Trilogiq SA (ISIN FR0010397901) – Another of those hidden French champions ?

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DISCLAIMER: The author might own the stock already before the release of this post. The stock discussed is very illiquid. Please do your own research. This is not a recommendation to buy or sell or anything.

As many readers might have figured out, I am currently looking a lot at French stocks. I already had mentioned in my August review that I am building up a stake in a company which I didn’t disclose back then. Well: here is the company: Trilogiq SA.

If one looks at Bloomberg, the description is quite short and meaningless:

Trilogiq SA manufactures a wide range of flow racks.

However, looking at the Corporate Website is much more revealing:

Trilogiq is manufacturing a modular system of flexible components which supports the material handling at an assembly line. The underlying philosophy is based on the Japanese “Kaizen”. More on that later.

The company went public in late 2006 at a price of EUR 28.59 per share, a level the share hasn’t seen since as the stock chart clearly shows:

Valuation:

Traditional value metrics look OK, but not super cheap (at 18,15 EUR) :

Market Cap: 68 mn EUR
P/B 1.46
P/E 12.0
P/S 1.1
Div. yield 0%
EV/EBITDA 6.0
Debt: Net cash of ~5 EUR per share

So why do I think the company is interesting ? Well, if we look into the last annual report, they seem to do something right:

Net Margin 8.6%
ROE of 12.2% BUT: ROIC (ex cash) is 20%

ROE was higher in previous years, but adjusted for Cash, ROICs are relatively constant at 20%.

EPS DIV ROE ROIC
29.12.2006 0.87 #N/A N/A 25.6% 25.7%
31.12.2007 1.48 #N/A N/A 29.0% #WERT!
31.12.2008 1.45 #N/A N/A 22.1% 19.7%
31.12.2009 1.64 0.50 20.7% 19.9%
31.12.2010 1.75 0.50 18.3% 18.7%
30.12.2011 1.50 0.50 12.6% 23.7%
31.12.2012 1.68 0.00 12.4% 20.7%

So this now gets interesting: We get a company with a (cash adjusted) PE of 8 and an ROIC over the last 7 years of around 20% and the company is growing. This is very good and hard to find these days. On top of that, the company is growing quite nicely and : only around 15% of the business is in France, 85% is “Export”.

So in current times, this definitely is a good reason to investigate the company further.

Business model:

In such a case as Trilogiq, where I do not know the company really well, I usually try to figure out what they are doing in more detail in the next step. Here, fortunately, we can still find the (French) IPO prospectus on Trilogiq’s web site

General Remark: IPO prospectuses are always a very good source for information about the business model, competitors etc. So if one can get hold of it and it is not too old and outdated, this is usually the single best source for such information. Much better than annual reports, because the risks are usually disclosed quite extensively.

The founder of the company worked as an engineer at Renault and had the task to study Japanese car manufacturing. He then started out on his own, producing equipment to improve manufacturing efficiency for Renault and Peugeot.

The basic “philosophy” is to have a lean flexible production process which avoids unnecessary material, handling steps, heavy machinery, large quantities etc. Among others, it is advised to transport small amounts only within the assembly lines, avoid unnecessary distances etc etc.

Now comes the interesting part: Trilogiq itself does not only provide the tools, but is offering the full consulting service as well. So a company calls Trilogiq and they start with simulating the production process on a computer (CAD) and then optimize it using their various tools. They will then go on site and then implement the stuff including full project management etc.

So in essence, Trilogiq rather seems to be a specialised consulting company with a physical product than your typical car parts supplier. This in my opinion also could explain the rather high margins which are quite unusual in the automobile industry.

A few videos which explain the principles:

(company movie)

Some product presentations

In order explore this thesis a little bit more, let’s look at two ratios:

– What amount of raw material etc in relation to sales does Trilogiq show against other companies ?
– What amount of sales do they generate per employee ?

Lets look at some companies, I have chosen 2 car parts companies + 3 of my portfolio companies as comparison:

material cost/Sales Sales per Employee (K EUR)
 
Trilogiq 43% 350
     
PWO 55% 33
Sogefi 56% 15
 
Poujoulat 59% 73
Installux 48% 198
Thermador 60% 389
     
G. Perrier 26% 90
 
Accenture   295
IGE 22% 284

The result is quite interesting. PWO and Sogefi are 2 “typical” car parts manufacturers. Material cost is more than 50% of sales, sales per employee are relatively small, so implicitly this is rather pretty “low tech” work.

If we look at my Portfolio companies, only Thermador has a similar per employee sales number but this is normal as it is primarily a trading and logistics company. Poujoulat for instance needs more material than Trilogiq as well as Installux and even Installux only manages 2/3 of Trilogiq’s sales per employee.

Just for fun, i also listed software company IGE + Xao and Accenture. Interestingly those companies generate similar sales per employee volume.

While this is clearly no scientific proof, I think it is however fair to say that Trilogiq is not your typical “manufacturer” but rather something different. It is no trading company either so I think my thesis that it is a kind of consulting company with a physical product might not be unrealistic.

Another interesting aspect shown on page 33 of the IPO prospectus is the aspect that they do create significant recurring revenues out of their products. According to this, they have a 4 year cycle. If they sell an amount of 100 in the first year, they will expect 20 maintenance revenue in year 2 and 3 and then (if renewed) another 40 in year 4.

Competitors:
They only consider 2 companies as direct competitors: Fastube in the US and Yakazi from Japan, both privately owned. As Trilogiq is currently expanding quickly in the US it seems like Fastube is maybe not the strongest competitor. They don’t seem to be active in Asia, maybe too much respect versus the Japanese “master” like STarbucks and Italy ? Of course, the “traditional way” is a competitor too.

Why is the stock cheap ?

– One reason is clearly the non-existent financial communication. Minimalistic reports in French only, only a few small research houses cover the stock (5 according to Bloomberg, only 2 in 2013). Interestingly, in 2007 and 2008 they still made some additional press releases about large new orders, but from 2009 on they only released their reports and nothing else
– they only paid a dividend once (50 cent in 2009). Since then they are accumulating cash.
– data for the company for instance in Bloomberg is not very accurate, 2011 and 2012 numbers are not updated. TheyWon’t show up in many screeners
– it is a French company and sentiment is still bad for France
– they are viewed as an “average” car parts producer

Now it gets interesting: Shareholders

No reliable data in Bloomberg. According to them, French value fund Amiral Gestion owns 2.13%.

According to this research report however, the founder still owns 77%, but Amiral Gestion owns 13%. Leaving a tiny free float of 10%. Amiral in my opinion is one of the better European Value companies and maybe the best in France.

Shareholder activism:

AMIRAL, actually has increased its stake to 13,55%. On the general assembly a few days ago they went kind of activist and demanded a special dividend of 3.75 EUR per share.

As the owner most likely seems to have been present at the AGM, I guess this was voted down, but nevertheless it clearly shows the strategy Amiral is running here. They are in for the long run and will press for some form of payout, be it dividend or share buy back.

In my opinion this is also an interesting kind of “insurance” against any unfriendly behaviour from the CEO and majority owner, as Amiral is not a small fund. With their 13% stake (which is more 56% of the free float) Amiral is automatically committed for the long-term as it will be extremely hard to get out of this stake via the rather illiquid market.

I found this interview with the founder and CEO (in French), where he explains the company and mentions that taking the company private would be worth a consideration….

There is a quite active discussion (in French) on Boursorama about Trilogiq and someone is even claiming that the special dividend was approved, however I am not sure that this is the case.

France / Portfolio concentration

As some readers might recall, I sold my Bouygues stocks when I bought Thermador because I thought that my exposure to France is big enough. With Trilogiq, I don’t have this problem. trilogiq has only 15% of its sales in France and is currently expanding rapidly outside France, especially in the US. So I don’t see an issue here.

Interestingly, french sales haven’t improved much over the past years, the growth came almost exclusively from outside France.

Summary:

In my opinion, Trilogiq is a very interesting company and might even be a true “Hidden champion”. For me it looks more like a consulting company with a physical product than a manufacturer which helps to explain the good margins and 20% ROICs.

There are clear reasons why the company is cheap compared to the quality of the business, especially the negligence of shareholders so far. However, with Amiral having built up a 13% stake, this could improve.

Nevertheless it shares many characteristics I like in a stock:

– founder/owner majority owned
– relatively illiquid and negelected from investors/analysts
– business model not too easy to understand
– negative headline news for home country

In my opinion, the company is worth much more than its current price. Conservatively I think if this would be a German or UK company, People would pay 15x earning plus the cash which would be 25 EUR +5 EUR or 30 EUR per share.

Trilogiq is therefore a clear “buy”. For the portfolio I assume that I was able to build up a position of 20000 shares at 18,27 EUR per share which is roughly 50% of the trading volume since July 1st and represents a 2.3% allocation of the portfolio.

Some links

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Investor letter of a very good value fund: RV Capital including short summaries on all the holdings (among others Tonnellerie, Hornbach, Bechtle, Atoss etc.) as well a thoughts on value investing and technologies and circle of competence.

Always worth watching: Jim Chanos on Bloomberg TV. Looks at companies which do a lot of acquisitions

Interesting special situation analysis on Prime Office REIT AG

Nice NYT article about a 99-year-old investor, Phillipp L. Carret. He was even a broker client of Buffet’s father Howard.

Must read: Detecting accounting fraud in Asia

Potential Level 3 mistake: CIR SpA

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Two months ago I looked briefly at CIR SpA ( or more precisely an analysis on beyondproxy), the Italian holding company which had the following special feature:

CIR carries a €564 million liability that has been booked as “Borrowings”. In reality, this is not borrowed money – it is a legal reserve for an infamous legal proceeding that has been making headlines in Italy for the past twenty years: the so-called ‘Lodo Mondadori’.

At that time the share price was around 95 cents. According to my analysis, the fair value of the shares at a 480 mn settlement would be around 1.12 EUR per share.

I wrote the following:

Although I like the unique aspect of this special situation, the potential upside is NOT attractive enough to justify an investment at current prices.

I will keep this on the radar but I would not invest above ~0.70 EUR. I would need 50% upside in order to justify the risk of the underlying companies which are clearly struggling.

Yesterday, the Italian top court finally decided that Berlusconi has to pay 500 mn.

The CIR stock then jumped to a price of 1.20 EUR,which over this 2 months would have been a nice gain of over 25%.

The question I am asking myself is: Was this a typical level 3 investment mistake, analysing a company but rejecting it and maybe even forthewrong reasons ?

If we compare the CIR share price with the two listed subsidiaries SOGEFI and Espresso, we can clearly se that the CIR share reacted mostly to the ruling, this wa not a fundamental revaluation o the businesses, although Espresso performed similar:

I am especially surprised that based on the stock price reaction, this positive ruling doesn’t seem to have been priced in at all or to a very small extent.

So looking back I think I made 3 mistakes:

– I might have overestimated the efficiency of the Italian stock market. I thought a lot of that would be priced in already.
– I could have “isolated” the special effect maybe with a FTSEMIB short position
– requiring a 50% “margin of safety” for such a short term catalyst was maybe too much

Additionally, I think it is important to look at the special situation as special situation first. It might be a mistake to apply both, my usual value criteria plus the “probabilty” approach to special situations.

A few more thoughts on Rhoen Klinikum

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In my recent post, I had made a very quick analysis how I looked at the news that Rhoen now sells 2/3 of their business to Fresenius in order to sidestep the blocking shareholders.

That was my conclusion:

So for the time being I will not sell the shares and watch what is going to happen. At some point in time, the stub itself coul dbe an interesting situation in itself, as it will most likely drop out of the index etc. Sow I guess I will sell before the extra dividend is actually paid.

Let’s move a step back before that:

Before we knew that Rhoen wanted to sell and Fresenius wanted to buy at around 22,50 EUR (old offer). Initially, before the Fresenius offer, the shares traded at ~15 EUR, which I would define the “undisturbed price” without any control premium. Until last week, the market seems to have valued a rather low probability for the deal going through.

Very simply, the implied probability was around (17,50-15)/(22,50-15) = 1/3 or 33%.

Now a deal seems to be much more likely, but it is unfortunately not as “clean” as the old deal. Instead of getting only cash, one now expects a certain amount of cash plus a remaining “stub”. On the other hand,”all in” the price seems to be even slightly better as the old 22,50 EUR.

So why is the share now trading only at ~19 EUR ?

There are three explanations for this in my opinion:

A) uncertainty the deal is NOT going to happen
B) what will the remaining company (“stub”) be worth ?
C) the effect of the withholding tax on the special dividend

In my opinion, the withholding tax is not very relevant. If I buy now at 19,15 and I pay the withholding tax next year, I can make a “wash sale” (sell at a loss and buy again) to set off the tax. For institutional investors this is no issue anyway.

I am also pretty sure that the likelihood of the deal happening is very high. After the fiasco two years ago, Fresenius and RHoen will have put a lot of effort into this deal. So I would think that there is at least a 90% probability that the deal is happening.

This leaves us with c): People don’t seem to like being stuck with the “stub”. If we look into the Rhoen 6 month report, we can see that on an annual basis, Rhoen earns around 300-310 mn EUR EBITDA. The part which was sold to Fresenius is clearly the currently more profitable part with EBITDA of 250 mn EUR according to the filing.

This leaves the stub with EBITDA of around 50 mn EUR. The “implied” valuation of the stub is around 340 mn EUR EV at the moment, so we are talking about an implied valuation of 6-7x EV/EBITDA which is not much. Rhoen announced that they intend to earn 150 mn EUR EBITDA in 2015 in the remaining company. Even if this is too optimistic, I still think the “stub” is implicitly very attractive as RHoen has a very long history in turning around hospitals.

So all in all, at the current price, the stub looks like a very interesting investment.. The only problem is that I need to invest the full 19 EUR now in order to get expsure to the 5,20 EUR implied valuation of the stub.

In theory, as a professional investor, I could borrow up to 13,80 EUR against the Rhoen shares to lower the amuont of capital I need to commit and increase my Return on Investment. At the moment, as I have a lot of cash anyway, I do not need to borrow.

Expectation management:

Just to make sure, I do not expect that the shares will jump 5 or 6 Euros until the dividend will be paid. One has to think about the stock rather as a 13,80 cash deposit plus a 5,30 EUR stock. There will be very poor “visibility” about the stub in the next few months until the deal is finally settled. So I do expect some price appreciation on the “deposit part” but not that much, rather like an implicit attractive deposit rate as off set for the execution risk or so. My return expectation until mid next year is rather something like +1 EUR with a very limited downside.

Qualitative aspect

What I do like is the fact, that funder, Mastermind and 12% shareholder Eugen Münch has to a large extent the same interests as the “Normal” shareholders. This is different from similar situations where the CEO just wants to get a big golden handshake. I think the adversaries (Braun and especially Asklepios) might even be tempted to take over the “stub” at some point in time before someone else thinks about buying this (then unlevered) turn around case.

Summary:

So instead of waiting and selling, which was my first reaction, I will actually increase my RHoen position to a full position (5%) as I think that the current risk/return relation is not spectacular but still very good and not correlated much to the overall market.

This translates into around 3.6% exposure on a portfolio basis to the cash payament (Risky deposit) and only 1.4% “true” equity exposure to the stub. I will watch this carefully and potentially increase the position up to 2.5% “stub exposure” if prices gow below 19 EUR. For me the “stub” is one of the most interesting special situations at the moment.

Short cuts: Rhoen Klinikum, Hornbach, Vivendi

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Rhoen Klinikum

KABOOM !! After a lot of corporate boardroom chess, Rhoen Klinikum and Fresenius today cam out swinging and announced that Rhoen will sell the mAjority of its business for 3.07 bn EUR to Fresenius.

Among other (and subject to regulatory approvals), Rhoen plan s to:

– pay a 13.80 EUR special dividend (this translates into ~1.9 bn EUR)
– and/or repurchase shares
– they will keep hospitals (mostly university hospitals) with an annual turnover of 1 bn where they expect an EBIDTA margin of ~15% in 2015
– the purchase price is cash, but Rhoen will use part of it to pay back debt
– the purchase price is priced at 12x EV/EBITDA

The stock price jumped initially today to 22 EUR and something but came back to ~ 19.50, giving Rhoen a current EV of around 3.5 bn (Net debt 800 mn)

The “stub” (remaining business) is currently then priced at around 500 mn EV but expected to earn 150 EBITDA in 2015. If we assume a Forward EV/EBITDA of around 6-8x, then a fair value of the current Rhoen shares (pre tax etc.) would be the current 19,50 plus 3,50 to 5 EUR per share or so. Slightly higher than the 22,50 Fresenius was ready to pay two years ago.

So for the time being I will not sell the shares and watch what is going to happen. At some point in time, the stub itself coul dbe an interesting situation in itself, as it will most likely drop out of the index etc. Sow I guess I will sell before the extra dividend is actually paid.

Hornbach

Quite a surprise: Kingfisher representatives, which owns 25% of the holding votes and 5% of the Baumarkt shares are actually leaving the supervisory board and planning to enter the German market.

They seem to target the “professional” market, not the retail sector. Clearly this is also the sector where Hornbach is strongest.

I am not sure how to interpret this. Clearly, it would be better if Praktiker (and MAx Bahr) would just disappear. I do not really understand why Kingfisher wants to enter the German market. Kingfisher is a great company, but in their major markets, UK and France they are number 1 with a clear size advantage. In Germany, they are a small fish and I would claim that the German retail market in general is one of the most brutal markets in teh world. Even WalMart didn’t have a chance here.

I am wondering if somehow now Hornbach enters the French market ? As far as I know, they so far operate some shops along the border which draw a lot of French people because prices are a lot lower in Germany.

Vivendi

Some 18 months ago, I had a quick look at Vivendi because Seth Klarman bought a stake.

Subsequently, he sold out again a large part at a loss. Now however, there seems to come some actual change. French “raider” Bolloré became vice chairman and the company announced the following:

Bowing to investor pressure to overhaul its structure, Vivendi will begin a formal study to separate its French phone unit SFR and assemble the rest of its businesses into a new international media group based in France, it said yesterday. Billionaire shareholder Vincent Bollore will become deputy chairman, as Vivendi ends its search for a new chief executive.

This is quite interesting. Thinking loud, Vodafone with all its Verizon Cash might be interested in the telephone part (after cashing out their minority participation to Vivendi some years ago….).

Nevertheless, I still hesitate to buy Vivendi. 2012 was a very bad year for them. Under my metric the made a loss, increased the share count and have 1 EUR per share more debt despite showing positive free cashflow.

Note to myself: Put Bolloré on my watch list. This guy seems to know what he is doing in France.

A quick look at the Stockopedia Screening tool + Quantitative value investing & Data quality

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It seems that I begin to harvest my successes as an investment blogger. After getting a free book, I now received already for the second time (temporary) free access to a stock screening tool. I wonder what comes next……maybe someone offering me 100 mn EUR to manage ?? 😉

A year and a half ago, I checked Tim Du Toit’s Eurosharelab screener which looked like a fair deal and a good tool

Now I checked the Stockopedia tool. I did only check the screening tool, they offer a lot of other stuff but I am not really interested in that.

From the beginning, I found their tool very easy to use. I don’t know the current status of Eurosharelab, but for me the biggest plus of the stockopedia screener is the fact that one can set up custom screens based on a large number of different variables. I was able to create my custom screens without reading any manuals etc. The navigation is very good, I liked especially the “Bloomberg” like selecting of fields for the queries.

The results are presented very well, it is very easy and convenient to drill down into the stocks or to check the fundamental data. This is even better than in Bloomberg and a big advantage of the fully web based technology. The speed of the queries was OK, could be a little bit faster.

I also liked the existing “Guru” screens, especially the “Screen of Screens” which kind of aggregates all existing screens. (Note: EGIS is the second best stock there after Dart. It looks like that my Boss model is not totally useless…..)-

The list of “in and outs” is interesting, too, where one can see which stocks newly qualified for the top positions and which stocks dropped out. The single stock monitor also looks very comprehensive, with a good data history. Up until now they offer only Europe but including many exotic countries like Bulgaria etc.

All in all it is a very good tool which is a lot of fun to work with. They told me that they would charge normally 499 GBP p.a. but if someone is interested, they would offer a “special rate” of 399 GBP. If I recollect correctly, Eurosharelab had also 3 month access which could be interesting for people who don’t need such a tool permanently.

For small investors, they should consider if the really need this. If you for example have a 50 K GBP portfolio, the 500 GBP full rate would eat up already a full 100 bps of annual returns or depending on what you expect at least 1/10th of your total return if you make on average 10% p.a.

Quantitative investing & Data issues. Example “Magic Sixes”

As I have written many times, I like using screeners as a basis, but I do not think that quantitative value investing, especially in the small cap sector, makes a lot of sense. The major issue is data quality.

In order to test the data quality of the Stockopedia screener, I did the following:

I set up a custom “Magic Sixes” screen (P/E lower than 6, P/B lower than 0.6, Div Yield higher than 6%, Europe) both, in Stockopedia and Bloomberg and compared the results. The results were quite surprising for me. Stockopedia returned 28 stocks, Bloomberg 19 stocks, but only 2 stocks showed up in both lists.

Here you find the results:

Stockopedia Magic Sixes   Bloomberg Magic Sixes  
 
    C21 21ST CENTURY TEC
AIRC Air China    
AURG Aurskog Sparebank    
    BTT BABCOCK-BSH AG
BQRE Banque de la Reunion SA    
BTG4 Bertelsmann SE Co KGaA    
ELMU Budapesti Elektromos Muvek Nyr… ELMU ELMU NYRT
CAT31 Caisse Regionale de Credit Agr…    
CCN Caisse Regionale de Credit Agr…    
6C4 Chimimport AD Sofia    
CICG Cinkarna Celje dd    
CSFG CSF    
CTC Cyprus Trading    
DOM Domstein ASA    
    DIOD DIOD
    MLDYN DYNAFOND SA
    MLEDS EDITIONS SIGNE
ERME Ermes Department Stores    
EMASZ Eszak Magyarorszagi Aramszolga…    
    MLEVE EVERSET
RAM F Ramada Investimentos SGPS SA    
    BSG GERMANIA-EPE AG
HJH H.J. Heinz Co    
HF HF SA    
HGM Highland Gold Mining HGM HIGHLAND GOLD MI
HSPG Holand og Setskog Sparebank    
    INOX INOX
MELG Melhus Sparebank  
    KYTH K KYTHREOTIS HOL
    KDHR KMECKA DRUZBA
    OAB OAB OSNABRUECKER
    PVA PESCANOVA
PVL Plastiques du Val de Loire SA  
    1PL POWERLAND AG
5BU Real Estate Fund Bulgaria ADSI…    
    ALRIC RICHEL SERRES DE
SALB Salling Bank A/S    
    SHFT SHAFT SINKERS HO
SPOG Sparebanken Ost    
PLUG Sparebanken Pluss    
SVEG Sparebanken Vest    
SHL Stademos Hotels    
    SZI1 STOLBERGER TEL
TOTA Totalbanken A/S    
    59X UNIPHARM AD-SOFI

Only Highland Gold Mining and Budapesti Elektromos showed up in both tools. When I digged into the detailed data, I was even more surprised. In total, I had 43 “diverging” entries. From those, 7 stocks were stocks where there were large bid/ask spreads and depending on the price the stock would either have 0.59 as P/B or 0.61 for instance, so this is a pure technical issue.

On the other hand, 20 diverging stocks were clearly mistakes in the data of Stockopedia (either wrong, outdated or missing data) and still 16 stocks were clear data mistakes by Bloomberg.

I emailed a little bit back and forth and it seems that they get their data from Reuters and are working hard on improving data quality. But nevertheless it is for me highly revealing that based on two different data sources, you get 2 almost completely different set of stocks with a few relatively basic filters.

Clearly, the Magic Sixes filter at the moment only throws out micro cap deep value stocks, where data is always an issue, but still, I wouldn’t have expected such a result. Also rankings might help to a certain extent. Nevertheless that mae me highly suspicious of any “automated” Value trading strategies no matter how good they look in backtests.

Summary:

I really liked the Stockopedia tool. If I would not have access to Bloomberg, I would seriously consider their tool . Although I would always use it as a screener only, not as a basis for a trading strategy,

Maybe it is not representative, but my Magic Sixes example clearly shows that data sources alone can have a huge impact how portfolios look like even if you use the exactly same criteria.

If one really digs deep into data like I had to for my boss model, one would detect even more disturbing data issues, but that is a topic for another post.

DISCLOSURE: I got free access to the tool but I do NOT get any referal fees etc.

Book review: Renditenperlen aus dem Scherbenhaufen

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Disclosure: One of the authors did send my a copy for free.

This (German language) book is a very unique book. It only deals with so-called Hybrid bank capital which clearly could be called a “distressed asset class”. Hybrid bank capital before the financial crisis was a “win-win-win”: Banks liked it because they could replace expensive equity capital and buy back shares. Regulators gave happily credit for it because the banks told them that if there would be trouble, those instruments would behave as equity. Investors were happy, because the banks told them that if there is trouble, the bonds will always pay because they were bonds.

Well, after the financial crisis, it was suddenly “loose-loose-loose”: The banks did not get equity credit anymore, the regulators were pissed of and a lot of bond investors were suddenly owning very equity like investments.

“Renditperlen aus dem Scherbenhaufen” is a collection of case studies about a couple of those hybrid bonds which traded at very attractive levels at various points in times. The special thing about this book is that it is written by individual investors which are active on at least one of the many German internet message boards. Nevertheless (or because of this ?), the case studies are better quality than anything you will ever read in analyst reports, newspapers etc.

There is a lot of extremely valuable knowledge in the book plus a lot of background about the capital structure of banks. When the book was released, some of the case studies were still “active” and generated very attractive outcomes since then.

For beginners, it is maybe a little bit too detailed, but for investors which like to increase their circle of competence, it is a must read in my opinion. Also for anyone wanting to buy a banking stock, this book will give a lot of insight how the balance sheet of a bank works. The only drawback is that it is only available in German.

Edit: The autors asked me to set a direct link to Amazon. As I do almost anything for a free book, here it is:

Paperback
Kindle

And no, I don’t get any money if you click the link and buy….

Correcting research mistakes: Pharmstandard – SELL

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A few days ago, I introduced Pharmstandard as a potential special situation with a catalyst in the form of a buy out offer.

Thanks to the input of a few commentators, I recognized that I got one very important detail wrong:

The record date for the potential 16,50 USD offer was already on July 5th, so a few days before they announced this offer. Anyone buying now will not be able to tender the shares. Interestingly, this information was nowhere to be found in the English language section of the official releases.

This of course wipes out the most significant part of the investment case at the current stage and explains the relatively low price.

As a consequence, I will therefore sell my 1% position as of today and watch the developement from the sideline. Maybe there will be another potentially interesting entry after they spin of the OTC drug unit.

In general, I think it is quite important to act quickly if a significant part of a stock analysis turns out to be wrong. It would be even better to identify this beforehand, but that is one of the drawbacks of not having an awful lot of time to analyze. In those cases it is even more important to start a position small in order to lower the risk of things turning out like they did here.

I think it is also a good example for extending the “Circle of Competence”: In this case I have learnt that you should not rely only on the English language announcements of a Russian company….

Anyway, thanks to all the commentators for their helpful comments !!! This is what makes blogging so much fun

Performance review August 2013 – Comment: “Circle of Competence”

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Performance

The portfolio lost -0.6% in August, compared with -1.1% in the BM (50% Eurostoxx, 30% Dax, 20% MDAX). YTD the portfolio is up 21.4% against 12.5% for the benchmark.

The major driver was of course the 25% cash allocation in a down month, the single stocks were all within low single digit perfomance in either direction, so nothing special here.

Portfolio transactions

August was a rather active month with 4 relevant transaction:

1. AS Creation was sold out
2. MIKO came in as new “Core Value” investment (half position)
3. A 1% position in Pharmstandard as potential special situation was established
4. In parallel, I am building up a position in a yet undisclosed French company where I did not yet manage to write a post but I include it “anonymously” in the portfolio

Portfolio as of August 31st 2013

Name Weight Perf. Incl. Div
CORE VALUE    
Hornbach Baumarkt 4.0% 5.0%
Miko 2.6% 2.6%
Tonnellerie Frere Paris 5.7% 82.6%
Vetropack 4.0% 6.8%
Installux 2.6% 14.2%
Poujoulat 0.9% 11.4%
Cranswick 5.4% 33.0%
April SA 4.1% 34.7%
SOL Spa 2.8% 42.3%
Gronlandsbanken 1.9% 12.3%
G. Perrier 3.6% 37.8%
IGE & XAO 2.1% 10.6%
EGIS 2.6% 2.5%
Thermador 2.6% 3.0%
Not yet disclosed 0.6% -1.9%
     
OPPORTUNITY    
KAS Bank NV 4.9% 37.0%
SIAS 5.1% 49.6%
Drägerwerk Genüsse D 8.5% 168.9%
DEPFA LT2 2015 2.6% 61.4%
HT1 Funding 4.2% 48.3%
EMAK SPA 4.8% 53.3%
Rhoen Klinikum 2.3% 17.0%
Pharmstandard 1.1% -0.6%
     
     
Short: Prada -1.0% -20.7%
     
Short Lyxor Cac40 -1.1% -13.0%
Short Ishares FTSE MIB -1.9% -11.5%
     
Short CHF EUR 0.2% 6.9%
     
Cash 24.8%  
     
     
     
Core Value 45.5%  
Opportunity 33.6%  
Short+ Hedges -3.8%  
Cash 24.8%  
  100.0%

Comment: Circle of Competence

For most value investors, Warren Buffet’s concept of “Circle of Competence” is a very important guideline.

Here is a video of the Oracle himself explaining the concept.

Most famously, he avoided the Dotcom bubble by staying within his circle of competence and not investing in tech companies. Many people therefore take this advice as granted and tend to stay in an area which they know best, like German small caps etc.

However I have a serious problem with this concept or at least with the interpretation of it.

First of all, in reality, each of us is born without any circle of competence with regard to investments. So whatever you consider as your CoC now, has been outside your initial CoC. So at one point in time one had to step out this “zero CoC” to build up any kind of competence.

It is also funny to listen to Warren Buffet explaining this concept. His CoC is HUGE. Clearly, his most well-known investments are Coca Cola, Gilette etc. But if your really follow his investment career, you can clearly see that he continuously expanded his circle of competence..

I mean he started with delivering newspapers and putting pinball machines into Barber shops, but then over his career he almost did everything. Starting with buying department stores, newspapers, he invested in commodities (Silver) Chinese companies, Israeli companies, sold CDS, S&P 500 puts, bought reinsurance companies, provided LBO financing etc. etc.

Expanding one’s CoC however only works if you step outside your CoC a least a little bit at one point in time. Clearly, jumping blindly without any knowledge for instance into US listed Chinese stocks normally does not end well.

I think the best way to expand one’s circle of competence is along the following dimensions:

a) Geographically
So if one has a lot of knowledge in one sector like for instance car manufacturers, it is not that difficult to look at those companies in other countries in order to gain experience. Due to the fact that many companies today are very international, this kind of knowledge in my opinion is extremely important anyway. Just looking at the 3 German car manufacturers for instance is a quite useless task. Usually it is easier to look at “familiar” countries first before going to more exotic places. In that way it is easier to learn about specific issues in other countries if you know the sector well.

b) Sector wise
Similar to geographically, it is also relatively easy to move from a sector one knows well to a sector which is in some way connected. So if you are strong in chemicals, to their direct suppliers (Oil companies) or customers should be easier if not necessary. If you know a lot about consumer staples, retailers would be logical next step etc. etc. For me for instance, it was much easier to understand IGE & XAO, the Electro Cad software company after I had analysed what their client G. Perrier is actually doing

c) Along the capital structure
A more unusual way to expand one’s circle of competence is along the capital structure of a company. Usually many people buy stocks and then maybe some bonds. However if you want to more systematically improve your knowledge, start with a company with a more complicated capital structure, including, bonds, loans, Hybrid debt, convertibles and work your way thorough. You will be rewarded with a much better understanding how the financial side of a company works and you might dicover some interesting opportunities along the way.

There are clealry many ways to expand one’s circle of competence, but the three mentioned have worked quite well for me. I think it is important to move in relatively small steps and be patient. Whenever you step out, you will most likely experience a set back, but one should consider this as an investment.

So to sum it up: Don’t let you fool you by Uncle Warren. If he would have stayed with delivering newspapers and putting pinball machines into Barber shops, he most likely would not be one of the richest people of the world. Only if you expand your circle of competence continuously, you will reap the reward over time. However make sure not to jump too far…..

Pharmstandard (US7171402065) – The Russian Job or interesting special situation with catalyst ?

Posted on by 16 comments

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.

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