Holding series 10 – Liberty Lilac

This is somewhat of a guru holding. I was holding Liberty Global when this was spun off, and I bought more of Lilac. With the hindsight I succumbed to what we would call social media frenzy over Liberty Lilac. Seeing many experienced investors on this name convinced me, as at the time I was not that experienced. The share price since tanked. However I think that it can now be attractive for long term returns.

Liberty Lilac is probably not a new name for my readers. It is a cable and telecommunications consolidator in Latin America and the Caribbeans. It is a tracking stock of Liberty Global. Its main assets are Cable in Chile and Puerto Rico, and sub sea cables and telecommunication services in The Caribbeans since the acquisition of CWC.

The company is combining these assets to find synergies in terms of services offered and costs. This is the classic liberty playbook, use debt or stock to buy more assets, find synergies, then buy more assets, buy back shares.

Cable equipment rates in the region are low and should increase in the long term. I do not think that the Caribbean region has fantastic growth prospects due to the Geography and weak demographics. Chile has great growth prospects. It would be interesting to see if Lilac would acquire a cable company in other large south american countries similar to Chile.

Lilac currently trades cheaply. Its market cap is $3.9 B usd. The operating cash flow is $1.1 B usd if I take the proportional non controlling interests. Total EV is higher due to the debt ($8.9 B usd – http://seekingalpha.com/article/4002365-much-debt-liberty-lilac-really). EV/Ebitda is then 7.8, using Lilac self defined Operating Cash flow (http://www.libertyglobal.com/pdf/presentations/Liberty-Global-Q3-2016-Investor-Call-Presentation-FINAL.pdf).

The value creation from now on is going to be clear. With strong EBITDA or OCW generation, some growth estimated at 7-9%, Liberty Lilac could reduce the enterprise value to Ebitda each year either by repurchasing shares, repaying debt, or growing revenue.

It is still a company hard to model due to the lack of clarity on Capex plan, and growth Capex required to reach this OCF growth. Currently the Capex is expected at 20% of revenues or $720 m USD annualy. This would leave us with an annual cash flow to reduce the EV of around $400 m. That is a 10% market cap reduction if all directed to the repurchases. I do not think that the funds will go to reduce debt (Liberty method) unless to prepare for another acquisition.

So to summarize, we have OCF growth of lets say 7% to be conservative, and market cap reduction of 10%. We also have a possible re-rating to an EV/EBIDTA of 10 as emerging markets go back into favour, which I think should happen since this is where the growth will be in the long term (See emerging markets in percentage of global GDP in the past 30 years for example), and a possible currency re-rating. If the stock re-rates higher, the capital allocation could go to more debt reduction. On top of that, we have a focused and experienced management team, and future synergies or acquisitions.

When I first bough it at around 35$ a share, CWC was not part of the company and it was rated higher. The country profile was better as Chile was a high percentage of revenues. Puerto Rico has also high wages compared to most of South America due to the USD.

But from today’s price point we should expect high value generation simply from existing cash flows and synergies.

The risks are;

-Weak macro in small countries where CWC operates.

-Local competition, its not possible to predict or clearly understand each competitive landscape as a shareholder unless you spend a lot of time following the company.

-Lack of disclosure clarity due to the tracking stock structure and generally messy reporting by Liberty Global.

 

 

 

 

 

Year 2016 summary and last minute shuffling

The year ended in this financial world and the lessons were immense. The learnings from Brexit to Oil to trump to some losses all point in the same direction; ignore the noise, focus on the underlying business.

I returned 14.5%. This is after -4% last year. This is quite average especially if you look that most of that return came from one position alone. So this year left a sour taste despite the good performance. Xilam was a 5 bagger and is now my largest position. I sold some, but the main thing is I was right, it was cheap and still is. Here is a link to my analysis of Xilam. I also got killed on a bad position in Concordia and I would not exclude it from my returns.

The family portfolio returned 31%, with speculative positions in WPX energy and Mittal.

Strategy

my purchase strategy will focus on what I know better. I am not comfortable with drug and industrial companies. Drug companies because I do not know at what price they can sell the drugs and when do competitors will enter a drug market. These companies have high gross and net margins but I feel that they are often value traps as they have no durable moat and need to reinvest their free cash flow not only to grow but to compensate for the loss of earning power that their current drug portfolio has. Industrial companies because you need to know where you are in a cycle with an extreme precision to perform. We saw that with Oil and Gas, Automobile suppliers. A diversified industrial conglomerate is still a possibility, but not a specialized industrial company.

I find that currently the obvious generational opportunities are emerging markets with undeserved populations in terms of equipment rates, and online services where the runway is huge. They also tend to be areas where I am comfortable and have some related work and life experience. I got caught in the fallacy that a portfolio has to have a bit of each sectors. I totally disagree with the notion now because some sectors are hard.

 

Some learnings;

-I should probably stay out of future heavily hated controversial companies since it did not work well, or wait until a turnaround has materialised.

-Its apparently more ethical to sell dangerous addictive substances (Soda) to third world country kids whose parents do not have an health an nutrition education, than to sell overpriced products that save lives, while no one is excluded from treatment. Or Maybe it is because your name is Warren Buffet. BTW I own and use both so I am totally neutral.

-It is better to diversify because you never know what might happen

-My goal of doing less was not achieved.

-Accept when you are wrong and move on, if facts change. This is my learning of 2016. I knew it already because I read it before but to actually do it is something else.

Portfolio clean up en of year

SELL CONCORDIA HEALTHCARE; This position was sold at a large loss when I saw a judgement from the UK competition authority it made me realize that the UK will probably tank this company. I was unlucky on this one but also stubborn to not exit quickly when facts changed (UK generic price controls). The short thesis being wrong also confused me. When I say wrong, is that the vocal people did not mention the regulatory problems but were rather stating some made up facts or not understanding GAAP earnings. Seeing that their thesis were wrong, I was reinforced in my long thesis. They were just lucky to be short for the wrong reasons. I am sure that other smart short and long investors exited knowing the future issues in the UK business.

-SELL SERITAGE; I felt that it was fairly valued and in Euros the gain was large. Nothing wrong with this for long term holders, I just got frustrated at the slow pace of renovations compared to the size of the real estate portfolio. I would rather have a company that can show the same growth rate without capex.

-SELL NATIONAL OILWELL VARCO; Due to the overall gains in 2015 I exited this position, for a swap to another position affected by oil prices but cheaper and with a clearer growth runway. It is still potentially undervalued but sometimes it is good to start fresh.

-BUY CRITEO ; Rapidly growing French ad tech company. Market leader, Net cash positive, and aggregates more and more services on top of the main re targeting business. Also very focused on R&D. This industry is controversial but I believe in its integrity, knowing the culture of excellence of the French scientific schools where the engineers and mathematicians come from.

-BUY KOOVS PLC; Indian startup in fashion e-commerce.  Burns cash. Its a bet as the chairman and management are all seasoned Asos executives. There is a strong investor base ready to support its growth such as media group Times of India and Waheed Alli. Waheed Alli was chairman of Asos for over ten years, bringing it to the success it was. Fashion e-commerce is a profitable subset of e-commerce due to quality differentiation. Indian e-commerce will boom. It is my first pure growth investment. It is from Masa Son (CEO of Softbank) influence that led me to do it.

-BUY ATLAS MARA; African Banking venture founded  by Bob Diamond and Ashish Thakhar, who is a serial African entrepreneur and founder of the Mara group. This bank is selling for under 0.5 times tangible book value, because investors are scared of Africa at the moment when it is the most exciting opportunity for Banking. Small position for now.

-These three investments are ones where I believe in the long term story. I also REINFORCED SOFTBANK

 Outlook:

Most of my stocks did have a bad 2016, so I am quite optimistic for 2017. Sears and Valeant got killed but I definitely see the value there. I have many emerging market stocks, long term stories, or hated stocks, so I do not suffer from the stock market overvaluation .

 

Portfolio, from biggest to smallest position,

-Xilam Animation

-My employer (IT sector)

-Bolloré and Financière de l’odet

-Softbank

-Altisource Portfolio Solutions

-Cosan Limited

-Exor SPA

-Sears Holdings

-Liberty Global

-Goodwin PLC

-Fiat Chrysler

-Criteo

-Expedia

-Au Feminin

-Koovs PLC

-Liberty LILAC

-Valeant

-Judges Scientific

-Atlas Mara

 

I intend to resume the holding series with Liberty Lilac next.

 

Updated watchlist and a lesson in humility

I have updated the watchlist page. And it consisted mostly of removing companies. I did this year an investment in Valeant and another one in Concordia Healthcare. It turned out that my analysis were mostly wrong, simply because the numbers of these companies kept deteriorating. My investments may eventually turn well, due to the large margin of safety created by the low entry multiples, as well as the deleveraging story, but it lead me to understand one thing; That I am no business analyst in all types of businesses. It is very hard, even for professional investors (Ackmann, Sequoia, Donville Kent), to understand the dynamic at play in specialised industries. And it leads to many headaches.

 

Hey, even in my own company where I work and listen to all the conference calls, internal and external, use the products, everyday for five years, I do not have a full grasp of how is the market, and how the margins will be in the long term. And when I read outside analysts, most have some dynamics or facts wrong. Not all, and I was sometimes impressed by some analysis. But none did think long terms in terms of products and margins.

And in terms of performance, in 2016, what I see is that companies somewhat related to my area of knowledge did well, as well as cheap holding companies (where we have a dedicated investor working for us), rather than beaten up shorted stories. This is definitely a lesson to learn, although the consensus may change quickly for some shorted stories in the Energy and Financial services sector.

But as a result, I decided to take Endo PLC, and BB Biotech out of the watchlist (I do not know the sector well enough), Indian companies, (I do not understand this country), and some Industrial holdings too (not my cup of tea, Already have some in my portfolio).

I do not have anything to add to the watchlist apart from Liberty Media who makes a return thanks to the focus on Formula one. I have analysed the indian group Godrej Industries which is interesting, but too complicated for me due to negative free cash flow and structure.

In terms of Portfolio updates, I got out of Liberty Broadband to enter Softbank, not that I do not like Liberty Broadband, but rather that I like the Softbank discounted assets and leadership, and because I am a Euro investor looking for a global balanced portfolio. I reduced some of my Xilam position after a large run up to enter Expedia.

Holding series 8 – Exor SPA

This will be a short update.. because the long thesis is well presented by someone else, I will not do better; Exor SPA is an attempt to build a new Berkshire Hathaway in Italy. And it will succeed. It will be a bit different, but I am very bullish.

See the video by Greenwood investors – a fund that I strongly recommend to follow.

EXOR Video: Lollapalooza

See also my quick post on Fiat Chrysler. FCAU

https://returnsandjourney.wordpress.com/2016/07/02/holding-series-7-fiat-chrysler-automobiles/

 

Family Portfolio updates

It has been very busy on the Family portfolio side:

  • We have opened an average size position in Disney. In a sea of overvalued stocks, Disney trades at a P/E ratio of 18, had an average P/E growth of 16 in the past three years, through a mix of investments and buybacks. Disney has top quality assets and a sound strategy, buying Marvel, Star Wars, opening the new park in China, investing in Hulu.. Its a very good stock for the long term, not a homerun but a true Garp stock. Hulu could be worth a lot of money if Disney decides to give it exclusivity.
  • We have reinforced our position in Bank of Ireland. It trades at 0.65 to book value, 4-5 times operating income and (according to gurufocus), 7 forward P/E. It went down a lot due to the Brexit, which reduced its NAV a bit and increase its pension liability due to the reduction in interest rates. The reaction was unfair in my opinion. First of all, the Brexit will not affect the long term growth prospects of the UK, and Ireland. The British are very smart as a nation and will always come out on top economically in the long term, EU or not. In the short term there will be some headwinds of course. For Ireland, it depends on the UK but it is very international in terms of exports. Ireland is one of the fastest developed economies, its demography is showing signs of rapid increase, and it still has not recovered fully from the 2009-2011 economic crisis, meaning that construction and investment has a lot of room to grow. The dividend will return next year unless the pension obligation increase requires a delay of a year. When you combine that with the forward P/E, it is very cheap and should more than double unless a terrible recession occurs in Ireland.
  • But the main event, is that we have invested in an apartment in an African country where we have personal links. This is to own a hard asset for the long term. The price was not huge due to the currency and local prices. To keep my privacy I will not give  many details but simply give some economics: Luxury type apartment in a well connected complex in one of the most important cities of the continent. No work required. Gross earning yield is 10.5%, net of all fees and costs it should be around 7%. If we are lucky and the currency recovers moderately (emerging market crisis), the yield for our purchase in euros would hit 15% gross and 10% net. The downside is limited that inflation would increase if the currency drops further. On top of this, I believe that Oil will increase in price and that Africa will recover and attract investment again soon.

 

For this portfolio, and in investing for the long run, I realise that its not necessarily getting homeruns that matter. Sure they do help, but sound management is also good and sufficient. This is why I think that Dividend Growth Investing is a sound strategy, despite not being the fastest.

Holding series 7 – Fiat Chrysler Automobiles

Here is a vastly undervalued company.

I first bought it when it was about 6-7 Euros but also owned Ferrari which was also worth 4-5 Euros a share. So the rest was nearly for free. Then they bought a majority stake in Chrysler and merged. Then I got the Ferrari spin off and used that money for other investments.

First a little bit of comparison

Toyota: market cap 155B$

GM: market cap 44B$

Ford: market cap 50B$

Volkswagen: market cap 64B$

Honda: market cap 45B$.

Based on market cap alone,

Renault: market cap 23B$

Hyundai motor: market cap 17B$

Peugeot: market cap 10B$

FCAU: market cap 10B$

We can see that Fiat Chrysler is in the lower league with smaller companies. However this is Fiat+Chrysler+Ram+Dodge+Jeep+Maserati+Alfa! With over 110B Euros of revenues planned for 2016.

The company is investing in upscale brands such as Alfa, Maserati, Jeep, and upscale Dodge and Chrysler models. This to move towards brand differentiation and higher margins.

All this with minimum presence in APAC (3% of sales) so maximum upside and economies of scale with an APAC expansion of Jeep, Alfa, and Maserati, minimum exposure to the coming downturn in the Chinese car market. Even if they go through cycles, the Asia region has massive upside.

The Italian brands are historically strong in Italy and Europe, where we are just coming out of the worst crisis for auto sales and we have years of growth ahead.

It is very cheap. It is deleveraging. It will try to merge or acquire a competitor and this would lead to incredible upside if it succeeds. It is focused on ROIC. It has the best CEO in the industry in terms of shareholder value and long term plans. Maybe some CEOs are better in making motors or wheels but not at turning around and growing a company.

It is a long story to summarise, with many moving parts, and I cannot really do a good summary of a complex case in a short brief, so I will link to Greenwood investors case study here: http://www.gwinvestors.com/2016/02/16/what-if-the-market-is-right/

 

 

Holding series 6 – Valeant Pharma

The mighty Valeant has appeared!

I will disappoint immediately: this blog post will not give you a 100% fool proof thesis to go and add a big position in Valeant. Rather the logic for opening a small position.

I will do only back of my head calculations. No need for precise numbers, since they are all moving pieces.

So I bought at around 25-30$ a small speculative position, at the time the guidance was $5.5B EBITDA for 2016. Now its about $4.5B.

With that $4.5B of EBITDA, Valeant states it can pay back $1.7B of debt, about $0.9B of sprout payments and milestones. It will also reduce administrative costs in 2016. That is after many guidance reductions. I hope this one with the new CEO will be at least met.

So valeant has $31B of net debt, lets make a quick mathematical projection (assuming all cash coming is kept in cash), assuming no recovery in EBITDA:

Jan 2017 net debt:

$29.3B

Jan 2018

$26.7B

Jan 2019

$24.1B

Jan 2020

$21.5B

And this is assuming there is no improvement on the business Ebitda despite a major disruption that happened recently with Philidor and the new Walgreen deal, and new product launches, as well as the ramp up of Salix.

in 2020 there are big repayments of debts, before that, it is covered largely by the FCF. We would have net debt/ebidta at 5 if we include no business improvements. I think that it will improve to probably $6B ebitda so the ratio could go to 3.5. At this stage the debt should be rolled over. If there are problems in 2020, Valeant will sell a piece of its business to get the missing $1/2B.

We will be left in 2020 with a business that will generate at least $2.5B of FCF, possibly more due to the expected improvements. The FCF will go to the shareholders in terms of deleveraging. Each year a value of at least $2.5B will be added to the market cap, at current prices its 30%. Ultimately the business will be worth at least 15 times the FCF. That will give us a market cap of $37.5B versus $8B today. Imagine if the business now makes $4B of FCF. Thats a $60B market cap. It could be worth less than 15 times due to the need to replace non durable cash flows from patented products. Fine, we do not need that to make money on Valeant.

But wait! there is more. At some stage after 2020, the management will be able to acquire again assets and take advantage of its scale, distribution network and tax rate. And who is managing it? Bill Ackman. Call him an idiot, he at least knows how to arbitrage debt repayment and cash flow from operating activities and he will do it when given the chance.

A word on the business practices: They are shady, especially on the dermatology front. I can understand why a life saving drug is expensive when you consider also surgery costs, as life has no price. I am not sure of the business impact, but Valeant should just go for volumes, sell the dermatology cheaply, so no missing reimbursements problems, and help more people, build good relationships with stakeholders, and still make good margins.

In the end, with Valeant, we have a homerun, unless everything breaks apart. There is a small risk of everything breaking apart, so I limited the size of the holding.

Of course there are not many value investors left, most people, even on value investing boards like cornerofberkshireandfairfax.ca/forum/investment-ideas/ , are bearish on Valeant. They suffer from a terrible bias called Recency Bias. “The peak recommended stock weighting came just after the peak of the internet bubble in early 2001 while the lowest recommended weighting came just after the lows of the financial crisis.” 

Imagine the sentiment outside of value investing circles! I will side with Lou Simpson, Ackman, and Francis Chou. Thank you, good bye.