverse merger frauds, China Medical Express is now sued by the SEC

And an interesting case of a beef/cow Ponzi scheme in Japan

Paul Krugman gets it wrong on Apple. Noone is forced to buy Iphones at high prices.

Why Bernanke is the wizard of Oz (Damodaran)

Chinese troubles

EDIT: Don’t miss this speech of value legend Michael Price