I had briefly covered deeply discounted rights issue as a potential “special situation” opportunity a couple of weeks ago.
Now, with KPN, we have an interesting non-financial candidate. This is what KPN issued today:
Dutch telecoms group KPN confirmed a €4bn rights issue to shore up its capital position after heavy expenses on bandwidth that have led to dividend cuts and lower profit margins.
The company announced the move along with its 2012 annual results, which showed a 3.5 per cent drop in revenues and a 12 per cent fall in earnings from the year before.
As one might expect, the stock tanked some 16% or so. Currently, at around 3.45 EUR per share, KPN has a market Cap of only 5 bn EUR, so raising 4 bn via a rights issue might require a large discount on potential new shares.
The “wild card” in this game will be Mexican Billionaire Carlos Slim who owns currently 27.5% of the company. If he fully participates as lead investor and even taking up more than his share, then the “forced selling” aspect might not be too relevant.
If for some reason, he would refuse to participate, the situation will become very interesting.
Just for fun, let’s look how the performance was for Unicredit. I would distinguish the following events / time periods:
– 4 weeks before announcement
– announcement day
– period between announcement and price setting (for new shares)
– price setting day
– period between price setting and start trading of subscription rights
– trading period
– 4 weeks after end of trading period
First the relevant dates:
Unicredit
Announcement first trade date
14.11.2011
Price setting of rights issue
04.01.2012
First trade date subscr. rights
09.01.2012
Subscription trading until
01.02.2012
Discount
43%
New share
2 new for 1 old
Now the relative performance:
Performance
UCG
MIB
Relative
– 4 weeks before announcement
-18.35%
-4.98%
-13.37%
– Date of announcement
-6.18%
-1.99%
-4.19%
– announcement until price setting
-14.40%
2.95%
-17.35%
– day of price setting
-17.27%
-3.65%
-13.62%
– price setting to start trading
-26.46%
-4.45%
-22.01%
– trading period
73.75%
12.94%
60.81%
– 4 weeks after trading period
0.05%
2.82%
-2.77%
– 6 months after trading period
-32.25%
-11.39%
-20.86%
– 12 months after trading period
12.53%
9.53%
3.00%
In the Unicredit example, clearly the period where the subscription rights were traded showed the best relative performance of the shares. Interestingly, on the announcement day, the price drop was much less in percentage points than KPN. This might have to do with the short selling ban which was in place (at least to my knowledge) when Unicredit announced the rights issue.
Again for fun, a quick look at Banco Popular’s rights issue from the end of last year.
Again the dates first:
POP
Announcement first trade date
01.10.2012
Price setting of rights issue
10.11.2012
First trade date subscr. rights
14.11.2012
Subscription trading until
28.11.2012
New share
3 new for 1 old
and then relative performance to the IBEX:
Performance
POP
IBEX
Relative
– 4 weeks before announcement
-3.95%
5.11%
-9.06%
– Date of announcement
-6.17%
0.98%
-7.15%
– announcement until price setting
-29.95%
-1.71%
-28.24%
– day of price setting
4.56%
-0.90%
5.46%
– price setting to start trading
-8.86%
1.39%
-10.25%
– trading period
8.12%
2.16%
5.96%
– 4 weeks after trading period
-6.71%
3.74%
-10.45%
One can see a similar pattern first, with the stock losing 4 weeks before announcement, as well as on the announcement date until the final price setting. However of the date of price setting, the stock jumped, until loosing only a little bit until starting of the trading period.
Then however, the gains within this period were relatively low compared to Unicredit. Overall it looks a lot less volatile than Unicredit, so maybe less forced selling here.
Back to KPN:
Other than Unicredit and Banco Popular, KPN had outperformed the AEX almost +11% in the last 4 weeks, so today’s large drop might compensate for this (unjustified) outperformance.
If the other two stocks are any guide, one could still expect lower prices until the price for the new shares will be set.
The stock price of KPN look really really ugly long term:
But make no mistake, any company which needs to go into deeply discounted rights issues is in trouble. This is “distressed” territory.
I started my small 2013 utilites project with E.On 2 weeks ago. Instead of working through the list of German utilities I wanted to focus on Swiss listed Energiedienst Holding AG first.
Energiedienst is a slightly unusual stock. It is listed on the Swiss stock exchange, but its balance sheet is in EUR. The company basically runs a number of big Hydro power plants along the Rhine River plus some smaller Hydro Power plants in Southern Germany and Switzerland as this map shows:
From a simple valuation point of view, Energiedienst does not look overly attractive, however one should mention that they do have net cash which is quite uncommon for utilities.
The company is majority owned by German ENBW (67%) plus a company called “Services Industriels de Genève (SIG)” which bought a 15% stake in 2011 from ENBW (remark: ENBW itself is in quite big trouble because of the Nuclear exit in Germany).
Business model
In addition to the Hydro plants, Energiedienst owns a distribution network with around 750 tsd clients in Switzerland and Southwestern Germany. The focus is clearly Germany with more than 80% of sales there. Energiedienst produces around 25% of its energy itself, the rest is bought in the market.
The interesting point is that their own electricity production is almost 100% Hydro power. Hydro power, in contrast to power from fossil fuel, is more or less a pure fixed cost business. You build the hydro plant, depreciate and that’s it. If electricity prices go up, you earn more, if they go down you earn less. You don’t have to worry about oil or coal prices. On the flip side, hydro power depends on the amount of water available, so in dry years you can produce less or more in wet years which introduces some uncertainty.
But in any case, a Hydro Power “pure play” is more or less a “bet” on electricity prices. In order to check this theory, I let’s look at EDHN’s share price (in EUR) against 1 year forward prices for German electricity (as a comparison, I plotted E.on as well):
I find it fascinating that over the past 2.5 years, Energiedienst more or less directly followed German power prices. We can see that E.on is much more volatile and most likely exposed to general stock market fluctuations.
Just for the complete picture a history of German wholesale electricity prices since 2007:
It is interesting to see that German power prices seem to be at the lowest level since the beginning of this time series in 2007. After the surprise phase out of nuclear power after Fukushima and the corresponding propaganda from E.on & Co, one might have expected exploding electricity prices. But it looks like that the new supply of alternative energy plus maybe reduction in consumption led to a dramatic decrease in electricity prices.
Digging deeper, I found for instance this German publication from 2011 which confirms the point, that the subsidized renewable energy will lower electricity prices in general. So for a renewable hydro player like Energiedienst, the subsidies to solar and wind have the “perverse” effect of lowering the profit of this very cheap type of electricity significantly.
The “trick” is that the electricity distributors have to buy the renewable electricity at fixed subsidized prices, but have to sell it at current market prices into the German electricity exchanges. The difference then gets charged to consumers. According to the paper, the electricity price clears at the level of the most expensive supplier. The mechanism for the renewable providers however introduces practically a big source of potentially extremely cheap electricity as it gets sold at market prices no matter how low they might be and “unelastic” to the actual demand.
Due to the low interest rates, subsidized wind parks and solar plants are still attractive investments despite the price for electricity being at multi year lows and demand being rather weak.
So the low prices are not a result of low demand, but mostly of subsidized renewable energy which will be sold as long as the price is higher than zero.
Zero hedge just had a post in its usual style, claiming that the falling energy prices are a harbinger for falling stock prices. That is correct for utilities but other than that it is just a result of the mechanism described above.
Summary:
The current system for renewable energy in Germany (selling renewable electricity into the market at any price with the consumer paying the difference) is hell for “traditional” utilities including hydro power.
The German utilities have maybe underestimated the extent of renewable production, otherwise they could have done the exactly same thing themselves. Now howver, the are in a kind of “death grip” between having to run their expensive black coal and gas plants for peaks and the articificially low electricity prices. Combined with unfavourable natural gas delivery contracts, especially for E.on the air will remain quite thin.
So unless something changes significantly, German utilities (including Energiedienst) will need a long long time to adjust capacity and change their business models.
Warren Buffet seems to be much more clever: If you can’t beat them, join them. I think this is the reason why his US utility is investing so much into Solar and Wind.
To be honest, I don’t think that the current portfolio has an equal upside potential like in the beginning of last year, mostly due to the lack of really interesting special situation investments. For instance, the upside of athe Draeger Genußschein was much higher when it trades at~2.5 times the pref shares than the current 4.5 times.
Well, I was obviously very wrong on that one. The portfolio gained gained 8.6% in January, the largest single month gain in the 25 months of the portfolio’s history. The Draegerwerke Genußschein alone gained 25%, other top performers were Tonnelerie (+19%), KAS Bank (+17%) and Dart & Cranswick 15% despite the strong Euro.
The outperformance again the Benchmark (4.9% outperformance) can be almost fully explained by the typical January small cap effect which has been covered quite well by Mebane Faber. The German small cap index SDAX for example gained 10% in January.
Portfolio as of January 31st
Name
Weight
Perf. Incl. Div
Hornbach Baumarkt
4.3%
9.5%
AS Creation Tapeten
4.0%
29.0%
WMF VZ
3.5%
57.0%
Tonnellerie Frere Paris
5.4%
56.2%
Vetropack
4.4%
4.6%
Total Produce
5.8%
55.9%
Installux
2.9%
6.7%
Poujoulat
0.9%
6.4%
Dart Group
3.8%
100.7%
Cranswick
5.1%
12.9%
April SA
3.4%
39.0%
SOL Spa
2.4%
6.8%
Gronlandsbanken
1.1%
24.4%
KAS Bank NV
5.1%
27.5%
BUZZI UNICEM SPA-RSP
5.2%
18.9%
SIAS
6.1%
59.5%
Bouygues
2.7%
8.7%
Drägerwerk Genüsse D
10.6%
142.9%
IVG Wandler
4.5%
13.7%
DEPFA LT2 2015
2.8%
56.6%
HT1 Funding
4.6%
44.9%
EMAK SPA
4.2%
23.1%
Rhoen Klinikum
2.2%
3.0%
Short: Focus Media Group
-0.9%
-2.7%
Short: Prada
-1.0%
-10.8%
Short Lyxor Cac40
-1.2%
-8.5%
Short Ishares FTSE MIB
-2.2%
-13.7%
Terminverkauf CHF EUR
0.3%
7.4%
Tagesgeldkonto 2%
10.0%
Value
47.0%
Opportunity
48.1%
Short+ Hedges
-5.1%
Cash
10.0%
100.0%
The only change to year-end is Sol Spa which was bought in the beginning of January. Cash is now exactly at my target level of 10%. that means any addition will trigger automatically a sale of another position.
He mentions one of the cardinal sins in current markets:
I’m writing this, of course, to focus myself. One of the hardest things to do is…. to do nothing. The instinctive reaction to a rising market is to pile on, add shares, up your leverage. But really that’s the absolute worst thing you can do. Don’t kid yourself.
Clearly, jumping into the market because you missed out the rally, especially in risky “high beta” stocks will most likely end in tears.
However another potentially big mistake should also not be underestimated: Taking profits too early. Most investors (including myself) get nervous if their stocks climb quickly 20-30%. What you then often hear is something like “It never hurts taking a profit” or “No one ever got bankrupt by taking a profit” or something similar.
The truth is: In order to generate above average returns, taking profits too early hurts badly. Statistically, the vast majority of investment ideas will be rather average, some will be bad, but some of them and usually only a small amount will be really really succesful.
If I look at my portfolio, most the outperfomance of ~23% over the last 25 months can be attributed to only a few positions especially Draegerwerk, Aire KgAa, Dart Group which have all doubled.
In all cases, it was and is always tempting to sell out and “take the profit” quickly. For Draegerwerk and Aire, I started selling too early, however I was lucky to start only with small amounts. Looking back over my 25 year investment “carreer”, I made many mistakes. However the most costly ones in the end were selling companies like Fuchs, Rational or Fielmann much to early.
Fuchs AG Vz. for example was one of the stocks I bought during the 2008/2009 around 12 EUR (adjusted for the split) and happily took the profit end of 2009 at 20 EUR, feeling like an investment genius. However, with the stock now at 58 EUR (plus a few Euros dividends in between), it looks pretty stupid. I knew that Fuchs was an outstanding company. Even worse, if I would have kept those shares the gains would have been tax free as they would have not been subject to the “Abgeltungssteuer” introduced in January 2009.
So looking back, “taking the profit” on a share like Fuchs (much) too early was maybe one of the biggest and most expensive mistakes in my investment career.
If we simply look at very basic profitability numbers, we can see that the numbers look almost too good to be true:
ROE
NI margin
Net debt per share
31.12.2002
27.1%
2.8%
-1.46
31.12.2003
28.5%
3.1%
-2.28
31.12.2004
34.5%
4.0%
-4.74
30.12.2005
38.0%
4.6%
-5.92
29.12.2006
39.1%
4.8%
-7.33
31.12.2007
35.3%
4.8%
-4.09
31.12.2008
24.3%
3.8%
-4.44
31.12.2009
13.3%
2.9%
-5.15
31.12.2010
16.7%
3.6%
-6.98
30.12.2011
21.2%
3.9%
-10.39
avg
27.8%
3.8%
The 10 years from 2002-2011 is a full cycle with boom and bust years, so achieving on average an ROE of 28% with a financially unlevered balance sheet is outstanding.
How do they do it ? The answer is (of course) effective capital management. I have used Bloomberg data for this but if we look at the last 6 years we can see that their capital management is really outstanding:
FY 2011
FY 2010
FY 2009
FY 2008
FY 2007
FY 2006
Goodwill
45.34
40.75
36.6
37.11
33.64
17.31
PPE
17.8
16.39
13.96
14.39
12.02
9.59
Inventory
21.74
20.8
24.23
24.14
21.17
7.95
Receivables
82.11
74.41
57
80.9
91.2
82.5
Prepayed expense
27.06
25.37
23.36
24.85
23.24
44.49
Accounts payable
96.9
81.88
70.95
93.26
92.58
80.06
Net Working capital
34.01
38.7
33.64
36.63
43.03
54.88
Revenue
583.91
443.06
395.84
499.62
482.97
424.98
Net income
22.68
15.83
11.51
18.9
23.19
20.2
PPE in % of sales
3.0%
3.7%
3.5%
2.9%
2.5%
2.3%
Net Working capital in % of sales
5.8%
8.7%
8.5%
7.3%
8.9%
12.9%
PPE+Net WC in % of sales
8.9%
12.4%
12.0%
10.2%
11.4%
15.2%
Running a business with only ~9% of “operating” net assets compared to sales is something you don’t see very often.
Let’s have a quick look at Kaufman & Broad, another French listed home and appartment builder:
FY 2011
FY 2010
FY 2009
FY 2008
FY 2007
FY 2006
Goodwill + int
151.52
150.82
150.5
149.71
149.81
69.96
PPE
5.88
5.99
5.93
7.27
9.47
8.87
Inventory
235.56
246.15
295.74
519.52
595.46
513.2
Receivables
305.67
203.33
203.77
296.26
405.7
309.13
Prepayed expense
141.26
159.48
139.43
158.64
147.39
122.14
Accounts payable
409.67
377.29
398.79
552.65
620.98
535.91
Net Working capital
272.82
231.67
240.15
421.77
527.57
408.56
Revenue
1,044.26
935.70
934.91
1,165.11
1,382.57
1,282.83
Net income
0
0
0
0
0
0
PPE in % of sales
0.6%
0.6%
0.6%
0.6%
0.7%
0.7%
Net Working capital in % of sales
26.1%
24.8%
25.7%
36.2%
38.2%
31.8%
PPE+Net WC in % of sales
26.7%
25.4%
26.3%
36.8%
38.8%
32.5%
Interestingly, Kaufman & Broad improved their capital management as well but they still need 3 times the operating net assets to generate roughly the same returns.
This of course shows in Profitability:
ROE
NI margin
Net debt per share
31.12.2002
21.4%
4.4%
5.90
31.12.2003
20.8%
4.5%
2.55
31.12.2004
20.1%
4.7%
3.46
30.12.2005
28.7%
5.9%
3.79
29.12.2006
33.5%
6.6%
4.64
31.12.2007
31.8%
6.1%
16.74
31.12.2008
4.6%
0.7%
19.90
31.12.2009
-31.1%
-3.2%
12.46
31.12.2010
19.4%
1.9%
9.92
30.12.2011
37.7%
4.5%
7.69
avg
18.7%
3.6%
Despite a significant leverage, ROE are lower on average and due to the leverage much more volatile.
Maybe this is one of the reasons why Maisons has outperformed larger Kaufman by a wide margin over the last 10 years.
Just for fun, let’s also look at Helma AG, a small homebuilder in the currently booming German market:
FY 2011
FY 2010
FY 2009
FY 2008
FY 2007
Goodwill + int
2.21
2.19
1.85
1.63
1.51
PPE
16.31
14.57
14.89
15.48
13.79
Inventory
19.83
8.63
5.61
5.8
6.67
Receivables
10.59
6.33
4.27
3.47
2.92
Prepayed expense
8.85
5.76
3.11
2.98
2.72
Accounts payable
5.85
5.02
0.76
0.79
4.72
Net Working capital
33.42
15.7
12.23
11.46
7.59
Revenue
139.50
118.50
106.68
103.59
74.54
Net income
5.2
3.4
2.36
2.31
1.3
PPE in % of sales
11.7%
12.3%
14.0%
14.9%
18.5%
Net Working capital in % of sales
24.0%
13.2%
11.5%
11.1%
10.2%
PPE+Net WC in % of sales
35.6%
25.5%
25.4%
26.0%
28.7%
Interestingly, the operate roughly at the level at Kaufmann & Broad but nowhere near MFC’s level. Helma by the way actually seems to have jumped into property developement which might explain the increase in operating assets.
So compared to two other homebuilders, the business model of Maisons France looks extremely “lean” from a capital management point of view. The big question of course is why are they so much better ?
I think the big “trick” was already mentioned in the Ennismore summary from last week’s post:
Unlike many other markets, in France there is virtually no development risk for the company because land is purchased separately by the customer and the house will only be built once it is fully financed.
In their annual report, there is a hint how they operate:
Under Note 4.8 (receivables) we find the interesting information, that the receivables amount on their balance sheet is a net amount. So the roughly 80 mn receivables translate into 320 mn gross receivables against which they show something like 250 mn prepayments.
Those prepayments, which they seem able to get are basically an interest free float which explains in my opinion the superior ROE and ROIC metrics compared to the other builders.
Summary:
From a pure capital management perspective, Maisons France Confort seems to have a very good business model. they seem to generate a lot of interest rate free “float” which greatly reduces the required amount of net operating assets.
I am not sure if currently is the right time to invest as the stock has run up quite fast and french housing might be slow this year, but is definitely a very interesting company.
The big quesiton is: Is such a business sustainable without an obvious “moat” ? In my opinon yes, because creating such a business model is not something you can do from scratch. 3-5% margins are not overly attractive for many competitors. Howevr, in any case some deeper research into to this will be necessary anyway before a final investment.
The weekend is always a good time to step away from the “micro level” i.e. single stocks to more general considerations.
More recently, if find myself more and more analysing French stockss, as they seem to be technically still quite cheap. In my portfolio, the weight of my French stocks Bouygues, Tonnelerie, Installux, April, Poujoulat is around 15% and growing.
On the other hand if you read especially “Anglo Saxon” media, it seems to be clear that France is in deep trouble.
The economist article greatly summarizes the overall view on the German economy of that time:
But it is now coming under pressure as never before. As economic growth stalls yet again, the country is being branded the sick man (or even the Japan) of Europe.
The reason was clear: A socialist Government and suspicious company bosses:
The red-green coalition government led by Gerhard Schröder since last October has “encouraged the suspicions of a corporate sector predisposed to fear the worst,” says Alison Cottrell, chief international economist at PaineWebber in London. The dark picture painted by Hans Eichel, Mr Lafontaine’s replacement, to justify fiscal belt-tightening has further unsettled industrial bosses. And a lack of corporate confidence has been one of the main factors that has kept unemployment so high.
The 1999 article mentions all the “standard” prerequisites for a better future like lowering corporate taxes, increasing flexibility but finishes with a quite bleak outlook:
It is, perhaps, not surprising that market-friendly politicians, including one or two in the government, now complain of Germany being a blockierte Gesellschaft (blocked society). Unblocking it will take determination. Without that, Germany is unlikely soon to shed its title as the sick man of Europe.
So what happened in between, how did the sick man of Europe become the (temporary) growth engine ?
Let’s look at Corporate taxes for instance:
It is interesting to see that the biggest drop in corporate tax rates actually happened in the 1998-2005 period where Gerhard Schroeder led a Social Democratic/Green government.
In my personal opinion, a combination of several factors has at least contributed to the change in fortune of Germany at least so far:
– lower tax rates on corporation which stimulated investment in Germany
– Hartz IV which “motivated” people to go back to work quicker when they lost a job
– increased labour flexibility (“Kurzarbeit”, etc.
– a generally cooperative climate between trade unions and employers with modest salary increases and more one time awards
– privatisation of major Government companies such as Deutsche Post, Deutsche Telekom etc.
A second set of developments which in my opinion is not so prominent but were nevertheless equally important:
The end of the “Deutschland AG” which was the description for the fact that almost all German companies were owned locally and/or by each other. Management of German companies did not have a lot of pressure because each manager sat on the board of several other companies. In the center of The Deutschland AG were the big financial institutions such as Deutsch Bank, Muenchener Rück, Commerzbank and Allianz.
The end of the “Deutschland AG” was driven in my opinion by 3 major developments:
– the removal of taxes on investment gains for corporations in 2002
– the problems of the large German financial institutions after the 2002/2003 crash which forced them to sell their shareholdings
– finally the Euro. Before the Euro, German Insurers for instance had to invest 95% of their investments in Deutschmark. So basically if they had to invest in German shares because there was no alternative. After that, the 5% restriction changed to “non Euro”, so suddenly german insurers could diversify their portfolios into the Eurozone.
Although there will always be a special relationship between companies in one country, one can say that the old “Deutschland AG” does not exist any more. One of the big examples for instance was the take over of Hochtief, the German construction company by ACS from Spain. 15 years ago, something like this would never had happened. Deutsch Bank or someone else would have organized a defense.
From the German example we know now that a title story in the economist might not be the best indicator for the future of a country. In the cae of France is see a few similarities to Germany in the end of the 90ties:
Without being an expert in French politics, however from my outside view this looks like a brilliant political move from Hollande. He gives his leftwing voters something directly and spectacular to calm them down. I would assume that a guy like Bernard arnault is not paying that much taxes in France anyway, so it doesn’t really hurt seeing him leaving.
But as history shows, at least in continental Europe, real labour reforms are mostly implemented by Socialist Governments, liberal or conservative ones. As always, the comment says that this is not enough:
Still, this is no Reagan (or even Schröder) Revolution. The unions will preserve counterproductive worker protections and welfare guarantees. The deal includes expanded privileges for union reps within companies and more reserved seats on company boards.
However, you have to start somewhere and together with his “U turn” in corporate taxation, this is a significant green shoot in my humble opinion.
Last but not least I see two other interesting factors at work which might point to a better future for France:
From a demographic standpoint, France and Germany are thus in radically different situations. While France has maintained a satisfactory fertility rate, almost sufficient to ensure the long-term stability of the population, Germany’s low birth rate will lead to a substantial and rapid decline in the total population and to much more pronounced ageing than in France (Figures 3 and 4).
At some not so very distant point in the future, there will be more Frenchies than Germans:
So yes, France has definitely a problem with youth unemployment, but part of the problem is that they actually do have a lot of young people which Germany does not have any more.
Africa
I am not able to comment on Mali or any other political issue here. But if at some point in time Africa will catch up with the rest of the world, French companies will benefit most due to their historical relationship etc.
Summary:
It is clear that France at the moment does not look like the future growth machine of Europe but neither was germany end of the 90ties. However I see a good chance that France finally gets it act together and implements the required reforms. If that happens, France could experience a somehow similar trajectory like germany over the last 10-15 years.
From an investment point of view, this might be one of the most interesting “secular” opportunities going forward despite (or because of) the very negative headline news. From a micro level, I find a lot more well managed, unlevered companies in France than in all the PIIGS countires combined.
From a portfolio point of view, I will accept a quite significant weighting of French stocks if I find additional interesting french companies. I could imagine having up to 30-50% of french stocks in my portfolio going forward.
But make no mistake, this will be a long journey and superior investment returns on French stocks might require more then 1 or 2 years to materialise.
And finally to make this a little bit funnier, the Monty Python take on the epic battle between the English and the French:
Rallye SA, France is the holding company for 49.97% of Casino Guichard, one of the big French retail chains.
In their annual report they present the company as follows:
Their major assets are:
– 49.93% of Casino Guichard Perrachon SA (ISIN FR0000125585)shares (61.24% of voting rights)
– 72.86% of Groupe Go Sport SA (ISIN FR0000072456)(78.73% of voting rights), another small listed French company
– “investment portfolio”.
There is some qualitative description of the “investment portfolio” on page 19 of the report, it seems to be a quite divers collection of participations and real estate.
Rallye’s investment portfolio was valued at €365 million as of December 31, 2011, compared to €435 million as of December 31,
2010. At the end of 2011, the portfolio consisted of financial investments with a market value(1) of €272 million (vs. €295 million
at end-2010) and real estate developments measured at historical cost(2) of €93 million (vs. €140 million at the end of 2010).
Net external debt stands at 3 bn as of year end 2011. Other than that i did not see major positions.
The trickiest part of Rallye’s balance sheet is the 2.5 bn EUR receivables position the show in their single entity balance sheet.^2.3 bn of that seem to be receivables against Group companies:
The current account advances made by Rallye to its subsidiaries are part of the Group’s centralized cash management system. They are
due within one year.
The point I am struggling with most is the following:
If those receivables are against Casino, then one would add those assets for the Rallye evaluation. If those receivables are against their various subholdings which also hold Casino shares, then one would need to fully eliminate them.
I have quickly checked the 2011 Casino annual report, but didn’t find any liability against Rally SA. So we should assume that those internal Rallye receivables are a technical position which is financing the Casino stack and should therefore not be counted extra. Only the “external” part (~200 mn) should be used).
So with that assumption we can now calculate the “sum of part” or intrinsic value of the Rallye SA share:
EUR mn
Casino Guichard (50%)
4,112.3
Group Go
34.8
Investment Portfolio
365.0
Receivables, other assets
220.0
Sum assets
4,732.1
Debt
-3,000.0
Other liabilites
-110.0
Net Assets at market
1,622.1
Number of shares
47.2
Value per share
34.37
Current market price:
25.80
“Discount”
24.9%
Overall, a 25% “discount” seems to be quite normal for such a slightly in transparent structure including extra financial debt. However if one thinks Casino is a great investment, then investing through Rallye might be a good idea:
Casino Guichard itself is not uninteresting. Although it is not cheap, they are growing pretty strongly. Especially interesting is the fact that 60% or more of their sales are now in LatAm (Brazil and Colombia), two markets which seem to be the most interesting retail markets at the moment.
On the other hand, I am not a big expert on retail chains, so from that point of view I will not analyze Rally/Casino further.
Summary:
If my assumptions are correct, the current “discount” of Rallye vs. its sum-of-parts as a holding of 50% Casino Guichard is only 25%. Considering the extra leverage and the lack of visibility, it does not look greatly undervalued.
The stock price directly crashed some 60% to 6 EUR (IPO price 15,50 EUR):
In some follow up news, the company reported that sales might have been inflated and the financial position might not be as good as stated in the IPO prospectus.
As a value investor, one wouldn’t invest in IPOs anyway.
The Hess AG IPO was priced at levels which one could only assume as “optimistic”, with a trailing P/E ratio of ~50. The price was justified with the supposed “growth” the company was showing in the past and the “story” of the “LED” based business model.
As usual, all parties involved in the IPO (Banks: Landesbank BaWü, Kempen, MM Warburg) will claim that they knew nothing and that you cannot protect against fraudulent management.
The auditors of course will claim the same, in the IPO prospectus they stated explicitly (in German) the follow:
Nicht Gegenstand unseres Auftrags ist die Pr¨ufung der Ausgangszahlen, einschließlich ihrer Anpassung an die Rechnungslegungsgrunds¨atze, Ausweis-,
Bilanzierungs- und Bewertungsmethoden der Gesellschaft sowie der in den Pro-Forma-Erl¨auterungen dargestellten Pro-Forma-Annahmen.
This says they explicitly didn’t check the underlying figures.
The big question of course is: Were there any red flags in the presented numbers ?
How do you “fake” sales anyway ? Well, this is quite simple. You have to organize some kind of “strawman” first, then sell the stuff to him/her and book the proceeds against receivebales. So whenever one sees a large increase in receivables, one should be extremely cautious.
In the case of Hess AG, one does not need to be a Rocket scientist to “smell the rat”. I have extracted the following working capital items from the balance sheet (page 64):
6M 2012
2011
2010
2009
Inventories
17.3
14.8
11.7
9.6
receivables
24.1
22
11.5
8.5
Payables
9.8
4
2.2
1.3
Net Working cap
32.8
21
16.8
“Sales”
68.3
55.7
52.4
Inv/sales
21.7%
21.0%
18.3%
Rec/Sales
32.2%
20.6%
16.2%
Payables/Sales
5.9%
3.9%
2.5%
NetWC/Sales
48.0%
37.7%
32.1%
So it is pretty easy to see, that receivables compared to sales almost doubled over 2 years. The increase in receivables almost exactly mirrors the actual increase in sales. It looks like that almost all the sales increase were actually generated by sales against receivables.
The next item to check is of course the cash flow statement. Here however we see something strange:
6M 2012
2011
2010
2009
Total
Op CF
3.4
-4.6
-1.4
3.6
1.0
inv CF
-7.3
-7.9
-1.5
-6.9
-23.6
Fin CF
6.2
14.2
2.3
2.6
25.3
At first it looks that in total, operating CF over the last 3 1/2 years was positive and the company did just invest a lot. But how did they manage the Turnaround ?
In the IPO prospectus they say the following (page 89) about the operating cashflow:
Operativer Cashflow
Vergleich der Halbjahre endend zum 30. Juni 2012 und 2011
Der operative Cashflow erh¨ohte sich von TEUR -3.133 im ersten Halbjahr 2011 um TEUR 6.494 auf TEUR 3.361 im ersten Halbjahr 2012. Wesentliche den operativen Cashflow bestimmende Faktoren waren ein erheblicher Mittelzufluss aus der Position „Veränderungen der Forderungen aus Lieferungen und Leistungen und sonstigen Forderungen und Vermögenswerte’’ in Höhe von TEUR 8.130 gegenüber einem Mittelabfluss im ersten Halbjahr 2011 in Höhe von TEUR 638, der Rückgang des Mittelabflusses aus der Veränderung der Vorräte in Höhe von nur TEUR -652 gegen¨uber TEUR -3.043 im ersten Halbjahr 2011 sowie eine deutliche Erhöhung der Position Abschreibungen in Höhe von TEUR 2.086 gegen¨uber TEUR 1.255 im ersten Halbjahr 2011. Gegenl¨aufig verhielt sich die die Position „Veränderungen der Verbindlichkeiten aus Lieferungen und Leistungen und sonstiger Verbindlichkeiten’’, die zu einem deutlich erh¨ohten Mittelabfluss in Höhe von TEUR -7.976 im ersten Halbjahr 2012 gegen¨uber TEUR -1.719 im ersten Halbjahr 2011 f¨uhrte.
This statement clearly shows that there is something very fishy going on. In the table I extracted above, we can clearly see that there was a NEGATIVE effect from receivables and inventories in the first half year and an unexplained very POSITIVE effect from payable. So why do they state the exact OPPOSITE in their explanation of the cash flow statement ?
Explanation 1: They just mixed up the vocabulary (which would be already a reason to fire the CFO)
Explanation 2: They included other balance sheet item here in order to obscure the fact that they have inflated sales.
Explanation 3: The 6m 2012 cashflow statement is just fabricated and does not fit together with the (fabricated balance sheet)
Just for fun, let’s compare the balance sheet positions with the entries in the operating cashflow statement:
OP CF statement
Balance sheet
calculated Op CF
Delta stated
6 M 2012
30.06.2012
31.12.2011
Change in inventory
-0.7
17.3
14.8
-2.5
-1.8
Change in receivables
8.1
24.1
22
-2.1
-10.2
Change in short term payables
-8.0
9.8
4
5.8
13.8
We can clearly see that the 6m “flow” numbers have absolutely nothing to do with the delta of the respective balance sheet numbers.
At that point in time one could already stop and conclude that there is either total incompetency or already fraud. Even taking into account all the other short term balance sheet figures, one never gets to the stated cash flow numbers.
In my experience, strongly rising receivables combined with an incomprehensible or even wrong operating cashflow calculation are a very reliable “red flag”.
Summary:
Although it sounds like “Monday morning quarterbacking”, a relatively superficial analysis of HEss AG’s IPO prospectus would have discovered some serious issues with receivables and operating cash flows. Whe someone starts to doctor around with fake sales, one usually gets negative operating cashflows. If the cashflow statement then looks incomprehensible or wrong, actual fraud is quite likely.
In cases like Hess, “red flags” in that magnitude could even be a very good indicator for an interesting short opportunity. In cases like Reply, where the inconsistencies are on a smaller scale, it is rather a hint to stay away from investing.
Edit: If someone thinks that Hess is now a good investment, because it is so “cheap”, then forget it. Eevn if there is some “sound” business left in the company, first of all there is no proof that they ever earned money and secondly I will assume that there will be quite some legal action on that one.
I was quite lucky that I didn’t join in the “trade“, despite considering it quite seriously. My final decision was based on the believe that in such a “crowded” market like merger arbitrage, if a situation looks too good to be true, most likely it isn’t true.
Interestingly enough, a lot of “players” must still have believed in the deal. Looking at the chart, we can see that TNT is now trading relatively close to the lower bound of the “undisturbed” price before UPS came up with the bid:
As discussed in the previous post, at the current level, TNT Express is still not cheap, for instance compared to FedEx.
On the other hand, UPS seems to have been better off without TNT Express if we believe in “Mr. Market” as they have outperfomed the Dow Jones by almost 10%:
To me, this looks like that the offered price of 9,50 EUR was way too high and UPS realized this at some point in time and did not really try hard to get the deal through. For a company like UPS, blaming it to the EC is always a “face-saving” possibility.
However that also means that the price tag of UPS might never be reached again, even if FedEx would show up as potential buyer. On the other hand, TNT Express might still benefit by being spun off from POstNL which is crippled by pension liabilities and the terminally declining mail business.
PostNL Was even hit harder, dropping to a new all time low:
At the moment, both, PostNl and TNT Express are too much “hot potato” type investments, but it is definitely something for my “special situation” watch list. I think it will be especially interesting to see if TNT Express is able to turn around the business on a standalone basis.
Alsi for the future, I think it is the safest to keep away from Merger Arbitrage situations for my special situation “bucket”, as this requires very special skills which I do not have.
value and opportunity 