Monthly Archives: July 2012

Bond yields and asset allocation

Allocating some percentage of your portfolio to bonds is a common practice that also theoretically makes sense: bond returns are inversely correlated with equity returns, creating a portfolio with a lower variance and better risk-adjusted returns. I don’t own any bonds though, because with the current low yields it’s hard to imagine that it is going to generate positive returns in the long run.

GMO publishes a monthly asset class forecast that mainly assumes that in 7 years time valuations return to long term averages. This simple approach correctly predicted poor long-term returns during the dot-com bubble and high returns in the middle of the financial crisis. Mean reversion does not bode well for the future of bond owners:

This is of course no rocket science. When some governments are selling 2 year bonds with a negative yield you can’t really expect positive returns after inflation. Instead of risk-free returns government bonds are giving return-free risks (don’t know who coined this term originally, but it’s a nice description for the current situation).

Bill Nygren’s OakMark seems to have the same view:

The 30-year U.S. Treasury Bond today yields about 2.7%. Just 10 years ago, its yield was 5.8%. If five years from now the yield simply returned to its level of a decade ago (and just in case you think I’m cherry picking, over the past 25 years it has averaged a 7.5% yield and at the low in 1981 was twice that), bond investors would suffer a meaningful loss of capital. The principal of the bond would decline by 43%, which would swamp the 14% interest income received over five years, leaving a total loss of 29%. That’s a high price to pay for reducing a portfolio’s risk level.

Contrast that to the S&P 500, which yields just a fraction of a percent less than the bond and we expect will grow earnings at about 6% per year for the next five years. If that growth rate is achieved, the current P/E multiple of 12.9 times would have to fall to 10 times for the S&P price to stay unchanged. The P/E would have to fall to about 7 times to match the loss that the bond investor would sustain if yields reverted to their decade ago level. With a historical average P/E of about 15 times, a 7 times multiple seems like quite an outlier.

A final note: in a lot of cases small individual investors would be crazy to buy government bonds. I’m Dutch, and our government just sold two year bonds today with a 0.003 percent yield. At the same time it is possible to park money in a CD for two years and receive a ~3.3 percent yield. Since this money is also guaranteed by the government (up to 100.000 euro) it would be stupid to park it in lower yielding bonds.

ChipMOS Technologies (IMOS)

ChipMOS is a technology company located in Taiwan, and according to it’s own desciption “the leading independent provider of semiconductor testing and assembly services”. The company caught my attention because it’s trading at just 2.4x FCF. So the big question: is the company indeed incredible cheap, or is there a good reason for the current valuation? Some quick stats from Yahoo:

Last price: 9.20
Shares outstanding: 27.03M
Market cap: 247.9M
Cash and Equivalents (mrq): 250.3M
Total Debt (mrq): 306.12M
Enterprise Value: 309.9M
EPS (ttm): -0.09
EV/EBITDA (ttm): 1.57x
P/B (mrq): 0.70x

Cash flow versus earnings

While ChipMos is generating significant cash flow the earnings paint a different picture. The main reason for this are big depreciation expenses related to capex done in 2006. Because a picture says more than a thousand words below a graph of historical capex and depreciation, and a second graph showing the difference between net income and free cash flow.

The high capital expendures in 2006 were financed with debt, and with a global recession just around the corner it created some serious problems for the company. The past years ChipMOS has been paying down debt aggressively, and it expects that it’s going to be debt free at the end of this year. At the end of Q1 2012 it reported a net debt position of $56.7 million. To continue with the graphs, here another one with the historical debt load of the company. Note that this graph, and also the two graphs above, don’t include the results of the first quarter of 2012.

When differences between capex and depreciation are big the question is of course what matches economic reality: does the high depreciation mean that we should expect high capital expenditures in the near future because old equipment needs to be replaced? The company is depreciating most of the capex in five years time. A potential positive is that this is almost certainly going to result in a nice earnings number for this year, but if this also means that a big part of their equipment needs to be replaced soon there would be little reason for joy.

The company has indicated that it expects to spend between $85 and $95 million on capex this year and to generate approximately $110 million in free cash flow. If we would assume that this is sustainable ChipMOS would be very undervalued. Throw an 8x multiple on the cash flow, implying an 12.5% yield, and the company would be worth 8 * 110 – 57 (debt) = 823M: more than three times it’s current valuation. That looks like a great upside, but I think this is missing some important points.

The business

Valuing ChipMOS at more than 800M would also value it at more than 2x book value. The company is at the moment trading at a 29% discount to it’s 349M book value. If we would value ChipMOS significantly above book value it would imply that there is some sort of mismatch between economic asset value and accounting asset value, or a big competitive advantage that allows the company to earn above average returns.

I don’t think there are real reasons to believe that something is wrong with the accounting: the majority of the assets that the company owns are machinery and equipment that is depreciated in five years. That doesn’t sound unreasonable for a company in the tech industry were new chip packaging technologies, bigger wafers and other developments presumably require regular upgrades of machinery.

I also don’t think the company has a real competitive advantage. For starters: there is no sign in the historical results that it was able to achieve a high return on equity or maintain a high and stable market share. That also makes sense if you understand what the company does: the testing and assembly of chips is no rocket science. Sure, the company is not making toasters, but all large electronic manufacturers should be able to enter the business (if they are not already in it).

What does happen in the industry is that smaller players decide to outsource testing and manufacturing to a third party like ChipMOS because there are economics of scale at work. The business is capital intensive and has large fixed costs. What is driving the improved performance the past years, compared with 2008/2009, are higher utilization rates. The company is active in a highly cyclical industry and has a lot of operating leverage (combining that with high financial leverage in 2006 was in my opinion a pretty poor decision). Currently things are pretty good, but there is no reason to believe that this is going to continue indefinitely. There will be good years, but also bad years.


Valuing a cyclical business in an evolving industry isn’t easy, but think that historical results are still a decent starting point. This is not going to produce a high valuation though. The past 10 years earnings have been negative on average and book value/share decreased with 20% in this period. Based on historical results the current discount to asset value doesn’t look that crazy. I do think that the company deserves some credit for the current performance though, but I’m not sure how much.


Insiders own almost no shares, just 1.8 percent of total shares outstanding. Another problem is in my opinion the share appreciation rights that are used as an incentive plan instead of an option plan. Options are also far from perfect, but giving cash bonuses based on share price performance doesn’t seem like a good tool to align incentives. Another thing that caught my eye was the following statement about the CEO:

Mr. Shih-Jye Cheng, our chairman and chief executive officer, was indicted by the Taipei District Prosecutor’s Office, or the prosecutor, in December 2005. Based upon information released by the prosecutor, the indictment alleges that Mr. Shih-Jye Cheng, as instructed by Mr. Hung-Chiu Hu, purchased repurchase notes on January 6, January 13, and January 28, 2004 from Founder Associates Limited, a British Virgin Islands company affiliated with Mega Securities Co., Ltd. (formerly known as Barits International Securities Co., Ltd.), with an aggregate principal amount of approximately US$29 million, by using corporate funds from ChipMOS Taiwan and ThaiLin. The indictment further alleges that these repurchase notes were used as a cover to misuse the corporate funds of Mosel, and its affiliated entities, including ChipMOS Taiwan and ThaiLin, in violation of ROC law. In addition, the indictment alleges that Mr. Hu and others were engaged in the insider trading of the securities of Mosel in violation of ROC law, but none of the current officers at ChipMOS Taiwan or ThaiLin was indicted in this regard.

Potential catalysts

Not everthing is negative, and the company does have a few things going for it that could be a catalyst for a higher valuation.

  1. The company expects that it will start paying a dividend at the end of this year
  2. The company will almost certainly report positive earnings for this year thanks to reduced depreciation charges.
  3. The company will probably list in Taiwan next year


What the exact value of ChipMOS is: no idea. I’m fairly certain that the bull case is too optimistic. Just looking at the current free cash flow yield is missing the decade of poor performance and the lack of asset value or competitive advantage. The almost nonexistent insider ownership is also worrying. I do think there could be value at current prices, because just a few more good years could generate a massive amount of cash. For me this company is one for the “too hard” basket though: just too many unknowns and risks. What do you think about the value?



Shorted some Vivus (VVUS)

Regular readers of my blog might think that I’m a long only value investor, but that’s not the case: I do sometimes take small short positions in companies that seem fraudulent, have a poor business model or are simply far too expensive. I always take a small position though: unfortunately the mechanics of short selling are such that the risk/reward ratio is not as favorable as taking a long position. You can get squeezed out of your position, and you have to find shares to borrow and pay to borrow them.

Another generic observation related to short selling: you often see emotional reactions from people who are long when short sellers make their case public. Instead of welcoming a critical view, a lot of longs prefer to ignore information that doesn’t confirm that they made an excellent decision buying the stock. This is fundamentally different than people who argue for the long case. You either get present longs to agree with you, because your view confirms with their view, or you have people without a position who are not emotionally invested, and don’t really care.

I think this behaviour might actually be one of the reasons why short selling opportunities can exist, even after research has been published that details everything that’s wrong with the company. There is always some voice that offers some kind of argument, no matter how poor, that discredits the short case. And believing something that fits with your view is way more convenient than looking into the possibility that you were wrong. It’s more common to see longs shout that the SEC should investigate the short sellers, than seeing longs investigating the short case.

The Vivus case

Ok, enough about short selling: time to talk about Vivus, a biopharmaceutical company. The company hit my radar after Citron Research released a report yesterday. Vivus’ future depends on one drug, a weight control pill, that got FDA approval earlier this year. The drug is simply a combination of two existing generic drugs, and the intellectual property protecting it is weak at best. And to make things worse the drug might be breaching IP from other big pharmaceutical companies. The IP-issue is discussed in a lot of detail on this blog, including plenty of links to publicly available documents to confirm the story.

Because of the IP issues the company might not be able to bring it’s product to the market, or just have a limited period of exclusivity. At the same time it has to compete with the two generic drugs, that are the basis for it’s own drug and that have been used for years for the same purpose. The questionable competitive position of the company is combined with insiders that are selling their shares as fast as they can. As a group they currently own just 0.29% of the >2.5 billion USD market cap company that is supposed to own the next blockbuster drug. I always see what insiders are doing as a key element in any investment: can you really believe that the company is going to have a bright future if insiders don’t believe it?


I don’t have any particular additional insight in the company besides the information provided in the two links above, but I do think that they make a compelling argument, and that’s all there is to it. Guess we’ll find out how successful Vivus is going to be bringing it’s drug to the market next year.


Author is short VVUS

Rella Holding A/S (RELLA.CO)

Rella Holding A/S is a Danish listed holding company that owns shares of Aller Holding: a Scandinavian publisher with a 60% market share. Rella Holdings own 58.2% of Aller Holdings and uses the dividends it receives from Aller to repurchase it’s own shares and more Aller shares. The big attraction of Rella Holdings is that it is almost trading at net cash value and at a discount to NCAV and book value. The company trades at approximately a 25 percent discount to NCAV and a less meaningful 67 discount to book value. Some quick stats:

Shares outstanding: 22.880.336
Last price: 32.00 DKK
Market cap: 732.2M DKK
NCAV per share: 42.67 DKK
BV per share: 98.79 DKK

It should be noted that the numbers above are based on my own calculations. Rella Holdings investment in Aller is listed on the balance sheet based on historical cost. The Aller Holding B-shares are unlisted, but do trade on some obscure Danish OTC market.

Asset value

There are three sources of value inside Aller.

  1. A big amount of cash and securities.
  2. Significant real estate holdings
  3. A profitable operating business in a declining industry

I’m going to start simple and value Aller based on it’s asset value and the book value of it’s real estate, while ignoring goodwill, publishing rights and licences, and other fixed assets such as machinery. The main tangible items of Aller’s balance sheet are reproduced below with the value of Rella’s Aller stake in the right column. There is also some debt at the Rella company level, creating the following picture:

The most meaningful measure of asset value is probably NCAV plus real estate value. Most of the current assets are cash and securities that are marked to market so there is little doubt about the value there. The real estate is the other big item and is mainly an office building that was bought in 2009 for 800M DKK and is located at the Copenhagen waterfront. You never know if it can also be sold again for that amount, but probably for an amount somewhere in that direction, and that’s close enough when you are buying assets at a >50% discount.

Looking at a 32DKK share price and 74DKK in tangible assets per share looks like a big upside, but we do need to discount this a bit. Holding companies almost always trade at a discount, and almost always for good reasons because it’s often not a tax efficient structure and there are overhead costs. Administrative expenses are minimal for Rella running at 1.3 million DKK yearly. This is just 0.1% of the current market cap and an even lower percentage if we look at the underlying asset value. So the biggest reason for a discount should be the tax inefficiencies. Aller dividends paid to Rella are taxed at a 15% rate, so a discount between 15% and 20% seems fair based on the expenses and tax inefficiencies.

Earnings power

Buying assets at a discount is not going to do you any good if value isn’t preserved, so the second big question is how much money is Aller making or losing. Some historical key figures from the Rella site:

As is visible the company has been profitable four out of the five last years with 2009 being the only negative year. Average EBIT, including results from associated companies, has been 142M a year. While it’s not directly visible from the numbers above the circulation numbers are declining. In 2006 Aller sold 3.3 million magazines weekly while last year it sold 2.7 million, a 20% decline.

One thing to realize is that the real estate on the balance sheet is used to generate the above earnings, so if we would simply take the sum of the cash + real estate + operating business we would be double counting a bit. If the company would need to lease an office building the net income would presumably be significantly lower.

This source gives a gross rental yield of around 5 percent for Denmark, and with 1.2B in Real Estate on the balance sheet this would imply that the company would need to pay 62M DKK in rent per year. Using the 5 year average number – which isn’t entirely accurate since the balance sheet changed in 2009 with the purchase of the new office building – this would give us an average EBIT of 90M a year.

There are some other questions that need to be answered before we can complete the valuation picture:

  • How much cash is excess cash?
  • How to measure earnings? Look at reported earnings or cash flow?
  • What is the right multiple for a declining business?

Excess cash

I don’t think there is a single right answer with regards the question “how much cash is excess cash?”. Given the current balance sheet I think it’s obvious that there is excess cash, but how much depends on what you think is a proper capital structure. I think the company could easily run without the 2.3B DKK securities position, and that would imply that it could return 54 DKK in cash per Rella share (ignoring taxes).

This would leave the company with 543M DKK in cash and 1,064M total in current assets while total liabilities excluding pension provisions would stand at 1,503M DKK. This is probably a bit on the aggressive side for a company in a declining industry, but the liabilities include 424M DKK in prepayments from subscribers, so it seems to me that it would be a workable capital position. When you have customers that prepay you don’t need a lot of working capital. Maybe it would be a bit more prudent to reserve 300M DKK of the securities to cover the pension provisions, so that would leave the company with 2.0B DKK in excess cash (still 41DKK per Rella share).

Long term debt is very low and stands currently at 28.8M DKK. There is a 437M item in the balance sheet titled “Other debt”, but based on the cash flow statement I think those are some sort of spontaneous liabilities, not interest bearing debt.


The earnings reported by the company seem to match economic reality to me, so that’s easy. Cash flow is significantly higher than reported income, but the company does spend a decent amount every year on new equipment and intangibles such as publishing rights. In 2011 the company invested 121M in goodwill and publishing rights and 71M in buildings and machinery/equipment. Cash from operating activities was 449M, subtract the 192M in capex and we get 257M in free cash flow: a reasonable match with the reported 220M operating income


It’s not easy to figure what kind of earnings multiple would be appropriate. How long can the company remain profitable while circulation numbers keep dropping? I don’t know, but magazines aren’t going to disappear overnight and the fact that Rella is a market leader in Scandinavia should be valuable in a declining industry. They should be one of the last companies in business since they can spread fixed costs over the biggest number of subscribers, and when competitors disappear Rella’s decline will slow down.

A PE multiple between 7.5 and 8.5x is appropriate for a business that isn’t growing, so that is absolutely an upper bound for the valuation of the company. I honestly don’t know what’s reasonable for Aller. The business doesn’t seem to be declining that fast, so I think that a multiple around 4x or 5x isn’t that bad of a guess. I don’t think being precise is very important, as long as the business does have a positive value I’m already in a good position thanks to the real estate value and excess cash.

A guess

Since a guess is better than nothing I’ve based a quick and easy valuation based on the following assumptions:

  • Excess cash is 2.3B in securities minus 300M in pension provisions
  • Real estate value is 1.3B, fictional rent 62M/year
  • Average EBIT is 142M, taxrate is 25%, interest expense is ~2M/year
  • PE-multiple: 4x
  • Holding company discount: 20%

These assumptions create the following picture:

This would imply that Rella is worth 67DKK per share while the current share price is 32DKK. It also shows that the valuation isn’t very sensitive to the exact value of the operating business: it’s mainly about the assets on the balance sheet.


Aller was founded in 1873 by Carl Julius Aller and the company is to this date controlled by the Aller family who own the A-shares (27% of total outstanding shares). Rella Holding owns 69% of the non-voting B-shares. The fact that Aller is fully controlled by the family is probably one of the key reasons the company is cheap: you don’t have to expect a catalyst from a private equity fund or activist investors.

I don’t think that’s a problem: value can be it’s own catalyst, and the fact that you are not competing with private equity funds or activist investors might actually be a reason why there is an opportunity in the first place. It does introduce one major risk: the Aller business is probably perceived as a family legacy, and when things go bad it’s easy to see the family throwing good money after bad in order to preserve the legacy. It’s a risk I’m willing to take given the large margin of safety based on the current asset value, and the fact that the family has a large economic interest in Aller as well. After the poor results in 2009 the company cut costs, and in the current annual report Aller also signals that it is willing to close down or sell non-strategic and/or loss-making activities.

Another small positive note is that insiders have bought Rella shares on multiple occasions the last few years, and the last purchase was in March this year when the company was trading at almost the same price as today.

Also interesting: not only Rella is buying back it’s own shares: Aller itself also started buying it’s own shares. Apparently some Danish regulation that prevented Aller from doing this before has been lifted.


There are a lot of uncertainties with regards to the exact value of Aller and Rella, but one thing is certain: there is a huge amount of asset value, and while magazines and weeklies are perhaps a dying business it is, for now, still a profitable business. This is really the key of the thesis: the easy to value assets are the biggest part of the pie, and the hard to value business isn’t that important as long as the business is not turning into a massive cash drain, and there is no real reason to expect that this is going to happen.

With the current discount I think there is a good margin of safety. A lot can go wrong and/or a lot of mistakes can made in the valuation before an investment at current prices will turn in a disaster.


Author is long RELLA.CO

Further reading

The company was written up earlier this year at Oddball Stocks when it was trading at a significantly lower price, so interesting to compare differences in valuation. A more recent write-up can be found on VIC.

Portfolio review 1H2012

With the first half of 2012 behind us it seemed a good idea to me to quickly review my portfolio. Not because a time frame this short is really useful in evaluating how good or bad certain picks have been, but a portfolio is not a static entity. Some positions could become more attractive over time because of new developments, insights or changes in price, while other positions become less attractive.

The performance of the various positions is summarized in the table below. As is visible I have a few positions with a small loss and some positions with a pretty good return with SALM being the icing on the cake. I wish I could attribute this to buying undervalued companies with good downside protection, but this is not yet even getting close to getting a sufficient sample size. Besides: the company with the highest return was (and still is) also the riskiest company based on the amount of leverage.

Ticker Purchase Date AVG Price Rating Dividend price Return
ORGN.PK May 10, 2012 1.45 8.5->7.5 0.38 1.45 26.2%
CNRD.PK Mar 29, 2012 16.50 9.0->8.5 14.92 -9.6%
SODI.OB Mar 26, 2012 3.09 8.0 2.96 -4.2%
DSWL Mar 6, 2012 2.11 8.5->8.0 0.02 2.84 35.6%
SALM Feb 21, 2012 2.65 8.0->8.5 0.07 5.64 115.5%
IAM.TO Jan 24, 2012 0.59 8.5 0.59 0.0%
ARGO.L Jan 3, 2012 14.69 8.5 1.3 12.84 -3.7%
URB-A.TO Nov 28, 2011 0.99 8.0->7.5 1.02 3.0%
0684.HK Nov 16, 2011 2.21 8.5 0.025 2.09 -4.3%
ASFI Nov 7, 2011 8.33 9.0 0.06 9.51 14.9%

I have also included how I would change the rating of the attractiveness of the various positions based on today’s stock price and information. I have summarized my reasons for the changes below. In most cases more details can be found in the comments on the original write-up or in a followup posting.

  • ORGN.PK: Have to say that this stock really showed the value of this blog for me. Got great feedback from multiple readers and realized that it’s currently trading closer to fair value than I initially thought. The positive return thanks to the fat dividend is purely luck and only showed I didn’t fully understand the risks (and luckily in this case the rewards!) of the interest rate swaps (now terminated).
  • CNRD.PK: Small re-rating based on some errors in my original write-up, mainly because there was less excess cash on the balance sheet than I thought.
  • DSWL: I’m more convinced than ever than I’m right that it isn’t a fraud thanks to the increase in regular dividend plus a special dividend this month. But since the stock price is also up a decent amount I think it’s less attractive today.
  • SALM: It’s up a lot, but still trading at a near 20% FCF yield. The refinancing possibility next year (missed this in my first write-up) and massive insider buying after I bought it are the reasons to upgrade my rating. But it was a close call: the increase in share price is obviously not positive for the risk/reward ratio.
  • URB-A.TO: The discount has been getting smaller since I initiated my position, and the recent transaction was also a small negative development.

So far there isn’t anything in my portfolio that I think I should sell right now. Cash is in my opinion one of the least attractive assets with an almost guaranteed negative real yield. But if a better opportunity comes along I do have two positions on the hot seat.


Long everything mentioned in this post.