Track Record

HIPS Performance Track Record (Q3 2015)

HIPS Performance Tracker Q3 2015

We continue to be disappointed with how much time we are actually spending on security selection and the blog which is reflected in the fact that 9 months into the blog we have only deployed 12.5% of our assets.

In the quarter we monetised Genterra Capital Inc after the owners made a combined take private and spin-off bid for the company. Whilst we were very disappointed with the clear undervalue the take private offer represented we were able to exit in the secondary market at an implied valuation of SpinCo that was ludicrously high and generated a profit of 72.8% / 1.72x MoM and an IRR of 162.3%.

Despite only deploying 17.5% of our portfolio at the peak we are up 2.8% net of costs for the first nine months against (1.8)% for the passive portfolio which is 95% invested.

Jubii Europe has reached the buy price we set in our previous article and we intend to revisit that security in the near future. In the meantime we have summarised developments during the quarter for our holdings below

Emerson Radio (MSN US)

We increased our position in Emerson to 7.5% of the portfolio post the late release of their 10K as: (i) the major risk of a negative outcome on the IRS tax investigation had been removed with Emerson achieving a positive outcome vs our case, and; (ii) the stock was trading below our entry price despite this positive news. Emerson’s main issues remain the underperformance of their white goods business and the resolution of the restructuring / liquidation of Emerson’s major shareholder, Grande Holdings, couples with the potential for bad acts by the controlling shareholder.

Since increasing our position Emerson released its June 2015 quarterly results in August which highlighted two areas of concern. The first relates to the profitability of their white goods business post revenue decline of 26.4% in the quarter which was in excess of management’s expected 15.0% decline due to discontinued lines by their customers. We had previously highlighted a concern that with lower customer orders Emerson may not benefit from the same competitive pricing from their suppliers that they were able to achieve on a higher order volume. This concern would appear to be being borne out by the fact that gross margin declined to 7.0% which is the lowest level since Q1 2014.

However, a much larger concern around the white good business is that Emerson management have actually increased their SG&A vs Q2 2014 by 11.2%. This is absolutely staggering and really needs to be addressed as the business is clearly in decline and now EBITDA negative. We remain of the view that the company should sell its white goods business or at the very least cut costs to the bone.

The second issue that is concerning us is that despite a large decrease in revenues trade receivables actually increased by $5m. It is also surprising that inventories have remained flat. We have stated in the past that the Emerson white goods business has a significant positive working capital balance (now $22.1m) and we would expect to see cash released as the white goods business declined. We hope this is just a timing issue as if not it would further point to the poor management of the business by FTI, the board and the executive management team.

Looking at the filings of the Grande Holdings liquidation they are still in the same dance of a perpetually delayed publication of their restructuring circular which is concerning as the restructuring is supposed to be wrapped up by December 2015 (seems very unlikely). As discussed before the process is very opaque and the controlling creditor / shareholder has engaged in questionable dealings both with Emerson and Grande so we will just have to keep close eye on developments.

Our updated fair value range for Emerson is $2.38 to $2.95 which ascribes no value to the white goods business and assumes the full $4.8m of dividend tax liabilities. Acquiring the stock today at $1.23 you are getting the valuable licensing business for free as the estate trades below cash. Furthermore even if you run rate Q2 2015 negative EBITDA from the white goods business and assume no working capital benefit the operating free cash flow yield would be c. 12.5%. We believe the investment thesis remains intact but will closely monitor developments at Grande as well as management actions at Emerson.

Caltagirone SpA (CALT IM)

The only major update in this story is that FCG Finanziaria, a holding company of Francesco Gaetano Caltagirone, made a takeout offer at €6.8 per share for the remaining shares of Vianini Lavori not owned by the connected parties of the Caltagirone Group. It has been recently confirmed that they have got to the 90% threshold in order to delist the company and will proceed to do so.

FCG’s offer represented a 16.5% premium to the last three months trading price but is still a 41.9% discount to our view of fair value (which does not give any value to their construction business).

Included below is our valuation of the Caltagirone complex both at investment date and as of Q3 2015 which shows that the only meaningful moves in valuation have been: (i) the increased market price of Vianini Lavori, and; (ii) the share price of Caltagirone SpA.

Caltagirone SpA Value Evolution

Caltagirone Editore SpA (CED IM)

Since our investment the CED IM’s discount to fair value has increased by 3.3% despite the underlying performance of the business significantly improving. In Q2 2015 the business posted positive EBITDA of €1.3m vs a loss of €0.4m in Q2 2014 representing an overall profitability improvement of €1.7m vs a similar improvement of €1.2m in Q1 2015. These improvements have meant that the business has moved from a €3.7m cash burn in H1 2014 to a €1.9m cash generation in H1 2015 which is a sterling effort.

The negative is clearly that revenues continue to decline with the positive performance in EBITDA being driven by continued cost cutting. Whilst CED IM’s online revenues are increasing strongly (11.5% increase in the quarter) we expect the need to see revenue stabilisation to see a real re-rating in the stock.

Hopefully the Caltagirone family will look to take advantage of the clear mispricing of CED IM in a similar way to Vianini Lavori although obviously we would hope it is at a price which more closely reflects fair market value.

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Investing in Legal / Litigation Plays

I often come across stub end securities where the remaining asset is either the subject of a dispute between the company and another party or is in the form of a litigation claim against a third party. Despite nearly all the situations trading at a substantial discount to the face value of the disputed assets/claims I have never found a security where I felt that either (a) there was a sufficient margin of safety vs the potential upside to warrant adding it to the portfolio or (b) where I had enough of an edge in evaluating the dispute / litigation to enable me to conclude that the security was mispricing the probability of success.

In this post I highlight two current situations I have evaluated where the investment hinges on the outcome of a litigation and whose securities are trading near a potential buy price. It would be great to hear from investors who have invested in similar situations or anyone who feels they have an edge in valuing the litigation assets in the two cases reviewed or others.

Jubii Europe

BUY @ EUR 0.05

Jubii is a long running liquidation that has priced at interesting levels at various times since the beginning of the liquidation process in December 2008. Today it is in the final stages with only two entities remaining and 1.5 employees.

The valuation of Jubii as of 30 Sep 2014 is as follows:

  • Cash – EUR 18,000,000
  • Accounts receivable – EUR 81,000
  • Prepaid expenses and other current assets – EUR 129,000
  • Accounts payable – EUR (690,000)
  • Other ST liabilities – EUR (281,000)
  • Provision – EUR (1,586,000)
  • Litigation Asset – EUR [?]
  • TEV – EUR 15,653,000

In arriving at this valuation I have excluded current tax assets of EUR 277,000 as the company is loss making (and has no revenue) so it is difficult to see how these could be monetised (outside of winning the litigation). Also worth noting that only the cash balance is as of September 2014 as Jubii only provides balance sheet granularity in their half and full year results.

Jubii has total shares outstanding of 311,576,344 (excluding treasury shares) which would put the current fair value at EUR 0.05 a share. However, this valuation is an overstatement from a margin of safety point of view as the enterprise is not generating any income and is currently burning through c. EUR 1,500,000 a year from a combination of the general running costs and the costs of pursuing the litigation.

Jubii’s litigation is being mounted by their Swedish subsidiary Yarps Network Services AB against the Swedish telecom company Telia Sonera for abuse of a dominant position in relation to the internet access business previously offered in Sweden. In another lawsuit by the Swedish Competition Authority, based on similar facts, a fine was imposed on TeliaSonera by the Stockholm District Court in the amount of 144 million SEK. TeliaSonera appealed the fine before the appellate Market Court and in 2013 the Market Court found that TeliaSonera had abused its dominant position through margin squeeze; however for a shorter period of time and the fine was lowered to 35 million SEK.

In Jubii’s case the face value of their claim against Telia Sonera is SEK385m which is worth c. EUR 41m today. The litigation was started in May 2011 and there still has not been a judgement in a court of first instance. Jubii has stated that delays have been caused by last minute objections from TeliaSonera and in their most recent report dated Sep 2014 Jubii updated that “The Stockholm District Court informed Yarps in October that the responsible judge in Yarps’ proceeding against TeliaSonera has retired and a new judge and assistant judge have been appointed to the case. This might result in further delay.”

Jubii has guided that the face value of their litigation claim is c. EUR 45m which was accurate in May 2011 when the litigation started and the SEK/EUR exchange rate was 0.112 but today the claim value will have diminished slightly to EUR 41m based on the current exchange rate of 0.107 and assuming the claim value is SEK 385m as reported on their lawyers website (Hammarskiold AB)

In order to pursue this claim the estate burnt EUR 741,000 of cash in H1 2014 on top of its normal running costs of c. EUR 250,000 for the period (my estimate). Given that almost four years have passed since the claim commenced and the most recent comments from Jubii on the status of the case a conservative assumption for the remaining time to a decision in first instance would be 3 years. I assume annual running costs of EUR 1,500,000 a year for a total cost of EUR 4,500,000. The one area of upside to this assumption could be that the provisions on the balance sheet already capture an estimation of Jubii’s future costs ex. the litigation which would mean I am double counting. It is also worth noting that in most courts the winner of a litigation will have their costs covered although this could be also be a downside for Jubii (unclear whether they could just liquidate Yarps without a look through claim onto the parent if they lost the litigation).

Adjusting my valuation for the remaining cost to a first instance decision gets me down to a fair value of EUR 11,153,000 or EUR 0.0358 per share. The share price close as of 20th Feb 2015 was EUR 0.052 which gives an enterprise value of EUR 16,199,888 which implies that the market is valuing the outcome of the litigation at EUR 5,046,888 against expected litigation proceeds of EUR 45,000,0000 (I have assumed the EUR 41m face value of claim plus cost recovery of EUR 4m).

In evaluating the risk/reward presented by Jubii I thought about it along two lines. First you could infer the probability the market is ascribing to Jubii being successful based on the implied value the market is ascribing to the claim (current market value less fair value) over the total size of the claim. Doing this maths would imply that the market is pricing in an 11% probability of success (21% if you factor in EUR 4.5m of cost awards to TeliaSonera if they win)

A second way of evaluating the risk reward is to look at your payoff ratio. In the case of Jubii you conservatively stand to loose EUR 9,546,888 (assume cost awards of EUR 4.5m if TeliaSonera wins) against a payoff of EUR 45,000,000 or a ratio of profit to loss of 4.7x.

Neither of these two ratios seem awful (particularly when compared with the Unitech example, albeit it is better in other ways) but my fundamental issue is that I could not do any research on the underlying asset (i.e. the litigation case). A big part of this was the language barrier, I was not even able to find the ruling of the Swedish Competition Authority and compare it with the Yarps claim (assuming either of these things are even public like they would be in the US or UK). Even if I had the competition authority’s case it is likely to be extremely complicated and fact specific making it difficult to assess the merits of Jubii’s case

I would add Jubii shares to my portfolio as a 2% position if the stock go to EUR 0.05 which would represent a 5 to 1 profit to loss ratio and seems like a reasonable payoff particularly as this ratio reflects cost awards to TeliaSonera which I am not sure they would ultimately recover if Yarps is liquidated on a loss (without cost awards it is a 8.9x payoff ratio).

Unitech Corporate Parks Plc

BUY @ £0.025

Unitech Corporate Parks was a London aim listed company that invested in Indian commercial real estate focused on the growing IT sector. On the 11th June 2014 the company announced that it has entered into an agreement with Brookfield Property Partners to sell all the assets of the group and dividend all the proceeds back to shareholders.

In consideration for the sale Unitech received £205.9m of gross assets less £15.7m of disputed assets held by two institutions and £1.2m payments to Unitech prior to completion resulting in £188.9m of cash being received by Unitech

The company made an initial distribution to shareholders of £177.3m on the 16th January 2015 which leaves the following assets

  • Cash – £11.6m
  • Disputed deposits – £15.8m
  • Winding Up costs of – £(3.6m)
  • Cost contingency – £(4.0m)
  • Tax contingency – £(4.0m)
  • TEV – £15.8m

The disputed deposits related to two cash deposits made by two of Unitech’s joint ventures (G2 & G1) into two different funds:

  • SREI Infrastructure Fund (on behalf of G2) – £9.731m
  • Aten Capital Pvt (on behalf of G2) – £0.241m
  • Aten Portfolio Managers Services Pvt (on behalf of both G2 & G1) – £5.791m

Interest is accruing on the SREI deposits of at a rate of 10.6% and 16% for the Aten deposits. In the £15.8m disputed deposits balance £1.14m of accrued interest is included.

One worrying comment in the disclosure is “the board is of the opinion that these transactions were not conducted in accordance with the group treasury policy.” However, more encouraging is the following:

“The maturity date in respect of all amounts deposited and invested has now expired and repayment has been demanded. No repayments have yet been received although the counterparties have failed to provide any justification for not returning the deposits and investments.

The Company has engaged English and Indian lawyers to assist in their recovery. The Board has received legal advice that, in the event that repayment is not forthcoming, the Company has recourse to alternative means to obtain redress and therefore continues to believe that the value of deposits and investments will be recovered. Accordingly, the Board has concluded that these amounts should be recorded in the Statement of Financial Position without impairment.

It is worth noting that G1 & G2 are real estate joint ventures with the Indian based Unitech which was a holder of 16% of the equity in Unitech Corporate Parks and also the source of some major shareholder dissent over loans and other practices that flouted good governance. All of that said they are also owed significant sums from these parties and should be helping on the ground.

In terms of the dispute parties SREI is a listed company and whilst it appears to be very levered based on quick review of market cap to total enterprise value (88% loan to value) it is not clear why they would not be honouring their debts. Aten is a harder company to evaluate as it is private and seems to have a number of business streams from corporate advisory, Indian debt recovery (ironic) and Indian fund management. Aten’s founder was previously the managing director for DE Shaw India and before that a MD at GE India both respectable firms. I cannot decide whether this is a warning sign (why would upstanding firms not pay money owned) or a positive sign that the money will ultimately be recovered.

In terms of the Indian debt recovery process I have very little insight or experience into the process. Turning to the world bank they rank India as 6 out of a scale of 1 to 12 for strength of legal rights. Whilst this might sound average countries such as Ireland, Finland and the Czech Republic score a 7. In the World Bank’s “Doing Business in India” Report (unfortunately dated 2009) they made the following salient points

  • In India, across the 17 cities, it takes on average 961 days to enforce a contract, faster than elsewhere in South Asia
  • Overall court costs and attorney fees across India add up to an average 26.6 % of the value of the claim, similar to the South Asia average of 27.2%
  • There is a material difference in timing depending on which state in India the claim is made 600 days to 1,420 days (Mumbai)
  • India’s population-to-judge ratio is approximately 14 judges per million people. In comparison, the ratio of judges per million people is 51 judges in the UK, 58 judges in Australia, 75 in Canada, and 107 in the US

The cash balance left after the extraordinary dividend was sized to cover the liabilities as outlined. Of those liabilities it is worth noting that the winding up costs have jumped up from a £1.2m estimate provided by the board in September. In the board’s opinion this estimate should cover all costs to achieving a final dividend by way of members voluntary liquidation. The board has received advice that no tax should be payable on the Brookfield transaction but they wanted to hold the £4m tax contingency until the filing of their tax returns on the 31 March 2015.

General

  • NOSH – 360,000,000
  • Px – £0.02725 (as of 20th Feb 2015 close)
  • Market Cap – £10,980,000

Downside Case

  • Cash – £11,700,000
  • Running costs to liquidation – £(3,600,000)
  • Additional Litigation costs – £(3,950,000) [assumed to be 25% of claim amount as per world bank guidance]
  • Net Recovery – £4,200,000

MoM – 0.42x

Profit / (Loss) – £(5,660,000)

Upside Case

  • Cash – £11,700,000
  • Running costs to liquidation – £(3,600,000)
  • Litigation recovery – £15,763,000
  • Net Recovery – £23,863,000

MoM – 2.43x

Profit / (Loss) – £14,053,000

The share price of Unitech is pricing in a c. 40% probability of success and a 2.48x pay-out to loss ratio. Given the straight forward nature of the claim this would seem attractive, however, I have serious concerns about the jurisdiction and likelihood of recovery and as a result think this represents good risk reward if you are getting a 3 to 1 pay-out ratio on your win vs loss scenario. The strength and straight forward nature of the claim (I gave you cash under terms that have not expired give it back) are offset by the difficult nature of the legal jurisdiction, lack of clarity on the issues as well as time and cost to resolve.

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