Investment memos

Caltagirone SpA – More “Hidden” Value

5th December 2015

We have not posted about one of our core holdings, the Caltagirone complex, for a while. In summary despite the security going up 11.6% since we initiated the position the discount to our fair value has remained broadly the same and the overall quality and certainty of the margin of safety has improved. Below we detail the main changes since our lost post on Caltagirone and we will also be increasing our holdings in CALT IM by another 2.5% to 5.0% at market open.

1. Vianini Lavori Take Private / Grandi Stazoni

On the 15th May 2015 FGC Finanziaria, a company controlled by Francesco Gaetano Caltagirone, made an offer of EUR 6.8 per share ex-div to buy out the 28.1% of Vianini Lavori not controlled by the Caltagirone group which represented a 16.8% premium to the 3 month average trading price immediately preceding the announcement date. In the offer Caltagirone stated that they would delist the entity if their offer was successful and at the a shareholders meeting on the 22 October 2015 it was announced that over 90% of Vianini’s shares were controlled by connected parties and they would be proceeding with a squeeze out and delisting.

We cannot fathom why the minority shareholders tendered their shares into this offer given that, excluding any value for Vianini’s stake in Grandi Stazioni, the offer represented a 48.9% discount to the value of the listed securities and cash net of all obligations that Vianini held. In fact, as we saw with Genterra, the controlling shareholders could fund the entire take out of the minorities with cash on the balance sheet.

Given the discount to a very conservative fair value we didn’t look further into Caltagirone’s motivations at the time or consider whether there was any other value we should have been taking into consideration. However, we know think that a big part of their motivation in this takeover was the upcoming privatisation of the Italian railway assets known as Grandi Stazioni in which Vianini has a stake through its 40% interest in EuroStazioni.

As a quick reminder Grandi Stazioni S.p.A. is a member company of Italy’s Ferrovie dello Stato (English: State Railways) group and was created to rehabilitate and manage the 13 biggest Italian railway stations. The company is 60% controlled by Ferrovie dello Stato and 40% controlled by EuroStazioni which is a consortium of private investors including the Benetton Group, Pirelli, SNCF and Vianini Lavori which has a 32.741% stake.

Interestingly it was reported at the beginning of July by Italy’s equivalent of the FT that the state was looking to sell Grandi Stazioni by the end of 2015 (article can be found: here). Having dug a bit deeper we were able to find a number of articles putting the price tag at EUR 1.0bn which we assume is a TEV not equity value (see example here).

With a bit more moderate sleuthing (and frankly something we should have done in our initial underwrite of the Caltagirone group) we were able to find the 2014 accounts of Grandi Stazioni with a view to trying to test the credibility of the rumoured EUR 1.0bn price take which you can find here.

It turns out that Grandi Stazoni is basically a real estate company which earns rent from commercial tenants located in the stations. Taking the latest annual accounts we stripped out the advertising and other revenue assuming a suitable EBITDA margin to arrive at the “clean” real estate earnings. Assuming a EUR 1.0bn TEV and adjusting out the value of the other businesses you would need to believe a purchaser would be willing to acquire the railway stations for a 5.6% rental yield or better. This would seem fair looking at CBRE data on Italian prime commercial rental yields which range from 4.00 – 5.50% (research can be found here). None of this gives any value to the Czech railway stations which they are currently redeveloping. We have included our workings on Grandi Stazioni valuation below:

Grandi Stazioni Valuation

 

All in all the additional value from Grandi Stazioni adds an additional 17.7% value to the Vianini stake which equates to 18.4% of the current CALT IM market cap.

Finally, in tracing all of this back we also noticed that we goofed up our initial memo by only attributing value from Caltagirone’s 50.045% direct stake in Vianini and missing an additional 6.426% stake that they held indirectly. This is worth an additional 14% of the current CALT IM market cap

So all in all we have “discovered” an additional 30% of value in Vianini when considering the market cap.

2. Caltagirone Editore

When we recommended an investment in the group Caltagirone Editore was EBITDA negative. This has now reversed with the group posting positive LTM EBITDA of EUR 3.2m driven by two things: (i) stabilisation / recovery in advertising revenue, and; (ii) continued effective cost cutting. Depending on the levels of employee and other provisions that get crystallised during 2015 the business will still burn a small amount of cash but not much. Below we have laid out all the quarterly financial and operational KPIs we could find in CED IM’s reporting so you can judge the performance of the company for yourself:

CED IM KPIssee pdf

To be clear CED IM is not out of the woods yet by any means particularly as the online contribution as a % of the total advertising revenue is only 11.6% as of Q3 2015. However, we still continue to hold a small position in CED IM as we believe that a discount of 53% to cash and listed securities represents a dislocation to fair value given the performance of the underlying business.

3. Cementir

Quick health warning that this asset represents a meaningful part of the CALT IM value story and we have not done a huge deep dive on it (obvious comment but you should always do your own diligence as this post shows we often make mistakes).

For the first 9months of 2015 Cementir has roughly stayed flat posting 0.7% revenue increase and a (1.9)% decline in EBITDA. Using Cementir’s LTM EBITDA to Sep 2015 the business is trading at a 7.2x multiple which seems inline to slightly cheap to the other albeit larger cement players such as Holcim, HeidelbergCement etc. At a high level the biggest concern that we have about Cementir is that it generates c. 28% of its revenues and c. 32% of its EBITDA in Turkey which is a potentially overheated economy and also has a higher political risk associated with it that we would normally be comfortable with.

CALT IM’s stake in Cementir represents 34% of our total fair value and it you excluded any value for Cementir then CALT would be trading at a 45% discount to our view of fair value.

4. Updated Valuation

See below for our updated valuation of CALT IM, in short we believe that it is trading at a 41.1% discount to fair value based on the current trading value of each listed entity and a 63.9% discount to our view of fair value.

Caltagirone Valuationsee pdf

Our full workings can be found here

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Gencan Capital Inc (GCA CN) – Smash & Grab 1.85x MoM – SELL above CAD$ 0.043

Our relationship with Gencan was even shorter than with it parent and listed predecessor Genterra Capital Inc (original memos can be found here & here). We exited our entire position at CAD$ 0.14 on the 11th November 2015

A quick potted history of the situation as a reminder for those who have not read all the previous posts:

  • Genterra Capital Inc was a Canadian Venture listed company which owned real estate, a solar park and some listed securities
  • On the 10th July 2015 the controlling shareholder made an offer to take Genterra private in the form of cash consideration of CAD$ 1.96 per share and two shares in Gencan Capital Inc an entity being spun out of Genterra which would own the solar asset
  • We exited our Genterra position in the market on the 4th August 2015 at an implied price for Gencan shares of CAD$ 0.195 which implied the market was paying a premium to the undiscounted cash flow streams of the solar park which is mad
  • We then got the opportunity to re-enter Genterra with a view to creating the Gencan spin-off cheap and acquired shares at an all in effective price of CAD$ 0.745 between the 14 & 16th of August 2015
  • The Gencan spin-off became effective on 28th October 2015 and the shares were listed to trade on the Canadian Securities Exchange as of the 30th October 2015

At the time we initiated the trade there was imperfect information on Gencan which had previously been a subsidiary of Genterra and therefore did not have separate reporting as well as having only limited trading history given it only recently started generating electricity as of August 2014. At the time of trade the majority of our information came from the Genterra takeover prospectus and the accompanying valuation report. Since then there has been additional disclosure specific to Gencan Capital Inc on sedar which revealed the following:

  • Rent – confirmed that Gencan has to pay rent to Genterra for the lease of the rooftop which equates to CAD$ 60,000 per year for 20 years (the life of the FiT). They also have a 10 year extension option in their favour (we assume to capture repowering opportunities)
  • Administrative Services Agreement – revealed that on top of the CAD$ 60,000 management fee Gencan would pay to Genterra it would also pay an annual CAD$ 6,000 administrative services fee
  • Overall Operating Expenses – the company is estimating CAD$ 270,000 of annual operating expenses (including interest)
  • Results – on the 5th November 2015 Gencan released its June 2015 9 month results which showed that if Q4 produced a similar amount of electricity as Q3 which would seem sensible given it covers the summer months of July – September then the company would likely hit its revenue target
  • Debt – nasty surprise here that the debt is due on 1st August 2019. Our assumption had come from page E-2 of the Genterra information circular where the independent valuer stated that “A loan from Genterra was used to finance the installation which bears interest at 4% and is assumed to be paid in five instalments of $511,594 on 30 September for the years 2030 to 2034.” On closer examination of the same document on page G-20 they state “Pursuant to an Amending Agreement made on July 16, 2015, the loan has been converted into a 5-year term loan repayable on August 1, 2019, with interest at a rate of 4% per annum calculated and payable monthly in arrears.” Why the valuer was using a different assumption from reality we have no idea but more fool us for not reading the document more carefully

Incorporating all this new information into our model we come to two key conclusions that you need to draw when valuing Gencan today:

  1. The total cumulative net cash flow to equity is likely to be in the range of CAD$ 2,677,286 (depending on your debt repayment assumptions)
  2. Given the 2019 debt maturity it is unlikely that Gencan will make any distributions to the equity until after the maturity as the business looks to build up cash to delever

In terms of valuing Gencan we have changed our base case to reflect the changes above and also show a build-up of cash until 2019 and then a repayment of the debt via a 100% free cash flow sweep. Only once the debt is repaid can you expect equity distributions. This is in-line with project financing agreements for similar solar park ventures that we have seen elsewhere.

We would sell our position in Gencan at an Equity Free Cash Flow (“EFCF”) yield below 10% (implied price of CAD$ 0.043) and start adding if the EFCF got above 15% (implied price of CAD$ 0.024). As a result we exited our position at a price of CAD$ 0.14 for a 1.85x MoM and a 413,575% IRR.

Updated model below

Gencan Capital Inc Memo (2015.11.15)

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Gencan Initiation

Recommendation: BUY, target price upto CAD$ 2.17 (including trading costs)

Share Price: CAD$ 2.15

Market Cap: CAD$ 17.9m

Free Float: 28.9%

Ave. Daily Trade Volume: CAD$ 1,288

This investment comes out of our previous involvement in Genterra and is focused on creating the spin-off entity Gencan at a reasonable return on equity over the life of the solar feed in tariff. We have written extensively about Genterra during our hold period and the key post describing the spin-off entity and how we value it is here.

Last week we loaded up on Genterra securities as they represented an excellent return on contracted cash flow. In creating the position we had to factor in the following two considerations:

  1. Position sizing post the demerger dividend – at the top end of our buy range only 10% of capital deployed will remain as the final position in Gencan. Obviously if we achieved better pricing than CAD$ 2.17 our stub position would represent an even smaller % of capital deployed.
  1. Trading fees – when creating the stub position for a maximum price of CAD$ 0.21 you have to be very sensitive to the effective creation price including your trading fees which changes depending on how many shares your purchase per trade (i.e. how spread out your fixed trading costs are). As a result of these factors it made sense for us to acquire 510 shares at CAD$ 2.0 which created the company to a 39.1% IRR in our downside case but if we have acquired 510 shares at our maximum buy price of CAD$ 2.17 our IRR would be only 10.9% which is below our target price of 15.0% IRR

Included below is an overview of how we calculated target trading levels depending on the amount of securities that were offered in the market

Genterra Trade Sizing

On the question of sizing we think this is very good risk as you are acquiring a fixed set of cash flows that have been set by the government with the energy being taken by the government (Ontario Power Authority). The only way for these cash flows to change would be by operation of law as you have seen in Spain which we see as unlikely to occur in Canada. As a result in the rosiest picture you could argue that you are buying a proxy for Canadian sovereign risk significantly wide of where their long dated bonds which trade at a Yield to Worse of 2.27% (unfortunately for what we can see Canada only have 21 sovereign bonds out and the longest maturities are 2021 and 2064 so we chose 2064 as the length of the contract goes to 2034)

We would have liked to have Gencan be a 7.5% position in the portfolio but mathematically we would have had to deploy more cash than we have available in the fund. Instead we took the view that we would deploy all our available cash less 7.5% in case we stumbled across another position we really liked. We expect the spin-off transaction to consummate before year end and to be left with a 5.7% position based on total net portfolio value as of Q3 2015.

In total we completed the following trades last week taking us to a full position size:

Gencan Completed Trades

Our net Genterra creation price of CAD$ 2.109 creates Gencan at a 22.5 – 26.9% IRR to renewable tariff expiry in 2034 and if held to maturity would represent a 3.9 – 4.6x MoM from contracted cash flow.

As with all investments there are risks which we split into pre & post spin off below:

  • Pre Spin-Off – up to consummation of the transaction we will have 80.7% of our fund in Genterra which is scary. We got comfortable with this risk as the transaction is being proposed by the 70% shareholder so the risk of the conditions precedent not being fulfilled is low (our guess is that tax clearance is potentially the only element not in their control). We also get comfortable with this concentration given our view that the controlling shareholder is acquiring Genterra at a significant undervalue vs our CAD $2.90 a share valuation of the enterprise. Finally the nature of the business (real estate and renewables) is very stable so the chance of a material adverse change in the business seems low
  • Post Spin-Off – we are faced with the same risks as we had when we invested in Genterra namely: (i) illiquidity of the security, (ii) controlling shareholder leaking value to themselves, and; (iii) poor capital allocation. Given our approach and focus we are inherently comfortable with risk (i) as it is the main driver of opportunity creation in our universe. We are more comfortable with risk (ii) as the controlling shareholder did conduct a valuation and got court approval for their take private of Genterra, however, we will just have to accept that if this happens at Gencan it will be at an undervalue and that the cost structure of the vehicle will not be optimised (which we reflect in our model). Finally we are probably most concerned with (iii) as the controlling shareholder may decide to use cash generated by the entity to invest in new solar projects at lower equity returns to either help with related party transactions or grow their fee base which would obviously dilute our return

Our model of Gencan can be found below:

Gencan Memo (2015.10.24)

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Internet America (GEEK US) Initiation

Recommendation: BUY, target price upto $0.025 per share

Share Price: $0.024

Market Cap: $0.402m

Free Float: 17.3%

Ave. Daily Trade Volume: $1,286

The simplest stories are the best and this one is very simple. Almost all the assets of Internet America were sold to JAB broad band in a sale that completed in late May / early June 2015. As part of the sale the shareholders received a liquidating dividend of $0.68 per share. What remains of Internet America is: (i) cash escrow from the sale, (ii) inventory and IP address assets that were not part of the sale to JAB, (iii) cash retained for wind down, and; (iv) small amount of debt.

Taking these assets in turn:

  • Cash Escrow – this is $700k of the purchase price for Internet America that has been held back against any purchase price reductions that may occur. The deadline for making a claim is the 80th day after the closing date (we am assuming this is the 25th June). The proxy statement does not detail what the purchase price reductions could be but we would imagine they relate to “locked box” style working capital which hopefully should be known and small
  • Inventory & IP Address Assets – these include receivables older than 60 days, c. 50k of IP addresses, name and trademarks as well as NOLs and inventories. Management have valued these at $300k
  • Cash for Wind Down – $350k
  • Estimated Debt – $(193k)

As always with liquidations another factor is the cost to realise the assets of the estate. Management have estimated this to be $250k and have also included $100k of contingency. What is comforting here is the meaningful equity stakes held by management and the acquirer who should be incentivised to (a) be conservative on outlook, and (b) minimise costs in order to maximise their returns from the business.

We have laid out the company’s plan of liquidation here and would recommend you read the proxy statement which you can find here which contains all the relevant details of the liquidation plan.

The simple facts are that at $0.025 per share you are creating the business to a 2.17x MoM with an expected distribution of 93% of the remaining assets within c. 3 months time based on managements plan. To this forecast you have upside from better realisations on the assets sales as well as lower post-closing costs. In terms of margin of safety if you assume all costs, including the management $100k contingency, and no value from the sale of the assets you could afford for 17.4% of the escrow to be called before you start to loose money.

We are looking to add this security as a 7.5% position in the HIPS portfolio at $0.025 and would grow it to a 15% position at $0.020. Unfortunately we only stumbled across this opportunity in early August as a result of a post by Schwab711 on the Corner of Berkshire and Fairfax message board and missed the only window of good trading so far which occurred from the 24th July until the 3rd August 2015. Given our flat trading fee structure from our broker and a view that we cannot really spend more than 10% of our acquisition cost in trading fees we need to acquire at least 8,000 – 10,000 shares per trade depending on whether the price is at $0.020 or 0.025. Time will tell if we are right to set this limit and chance our hand by waiting.

Would be great to hear from anyone that knows a good broker for these very small illiquid situations that has a more reasonable charging structure that would allow us acquire small share lots.

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Genterra Capital Inc (GIC CN) – From an Irrational Price to an Irrational Price

God the market is weird. For over 4 years Genterra traded at a totally irrational price (see my original investment memo). Immediately after the company announced a share buyback and spin off worth CAD$ 2.25 (CAD$ 1.96 in cash and $0.29 of value in a new security) there were two trades at $1.91 and $1.97 allowing you to create Genterra Energy for free (see my update article). Now the security trades at $2.45 valuing Genterra Energy (“GEI”) at an equity return as low as c. 2.6% for a yield stock with no growth prospects.

In addition to the valuation of GEI I was also going to comment on independent valuation included in the management information circular as I think it is flawed in a number of places but have decided against it as my time is probably better spent searching for the next Genterra as opposed to railing against being short changed vs fair value.

To be clear I am selling my Genterra stock tomorrow as soon as there is a bid in the market.

Genterra Energy

You can find the management information circular here which provides all the detailed background on the transaction and GEI.

Appendix E deals with the valuation of GEI and provides you with the following key inputs:

  • The annual energy output is 812,495KWh
  • The Feed In Tariff (FiT) has a 20year life expiring in 2014 and is set at CAD$ 0.635 per KWh
  • To reflect the decline rate in the solar panels over time you should reduce the energy output but 0.7% per year
  • GEI has a $60k per year management agreement with Highroad (related party owned by the Letwin family)
  • There is a loan of $2,557,970 which bears a 4% interest rate and amortises in equal instalments of $511,594 in years 2030 to 3034

There is no mention of rent payable by GEI to Genterra but in previous reports of Genterra they have mentioned that $50k per year of rent was payable by GEI for use of the roof of their properties. It is also worth noting that Highroad was previously happy to manage the solar park for $30k per year as per the last Genterra reporting.

I built a rough and ready model for GEI the output of which you can find here: Genterra Energy Valuation (2015.08.02).

My model shows equity free cash flow without ongoing rental payments from GEI to Genterra and also net as it is not clear from the circular. It is worth noting that operating and administrative expenses for GEI for the first 6 months equated to c. $67k which might point to rent being paid going forward. It also does not ascribe any value to the solar equipment at the end of its 20 year life. From the little I know there is value to the “repowering” of solar parks at the end of their life but given GEI doesn’t own the land on which its solar assets are on I don’t think you can assume that any benefits would accrue to GEI in this case.

The market is currently valuing GEI at CAD$ 0.49 vs my view of fair value at CAD$ 0.21 which is derived from wanting a 15% equity return over the life of the FiT whilst assuming no repowering and also that Genterra charges you rent.

Put another way the current price indicates that investors are willing to earn a 2.57 – 4.55% equity return over the 18 years depending on the answer to the rental question. On top of this the security will be very illiquid as the free float will remain at 28% of total shares. In addition you will still have the risk of related party transactions as you did owning Genterra, namely that Genterra related entities are providing: all management services for GEI, are the landlord for the site your park is on, and; are your lender.

It feels great to take advantage of Mr Market’s irrationality both on the way in and the on the way out as my track record is much closer to both buying and selling too early.

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Emerson Radio (MSN US) – The Hour Between the Dog and Wolf

The Hour Between the Dog and Wolf is originally a French saying (Entre chien et loup) which is multi-layered. It is used to describe a specific time of day, just before night, when the light is so dim you can’t distinguish a dog from a wolf, however, it also expresses that limit between the familiar, the comfortable versus the unknown and the dangerous (or between the domestic and the wild). It is an uncertain threshold between hope and fear.

This is very much the feeling I have when I contemplate the latest developments at Emerson radio (see: original memo)

As a quick summary refresher the Emerson Radio long thesis can be boiled down into the following salient points:

  • Ugly company, in an ugly situation and with very ugly corporate governance issues
  • Company has two US businesses: (i) low grade white goods distribution (micro waves & fridges), and; (ii) license / royalty business for the Emerson TV brand in the US
  • The white goods business is roughly cash flow breakeven whilst the royalty business generates between $7.5 and 8.7m of cash flow a year which on the market cap net of cash is a monster free cash flow yield
  • The controlling shareholder, Grande Holdings, has been in bankruptcy in Hong Kong since June 2011 and its owner has a history of bad acts both at Emerson and elsewhere. It has been working on an emergence from bankruptcy but has been rolling delays since June 2014
  • The company has contingent liabilities totalling $20.1m in the form of three pieces of unpaid US tax claimed by the IRS which the company is disputing. At least one of the IRS’ claims which is a liability of $4.8m seems to be a strong case for the IRS in my opinion
  • At the time of investment I had a low / high recovery of  $1.96 – $3.19 per share assuming no value for the US white goods business
  • I initiated a 5.0% my position on the 27th April 2015 at $1.35 per share

Since then it has been a bit of a rollercoaster as described below

Delayed Filing of Annual Report (WOLF!)

On the 29th June 2015 the company filed a NT 10-K which stated that:

“Emerson Radio Corp. (the “Company”) is unable to file its annual report on Form 10-K for the year ended March 31, 2015 (the “2015 Form 10-K”), within the time period prescribed for such report without unreasonable effort or expense. The delay in filing is principally attributable to the Company’s need to analyse certain transactions and additional information relating to income taxes and potential income tax liability resulting from the U.S. Internal Revenue Service assessments and the Company’s appeal thereof in order to complete the disclosure in the Registrant’s financial statements and the 2015 Form 10-K. Please refer to the Company’s periodic reports filed with the Securities and Exchange Commission for additional detail regarding such tax assessments. The Registrant anticipates that it will file its 2015 Form 10-K no later than the fifteenth calendar day following the prescribed filing date.”

The stock duly tumbled from a trading range of $1.30 – $1.40 to $1.12 and ultimately a low of $1.07 per share. As discussed in my original investment memo I was not able to get any colour or edge on the tax claims save that they were historic in nature and the company was confident that they would be defeated. Given the track record of the company and the fact that they had not changed their auditors from the bad old days their statements gave me no confidence. Ultimately I was not in a position to add to my holdings post the drop due to a lack of conviction around the tax outcome which is never a good place to be. However, I was confident that even if everything went against Emerson the intrinsic value was still 40% above where I acquired the security.

The Published Annual Report (DOG!)

Emerson published their annual report on the 14th July 2015 and it was a beat to worst case expectations.

As a reminder the tax issues were (i) two disputes related to income tax issues concerning overseas income (NOPA 1 & 2) totalling $15.3m of maximum liability, and; (ii) one dispute regarding withholding tax on dividends totalling $4.8m. On the NOPA 1 & 2 claims Emerson has reached a settlement with the IRS where it estimates that it is subject to additional federal and state income tax of $3.0m. The IRS has also agreed to not impose any penalties, a substantial beat to the $15.3m worst case (pre penalties).

What is really unclear to me based on the reporting is whether the $3.0m has already been paid by the company, eaten up by their NOLs, or is still a cash outflow to come. In the 10K Note 5 they make reference to the total $3.0m being recorded as income tax expense in Q4 2013-2015 (Q4 2015 being March 2015, i.e. their 10K). Further on in the note it suggests that they have provisioned the full $3.0m of tax for 2015 but also show a tax benefit of c. $1.5m for 2014. Finally on the balance sheet I cannot find either the $3.0m provision or the net provision of $1.5m. The only item that definitely captures the tax liability is $847k of Income Tax Payable. There are also new liabilities of $500k due to affiliates and $481k long term liabilities. It is a totally mystery to me so if anyone has cracked it or got an answer from the company it would be grate to connect.

Turning to the operating results the big negative announcement was that company expects that its customers (basically Target & Walmart) will cancel further product offerings during fiscal 2016 which will account for c. 15.0% of gross revenue. This comes off the back of Walmart cancelling two microwave oven products commencing in Spring 2013 which knocked off c. 30% of Emerson’s revenue (2014 revenue declined by 42% vs 2013) and pushed them from $5.2m of EBITDA in the US business to $(655)k of EBITDA. Stripping out exceptional legal and tax advisory related to the IRS dispute the US retail business was roughly flat in terms of EBITDA. The business has a positive working capital position so the decline in revenues will release some cash.

Licensing revenue was basically flat YoY, however, 2013 licensing revenue was inflated by unreported licensing revenues from one of the Emerson’s licensees of $1.2m being recognised in the period meaning that the actual like for like increase in revenue was 15.2% which will have partially been driven by the new licensing agreement with Funai which lasts until 2018.

See below for an updated net creation value on a high and low case as well as an summary of the historical results of the business which should provide some colour (apologies I have not included the balance sheet and cash flow as they are v. vanilla).

Emerson Radio Creation Value (2015.07.25)

Emerson Radio Summary Financial Results (2015.07.25)

Given the developments and a trading price of $1.15 per share the business is now trading below cash despite a healthy cash flow generation from the royalty stream net of the losses on the US retail business. My biggest worry around the business is the fixed cost nature of the Emerson’s US white goods business. Conceptually I would have thought that what is effectively a pure play distributor and brand owner would be able to adjust their cost base to declines in revenue in order to maintain a similar margin but the 2014 EBITDA decline suggests otherwise. The only reason I could think for this not being the case is either: (i) a reduction in product units ordered means that the manufacturers have increased their unit prices cutting into margins, or (ii) insufficient cost cutting by Emerson management. We will have to watch the quarterly results closely to see how they deal with a further 15% reduction in revenues.

Grande Restructuring Update (DOG OR WOLF?????)

As a reminder Grande is the ultimate holding company of the entity that owns c. 56% of the Emerson shares. It went into liquidation in June 2011 and originally the liquidators had envisaged selling Emerson as part of the process, however, in May 2014 they reached an agreement with Grande’s main creditor Sino Bright (later revealed as an entity controlled by Mr Ho the controlling shareholder of Grande before it filed for liquidation) which envisaged a restructuring and resumption of trading on the Hong Kong exchange. Since May 2014 there has been an almost comical string of announcements declaring the delay in the publication of the restructuring circular and resumption proposal due to further scrutiny from the stock exchange regulator and promising a resolution 2/3 months after the date of the update.

It seems there has finally been a breakthrough on the 1st June 2015 when Grande announced that “the Stock Exchange has decided to allow the Company to proceed with the Updated Resumption Proposal subject to satisfying its conditions by the 21 December 2015.” The conditions are effectively the release of the shareholder circular and implementation of all the restructuring steps. This is clearly the next catalyst in the Emerson story with the Circular due on or before the 31 August 2015 (it must have happened at least 5 times).

Unfortunately only time will tell whether Grande and Mr Ho take the form of a dog or wolf. In my mind shareholder bad acts remain the biggest risk to this investment with the performance of the US white goods business coming in a distant second. I think there is a good chance that a dividend of a significant portion of Emerson’s cash balance may be part of the Grande restructuring proposal in order to ensure the company is well capitalised and also to fund the takeout of non-consenting creditors which hopefully will lead to a re-rating in the stock as the market is forced to consider the cash flow generation of the combined Emerson business vs the market cap.

A combination of the revised upside/downside metrics and my evolving thoughts on portfolio concentration I am adding an additional 2.5% to upsize my Emerson position to 7.5% of my portfolio.

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As an aside the Hour Between the Dog and Wolf is also an excellent book by John Coates who was a successful wall street derivatives trader turned Cambridge neuroscientist which examines the body’s chemical influence on risk in men. In short there is a feedback loop between testosterone and success that dramatically lowers the fear of risk in men and similarly a loop between intense failure and a rise in levels of cortisol the anti-testosterone hormone that lowers the appetite for risk across an entire spectrum of decisions.

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Investment memos

Caltagirone Editore – Q1 2015 Results, Onwards & Upwards

I originally posted about Caltagirone Editore on the 15th March 2015 where I initiated a 2.5% position at EUR 1.000 (see: original post). As is the way since adding the position the stock has got drilled falling to a low of EUR 0.820 and currently residing at EUR 0.858 a healthy 14.2% loss since initiation. However, the Q1 2015 results released on the 7th July 2015 tell a different and more positive story.

As a brief reminder Caltagirone Editore owns 6 newspaper titles, 1 TV station, an ad agency and a web portal in Italy. It is part of the wider Caltagirone SpA which is a complex web of companies that form the family holdings of Francesco Gaetano Caltagirone an Italian billionaire ranked number 258 on the Forbes list (as an aside I have a position in the holding company which I will update on separately).

At investment my basic thesis on Caltagirone Editore was:

  • Market cap was trading at a 50.6% discount to (i) cash on balance sheet, (ii) equity stakes in Unicredit & Generali, and (iii) liabilities without ascribing any value to the operating business
  • Caltagirone Editore is the second largest Italian newspaper group with c. 22.5% share of average daily readers and also has the 4th most visited news website in Italy. Pulling all the titles together the group has a 61.4% share of average daily readers in Central Italy vs Gruppo Espresso at 28.3%
  • From a macro perspective Italy has the lowest internet penetration in the European Union and the highest number of Small & Medium enterprises meaning that Caltagirone should have the time and opportunity to ride the internet wave as opposed to having been already left behind by google and other first movers
  • Finally, and most importantly, whilst Caltagirone is EBITDA negative the cash burn of the group is very small vs its liquid net assets and has been improving due to (a) reducing rate of revenue declines, and; (b) impressive cost cutting by management

So what has changed since investment?

2014 FY Results & Q1 2015 Results

The first thing that is illustrative is to look at the creation value of Caltagirone Editore at the time I invested vs today

Caltagirone Editore Creation Price (2015.07.25)

Not a huge amount has changed with cash increases (some of which will be season working capital) offsetting the decline in value of their stakes in Unicredit & Generali.

What is much more interesting and informative is the performance of the business in Q4 2014/FY 2014 & Q1 2015

Caltagirone Editore LforL Results Evolution (2015.07.25)

Positive takeaways

  • Ad revenues have shown a continued reduction in decline rate which I hoped for as Europe and in particular as Italy recovers from the crisis and is helped by Dragi’s QE binge
  • They continue to successfully cut costs to address the declining top line
  • The business was P&L EBITDA positive for FY 2014 for the first time since LTM H1 2011! This trend has continued into 2015
  • Cash burn is decreasing driven YoY and if they maintain the latest run rate you are only burning 1.3% of your c. 60% margin of safety a year

Negative takeaways

  • The pace of circulation revenue decline is increasing which is worrying. The business in the past has been able to offset readership decline which began in 2008 and as of 2013 ran at 12.2% decline YoY with price increases. If they have reached the limit the customer will bear we could see double digit decline rates on this line item
  • Cash taxes are high. I think this is because each paper is owned in a separate entity and whilst the combined group is PBT negative some of the titles are tax payers. This is really annoying as without tax they are in touching distance of cash flow breakeven

Unfortunately IR has not yet posted the 2015 annual general meeting presentation which in the past has contained useful data on the market including Caltagirone’s average daily readers which allows you to look at revenues and costs on a per reader basis which I think is a more insightful way to analyse the evolving performance of the business. As an aside I have spread annual performance back to 2007 and quarterly performance to Q1 2012 and am happy to share with people but haven’t posted as it is in a messy format. Also the business only produces a cash flow at the half and full year so we unfortunately cannot look at cash burn on a quarterly basis.

Caltagirone Editore is not for the faint hearted. Whilst there is a massive pile of cash and liquid securities vs where you are creating the company if they stop being able to cut costs or push through price increases to offset the declining readership (the pace of which has not stemmed yet) then the cash burn could absolutely balloon. Newspapers are also trophy and political assets to the owners and the Caltagirone family may value having the influence these titles bring over protecting the value in the group by shutting down struggling titles.

Ultimately I think that creating a business that has real market leadership in the 8th largest economy in the world for free and being protected by monetisable asset worth 2x your creation price is too cheap an opportunity not to have in my portfolio. Having said this I have only sized the position at 2.5% which speaks volumes although I do have a 2.5% position in Caltagirone SpA which at the time I thought was effectively a 5.0% position in the Caltagirone complex as they were effectively correlated (not sure this is really true).

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