Emerging markets part 3: JSFC Sistema ADRs (ISIN US48122U2042) – Is a Russian company investible (1)?

Posted on by 25 comments

This is the third installment of my little “Emerging Markets” series (part 1: Ashmore Plc, part 2: Koc Holding).

As the post got really long, I will divide it into 2 parts. Sorry for the “cliff hanger”….

Investing in Russia

Some readers may recollect that I invested into the Russian pharmaceutical company Pharmstandard last year and was very lucky to get out early before the stock subsequently lost more than 50%. My interpretation of this experience is that an actually relatively well-managed company got bullied into buying a worthless company and thereby shifting a lot of company funds to some shady people.

This should be a reminder that investing in Russia is somehow different. Although one shouldn’t be surprised too much about this. Russia is still at a very early stage in capitalism. It is only 20+ years since privatization started really kicking off. For me, the current state of Russia’s capital markets looks a little bit like the US in the 1910s and 1920s, the age of the famous “Robber Barons”. Bullying other people, “unfriendly” take overs using brute force were quite common in those times as well.

Russia itself is clearly different to any other country as well. In contrast to Turkey for instance, Russia is resource rich, on the other hand it looks like very poorly governed from the outside. Resource rich countries are always at risk to fall for the “resource curse”. This is how Wikipedia defines it:

The resource curse, also known as the paradox of plenty, refers to the paradox that countries and regions with an abundance of natural resources, specifically point-source non-renewable resources like minerals and fuels, tend to have less economic growth and worse development outcomes than countries with fewer natural resources. This is hypothesized to happen for many different reasons, including a decline in the competitiveness of other economic sectors (caused by appreciation of the real exchange rate as resource revenues enter an economy, a phenomenon known as Dutch disease), volatility of revenues from the natural resource sector due to exposure to global commodity market swings, government mismanagement of resources, or weak, ineffectual, unstable or corrupt institutions (possibly due to the easily diverted actual or anticipated revenue stream from extractive activities).

This sounds logical, although further down, Wikipedia cites some other studies which seem to contradict this to a certain extent.

So investing in Russia is clearly an adventure. But again, similar to Turkey, the problems are not a secret. The Russian stock market is currently the cheapest in the world, with a p/E of around 5x, P/B of 0,72 and a dividend yield of 4,3%. In EUR terms, the Russian stock Market lost -34,5% since the end of 2010 compared to +37% for instance for the DAX.

I have a compiled a short table, comparing performance (10 year, 5 Year, 3 Year, 1 Year) and valuation of different Emerging markets:

10 5 3 1   P/E P/B
MICEX 8,26% 18,09% -10,24% -18,12%   5,4 0,7
SENSEX 11,09% 14,26% -3,10% -5,02%   17,1 2,6
IBOV 9,33% 2,89% -20,78% -34,32%   17,1 1,1
SHCOMP 6,54% 2,38% -6,62% -14,04%   10,3 1,4
               
Turkey 8,92% 15,92% -7,31% -37,75%   8,8 1,3
Indonesia 17,87% 30,67% 2,43% -22,43%   21,3 2,6
Philipines 21,00% 32,37% 21,75% -15,48%   19,0 2,8

It is interesting to see that Russia didn’t do so bad over a 10 year horizon, but especially underperformed over the last 3 years. In contrast, the valuation level compared to other EM is really stunning. So one can assume that a lot of bad sentiment seems to be priced in.

Interestingly, I just came across this some recent study, which says that “traditional” value investing, i.e. buying contrarian and cheap, works very well in Emerging Markets, much better than small cap investing or momentum.

Fraud, quality of accounts etc.

Personally, I would not make general distinctions between EM countries, but rather on a company levels. I think fraud and fraudulent accounting is much more probable in those countries than in “developed” markets, although even in developed markets fraud might be more widespread that commonly believed. I think it is more important to look at individual companies and their track record in order to get an idea.

Another aspect is to look out for and avoid systemic fraud. I have written quite often about the so-called “German-Chinese” companies. In this case, Chinese companies sold shares abroad to raise “fresh” money mostly for old shareholders which then got transferred directly to mainland China. In many cases, if you looked at the balance sheet of those companies, there was no need to raise money at ridiculously low valuations as they were supposed to be super profitable and sitting on huge cash piles anyway. So not having a domestic listing and use foreign listings in order to help old shareholders cash out implies a high probability of fraud.

I would however make a distinction for companies which have a local listing and subsequently seek a foreign listing without issuing a ton of new shares or old shareholders cashing out. In many of those cases, companies do so in order to raise their profile and make the company more attractive to foreigners. When they do commit fraud, at least the have to face local law enforcement, no matter how weak that might be. For the German-Chinese companies in contrast, fraud has absolutely no consequences as defrauding Non-Chinese investors is not a crime in China. It looks even that in many Chinese fraud cases, authorities support the fraudulent companies in order to avoid a bad image.

Premium/Discount for Russian ADRs

For some reason, Russian ADRs in general seem to trade in relatively wide bands against local shares. At the time of writing, Sistema ADRs trade around 8-9% higher than local shares. Interestingly, there seems to be no real rule for a premium or discount. This is a list of the most traded Russian ADRs on the London exchange:

Last Px Premium Best
GAZPROM-ADR 0.79%
LSR GROUP – GDR 1.12%
LUKOIL OAO-ADR 0.26%
MAGNIT OJSC-SPON 17.18%
MAGNITOGORSK-GDR 0.24%
MEGAFON-REGS GDR 3.94%
MMC NORILSK ADR 2.14%
NOMOS B-GDR 0.31%
NOVATEK OAO-GDR 11.54%
NOVOLIP-GDR REGS 0.47%
PHOSAGR0-GDR 0.69%
PIK GROUP-GDR -1.37%
ROSNEFT OJSC-GDR 0.35%
RUSHYDRO JSC-ADR -1.70%
SBERBANK-SP ADR 3.17%
SEVERSTAL-GDR 0.45%
SISTEMA JSFC-GDR 8.42%
SURGUTNEFTEG-ADR -0.41%
TATNEFT-ADR 2.77%
TMK-GDR REG S -0.79%
URALKALI-GDR 0.53%
VTB BANK-GDR -2.37%

So Sistema trades at the 3rd largest premium, but honestly I have no idea why this is the case. For some reason, the ADR/local share arbitrage doesn’t seem to work here. The premium compared to the valuation is not huge but still should be kept in mind.

A few thoughts on Ukraine / Crimea

I don’t want to enter any political discussions here but just a few observations from my side:

– Crimea was for long time part of the Russian Empire
– It became part of Ukraine only in 1954 without being asked
– It already has an autonomous status within Ukraine

In my opinion, neither Russia nor Europe have a big interest in escalating this issue. Europe depends on the natural gas, oil and other resources from Russia and Russia depends on the money. For me from the outside this looks rather like a defensive move from the Russians in order not to loose their access to the Black Sea. But of course I could be dead wrong and this could also be the start for a real big crisis. No one knows.

Why not invest in Ukraine ?

I have looked at a couple of Ukrainian companies as well, but with most of them I do not feel comfortable. I don’t think that agricultural businesses are very attractive and for the rest I didn’t find any company which was remotely interesting to me. Ukrainian international Government bonds could be an alternative at some point in time.

Timing considerations

Similar to Turkey, most of the people I asked have a clear opinion on Russia: It will get worse before it gets better and one should just wait a little bit when prices are cheaper and things look better and then make a “safe and cheap” investment. Interestingly, I saw this way of thinking really often but it almost always doesn’t work.

As long as a share,a sector or a market goes up, people are happily buying. As soon as something bad is happening, investors panic , sell into a crash. If they enter at all, they will buy again when prices are much higher, not when prices are low. I actually know very few people who are actually buying when things look bad and assets are cheap.

Something very similar is now happening with PIIGS stock. Two years ago, when the headlines were that the Euro zone will break within a few days, people sold stocks at absurdly low valuations just to get rid of them. Now everyone is happily jumping back into the very same stocks, although they are two or three times more expensive. Why is that so ?

I am not 100% sure but I guess much of that can be explained by the behaviour of “typical” institutional investors with a strong hierarchy. If everything goes well, of course the big boss on the top is responsible for the success. If something goes wrong and clients or analysts are calling, the safest thing to do is to get rid of the exposure as quickly as possible. In many large institutions, the number of controllers, “risk managers”, auditors etc. far outnumber the ranks of the actual risk takers. In order to justify their existence, they will show the boss that they are “on the floor” and will force people to cut risks aggressively irrespective of price level.

As a risk taker in such organisations, it is almost impossible to invest in something with bad headline news and falling prices. You buy something and the probability that it falls further is high. So you will look stupid at the end of the month and your boss and a legion of risk managers will yell at you why you are so stupid. You do this a second time and you will lose your job. So the safest thing to do is nothing, until headline news turns positive and prices are climbing, because then the chances to look good in the short term are much better and your bonus will be higher.

So in my opinion, you can’t have it both. You don’t get super cheap prices and “improving” headline news. Either you accept low prices and bad news or “better” news and (much) higher prices.

JSFC Sistema

As the first company to analyse in Russia, I used Sistema, a major Russian conglomerate. Why so ? Three major reasons from my side:

– Sistema is a conglomerate, so it offers a broader exposure to Russia
– it seems to be a large and relatively well-connected company. So the risk of being bullied like Pharmstandard looks remote
– Shares of the company are listed widely, in the US, London and Germany

This is how Sistema describes itself on its homepage:

Incorporated in 1993, Sistema is now one of Russia’s top-10 companies by revenues and is one of the largest publicly traded diversified holding companies in the world. Sistema was ranked number 315 in the Fortune Global 500 list.

Valuation wise, Sistema looks ridiculously cheap as many Russian companies:

P/E 4,9
P/B 0,9
Div. Yield 2,6%
MArket Cap: 7,1 bn EUR
EV/EBIT ~4,1x

To be continued soon……..

Short cuts: Gronlandsbanken, SIAS SpA, Thermador, April

Posted on by 2 comments

Gronlandsbanken

Already some weeks age, Gronlandsbanken reported 2013 numbers and published their 2013 annual report, which is again a must read for anyone interested in Greenland. The bank seems to be a little bit more optimistic than last year.

Profit was around 10% lower than in 2012, which is not bad for a stagnant economy. The dividend has been kept stable which means the dividend yield of around 7,8% at current prices. Overall, Gronlandsbanken in my opinion still offers a lot of positive optimality, although it might need a few more years to really see an impact of potential large-scale mining projects. Better than with a “classical” option, I get paid for waiting.

SIAS Spa

Sias released 2013 results last week (in Italian only). Traffic was again down compared to 2012, but revenues increased due to the purchases out of the South America proceeds. They earned 0,61 EUR per share resulting in a trailing P/E of 13.8. For a “average” company like SIAS, this is already relatively expensive in my opinion, so I will sell down half of my current position (5,3%) at current prices, which would result in a profit of close to 100% for this part.

Thermador

Finally, Thermador released 2013 numbers and its English language annual report. Sales declined in a tough market by -2%, profit slightly more from 4.96 EUR per share to 4,68 EUR. Cash flow however was very strong due to a significant release of working capital, net cash is now around 32 mn EUR or ~ 7,4 EUR per share. The cash adjusted P/E of around 14 for a high quality firm like Thermador is in my opinion still adequate.

April SA

Already a few day<s ago, April presented preliminary 2013 results. Overall profits were a little bit lower than in 2012 resulting in 1.22 EUR Earnings per share against 1,38 EUR in 2012. Although this is the 5th decline in a row, this time the reason seems to be almost exclusively in the lower interest rates. I think one can expect that from a operational point of view, the bottom should be near.

Interestingly, they still earn very nice ROCEs even at those depressed levels. Adjusted for cash, they trade at single digit P/E which implies in my opinion still a good risk/return relationship.

Some links

Posted on by 5 comments

Must Read: Sequoia fund 2013 annual letter. They had a good year but didn’t make a single new investment in 2013

Wintergreen fund 2013 letter. Not a good year for them.

A very good lecture on value investing by Vito Maida, the boss of Canadian firm Patient Capital (nice name for a value investing company by the way…)

A “sober view” on the crisis in Ukraine and the success story of another “divorce victim” Slovakia

Finally a “new” blog which I found interesting:

Strictly Financial, a blog of two financial professionals with some interesting post for instance on Korean Preferred shares or the Whatasapp transaction

Follow up: East Asiatic Company (DK0010006329) – Sale of Venezuelan Business

Posted on by 2 comments

East Asiatic was part of my “strange stocks” series almost a year ago.

The stock looked extremely cheap, but the issue was that for their Venezuelan, they had to use the official Bolivar exchange rate. That was my final assessment:

All in all, EAC is not only a “strange” stock but also an interesting stock. Although both subsidiaries are struggling, I see some “real option” value here. The Santa Fe business, if the execute as planned, is worth more or less the whole market cap at the moment. Therefore, Plumrose, the Venezuelan pork producer is like a “free” option betting on a better future for Venezuela. This future is highly uncertain, but some positive signs are also visible.

Now something interesting happened: EAC announced last week that they sold its Venezuelan Business for DKK 390 mn and plan to pay a special dividend of 16 DKK:

• EAC divests Plumrose for a total consideration of approx. DKK 390m
• Due to the requirement under IFRS accounting standards to use the official VEF/USD exchange
rate, the transaction entails a significant accounting loss. However, when measured at the parallel
market VEF/USD exchange rate, the price represents a gain over book value.
• EAC’s Board of Directors considers the price attractive and intends to distribute DKK 200m to
EAC’s shareholders as an interim dividend (DKK 16 per share) once the consideration has been
received in full.

The shareholder friendly approach of the company can be seen via the video they produced, where they are explaining why they sold (very funny, Danish with English subtitles).

With a current market cap of ~1.100 mn DKK, receiving 390 mn DKK in cash is not insignificant. What remains is the Santa Fe subsidiary. That’s what i Wrote back then:

Simple valuation of Santa Fe:

Plan: 5% CAGR until 2016, 300 mn EBITDA. EV/EBITDA of 6-8x realistic ?

Current borrowings 500 mn, growth by 5% in line with sales –> 600 mn debt in 2016

EV of 1.800 -2.400 –> equity value of 1.200 -1.800 in 2016. Discount by 15% for 3 years: NPV of Santa Fee according to this: 790 – 1.180 mn DKK

The problem with that projection is: Santa Fee is not doing well at the moment. Based on the latest Q3 report, Sales for the first 9 months declined by 2% and EBITDA declined even more from 121 mn DKK 9M 2012 to 93 mn DKK 9M 2013. So achieving 300 mn EBITDA in 2016 looks somehow optimistic.

Interestingly, the stock price spiked quickly after the announcement but is now already on the way back down:

If we assume EBITDA for Santa Fe of around 130 mn DKK this year, this business is now implictly valued around 8-9 times EV/EBITDA. Maybe on a depressed level but as I am not a turnaround investor, I will pass on East Asiatic for the time being. Nvertheless, at some point in time, EAC could be a buy if the price stays low and they manage to turn around their remaining operations.

Performance review February 2014 – Comment “Is small still beautiful ?”

Posted on by Leave a comment

Performance review:

In February, the portfolio performed +2,7%, which is -2,5% lower than the Benchmark (25% Eurostoxx 50, 25% Eurostoxx small, 30% DAX and 20% MDAX). YTD, the portfolio is up +6,5% vs. 3,2% for the Benchmark.

Main contributors for February were G. Perrier with +22,5%, TGS Nopec with +16,9%, SIAS with +10,4% and IGE & XAO +7,1%. Major looser was Cranswick with -5% (in EUR) and Vetropack (-2,8%).

Portfolio transactions

If I look at my transactions in February, I almost feel like a high frequency trader: I sold the final Rhoen Klinikum position as well as EMAK and SOL. I increased positions in MIKO and TGS Nopec and finally I invested in 3 (!!!!) new stocks: Energiedienst, Koc Holding and Ashmore. Cash is now at 13,5%.

The current portfolio can be found here.

Comment: “Is small still beautiful ?”

2014 again showed the usual pattern in the past few years: Small and Midcaps outperform everything else by a wide margin. This is how the constituents of my own benchmark performed YTD:

Perf. YTD
Eurostoxx50 (Perf.Ind) (25%) 1,51%
Eurostoxx small 200 (25) 8,06%
DAX (30%) 1,46%
MDAX (20%) 1,91%

So European small caps seem to be THE hot asset class. A long time ago, when I went to university (early nineties), I still remember when the finance professor talked about efficient markets. He didn’t believe in them and one of the example quoted was the famous “small cap” effect, the “fact” that small caps over the long run perform better than large caps.

Looking at most markets today, the history speaks for itself. Just look at the Charts:

S&P 500 vs. Russel 2000

or even more drastic: Dax vs. MDAX

Back to the “old times”: When I started to work for a financial institution in the mid nineties, one of my job was to monitor and explain the performance of a German small/mid cap fund. Every Quarter or so, I had to explain why again the fund had underperformed the DAX by a wide margin and the fund was finally closed end of 1999. Just to give an indication how badly Midcaps performed in this period: From the end of 1994 until end of 1999, the DAX performed ~26,4% p.a. against the MDAX with 10,6%, an underperformance of -16,4% p.a., or in absolute terms +221,96% against 65,55%. No matter what academia would say, the decision makers were tired of looking stupid and pulled the plug.

Consensus at that time was that in the age of globalization, the big international companies would be the stars and the small companies would be crushed. We all know how this story ended.

Let’s look at some more recent numbers: Since the end of 2009, the MDAX has performed 21,5% p.a. vs. 12,4% p.a. for the Dax. The French Small&Mid Cap index has performed 13,9% p.a. vs. 5,95% for the CAC in the same period. So again, many “asset allocators” are faced with a situation, where the logical thing to do is to allocate as much as possible into the much better performing asset class.

However, this past performance is only one side of the medal. Let’s again look back and look at something else this time: Valuation

When my employer at the end of the nineties decided to pull the plug of the small/midcap fund, the DAX was trading at a P/E of 32 vs. the MDAX at 16. Interstingly enough, the situation now is just the inverse: The MDAX now trades at 28 times earnings against the DAX at around 16 times. The situation looks similar in other markets. The Russel 22000 for instance trades at ~50 times 2013 earnings against 17x for the S&P 500. Of course, profits in small and midcaps could continue to grow much faster than in large caps, but at current valuation levels they have to grow much faster than for large caps in order to justify their valuation.

There seems to be so much money flowing into small caps at the moment that even the weak companies enjoy their day in the sun. So what to do now ? Chase the few remaining “cheap” small caps and hope that they get pushed up by the momentum ? Or exit completely ? I don’t know, but for instance European small caps have almost completely disappeared in my BOSS score database from the “attractive” bucket. The few remaining ones are rather “deep value” cases.

In any case, one should be very careful with small caps going forward. Based on current valuations, profits at most small cap companies (Europe and US) would have to increase really strongly in order to be able to produce additional outperformance in the next few years. There might be a few remaining opportunities, but overall “the air is getting thinner”. We will see how this plays out, but experience shows that multiple expanions will stop at some level and then usually reverse quite drastically and for long time periods. So be careful with small caps. Maybe “big is beautiful” might come again….

Some links

Posted on by 2 comments

If you read only one piece this weekend, then read RV Capital’s 2013 investor letter with some really deep thoughts from a great investor.

WertArt Capital has a great post on Dundee Capital.

A good overview on Korean Preferred stocks can be found here

Cassandra on an epic short squeeze in the Japanese market

The “joyful investor” with a great analysis of Standard Chartered Bank. Standard Chartered is on my list for the Emerging Markets series …..(Great blog by the way).

Finally a link to a very interesting blog which has a lot of good stuff, among others a series on the UK alternative market AIM: Investing Sidekick. Check it out !!!

By the way, I am happy to link to any good investment blog out there. Just send me an Email.

AND of course do I wait for Warren BuffetT‘s 2013 letter which is supposed to come out this week-end……

UPDATE -THERE IT IS: BERKSHIRE 2013 SHAREHOLDER LETTER

Emerging Markets series part 2: Koc Holding ADRs (US49989A1097) – the best of Turkey in one stock ?

Posted on by 21 comments

As this is a long post, a short summary in the beginning:

– despite the bad headline news, for me Turkey is one of the more attractive Emerging Markets, as valuations are moderate and most problems are clearly visible
– Koc Holding, the holding company of the KOC family offers an interesting opportunity to invest in a portfolio of Turkish companies with dominant market positions
– further, Koc Holding seems to be a professionally managed company with good capital allocation and very good long-term track record
– nevertheless, stand-alone the investment is clearly very risky at least in the short-term and should be part of a broader EM strategy

Turkey background: Lots of problems

Turkey is clearly the Emerging market country with the most obvious issues at the moment. The decline of the Lira triggered a massive interest increase by the Turkish National Bank, which clearly is not really a tailwind for the local economy. When people now speak about emerging markets, they usually distinguish between those who are still OK like China, Mexico and the Philippines and those who have problems (Turkey, Indonesia, India etc.).

Personally, in my experience in such situations, this distinction is most often wrong. Like in the beginning of the Euro crisis, when people for instance thought that Spain is OK, usually all countries in such a “bucket” have problems and the only difference is that the problems surface quicker in some countries than in the other.

That’s why I somehow like Turkey, the current problems are clearly on the table:

– Declining Turkish Lira
– Political issues with Erdogan/Gülen
– Protests and fights in Istanbul
– current account deficit
– war/conflicts in neighbouring countries
– Kurdish minority
– FX loans from companies

Expectations are low, you hardly find anyone who is positive, the consensus view is: “It will get much worse before it gets any better”.

Honestly, I do not have a magic crystal ball to look into the future, but experience shows that once the problems are on the table, the possibility of those issues already being priced in into the stock market are quite high.

From my point of view there are also a lot of positives for Turkey

– strategic well positioned between Europe and Middle East
– no resource course, people have to work in order to get richer
– young, growing population
– main beneficiary if political situation in neighbouring countries improves
– a depreciating currency automatically improves the competitive position. During the Euro crisis, almost everyone said it would be much easier for the “club Med” if they were not in the Euro.

Just as a reminder the map of Turkey and its “friendly neighbours”:

How to invest

There are clearly several aspects to consider. Corporate governance and shareholder rights in Turkey for sure are not at levels as in Anglo-Saxon or Northern European markets. Without a local account in Turkey, it is hard to trade Turkish stocks. So either one invests into a Turkey ETF, which has the disadvantage of a rather high banking exposure (~40 percent of the main indices) or one needs to focus on the stocks traded outside Turkey. To my knowledge, only 3 stocks are traded more or less liquid outside Turkey which are:

– Turkcell (largest Mobile operator)
– Anadolou Efes (Beer)
– KOC Holding, a conglomerate

As I am not so bullish on mobile carriers (see Whatsapp), and Anadolou Efes looked a little bit too hard for me after some merger activities, I looked a little bit more into Koc Holding.

Koc Holding

Koc Holding is the Holding company of the Koc Family of various subsidiaries mostly operating in Turkey. The Koc family directly and indirectly controls ~78% of the shares, leaving a free float of only 22%.

The company looks relatively cheap, but we should not forget that interest rates in Turkey are at around 10% (at 8,10 TRY per share):

P/E 7,7
P/B 1.1
Div. Yield 2.3%
Market Cap ~ 7 bn EUR

The interesting thing about Koc is that almost all subsidiaries are listed subsidiaries. For some reason, a lot of the Koc companies are JVs with foreign companies where Koc “only” owns around 40%. I tried to compile the list of listed subsidiaries. Additionally, I added net cash at holding level and the non-listed companies at book in order to come up with a “sum of part” calculation:

Company Percentage Koc MV EUR mn P/E
Arcelik 40,5% 1.048,0 13,2
Tofas 37,6% 645,5 12,1
Turk Traktor 37,5% 366,7 10,6
aygaz 40,7% 334,6 12,2
Otokar 44,7% 173,4 12,3
Tat gida 43,7% 41,6 106,9
Marmaris 36,8% 7,7 62,0
Altinyunus 30,0% 6,8 282,8
Ford Oto 41,0% 912,7 10,6
Tupras 51,0% 1.623,6 8,1
Yapi Kredi Bank 41,4% 1.536,8 6,1
Yapi Koray 10,7% 1,5 #N/A N/A
Yapi Tipi 4,5% 1,4 #N/A N/A
       
Sum unlisted   602,56  
Net cash Holding   580,00  
       
Sum of part   7.882,81  
Market Cap Koc Holding   6.718,39  
“Discount”   14,8%

We can see, that around 86% of the total value is invested in observable, listed companies. Additionally, we can see that the “discount” is currently ~15% to the sum of part. This is not much compared to other holding companies, but we come to this later. Another important point is that financials (Yapi Bank) are only 20% of the overall value, so a lot less than in the Turkish stock index. The overall low P/E of Koc is clearly driven by Yapi Kredit and Tupras, also something which one should be aware of.

The major businesses:

Tupras is basically a refinery. Normally not a very attractive business, unless you are the ONLY refinery in a country. Tofas and Ford Oto are both car manufacturing JVs, Tofas with Fiat and Ford Oto of course with Ford. Together, they have around 20% market share in Turkey, but much more interesting, around 50% of the production is being exported. So they should make up a lot of lower domestic demand by exporting more.

Arcelik is a “white goods” household manufacturer (among others with the Beko brand) which has also significant export business. Turk tractor has 50% market share in tractors in Turkey plus a 50% export share. Yapi Kredi finally is Turkey’s 4th largest bank and a JV with Unicredit. It has average profitability compared to its peers.

All in all, Koc claims to generate 10% of Turkey’s GDP, which at least in my opinion is the highest concentration I am aware of in any country for a single Group.

So at a first glance, Koc Holding seems to be a very good way to invest into the Turkish economy with an underweight in financials and an overweight in market leading companies with a significant export share.

Qualitative assessment / other considerations:

When I looked into the 2012 annual report and also into the available investor information , I was genuinely surprised how good the material is.

Koc 2012 annual report is a must read for anyone interested in the Turkish economy although Koc clearly is subjectively maybe more optimistic. At the time of writing, Koc just issued their preliminary 2013 earnings and the results look surprisingly robust (+15% including gain on Insurance co sale, unchanged excluding)

In my opinion, Koc has many aspects which are lacking even in most developed markets companies:

– Clear targets: Grow above Turkish GDP and create shareholder value, IRR hurdle of 15%
– clear dividend policy (20% of Earnings)
– Some businesses profit from Lira weakness (50% of cars and tractors are exported, Beko white goods etc.)

I also liked how they explained their strategy: Expand into other sectors only in the home market, expand internationally only in sectors where they have significant experience int he home market

What kind of Holding company is Koc ?

I do think that Koc is actually a value adding Holdco. I make this subjective assessment on 3 major observations based on their excellent, regularly updated investor information :

First, they are not shying away from selling subsidiaries if the consider them as not good enough, such as the very well-timed sale of their insurance subsidiary at the peak in 2013 and several other subsidiaries in the last years

Secondly, especially for a Turkish company, I was very surprised how clearly they formulate their strategy. They have clear IRR target and also a clear strategy where and when to invest.

And thirdly, their track record is surprisingly good. Over the last 20 years, total return for Koc Holding was 33.8% p.a. in local currency. This translates into 7.9% p.a. in EUR or 8.6% in USD. It is slightly lower than the S&P 500 (9.5% USD) and DAX (8,4% EUR), but we need to consider that:

– Koc is currently trading 50% below their peak valuation in June 2013 (whereas both, DAX and S&P trade at all-time-highs
– in the last 20 years, Koc had to withstand, among other issues a hyperinflationary environment which culminated in a new currency in 2005 which had exactly 6 zeros less than the old one

For me, this is a quite convincing track record in generating and maintaining shareholder value in the long run. much better than anything I have seen in other “Club Med” countries.

Koc and Erdogan:

Following the protests in Istanbul, there were some stories that the Koc family took position against Erdogan. As a kind of revenge, then Erdogan sent special tax auditors to Tupras. However, as this very nuanced article points out, this could have been it already.

I am clearly no expert here, but the fact that the Koc family, among others, survived 3 military coups, the second world war and hyperinflation, the probability is maybe relatively high that they survive the current episode, but risks are clearly there.

Stock Price

Looking at the stock price, one has to look at the stock price in hard currency:

We are clearly not at the lowest level but still around -50% off the peak from June last year. Funny, how optimistic people seem to have been only 8 months ago…..

Valuation:

Koc currently trades at an P/E of around 7,7x 2013 earnings. Without the insurance sale, this would rather be like 9 times but still cheap.

In my opinion, under normal circumstances, a company like Koc with a lot of market leading subsidiaries and a great track record could trade easily at 10-15 times P/E. If we assume that the Lira will make back at least some of its decline (maybe 10-15%), we could see a potential upside without assuming any growth over 3 years 35%-100%. If we assume some growth, Koc could be more than a double, especially compared to current valuations elsewhere in Southern Europe.

Summary:

In total, I think KoC Holding is clearly a risky but interesting stock in an interesting market. The combination of a good long term track record and a diversified group of well positiioned local companies reduces the individual risk to a certain extent, although the political issues between the Koc family and Erdogan have to be kept in mind.

At the current valuation, the upside is large enough so I do not need to try to time the market and will establish a 2.5% position in KOC Holding ADRs at current prices (USD 18,20 per ADR) for the portfolio.

Short term, the stock price could (and most likely will) go lower than the current level, when “risk off” mentality returns to the market.

A final warning: This stock is clearly more volatile than my average stock picks and should be seen as part of a more diversified “excursion” into Emerging markets. I plan to invest at least into 4-6 different EM companies with a total portfolio weight of 10-15%, the start was already made with a first Ashmore position earlier this week.

In parallel, I am also selling down most of my last Italian positions in order to derisk this part of the portfolio, as the valuations (and risk return relationships) for Italian stocks have become mediocre at best as people have become very optimistic.

Distressed debt: Quick update IVG convertible – insolvency plan released

Posted on by 8 comments

As a former IVG convertible investor, I still follow what is happening there in order to learn how this “new” German bankruptcy process works.

Yesterday, IVG came out with their “insolvency plan”. Some of the detail sare:

– not surprisingly, shareholders and Hybrids get fully wiped out
– they actually plan to delist the stock
– part of the secured loans (Syn loan II) experience no hair cut at all and receive even interest
– the other part (Syn loan I, LBBW loan) AND the convertible get shares in the “NEwCo”
– The convertible holders will get 20% of NewCo which, without giving details is calculated as a 68% recovery

What I find especially interesting is the fact that the convertible still trades at around 75%:

What that means is that convertible holders think that the stock they will receive is worth a lot more than 68% even if it comes in a non-listed form and will be hard to sell.

This in fact means that in theory, under a completely “fair” insolvency proceeding, something could have been left for the Hybrid holders. Under the current insolvency regime, however it seems to be really possible to kick out subordinated holders even if the asset value would imply some recovery as the hybrid holders are not a creditor group.

For me, this doesn’t look fair. It is a clear invitation to distressed debt funds to look at German companies with significant hybrid debt, force them into bankruptcy and kick out the hybrid holders at zero.

Maybe this is also the reason why they want to delist the stock, so that the “True” recovery does not become public directly after the debt/equity swap.

My five (Value) cents on Whatsapp: Network effect meets Lollapalooza

Posted on by 35 comments

No breaking news here, the acquisition of Whatsapp by Facebook for 19 bn USD has been widely commented already many times.

Some of the more notable comments were:

Damodaran looks at it from a value and trading perspective and sees only merit as a trade

John Hempton feels “out of tune with the time” about the deal becasue the Facebook stock didn’t fall after the announcement

Henry Blodget has a slightly more positive take on the deal

What those comments have in common is that they all look at Whatsapp as another social media app like Twitter, Tumblr etc. In my opinion and my experience, Whatsapp IS NOT a social media app, at least not intentionally.

Whatsapp is so successful because it offers two big advantages for users:

– its cheaper than traditional SMS
– it is also much easier to use (nicer smileys, you can look if someone is online, easily send pictures etc.)

In my opinion, Whatsapp only “accidentally” became something like a “social media” platform as it allowed group communication more easily und unobserved compared to Facebook. If you use facebook nowerdays, efficient communication among friends is not that easy any more with all those crappy “likes”, advertising etc.

Back to Whatsapp “roots” as an SMS killer: There was an interesting article on Bloomberg.com about the amounts lost by mobile carriers due to Whatsapp & Co with the following estimates:

Free social-messaging applications like WhatsApp cost phone providers around the world — from Vodafone Group Plc (VOD) to America Movil SAB (AMXL) and Verizon Communications Corp. — $32.5 billion in texting fees in 2013, according to research from Ovum Ltd. That figure is projected to reach $54 billion by 2016.

So instead of thinking about a “social media app” one could also think of Whatsapp as a “Mobile communication company” which concentrates on a very specific part of the value chain of mobile phone carriers.

After the initial euphoria, mobile telecommunication has not turned out as such a great business as one would have thought. The high capital required for licences, tower infrastructure, retail outlets etc. plus the regulation has turned the business pretty much into a commodity business. As in many commodity business like car insurance etc., the carriers tried to discount their main offer as low as possible and then charge all different extra stuff, especially SMS. There was for instance a “scandal” in Germany, when providers let people especially kids, send SMS although the prepaid money was already used up. Many parents then were surprised when they then got extra bills or had to load unexpected high amounts in order to get the phone working again.

So one can imagine how quickly especially kids or poorer people with limited prepaid budgets (but a data plan included) adopted a free service like Whatsapp. This also applies to generally poorer countries where mobile phone expenses use up significantly higher shares of total budgets than for instance in Germany or the US.

Compared to the full value chain of mobile carriers, a texting app requires almost no infrastructure, no retail outlets etc. You can easily rent cloud processing capacity for very small money from Amazon on a variable basis and scale up if you need more.

Similar cases: Mobile phone contract resellers

A very similar business model is that of the classical mobile phone contract “reseller”. Freenet AG for instance, a German mobile phone “reseller” managed to get a 3 bn market cap just by reselling plans from existing mobile phone Providers.

Compared to moble phone carriers, this business is clearly attractive as one doesn’t need to buy the licences ec. Compared to Whatsapp however, the business model looks rather shitty as you need to advertise constantly, prefund the phones, maintain a retail outlet etc. And remember: This 3 bn market cap has been achieved with “only” 8.5 mn clients in one country. If Whatsapp for instance would decide to go into reselling, they could make live difficult for those guys as well.

No cashburn

What I found also very interesting is the fact, that Whatsapp didn’t burn a lot of cash. According to some articles, Sequoia capital only injected 58 mn UD in total “outside” capital. So this is another big difference to many other internet or social media companies: very little “cash burn”. I guess one reason is that they didn’t need to make a lot of advertising. As the reputation of mobile phone companies is bad enough, their service was just such a “No brainer” or “killer app” for many that it went “viral” without spending any money on advertising. I am not sure if they have to pay to Google or Apple for the app stores, but overall, distribution cost seemed to have been quasi non-existent.

Moat /network effect

In another comment on Slate about the Whatsapp deal, the author says the following:

The different pricing schemes they come up with are just different ways of trying to maximize the value they extract from consumers. In a world without WhatsApp, selling SMS separately from data is the best way to do that. Then along comes WhatsApp to exploit a hole in the pricing system. But if WhatsApp gets big enough, then carrier strategy is going to change. You stop selling separate SMS plans and just have a take-it-or-leave-it overall package. And then suddenly WhatsApp isn’t doing anything.

I can clearly not look into the future but there are some obvious mistakes in that argument for instance:

1. Big companies hate to cannibalize itself. Whatsapp is already big enough but they haven’t done anything because more often than not, it is “easier” being cannibalized by someone else than by a guy or a division within the own organization
2. Anyone using Whatsapp will not go back using SMS again. Only few people prefer to live in the stone age if they have a choice
3. Although it was easy and cheap for Whatsapp to get to this stage, it is not as cheap and easy for any potential competitor to achieve critical mass. Absent any further technological break through, the “network effect” of the established leader will make it extremely expensive for any competitor to “scale up” in this business. In a sector where the network effect is so string, the “barrier to entry” increases tremendously if there is a dominating player with a large market share.

Especially the last point is important in my opinion. As long as this segment is growing, it makes a lot of sense for Whatsapp to provide this service as cheap as possible in order to avoid making it attractive for other competitors. Especially as it doesn’t seem to cost a lot of money to run it for a couple of hundred million people, they have a lot of time to actually increase profits.

Oh, and by the way, forget about that shitty Blackberry messenger app, this won’t save them (see number 3 above).

Lollapalooza effect

Warren BuffetT‘s “sidekick” Charlie Munger has coined this term. I copy the definition from this blog post:

The lollapalooza effect is what happens when you have more than one bias/incentive acting at the same time. It means the confluence of several themes heading in the same direction to produce a given result which can either be positive or negative. And, as it becomes hugely powerful, it also becomes a major driver of human misjudgment.

The current confluence of at least 4 important “streams” that are mobile communicication, faster internet, smartphones and Mobile micro payment is a good example of such an effect. On a single basis, a “product” like Whatsapp would not even exist. With my old Nokia 6110, I could only send sms and take calls. With my first “multimedia” phone (a Siemens Benq…what was that again ?) I could only surf some specialised web sites chosen by the mobile carrier at a horrendous cost and slow spead. But now, with full and fast internet access, easy to navigate touch screens, app stores and a cheap internet data plans, a couple of guys in SFC can create a product at a cost of 60 mn USD which is used by 450 mn people globally after only 5 years.

Valuing companies in such an environment is indeed very difficult as anything could happen, both to the positive and the negative side. I think we should prepare for much more “killer apps” coming out of this Lollapalooza environment which have the capacity to challenge or even destroy other established business models. And I do not mean only print magazines, Nintendo DS or alarm clocks.

What about the 19 bn USD paid ?

If we look at the Bloomberg article above and i we consider Whatsapp as a mobile communication company, one could make the following calculation:

If messaging really lowers mobile carriers revenues by 56 bn uSD globally in 2016, one could argue (among many other scenarios) in the following way:

– if Whatsapp is responsible for 20% of this, then their “damage” or cost saved for the mobile client is 10.8 bn annual
– if Whatsapp manages to charge 25% of the saved amount at some time, this would mean around 2.7 bn USD p.a.
– as the costs seem to be low (they don’t need to buy licences etc.), a net profit margin of 60% might not be unreasonable

So all in all we would expect under those (maybe too optimistic assumptions) around 1.6 bn in profits. Going back to professor Damodaran, this would be still lower than to justify the paid value:

Whatever the model, though, you would still have to generate at least $2.2 billion in after-tax income from advertising to Whatsapp users to break even.

but still, Whatsapp could turn out to be quite a valuable asset. This does not even include the possibility that Whatsapp moves further along the mobile communciation value chain, like actually handling all communication including calls and “degrading” carriers to exchangeable capacity providers which would be one option.

Now how about Facebook ?

First a short disclosure: I have never owned and will never own Facebook shares, that is on my “too hard pile”.

But overall, I am not sure that Facebook is the best fit for Whatsapp. Facebook didn’t get mobile unless a few months ago and I am not sure if they will get it now. For me, Google would have been a much better fit or even Microsoft or Apple. But again, who knows ? The biggest danger for Whatsapp in my opinion would be indeed if facebook would force a connection with their services or something similar as, in my opinion, Whatsapp IS NOT a social media app but a mobile communication platform with the potential to take out an even larger share of mobile carrier’s revenue in the future.

Summary:

Many people see the 19 bn Whatsapp purchase as a sure sign for a top in the social media hype. Although it might turnout as such, in my opinion Whatsapp itself is a very interesting mobile communication business with the potential to further shaka up this business.

Due to the network effect, Whatsapp has created a huge barrier to entry for any competitor, supported by the fact that they still offer this at basically no cost. The pricing power of Whatsapp in my opinion is much bigger than “social media” as customers clearly understand the savings against traditional mobile carrier charges. Going forward, Whatsapp seems to be well positioned to move even further into the territory of mobile carriers, resellers etc.

The price paid by Facebook clearly looks very rich, but looking at mobile carriers and the implied profit potential rather that social media businesses, it might not be unreasonable. It remains to be seen however what Facebook is doing with this acquisition.

If Whatsapp would be a listed company, I might even forget my traditional value metrics and buy it, maybe not at 19 bn but still, at a “non-value” valuation.

Emerging markets series part 1: Ashmore Group PLC (ISIN GB00B132NW22)

Posted on by 22 comments

As I have written a few weeks ago, I am trying to extend my circle of competence a little bit with regard to Emerging markets. The first company in this series is Ashmore Group.

Ashmore Group is a kind of “intermediate” step in this regard: They are a UK-based asset manager who specialises exclusively in Emerging markets.

The history of the company is well described on their homepage:

Based in London, the business was founded in 1992 as part of the Australia and New Zealand Banking Group. In 1999, Ashmore became independent and today manages $75.3bn (as at 31 December 2013) across a range of investment themes in pooled funds, segregated accounts and structured products. Ashmore Group plc has been listed on the London Stock Exchange since 2006.

Asset Management as a business

Asset management in general as a business used to be as good as it gets. Asset Management is an “asset light” business model. You collect fees and sometimes even participate if things work out well. Once money is invested, it is often surprisingly “sticky”. So it is no surprise that among the richest people in the world, a surprisingly large number of people are Hedgefund asset managers.

On the other side, “normal” active portfolio management is squeezed from different sides. Cost efficient Index ETFs from one side and hedge funds from the other. Also, with overall lower yields it is clearly more difficult to achieve the same fee levels as relative to the yield they represent a much bigger percentage

Back to Ashmore, this is how they have done historically since they went public:

EPS FCF ROE Net margin
2006 0,14 0,15 62,5% 60,7%
2007 0,21 0,22 60,2% 58,3%
2008 0,17 0,15 39,6% 46,8%
2009 0,24 0,26 47,1% 56,9%
2010 0,28 0,21 43,5% 55,1%
2011 0,27 0,18 35,0% 54,3%
2012 0,30 0,18 34,7% 56,9%

So no complaints here, ROE went down somewhat as equity was built up, but nevertheless it looks like very very attractive business. Compared to those numbers, Ashmore’s current valuation looks like a joke (at 330):

P/E 11.1
Div. Yield 5.35%
EV/EBITDA 7.8
EV/EBIT 8.3
P/B 3.8
Mkt Cap 2.4 bn GBP
No debt, net Cash 500 mn GBP or~0.71 GBP per share

Plus there is more to like:

– the CEO owns 42% of the shares and with an age of 54 not close to retirement
– they seem to have some sort of “Outsider” qualities for instance fixed salaries are capped at 100 k GBP which keeps down fixed costs

But there is of course a reason why the stock is “cheap”:

– clients are pulling money from the funds
– average fees have been declining for 5 years in a row (until recently compensated by higher AuM)
– Performance fees will be low or non-existent for the foreseeable future
– revenues will decrease with falling market valuations for EM

Why I like the company anyway:

+ It is an easy way to “play” the entire Emerging market universe without incurring country specific risk
+ the company does not have any valuable own assets locked in difficult emerging markets, the assets are owned by the clients
+ long-term, EM capital markets will grow
+ EM are difficult to replicate via index ETFs, especially for bonds. Index ETFs are not really a competitor in the EM bond area (too illiquid, to many different bonds per issuer etc.)
+ As an EM specialist, they are much more credible than a large asset management company with some EM funds among many other offerings

Is there a “moat” ?

In theory, setting up any fund management company is relatively easy. Yes, one needs licences but they are easy to obtain. However, Emerging markets are a little bit different. While it is relatively easy to gain exposure to some assets, like EUR or USD bonds from EM issuers, getting access to local markets is much harder. Ashmore with its long EM market experience does have some advantages here, for instance they are the first non-Hongkong based fund manager to get a license to invest directly into the China “On shore” market early this year.

The current problems with EM led already to the exit of some high-profile AM companies from that area, among others, famous hedge fund Brevan Howard closed its once high-flying EM funds just recently.

Ashmore doesn’t have any “star portfolio managers” who might be able to jump to another company and take a lot of client money with them. Still, the single most important factor for any asset manager ist the historic track record. Performance is normally measured both in absolute and relative terms. For many so-called “asset allocators”, relative performance to other asset managers is the most important number. In order to find out how Ashmore scores in this regard, I looked at the publicly traded Ashmore funds. Bloomberg shows the relative ranking of such funds within their category over different time horizons. Those are the results for the traded Ashmore funds:

mn USD 1y 3y 5y fee
Ashmore Emerging Markets Corporate Debt 3690 84% 69% n.a. 1,15%
Ashmore Emerging Markets Liquid Investment Portfolio 3910 78% 96% 81% 1,50%
Ashmore Emerging Markets Local Currency Bond 2340 5% 23%   0,95%
Ashmore SICAV – Emerging Markets Debt Fund 1400 46% n.a. n.a. 0,95%
Ashmore SICAV – Emerging Markets Global Small-Cap Equity 100 86% n.a. n.a. 1,50%
Ashmore Asian Recovery Fund (“ARF”) 224 37% 1% n.a. 1,50%
Ashmore Emerging Markets Total Return 684 32% n.a. n.a. 1,10%
AshmoreEMM Middle East Fund 449 97% 97% 79% 1,50%

The number have to be interpreted the following way: The 84% under the 1Y column for the Ashmore Emerging Markets Corporate Debt fund says that the fund performed BETTER than 84% of all fund in that category , which, by the way is a very very good score. We can see that not all the funds are doing well, but at least the big flagships are doing well and some of the smaller specialist funds. Overall, from a performance perspective, it looks like Ashmore has at least some “edge” in its core mandates which will help them a lot, once money is flowing back into EM mandates.

Funnily enough, everyone knows that past performance is not a very good indicator of future performance, bt the majority of institutional money gets allocated based only on past performance.

How much would I be prepared to pay ?

To keep ist simple, I would think a “full” price for a company like Ashmore would be around 15x P/E. If I could buy it for (cash adjusted) at 10 x P/E based on potentially depressed next 2-3 year earnings levels, this would leave a decent upside.

Current estimates for 2014 are ~ 0,24 GBP per share, including 0.70 GBP net cash per share, this would mean I would be a buyer at around 310 pence per share or some -10% lower against the current share price to give me my required upside. So for the time being I will stay on the sidelines and watch and buy only below 310 pence per share.

As I am not a Chartist it is still interesting to look at the chart:

My target level for the purchase does look a little bit like a “support” level for the stock, which, if broken, might lead to a larger drop in the share price. So for the time being, I will watch Ashmore going forward but wait if either, business turns out to be better as expected or the price drops below 310 pence.

« Older Entries Recent Entries »