Arkeh Capital

Deep value, special situations, long only, contrarian
Arkeh Capital
Deep value, special situations, long only, contrarian
Contributor since: 2014
So either you buy cheap and need patience or you wait for the visibility and pay for this. Point is, in my view, that any bit of positive news can trigger a return of the share price into the low twenties. And this makes think about how to play the longer term story.
Steel, coal, iron ore, cars (to be the next), graphite electrodes, Oil, some agricultural furtulizers, electricity production capacities in Europe, shipping ... BRIC growth last decade has set extreme price signals and triggered excessive investement. Adjusting these excess capacities and the associated financing is our problem. NO?
Financing of US comps is stronger capital market biased (bonds) as opposed to the loan bias in Europe (banks' balance sheets in Europe). Therefore a) the financial crisis represented more in terms of balance sheet risk to European banks, and b) the subsequent regulatory changes turned more into a bottle neck in Europe than in the US. c) The ECB cut rates to zero only later when asset prices had their recovery already behind. At least as far as Germany is concerned, US banks are still enjoying a steeper yield curve. So simply put: large balance sheet and low yields do not help when risk weighted assets are inflated while you have little opportunity to make money with your balance sheet. And if banks need to cut their balance sheets as a concequence, you cannot expect the economies to grow and the banks share prices to perform.
One of the biggest earnings drain for DBK, beside litigation, has been the NCOU (non-core operating unit) were they reduced risk asset left over from the financial crisis. Assets have been reduced by 100bn to 41bn beween 2012 and Q3 2015. They are targeting a sharp reduction to below 10bn in 2016 and if they have been agressive in Q4 (accompanied by realising losses), it helps explain the weakness of results. Their quick progress there would be co-financed by lower bonuses and no dividend. If the stock tanked again in response to results in reflection of a forward shifting of burdens into 2015, DBK is ultra cheap. FOMC is today. Results conference call tomorrow morning. Who is willing to go short into this? For DBK to jump you need nothing more than back to benchmark of long funds and a temporary short covering.
You started strong, but lost me on the way ... If there is a thing to dislike over capitalism, it is the following: a) the system is extremely poor in adressing excess capacity issues in a socially responsible manner (as coordinated action of producers is unwarranted), and b) this is resulting in unwarranted swings in profitability and in financial markets, which in itself exacerbate the problem. ==> we are caught in a global excess supply problem and are trying to deal with it by stimulating demand with easy money rather than by cutting capacity: Not precisely the remedy a reasonable doctor would prescribe???
If management delivers on its restructuring plan, the shares could trade in the mid to high 30 € range (vs 16.6€ today). 2015 results are a kitchen sinking excersize of the new CEO. Share price momentum to the downside has been intensified by open interest in derivative markets (short put positions), etc. Lack of visibility is certainly an issue, lack of dividend as a downside protection in overall fragile markets does not help either. But stock is absolutely bombed-out and management is holding its analyst conference on pre-announced 2015 results on Thursday morning. Coinciding with severe cash market weakness today (-5.5%) there has been massive Call Buying (eg almost 15.500 contracts in Dec2016 Calls today). I bought cash and calls today, which is obviously brave in this sort of a market.
I would assume there is little reason to believe the US auto market will grow forever. If we are close to peak in volumes, there will be only one dirction to earnings: down. And this is reflected in the multiples. When the market starts to decline, margins and earnings will take a beating. Hence, the discount in valuation. A car company should not trade on 15x as a starting point. And it may go to 6x times when the market starts to decline and forecast earnings are too high.
Thanks for the article. I am however not sure why you recommended VW in the first place. Neither do I believe that your reasons for revision are new news, nor do I believe VW will face recall costs of the magnitude you mention. There are admittedly a number of really huge unknowns, which make VW a target for hedgies and shorties.
Audi at Frankfurt Motor Show 2015 showing new A4 model (20%+ of Audi sales); showing fully electric SUV concept car with 500km range; 40% of product renewed in 2016/17; Audi contributed c35% of operating profit in 2014 (excl. Chinese JVs):
http://bit.ly/1OT0X8h
Vorsprung durch Technik is more than Leading by Software :o)
@David Muncier: VW cheating is on 2009-2015 cars under EURO 5 emission standard. Apparently, the BMW X5 passed under RDE and US standard. You may use the google translator for this link. http://bit.ly/1O8UxjH
Re: the the academic question on cheating and coal plants: the answer depends on the reference; a) laboratory result vs road (you) or b) allowed standard in Europe vs road.
Given low diesel share in US OEM product and strict standard, the Europeans consider US rules to be something like a non-tariff barier to entry. You pollute CO2 like hell and complain if a low CO2 / high milleage car has higher on NOX. I guess the low market share of VW would not have allowed for "clean" market entry with diesel. Staying out or concentrating on gasoline would have been cheaper, so.
German weekly "Der Spiegel" will apparently report VW's supervisory board had been informed Wednesday that adjusting emissions could cost some EUR3bm; part of the cars can be fixed by software adjustment; part will need physical devices.
The degree of cheating is lower in Europe due to less strict emission standards. So it is less coal plants, but still quite unethical behaviour. Whether this qualifies as fraud will certainly depend on each jurisdiction. I doubt that the car dealer knew about the deficiancy; I doubt the sales arm of the company knew. In so far, the selling process is probably not where the dishonesty is. It is the point of getting regulatory approval for the model.
In Europe there is no class action. Forget about an individual suing a company. What about offering an attractive deal on a new car to boost sales??? In Germany, once the emission issue is dealt with, there is no damage for the owner. The car is legal to be driven. They did not make the NOX emissions a sellling point. So my view is US will be less than the 18bn USD re EPA (Bernstein believes max 7.5bn USD), criminal charges are uncertain (look recent media), class action?; you will tell me. Europe to me is less than 11bn Euro and this is the cash to be used within the next 12m (no problem given cash reserves and inflows of 5bn Euro from sale of Leaseplan and Suzuki stake). So I take EUR88bn equity - 20bn costs -20bn buffer (buffer is 40 Euro per share) and I am fine owning them around Eur100, with a view to the product pipeline and the cost savings from MQB.
Jonathan, I am long VW and the greatest risk is acutally shorties and lack of visiblility on the risk situation that triggers selling by risk adverse holders. There is nothing like a sum of the parts when litigation is not to grasp and US investors drop more than German / European investors can swallow. Some of your assumptions are invalid. Given the integration of R&D, joint production of engines, modules, joint purchasing and financing, you cannot sell individual brands like Audi or Porsche (that easily). You could sell trucks - if needed. You could also sell minorities in Audi or in Porsche. More suitable would however be to approach a strategic investor for a stake in the ordinaries in order to improve financial flexibility and destroy any doubts of rating agancies for even the most adverse scenarios. Volkswagen sales in the US do not matter in a group context; diesel is no issue in China; diesel matters in Europe; new product requires to met Euro 6 emission standards since 1 Sep 2015 in Europe. VW believe they are fine. They will hence need to fix the 2009-2015 problem / will be manageable. People over here are very satisfied with the performance of their cars and more afraid that performace might be lost than that they actually worry over NOX emissions. And as concerns the fines: after all the media hype we will find out that nothing is eaten as hot as it is cooked.
No final figs on this; but depending very much on whether you need to physically adjust or whether adjusting software will do. If you assume a physical adjustment and assume cost of 1000 per car you will be left with some 11bn Euro. If it is software, it may be 1/5 of this.
I guess a difference between a normal industrial and an auto OEM is that the German car companies have a car financing arm attached to it. I therefore dislike looking at VW on EV/EBIT or EV/EBITDA multiples unless you look at the industrial business. EV/EBIT may be more appropriate given high investment into assets and models.
Media coverage, political attention and legal procecution is probably as high as the BP desaster or Fokushima. It is a serious issue and without any justification. It happened. Everybody knows it know. It needs to be dealt with - with calm and not with the sensational bias we have at this point. The issue is related to an engine no longer in production. This is good. If VW is clever, they can manage the problem actively by turning a complaining owner into a buyer of a newer model; then fix the technical issue of the traded-in cars, and this way rather invest into market share gains than damage compensation payments. Again, this is a crisis to be dealt with. The company has a very strong model pipeline for the coming years. One needs a stomach and patience, but it is a buying opportunity.
bullchin, what exactly is your financial interest in all your comments? Mine is obviously disclosed as well.
There is nothing wrong with your thinking, but you could also take a different logic: 1) there are liquidity concerns for less liquid bond issues at this point; 2) the operational dynamics of the company are still rather disappointing (company wanted to gererate cash by operations and inventory reduction to repay, but needs to refinance instead), 3) preferred debt is for 7% as was the subordinated note, but 4) subordinated note was discounted, so payable with accrued interest at maturity; w/o checking I would assume preferred stock needs to be paid for in each period. 5) Some investors who had hoped for getting into equity via debt (ie your risk case as a chance) will likely have to reconsider and may want to buy stock; 6) there is still a rating decision pending. This is not saying that you are wrong. This is just saying there is more to the story. How can I buy the bonds? I am sitting in Germany / ie where are they traded?
Downside to Brookfield limited as liquidity issues removed; upside towards 12-14 (3-5 years horizon) if prices and vols recover and costs are significantly reduced. Catalysts: rising needle coke would a) result in rising electrode prices and b) remove a three-year margin drag from higher cost inventory flowing through with a lag and turn to the opposite; this is easily a 8-10% swing factor in margins of graphite electrodes. For investors: potential for a fight for control between Brookfield and Milikowsky; if Brookfield comes with a bid at 5.05 you are paid to take the option for this bidding war to come. Milikowsky & friends get c200m in cash for the expiring bonds; buys almost 30% of shares; liquidity is good, short-interest will be gone by mid-May. There are option positions of trades in 5$ calls that served to protect short bets and that could be used to play long. Discl: long GTI
Downside to Brookfield limited as liquidity issues removed; upside towards 12-14 (3-5 years horizon) if prices and vols recover and costs are significantly reduced. Catalysts: rising needle coke would a) result in rising electrode prices and b) remove a three-year margin drag from higher cost inventory flowing through with a lag and turn to the opposite; this is easily a 8-10% swing factor in margins of graphite electrodes. For investors: potential for a fight for control between Brookfield and Milikowsky; if Brookfield comes with a bid at 5.05 you are paid to take the option for this bidding war to come. Milikowsky & friends get c200m in cash for the expiring bonds; buys almost 30% of shares; liquidity is good, short-interest will be gone by mid-May; there are option positions of trades in 5$ calls that served to protect short bets and that could be used to play long. Discl: long GTI
Market will be rising as long as long as the least informed investor group keeps buying a comparitively small market. You cannot stay in the way of US investors (and US investment banks). It is simply a question of size that the market goes their way. But we warned: the dollar trend appears challenged; and the FX trade has been the driver of the rally. Over extended trends appear to be nearing their inflection points ...
As you say: the actual problem is the physical borrowing of stock. M would be the natural lender. He could be providing the shares at a low rate to the party he swaps returns with. However, the proxy material appears to say that no arrangement regarding loans has been in place in the last year. Pls note: other statements refer to a period of two years. Borrowing stock from the market rather than from M himself is certainly more costly.
I am always on high alert when US investors become the driving force behind a bull or bear market in the DAX....
- France is likely the additional restructuring in ES that they guided for; charge of $10m in H1; savings of $5m annually (or 10m cost for 50m to 70m value gain).
- the note to be refinanced carries a 7% interest charge. I doubt it will be more after refinancing. They might need to refinance less than 200m (subject to FCF generation this year).
- Graphene is very old hype; never gave anything on this; completely priced out; if anything an option I would not pay for.
I said nothing re a short position. But I have raised the question whether M has been hedged on his stake with a total return swap. A total return swap is actually a contract with respect to the RETURN of a security. M declared in proxy solicitation material that there have not been any contracts with respect to the SECURITIES of GTI. Whether this declaration does or does not cover a total return swap is something to be judged by a legal expert or to be clarified by M. If M has had a total return swap on, the contract party would have bought shares to reduce its own short position while the contract is step by step unwound. M's acutal holding would not have changed nor would he himself have purchased any stock. Short interest is down some 7.5m shares since Sep 30, 2014. Holdings of ten largest shareholders are down close to 10m shares in the same period. In case there has been a total return swap, it would have been stupid for M to buy stock in the market (create an announcement effect and a rising share price and thereby reduce the profit on the total return swap). That means if there has been one, it is first winding down the swap, then buying in the market. Not the other way around.
CLARIFICATION: Safe GrafTech filed (within its proxy solicitation material) the following declaration: "...none of the members of Save GrafTech, or the persons listed on Annex A of this Proxy Statement, including the Nominees, ... is, or was within the past year, a party to any contract, arrangement or understanding with any person with respect to any of the Company's securities including, but not limited to, joint ventures, loan or option arrangements, puts or calls, guarantees against loss or guarantees of profit, division of losses or profits, or the giving or withholding of proxies. IMPLICATIONS: The article above suggests that the short interest in GTI has exceeded the stake of Daniel and Nathan Milikowsky during the last proxy fight and during the sell-off in the shares in September 2014. It also points out that short interest exactly matched the stake of the Milikowsky's on Sep 30, 2014, ie at a time when short selling traders should have closed their shorts to realize their profits. While the factual statements remain valid, the declaration of Safe GrafTech, if correct, appears to be incompatible with the actual existence of a total return swap. This said, the declaration does not alter the fact that the representation of the Milikowsky's is already disproportionate to their shareholding and that the Milikowsky's interests are not alligned with outside shareholders given their position as a creditor to the company and a likely intention to expand influence beyond pure control of the board of the company. In addition, I completely fail to see how the boards' sector specific knowledge could be raised by adding the proposed candidates of Mr. Milikowsky, thus substituting current directors with a steel industry background or electronics industry background (relevance for GTI's ES business) with candidates whose proficiency is completely unrelated to the business of GTI.
Funny logic??? He needs votes to win the proxy fight. He has very little equity exposure as of now. And you would buy into GTI AFTER he won the proxy fight? I sold at >$11 after he won last year.
Let's put it this way: Given that M was 1/3 paid in stock for selling Seadrift and C/G Electrodes to GTI and given that he is now interested in taking over complete control, we are talking about the same person benefiting from extrems in the share price. This blaming game on management serves a purpose, in my view. And the arguments made are false on top: I am also critical of management holdings in GTI, but I am not happy about management getting so much stock within their compensation schemes. Their selling is program selling to pay for taxes upon vesting of shares. Having so much stock in GTI as a concentrated position does not necessarily argue for adding additional private funds. Every investment advisor would advise otherwise. All these arguments have been made bevor under the name of Gloria :o)
I wonder whether the rise in the price of the price in the GTI note maturing 2019 from c $80 to c $90 is an idication for future performance of the stock ...
Indisputed that stock is risky; downside is max 4$, upside 8-12$ over three to four years. In my view, stock is much higher risk with M in control. I will be out if he wins the proxy fight. Management is not as bad as you think. Randy responds to M's letter is excellent. Again, management removed the refinancing threat for Nov, they did so as swift as you could have hoped for. They took tough action on savings. What is needed is a bit of tailwind on the demand and pricing side. If they get it now and we start with raw mat costs for new product from such a low level, we could get a really nice run. Again: a bit of tailwind would not hurt.