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Eredene Capital (GB00B064S565)

Published on July 13, 2014

The following investment case concerns a security which is very thinly traded and where only limited information is available. The author owns the security.

This private equity investor is currently in the process of liquidating its Indian investment portfolio. Despite an improved sentiment in the course of the Indian elections in May, the stock trended downwards, currently offering a 44% discount to NAV. Based on current NAV and  assuming that the company will be liquidated until September 2017, an investment offers an 18% IRR and a 1.6x equity multiple over a 40 months holding period.

Eredene Capital is a private equity investor in Indian infrastructure operating companies. Private equity in India has been one of the worst performing asset classes. The aggregate dollars invested in India based on private equity funds from 2000 to 2009 have produced an IRR of less than 4%. The situation is even worse for investors, who piled into the country in 2007 and 2008, when the economy was expanding at 9% to 10%. Since then, growth has fallen, sliding to 5% to 6% mostly due to a slowdown in both public and private sector investment. Many investments made 6 to 7 years ago are now down 30% to 40%.

One of the major reasons is the fall of the Indian rupee, which has lost roughly 51% against the USD dollar since September 2007. This was caused by rising interest rates and inflation coupled with a reduction in foreign direct investments.

Apart from that, corporate governance standards and quality of management for many investments falls well short of the minimum standards required. In some instances, promoters acted fraudulent. At the same time legal proceedings against these promoters are complicated due to an inefficient court system. Moreover, land accumulation (for real estate and infrastructure investments) is very time consuming. A high level of bureaucracy, inefficient taxation policies and corruption complete the picture.

Based on this paper from the beginning of 2014, negative investment sentiment is expected to lead to a continued decline in allocation of funds to India in the near term as a result of slowing growth and increased competition from the next wave of emerging economies like sub-Saharan Africa and Southeast Asia. In addition, high entry valuations and a difficult exit environment are currently major deterrents to investing in India.

However, there are indications that investor sentiment has improved after the recent elections in May and that fund raising for new funds is accelerating. For the first time in 30 years, a single political party won a clear mandate from Indian voters for a five year mandate. The new administration headed by Narendra Modi, stands for a new government approach with streamlined decision making and improvement of accountability. As Chief Minister of Gujarat, Mr. Modi was already quite successful in implementing reforms and generating relatively high levels of growth. The question will be whether the new government can implement their approach for the benefit of the whole country and whether they can continue and improve the former government’s attempt to contain the current account deficit, support the currency, and better regulate the banking sector. On thursday, the new government released its budget plans.  They plan to reduce the budget deficit from 4.1% for this year to 3% for 2016/17. In terms of tax reform, the implementation of a goods and service tax was highlighted. They also announced a programme to boost infrastructure investments.

The Indian stock market has reacted very positively with the BSE SESEX increasing by 20% and the BSE Small Cap Index increasing more than 40% since the beginning of 2014:

As a consequence, overall expectations are quite high now. At the same time, Eredene’s stock price has trended downwards since the beginning of the year losing more than 30% of its value and was not positively affected by the improved sentiment. During that time GBP/INR has been more or less flat. Reasons for the underperformance might be Eredene’s listing on the AIM in London and its small market cap leading to less attention from investors.

Description of Eredene Capital

Over the last years infrastructure investments in particular have been negatively affected due to a delay in project approvals and failures to accumulate land combined with increasing interest rates. As a consequence, the number of non-performing assets increased and banks became more reluctant to provide financing. However, this has not reduced the overall need for high quality infrastructure which is one of the most important requirements for the Indian economy to make use of its growth potential on a consistent basis. Based on my information, most of Eredene’s investments provide for relatively high quality infrastructure assets with some of them meeting Western standards.

Between 2006 and 2011 Eredene Capital raised roughly GBP 90 m. After withdrawing from the Ennore Container Terminal project in 2012 and the disposition of the fund’s share in Ocean Sparkle in 2013 the company returned so far GBP 35.4 m to shareholders. The current portfolio consists of investments made in 2007 and 2008. Eredene will release its annual accounts as of March 31, 2014, at the end of July. My estimation of current NAV is GBP 24.4 m leading to a discount to NAV of 44% compared to the current market cap.

Eredene Capital is registered in the UK. Its investments are held through holding companies (SPVs) in Mauritius, which has a double tax agreement with India. Each investment is made through a dedicated pair of SPVs in Mauritius, giving flexible realisation options by allowing the sale of the lower tier Mauritian company rather than selling the investment directly. The company believes that proceeds of such sales held in Mauritius will not be subject to tax and, if remitted to the UK, may not be subject to tax there.

Eredene’s investment portfolio

MJ Logistic Services (MJL) operates a logistics center in Palwal on the Delhi-Agra Highway. The high-tech warehouse at Palwal provides both cold and ambient storage over 200,000 square feet. MJL also operates leased warehouses, and including Palwal it has a total warehouse capacity in North India of 800,000 square feet. The major ambient customer is Tata Motors. Cold chain customers include Domino’sPizza, Subway Du Pont Danisco and Unilever. MJL is dependent on two customers with one customer representing 36% of revenue and the other 33% of revenue. The company owns additional land around its current site to be developed for capacity expansion.

MJL, posted revenue of GBP 4.2m for the financial year ended March 31, 2013, a 23% increase over the previous year in Indian Rupee terms, and generated positive EBITDA.

Eredene is holding an 86% share in the company. The remainder is held by the management. Eredene’s equity injection of GBP 10.9 m in 2008 secured an initial 90% of the company, which can be diluted to 74% due to the conversion of preference shares into ordinary shares by the MJL management team following the achievement of performance milestones.

There is an interesting interview with the promoter Anil Arora available, where he explains why the company is increasing its cold storage capacity and how the company will profit from an implementation of a GST tax and increased infrastructure spending. Based on my research the promoter seems to know what he is doing.

Contrans Logistic CFS services bulk cargo and containers through the Maersk operated port of Pipavav in Gujarat. Major customers include shippers Maersk India, Hapag-Lloyd and J.M. Baxi & Co, global chemical and textile company GHCL and logistics providers Shreenathji Worldwide and Gudwin Logistics. The CFS is currently using 23 acres of its 79-acre site and has an annual throughput capacity of 0.1 m TEUs (twenty foot equivalent units, the length of a standard container). A CFS is an off-dock facility close to a port, helping to de-congest the port by shifting cargo and customs related activities outside the port itself.

The CFS is located 700m from the Pipavav port gates. Pipavav is the first privately owned port in India having begun cargo handling operations in 1996. The port’s operating company is listed on the stock exchange. Based on this press release, France’s CMA CGM Group is going to partner with one of Pipavav’s rivals to build a new container port leading to more competition. Based on this presentation, the Pipavav port grew revenues by 135% from 2009 to 2013 to INR 5.2 bn. In 2013 they generated a profit margin of 37% and a ROCE of 13%. At the same time, debt has been steadily reduced and is 20% of equity as of 2013. It is planned to increase the container handling capacity from 0.85 m TEUs to 1.35 m TEUs. In addition, Maersk took measures to increase traffic at Pipavav port by adding Pipavav to its India-Middle East-East Coast service, thereby connecting its customers in Gujarat and the North India hinterland to the US market.

Based on this document, the Indian rating agency ICRA assigned a BB- rating to Contrans Logistic in 2012. They had debt outstanding of INR 170 m. Based on the current valuation, this translates into a gearing ratio of 0.1x.  The business generated revenues of INR 133 m for fiscal year 2012 and a small profit. I could not find any information about 2013, despite Eredene reporting that revenues fell due to a decline in volume. The promoters have several years of experience in the industry and have been operating a CFS at the Port of Mundra in the North of Gujarat State since 2003. In addition, there seems to be limited competition for Contrans Logistic CFS.

Contrans Logistics’ second project is a 128-acre site at Baroda in central Gujarat which has planning permission to develop a road and rail Inland Container Depot on the busy Delhi-Mumbai freight corridor. Based on Eredene’s information, the market value of the site is at a significant premium to the original purchase price. Currently, the company is trying to sell the site.

Eredene invested GBP 5.7 m for a 44% stake in the two projects. The current valuation of Eredene’s share is GBP 6.0 m. Most of the value seems to be attributable to the land held by the company.

Although relatively small, the most successful investment to date has been Sattva Vichoor in Tamil Nadu, which is profitable and dividend paying. Eredene invested GBP 0.7 m and is holding 39% of the operating company. It operates on a 26-acre site and handles containers from Chennai Port and also provides facilities for on-site assembly of imported machinery. Customers include South Korean machinery manufacturer Doosan, NYK Line and Maersk. The container freight station handled 75,300 TEUs in 2012-13, compared to 68,000 TEUs in the previous year, an 11% increase. The business posted annual revenue of GBP 3.7 m, a year-on-year increase of 5% in Indian Rupee terms. A new 10,000 square feet export warehouse is under construction which will take the total warehousing capacity on the 26-acre site to 97,500 square feet.

Sattva Vichoor Container Freight Station is one of two joint investments with the Sattva Business Group. Sattva Business acquired a 10% stake of the investment from Eredene at the beginning of 2012. Hence, chances are good that the remainder will also be sold to Sattva. Based on this analyst report from 2008, the project was financed with debt of INR 282 m. Based on the current valuation the gearing ratio is 0.3x. Eredene’s share in the business is valued at GBP 3.8 m.

After this successful joint venture with with Sattva Business Group, Eredene invested another GBP 3.8 m for an 83% share in Sattwa Conware also located in Tamil Nadu. This Container freight station on a 60-acre site is located within reach of both Ennore and Chennai ports and the newly opened Kattupalli container terminal and has a total warehousing capacity of 74,000 square feet. However, so far the business was unable to launch its export-import container business due to a lack of the necessary Government-allocated customs staff. At the moment, the container freight station is only handling empty container boxes from Wan Hai and NYK shipping lines and domestic cargo for Ford India.

Eredene has two logistic parks in East India with investment partner Apeejay Surrendra Group, a Kolkata-based conglomerate. The two facilities are operated in a 50/50 joint venture.

The Apeejay Infra logistics park in Haldia operates on a 90-acre site close to the port of Haldia, a petrochemical hub at the mouth of the Hooghly River and the major gateway to Kolkata. It has a warehouse capacity of 140,000 square feet and a container yard of 300,000 square feet. Haldia Port has recently seen a reduction in container volumes and Apeejay’s logistics park has been impacted by a restriction on containers being handled by external CFS imposed by Haldia Port Trust. Eredene has written down the value of its investment in Apeejay Infralogistics as a result of the reduced prospects for the Haldia logistics park.

Apeejay Infra-Logistics’ second logistics park at Kalinganagar is the first purpose-built transport and warehouse facility in Orissa State and has been set up to service the local steel and metallurgical industry. The 30-acre facility has a warehouse capacity of 84,000 square feet and a container yard of 185,000 square feet. The domestic warehouse and a substantial area of the open yard are leased to logistics services provider Tata TKM.

Based on Eredene’s notes in the financial report, the SPV for this investment has entered into two deeds of undertaking with the financing bank. Under the terms of those undertakings, the SPV has agreed to provide additional funds to Apeejay Infra-Logistics in the event that there is a shortfall in the Apeejay Infra-Logistics Group’s ability to service its debt. The debt facilities provided by the bank total to INR 778.3m (GBP 7.6 m) and the undertaking is provided on a joint and several basis by the SPV and its joint venture partner. Assuming that the whole facility has been drawn, this would translate into a gearing ratio of 1.65x based on the latest valuation. However, in this article  the chairman of Apeejay Surendra states that total investment for the two projects was INR 2.5 bn (GBP 24.7 m). So it is likely, that there is more debt outstanding up to a gearing ratio of 4.4x.

Nevertheless, Eredene’s joint venture partner seems to be pretty solvent. Apeejay Surendra, is a privately held conglomerate. They own a hotel chain, have one of India’s largest privately held shipping lines and are the third largest Indian tea producer. Based on Indian credit agency ICRA, their other businesses are all graded with A grade ratings as can be seen here, here, and here. Apart from that, their hotel chain raised USD 55 m from one of Credit Suisse’s real estate funds in 2007 for a 15% stake in the company.

Eredene invested GBP 2.9 m for a 50% stake in the two logistics parks. Eredene’s share is valued at GBP 2.3 m.

Eredene is also holding a majority stake in a low-cost housing real estate project, Matheran Realty, near Mumbai. Eredene invested GBP 15.3 m. They have been trying to sell the project for quite some time, but have not been successful so far. As of September 2013, the potential sales price was GBP 3 m and Eredene wrote the realisable value down to that price in the accounts. They also reported, that if a sale is not achieved then it would be the company’s intention to work with Matheran to complete the first phase of the affordable housing development prior to any subsequent sale. This may require further funding from the company.

New Investment Manager and liquidation of the company

After withdrawing from the Ennore Project in September 2012, Eredene decided to make no further investments in new projects in India and in 2013 decided to liquidate the company. After an independent financial and legal review of the principal investments the company reported it may take until September 2016 to sell all investments and to return the sales proceeds to shareholders.

In addition to that, Eredene transferred the investment management to Ocean Dial Asset Management in September 2013. The investment management agreement is for a 24 month period and thereafter can be terminated with three months’ notice. The transfer leads to a significant cost reduction. Eredene is saying that holding costs will be reduced from GBP 1.8 m p.a. to GBP 0.85 m p.a. Ocean Dial used to be wholly owned by Caledonia Investments, a 21% shareholder in Eredene. In May 2013, Caledonia disposed of its entire shareholding in Ocean Dial to the Ocean Dial management team. The team on the ground in India is led by Raju Shukla, a former country head of Barclays Capital India. Apart from the Eredene mandate, Ocean Dial is managing to Indian public equity funds with combined AUM of roughly USD 190 m. Ocean Dial receives a capped performance fee on the sale of each investment, of 0.4% to 0.6% of the sales proceeds per investment. Should a sale of Matheran Realty not occur, Ocean Dial will manage the assets and will receive a capped performance fee which varies from 0.67% to a maximum of 5.0% of proceeds depending on the sales value achieved.

Ocean Dial is supported by Ranveer Sharma and his team to identify and execute the sale of the investments. Mr. Sharma has already worked alongside the former investment manager since the setup of Eredene Capital. The above mentioned holding costs of GBP 0.85 m p.a. include his work for the company.


Below you can find my estimations of the current NAVs, gearing and gross values for the single investments and the company:

The investments Sattva Vichoor, Contrans and Apeejay are held in the accounts at fair value and that fair value was determined by Grant Thornton India. The appraisers used a 19% discount factor for Apeejay and 16% discount factors for the other two investments. In addition, they used a terminal growth rate of 4% and a marketability discount of 15%.

I do not believe in a sale of Matheran Realty, as management has already made an announcement in this regard two years ago. So I assume that the current liquidation value of this investment is zero, but that any future injections into the project will flow back to Eredene.

The two direct majority stakes in MJ Logistic and Sattva Conwave are consolidated on the balance sheet. For the NAV computation I have used book value including goodwill arising from the original acquisition of MJ Logistic which is subject to impairment. In the notes of the latest annual report management states regarding the value of goodwill that:

“Sensitivity analysis has determined that no reasonably possible change in the key assumptions used will result in significant impairment and that there is sufficient headroom in all of the key assumptions before the carrying value becomes impaired.”

From my perspective, this is an indication that book value might be a conservative estimate of intrinsic value for MJ Logistic.

Apart from that, I have reduced the cash balance by GBP 0.6 m compared to September 30, 2013 to account for holding costs from October 2013 to June 2014.

Management has set the target to liquidate the company until September 2016. I think it makes sense to be more conservative here. I assume that half of the NAV will be returned to shareholders until September 2016 and the other half until September 2017. For the period from July 2014 to September 2017, I include holding costs of GBP 2.8 m in my calculation and I assume that Ocean Dial will receive a performance fee of 0.6% of sales proceeds in September 2017. Based on these assumptions an investment in Eredene returns an 18% IRR and an equity multiple of 1.6x.

The following sensitivity analysis shows the total returns under different scenarios based on changes in gross values of the investment portfolio and foreign exchange fluctuation (INR/GBP).

First, for the internal rate of return:

Second, for the equity multiple:


The liquidation of Eredene’s portfolio will take time. Further setbacks are likely given the difficulties to conduct business in India and the country’s current economic weakness. Expectations on the new government seem to be very high. At the same time, there is a general view that it can’t get worse after the former government. The announcements made regarding an investment programme and the implementation of a GST tax are a first step into the right direction for India’s infrastructure sector.

From my perspective, the decision to liquidate the company and to change the investment manager shows the strong influence of the two largest shareholders. Both Ruffer and Caledonia are each holding more than 20% of the shares outstanding. The decision to transfer the investment management to Ocean Dial, a former affiliate of Caledonia, is a positive not only from a cost perspective. Ocean Dial is a small owner operated investment boutique and the Eredene mandate gives them the opportunity to prove their abilities in the management of private equity investments. If successful, they should be able to attract further mandates and to grow assets under management. Apart from that, the quality of the promoters seems to be relatively good. In addition, the stock price has not reacted to the improved sentiment in India and the large discount to NAV provides a healthy margin of safety.

Since April 2, 2014 there have been no news and the stock traded in a range between 5.3 pence and 6.0 pence. Due to the stock’s low liquidity I assume that I have traded one third of the volume since then at a VWAP of 5.6 pence. This leads to a current portfolio position of 1.6%. I will add to this position until reaching a 2.5% position with a limit of 5.8 pence.


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!

3 Comments  comments 

Q2 2014 Performance & Portfolio Update

Published on July 2, 2014

Below you can find an overview of the current portfolio as of June 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






















1)      Performance in EUR inc. dividends/interest

The portfolio gained 2.3% during the quarter. During the same period the benchmark increased by 1.9%.  Over the last three months the top contributors to portfolio performance were City of London (+0.8%), Fairfax Financial (+0.5%), Dundee (+0.5%), RealDolmen (+0.3%), Equal Energy (+0.3%; sold) and Miba (+0.3%). The detractors were Broedrene A&O (-0.3%), Magix (-0.2%; sold) and Passat ( -0.2%).

Corporate risk reduction and stock market volatility

Since the last considerable market woes in mid-2012, volatility has remained at low levels in the Western markets. During the same time indices like the S&P 500, EURO STOXX 50 and DAX steadily increased and are now 50% higher. Back in 2012, when fears again peaked over Europe’s debt crisis the German blue chip index DAX lost roughly 15% from mid-March to the end of May. During the same period the volatility index VDAX spiked from 17.8 to 31.2. Since then, the VDAX decreased to a low of 11.5 in October 2013 and currently stands at 12.5. Generally, periods of low volatility are good for momentum guys, but not for value investors, as more and more investment opportunities tend to exceed their intrinsic value. In addition, many mistakes will be excused by the market during these periods (just want to mention my recent experience with Magix where I got off lightly).

Recently I read this very interesting paper from Horizon Kinetics. They state that increasing cash levels and therefore reduced balance sheet risks of the major S&P 500 components (e.g. Apple, Google, Microsoft, Johnson&Johnson, etc.) have led and will lead to low volatility of the S&P 500. Based on their paper, for the 12 largest nonfinancial companies in the S&P 500 cash as a percent of total corporate assets is 23.3% on average.

They conclude that,

“Companies like these have come to dominate the S&P 500 in recent years. With such liquid balance sheets, their stocks are necessarily much less volatile than the stocks of market leaders of the previous generation. For example, companies in a prior era, like Ford, U.S. Steel and General Motors, did not maintain anything close to this level of liquidity. Their earnings were much more volatile than those of the companies that lead the S&P 500 today. What we might be looking at is an equity market that is less volatile than the historical average.”

They add that,

“For many of these companies, the priority placed on liquidity comes at the expense of investment. Along with other headwinds discussed in past commentaries, the unwillingness to deploy cash reserves seems likely to adversely impact earnings for the largest companies and indexes going forward, such that the companies and sectors with the most attractive predictive attributes will be found outside of the major stock indexes.”

While I perfectly agree with the statements in the second paragraph, I am wondering whether high cash levels are in general predicting low stock market volatility (as mentioned in the first paragraph). So, let’s get back to the German DAX. As you can see from the chart below, volatility for the DAX (VDAX) and for the S&P 500 (VIX) have highly correlated over the last three years.

I have prepared a similar overview for the DAX as Horizon Kinetics did for the S&P 500. The table below shows cash and short term investments as a percentage of total assets for the largest 10 DAX components. In addition, I am comparing the cash levels in 2013 with 2009.

First, the ten largest DAX companies did not increase their cash level over the last four years. Second, the overall cash level stands at roughly 8% of total assets, which seems to be prudent and in line with historic levels. At the same time the DAX and the S&P 500 highly correlated in terms of volatility.

As a result, there seems to be no correlation between cash levels on corporate balance sheets of the DAX components and stock market volatility. Consequently, it seems that an increase in cash levels does not cause lower volatility. I believe that the same applies to the S&P 500 and that other factors like yield hunting due to the low interest rate environment are more important. So is it different this time? Not at all! I believe that periods of low volatility can continue for quite some time. However, the longer this period lasts, the more volatile it gets afterwards.

Investment Update

RealDolmen reported good numbers for the year ended March 2014. They also sold their French subsidiary to a French rival. Given the weak market position, the company had in France, this seems to be the right step.

TMW Weltfonds sold its trophy asset in Hamburg. However, the sales price was quite disappointing. Their largest asset in the remaining portfolio, Eastview in Paris, is now fully leased for a 12 year period. The other assets in the Netherlands face problems due to market conditions in general. They also sold one of the four Dutch properties for a gross yield of roughly 12% which is better than my estimation in my original write up. I think that a liquidation value of EUR 19.3 per share is still achievable. However, it might take longer than originally expected. At the current price, I see limited downside risk. The major problem is, that the people in charge are not really incentivised to liquidate the portfolio at the best price.

Broedrene A&O Johansen reported weak Q1 2014 numbers and lowered its annual pre-tax profit guidance from DKK 125 m to DKK 75 m “due to increased competition and uncertain market forecasts.” I plan to come up with an update on this investment.

Passat reported a revenue decline of 19.6% for the first three months. Revenue in France (82 of total) declined by 14.5%. Up to now, France used to be the company’s stronghold, so this is quite alarming. The company expects to stabilize sales with new product releases in the coming months.

In a rather opaque presentation, RHJI’s management presented the goal to achieve a EUR 60 m pre-tax profit within the next two years. This would translate into a pre-tax return on equity of roughly 8%. This seems to be at the low end of achievable returns in the private banking business under normal circumstances. In terms of valuation, this translates into a 5.3 times pre-tax profit multiple. So despite the issues the company has (as already outlined in former posts), valuation is attractive based on a moderate profit expectation.

Portfolio Transactions in Q2 2014

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

Item Date Amount in EUR
Beginning Balance 4/1/2014 6,481,937
Miba 4/1/2014 to 5/22/2014 -95,850
Equal Energy 4/14/2014 -204,652
Lectra Dividend 5/7/2014 6,779
Olympic Entert. Div. 5/13/2014 15,766
Magix 5/20/2014 110,607
Lenzing 5/26/2014 -306,855
Equal Energy Div. 5/28/2014 2,197
Equal Energy 6/13/2014 237,736
AGCO 6/27/2014 -413,846
Interest on cash 4/1/2014 to 6/30/2014 15,395
Current Balance 6/30/2014 5,849,214


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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Published on June 27, 2014

This farm equipment manufacturer has a strong presence around the world and is therefore very well positioned to profit from growth in farming in the developing world. Increasing world population and a reduction in the number of farmworkers provides accelerating demand for efficient farming equipment. The company’s diversified revenue stream does also help to reduce weather related risks which play a major role in the farming industry. In addition, a wide range of products are helping the company to differentiate itself from its competitors. Apart from that, management makes substantial progress in improving profitability. On top of that, the company is currently in the process of repurchasing 10% of shares outstanding and seems to be focused on increasing shareholder value. Currently, the market seems to be afraid of a softer demand in the US and Brazil ignoring the progress in profitability and the long term growth potential for this company.

AGCO manufactures tractors (60% of revenue), hay tools and forage equipment (9%), grain storage systems and protein product equipment (7%), combines (6%), and application equipment (5%). In addition to sales of new equipment, the replacement parts business (13%) provides a less cyclical higher profitable revenue stream for the company. Since most of their products can be economically maintained with parts and service for a period of 10 to 20 years, each product that enters the marketplace provides them with a potential long-term revenue stream.

The company has established a distribution network of 3,100 independent dealers and distributors in more than 140 countries.

AGCO Finance provides retail financing (83% of total) and wholesale financing (17%) to Agco’s dealers. AGCO Finance is a joint ventures owned 49% by AGCO and 51% by Dutch Rabobank. The majority of the assets of the retail finance joint ventures represents finance receivables. The majority of the liabilities represents notes payable and accrued interest. Rabobank provides financing to the joint venture. So AGCO does not guarantee the debt obligations of the joint ventures (except from a small amount). The wholesale receivables are either sold directly to AGCO Finance without recourse from AGCO or AGCO Finance provides the financing directly to the dealers. The total finance portfolio in the joint venture was approx. USD 9.4 bn (88% of revenues) as of December 31, 2013. AGCO Finance’s assets are not consolidated on AGCO’s balance sheet and earnings of the retail finance joint venture are only included in “Equity in net earnings of affiliates” in the P&L. In 2013 the joint venture contributed USD 48.8 m to AGCO’s net income (8% of total net income).

Geographical Diversification

The company generates 51% of revenues in the EMEA region (Europe, Middle East, Africa). Europe in general is a mature market dominated by replacement revenue where growth potential comes from new technologies. However, the management sees attractive growth opportunities in Eastern Europe due to underinvestment in the past and low productivity. The company has extended its dealer network to profit from a potential increase in investment activity in this region. Apart from that, the company is also planning to expand its operations in the African markets.

North America contributes 26% to revenues. An increase in farm income over the last couple of years has led to a strong market for farm equipment. In addition, given the low interest environment, farmers have been refreshing their fleet to lower the lease rate and renew warranties. For the coming years, the company forecasts a softer demand. This might be also due to an expiration of a tax break concerning the accelerated depreciation of equipment purchases. The company has a good position in the middle sized horse power segment. Nevertheless, going forward management wants to grab a higher share in the more profitable market for high horse power tractors. They have been working on improving and consolidating their dealership mainly due to a collaboration with the Caterpillar dealer network. In addition, they plan to import low horse power tractors from their plant in China to offer a low priced alternative to small farmers.

19% of revenues come from South America. AGCO has a very strong presence in Brazil with a market share of 40% in the tractor segment. AGCO lost market share to Deere over the last couple of years, as the world largest tractor manufacturer grabbed market share with a low price strategy. Over the long run, Brazil is expected to add 2% to 3% of new production capacity per annum. In addition, given AGCO’s large product range, the company also profits from a shift from standard products to special products. Farm income has been quite strong as Brazilian farmers profit from the weak currency and input costs in USD make up only 40% of total input costs. However, Brazil is currently suffering from a lack in financing due to a delay in the Government financing programmes and rising borrowing costs. This leads to softer demand in 2014. From January to May 2014 AGCO’ tractor sales declined by 16% year over year combined to 20% for the whole market. The decline has been lower for AGCO during the first two months of the second quarter while the market continued its weak performance (9% for AGCO vs. 18% for the market)

Currently, Asia plays a minor as the company generates only 4% of revenues in this region. In China, the company is still in the start-up phase. They have a new production site with a capacity of 30,000 tractors per annum located in Changzhou (close to Shanghai) exporting tractors mainly to the US and other developed markets. This is expected change as management wants to participate in the urbanization trend in China. As more and more farm workers move to the cities China needs higher efficiency production and agricultural machinery to develop their arable land. In India the, the largest market for low horse power tractors, the company participates through license payments from third party manufacturers.

Continuous extension of product range and product differentiation

AGCO is now focusing on internal product development and integration of existing brands. Historically, the company has grown through acquisitions. Acquisitions include Massey Ferguson in 1994, Fendt in 1997, Challenger in 2002, and Valtra in 2004. The recent acquisition of GSI in 2011 led to an attractive extension of the company’s product range as AGCO entered the market for grain storage and protein product equipment. In this segment, management sees ample room for growth for the following reasons:

GSI is a relatively high margin business and management is looking to shift revenues from GSI’s home market in the US to its European, South American and Asian markets. In terms of cross selling products, it also helps to differentiate its product range from larger competitors like Deere and CNH.

With regard to grain storage a relatively large share of grain harvest is wasted due to insufficient storage capacity in the emerging world. With increasing demand for food, this problem can be solved with improved food storage equipment. In addition, farmers are incentivized to invest more in food storage due to the increasing volatility of crop prices. Having the opportunity to store the harvest, enables them to wait for the right time to sell their crops to the market.

In general, an increasing demand for animal protein products in the emerging world is good for GSI. In addition, this segment is somehow countercyclical as lower grain prices increase profit margins for stock farmers which should lead to increased demand for protein product equipment stabilizing the overall business.

Operating Performance and margin enhancement

Over the last couple of years AGCO has been able to enhance profitability. Management targets a 10% operating margin within the next two to three years (2013: 8.4%). The progress in margin improvement is due to the following reasons:

Material costs make up a large portion of total costs. The company is in the process of converting from a regional purchasing organization to a globalized organization. As a result, better buying power is a key driver to reduce input costs and improve profitability.

In addition, management has been heavily investing in existing plants to achieve productivity gains. AGCO is a multi-brand company comparable to Volkswagen or GM in the automotive industry. To become more profitable, they are currently working on a platform solution (as Volkswagen did some years ago) to streamline production. Capital expenditures should reach its peak in 2014. This should translate into higher free cash flow margins starting from 2015.

On top of that, management focuses on the sale of higher horse power equipment to professional farmers in the developed markets to achieve margin enhancement.

Risks and Red Flags

In terms of working capital management, the company experienced a spike in its inventory levels in Q1 2014. The below table shows, that days sales in inventory jumped 25 days both quarter over quarter and year over year:

During the Q1 2014 conference call, management stated that they are “dissatisfied” with the current situation. They target an inventory level for the end of the year 2014 which is below the Q4 2013 level (DSI of 98). At least, comparing finished goods and replacement parts with raw materials and work in process there is no negative component divergence, as the increase in days sales in finished goods/replacement parts is in line with the combined increase in days sales in raw materials/work in process. This means that finished goods do not pile up in excess of raw materials and work in process which would be an indicator for future inventory write downs. Nevertheless, the run up in inventory is a concern and I will monitor this closely over the next quarters.

Apart from that and a potential economic downturn in AGCO’s markets, I see the following risks:

AGCO’s business model heavily depends on the availability of affordable financing and the credit quality of the finance portfolio. An increase in interest rates and/or a lack of financing provided by the company’s joint venture partner Rabobank could harm AGCO’s business. In addition, given the size of the portfolio relative to the joint ventures’ level of equity, a significant adverse change in the joint ventures’ performance would have a material impact on the company’s operating results.

Though the company is highly cash generative a significant portion of the operations are held through foreign holding companies. As a result, it is difficult from a tax perspective (as for most other US multinational companies) to repatriate cash back to the US. This hinders the potential of the company to return capital to shareholders.

In addition, in many markets demand for the company’s product depend on Government schemes and subsidies. Moreover, the company is currently profiting from low steel prices, which could change when excess capacity in the steel industry is reduced.

Valuation and competition

AGCO competes primarily with Deere and CNH. Deere is also involved in the forestry and construction businesses, while CNH derives part of its sales from construction and transportation. AGCO is the only major pure play on agriculture equipment. Below you can find a comparison of the three companies:

It is important to note that Deere and CNH consolidate their financing division in the financials, whereas AGCO does not. To compare the three companies, I excluded the financial division’s obligations to receive adjusted numbers for total debt (incl. pension liabilities and operating leases) and enterprise value. In addition, I adjusted EBIT and EBITDA for finance income and interest payments relating to the finance division. As a result, income from the finance division is only included on the net income level (P/E, ROE) as it is the case in AGCO’s P&L.

Deere seems to be more efficient than AGCO from an operational perspective. However, it becomes also clear that Deere’s high return on equity depends to a large extend on the company’s finance division. The same applies to a lesser extend to CNH. On the other hand, AGCO’s finance division seems to have a much smaller impact on net income.

Overall, Deere might have a better market position and advantages in terms of scale and distribution. However, I regard AGCO as less risky with regard to their balance sheet. AGCO will be affected by a deterioration of the finance portfolio, but the company is not liable for the portfolio. In addition, they carry less debt than Deere or CNH on their balance sheet. Compared to the two larger competitors, I view AGCO’s valuation as attractive given that further margin improvement might get AGCO closer to Deere’s level of profitability (ignoring income from the finance division).

Free cash flow approach: If we assume that AGCO is currently able to generate roughly USD 800 m of operating cash and that capex will go down to USD 300 m, then the company is currently trading with a price to free cash flow multiple of approx. 12x. From my perspective, this is an attractive multiple given the current market environment and the existing growth opportunities for the company.


AGCO’s sales depend on agricultural spending which is mostly driven by farm income. Farm income in the U.S. and Brazil has grown strongly over the last years.  A slowdown of investment activity in these regions over the medium term is likely.  However, AGCO has a strong global presence and should be able to profit from recovering demand in Europe and growth in other developing countries. In addition, margin improvement should help to compensate for lower top line growth. A solid balance sheet combined with strong cash flow generation, an attractive valuation and management’s commitment to return excess capital to shareholders completes the investment case.

Over the long run, an increase in protein diet per capita, a larger world population, less affordable labour available for farming and the need to increase crop yields due to a limited amount of arable land should provide for rising demand of AGCO’s products. From my perspective, AGCO is very well positioned to benefit from this scenario.

For the portfolio I purchase a 4% portfolio position at today’s VWAP.


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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Equal Energy – Sell

Published on June 13, 2014

You can find my initial investment thesis here.

Yesterday, EQU’s management filed the definitive  proxy statement with respect to EQU being acquired by Petroflow.

Under the Arrangement, Petroflow Sub will acquire all of the outstanding common shares of Equal for USD 5.43 per share, payable in cash. Upon completion of the Arrangement, Equal Shareholders will also receive a cash dividend of  USD 0.05 per share. A USD 0.05 dividend per share was already paid to investors in May being part of an increased offer to shareholders due to a delay in the acquisition process. Hence, since my initial write-up Petroflow’s offer to shareholder’s increased by USD 0.1 per share.

A shareholder meeting will be held on July 8, 2014. At least 66  2 3 % of the votes must be voted in favour of the transaction. In addition, the transaction is subject to a minority approval. Lawndale Capital Management, holding roughly 4.8% of EQU’s shares, has already indicated that they will vote against the transaction. So despite the efforts made by EQU’s management to get the deal done, I believe it is still likely that the deal falls apart.

With the share price currently trading at the offer price of USD 5.43, I will skip the additional USD 0.05 per share dividend to be paid after deal completion. I will start to sell my position from today with a limit of USD 5.40. This implies a total return incl. dividends of roughly 15% over a two months holding period.

Lessons learned

Not only me, but also the market underestimated EQU’s management’s willingness to get the deal done, as they are highly incentivized. In my original scenario analysis I estimated a 25% probability that the deal will be completed. In hindsight this was far too low. (Though the deal has not been commpleted yet)

Given that I saw a 75% probability that the deal falls apart, I planned to increase my initial 2% portfolio position after a drop in the share price (triggered by the unsuccesful transaction). Nevertheless, based on the original scenario analysis, all the potential outcomes led to a higher share price. So it might have been a better strategy to establish a larger position right at the beginning given this high conviction investment.

Edit 6/15/2014: Position sold on 6/13/2014 for an VWAP of USD 5.41. Realized gain of 17.2%.


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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Lenzing (AT0000644505)

Published on May 24, 2014

Lenzing is the world leader in terms of production and technology of man-made cellulose fibers (MMCFs). MMCFs are used in the textile industry (women’s outerwear, sportswear, home textiles) and the nonwovens industry (hygiene products, cosmetics). The company holds a market share of 20% in its industry. Currently, an increase in capacity coming mostly from China is harming the industry’s profitability. After a consolidation of the industry and a reversion of prices for MMFCs from their low level, I expect Lenzing to profit from ongoing cost reductions and product mix improvements. From my perspective, the current share price is not reflecting the potential upside in Lenzing’s profitability coming from a structural demand growth for MMCFs and a decline in the growth rate of capacity expansion.

The raw material for Lenzing’s fibers is wood, which is the basis for producing dissolving wood pulp subsequently processed into cellulose fibers. Wood Pulp is the main input factor with a 31% share of total costs. 52% of the wood pulp supply are secured through own production and 40% over long term supply contracts linked to the paper pulp index and not the spot price. The vertical integration of the company’s wood pulp supply leads to cost advantages of 20% compared to the current spot price for wood pulp.

Lenzing has seven production sites located in Austria, Indonesia, Czech Republic (pulp production), UK, US and China. The company’s total fiber production increased from 334,000 tonnes in 2000 to 891,000 tonnes in 2013 with revenues increasing from EUR 599 m to EUR 1,909 m.

Over the last years the company shifted its product mix towards higher quality specialty fibers. For the company’s trademarks Tencel and Modal customers pay premiums of up to 50% compared to the standard viscose fiber prices. Specialty fibers make up 35% of revenue and the company has a market share of more than 80% in this segment. With the new Tencel production line in Austria to be completed in 2014, the company meets the growing demand from spinning mills. Lenzing specialty fibers have comparable characteristics to cotton and are more sustainable from an environmental perspective. The environmental impact from cellulose fibers is 17.5x lower than from cotton. Lenzing is not only producing a product which is more sustainable than its substitutes, but is also the leader in terms of sustainability within its industry. Companies like Marks & Spencer, H&M, Ikea and Inditex are aware of the positive effects for their brands, if they make use of sustainable materials in their products. Given Lenzing’s position in its industry this offers substantial growth potential for the company. Recently, H&M started a large sustainability campaign called “H&M Consciuos Fashion”. Lenzing’s Tencel fiber is one of the materials used in H&M’s Conscious Fashion line.

Current Obstacles

After a record year in 2011, the company faced a steady decrease in the price for viscose fibers from a high of EUR 2.40/kg in Q2 2011 to a low of EUR 1.56/kg in Q1 2014. There are two major reasons for this development:

1) Overcapacity in the industry

Despite growing demand for MMCFs, increasing capacity in the industry puts continuous pressure on pricing. Since 2011 world production capacity has increased by 23%. In the latest conference call, management reported that capacity increases have come down to single digit growth numbers and that many Chinese fiber producers face liquidity constrains at the current price level. As a consequence, Lenzing is operating in a cash driven industry. The company’s Chinese competitors are currently producing at 85% of total capacity to generate cash serving their large debt burdens. Further credit tightening in China is limiting their financial flexibility. Consequently, they have no ability at the moment to decrease utilisation rates and influence prices upwards, although price agreements between these companies seem to be common. The following table provides an industry overview:

1)      Private company

As you can see from the table above, Lenzing has the second lowest production costs for viscose fibers despite the company’s focus on sustainable production. Financial information is not available for Grasim and Fulida, but solvency ratios for the other companies look stressed compared to Lenzing.

2) The price for cotton

Cotton is the major substitute for men-made cellulose fibers. After a price spike in 2011, the price for cotton has trended downwards. Prices for Lenzing products generally have a high correlation with the cotton price. The U.S. Department of Agriculture’s (USDA) world 2014/15 cotton projections anticipate that cotton production will exceed consumption for the fifth consecutive season. This is mostly due to overproduction in China.

China, the world’s largest cotton producer, implemented a price floor for cotton in 2011 that exceeds world prices and a stock-building policy to support local farmers.  Consequently, world stocks more than doubled between 2009/10 and 2013/14. China’s stocks are now 146% of 2013/14 domestic consumption, surpassing the previous stocks-to-use record set in 1998/99. The USDA expects the Chinese state reserve to purchase 85 % of the total 2013/14 Chinese crop to maintain internal prices substantially above world price levels. As a consequence, the Chinese textile industry currently substitutes cheaper man-made fiber in finished goods, which is positive for Lenzing but has so far not led to price increases for fiber viscose.

There are signs that the Chinese government is now reducing incentives to cotton farmers outside of the Xinjiang province (where half of China’s cotton is produced and quality reaches world standards) and that a growing number of farmers is diverting from cotton into food crops. The Government is now also trying to actively reduce its stock pile. However, it is important to note that most of the cotton produced in China is of secondary quality and that local mills prefer imported fibers. Due to the market distortion in China the correlation between world cotton prices and man-made fibers decreased over the last years. Without the Chinese intervention the world cotton price should be much lower.

The situation is different in the rest of the world. Here the stock-to-use ratio is only 54% which is rather at the lower end of the range from a historic perspective. Overall, the market for cotton is highly distorted which makes it even more difficult to forecast the price development over the short term.

Operating Performance

From the table below you can see, that the company witnessed strong top line growth until 2011:

Despite a 30% price decline since 2011, revenues have been relatively stable mainly due to an increase in sales volumes from 713,000 tonnes in 2011 to 891,000 tonnes in 2013 and an improved product mix. It is also noteworthy that the company sold its plastics segment concluded in the middle of 2013 leading to a revenue reduction of roughly EUR 65 m in 2013. The company will reach a production capacity of close to one million tonnes in 2014 (17% of world capacity). Management expects that the company’s production lines will remain fully booked in 2014.

With surplus production capacities for viscose fibers and Chinese manufacturers keeping capacity utilization as high as possible in order to generate cash, profitability came further under pressure in 2013. This development was supported by the partially lower prices for wood pulp, the most important raw material used in manufacturing viscose. Lower prices combined with high capacity utilization led to market share gains on the part of Chinese producers.

As a consequence, the company started a cost savings initiative in 2013 in order to achieve a declared objective of generating annual cost savings of EUR 120 m p.a. Management estimates that the programme will already positively impact earnings to the amount of up to EUR 80 m in the course of 2014. In addition, the company decided to postpone any capacity expansion projects with the exception of the new Tencel plant in Lenzing, Austria.

Returns on capital are now under pressure. However, with decreasing capacity expansion in the industry and continuing demand growth for MMCFs a reversion to higher profitability over the next two years seems to be a likely outcome. So let me point out to you the general reasons for an investment in the next paragraph.

The long term investment thesis

First, over the long term it seems to be pretty clear that the demand for fibers will rise due to population growth and an overall increase of GDP per capita. In addition, there are structural limitations in cotton production due to a lack of arable land and water supply, a potential peak in cotton yields and caprious weather. So there is reason to believe that the proportion of MMCFs as a percentage of total cellulose fiber production will continue to grow disproportionately.

Second, Lenzing is the technological leader in its industry. The company owns approx. 1,400 patent applications and patents in 63 countries mainly for its Tencel products where it has been active for more than 20 years. The production of Tencel is quite complicated and Lenzing’s competitors are still trying to get an edge in this segment.

Third, Lenzing enjoys cost advantages on the basis of pulp integration, and benefits from economies of scale. The integration of pulp production and long-term pulp delivery contracts for its most important raw material give the company a competitive edge. Lenzing also profits from its size. Lenzing operates the largest and second largest production plants for man-made cellulose fibers.

Fourth, Lenzing sets the highest environmental standards in the industry. The required raw material wood is derived from ecologically sound forests and a large portion of energy consumption comes from renewable resources. In addition, the integrated wood pulp production reduces the need for drying, packaging and transportation of pulp. With the improving sustainability awareness among end-users Lenzing provides an almost perfect product to the textile and nonwoven industry.

However, I don’t want to be too enthusiastic here. Needless to say, there are also a number of risks:

Lenzing is operating a commodity business where barriers to entry are low as can be seen from the recent entry of new competitors after the high price levels for MMCFs in 2010 and 2011. In addition, Lenzing’s strategy of product differentiation will only work as long as it keeps its technological leadership. Moreover, price agreements between Lenzing’s Chinese competitors seem to be standard and provide a structural disadvantage to the company. Though I do not believe that China will also start to subsidise its MMCFs industry, market intervention from the Government is also a potential risk.


First, I try to model the company’s profitability with regard to the average realized price for Lenzing’s products. Based on the company’s information a EUR 0.01 change in the fiber price per kg is equal to a EUR 10 m change in EBITDA.

In 2013, Lenzing realized an average price of EUR 1.70/kg at an utilisation rate of 97% (Total capacity 921,000 tonnes) leading to a revenue in the fiber segment of EUR 1,512 m. The company will add another 67,000 tonnes of Tencel production to its capacity in 2014. Assuming that the new production line will have the same utilisation rate, but ignoring any price premiums for Tencel this will add another EUR 110 m of revenue.

I also assume that other revenues from the engineering segment and the sale of raw materials will stay flat.

In addition, I imply a EUR 100 m cost reduction which is EUR 20 m below the management’s target.

Based on these assumptions, I come up with an estimation of EBITDA for different price levels. To get to the EBIT number I use an annual depreciation of EUR 130 m.

This is only an approximation of the actual profitability potential, but it shows the upside potential of the share price should the fiber price recover from its currently low level.

Second, with an equity ratio of 45%, no goodwill and intangibles making up only 3.6% of total assets, the balance sheet looks solid. The average ROCE is 13.0% and the average ROE is 16.0% over the last ten years. At the same time the company is only trading with a price-to-book ratio of 1.1x.


An investment in Lenzing is a bet on the company’s ability to keep its strong market position and that prices for MMCFs will revert from their low levels. As outlined above, I think there is reason to believe that demand for MMCFs will grow further in the future. The price increases in 2010/11 led to enormous capacity expansion. The current overcapacity puts pressure on the return on capital of all industry participants. So it should take some time for the oversupply to be reduced ultimately leading to higher pricing levels. At the end of this process Lenzing could be in an even stronger position than before given a more effective cost structure and a more diversified product range.

I will establish a 3% portfolio position with a share price limit of EUR 47.


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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Magix – Sell

Published on May 20, 2014

Today Magix announced that they will delist their shares from the stock exchange in November 2014. This is bad news.

As the company is listed on the unregulated segment of the stock exchange (“Entry Standard”), management is not obliged to provide the minority shareholders with a delisting offer.  The German Federal Supreme Court (BGH) decided in 2013 that a downlisting or delisting does not require any more an approval from the shareholders’ meeting and a compensatory offer by either the stock corporation itself or its majority shareholder to the outstanding minority shareholders to acquire their shares against adequate monetary consideration. (I edited this paragraph on 5/21/2014).

In hindsight, this step seems to be predictable as the company moved its listing from the regulated “Prime Standard” to the unregulated “Entry standard” just last year. In addition, management has been aggressively repurchasing shares over the last couple of years leading to a steady decline in the free float.

For the portfolio I start selling shares today with a limit of EUR 2.90 which is close to my entry level.

Edit 5/21/2014: Position sold on 5/20/2014 for an VWAP of EUR 3.03. Realized gain of 3.0%.


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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Equal Energy (EQU:NYSE)

Published on April 14, 2014

The current offer for this company seems to be substantially below its intrinsic value. At the same time there is a high probability that the deal will fall apart which is also reflected in the share price trading at a high discount to the purchase offer. Activist investors are currently working on other options to unlock shareholder value and it is also likely that other potential buyers might step in to acquire the company. Based on a scenario analysis I come up with a 25% upside potential for the company’s share price over the next twelve months.

Equal Energy is an oil and gas producer with operations in the U.S. (Oklahoma). In December 2013, management announced the execution of a definitive sales agreement with Petroflow to be taken over for USD 5.43 per share in cash.

Before you continue to read this write up, I highly recommend reading the “Background of the arrangement” section in Equal’s preliminary proxy statement. After that, it is also interesting to read this negative assessement of Equal’s management published by one of the former activist shareholders mentioned in the proxy statement. Equal took legal proceedings against this shareholder and entered into a settlement at the beginning of 2013.

There are different parties involved:

Based on the sales agreement the deal has to be completed until May 1st 2014. For Petroflow to get the deal done they need to obtain financing. This seems to be one of the major obstacles at the moment and the reason why the market is currently sceptical about a successful completion of the transaction. The stock price is currently trading at USD 4.68 or 14% below Petroflow’s offer. During Q4 2013, when the stock price was trading close to the offer price, merger arbitrage funds accumulated large positions in the company. As a successful acquisition became less likely at the beginning of 2014, these funds might have reduced their positions putting pressure on the share price.

The other major obstacle is that there are different shareholder groups who might not vote in favour of the deal as they do regard Petroflow’s offer as not adequate for Equal’s shareholders. To be completed the deal needs to be approved by two-thirds of shareholders. In addition, the transaction is subject to the condition that dissent rights will not have been exercised in respect of more than 5% of the Equal shares calculated on a fully-diluted basis.

Lawndale Capital Management, holding roughly 4.8% of EQU’s shares, has already indicated that they have concerns over the transaction. You can also find a letter as of April 2013 from Lawndale to Equal, where they request a change of the board of directors among other things.

Montclair actually started the bidding process for Equal, when they offered USD 4.0 per share in March 2013. After that, they increased their offer in two steps up to USD 4.85 per share. Based on Equal’s preliminary proxy statement they even made an unbinding offer of USD 5.40 per share briefly before Equal’s board decided that Petroflow’s offer would be superior to Montclair’s. Montclair is currently holding approx. 4.5% of Equal’s shares. Interestingly, Equal acquired their current operations in Oklahoma from nobody else than Montclair and Petroflow for approx. USD 246 m or USD 44,727 per flowing boe in 2006. Hence, both parties should have a good insight into the future operational potential of Equal’s assets. Obviously, Montclair is also questioning Petroflow’s bid and on April 11th 2014, Montclair proposed a leveraged share repurchase, which in their view will deliver superior value to Equal’s shareholders than a sale of the company to Petroflow. Based on a USD 6.0 per share tender offer for 48% of outstanding shares they estimate a minimum potential upside of 49% for shareholders assuming that the company will be valued at a peer group median price-earnings multiple after the repurchase. They argue that the Petroflow offer represents a high discount versus the peer group. In addition, they claim that Equal’s shareholders have borne the costs of the company’s drilling programme, but much of the resulting cash flow will only accrue to Petroflow’s benefit. Moreover, from their perspective the recent price increase in EQU’s three product streams is not adequatley reflected in the projections of Equal’s preliminary proxy statement. Apart from that, it is also noteworthy that based on the company’s latest 10-K for 2013 , proved reserves increased by 23% from the prior year.

In addition, Equal’s board and management are facing several class action lawsuits from different parties. The complaints, allege that in connection with the sales agreement, the members of the board and management breached their fiduciary duties to the Equal Shareholders. The complaints also allege that the agreement involves an unfair price, unfair sales process, self-dealing and unfairly preclusive deal protection devices.

Deal completion probability

Given the uncertainty about Petroflow’s ability to finance the deal and shareholders resistance, at the moment a completion of this deal seems to be rather unlikely. However, Equal’s management and board members have a lot of skin in the game. Though they hold only 1.9% of the outstanding shares, the execution of the deal would provide a large pay out for them. In total, Equal’s CEO alone will receive USD 3.4 m, if the deal is successful. So I believe that they will do everything they can to get the transaction done.

One can calculate the probability of a deal completion based on market prices. For example the price before Montclair offered USD 4.0 per share and put Equal in play as of March 25th 2013 was USD 3.5 per share. In addition, the share price before Montclair’s proposal of a share repurchase on April 11th 2014 was USD 4.37. So at that time the market implied a probability (Y) of 45% to a successful deal completion:

4.37 = 5.43 x (Y) + 3.50 x (1-Y) à Y= 45%

However, one can also use the price before the company announced that it has entered into exclusive negotiations for a proposed transaction on November 18, 2013 (USD 4.40 per share). Based on this share price the market implied a probability (Y) of 0% to a successful deal completion.

From my perspective a 25% probability that the transaction will be completed is a realistic estimate.

Broken deal scenarios and probabilities

Operating on a stand-alone basis

There is the possibility that Equal will continue its operations on a stand-alone basis. Based on a peer group analysis, the company is currently trading with a discount of roughly 50% to its peer group:

1) BOE: barrel of oil equivalent of natural gas and crude oil on the basis of 1 BOE for 6 Mcf of natural gas

From my perspective there are a couple of reasons why the company should trade with a discount to its peer group. Management has been criticised in the past for not being able to unlock shareholder value (as outlined above). The company has also some weaknesses with regard to their internal control mechanism as outlined by their auditors in the latest annual report. In addition, Equal’s profitability is below average as outlined by Montclair. Nevertheless, I believe that a 35% discount to the peer group would be more than sufficient to reflect these factors implying an intrinsic value of USD 6.10 per share. In a broken deal scenario I estimate a 25% probability for this outcome.

Operating on a stand-alone basis and implementation of share repurchase

Montclair estimates an intrinsic value of at least USD 7.01 per share, if Equal implements the leveraged share repurchase and improves its operational and financial efficiency. I think this outcome has a probability of 25%.

Equal will be acquired by another buyer

In the case of a broken deal, I believe it is highly likely that another buyer will step in. Provided that there will be no external shocks or unforeseen operational difficulties I think that the minimum offer will not be below Petroflow’s purchase price of USD 5.43 per share. I assume that the probability of this outcome is 50%.


From these scenarios I calculate an expected value of USD 5.85 per share implying a potential upside of 25% based on a current share price of USD 4.68 per share.

5.85 = 0.25x (5.43) + 0.75x (0.25x 6.10 +0.25x 7.01 +0.50x 5.43)


It is certainly questionable, whether Equal’s board and management act in the best interest of shareholders. However, in this case activist investors are involved and there is a good chance that they will influence the company’s representatives to move into the right direction. In addition, the current share price is trading substantially below Petroflow’s offer, though there are good reasons that this offer not only underestimates Equal’s private market value but also its public market value. So from my perspective the downside is limited.

Nevertheless, short term volatility has to be expected. If the deal breaks, the merger arbitrage funds might dump their remaining shares which could provide an attractive buying opportunity.

For the time being I will establish a 2% position for the portfolio with a share price limit of USD 4.70. Please click here for more information on WertArt Capital and the virtual portfolio.

Edit (4/14/2014): limit increase to USD 4.85.


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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Q1 2014 Performance & Portfolio Update

Published on April 3, 2014

Below you find an overview of the current portfolio as of March 31, 2014:

# Investment Currency Purchase Price Current Price Gain/Loss1 Portfolio Share
1 Passat EUR 9.69 9.57 -1.3% 1.9%
2 RHJI EUR 3.86 3.65 -5.4% 2.8%
3 Fairfax Financial CAD 441 480 3.3% 4.9%
4 Real Dolmen EUR 17.2 20.1 16.9% 2.3%
5 Lectra EUR 6.49 7.83 20.6% 2.4%
6 Retail Holdings USD 18.5 19.2 3.0% 3.0%
7 Broedrene A&O DKK 1,342 1,486 10.7% 3.2%
8 City of London GBP 2.41 2.55 9.3% 4.1%
9 Magix EUR 2.94 3.74 27.1% 1.3%
10 Olympic Entert. EUR 1.90 1.87 -1.7% 2.9%
11 Miba EUR 343 350 2.1% 1.0%
12 Dundee Corp. CAD 16.9 15.9 -5.0% 3.7%
13 TMW Weltfonds EUR 15.9 17.1 7.5% 2.9%
Portfolio 36.6%
Cash 63.4%
Total       2.3% 100.0%

1)      Performance in EUR inc. dividends/interest

From a relative perspective the portfolio suffered from the large cash position during the quarter. The portflio’s benchmark (Euromoney Smaller Europe exc. UK Weight 70%; Euromoney Smaller World Weight 30%) increased by a sensational 7.5% against a not so sensational 1.6% increase of the virtual portfolio.

Eurozone small cap equities continue to be one of the best performing market segments. Since the end of 2012 the Euromoney Smaller Europe (Exc. UK) Total Return Index has increased by 48%. The index consists of more than thousand companies in 15 different countries with an average market cap of EUR 850 m. So it provides a pretty good approximation for this market segment. Sometimes it can be frustrating to watch the prices reaching one all time high after the other and at the same time to reject investment ideas given that they simply do not match the investment criteria.

These criteria are pretty straight forward. An investment opportunity needs to deliver a margin of safety based on a conservative estimation of intrinsic value. For the estimation of intrinsic value I am using either a normalized free cash flow or a sum-of-the parts approach. Apart from that, a company I want to invest in should meet a couple of preconditions:

- Generating sustainable returns on invested capital

- Management needs to be capable and willing to allocate capital in shareholders’ best interest

- Relatively low level of financial leverage

- Relatively high earnings-quality (identifying any red flags in the financial statements)

Despite the recent market increases, for me it is essential to control emotions and to stick to my disciplined absolute value approach.

Investment Update

While Fairfax’s insurance business performed very well in 2013 (with a combined ratio of 92.7%), the investment return was negative (for the third time since the company’s inception in 1986). This was mostly due to the equity hedges in place which cost the company approx.  USD 2 bn (realized and unrealized), but also due to a decline in the fixed income portfolio.

In his letter to shareholders, Prem Watsa once again states the reasoning for Fairfax’s defensive investment strategy.  They continue to worry about the consequences of the massive fiscal and monetary stimulus not only in the Western world, but also in China. From their perspective, debt to GDP ratios are at a very high level and they forecast significant deleveraging yet to come. In addition, speculative excesses and once again the built-up of additional vast financial leverage will eventually cause tremendous instability, ultimately leading to a deflationary environment.

I think they have a point here. Looking at the US and Europe there is still a large employment gap in place. At the same time many jobs that are created are being filled by over-qualified labour no longer able to wait for compensation levels similar to what they had before. Thus, people need to shift down the way they life or how they expect to live. As a consequence, the willingness to save increases, leaving less resources for consumption. In the case of China, the booming economy fuelled by overinvestment has not only created speculation and large amounts of uncontrolled credit but also a tide of inflation (price/wage spiral). At the same time cost of living outpaces wage increases. Once the Government reduces credit and fights speculation, it risks a deflationary collapse. Eventually this process will not be started by the Government, but by the market when the speculative capital leaves. As a side effect of this scenario commodity price will obviously collapse.

Ned Goodman of Dundee Corp. is also worried by the unintended consequences of stimulus. However, his conclusion is quite the opposite. From his perspective, in order to handle the elevated debt levels and to prevent a market collapse the Fed and other central banks will continue to monetize Government debt and other types of debt (i.e. mortgages) and keep interest rates down. This will ultimately lead to money debasement in the Western world. At the same time he is very bullish on the rise of the middle class in the emerging markets leading to continuation of the secular trend in commodity prices.

Due to their contrary views, Fairfax and Dundee have allocated their capital to different types of assets as you can read in the two initial write ups here and here. While I do not know, whether both will be wrong or whether one of them will be right, I am comfortable to own these companies for the following reasons:

Both provide an attractively priced hedge for two different tale risk scenarios. In addition, both of them Prem Watsa and Ned Goodman proved in the past that they have an edge in the allocation of capital and I expect them to do so in the future. Apart from that, I believe that the risk of a permanent loss of capital is limited, as both companies own a variety of high quality businesses which should perform relatively well regardless of the actual economic environment.

Finally, KBG closed the BHF transaction at the end of the first quarter. The purchase price has been further reduced to EUR 340 m or 0.69x book value. After a capital increase RHJI’s share in KBG decreased to 65.8% while the balance of 34.2% is now being held by three co-investors. The value of RHJI’s 100% stake in KBG that existed prior to the BHF acquisition was adjusted downwards from EUR 320 m to EUR 294 m or 0.69x book value (EUR 194 m based on the new 65.8% share) for the purpose of the transaction. From that perspective the deal has been unfavourable for shareholders as the downward adjustment required a larger cash payment from RHJI than what the company would have had to pay based on KBG’s original valuation to complete the transaction.

91% of BHF Bank are now being held by KBG. 9% have been acquired directly by RHJI. To satisfy the EUR 30.6 m equity consideration for the 9% stake, RHJI has issued 5.5 million additional shares. This has resulted in a revised total share count of 91.0 million shares and Deutsche Bank becoming a significant shareholder with an approximate 6.0% stake in RHJI. The new shares were issued at EUR 5.56 which is substantially above the current share price leading to an additional source of discount of the transaction of approx. EUR 9.7 m. So this is generally favourable for RHJI’s shareholders. However, for some reason management plans to allocate the discount across RHJI and its co investors on a pro rata basis resulting in a reduction of RHJI’s ownership in KBG to 65.13%, with the offsetting increases being reflected in the individual co-investors’ stakes.

Why are they doing this? Management is actually planning a further simplification of the structure. Following the completion of the BHF acquisition, they are now discussing with the co-investors the future conversion of their interests in Kleinwort Benson Group into RHJI shares. From that perspective, treating the co-investors equally as if they were shareholders might make sense and might be even value enhancing for RHJI’s existing shareholders once the structure has been simplified. However, currently it is clearly reducing RHJI’s net asset value. Based on my estimation, since my original write up  RHJI’s NAV decreased by 7.3% to EUR 4.8 per share.

With the completion of the BHF transaction a return of the company’s former large cash pile to shareholders is off the table now. For RHJI’s activist investors the investment case has now changed and it will be interesting to watch whether they will sell their shares. Recently, Third Avenue Management, another non-activist but very respectable firm, reduced its holding in RHJI. Apart from that, there is Deutsche Bank which based on the management’s information already announced that their stake in RHJI is not a strategic investment.

RHJI’s management will present indications for financial targets at the next investor’s call on May 15th 2014. They will have to be very precise in explaining to investors how they will turn the combined entity into a private bank that earns an acceptable return on equity. I will then try to come up with a conclusion whether RHJI’s management still matches my investment criteria.

Portfolio Transactions in Q1 2014

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

Item Date Amount in EUR
Beginning Balance 1/1/2014 7,860,550
Passat 1/2/2014 to 2/14/2014 -60,963
Broedrene A&O 1/2/2014 -100,000
Magix 1/2/2014 to 2/6/2014 -77,235
Fairfax Dividend 1/19/2014 11,620
City of London 1/22/2014 -100,000
Olympic Entert. 1/16/2014 to 1/17/2014 -300,000
Miba 2/14/2014 to 3/31/2014 -104,175
Dundee Corp. 2/28/2014 -400,000
City of London Dividend 2/28/2014 13,350
TMW Weltfonds 3/17/2014 to 3/26/2014 -279,116
Interest on cash 12/31/2013 to 3/31/2014 17,906
Current Balance 3/31/2014 6,481,937

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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TMW Immobilien Weltfonds (DE000A0DJ328)

Published on March 17, 2014

Currently, I see a window of opportunity for some German open-end real estate funds, which are in the liquidation phase. With seven properties to sell visibility in the case of TMW Weltfonds is quite high. In addition, two assets have recently improved their attractiveness to potential buyers. Based on conservative estimates, an investment offers a potential 26% IRR over a projected 34 month holding period.


Open-end real estate funds are still the most important retail investment vehicle for real estate in Germany. Currently, these funds are managing in total approx. EUR 80 bn which amounts to roughly 10% of German investment funds’ assets.

In 2008/2009, large withdrawal of capital at open-end real estate funds started and triggered a liquidity shortage at many funds. Therefore, these funds had to suspend the redemption of units. Based on legal provisions, this suspension can only be done for a maximum of two years. After this time period, most of the closed funds were not able to reopen. As a consequence, their managers decided that the right consequence should be to terminate the fund’s management with a three year notice. During this three-year period, the fund manager has to sell all the fund’s assets and distribute the generated liquidity step by step to the investors. If the fund manager cannot sell all assets within the three-year period, all remaining assets will by law be transferred to the fund’s custodian bank, which then has to liquidate the assets and distribute cash to the investors. This transfer triggers real estate transfer tax, and the custodian bank is normally not prepared to manage the remaining assets. However, so far the concerned custodian banks just handed back management of the liquidation process to the former fund manager. Most of the funds which are currently in the liquidation phase are trading at a substantial discount to its NAV. In some cases, this offers attractive investment opportunities due to good visibility of upcoming cash flows to unit holders. More information can be found here and here.

TMW Immobilien Weltfonds

TMW Immobilien Weltfonds (TMW) is currently at the end of the 3 year liquidation phase. The remaining assets will be transferred to the custodian bank at the end of May 2014. The remaining portfolio consists of six properties located in Hamburg, Paris, Amsterdam, Rotterdam and Houten. Apart from that, the fund indirectly owns a property in Bologna.

As of February the fund has approx. EUR 24 m of recourse debt. The remainder of EUR 22 m is related to the Italian entity. So far the fund made only minor distributions to its shareholders and used the majority of sales proceeds to reduce the debt amount. As of September 2013, they had provisions of EUR 16 m on their balance sheet. The current cash balance is EUR 89 m. The current appraisal value of the six properties is EUR 325 m. The NAV of the Italian entity and other indirect holdings is approx. EUR 9 m. Other assets sum up to approx. EUR 10 m (claims from accumulated interest and fx hedging). Hence, the official NAV as of February is EUR 395 m or EUR 26 per share. The share is currently trading at EUR 16 implying a 38% discount.

As the structuring of the Italian investment was not accepted by the Italian tax authorities, the entity holding this property has an exceptional tax liability of EUR 30 m. Nevertheless, there is the possibility that after the disposition of the property the fund will receive a small cash amount from this investment. To keep it simple, I will assume that the NAV of this investment is zero. I will also ignore the value of other assets in my estimation of TMW’s liquidation value.

It is to be expected that in a disposal process like this some of the last assets will be those that are the hardest to sell. However, the two largest properties in their remaining portfolio showed a very good performance over the last twelve months:

Sumatrakontor is a mixed-use grade A building in Hamburg which was completed in 2011. Occupancy has been gradually increased and has reached 90%. Current annual rental income is approx. EUR 7.2 m. The last appraisal was in October 2013, when the property was only 75% leased. Demand for these type of core assets is currently very high.

Prime office in Hamburg is currently trading at net yields (new asset, prime location, 100% leased) of 4.6%. For some reasons German open-ended funds are using gross yields instead of cap rates. To come up with an estimate of a prime gross yield, I am using a 20% operating expense ratio (which I think is conservative). This leads to a 5.8% prime gross yield. Given that Sumatrakontor has not been fully leased yet, I add 40 bps, which leads to an estimate of a 6.2% gross yield for this asset. This translates into a potential sales price of EUR 116 m.

Fortunately, there is also a comparable transaction of a property which is located close to Sumatrakontor. In March 2013 Dundee International REIT (an affiliate of Dundee Corp.) acquired the ABC-Bogen for a purchase price of CAD 93.6 m (EUR 70.4 m) from SEB Immoinvest. SEB Immoinvest is another German open-end fund which is currently in the liquidation phase. The purchase price was in line with the latest appraisal value. Based on a rental income of EUR 3.8 m the resulting gross yield is 5.4%. At the time of the transaction the property was 94% leased.

So I believe that a 6.2% gross yield for the Sumatrakontor is a relatively conservative estimate given the current market environment in Hamburg.

Eastview is an office building in a B grade location on the Eastern Inner Rim in Paris. After the completion of a redevelopment in 2010, the building had been on the market for quite some time. Last year the fund management found a tenant (Orange) for 82% of the leasable area. The lease term is 12 years.

The fact that the Eastern Inner Rim submarket is both central and cheaper than the Western Crescent of Paris and La Defense has been attracting occupiers over the last years. In May 2013 TMW sold Tour Vista located in Puteaux, the Western Crescent of Paris, for a gross yield of 6.5% (based on an occupancy rate of 77%). The building was redeveloped in 2007. Given the inferior location of Eastview, I apply a 50 bps premium, which leads to a 7.0% gross yield or a potential sales price of EUR 80.4 m (Based on an 82% occupancy rate and the latest available appraisal rent of EUR 6.9 m).

Apart from that, the Fund is holding four properties in the Netherlands. The Dutch real estate market is currently trading at a heavy discount compared to its neighbouring core markets reflecting the weak economic environment in the country. In addition, the total office stock is still too large and the options for transformation are limited.  Vacancy rates in Amsterdam and Rotterdam are currently standing at approx. 20%. In the second half of 2013 transaction volume increased substantially as opportunistic buyers entered the market.

However, they still mainly focused on core office properties.  Based on my information, TMW’s Dutch properties are all located in secondary locations. This is also the segment of the market where potential tenants can currently negotiate the highest incentives. In addition, Crystal Tower (Amsterdam) and Europoint III (Rotterdam) are both single tenant properties and have a remaining lease term of less than 12 months. I will apply a 20% gross yield for these two assets. Koningshof (Amsterdam) is currently 53% leased with an average lease term until 2019. I will take a 13% gross yield based on current rental income. Kromme Schaft in Houten is 100% leased to KPN until 2020. I will take a 15% gross yield given the extremely negative outlook for Houten. The current rent level for the fund’s Dutch assets is between EUR 10 per sqm (Europoint III) and EUR 16 (Crystal Tower). Though the current rent level for Crystal Tower might not be sustainable going forward, overall I don’t think that the assets are extremely over rented. The information I am using is coming from CBRE’S research site.

Below you can find an overview of the current portfolio excluding the asset in Bologna (numbers are in EUR millions):

For the remaining portfolio, I assume a liquidation value of EUR 253 m, which is 22% below the current appraisal value of TMW’s portfolio. From my perspective it is highly likely, that the management will be able to sale Sumatrakontor and Eastview before the handover of the fund’s assets to the custodian bank.

As already mentioned, real estate transfer tax will be triggered by the transfer to the custodian bank. Based on my information, fund managers are calculating with an 8% cost level. Based on the current appraisal value of the Dutch assets and the Italian property this translates into an additional provision of EUR 13 m or EUR 0.8 per share.

As a consequence, we have a portfolio liquidation value of EUR 253 m or EUR 16.7 per share. In addition excess cash is EUR 38 m (EUR 89 m-EUR 22 m-EUR 16 m-EUR 13 m) or EUR 2.5 per share. This translates into a liquidation value of EUR 19.3 per share or an upside potential of 20%.

Based on my projection, cash proceeds from the sale of Sumatrakontor and Eastview are EUR 197 m or EUR 13.0 per share. So assuming that the Fund will keep its current cash, but will distribute the sales proceeds, shareholders can expect a distribution of EUR 13.0 at the end of May 2014. In addition, I assume that shareholders will receive two distributions of EUR 3.1 each at the end of 2015 and at the end of 2016. Hence, an investor can expect a 26% IRR over a 34 month investment period.


Investor appetite for this type of investment seems to be relatively low given the negative returns many German open-end reals estate funds generated so far and the bad press they had. Though I have used conservative estimates, the risk return profile in the case of TMW seems to be compelling.

To put it differently, after a dividend of perhaps EUR 13.0 in May, shareholders would retain a stub position with an equity value of EUR 6.3 at an implied cost of EUR 3.0 to EUR 3.5, which gives upside on the remaining holding of approx. 100% over the next two and a half years.

I will establish a 5% position for the portfolio with a share price limit of EUR 16.5. Liquidity is low and it might take approx. 10 trading days to build the position assuming Wertart Capital trades one third of daily volume. Please click here for more information on WertArt Capital and 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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Dundee Corp (DC/A:Toronto)

Published on February 28, 2014

While past performance is no guarantee of future results, Dundee has generated an impressive track record over the past twenty years for its shareholders. In addition, an investment in Dundee is providing a low priced hedge against a potential tail risk scenario. The share price is currently trading at a steep discount to its NAV leading to substantial positive optionality for the company’s private equity portfolio.

Over the last years, the fear of accelerated inflation spread around the world as central banks provided ever increasing amounts of liquidity. So far, this scenario has not played out yet as austerity, balance sheet recession and overcapacity put deflationary pressure on many economies. In fact, the IMF warns of deflation risk in its latest economic forecast. One investor who has proclaimed the risk of money debasement for some years now and has further increased the weighting towards hard assets in his portfolio is Ned Goodman, CEO, founder and largest shareholder of Dundee Corp. (Dundee). In his latest letter to shareholders, he makes the following comment:


“As the biggest buyer of Treasuries, it is almost impossible for the US Fed to turn around and sell without chances of collapsing the market. Surely any other holders of treasuries would want to front run the Fed, and what buyer would be foolish enough to get in front of the Fed freight train? The bottom line is that it is impossible for the Fed to fight inflation, which is precisely why it’s my view that they will never acknowledge the existence of any inflation to fight. Without the Fed’s buying, it would be impossible for the US Treasury to finance its new debt at rates it can afford. That is precisely why Dr. Bernanke has chosen to monetize the debt. Of course, officially acknowledging that fact would make his job that much harder. Without the monetization safety valve, the government would have to make massive immediate cuts in all entitlements and national defense, plus add big tax increases on the middle class, or any class. …If the Fed actually raised rates as a result of one of its movable goal posts being hit, the result could be a much greater financial crisis than the one we lived through in 2008. The bond bubble would burst, interest rates and unemployment would soar, housing prices would collapse, banks would fail, borrowers would default, budget deficits would swell, and there would be no way to finance another round of bailouts for anyone, including the Federal Government itself. It’s not really safe out there. In order to generate phony economic growth and to “pay” the US debts in the most dishonest manner possible, it appears that the Federal Reserve is leading the world to the destruction of the dollar. Anyone with wealth in the U.S. dollar should be concerned that the economic leadership is firmly in the hands of bureaucrats who are committed to an ivory tower version of reality that bears no resemblance to the world as it really is.”


So just another guy who is worried about inflation (stagflation)? Will the large central banks be able to take liquidity out of the economies before inflation becomes an issue? Will this be the big story of the next decade as everybody was preparing for inflation but it just did not come? Nobody knows for sure.

Though I define myself as a bottom up investor, I am not oblivious to macro trends in my investment approach. Moreover, in my capital allocation process I try to get exposure to investments that should benefit from tail risk scenarios. One of these scenarios is an inflationary environment. As a portfolio manager, I am looking for opportunities to profit from this potential outcome by investing in assets providing a margin of safety (This is not always easy as most of the time hedging is quite expensive). As a consequence, even if this scenario will not materialize, the odds that I will face the major investment risk, a permanent loss of capital, are low.

Investment thesis

This brings me back to Dundee Corp. The overall investment thesis here is quite simple. Dundee is a Canadian holding company and has a variety of assets that are publicly-traded and some that are privately-traded. As the table below shows, at the current share price Dundee’s enterprise value is close to the value of its public securities holdings:



Currently, an investor is not paying for the company’s debt securities portfolio (book value of CAD 215 m), the private investment portfolio (CAD 202 m) and private subsidiaries (roughly CAD 150 m), which together are more than half of Dundee’s market value. Hence, the company is trading at something like a 35% to 40% discount to my assessment of NAV.

Major Holdings

DREAM  is a real estate company with approx. 9,000 acres of undeveloped land in Saskatchewan and Alberta, Canada. Dream is converting undeveloped land for end use in developed lots. The company also owns the largest residential home builder in Saskatchewan and an option to build on the developed lots or sell them to independent home builders. In addition, the company has approx. 2,100 condominiums in various stages of active development in the greater Toronto area. Apart from that, the company also has a contract to manage approximately CAD 10 bn of real estate assets across three publicly traded REITs (Dundee REIT, Dundee Industrial REIT and Dundee International REIT). In 2013, DREAM received management fees of approx. CAD 40 m on the assets of the three REITs. As this is kind of an open ended funds, the company can rely on an ongoing cash flow from a permanent capital base. DREAM is a spin-off from Dundee Corp. and has been listed at the Toronto Stock Exchange since May 2013.

Dundee Precious Metals owns two operational mines in Bulgaria and Armenia producing Gold, Silver and Cooper. Apart from that, the company owns a smelter in Namibia and has an interest in a number of other mining projects. With net debt of only CAD 35 m and relatively low cash costs the company seems to be well positioned in the current difficult environment for mining companies.

Dundee REIT  and Dundee International REIT  are both managed by DREAM. Dundee Corp. did not participate in the latest rounds of capital increases. So their share in these two REITs declined over the last couple of years. At the current price Dundee REIT provides investors with an 8% yield which is above average compared with its Canadian peers (6% to 7%), but is even more compelling if one compares this to the US REITs which currently yield on average below 5%. It is important to note that Canadian REITs have a lower payout ratio than their US counterparts. In addition, with a loan-to-value of 50% Dundee REIT seems to be rather conservatively financed. Dundee International REIT is investing in German commercial real estate and acquired over CAD 1.0 bn of office properties in 2013 doubling its assets under management. Current loan-to-value is 54%. Both REITs are currently trading slightly below book value.

The major private equity subsidiaries are:

Dundee Agricultural focuses on sustainable agriculture investments. Its largest holding is an 82% share in Blue Goose which is producing organic beef, chicken and fish. Blue Goose is the largest organic beef operator in North America, with operations in British Columbia, Ontario and Colorado and more than one million acres of predominately certified farm land under management. Blue Goose’ branded beef is sold to major grocery retailers and to luxury restaurants and hotels in Canada and the U.S. The acquisition of suitable capital grazing land to date gives Blue Goose the ability to handle up to 45,000 heads of cattle.

Management has a clear vision about the future of this company:


“Blue Goose is building a strong operating platform backed by valuable real estate that will leverage three critical factors: the burgeoning global population, the limited availability of arable land and the trend towards healthy, safe, clean food. The opportunity to build a premium brand of protein that connects with customers has never been better. “


Nichromet Extraction  is a private research and development company. Recently, the company has developed a process that can extract gold from a mine’s gold ore concentrate without the use of cyanide. Cyanide has been banned for usage by most countries and there are many gold ore bodies that are lying idle for lack of a process that can extract the gold without cyanide. Nichromet process operation costs are similar to cyanidation on a USD/oz basis. Hence, this could be a game changer for the gold mining industry.

United Hydrocarbon is a private, oil and gas exploration, development and production company with activities in the Republic of Chad. Since 2012 the company owns the exclusive right to explore and develop oil and gas reserves in two proven oil basins by having paid a fee of USD 92.2 m to the Government of Chad. In case of successful oil production there will be made additional royalty payments to the Government of Chad. The total area covered under the agreement is approximately 5.3 million acres. The company targets a production of up to 10,000 barrels per day in mid 2015. If successful this oil production will be only 14 km away from a currently underutilized pipeline to the Atlantic coast. The company is also planning an IPO once production has started. Definitely very risky.

Apart from that, the company’s private investment portfolio consists of a variety of minority interests predominantly in small and mid sized mining companies. For the last four years alone, I counted 28 investments in different mining companies with an average equity investment of approx. CAD 3.0 m. Information is limited. Most of these companies seem to be in an exploration stage, so uncertainty is quite high here.

I could not find detailed information about the company’s debt securities portfolio. Part of it (CAD 66.7 m or 31%) seems to be invested in senior secured convertible bonds in relation to United Hydrocarbon. This hints to a relatively high risky below investment grade fixed income portfolio.

Why is the company cheap?

There are several reasons why the company trades at a discount to its NAV.

First, the company is seen as a conglomerate by the market and this provides for some complexity in valuing its assets or estimating the future cash flow generation of Dundee Corp. as a whole. However, it is important to note, that Dundee has generated an impressive 18% annualized return for its shareholders over the past twenty years. This has come from superior capital allocation and a shareholder friendly policy, where Dundee’s management has consistently worked on eliminating the discount to intrinsic value. The latest example is the spin-off of DREAM as the management regarded the value of this holding not reasonably reflected in Dundee’s share price. The same applies to the former listing of its REITs. To some degree this strategy is also comparable to the much larger Brookfield Asset Management where they unlock the value and then get management fees up to the top parent corporation. So I believe that in the future an investor can expect additional share buybacks and corporate transactions which are in the interest of shareholders. To borrow from valueandopportunity’s categorization of holding companies, I would argue that Dundee is a value adding Holdco in which case no discount should be appropriate.

Apart from that, the company’s holdings happen to be in sectors that are difficult times right now. For instance, concerns about a bubble in the Canadian housing market and a potential correction continue to linger. The Canadian market did not have a comparable decline like in the US. To the contrary, the volume of outstanding mortgages has almost doubled between 2006 and 2012. Housing expenditures make up a substantial 17% of GDP. However, there seem to be some important differences between the Canadian and US mortgage market.  There is a very informative report about the Canadian housing market from CMHC, the Canadian public mortgage insurer, available. Based on this report, the Government implemented more stringent rules as to requirements to getting loans and requirements for servicing current loans (e.g. lowering max LTV, reducing the max amortization period). In addition, the rate of 90 days mortgage arrears in Canada is only 0.31% as at August 2013 (average since 1990 is 0.41%), according to the Canadian Bankers Association. This compares to about 1.26 % for prime fixed-rate mortgages in the U.S. for the first quarter of 2013, according to the U.S. Mortgage Bankers Association. Most of DREAM’s assets are in Saskatchewan, where there is a large presence from the mining industry, and which is experiencing very high new household growth and very high job growth. Residential building permits increased from 3,193 in 2003 to 8,643 in 2012.

That’s what Mr. Cooper, CEO of DREAM, is saying about a potential bubble in the market:


“We have been dealing with this sentiment for a long time, however, that doesn’t mean that it’s not going to happen. CMHC (public mortgage insurer) is calling for a reduction in housing starts next year, but when you drill into it, our markets are predicted to have very high housing starts although not quite as high as 2012. Our lands are in very attractive markets and are among the best in each market. Although there is always risk, having the best lands in growing communities is the best place to be. Our balance sheet is very strong and we are well positioned to manage our way through tough times, should they appear, and, at the same time, we are well positioned to benefit from continued strength in our four major markets.”


In addition, most investors shun away from the mining industry as falling commodity prices and ever increasing costs have a negative effect on profit margins. The mining industry is one of the few industries at the moment where capital is a scarce resource. In 2013, Dundee sold its remaining stake in Bank of Nova Scotia and invested part of the proceeds in additional mining investments. Dundee as an investor with strong expertise in the mining industry (Ned Goodmann is actually a geologist) should be able to negotiate attractive deals with miners and should be able to profit from the current situation. So Dundee could be a good investment vehicle to participate in a recovery of this industry. Furthermore, as an individual investor I get in the position to not being diluted again and again which seems to be specific for equity investments in the junior mining industry.


Dundee provides an attractive hedge against a potential tail risk scenario. There are certainly other potential investments available in other industries which are also inflation proof (Mastercard would be an example as the company gets a fixed share of credit card transaction volume). However, from my perspective Dundee is also trading at an attractive valuation as many potential risks are reflected in the current share price. In addition, I see the potential for a recovery in the mining industry. Dundee might be a good investment vehicle to profit from a rebound. Furthermore, given that the current enterprise value is covered by the public holdings, the private assets contain substantial positive optionality.

I will establish a 4% position for the portfolio with a share price limit of CAD 17.2. Please click here for more information on WertArt Capital and 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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