On Thursday after close, Fossil came out with their Q3 numbers. Without adjusting for currencies, numbers looked pretty bad. Sales were down 14%, watches even -17%. In the earnings call they blame most of the decline on Michael Kors:
Movado is the second US-based company specializing in watches (see my previous posts on Fossil part 1 and part 2). The company has a quite interesting history. Cuban Refugee Gerry Grinberg founded the company in the 1960ties basically as a Swiss Watch importer. Later on they actually acquired the rights to the Movado brand with the iconic Museum Watch.
Market Folly with notes on all pitches from the “Invest for Kids” conference
You still believe that Operating Cash Flows are a better indicator than earnings ? Well, maybe not at Valeant.
Whole Foods is having a pretty hard time right now, maybe it’s worth having a closer look into ?
Wexboy likes Finish company Saga Furs
A rare glimpse into Baupost Group, especially they way the look at cash (H/T Valueinvestingworld)
Carl Icahn tells his story (8 minute video)
Adjusted EBITDA conquers the world or at least the S&P 500…..
The success story of Berkshire for a long time has focused only on Warren Buffett, the front man with the knack of explaining even the most complicated issues in a funny and folksy manner. Charlie Munger was for a long time only considered to be the “funny side-kick” who seems to be asleep most of the time during Berkshire’s annual share holder meeting.
This changed somehow in the last few years, among them the excellent “Poor Charlie’s Almanack” from Peter Kaufmann and there seem to be a couple of Charlie Munger books already released or in the pipeline.
So I was pretty surprised that there is a much older book about Charlie than the others. “Damn Right” was written and released in 2000 and is based on many interviews, some with Charlie Munger directly but also with his family and former colleagues and friends. 2000 was a year where many people thought that Berkshire had lost it, maybe one reason why the book didn’t become more well-known.
The book starts slowly with some stories on his parents and grand parents but gets more interesting pretty quickly. Munger started early on as a lawyer but discovered that he can make more money by being a real estate developer and started buying plots, building and selling apartments and houses. He then started to buy parts of or whole small companies. For a very long time he did so as a pure “Graham investor”, picking up bargains or even net nets.
Munger then started Munger Wheeler in the 60ies but was already discussing investment ideas with Buffett over the phone. He also invested together with Buffett and another Californian investor and friend Rick Guierin (One of Buffett’s “Superinvestors”) into the same companies sometimes even closely held ones. The most famous common acquisition of this time was the Blue Stamp company.
Wheeler & Munger performed greatly from 1962 to 1969 but did badly the next few years when Warren Buffett hat already closed his partnership. Munger dissolved the partnership in 1976 but still had a track record of making ~24% p.a.against 6% p.a. fr the Dow Jones.
The changing point in his history is clearly the purchase of See’s where they paid, for the first time in their history, above book value for a company. Munger is quoted that they would not have bought Coke if they hadn’t started with See’s.
After that the book covers some of the major Berkshire stories but with an interesting perspective. For me the most surprising facts from the book were:
– Munger and Buffett were fined by the SEC in 1974 (WESCO)
– Munger’s Partner had the original See’s Candy idea
– Munger was a “Graham style investor” for a very long time
– there were really big draw downs in the Munger partnership
Interestingly enough, the book says that already in the late 90ies, Munger wasn’t involved that actively in Berkshire anymore. For me the question always remains: Would Buffett had been as succesful without meeting Munger or would he would have become “just another succesful” investor ? Who knows.
Overall the book is definitely a good read for any value investor and tells most of the Berkshire story from a slightly different perspective. HIGHLY RECOMMENDED.
This is a follow-up to my first post on Fossil. The short summary:
Fossil has a good but not great business with some issues, among others the potential success of smart watches. The reason to dig deeper was the unusual combination of CEO/owner with zero salary and capital allocation with a focus on share buy backs.
Share buy backs
There is a great collection of articles on Teledyne and Henry Singleton “available at CS Investing. One absolute gem inside is a classification of stock buy backs in order of usefulness to shareholders from Hedge Fund Honcho Leon Cooperman:
Although I usually don’t care that much about quarterly earnings, let’s start with two interesting ones:
Handelsbanken
Handelsbanken is on my watch list, I consider them as one of the best bank franchises globally but still a little bit too expensive. Officially, “Mr. Market” was disappointed because earnings were below expectations. The stock dropped around 8% on that day:
Over the last few weeks, I discussed the Globo Plc case quite extensively with other investors. I think many people were attracted to it because it looked so cheap despite having a “sexy business”. Sometimes I was succesful in my efforts to talk people out of it, sometimes not.
And just to be clear: I don’t think that investors who owned Globo shares are stupid. As it seems for now, Globo has been a “pretty well-managed” fraud with a true core and very good actors as management. Everyone makes mistakes and the only sin is not to learn from them for the future.
What I found interesting is that some arguments in my discussions tend to show up almost each and every time in those situations, for instance also in the German-Chinese fraud cases I had written about. Most of the arguments circle around certain facts that because x, y or z is involved it cannot be a fraud, which often turns out to be not the case. So without wanting to insult anyone who I talked to or trying to be the “head teacher”, I just wanted to list some of the arguments I encountered multiple times in those discussions. Maybe they help in the next case, maybe not.
1. Famous investor xyz has a big position in the stock and they are well-known for in-depth due diligence and direct contact to managemnt
Everyone makes mistakes, even the most famous investors. Don’t outsource your due diligence to famous investors. You never know if the “famous investor” has deeply looked into the stock or just a (soon to be fired) junior associate.
2. I have actually talked to famous investor xyz with the big position about that stock and they seem to be really sure about it
Well, what would you expect if you talk to an investor who has a large position ? Will he tell you “I am not sure anymore and I will start selling next week” ? Most probably not. This is the famous “Don’t ask the barber if you need a haircut” situation. In situations like this it is much more helpful to talk with investors who don’t own the stock or who are even short. Everything else is just playing into the “Confirmation Bias” behaviour.
3. But they have an (well-known) audit company who checks the accounts
Many investors seem not to be aware what auditors actually do. Auditors are not responsible to uncover fraud. They are only responsible for checking the documents provided by the company for consistency. It is not the responsibility of the auditors to detect a “consistent fraud”. Don’t outsource due diligence to auditors, they don’t work for investors, only for the management of the company. Auditors get paid for the fees they generate, not for being right or wrong.
4. Reputable bank ABC has lent them money. They would not do this if there would be something wrong
Well, if this would be a general rule, we would have not had a financial crisis. In Globo’s case, significant “upfront fees” were involved with the loans. Anyone who has contacts with banks knows that once there are “juicy fees”, lending standards often become secondary. In most of the German-Chinese frauds, reputable banks extended loans as well. As with the famous investors, don’t outsource your research to others especially not banks !!
5. Reputable bank ABC has a “buy” rating on the stock
Sell side research is really the least reliable source of true information in capital markets. Most of the research is still driven by a desire to get business and most sell side researchers who are really good don’t work there very long.
6. I have spoken to management directly and they explained me this and that. They were really nice guys.
My experience is the following: If you really have large-scale fraud, the people running the scheme are often brilliant and charismatic. Otherwise they would have been detected much earlier. Direct involvement with those persons often doesn’t help, in contrast, one gets entangled by their “charisma” and accepts things which are simply not acceptable seen from a distance. Bernie Madoff seems to have been a very charming guy when you met him privately. The longer the fraud works, the more confident people get. I have read lot of books on frauds and in quite a lot of cases, the fraudsters at some point started to believe their own lies which made them even more convincing. At remember: As with driving a car, on average we are only average judges of people and character.
7. I have spoken to management and they gave me additional reassuring info which is not in the official reports
Well, this is a big RED FLAG. Management disclosing material non-public info to investors in “one-on-ones” is in my opinion a big problem. Any reputable management would never do this. As the recipient of this information, you feel privileged but on the other side: If they cheat the other investors by selectively disclosing stuff to you, then it is not a big step to cheat everyone.
8. They account aggressively because everyone in Tech does it
Well, no. Not everyone accounts aggressively, even within tech. As a value investor, the trick is to find those who run their business conservatively and stay away from aggressive ones.
9. It can’t be a fraud. I have seen the product, it is for real
Many frauds have a “real” core. Enron had some divisions which made money, even Bernie Madoff ran a “real” brokerage business as a front. Rarely, everything is totally made up. The question is not “do they have a real product” but “Do they have real sales and real profits”.
10. The company is so cheap, even when this one thing turns out to be fraud, the stock is still a bargain
Charlie Munger said something like this: “Cockroaches rarely travel alone”. Which means if there is one big problem that you can see, there are often many more problems that you don’t see. Once there is serious doubt with regard to integrity of the management, there is no margin of safety anymore.
11. They are financially unsophisticated, that’s why they did this and that one normally wouldn’t do
In Globo’s case it was the super-expensive loan and the potential bond, in the Chinese cases it was why they were selling new shares at a P/E of 4 or lower. When it comes to loans and new shares, one can be pretty sure that management is quite sophisticated. Especially when a company does a lot of M&A, uses a complex structure to avoid taxes and claims to do things like cash pooling, then unsophistication is a pretty unprobable explanation for strange and unlogical things. Underestimating the sophistication of a potential fraudster is not very sophisticated from an investor’s perspective.
Summary:
Most of the prinicipal issues which I see in cases like Globo can be summarized in 3 major points:
1. Don’t outsource due dilligence to 3rd parties (auditors, banks, other investors)
2. Don’t believe in what management says, especially when it is on a “privileged” basis.
3. Don’t underestimate potential fraudsters.
The best strategy to hopefully avoid such cases in my opinion is to fight the Confirmation Bias and search for opposing opinions wherever you can find them.
From Globo’s website:
FOR IMMEDIATE RELEASE
GLOBO plc
(“Globo” or “the Group”)
Company Statement
Globo plc issues the following statement:
On Friday 23 October 2015 the Board of Directors of the Group became aware of a report published by Quintessential Capital Management (“QCM”).
Following the announcement by the Company on the morning of Friday 23 October 2015, an emergency Board meeting was convened as soon as practicable for Saturday 24 October 2015 to discuss the allegations in the report and to ascertain the actions that would be required to resolve the matter. It was intended that an appropriate independent forensic accounting team be appointed to investigate the claims.
However, at the Board meeting, Costis Papadimitrakopoulos the CEO of the Group brought to the attention of the Board certain matters regarding the falsification of data and the misrepresentation of the Company’s financial situation, and offered his resignation, as did Dimitris Gryparis the CFO of the Group.
Following the meeting and receipt of legal advice, a committee of the board was set up, comprising the non-executive Directors only (the “Committee”). The Committee has accepted the resignations of Costis Papadimitrakopoulos and Dimitris Gryparis from the Company with immediate effect. Gerasimos (Makis) Bonanos (the COO) has been suspended from his duties with the Company also with immediate effect, pending the outcome of appropriate investigations. All of the executive directors have agreed to make themselves available and fully co-operate with any investigations.
The Committee has initiated discussions with appropriate advisers in relation to the next steps and to ascertain the true financial position of the Company. In addition, the Committee has asked the Company’s lawyers to notify the matter to the appropriate authorities and the Committee has informed the Company’s principal bankers.
Further announcements will be made in due course. In the meantime the Company’s shares will remain suspended from trading as per the dealing notice on Friday 23 October 2015.
Edit: It keeps getting better:
Globo also said that Papadimitrakopoulos had informed the company that up to last Thursday he has sold 42.05 million shares in the company, and pledged 10 million shares under a personal loan agreement with Lantau Holdings Ltd – a loan that will default at close of business Monday due to two consecutive days of the suspension of the company’s shares from trading.
At Globo’s last quoted price before suspension of 29.45 pence, the share sale would amount to GBP11.9 million.
This means Papadimitrakopoulos’ holding in the company has been reduced from 18.67%, or 69.78 million shares, to 7.42%, or 27.73 million shares. Globo noted that it has requested additional details about these dealings, and does not yet “possess all relevant information about their timing and nature.” It will make a further announcement once this information is received.
A bad week for Globo: Bond issuance cancelled, detailed short thesis published (“Greek Parmalat), shares suspended
MUST WATCH: Wiliam Thorndike (“The Outsiders”) gives a “Google Talk” (Note to myself: Check Colfax, Arch Re, Crown Castle)
Damodaran looks at the Beer-Mega-Merger. A very good template for how to look at mergers / M&A.
Interesting look at “FitBits”, a potential “Watch killer”
Einhorn’s Greenlight Q3 2015 comment (Defends SUNE, bought Michael Kors, sold Citizen)
Why driverless Uber cars might not be the individual car killers generally thought
John Hempton (Bronte) scores big against Valeant plus of course the Citron Report on Valeant
8 reasons why no one cares for earnings anymore these day…
Finally Ben from WertArt on Rolls Royce and “investor hearding”
Fossil is a relatively well-known, US-based company which sells mostly watches and other accessories across the world, under its own brand but also under licenses from other famous labels (Michael Kors, Armani etc).
The stock has been hit hard in the last months and has lost more than 50% since its peak in 2012/2013. The Stock chart is a typical “falling knife”:
Fundamentally the stock looks very cheap, especially compared to historic profitability and growth:
Market cap: 2.660 mn USD (55 USD per share)
P/B 3,2
EV/EBIT 7,8
P/E Trailing 7,8
P/E est (2015) 10,7
10 year averages:
– P/E 17,7
– Profit margin 9,9%
– ROE 23%
– EPS growth 19,1%
So only looking at those historic numbers, Fossil looks like a high growth, capital light and highly profitable company at a bargain price. But as I have written before: Especially in an environment like now, cheap stocks are cheap for a reason.
Why is the stock cheap ?
There is a pretty decent Value Investor’s Club short thesis from late 2014 which lists a lot of the issues issues nicely. I would summarize it as follows:
1. The watch market in general is cooling down rom a high growth period
2. One of the main drivers, the Michael Kors brand (~1/4 of Fossil’s total sales) is having problems and the license agreement was expiring
3. The potential impact of Smart Watches.
I would personally add another fundamental issue which is:
4. Changes in the distribution structure & Social media branding
Let’s look Smart Watches first
Smart watches (and other wearables) are clearly a threat for established watch makers. It is hard to say if they will replace a significant share of traditional watches. With regard to Fossil one can make however the following observations:
a) Fossil is clearly NOT a first mover. They unveiled some first models in August and want to be on the market before Christmas but Sony ,Samsung, Motorola and of course Apple were much faster. Samsung now has 2 years experience and the new Gear S2 looks pretty good.
b) However the BIG question for Fossil is: If Smart Watches are succesful, will “Branding” work for Smart Watches the same way as for normal watches ? Fossil makes most of its money with branding, i.e. buying the stuff cheap in China, getting a license and putting a fancy name like Michael Kors on it and sell it expensively.
If you look at smartphones, branding for smartphones doesn’t really work. There was the Prada phone from LG but this seems to be not worked very well as I haven’t seen any new Prada phones since 2012. Most phones are sold under the name of the producer more like “regular” electronics. Why doesn’t branding work for smart phones ? I am not sure but I think it has to do with several factors such as rapid technological change. A brand like Samsung or Sony stands for technical excellence and people won’t pay more for a fancy name. If you want something fancy then you buy yourself maybe a Hermes Iphone case for 340 USD but not a Hermes branded phone.
I could imagine that Sports branding could work, as Smart Watches seem to focus on health and activity. For some reason however, adidas seems to have launched their first version of a smart watch already 2 years without the help of Fossil. So it seems that the Adidas license does not cover automatically all kind of watches.
Finally an interesting quote from the Michael Kors CEO with regard to slowing watch sales under the Michael Kors brand (from Bloomberg):
“A slowdown in our watch business, that has been significant and it happened very, very quickly. While I think many people think it is a result of the Apple Watch, it’s actually not. I think it is a result of the iPhone 6 where we did see some softening in our business when iPhone 6 was introduced. There’s clearly a younger customer, in particular, in America who is wearing watches less because they view the iPhone as something that they tell time with and watch becomes slightly less relevant.”
John D. Idol – Chairman, CEO, Michael Kors, Deutsche Bank db Access Global Consumer Conference, June 11, 2015
It could easily be that the Michael Cors CEO tries to blame the Iphone for the decline of his own brands but interesting nevertheless.
Changes in distribution & Social media branding
Historically,the distribution system of Fossil was clearly one of the competitive advantages. They did have own stores but most of their watches were sold in department stores like Macy’s or JC Penney plus Walmart. However as the department store format works less well, they have to adapt. They seem to do this by opening more and more own stores. They also clearly try to sell more online. However, as I experienced with Piquadro more than 3 years ago, moving from a more wholesale oriented model to a direct one is not easy.
Renting and running own stores is very different from delivering watches to a department store. It is riskier, you need more inventory and you need expertise in real estate.
Another threat is that the internet and social media seem to have lowered the barriers to entry. I had linked a few days ago to a story about Brandtech, the way some companies like Tesla use social media to create powerful brands.
If you go on Amazon and search for watches, the first page is dominated by “Daniel Wellington” watches. On the German site Amazon.de, the 20 most sold Watches are dominated either by super cheap no names below 10 EUR or Daniel Wellington. 6 of the 20 most sold watches are Daniel Wellington with an average price of 100 EUR, only 2 are Fossil watches. Amazon’s US top selling watches are interestingly allmost all very cheap models with Casio dominating the rankings.
Daniel Wellington is an only 4-year-old Swedish company which managed to go from zero to more than 200 mn USD sales in 4 years. The trick seems to be aggressive promotion via social media as outlined in the Brandtech article:
Tysander refuses to pay for traditional advertising, instead working with thousands of bloggers, celebrities, and other “influencers” worldwide. One of them, Blake Scott, 27, has been collaborating with Daniel Wellington for a little more than a year, sharing the watches with his 318,000 Instagram followers. “I first found out about Daniel Wellington via Instagram: Everyone outside the States was wearing one, and it seemed so cool,” he says. Soon after, someone from the brand reached out and said he wanted to give Scott a couple of watches to post on his feed. Eventually he negotiated a deal with the company, which paid a few hundred dollars for a multiweek campaign.
Other than that, they do exactly the same thing as Fossil:
Although DW bills itself as a Swedish company, the watches are manufactured in China, which is how the company keeps prices so low. The internal quartz movements—a battery and vibrating crystal to keep the time, essentially—come from Miyota, a Japanese supplier popular with lower-price brands, because their products are reliable and they always have a massive inventory. The rest of the components are made and assembled in Shenzhen, a manufacturing hub.
So clearly Fossil does not have anything like a moat, even the wholesale distribution network seems to be quite open for newcomers like Daniel Wellington. If you can build fresh brands as quickly as that, one also needs to think about how this changes the value of licenses of “famous” brands at least in the fashion category. One needs yet to see if Daniel Wellington is only a short-lived outlier or if more is to come.
What I like about the company
In general I found their annual reports pretty good and informative. If a company is in a situation like Fossil, with growth going away and cash flows still coming in, the danger is always that they do something stupid and/or incentives of management and shareholders are not aligned.
At Fossil however I found two statements which are quite impressive and indicate an above average management quality of the company.
This is a statemnt from the annual proxy statement about Kosta Kartsotis, Co-founder, CEO and 13% shareholder:
The Board believes that this structure is effective and best for the Company at this point in time for several reasons. Mr. Kartsotis joined the Company in 1988 and has been a director since 1990. He holds a significant number of shares of our Common Stock, and since 2005 he has refused all forms of compensation for his service as an executive officer, expressing his belief that his primary compensation is met by continuing to drive stock price growth.
Compared to this, Warren Buffett looks quite greedy in earning 100 K a year for being CEo. Mr. Kastsotis is basically working here for free. He has reduced his stake over time but in the last few years very little. Clearly without a salary he needs to sell some shares in order to get cash, but it would be quite easy for him to command a normal salary which could be at lest a mid single million USD number and no one could complain.
There was another great statement in the annual report on capital allocation and dividends:
Cash Dividend Policy.
We did not pay any cash dividends in fiscal years 2014, 2013 or 2012. We expect that for the foreseeable future, we will retain all available earnings generated by our operations for the development and growth of our business and for the repurchase of shares of our common stock
Fossil has bought back massive amounts of its own stocks in the last few years, around 1/3 of the outstanding shares have been bought back and they continue to buy more. Although part of thse stocks have been bought at 100 USD or more, I prefer this kind of capital allocation to doing stupid M&A transactions.
Summary part 1:
Fossil clearly has some fundamental issues to cope with. A general slow down in the industry combined with expiring license agreements has had direct and short-term negative effects on margins. The thread of smart watches adds further uncertainty. On top of that new competitors like Daniel Wellington seem to have no problems to enter the market and quickly gain market share.
Such a uncertain situation would normally be a clear reason NOT TO INVEST and stop researching as any margin of safety could quickly disappear.
On the other hand, Management seems to be properly incentivised and the capital allocation looks top notch. So I will digg a little deeper and try to come up with a valuation in a second post.
value and opportunity 