Monthly Archives: January 2013

Couple of quick updates (RELLA.CO, ASFI, IAM.TO)

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While I was on vacation last week a couple of companies released their yearly results (RELLA.CO and ASFI), and another holding of mine was finally sold (IAM.TO). I’ll briefly discuss the various developments.

Rella Holding A/S

Rella is the holding company that owns the biggest part of Aller, a Scandinavian publisher of mostly weeklies. Aller only reports once a year, so when they do it’s a good moment to review how the company is performing. Comparing the balance sheet of Aller with previous year version should give a good indication on what happened with the asset value:

Rella/Aller 2011 and 2012 balance sheets side-by-sideWhile the share price of Rella is up roughly 25% since I first wrote about the company it’s almost just as cheap today as it was then. The book value of Aller is growing while it’s repurchasing shares and paying out dividends, and as a result Rella is owning an increasingly bigger part of Aller. At the same time Rella is using the dividends received from Aller to repurchase it’s own shares. That’s a combination I like!

The biggest part of Rella’s value consists of the securities on Aller’s balance sheet, but it’s also important that the operating entity remains profitable. The results of primary activities were down significantly in 2012 compared with 2011: 142M DKK in 2012 versus 246M DKK in 2011. This decease is primarily due to employee costs in connection with staff reductions. Revenue is actually up a tiny bit, and I also think it’s positive to see that prepayments from subscribers are up a bit compared to last year. Weeklies aren’t dead yet, and next year should also be slightly profitable:

Based on the current activity level and the 2012/13 budget figures from the leading subsidiaries and the accounts for the latest time periods, a result of primary activities (EBIT) of DKK 100-150m is expected.

As long as Rella continues to trade significantly below tangible asset value, Aller remains profitable and both companies continue repurchasing shares I’m not going anywhere.

Asta Funding

After a bit of a delay Asta Funding finally published it’s 10K last week. I haven’t found any big surprises in the 10K compared with the press release that was issued a month ago. Due to some accounting peculiarities it’s not directly visible how cheap ASFI is based on it’s asset value, but it certainly is. The company has currently a $123M market cap while it owns $106M in cash and investments, and it does not have any big liabilities (there is only non-recourse debt). Besides the cash we find $12.3M in consumer receivables on the balance sheet and $18.6M is invested in the personal injury litigation financing business.

Besides these assets that are visible on the balance sheet the company also owns a large number of consumer receivables that have zero book value (fully amortized portfolio’s). Last year these assets generated $36.4M in zero basis revenue. Since the company is not replacing it’s aging portfolio of consumer receivables we should expect that revenue’s will drop in the future, and this could become problematic if there are a lot of fixed costs. They can’t continue on the current path indefinitely. So this is something to keep an eye on, but so far ASFI is still cheap and using a lot of cash productively by repurchasing shares.

Integrated Asset Management

Buying this company last year was a mistake. It looked cheap because it had a negative enterprise value and had a history of profitability, but in what could best be described as a beginners mistake I  failed to realize that there were a lot of accounts payable and a lot less accounts receivable. So logically the company had to use a bunch of their cash this year, and IAM was not as cheap as I thought. At the same time the financial performance of the company was also disappointing last year. Since the company is very illiquid it took some time for me to exit my position, but managed to do so this month at a small loss (-3.4%).

Disclosure

Long RELLA.CO and ASFI

PPG/GGC odd lot exchange offer arbitrage

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I was alerted to an interesting odd lot arbitrage opportunity in PPG & GGC thanks to Whopper Investments. PPG Industries is a 22 billion dollar company that is selling/spinning off its commodity chemicals business in a complicated transaction to minimize taxes using a Reverse Morris Trust. The steps of the transaction are described here in the prospectus. Since a picture says more than a thousand words: the transaction explained in diagrams:

PPG/GGC transaction before

PPG/GGC transaction completedSo I hear you thinking: this is all very interesting, but where is the opportunity? The opportunity lies within the fact that PPG shareholders can exchange their shares for GGC shares at a discounted price. $100 dollar worth of PPG shares can be exchanged for $111 worth of GGC shares. Because GGC is significantly smaller than PPG not all PPG shares can be accepted in the exchange offer: PPG has 153M shares outstanding and approximately 10.7 million PPG shares can be exchanged for GGC shares. Given the title of the post you can guess that there is an exception: if you own less than 100 PPG shares (an odd lot) you can exchange your shares for GGC shares without being prorated. Given the fact that PPG is trading for ~$143/share this means that you can create a sizable position, and that the expected profit for a long PPG/short GGC trade is a not too shabby ~1500 dollars.

How much you will make on the trade is at the moment not yet known, because the number of GGC shares you will receive for every PPG share is not yet determined. This will be based on the VWAP prices of both stocks on 23, 24 and 25 January. Indicative values are provided daily by PPG. I have created a very simple spreadsheet that can be used to calculate the expected profit of the trade based on the current share price of PPG/GGC, and the latest ‘Indicative Calculated Per-Share Value’.

Expected value PPG/GGC tradeAs is visible the expected value of the trade today is lower than what you would expect based on the 1.11x exchange ratio. This is because the exchange ratio is calculated using the 3 day average VWAP price, and not the current market price. So you are expected to make 11.1% on a ~14K position, but it could be a bit more or less depending on when you initiate your position and how PPG and GGC will trade relative to each other the last days.

A related problem is that you also don’t know yet how many GGC shares you should short to remove most of the market risk from the position. I will simply wait till the last moment to initiate my position. My broker (Interactive Brokers) allows you to tender shares that are bought in the morning of January 25, and at that time the exchange ratio will be mostly fixed. Other brokers often require that you buy several days in advance to be able to participate in a tender offer. In that case hedging is a bit more difficult, but don’t think that’s really problematic. If you are expected to make ~11% you can handle some negative variance without losing money, and you could get some positive variance as well.

Disclosure

Will be long PPG and short GGC soon

Exited NKBP and SHP

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Quick update to let you know that I sold out of China Nuokang Bio-Pharmaceutical (NKBP) and ShangPharma (SHP). The first transaction is almost complete, and the spread between the buyout price and the market price is just a few cents anymore. The finish for the SHP deal on the other hand is just as far away as when I initiated my position, but at the same time a large part of the spread is already gone. I made an 8.1% return on NKBP in a bit less than three months time, and a 1.8% return on the SHP position in a bit more than a week. I prefer to buy a position and stick with it until the deal is finished, but I wanted to exit some positions to manage my risk exposure since I did initiate multiple new positions recently.

Disclosure

No position in NKBP and SHP anymore

Pricing discrepancy in PRISA capital structure

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Promotora de Informaciones (PRISA) describes itself as world’s leading Spanish and Portuguese-language media group. The company gets most of it’s revenue’s from Spain, but it also has a sizable presence in Latin America. It’s heavily indebted and not doing very well. But that doesn’t matter a lot for the following idea: even a bankruptcy shouldn’t be a disaster, although It’s not a best case scenario.

PRISA has two different share classes: ordinary Class A shares and convertible non-voting Class B shares. The B shares are convertible to A shares at any time. From the prospectus:

Holders of Prisa Class B convertible non-voting shares may at any time give Prisa notice of their election to convert the shares into one Prisa Class A ordinary share for each Prisa Class B convertible non-voting share. Prisa’s board (or a duly authorized committee) will, within five business days following the end of each month, issue Prisa Class A ordinary shares in respect of the Prisa Class B convertible non-voting shares whose holders have elected conversion during that prior month. Prisa will register with the Mercantile Register all Prisa Class A ordinary shares issued upon conversion as soon as practicably possible before the end of the month in which the Prisa Class A ordinary shares are issued.

So logic would dictate that the price of the Class B shares is at least equal to the price of the Class A shares. The market is currently failing to recognize this with the PRIS ADR trading at $1.70 at the time of writing while the PRIS-B ADR is trading at $1.57: that’s an eight percent discount for a security that has at least an equal value. Both ADR’s contain four shares.

While this is already noteworthy the discrepancy is even bigger when you realize that the Class B shares are actually far better than the Class A shares. The Class B shares not only receive a dividend (7 Class A shares for 40 Class B shares), they will also be automatically converted to Class A shares in 2014. When the Class A shares are trading below €2.00 the conversion will be increased from 1:1 to a maximum of 1.33 A shares for every B share:

Any Prisa Class B convertible non-voting share still outstanding on the date that is 42 months after its issue date will automatically convert into one Prisa Class A ordinary share, without any action by the holder. In the event of automatic conversion, if the volume-weighted average price of Prisa Class A ordinary shares on the Spanish Continuous Market Exchange (Sistema de Interconexión Bursátil-Mercado Continuo) during the 20 consecutive trading days immediately preceding the conversion date, or the twenty-day trailing average, is below €2.00, then the conversion rate will be modified. In this event, the number of Prisa Class A ordinary shares into which each Prisa Class B convertible non-voting share will convert will be equal to a fraction (expressed as a decimal), the numerator of which will be €2.00 and the denominator of which will be the twenty-day trailing average, subject to a maximum conversion rate of 1.33 Prisa Class A ordinary shares per Prisa Class B convertible non-voting share. If the twenty-day trailing average is less than €2.00, Prisa may also choose to retain the 1:1 conversion ratio, in which case Prisa would pay a per share amount of cash equal to the difference between €2.00 and the twenty-day trailing average, subject to a maximum of €0.50 per Prisa Class B convertible non-voting share. The balance of the premium reserve in respect of the Prisa Class B convertible non-voting shares, if any, will be made available to pay the nominal value of the Prisa Class A ordinary shares to be issued in excess of the Prisa Class B convertible non-voting shares to be converted.

With the Class A shares currently trading at €0.335 in Madrid it seems quite probable that holders of Class B shares will not only receive a few years of dividend payments before the automatic conversion in 2014, but that they will also receive 1.33x Class A shares for every Class B share bought today. So I think it’s quite obvious why I think the current market pricing is just wrong, and I haven’t even mentioned yet that the Class B shares rank above the Class A shares in case of a liquidation. While a liquidation is probably not a disaster for a long/short trade it’s not the best outcome if it would mean that both classes go to zero.

In a liquidation of Prisa, the Prisa Class B convertible non-voting shares would be entitled to receive, on a preferential basis according to applicable law, their stated value per share, before any distribution is made to the holders of Prisa Class A ordinary shares. In the event that Prisa has, immediately prior to any liquidation, distributable profits or share premium reserves in respect of the Prisa Class B convertible non-voting shares, the holders of the Prisa Class B convertible non-voting shares would receive any unpaid minimum dividend, including any accumulated unpaid dividends from prior years, in respect of the prior and then current fiscal year.

Holding the Class B shares to maturity and hedging the exposure to PRISA with a short Class A position is a pretty decent idea, but it’s also possible to buy PRIS-B shares and convert them directly to Class A shares. Not only will you capture the price difference between the two share classes, you also receive the accumulated dividends. Based on the declining number of Class B outstanding and the increasing amount of Class A shares there are people who are doing this trade. Last month 12 million Class B shares were converted to 14.1 million Class A shares (the dividend is paid in Class A shares).

Both trades have one big risk: being able to maintain the short position in the Class A shares as a hedge. There aren’t a lot of shares available for shorting, and you are paying at the moment 5% annually for the borrow. If you lose your borrow you could be forced to buy-in at exactly the wrong time, or the borrow fee might go through the roof. Think this risk is significant, but at the same time it’s really the only risk you are taking here.

A bit of good news is that the short term arbitrageurs should both increase the supply of Class A shares available for borrow and increase the price of the Class B shares. It’s also good news for the people who are long PRISA: a lower amount of Class B shares outstanding means less dilution in the future.

Conclusion

The PRISA Class B shares have been relatively cheap ever since they were created, and I have had a long position in the Class B shares since 2011 (my worst investment ever). But with the spread between the two share classes at an historic low, and the automatic conversion only getting closer I couldn’t resist buying some PRIS-B shares. This time I’m not making the mistake of not hedging my long exposure though.

Disclosure

Short PRIS, Long PRIS-B

Suntech Power (STP) short

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The Credit Bubble Stocks blog has written repeatedly about the overvaluation of Suntech Power, a Chinese manufacturer of solar panels. The Company has $541 million of bonds that are due in March and are trading for roughly 50 cents on the dollar for a yield to maturity of almost 500%. Despite the fact that the senior part of the capital structure expects to lose money the equity part of Suntech Power has a significant market capitalization. The stock has more than doubled last month and the company is now valued by the market at $340M.

Just based on the discrepancy between bond and equity prices you know that something doesn’t add up, and if you start looking at the financials I think it’s pretty obvious what part of the equation is right. The company has approximately 2 billion in debt and isn’t earning any money at the moment. EBITDA for the last twelve months is minus $117M, and that is a number that’s not including some very real costs. Last year the company paid for example roughly $100M in interest. It’s a bit unclear what the current financial condition of Suntech is. While the company announced financial results for the third quarter last month it’s a press release short on details: I don’t think I’ve ever seen a company announce financial results, but not tell anything about the achieved earnings or EBITDA. The latest complete financial numbers are from the first quarter of 2012.

What we do have is a nice presentation for bondholders that the company filed with the SEC last November. Included is for example a graph of the debt maturity profile:

Suntech Power Holdings debt maturity profileSuntech has been able to work with bank lenders to refinance their existing domestic loans, but the offshore debt that will reach maturity this quarter is more problematic. Suntech included the follow slide in the presentation about possible solutions:

Suntech Power Holdings Capital Structure Objectives And AlternativesAs is visible the company doesn’t expect to have a lot of options. Chinese banks are not willing to refinance the offshore debt, and issuing new bonds also doesn’t seem to be an option. So that means that there are basically two options left: bankruptcy or a conversion of the bonds to equity. It’s hard to see how that could work out favorable for equity holders…

It’s not a long, but is it a short?

Just because a company is a terrible investment it doesn’t have to be a good short. Especially when something is obviously overvalued there is often no cost effective way to go short. It might be impossible to borrow shares or the annualized cost of borrowing might be through the roof (100%+ was not uncommon for Chinese frauds). Not only can a short position be difficult and expensive to maintain, if it’s a popular trade you also risk a short squeeze. At the same time you also see that the implied volatility of put options increases dramatically. So what often happens is that you end up with a situation that can only be ‘arbitraged’ away by people that are currently long the stock.

Suntech Power certainly falls in the ‘obvious short’ category. My broker has currently just a handful of shares available for shorting and for the privilege of borrowing these you’ll have to pay a 25% annualized fee. With a possible catalyst in March when the bonds reach maturity this might be doable, but it’s certainly not perfect. Same can be said about buying put options. If you think that STP will go to zero in a few months time you can make a profitable bet, but profiting from a small(er) decline isn’t that easy.

Mini Short Certificates

Luckily for us there are also some exchange traded structured products that have STP as an underlying that make it possible to initiate a cost effective short position. RBS is offering several STP Mini Long and Mini Short Certificates. These are popular retail products (marketing names of similar products: Turbo’s, Speeders, Sprinters) in Europa that offer the possibility of creating a levered long or short position with some build-in risk-management since you can’t lose more than your initial investment.

Let’s take a look at the Suntech Power Mini Short Certificate with a $3.40 stop loss and a $4.08 financing level. The value of the product is the financing level minus the value of the underlying, so with STP trading at $1.75 this product is currently worth $2.33 (€1.78). When STP reaches the $3.40 stop loss the product will be liquidated. In theory you should receive roughly the difference between $4.08 and $3.40 when this happens, but it could also be zero if, for example, STP gapped up on open to more than $4.08. So the risk that RBS is taking is limited: only when the price moves up more than 20% above the stop loss they will need to take a loss. But it’s nice that they offer some insurance against a tail event: you basically get a call option with a $4.08 strike. Because the financing level of this product is high relative to the share price the leverage is less than one (0.84x).

RBS offers a few different variants: this certificate has a lower financing level ($2.52) and has as a result more leverage (2.2x). The downside is that you will be stopped out of your position as soon as the STP price reaches the $2.10 level. I suspect that the Mini Short Certificates are relatively cheap because they are targeted towards retail investors, and RBS does not have a need to hedge their short position and borrow shares if they sell more long certificates then short certificates. The bid/ask spread for the certificate with a $3.40 stop loss is at the moment of writing €1.79/€1.82, so you are paying a very small premium.

Investing in structured products does have a number of risks. It’s a retail product, but it’s nearly impossible to figure out how it exactly works. The base prospectus (that should be read in combination with the final terms) is ~1000 pages thick. Despite the number of pages the document is surprisingly short on details. A search for the words “reasonable discretion” (my translation: we do what the fuck we want, and if we can screw you, we will) generates 516 hits. The fact that RBS is issuer, counterparty, and the only market maker is probably also not working in your advantage.

Conclusion

It’s obvious that I’m not a lover of Turbo’s and similar structured products, but compared to simply shorting the stock or buying puts I think it’s in this case a superior solution. That STP itself is a good short actually doesn’t need a whole lot of in-depth analysis. Based on the bond prices, the maturity profile, EBITDA and the short interest in the stock it’s clear that the current stock price is too high. With the bonds maturing in March it shouldn’t take too long to see how this is going to work out.

Disclosure

Short STP through a long position in STP Mini Short Certificates ($3.40 stop loss)