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Axa Immoselect (DE0009846451)

Published on December 5, 2014

After publishing an analysis about TMW Weltfonds in March 2014, I am presenting  another opportunity to participate in the ongoing liquidation of several German open-end real estate funds. Similarly to TMW, Axa Immoselect is also in the final phase of selling its remaining assets. The values of the remaining portfolio were adjusted downwards several times in the past and the properties are located in different parts of Europe. Based on conservative estimates, an investment offers a potential 10% IRR over a projected five year holding period.

In case you are not familiar with this topic, I recommend to you reading first the write up about TMW Weltfonds where I give a brief introduction to this topic.

Limited downside risk due to high cash balance and large discount to net asset value (NAV)

After a three year liquidation phase the remaining assets of Axa Immoselect (the fund) were transferred to the custodian bank at the end of October 2014. After the transfer, the custodian bank decided to keep Axa Investment Managers Deutschland GmbH as investment manager. The total management fee remains unchanged at 0.6% p.a. of NAV.

The current NAV is EUR 793 m or EUR 16.47 per share. The current cash balance is EUR 375 m or EUR 7.78 per share. As of September 2014, the fund had provisions of EUR 32 m on the balance sheet. In the meantime fund management reported a reduction in provisions by EUR 15 m. The current appraisal value of the eight properties is EUR 413 m. As of December the fund has approx. EUR 30 m of non-recourse debt in its Italian entity. Apart from that, there is no bank debt outstanding. The share is currently trading at EUR 12 implying a 27% discount to NAV. More importantly 65% of NAV is made up of cash. Excluding cash the discount widens to 51%.

The fund management plans to make a distribution in late December this year. However, not all of the cash will be distributed. The management is incentivized to hold a large cash pile as they can charge higher management fees. Their official reasoning is that they need to hold the cash until all warranties and potential tax claims will expire. I assume that they will distribute EUR 168 m or EUR 3.5 in December and keep the rest as restricted cash.

Estimation of liquidation value and timing of future distributions

Originally, the fund had 65 properties before the decision was made to wind down. Today, the remaining portfolio consists of eight properties in eight different European countries:

The largest asset is a 52% holding in an office building in Dusseldorf, Germany. It’s a single tenant building leased to IKB Bank with a long term lease (more than 10 years). IKB Bank was the first German victim from the financial crisis and had to be bailed out by the German government. The bank’s operational focus has been reshiftedto the German Mittelstand and it returned to profitability in 2014. The current owner, Lonestar, is currently trying to sell the bank.

Based on the current appraisal value this asset makes up 13% of NAV. It is valued at a 5.6% gross yield or EUR 2,736 per sqm. The current valuation implies a rent per sqm of EUR 13 per month. This is slightly below the market rent. Given that the fund is not holding a 100% share a small discount to the appraisal value might be necessary. However, overall I believe that this asset can be marketed relatively easily close to current valuation.

The most problematic asset is located in Amersfoort, Netherlands. Based on current valuation, the office building contributes 9% to NAV. A number of downward value adjustments have been made in the past. However, the tenant will leave the building as the lease expires next year. So a large discount to appraisal value (up to 50%) seems to be warranted as the Dutch commercial real estate market is still in the doldrums. In addition, the asset was not included in a portfolio deal, when the fund sold all of its other Dutch buildings.

The retail centre in Antegnate, Italy, is 94% leased including a ten year lease to the anchor tenant, who is operating a hyper market in the centre (28% of space). The property makes up 7% of NAV and the current valuation implies an 8.1% yield based on appraised gross rents. Taking into account a risk premium for Southern European real estate, I believe that potential buyers might be eager to acquire the property at a 10% gross yield implying a 29% discount to the current NAV.

The fund owns a complex of two bordering shopping centres located seven kilometres from the city centre of Malmö, Sweden. The assets comprise 7% of the fund’s NAV. The property is 79% leased and the fund management is currently in negotiations with new potential tenants. At a 9% gross yield the property should be marketable implying a discount of 13% to NAV.

In Madrid, the fund owns a cinema complex including restaurants and parking lots (4% of NAV). The rental agreement with the cinema operator was extended recently and a new operator for the parking space was found. Occupancy rate is 92% and the valuation implies a 7.5% gross yield. With a 10% gross yield, the asset should be a very good deal for a potential buyer implying a discount to current NAV of one third.

Apart from that, the fund owns three office buildings in Prague (4% of NAV), Brussels (3% of NAV) and Luxembourg (2% of NAV). While the one in Prague is 85% occupied the other two properties face a very difficult market environment with high vacancy rates. While I apply a 10% gross yield for the Czech property, I take 12% for both Brussels and Luxembourg. This leads to a discount of 24% to current NAV for the three assets combined.

As a result, I come up with an estimate of liquidation value of EUR 14.4 per share. This implies a 20% upside to current share price. I think this is a very conservative estimate.

Going further, I assume that the properties in Dusseldorf, Antegnate, Malmö and Madrid can be sold throughout 2015 with two evenly split distributions taking place in June and December 2015. Moreover, I assume that the problem assets can be sold throughout 2016 with a distribution taking place in December 2016. This distribution should also include EUR 50 m of freed up cash. I expect the remaining cash and assets to be distributed to shareholders at the end of 2019. This leads to an expected IRR of 10.4% over a five year holding period.


I believe that the inefficiency in this market segment is the result of the large retail ownership in theses type of  funds. Many retail investors are “disappointed” and just want to get out. Moreover, their banks advise them to sell these funds and to buy other products where the bank can make money with. In addition, for retail investors there is an unfavourable tax treatment in place concerning the downward adjustment of appraisal values which can lead to time consuming discussions with tax officers. Apart from that, there is limited interest from professional investors as many of them cannot invest due to regulatory reasons or due to insufficient liquidity.

Nevertheless, part of the discount is also justified due to the limited alignment of interest between fund management and fund holders. In addition, fund holders have almost no rights of participation during liquidation process.

Overall, I am of the opinion, that at current prices the fund provides another attractive investment opportunity in the field of open ended German real estate funds under liquidation.

For the portfolio, I will therefore establish a 4% position with a price limit of EUR 12.0 starting from today.

Edit 12/5/2014: Shortly after publishing this post, the fund announced that they will distribute EUR 4.8 per share on December 18th 2014. This is quite positive and substantially above the estimate in my analysis. I will therefore increase my purchase limit to EUR 12.5  per share.


The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!

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Renk – Investment Case

Published on November 26, 2014

Renk is well positioned in a number of niche markets offering a wide range of products. The market is not giving much credit to the good operating results valuing the company at just six times operating earnings. Apart from that, a potential corporate event could emerge as a catalyst.

Renk is a supplier of propulsion equipment and test systems for a wide variety of applications. The company is headquartered in Augsburg, Germany. 35% of sales come in Germany, 23% in Asia, 22% in the rest of Europe and 15% in North America. According to the company, in tracked vehicle transmissions, slide bearings for electrical machinery and naval gear units, Renk is undisputed world market leader.

A wide product range serving different niche markets

Renk divides its business into four divisions:

The vehicle transmissions division (20% of sales) is a manufacturer of automatic transmissions for tracked vehicles (tanks and armoured carriers). The sale of vehicle transmissions is characterized by a small number of long-term procurement programs, with small volumes and only a few annual shipments. The French subsidiary provides maintenance work on the tank transmissions of the French army. This has been a long term relationship generating recurring revenue. In 2013 the company received a follow-up order for logistical services in South Korea following the delivery of an order. Also included in this division is Renk Test System that supplies testing systems for development, production and quality assurance in the automotive, rail vehicle, aviation and defence industries.

Management sees further potential in growing the aftermarket revenue as clients (in most cases the land forces of the respective country) extend the life of implemented machines. This might increase the potential to generate more aftermarket revenue going further. Concerning the demand side for new transmissions there is a mixed picture. Defence budget cuts and the end of military operations in Afghanistan and Iraq have a negative effect on demand. At the same time significant growth is expected to come from Asia-Pacific and Middle East.  Apart from that, there is also competition between tracked and wheeled vehicles. In particular smaller countries have to make a decision which type of propulsion they want to use.

The slide bearings division (21% of sales) supplies hydrodynamic lubricated slide bearings for applications such as electric motors, generators, pumps and marine propulsion. With an operating margin of more than 20% this is Renk’s most profitable segment.

In this segment the company is competing with one of my other portfolio holdings, Miba. Renk is observing an increase in competition, as competitors target this lucrative market segment. In addition, the company’s established customers from Europe and Japan are losing market share against competitors from emerging markets who are not Renk’s customers. As a consequence, margins are expected to decrease in the future. In May 2014 the company sold its affiliate ADMOS. Going forward, this will reduce revenue by roughly EUR 10 m.

Management still sees growth potential for the future. For instance, there is a trend toward local, flexible energy production and the general increase in demand for energy in emerging markets. In addition, accessing new natural gas deposits might further increase the demand for electrical and turbo machines for extraction, transport and energy conversion.

The special gear units division (35% of sales) produces gear units for fast ships and naval applications as well as stationary gear units for a variety of industrial applications as in the cement industry or power generation. Renk’s turbo gear units have capacities of up to 140 MW.

While the market for stationary industrial gear units (e.g. cement and power plants) is subject to fierce competitive pressure, Renk has a very solid position in the market for marine gear units within the special gear units division. Here Renk’s product range includes technical drive solutions for frigates, corvettes, patrol craft and mega yachts designed to run on a combination of propulsion options as required.

Comparable to the transmissions division, the marine segment is characterized by multiyear procurement programs. Turbo gear units are produced at Renk-Maag in Switzerland. The affiliate is currently suffering from the strong Swiss franc and low demand from China.

The Standard gear units division (24% of sales) includes the production of marine gear units for merchant and supply vessels, for liquid gas tankers and ferries. Also part of the division are gear systems for turbine, pump and compressor applications as well as gear units for the 5-MW offshore wind energy market and industrial couplings.

The segment is currently profiting from strong demand in the market for LNG tankers and specialty offshore vessels. Here orders are currently outnumbering the shortfall in the offshore wind energy sector, other ship projects, turbo gear units for energy production and couplings.

High margins and high return on capital can be maintained during economic downturns

Renk - operating performance

The company showed strong top-line growth until 2008. After that the order book dropped from more than EUR 400 m to below EUR 300 m, but since then has recovered to EUR 650 m. Margins were not affected by the downturn. Over the last two years revenue also recovered to the pre-crisis level. Given my assessment of the company’s four divisions above, I believe a stable revenue development going further can at least be expected.

Margins grew until 2007 together with revenue and have been pretty stable since then. Return on capital looks very good. Management makes the following statement regarding the calculation of capital employed in the annual report:

For capital management purposes, the company’s capital employed (CE) comprises total assets excluding financial funds and tax assets, less all accruals and liabilities other than financial debts, pension accruals and taxes. Additionally eliminated from CE are any material M&A-related effects produced by finite-lived tangible and intangible assets. Prepayments received are not deducted unless they have already been applied to contract work.

There are two things I want to know. First, to what extent prepayments applied to contract work influence CE. Second, how much unrestricted cash Renk has available.

In Renk’s balance sheet prepayments make up a large contribution to current liabilities. Deferred revenue increased from EUR 63 m in 2004 to EUR 133 m in 2013. According to the annual report, CE at YE 2013 was EUR 167 m.  All the components of the CE are available from the report except from M&A related effects (which I believe are not material) and prepayments applied to contract work. Assuming that M&A related effects are EUR 10 m, I estimate that prepayments applied to contract work come close to EUR 115 m or 86% of total prepayments at YE 2013. Hence, prepayments have a substantial effect on working capital and return on capital employed (ROCE).

Apart from that, I can also use my estimate of prepayments applied to contract work to come up with an estimate of unrestricted cash. Assuming that 14% (=100%-86%) of prepayments have not been applied to contract work yet, I can deduct them from the cash balance to receive an estimate for unrestricted cash.

Gross OCF is operating cash flow before changes in working capital. In Renk’s case I prefer this number as working capital fluctuates quite a lot (mostly due to prepayments). Overall, cash flow generation seems to be very healthy. In addition to that, the company grew book value at an annual CAGR of 16.4% from 2004 until 2013 (after dividend payments and without undertaking any share repurchases).


Renk has a market cap of EUR 530 m. The company has no outstanding debt financing on its balance sheet. Net cash is EUR 117 m after pension liabilities and prepayments not applied to contract work. This implies Renk is valued at just six times its operating profit.

Renk’s uncertain future as part of  Volkswagen Group

Renk has been part of Munich based MAN since 1923. MAN owns a 76% stake in Renk’s capital stock. Renk is therefore fully consolidated in MAN’s financials. Over the years there were rumours coming and going that MAN could either sell Renk or fully integrate it. However, nothing happened.

Within the MAN Group, Renk is part of the “Power Engineering business area”. Apart from Renk, this includes MAN Diesel & Turbo which according to the company is one of the world’s leading developers and manufacturers of two-stroke diesel engines for propulsion systems in large ships, in the development and manufacture of four-stroke diesel engines built into smaller vessels and used as auxiliary engines, and in four-stroke engines for electricity generation at power plants. This business area generates 25% of MAN’s total revenue or EUR 3.9 bn.

In 2011, Volkswagen gained control of MAN. Two years later they reached the threshold of 75% of MAN’s capital stock, which enabled Volkswagen to sign a profit and loss transfer agreement (Beherrschungs-und Gewinnabführungsvertrag) with MAN. Together with MAN and Swedish Scania, Volkswagen is currently in the process of consolidating its commercial vehicle business segment.

Volkswagen has three segments: the passenger car segment with Volkswagen, Audi, Skoda, Seat, Bentley, Lamborghini and Ducati, the commercial vehicle segment with MAN and Scania and the financial services segment. It’s obvious that MAN’s power engineering business incl Renk does not fit into the Volkswagen Group. It generates only 2% of Volkswagen’s total revenue and is operating in a different industry. The only overlap exists between Volkswagen and Renk Test System, where Renk delivers test systems to Scania, Audi and Porsche.

What kind of options does Volkswagen have concerning Renk?

First, Volkswagen can do nothing, in which case cash distributions from Renk to MAN will stay at roughly EUR 11 m per annum. Minority investors would keep holding undervalued shares of a quality company which is growing book value at a double digit rate paying a stable dividend (current dividend yield 2.6%).

Second, Renk could make use of its net cash. I believe that between EUR 10 and EUR 15 per share (between 13% and 19% of the current share price) are not being used for operating activities. So either an acquisition or a special dividend/share repurchase might be adequate tools to enhance the capital structure. It is highly likely that the share price would appreciate under this scenario.

Third, Volkswagen can decide that Renk will become an independent public company by either selling their shares to the public or passing them on to Volkswagen shareholders. As a consequence, an increase in free float should enhance investor interest for Renk.

Fourth, Volkswagen could take Renk private first by entering into a profit and loss transfer agreement with Renk and thereafter squeezing out minority shareholders. They could then sell Renk (perhaps together with the rest of MAN’s power engineering unit) to a competitor or financial investor. Under this scenario, it seems to be highly likely that Volkswagen would have to pay a premium over the current share price to minority shareholders. However, for Volkswagen this might be negligible given that they are already holding the vast majority and that they should be able to sell the entity at an attractive price.


Renk’s share is trading at a low multiple. Combined with an extremely solid balance sheet the company presents a favourable investment. One could argue that the low valuation is just a result of a temporary expansion or upcycle in Renk’s markets. While that is correct for some of Renk’s markets the situation is rather bleak in other markets. So the company profits from different cycles in the respective niche markets. This has an offsetting effect with regard to total revenue generation. Apart from that, a potential corporate event offers additional return for the patient investor.

In one of my last posts, I announced that I will start to accumulate a position in Renk. Based on the assumption that I trade one third of the daily volume, I have accumulated a 1.2% position from October 16th, 2014 until October 27th 2014 at a VWAP of EUR 75.9. Going further I will increase the limit to EUR 82 and I will target a 3% position for the virtual portfolio.


The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!

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Update on Eredene Capital, City of London Investment Group and AO Johansen

Published on November 21, 2014

Eredene Capital announced a tender offer, closing  on 2 December, for up to 12% of the company’s issued shares at 10 pence per share, which is close to current NAV. I will tender 40% of my holding hoping that some shareholders make no use of tendering their shares. This tender offer will lead to a payback of at least 20% of my initially invested capital. Apart from that, the company announced the already expected delisting from the London Stock Exchange. As already discussed, I do not belive that this step is detrimental to my original investment case given that the company is in the process of selling its assets and distributing the net proceeds to shareholders and given that management’s interests are well aligned with minority shareholders. To the contrary, I plan to increase my position in case that the share price decreases before the last trading day on December 10th 2014.

Edit 12/8/2014: I was able to tender 12.09% of my shares at a price of 10 pence each. Tomorrow is the last trading date. It seems that a number of shareholders want to sell their holding by accepting a large discount to NAV. Therefore, I will increase my position by 100 bps with a limit of 4.5 pence trading a max of one third of daily volume starting from today.

City of London Investment Group has been one of the best performers this year in my portfolio. I still think that the company is modestly valued. However, given that the allocation to my portfolio has reached more than 5%, I will decrease my position by 100bps selling at the current share price starting from today.  Apart from the increase in the share price, the intention of City of London Investment Group’s chairman and largest shareholder Mr. Ollif to start selling shares at 350 pence (currrent price 330 pence) could hinder further stock price appreciation. Moreover, the company recently bought a large number of shares or their Employee Share Option Plan. I am wondering why they did not make use of the lower share price level some months ago.

AO Johansen today reported Q3 2014 figures. The numbers have been better than what I expected.Management now expects the EBIT to be close to DKK 100 m for 2014. As recently outlined, I believe that the share price is substantially below intrinsic value despite the difficult market environment in Denmark and the company’s complex capital structure. I will therefore increase the current allocation of this investment to my portfolio by 100bps with a share price limit of DKK 1,210 starting from today.


The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!



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Telefonica Deutschland – A Valuation Exercise

Published on November 11, 2014

Less than one year after going public Telefonica Deutschland announced the acquisition of its German rival E-Plus from KPN. One year later, after clearance from the EU commission and a highly dilutive rights issue the deal has closed for thirty days now. As a consequence, the competitive German wireless market has been consolidated from four network operators to three. Management expects the deal to bring substantial operating and capital expenditure savings as the combined entity will spread procurement, customer service, network expansion and maintenance costs over a much larger customer base. The clearance of the merger might signal a first step towards more deregulation giving the wireless operators incentives to make larger investments in their network infrastructure. The purpose of this write up is to prepare a valuation for the combined entity.

As announced in one of my last posts, for the portfolio I have established a 3% position in Telefonica Deutschland (TEF) shares for a VWAP of EUR 3.54 on October 16th 2014. I use this price as a reference point for the valuation throughout the analysis.

Overview of the German wireless market and the regulatory environment

The graph below shows the sales trend for the different segments of the German telecommunications industry (click on the picture to enlarge):

German telecommunications market

Source: Dialog Consult

Revenues of the German wireless market remained stable over the last years at roughly EUR 25 bn (postpaid: EUR 19 bn, prepaid: EUR 6 bn). There are roughly 117 m distributed SIM cards (postpaid+prepaid) which corresponds to a penetration rate of 144%. However, a large portion of prepaid SIM cards is not active.

TEF (incl E-Plus) controls 39% of distributed SIM cards, followed by Deutsche Telekom with 34% and Vodafone with 27%. However, TEF’s market share in the important postpaid segment is much smaller with 32% slightly ahead of Vodafone and far behind Deutsche Telekom with a 37% market share. TEF has a strong position in the consumer client segment, but falls behind Deutsche Telekom and Vodafone in the business client segment. The companies’ respective market shares include mobile virtual network operator (MVNO) related customers. In Germany the largest MVNOs are United Internet and Drillisch, but there is a large number of other players. These wholesalers acquire mobile data and minutes from the network operators at regulated mobile termination rates (MTR, Mobile Terminierungsentgelte). If separated from the three operators MVNOs have a combined market share of roughly 15%.

Although the total number of SIM cards has been stable since 2011, there has been growth in the number of postpaid subscriber contracts. The major reason for that is the rise of the smartphone. The number of smartphones in use increased to 40 m at an annual CAGR growth rate of 47.7% from 2009 until 2013. Smartphones can handle the increasing usage of data. Mobile data usage measured in million gigabyte increased at an annual CAGR growth rate of 68.6% from 2009 to 2013. I expect this trend to continue due to the ongoing smartphone and tablet penetration. Smartphones are relatively expensive. Within a contract customers do not have to pay for a new smartphone upfront and they can sign for a flat-tariff which appears to be cheaper than buying data and voice on a prepaid basis. As a consequence, there is an ongoing prepaid-postpaid substitution in the German market.

Average revenue per user (ARPU) is four times higher for postpaid customers than for prepaid (incl inactive prepaid cards). Nevertheless, the increasing number of postpaid contracts has not let to increasing mobile service revenues for the whole market. To the contrary, between the first quarter of 2012 and the second quarter of 2014, mobile service revenues declined slightly by 3.7% to EUR 4.7 bn. Reasons for that are regulatory price cuts (especially roaming), fast substitution of SMS-messaging through online messages services like WhatsApp and a high degree of price competition among the service providers incl the migration to lower priced bundled tariffs.

From the first quarter of 2012 until the second quarter of 2014 the number of postpaid customers grew at a quarterly cumulative average growth rate (CAGR) of 1.6% from 52.1 m to 60.2 m. However, monthly ARPU declined at a quarterly CAGR of 2.0% from EUR 31.2 to EUR 26.1.

The regulatory impact on the industry plays a major role. In Germany there is the national regulator (Bundesnetzagentur) and on the European level there are the EU regulator and EU antitrust authorities.

National regulators (there are 28 in Europe) have often come to different conclusions how to interpret pan-European legislation/recommendation due to differing goals and most of the time detrimental to the industry’s interests. In addition, so far the EU antitrust commission tried to prevent industry consolidation to protect consumers from price increases.

In July 2014, Germany was the first large EU country where a consolidation from four to three wireless operators was allowed (so far consolidation was also allowed in Austria and Ireland). The question is, whether the approval of the consolidation in Germany marks a turning point in terms of regulation meaning that regulators will allow wireless operators to earn a higher return on capital to be able to finance the required investments in network infrastructure.

So far, the consumer friendly regulation led to declining returns on capital for the operators. Returns might have reached a level where the heavy expenditure for spectrum licenses and new state of the art networks is no longer justifiable from an economic perspective. While regulation has benefited customers in terms of pricing, this might come at the cost of low network quality. The large EU operators are currently focusing their lobbying on the EU falling behind the US in terms of quality of telecom services provided.

Indeed, while telecom revenues have been flat or declining across the big EU telcos, they have been investing little while paying high dividends to their owners. At the same time most operators are carrying high net debt on their balance sheet. I believe that regulators are beginning to consider a less restrictive stance towards the operators, which should give the industry the opportunity to stop the shareholder value destruction which took place over the last years.

First key parameter: number of mobile subscribers

In the market environment described above, TEF increased the number of users from 18.6 m (postpaid 9.5 m, prepaid 9.1 m) in the first quarter of 2012 to 19.6 m (10.6 m, 9.0 m) in the third quarter of 2014 at a quarterly CAGR of 0.6% (1.2%,-0.2%). From Q1 2012 until Q2 2014 TEF’s market share in terms of postpaid customers declined from 18.2% to 17.5%.

E-Plus increased the number of users from 23.1 m (postpaid 7.6 m, prepaid 15.5 m) from the first quarter of 2012 to 25.8 m (8.9 m, 16.9 m) until the second quarter of 2014 at a quarterly CAGR of 1.2% (1.8%,1.0%). During this period the E-Plus market share in terms of postpaid customers increased slightly from 14.6% to 14.7%.

In my scenario, the detailed forecast period runs from Q3 2014 until Q4 2019 (under consideration of the TEF stand-alone numbers for Q3 2014 which were released on November 10th 2014). In this period, I expect the German postpaid market to grow to a client base of 72 m at half the rate the market grew from the beginning of 2012 until mid-2014. This equals a quarterly CAGR of 0.8% (3.3% annualized). Afterwards, contract customer net additions should be much lower. For a country with 81 m inhabitants this appears to be a high penetration rate. However, current smart phone penetration (roughly 50%) is relatively low compared to other countries. In addition, the share of prepaid customers is still relatively high. As a consequence, the shift from prepaid to postpaid should continue for some years. Apart from that, the number of users continuously rises who have access to several SIM cards because they are using different end devices like private phone, business phone and tablet. Moreover, machine to machine (M2M) SIM penetration is growing rapidly. M2M refers to technologies that allow both mobile and wired systems to communicate with other devices of the same ability. Currently, this market segment is estimated to present roughly 6% of all SIM cards in use, and is expected to grow revenues by 17% per annum until 2017. If this scenario plays out, postpaid contracts might increase even more rapidly.

How does this translate to the TEF and E-Plus customer base? On a standalone basis, I assume that both companies will grow their postpaid customer base in line with the market at a quarterly CAGR of +0.8% defending their market share. I expect the number of prepaid clients to decline by 1% per annum mainly due to prepaid-postpaid substitution. However, given that E-Plus and TEF have a relatively large prepaid customer base where they can source postpaid clients from, an above market growth in the postpaid segment might also be a possible scenario.

Regarding E-Plus, KPN started to increase costs at E-Plus in 2013 to regain market share momentum. This extra EUR 350 m of operating expenditure (incl handset subsidies) has led to accelerated growth in net additions of customers in 2013/2014. Going forward I assume that this expansion programme is being stopped as much of this would be duplicative to TEF’s operation, but that it will have a remaining positive impact on E-Plus customers in 2015 (net additions 3.8% postpaid, 1% prepaid).

Second key parameter: average revenue per user (ARPU)

From Q1 2012 to Q3 2014 TEF’s monthly ARPU decreased from EUR 13.5 (EUR 21.4, EUR 5.3) to EUR 12.7 (EUR 19.1, EUR 5.3) at a quarterly CAGR of -0.6% (-1.1%,0.0%).

From Q1 2012 to Q2 2014 the monthly ARPU at E-Plus decreased from EUR 11 (EUR 21, EUR 6) to EUR 10 (EUR 19, EUR 5) at a quarterly CAGR of -1.1% (-1.1%,-2.0%).

I expect 2017 to be an inflection point, when ARPU should increase for the first time after several years of decline.

In 2017, non-SMS over data revenues of TEF and E-Plus should have reached more than 90%. Increase in mobile data usage should continue to more than compensate for the negative effect of falling text messaging use and stagnating voice connections. For the whole industry text messaging revenue declined from EUR 2.7 bn in 2009 to an expected EUR 1.3 bn in 2014. During the same period revenue from mobile internet access increased from EUR 2.8 bn to EUR 8.2 bn. Roughly 45% of data usage is currently routed through the 4G (LTE) network. For TEF and E-Plus this ratio should be lower as they are behind T-Mobile and Vodafone in terms of network expansion. According to TEF, data consumption for an LTE client is three times larger than for a conventional client and ARPU is roughly 30% higher. As a result, with the ongoing network expansion and additions of LTE customers revenues from mobile internet data should continue to grow between 20% and 30% per annum until 2019.

As already mentioned, TEF and E-Plus include mobile virtual network operator (MVNO) related customers in their statistics. These wholesalers acquire mobile data and minutes from network operators (Deutsche Telekom, Vodafone, Telefonica Deutschland and E-Plus) at regulated mobile termination rates (MTR, Mobile Terminierungsentgelte). Regulators have pushed for an increasing cost-based orientation in setting MTRs. The German regulator Bundesnetzagentur has continuously decreased MTRs from 8.80 cents per minute in 2009 to 1.79 cents in 2013.

This explains part of the difference between market ARPUs (EUR 26.1) and ARPUs of TEF (EUR 19.1) and E-Plus (EUR 19), as revenues generated with wholesale accesses are substantially below direct client revenues. Another reason is that premium customers are willing to pay higher prices for access to the D-network (D- Netz) from Deutsche Telekom and Vodafone. 3G coverage of E-Plus and TEFD still lags the big two operators and both competitors are ahead with the building of the LTE network. While this gap might exist for the long term, the merger between TEF and E-Plus will bring the new TEF in a better position to compete in terms of network quality.

There are two major regulatory factors affecting ARPU to look at:

First, MRTs have already been reduced substantially, but the European commission has repeatedly criticised Berlin for the rate mobile operators are allowed to charge rivals to connect calls in Germany, which are among the highest in Europe. So there is a risk that rates will be further reduced below 1.0 cents per minute in November 2014. This would then be at the lower range of the European peer group. Hence, I do not assume that after this reduction there will be large additional cuts in the future.

The second factor is roaming rates. The European Parliament approved a new roaming regulation in June 2012 that set new caps for roaming charges. The last cut took place in July 2014. This means that both the retail price that users pay for making and receiving calls while abroad, and the wholesale rates that network operators charge each other for providing roaming services have decreased since 2011 from 70 cents to 20 cents per MB, from 11 cents to 6 cents per SMS from 35 cents to 19 cents per call out minute and from 11 cents to 5 cents per call in minute. However, despite these reductions these rates are still much higher than average national tariffs compared to relative costs.

In addition to that, in April 2014 the European parliament voted to end roaming fees within the European Union from December 2015. According to the proposed regulation, any service offered by a mobile operator must not cost more when roaming inside the EU than on the mobile operator’s own network (“roam like at home”). However, considerable delays in the process of agreeing the legislation and resistance to a number of its elements can be expected as the proposal implies some severe consequences. For instance, a customer could just switch to a lower-cost operator outside of his home nation and then use his phone to make and receive calls anywhere in Europe, without ever incurring roaming charges. At the same time the operator would not have to invest in any network. Obviously, regulators are aware of these issues and it is unlikely that this scenario becomes reality. Nevertheless, the new rule should tailor a single EU market for mobile services favouring pan-European operators like Telefonica Deutschland which is actually a listed affiliate of Spanish big telco Telefónica. In addition, the decrease in roaming tariffs could be partially made up for by additional usage due to lower prices. Apart from that, thanks to growing global usage of non-EU roaming tariffs, which are not regulated, could also make up for part of the income decrease. However, ultimately it should be expected that Telefonica Deutschland will completely lose a very profitable revenue stream either in 2016 or at a later point in time.

How does this translate to the TEF and E-Plus ARPU? I estimate that postpaid ARPU will decrease by 2% in 2015, will be flat in 2016 and will then increase by 2.5% per annum until 2019 based on the assumption that the increase in data usage and reduced price pressure will gradually outweigh the short term regulatory impact and the migration from SMS/voice usage to data usage. Apart from that, I expect that after the merger the quality of TEF’s network will improve and will come closer to the network quality of Deutsche Telekom and Vodafone, enabling TEF to reduce the premium paid by customers for the D-Netz. In terms of prepaid ARPU I assume that it will decrease at an annual rate of 1% in 2015 and 2016 and will then be stable until 2019 reflecting a lower usage of data services than in the postpaid segment.

Arising uncertainty from the agreement with German MVNO Drillisch

To receive clearance from the European Commission for the acquisition of E-Plus, TEF agreed to sell upfront 20 % of its combined mobile network capacity to Drillisch (measured with mobile data usage) using a Mobile Bitstream Access model, with the opportunity to extend up to an additional 10%.

There is only limited information available about the details of the agreement. It will become effective in January 2015 and will give Drillisch the opportunity to gradually increase capacity used to 20% until 2019. In addition, the agremment provides Drillisch with two extension options for additional five years. Drillisch can take over up to 600 stores from E-Plus and TEF. Drillisch will be the only MVNO having exclusive access to TEF’s LTE network for a 12 month period. As far as I understand, Drillisch will also contribute to the extension of TEF’s network. They will make an upfront payment of EUR 150 m to TEF in 2015.

For a small company like Drillisch with revenues of roughly EUR 300 m this deal provides a great opportunity. However, it also comes with tremendous risk, as they have to pay upfront for the use of capacity and have to substantially increase their cost base to deliver sufficient customers.

What are the consequences of this deal to TEF? As I do not know the purchase conditions for the mobile data under the agreement, it is difficult to come up with an estimate of the effect on the income statement. TEF’s management is eager to emphasise that the conditions were negotiated on commercial terms. In terms of capacity TEF plans to reduce network sites by 14,000 units during the integration of E-Plus. So I assume that there will be enough capacity for TEF’s and Drillisch’s combined expansion plans. Overall, I think it is conservative to assume that network revenues from Drillisch equal expenses. Hence, I expect that the Drillisch contract is neutral on EBITDA and EBIT in the P&L. As a consequence, I ignore the revenue contribution from Drillisch. To be consistent with this approach I do also exclude the EUR 150 m upfront payment from Drillisch to TEF in my scenario.

Revenue projection

Apart from the main revenue component mobile services which I described above, I assume that handset revenue after reaching its peak in 2013 is slightly declining due to lower growth rates in net additions to postpaid subscribers and falling prices for smartphones.

TEF is also operating a wireline business offering fixed telephony and internet (narrowband/broadband) accesses to direct clients and wholesalers. In this segment the company has been steadily losing DSL customers. There is growing competition from cable operators due to rising demand for broadband speeds faster than DSL and attractive offers of triple play bundles of TV, Internet and wireline voice. Cable operators also have a competitive advantage as wholesale fibre pricing is deregulated. With fibre pricing deregulated, cable operators can charge high prices from wireless operators to prevent them from entering the market. At the same time, they have access to subsidized mobile phone service which they can include in their offerings to attract new customers.

Apart from that, the resale of TEF’s ULL (Unconditioned Local Loop) is expected to be discontinued in 2017, as resellers are increasingly migrating to other operators.  TEF is now in the process of using the fast VDSL network from Deutsche Telekom for resale to its clients. While this might stabilize the company’s client base over the long run, I expect the current trend to continue with revenues declining annually by 5% until 2017 and by 2.5% in 2018 and 2019.

Putting this all together, I come up with the following projection of combined revenues for TEF and E-Plus over a five year detailed planning phase (click on the picture to enlarge):

Revenue projection for TEF plus E-Plus

On February 11th, 2014, the company held an extraordinary meeting to vote on the proposed acquisition of E-Plus. Attached to the report of the executive board was a valuation report of PriceWaterhouseCoopers (PWC report) analysing the merger of the two companies. The assumption made in the PWC report are mostly based on management’s business plan for the next five years. This report is quite helpful, as I can use it as a sanity check and source of information for my analysis. PWC’s revenue estimates are quite similar to the revenue projection presented above.

Projection of merger synergies, expenses and operating lease payments

As a consequence of the E-Plus acquisition, TEF expects to unlock significant value with synergies reaching EUR 800 m pa after a five year integration period. Within the PWC report there is a detailed forecast of the synergies to be generated from the merger between TEF and E-Plus. I am using these assumptions with the exception that the deal will be cash flow accretive only from 2016 on and not 2015 as PWC and the management is projecting:

Projection of net savings from the merger of TEF and E-Plus

PWC (and TEF’s management) argues that the net present value (NPV) of synergies is roughly EUR 5.5 bn. However, it is noteworthy that this projection is based on a discount rate (cost of equity) of 6.6%. Hence, the NPV of net savings might be exaggerated. Using a more realistic discount rate (8%) and the same cash flow stream as in the PWC report incl a 0.5% terminal growth rate, the NPV declines to roughly EUR 4.2 bn.

Both companies TEF and E-Plus have substantial operating lease liabilities with regard to the sales network (i.e. shops), antenna sites and network equipment. For my DCF model I am using free-cash-flow-to-the-firm (which is before interest payments). Therefore, I need to add all liabilities to the enterprise value computation incl off-balance sheet items like operating leases. However, as operating lease payments are treated as operating expenses in the income statement, I need to make an adjustment to the income statement.  This includes the conversion of the operating lease payments into a depreciation component and an interest component. In other words, I am converting the operating lease liabilities into finance lease liabilities. As a result, I exclude the operating lease payment from operating expenditures (positive effect on EBITDA and EBIT). At the same time I am adding the depreciation component to D&A and the interest component to interest expenses. Hence, EBITDA and EBIT will increase due to the adjustment, while simultaneously the enterprise value incl operating lease liabilities reflects the true picture of the company’s amount of debt.

Regarding operating expenses and depreciation/capex I am taking the lead from the PWC report. I have made adjustments where PWC’s estimates for 2014 differ from the extrapolated second/third quarter 2014 numbers, but these adjustments are minor. Overall a slight decrease of operating expenditures over the detailed planning period is supported by a reduction in personnel/supplies expenses at E-Plus based on the assumption that the company will reduce its large investments in customer acquisitions and a decline in material costs for both companies due to reduced interconnection prices/MTRs and declining prices for smartphones. In terms of capital expenditures, I have adopted PWC’s projection of a gradual increase until the end of the detailed planning period. I am also following PWC’s approach to include payments for upcoming auctions for spectrum in the capex computation of the terminal value. However, it is important to emphasize that they do not include potential savings from future spectrum auctions as bidding tension might be lower as a consequence of the merger between TEF and E-Plus. Savings for the operators might be substantial going forward.

Valuation – DCF approach

Based on the assumptions described above, I have computed the following forecast for a five year period reflecting the integration of E-Plus and a normative estimate for the calculation of the terminal value:

DCF forecast

Both companies have substantial tax assets. On a stand-alone basis, PWC assumes that E-Plus will start paying taxes in 2015 gradually increasing to 31.3% until 2017. TEF is expected to pay taxes starting from 2017. For the terminal value calculation they use a 17.3% tax rate. Synergies are assumed to be taxed with 30.6%. I have used the blended tax rate from these three components, although there might be additional tax synergies to be generated.

The following graph presents the drivers of EBITDA from 2014 until 2019:

EBITDA attribution 2014 vs 2019

As a result, this financial scenario leads to a value per share of EUR 4.46. This represents a price-to-value ratio of 0.79x at the time of investment:

DCF valuation outcome

For the discount rate, I use the weighted average cost of capital (WACC). At the beginning of 2014, the company issued a seven year bond with an effective interest rate of roughly 2.5%. I add 50 bps and make the assumption that the company’s cost of debt before tax is 3.0%. My estimation of the cost of equity is 8.0% based on a risk free rate of 2.0%, a beta of 1.0 and a market risk premium of 6.0%. In my scenario, I assume that the terminal growth rate is 0.5% slightly lower than long term GDP growth. Below you can find a sensitivity analysis of the price-to-value ratio in relation to the cost of equity component of the WACC and the terminal growth rate:

Sensitivity I

As mentioned above, for the revenue forecast I assume that net postpaid subscriber growth equals 3.3% per annum during the detailed planning period. At the same time, I expect postpaid ARPU to rise by 2.5% per annum from 2017 until 2019. The following table provides a sensitivity analysis of the price-to-value ratio in relation to annual net postpaid subscriber growth and postpaid ARPU (while keeping expenses stable):

Sensitiity II

Valuation – peer group analysis

The table below provides some key figures and ratios for companies of the telecommunication industry as of YE 2013:

Peer group analysis

From my perspective, there are three key takeaways in comparing TEF to its other industry members. First, the market seems not to give any credit for TEF’s relatively low debt level. Second, I believe that the market has yet to ascribe any value to the potential rise in profitability due to the generation of synergies from the E-Plus acquisition. In addition, the current EV/EBITDA multiple is also modest when considering the company’s substantial tax assets, which will lead to a reduced tax rate for a number of years.


In this analysis, I value a business of average quality that is part of an industry which is currently under severe regulatory pressure. While I incorporate substantial net savings from the merger with E-Plus there is still significant potential for value enhancement coming from a more deregulated market in the future which I do not include in my valuation. Apart from that, TEF seems to be a platform for Spanish Telefonica to create a German telecommunications business not only restricted to the wireless segment. For instance, a merger with a cable operator might be an option in some years from now (see the acquisition of Kabel Deutschland by Vodafone).

I use the discounted cash flow approach to model the integration and transformation of the two entities over the next five years. The goal of this exercise is to come up with a conservative appraisal that can stand up most scenarios. While I think that considerable synergies will be achieved, I exclude potential savings from spectrum auctions and assume that the acquisition of E-Plus will be cash flow accretive not until the third year of the merger. I also take a conservative approach on the agreement with Drillisch.

I assume that the company’s cost of capital is 6.3%. The after tax cost of debt component of 2.2% reflects the current low interest environment and more importantly the company’s access to debt capital at more attractive terms than its peer group. An 8% cost of equity component might appear low, but it is still 200 bps above the discount rate PWC used in its valuation of TEF and E-Plus.

After year five I assume little growth at a rate of 0.5% for the calculation of the terminal value. Hence, I make the assumption that TEF will grow at a lower rate than GDP. As a result, I come to the conclusion that TEF’s share price is trading with a discount to its intrinsic value. This absolute perspective is supported by a peer group analysis showing that TEF’s low financial leverage and potential net savings from the E-Plus acquisition have not been reflected in the share price yet.

I used the following sources for my analysis:


The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!

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Steico – Investment Case

Published on October 19, 2014

As a market leader in terms of quantity and product diversity Steico is in a good position to continue prospering in its growing niche markets. Recently, the appearance of new capacities of competitors put pressure on margins. Therefore, the company is currently trading at a large discount to my estimate of replacement costs. However, the time has come that competitors are leaving the market or seem to be unwilling to grant further price reductions to customers. Therefore, I expect that the company will profit from an improvement in the industry’s demand supply situation. On top of that, an optimization of the capital structure and a reduction in growth capex after 2016 should gradually enhance return on equity and free cash flow.

Steico is a German building supplier of wood fiber insulation materials and wood based construction materials operating throughout Europe.

Steico is operating in different niche markets

According to the company, Steico is the European leader in the manufacture and sale of wood fibre insulation materials with a market share of 35%. This niche segment makes up only 4% to 5% of the whole insulation market based on estimates from The German “Institut für Wärmeschutz”.  The largest share is represented by organic foams (i.e. polystyrene rigid foam -Styropor) with around 40-45%, glass fibre insulation and stone wool (rock wool) insulation both have a share of around 25-30%.). Natural eco-friendly insulation products such as wood fibre are gaining popularity in the building sector and are more and more in consideration when it comes to renovation work on existing and new buildings. In Germany the awareness to understand wood fiber insulation as a conventional insulation material rose tremendously over the last couple of years. Here, the company has also a strong position in the market for loft conversions.  The sale of wood fiber insulation materials in Germany has increased rapidly from 0.1 million m3 in 1990 to 1.25 million in 2011. Over the long term the market share of wood fiber insulation is expected to increase to a level between 9% and 13%.

While Steico generates more than 60% of its revenues with wood fibre insulation, they are also producing wood based construction material. The company is the leading manufacturer of I-joists (Stegträger) in Europe. These are mostly exported to the UK with the country’s strong exposure to timber constructions. In the UK, housing starts are picking up resulting in strong momentum for segment sales in the current fiscal year. Based on the management’s information, they see increasing demand for this type of product not only in the UK but also in the rest of Europe. This segment is currently generating 11% of revenues.

The remaining revenue comes from lumber trade, specialty products, natural fibre boards and laminated veneer lumber (LVL; Furnierschichtholz).

Wide product range, efficient and integrated production and diversified revenue stream

Steico’s strategy focuses on being a system provider, offering a complete building solution for timber construction, which consists of I Joists, LVL, flooring products and different types of insulation materials. For instance, the good positioning in the sale of I-joists in the UK can be used as a door opener for the sale of insulation materials in this market. In addition, each of the company’s plants covers a large part of the total product range allowing merchants to order mixed deliveries to optimize their inventories. This presents an advantage compared to competitors as most of them have single product factories in place.

All Steico products are produced in three relatively new plants of which two are located in Poland (Czarna Woda and Czarnków) and one in France (Casteljaloux).  Raw material costs make up roughly 40% of revenue. Raw material is mostly consisting of wood. For the Polish plants the company uses pinewood and has a long term contract with the Polish forestry authority. Wood prices are fixed at the beginning of each year in an auction process. Based on the company’s information prices remained stable in 2014. In France the wood is purchased at the local lumber market.

From a geographical point of view, Germany (35% of revenue) is Steico’s largest market followed by the UK (14%), France (12%) and Poland (8%). Since 2007 most of the 63% growth in revenue has been generated in Germany and UK, while France, Poland and most of the other markets were flat or slightly declining.

Clients are trade intermediaries, construction companies and DIY chains. The largest client contributed 3.3% to revenues in 2013.

Long term catalyst for the industry

Over the long run, demand for Steico’s products should be supported by an EU directive urging member states to ensure that by 2020, all new buildings are nearly zero- energy buildings. In addition, buildings that undergo major renovation have to meet minimum energy performance requirements after renovation. As most new and existing homes are currently unable to meet the future requirements for energy consumption and thermal efficiency, the implementation of the EU directive in the member states might also lead to additional demand for Steico’s products as the year 2020 approaches. The recently completed new headquarters on the outskirts of Munich are already today in compliance with the zero-energy standard. During construction Steico’s construction and insulation products have been used. Hence, the building also provides a state of the art example of the company’s building solution to potential clients how to comply with the upcoming legislation.

Current investment programme targets margin enhancement and extension of product range

So far the company was not able to exploit the full growth potential in the I-joists segment as they faced problems in the supply of laminated veneered lumber (LVL) which is used to produce I-joists. As a consequence, management recently decided to build an in-house production facility for LVL until the end of 2015 to become independent of suppliers and increase margins in this segment. The production line will have a capacity of 80,000 m3 and is expected to break even at a 50% utilization rate. In addition, the company will be able to produce wider LVL’s than the current supplier is able to deliver. This project is the cornerstone of the company’s plan to invest up to EUR 60 m until 2016.

The other part of the investment programme comprises the production of very thin wood fiber insulation through eco-friendly wet process, where the company witnesses strong demand and low competition. Completion of the new insulation production line is expected for the end of 2014. This investment will potentially drive revenues and Steico will attain more flexibility on its capacities. Both investments represent extensions of the company’s existing plants.

The investment volume will come through a bank loan financing and operating cash flow. The company is currently very solidly financed. An optimization of the capital structure should have a positive effect on the return on equity and might therefore lead to more attention from financial market participants. In addition, the company can make use of the appealing current interest rate environment given its relatively high solvency.

Attractive access to capital, fierce competition and reverting returns on capital

The table below provides an overview of the key performance indicators since 2007:

In 2007, just at the right time, Steico went public at EUR 17.50 per share (current price EUR 5.50). The company raised roughly EUR 70 m from investors. Most of this capital was used to extend the two existing production sites in Poland and to acquire and modernize the production site Casteljaloux in France.

In 2008, Steico was hit by the crisis, but recovered quickly in 2009 and 2010. In 2011, massive pressure on Steico arose by the appearance of new capacities of competitors in the wood fibre insulation market. The expansion of many players in the market reflected the growing demand for wood fibre insulation in the years to come. As a consequence, though there has been plenty demand for Steico’s products, so far the company has not been able to return to 2009/10 profitability. For instance, the company’s production of insulation material increased by 17% from 158,934 tonnes in 2010 to 185,631 tonnes in 2013. During the same period, revenue per tonne decreased by roughly 7%.

Pricing pressure has been slightly reduced since 2013 as the consolidation process found its first victims. Finish Fibreboard closed a production site and the small competitors Smrecina Hofatex (Slovakia) and KZZP Koniecpol (Poland) both went bankrupt. Even more interesting, Swiss Pavatex, one of the strongest competitors of Steico, recently had to substantially reduce production at a one product plant in France which just had been finished in 2013. At the same time, Steico is producing at full capacity. Steico seems to profit from its large investments in efficiency, growing the product range, improving the distribution network and sales structures and to a certain extent from its larger scale being the European market leader.

From my perspective, management made use of extremely attractive access to equity markets in 2007. In contrast to Francotyp Postalia (one of my other investments), management did not burn the cash proceeds from the IPO by undertaking overpriced acquisitions. To the contrary, management allocated the capital to extend production capacities in order to react to higher demand for wood fibre products and to reinforce the company’s position in its industry.

So far these investments have not produced an attractive return on capital. Nevertheless, the company has been able to weather the overcapacity in its industry relatively well. Once the consolidation process will come to an end, I expect Steico to earn a substantially higher return on assets.

In addition, in spite of the large capital expenditures over the last years, the company’s financial position is very solid. With an equity ratio of 63% and a debt-to-equity ratio of 0.2x, banks are willing to finance the ongoing EUR 60 m investment programme at a relatively low cost of capital. Compare this to one of Steico’s competitors, Homann Holzwerkstoffe. They are currently paying a 7% coupon on their EUR 100 m five year bond which was issued in 2013.

As already mentioned, return on capital is relatively low. It remains to be seen, if Steico can translate the top line growth into an improvement on the margin side. Assuming that the European construction market will remain stable, wood fibre insulation will continue to gain market share from the conventional insulation market and that overcapacity will be reduced, I think that return on assets should easily approach 4% again. Going one step further and assuming that the current investment programme will increase total assets by EUR 40 m to EUR 200 m until 2016, potential net profit can reach EUR 8 m per annum or EUR 0.63 per share. Taking into account an improvement of the capital structure targeting a financial leverage ratio of 2 times, return on equity could reach 8%.

For 2014 management’s guidance is a 10% year on year increase in EBITDA and EBIT to EUR 23.5 m and EUR 10.2 m combined with a slightly lower growth rate in revenues.

Why market participants might hesitate to buy Steico shares

First, Steico is an owner-managed company. Udo Schramek is holding 67.2% of the share capital. This leaves only a small free float of 4.2 m shares or roughly EUR 23 m.

Second, Mr. Schramek’s wife has a board seat. Moreover, members of the board seem to be replaced infrequently.

Third, Steico prepares their consolidated financial statements under German GAAP (HGB) and investor relation material is only available in German.

In addition, the company is listed on the Entry Standard, where the reporting requirements are very low. This is aggravated by the fact, that the Entry Standard is forming a reservoir of potential delisting candidates in Germany. Due to the current legislation an investment in a potential delisting candidate presents a risk to minority shareholders.

Apart from that, in 2013 the company completed its new headquarter. Investors might ask whether there are better opportunities to allocate capital.

Most importantly, the company faces the risk of entering a period of recession while at the same time adding substantial capacity to the market once the investment programme will be finished.

What does that mean to me?

Generally, I like owner operators and the alignment of interests with minority shareholders. In this case minority shareholders could get screwed for instance by a delisting of the company. However, during my research it became obvious to me that the company pursues a transparent reporting and continuously tries to attract the attention from potential investors. This year the company held presentations at five different financial market conferences. In addition, the company exceeds the reporting requirements of the Entry Standard by releasing quarterly reports. According to the company, one of the reasons why Steico does not upgrade its listing to a higher segment of the stock exchange is the resulting requirement to change the reporting standards from German GAAP to IFRS. From the management perspective this would not be worth the effort.

Of course, a downturn in the construction market would hit the company. However, a diversified product range, broad geographic positioning and very solid financials should ensure that Steico can weather another recession relatively well. Over the long run Steico seems to be part of a growing industry.


First I will focus on what a new entrant will have to spend to reproduce a similar company like Steico:

From my perspective in Steico’s case reported asset values on the balance sheet provide a good proxy for an estimate of reproduction costs for a new entrant.

I know that management has invested roughly EUR 150 m in fixed assets since 2004 to get the company where it stands today (from company reports and the IPO prospectus). Before 2004 they had roughly 30% of today’s production capacity in place. So one could assume that the reproduction of the fixed assets costs EUR 215 m ignoring depreciation. However, net fixed assets on the balance sheet total only EUR 100 m comprising of land and buildings (37%) and machinery and equipment (63%). From my perspective it is questionable, whether the company’s production facilities have already lost EUR 115 m in value since completion. So I feel very comfortable to make the assumption that the reproduction of fixed assets costs at an absolute minimum EUR 100 m.

On top of that, to estimate hidden assets not shown on the balance sheet like the distribution network, customer relationships, IT systems and R&D expenses, I consider the annual expenses in the P&L which are used to create these assets. In 2013, the company spent roughly EUR 5 m on distribution, advertising, IT and R&D/patents. I make the assumption that hidden assets add two times worth of these costs or EUR 10 m to the total reproduction costs. Again a conservative estimate.

Current assets consist of inventory, accounts receivables and other current assets. Days of inventory showed low volatility over the last years and prices for finished goods have been stabilized recently. So I assume that the reproduction cost of inventory is in line with the reported numbers. The cost of reproducing an existing’s firm accounts receivables should be more than the book amount as some customers do not pay their bills. In the footnotes I could not figure out the amount of allowances contained in receivables. So I decided to be conservative and use the book value of receivables. Other current assets are cash or will be due in short term, so book value should be appropriate here as well.

On the liability side we have current liabilities consisting of accounts payable to suppliers and other short term liabilities. I assume that this equals the amount a new entrant would have to pay to duplicate what Steico has.

In conclusion, I come up with the following estimation of reproduction costs for Steico’s operations:

Steico has a market cap of EUR 70 m and net debt is EUR 25 m. So a potential buyer could pay a 69% premium on the current stock price and would still be indifferent between reproducing the business on his own and taking Steico private.

However, obviously the question is whether a potential entrant in the market would be interested to invest that much capital either by reproducing the assets or by acquiring Steico. Based on the current guidance for 2014, Steico would be valued with an EBITDA multiple of 5.9x and an EBIT multiple of 13.6x when using reproduction costs as a proxy for enterprise value. This appears pretty rich for a company currently earning a mid-single digit return on invested capital.

Currently, the market is valuing the company with a price-to-tangible book ratio of only 0.7x, a P/E of 13.1x and an EV/EBITDA of 4.0x. So it seems, that the market is giving the company no credit for its high solvency and asset quality which I expect to be converted in higher earnings and cash flow going forward.


In conclusion, for a potential competitor it is currently not attractive to enter the industry. At the same time there is a number of still existing small players who will potentially leave the industry due to competitive disadvantages in terms of economies of scale, product diversity and dependency on local markets. Steico could profit from this trend in the upcoming years. Combined with a more efficient capital structure and a reduction in growth capex, this should result in a higher return on equity and cash flow yields which should close the gap between market value and reproduction costs over the next three years.

In one of my last posts, I announced that I will start to accumulate a position in Steico. Based on the assumption that I trade one third of the daily volume, my target is to accumulate a 2% position for the virtual portfolio with a stock price limit of EUR 5.70 starting from October 13th, 2014.


The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!

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Renk (DE0007850000)

Published on October 16, 2014

From today on, I start buying Renk shares targeting a 2% position for the virtual portfolio with a stock price limit of EUR 75.

A write-up of my investment case for Renk will follow asap.

Edit 10/17/2014: I increase the stockprice limit to EUR 78.


The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!

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Telefonica Deutschland Holding (DE000A1J5RX9)

Published on October 16, 2014

From today on, I start buying Telefonica Deutschland shares targeting a 3% position for the virtual portfolio with a stock price limit of EUR 3.55.

A write-up of my investment case for Telefonica Deutschland will follow asap.


The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!

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Steico (DE000A0LR936)

Published on October 13, 2014

From today on, I start buying Steico shares targeting a 2% position for the virtual portfolio with a stock price limit of EUR 5.40.

A write-up of my investment case for Steico will follow this week.

Edit 10/17/2014: I increase the stock price limit to EUR 5.70.


The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!

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UMS – Add to exisiting position

Published on October 6, 2014

Since my initial write up the extraordinary general meeting held on September 25th 2014 has approved the disposition of UMS (DE). Over the last couple of days the share price trended downwards. At the same time trading volume has been relatively high.

There have not been any significant changes to my investment thesis (at least as far as I am aware of). On a positive note, management expects a higher total payout to shareholders of EUR 11.1 per share compared to my estimate of EUR 10.9. However, the second expected payment to shareholders of roughly EUR 3.6 per share might be postponed to July 2017 in case the pending court trial and the liquidation of an Italian affiliate take longer than originally anticipated. Taking these two factors into consideration the expected IRR decreases by 80 bps compared to my initial analysis (IRR:10.7%).

However, the lower share price (currently at EUR 9.3) further increases the attractivness of this investment adding 320 bps to the originally expexted IRR. Therefore, I will add to my existing position starting from today until reaching a 3.5% portfolio share with a share price limit of EUR 9.40. I am currently holding a 2.5% portfolio position which I purchased at a volume weighted average price of EUR 9.63.


The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!

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Q3 2014 Performance & Portfolio Update

Published on October 2, 2014

Below you can find an overview of the current portfolio as of September 30, 2014:

# Investment


Purchase Price

Current Price


Portfolio Share

1 Passat












3 Fairfax Financial






4 Real Dolmen






5 Lectra






6 Retail Holdings






7 Broedrene A&O






8 City of London






9 Olympic Entert.






10 Miba






11 Dundee Corp.






12 TMW Weltfonds






13 Lenzing












15 Eredene Capital






16 Lancashire






17 Francotyp






18 UMS
















1) incl dividends/interest and fx movements

The portfolio gained 1.1% during the quarter. Foreign exchange movements had a positive effect of 110 bps. Hence, excluding fx movements the portfolio performance for the quarter would have been +0%. During the same period the benchmark decreased by 3.2%. Over the last three months the top contributors to portfolio performance were City of London (+0.5%) and Retail Holdings (+0.5%). The detractors were AGCO (-0.4%) and Passat (-0.3%). During the quarter there have been four additions to the portfolio with Eredene Capital, Lancashire Holdings, Francotyp-Postalia and UMS. No dispositions were made.

Investment Update

In July, I invested in Eredene Capital. Since then they have made two dispositions. They sold a 23% share in their best performing asset Sattva CFS for GBP 1.9 m. At the same time they managed to sell their worst performing asset Matheran Realty for GBP 3.0 m. On top of that, subject to the future profitability of Matheran, they can receive another INR 200 m in September 2017. That is encouraging as I did not assume any value for this investment in my original analysis. Cash at hand is now GBP 5.4 m and management indicated that they plan to make a distribution to shareholders.

In August, the second largest shareholder Ruffer sold its 25.4% stake to the Chairman of Ocean Dial (asset manager of Eredene) for a price of 3.0 pence per share. That represents a discount of 43% to the public market price at that time and a 70% discount to my original estimate of NAV. There is definitely a lack of interest for this type of illiquid and exotic asset, but I doubt that there would not have been another investor willing to pay a higher price. For instance, Miton Group has been aggressively purchasing shares of Eredene Capital over the last months. Apart from that, it is important to note that the buyer is not a third party investor, but the asset manager. As a consequence, Ocean Dial’s interests become even more aligned with shareholder interests which I think is very positive.

Management also indicated that at some point in time they plan to delist Eredene from the AIM segment. Normally, this would be worrisome for me. However, in this case, I believe that most stakeholders are interested in a fast wind down of the company. In addition, as I plan to hold the shares until the completion of the liquidation and given the illiquidity of the listed shares the usefulness of a listing for me is limited to the reporting requirements of an AIM listed company. If Eredene was to delist there will no longer be any requirements to report interim results or announce any transactions. The only necessity would be to publish annual accounts. However, in this case I believe that this is not a game changer with regard to my initial investment case.

In my last quarterly report, I mentioned that I will write an update on Broedrene A&O Johansen (AO). The company reported half year numbers at the end of August. As already indicated at the beginning of the year revenues and profits are under pressure due to a declining market in general and increased competition. In particular, this was the case in the sanitary segment, where the third largest market participant, Sanistaal, tried to gain market share by aggressively cutting prices. Dhal which is an affiliate of Saint Gobain and the number one in this market reacted and a downward spiral started, which has not been stopped yet.

Since a debt restructuring in 2011, 72% of Sanistaal shares have been held by a consortium of banks (Danske Bank, Nordea and Jyske). It seems likely, that in the foreseeable future the consortium will try to sell Sanistaal to a third party. AO might be one of the potential buyers. Against the background that Sanistaal is holding 39% of AO’s capital, a merger of the two companies could be a potential solution for the current complex shareholding structure. Apart from that, AO’s management reported that they have been in talks with Sanistaal to acquire Sanistaal’s share in AO. However, they have not been able to agree on a price yet. Given that one of their major competitors is holding a large share of AO’s capital, no dividend payments were made for a couple of years. Management indicated that after a solution with respect to the shareholding structure, the company plans to reinitiate the payment of a dividend.

Management expects EBT to be in a range of DKK 75 m to DKK 100 m for 2014 (38% to 17% below 2013). Based on the company’s information, this year the overall market might decline by 4% to 5% and is expected to stabilize in 2015. At the end of 2014 the company will reach the end of an investment cycle and expects capex to go down to DKK 25 m for the upcoming years. At the same time D&A will be roughly DKK 45 m p.a. Assuming that the low end of the management’s target range for profit will be achievable in the upcoming years and subtracting taxes, the company is currently trading for a free cash flow multiple of 8.4x. At the same time book value per share grew by 10.4% p.a. since 2009 and the share is trading at a P/B of 0.8x.

Nevertheless, it is important to reiterate that Mr. Johansen (CEO and Chairman), though he is only holding 10.2% of the share capital, owns 52.4% of the votes. As a consequence, he cannot be overruled and this is definitely a risk for minority shareholders. Apart from that, the Danish housing market is facing a difficult environment due to the enormous amount of outstanding mortgage debt. That’s the reason why some hedge funds have been/are short the Danish krone, Danish sovereign debt and bought credit default swaps on Danish banks. So a sudden drop in investor confidence and/or a prolonged recession in the Danish housing market will affect AO. However, the company has done remarkably well after the financial crisis compared to its peers, it is relatively well positioned in the market, it has a very sound balance sheet and the valuation is very modest. Therefore, I hold the position and might increase it when the stock price comes down.

AGCO reported weak Q2 2014 numbers and lowered its guidance for the rest of the year. The market reacted disappointed sending the shares down by 18% during the quarter. Interestingly, the activist hedge fund Blue Harbour recently disclosed a 0.9% share in AGCO. In addition, AGCO’s Indian JV partner TAFE, the third-largest tractor manufacturer in the world and second-largest in India increased its shareholding in AGCO to 9.1% of shares outstanding. In September AGCO and TAFE  reached an agreement that TAFE may not increase the stake to more than 12.5% by acquiring shares in the market. However, the agreement allows TAFE to make a non-public offer to acquire all or a part of AGCO or propose another similar strategic transaction that would result in a change of control of the Issuer. Apart from that, the agreement gives TAFE a right of first refusal in case AGCO sells its global Fendt/Massey Ferguson franchise. So that’s an interesting development to watch given that at the same time AGCO is holding a 23.8% interest in TAFE.

RHJI presented operational progress with the release of the first half 2014 results. While BHF Bank and Kleinwort Benson Investors are both generating operating profits, Kleinwort Benson Wealth Management is still loss making.

Apart from that, management has reached an agreement with the co-investors in the BHF-BANK transaction to convert their ownership of 35.13% in KBG into RHJI shares. In exchange for the co-investors’ share in KBG, 41.2 m new shares of RHJI were issued, bringing the total number of issued and outstanding shares from 91.0 m to 132.2 m. As the co-investors originally injected a total of EUR 179.4 m in KBG, they actually paid EUR 4.35 per RHJI share representing a premium of 12% to the current share price. The co-investor’s shares have a lock up period until 2017. The conversion further reduces holding costs through the elimination of KBG. RHJI plans to rename to Kleinwort Benson-BHF Holdings. Though there is still a long way to go, the results and the fast implementation of the ownership conversion send a positive signal and seem to be another step in the right direction.

Portfolio Transactions in Q3 2014

Just for your information below you can find the quarterly portfolio transactions for the virtual portfolio:

Item Date

Amount in EUR

Beginning Cash Balance 7/1/2014


Eredene Capital 4/2/2014 to 8/14/2014


Miba dividend 7/4/2014


TMW dividend 7/9/2014


Passat dividend 7/15/2014


Lancashire 8/1/2014


Francotyp 8/28/2014 to 9/2/2014


UMS 9/8/2014


Interest on cash 7/1/2014 to 9/30/2014


Correct interest Eredene 4/2/2014 to 6/30/2014


Current Cash Balance 6/30/2014



The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!

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