Wilh. Wilhelmsen ASA – Deeply Discounted Blue Ship Specialty Shipping Company With A Major Catalyst

I’m back with what I believe is the best value idea I have dug up in some time, one I haven’t seen covered anywhere else. I submitted it to Value Investors Club, but they didn’t like it. (So no membership for me, at least for now.) Nonetheless, I believe this is an extremely compelling scenario, so I present it to you.

Capture

Wilh. Wilhelmsen ASA – WWASA:Oslo

Deeply Discounted Blue Ship Specialty Shipping Company With A Major Catalyst

Wilh. Wilhelmsen ASA is one of the world’s largest owners and operators of roll-on roll-off “roro” carriers, specialized ships designed to transport automobiles and other large equipment between continents. Broadly speaking, shipping is not an attractive business. The industry is capital-intensive, deeply cyclical, and heavily commoditized. Most shipowners and operators are price-takers. Wilhelmsen, on the other hand, has a knack for identifying and investing in specialized shipping niches that require differentiated vessels and deep operational expertise. As a result, Wilhelmsen is less exposed to the shipping cycle and earns healthy margins returns and returns on capital.

The company also operates an extensive global automotive shipping logistics network. Wilhselmsen’s activities are carried out through a series of joint ventures and associated companies. Wilhelmsen categorizes its business activities in two segments: shipping and logistics.

Shipping – Wilhelmsen owns 40% of EUKOR Car Carriers, 50% of Wallenius Wilhelmsen Logistics, and 50% of American Roll-On Roll-Off Carrier. Together, these companies account for 25% of the global roro market. EUKOR’s largest customers are Hyundai and Kia, while American Roll-On Roll-Off Carrier’s main customer is the US government.

Logistics – Wilhelmsen’s main logistics joint venture is Wallenius Wilhelmsen Logistics. Its other joint ventures are American Auto Logistics and American Logistics Network. These companies provide terminal services, technical services (repairs, quality control, etc.) and inland distribution, moving vehicles from port to final destination. Wilhelmsen’s logistics division also includes an extremely valuable ownership stake in a publicly-traded Korean auto shipping and logistics company, Hyundai Glovis Co. Ltd. Wilhelmsen was an early investor in Glovis and their 12% ownership stake is worth $720 million.

Shares of Wilh. Wilhelmsen trade at an extremely attractive price of 5.5x trailing earnings, adjusted for one-time gains, provisions, and excess corporate cash. Wilhelmsen shares also trade at just 57% of book value. However, Wilhelmsen shares will experience an extraordinary catalyst in the upcoming spin-off of their stake in Hyundai Glovis as a public entity to be named Treasure ASA. Assuming Treasure trades at any reasonable discount to the value of the Hyundai Glovis shares it will hold, buyers of Wilhelmsen shares today are creating the company at below 3x trailing normalized earnings and less than one-third of book value.

First, a look at Wilhelmsen’s earnings. Though shares trade in NOK, Wilhelmsen operates and reports in US Dollars. Because it operates through so many joint ventures and associates, Wilhelmsen’s income statement is reported via the proportional method. For 2015, Wilhelmsen reported $2.31 billion in revenues, $435 million in adjusted EBITDA and $278 million in adjusted EBIT. (EBITDA and EBIT are adjusted for a $200 million provision against possible anti-trust penalties, and a $29 million one-time gain related to the sale of Hyundai Glovis shares.) Interest expense is a little trickier, as Wilhelmsen does not report proportional interest expense. The company does provide proportional total debt: $2,026 million at year-end 2015. The average rate on Wilhelmsen’s debt was 4.4% in 2014 and was extremely similar in 2015, based on the minimal variation in interest expense reported for the full 2015 year in the company’s fourth quarter report. At a 4.4% rate, interest expense on the company’s $2,026 million in proportional debt is $89 million, yielding pre-tax income of $189 million. Finally, taxes. Norway’s corporate tax is 27%, which puts Wilhelmsen’s adjusted 2015 net income at $138 million.

On a market-capitalization basis, net income of $138 million puts Wilhelmsen shares at 6.9x adjusted trailing earnings. However, Wilhelmsen holds substantial cash and short-term investments at the company level: $349 million. (The company’s proportional interest in its joint ventures provides another $263 million in cash, but the conservative approach is to ignore these assets.) Of this $349 million in corporate cash and equivalents, I estimate at least $200 million to be excess capital available for investment. Backing that $200 million out of the company’s market capitalization yields a trailing adjusted P/E ratio of 5.4. Of course, Wilhelmsen’s actual financial statements rarely show net income close to normalized levels. The company conducts a lot of bunker, interest rate and currency hedging, which creates a lot of noise in the statements. The complicated statements may be one reason why shares trade so cheaply.

Now: on to the spin-off! Wilhelmsen has announced it will spin-off its ownership of Hyundai Glovis in summer 2016. The new company will be named Treasure ASA, and its only assets will be the 12% stake in Hyundai Glovis, plus de minimus cash. The gross value of the Hyundai Glovis shares is currently $720 million, but Wilhelmsen’s $346 million cost basis in Hyundai Glovis does create a tax liability. At the 27% tax rate, Treasure ASA’s tax liability in a sale of all Hyundai Glovis shares would be $101 million. I expect shares of Treasure ASA to trade at a moderate discount to the value of the Hyundai Glovis shares, less tax. At a 15% discount, Treasure ASA would be worth $526 million. In their fourth quarter earnings call, the company said it would consider taking steps to narrow the gap if Treasure ASA traded at a meaningful discount, so I believe that 15% is a reasonable estimate.

Though the spin-off’s pro forma market value is more than half of Wilhelmsen’s market capitalization, the spin-off’s impact on Wilhelmsen’s earnings will be much smaller. In 2015, Hyundai Glovis contributed only $36 million in equity income to Wilhelmsen’s results, 26% of pro forma net income.

Assuming Treasure ASA trades with a market capitalization of $526 million when spun off this summer, Wilh. Wilhelmsen’s current implied market capitalization is $421 million. Net of $200 million in excess corporate cash, Wilhelmsen’s market capitalization is $221 million. Pro forma net income is $102 million after deducting Hyundai Glovis’ $36 million contribution. That leaves Wilhelmsen trading at a pro forma trailing cash-adjusted P/E ratio of 2.2, a price to book ratio of 32%.

I do not expect the market to allow a conservatively run, consistently profitable, well financed blue chip shipping company trading at 2.2x earnings for long.

Risks to this analysis include the possibility that Hyundai Glovis shares trade down significantly, perhaps on news of lower Hyundai and Kia sales in the US or a weakening appetite for imports. The company is exposed to the global auto market as well as the market for heavy mining and construction equipment, and slowdowns in those sectors have had an impact and will continue to do so. There is also the risk that Wilhelmsen’s liabilities for anti-trust penalties within the roro market exceed the company’s own estimates, or come due faster than anticipated. (I view the company’s $200 million provision as exceedingly conservative, as future penalties will arrive piecemeal and over the course of many years. Courts don’t move quickly. The value of potential anti-trust liabilities in both absolute and present value terms is likely far less than $200 million.) Regardless, potential penalties are adequately funded by cash within the company’s joint ventures.

The coming spin-off of Hyundai Glovis into a vehicle named Treasure ASA will force the market to recognize how extraordinarily cheap Wilh. Wilhelmsen ASA’s remaining operations are trading. Treasure ASA’s market value is over half of Wilhelmsen’s total market capitalization, yet Treasure ASA accounts for only 26% of Wilhelmsen’s pro forma net income. Wilh. Wilhelmsen’s pro forma valuation of 2.2x normalized ex-cash earnings and 32% of book valuable is untenable and the situation will be corrected by the market.

Alluvial Capital Management, LLC holds shares of Wilh. Wilhelmsen ASA for client accounts. Alluvial may buy or sell shares of Wilh. Wilhelmsen ASA at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

Posted in Uncategorized | 26 Comments

Toronto MicroCap Conference and a Canadian Merger Play

I am happy to announce I will be speaking at The MicroCap Conference in Toronto, April 11-12. This conference will be a great opportunity to network, hear presentations from many promising small companies outside the natural resources sector and to meet with management. The Canadian market is a rich hunting ground for quality microcap companies, many of which have seen their share prices unfairly punished by the turmoil in the oil and gas industries.

Best of all, this conference is free to attend! Blog subscribers are eligible for a special rate on rooms at the Toronto Hilton, plus half off the price of tickets for the investors’ dinner on the 11th. I’ll be e-mailing the details to blog subscribers in a few days, so please be sure to subscribe to OTC Adventures by then if you would like to be included in the mailing.

I really enjoyed meeting many blog readers at the last conference in Philadelphia. Please let me know if you will be attending the Toronto conference and we can grab coffee or a beer.

While on the topic of Canada, I’d like to present an interesting merger arbitrage opportunity in a very obscure income fund.

Dominion Citrus Income Fund is a tiny, tiny Canadian trust that operates produce growers and logistics companies. The company grows, processes, and distributes various fruits and vegetables in multiple Canadian cities. Some of the company’s subsidiaries are nearly 100 years old. The company’s history is rather complicated. Dominion Citrus Limited was once a subsidiary of Algonquin Mercantile Corp. Algonquin spun off Dominion Citrus Limited to its shareholders in 2000. (Algonquin Mercantile would go on to become Automodular Corp., which will be well-known to some value investors.)

For the next few years, Dominion Citrus Limited operated as an ordinary corporation. The company issued Series A Preferred Stock in 2002 to help finance the acquisition of a subsidiary. In 2006, the company merged with the newly-created Dominion Citrus Income Fund. Under Canadian law at the time, income funds were exempt from corporate taxation as long as they paid out substantially all their earnings to shareholders, much like a REIT. The income fund acquired all of Dominion Citrus Limited’s common shares in exchange for fund units. The fund did not acquire Dominion Citrus Limited’s preferred shares. The fund intended to do so, but the necessary shareholder vote failed. So, the preferred shares remained outstanding, an unusual feature for an income trust. Most critically, the transaction created a substantial amount of inter-company debt owed by the operating company to the fund. Dominion Citrus Limited now owed the fund $19.3 million in participating notes due in 2016 at effective interest rates as high as 18.5%.

Changes to Canadian law soon made the income trust legal structure unattractive, so in 2008 the fund decided to convert back into a corporation. Throughout the 2000s, Dominion undertook a variety of small acquisitions and marketing efforts in an attempt to grow its sales and earnings, but nothing ever really worked for long. Revenues and profits entered a long slow decline and in 2009, the fund and the operating company restructured the participating notes. The base rate on the notes was cut to 5%, but the notes still contained provisions that could require the operating company to surrender all its pre-tax income to the fund as additional interest. Even the restructuring wasn’t enough, and the fund provided an extended interest “holiday” to the operating company, forgoing payment on the participating notes in exchange for an option to purchase the operating company’s main operating asset at fair market value.

Things came to a head in 2014. The operating company had not made principal or interest payments to the fund for a number of years, and the fund had long since ceased making dividend payments to unit holders. Holders of the preferred shares had essentially no chance of seeing a dividend, as the terms of the participating notes would shuttle all of Dominion Citrus Limited’s potential earnings to the fund itself. The fund announced it would explore strategic alternatives and made efforts to market the operating company for sale. However, these efforts fell apart as holders of the preferred stock sued over the original terms of the participating notes, arguing the fund had unjustly enriched itself at the expense of the preferred shares. The search for a solution continued throughout 2015.

If this all sounds a little byzantine, it is. I’ve created an ownership chart below.

Capture

To summarize, the fund itself owns three assets: 100% of Dominion Citrus Limited’s common stock, $19.3 million in intercompany participating notes, and an option to purchase Dominion Citrus Limited’s most substantial subsidiary, Dominion Farm Produce Limited. The fund does not own Dominion Citrus Limited’s preferred stock, which is publically traded.

In November of 2015, with the participating notes coming due in just weeks, Dominion Citrus Income Fund indicated it would no longer be willing to excuse its operating company’s lack of payment and indicated it would exercise its option to purchase Dominion Farm Produce Limited. The fund commissioned a valuation company to prepare a valuation report for the subsidiary. Klein Farber’s report valued Dominion Farm produce at between $7.9 and $9.8 million, and the whole of Dominion Citrus Limited at between $10.3 and $13.5 million. Of course, the fund never really intended to purchase the subsidiary, as it would essentially just be paying itself and reducing the balance of the participating notes. The purpose of the exercise was to establish a valuation for a third party to purchase the fund’s entire asset base, participating notes, option to purchase and all.

The fund found its purchaser in Paul Scarafile, the interim CEO of Dominion Citrus Limited. Mr. Scarafile offered $10.8 million for all of the fund’s assets. This works out to CAD $0.51 per fund unit. Because the offer price falls within the valuation range produced by Klein Farber, the fund’s board has recommended the offer to unitholders. The fund itself has no material liabilities.

Should the offer go through, fund owners could realize a large gain. Fund units are currently offered at CAD $0.37, with a wide bid/ask of $0.25/$0.37. 51 cents per fund unit would represent a gain of 38% from the ask price. However, there are several uncertainties. The press release describing the offer indicated that the offer is not entirely cash, so the fund may end up owning risky promissory notes. Also, the offer itself is conditional and includes financing and due diligence contingencies. Even if the transaction goes off without a hitch, the fund may incur substantial costs during its wind-down, including additional litigation from the holders of the preferred stock. There may be an opportunity here for aggressive investors, but caution is necessary. Personally, I am always sad to see one of the truly strange companies of the microcap world disappear.

Alluvial Capital Management, LLC does not hold shares of Dominion Citrus Income Fund or Dominion Citrus Limited Series A Preferred Stock for the accounts of clients or principals. Alluvial may buy or sell shares of Dominion Citrus Income Fund or Dominion Citrus Limited Series A Preferred Stock at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

 

 

 

Posted in Uncategorized | 3 Comments

Alluvial Capital Management, LLC Fourth Quarter 2015 Letter to Clients

Follow the link below to view Alluvial Capital Management’s fourth quarter letter to clients. 2015 was a strong year despite a difficult market environment. I welcome your comments and feedback.

Alluvial Capital Management, LLC Fourth Quarter 2015 Letter to Clients

I don’t get to write here at OTC Adventures as much as I used to or as much as I would like. As my professional and personal responsibilities increase, I no longer possess the hours in my week necessary to put out content at the level I feel I owe my readers, at least with any frequency. But readers can expect me to pop up here and there in 2016 with a profile of some interesting company, domestic or international. Thanks again for taking the time to read my humble blog.

-Dave Waters

Posted in Uncategorized | 5 Comments

Central Parking Finance Trust – CRLKP

One more investing idea to close out the year. And for the first time on this blog, it’s a fixed income security. Central Parking Finance Trust Convertible Preferred Securities offer a very attractive current yield and yield to maturity, plus a valuable embedded put option.

The Central Parking Finance Trust was created in 1998 to invest in junior subordinated deferrable interest convertible debentures issued by Central Parking Corporation. Despite the complicated title, these were essentially just convertible bonds with a provision for temporarily postponing interest payments if necessary. The bonds had a maturity of April 1, 2028, and were convertible into common shares of Central Parking Corporation at 0.4545 shares per $25 par value bond. To finance the purchase of this bond issue, the trust issued convertible preferred securities with substantially identical terms. These preferreds trade over-the-counter with the ticker CRLKP.

CRLKP’s current bid/ask is $19.40/$19.75. Yield-to-maturity in 2028 is a juicy 8.2%. The current yield is 6.8%, adjusting for accrued dividends. Looks like a nice rate of return. But then again, yield never exists in a vacuum. Long-term fixed income securities offer multiple ways to lose. Rising interest rates and widening credit spreads can create a lot of tears for yield-chasing investors.

However, remember the convertible part of these securities’ title? Well, Central Parking Corporation was acquired by a consortium of private equity firms lead by KKR in 2007. As a result of the transaction, the conversion rights of the trust preferred securities were canceled. From the time of the transaction until their maturity in 2028, holders instead have the ability to redeem their shares at any time for $19.18 per share. Currently, these units are the ultimate liability of SP Plus Corporation, which acquired Central Parking from its private equity owners in 2012.

This is a put option, and it dramatically decreases the risk of holding CRLKP. Interest rate risk is all but eliminated. Even a dramatic rise in yields across the curve would produce a maximum loss of 2%, the difference between CRLKP’s current price and the put strike of $19.18. Credit risk is greatly reduced, because holders can effectively choose their own maturity and put the securities back to the company at any time should SP Plus’ financial ratios begin to deteriorate.

If there’s a downside to these securities, it is definitely their illiquidity. By my calculation, only about 60,000 of these securities remain outstanding following years of redemptions by holders. Additionally, SP Plus has been in the market buying CRLKP back. SP Plus’ cost of debt is only around 4.7%, so naturally they are eager to retire these expensive securities. Anyone purchasing these securities should view the investment as long-term.

Alluvial Capital Management, LLC does not hold shares of Central Parking Finance Trust for client accounts. Alluvial may buy or sell shares of Central Parking Finance Trust at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

Posted in Uncategorized | 19 Comments

Global Ports Investments Plc – GLPR:London

Before I begin, I wanted to let readers know I will be in NYC on November 10 and 11 for a series of meetings. If anyone would like to schedule a meeting or just grab coffee, let me know and I’ll see what I can do. I always enjoy meeting blog readers. They’re a sophisticated set. 

So, who’s interested in buying shares in a leveraged, capital intensive business operating in one of the world’s least attractive geographies and fraught with political risk? What if I also told you that this company’s revenues are down 25% year-over-year and that this weakness may continue for the foreseeable future? If you’re still reading, I suppose I should also tell you this company produces huge and sustainable cash flows, operates with barriers to entry, enjoys the backing of the world’s premier operator in its industry, and benefits from US dollar strength.

This company is Global Ports Investments Plc. True to its name, the company owns and operates 10 different marine terminals, in whole or in part. Despite the ambitious moniker, the terminals are actually clustered in and around St. Petersburg, with two in Finland, one in Estonia, and the final terminal on Russia’s eastern coast.

Capture

Global Ports Investments has existed in its current form since late 2013, when the company merged with rival NCC Group to form Eastern Europe’s largest container terminal operator. The resulting firm has 537.2 million shares outstanding, of which 20.5% are publicly floating. Global Ports Investments shares trade as Global Depositary Units on the London Stock Exchange, where one GDR equals three shares. The GDRs are denominated in US Dollars. The remaining 79.5% of Global Ports’ shares are held by various large port and marine terminal operators. Major international terminal operator APM Terminals (part of the A.P. Moller-Maersk empire) owns 30.75%, and Russian transportation group TIHL owns another 30.75%. The remaining 18% is held by the former owners of NCC Group.

 

Capture

St. Petersburg’s proximity to Moscow and Russia’s populated regions makes it the port of choice for Russian imports and exports to the West. In 2014, Global Ports had throughput of 2.7 million container equivalents. This represented 53% of Russia’s total 2014 container volume, which has grown rapidly over the last decade. Unfortunately, Russia’s current woes (slumping commodities prices, the plunging ruble, internationally condemned military actions, crippling social issues, and more!) have taken their toll and the nation’s import and export activity has plunged. Container market volumes are set to finish 2015 at 2008 levels, down 26% from 2014.

CaptureGlobal Ports has not avoided the carnage. The company’s first half 2015 report showed consolidated revenues down 25%. Below is a look at Global Ports’ recent results as reported. I have adjusted EBIT and EBITDA for one-time figures like writedowns, but otherwise I am simply parroting the company’s earnings releases. The presence of minority interests complicates the financial reporting somewhat, but I’ll get to that in a bit. Results are in USD, Global Ports’ operating and reporting currency.

Capture

At first glance, things look bleak. Revenues, EBITDA, EBIT, free cash flow, all down. But there’s something extraordinary here, the EBIT margin! In an environment of falling revenues and utilization, Global Ports managed to expand its operating margin by a full 1,240 basis points. That is an extraordinary achievement. The company credits the results to cost control. Indeed, Global Ports’ cash operating costs declined 37% from 2014. The cuts were achieved by heading headcount by 10%, idling 15% of equipment and looking for administrative cost savings. Impressive. Not many companies mount this kind of all-out assault on costs during difficult revenue environments. However, the company also had a very important tailwind: the crash of the ruble. Nearly half of Global Ports’ operating costs are staff-related, and the plunging Russian currency accomplished the company’s goals quite neatly, effectively reducing salaries for Russian employees by 40%.

So that’s how Global Ports has been able to withstand a dramatic decline in revenues: an equally dramatic decline in operating costs. I do expect that trade volumes will recover eventually, and continue their growth path in the long run. I am confident that on the whole, world trade will continue to increase in the decades to come. I also expect the trend toward containerization to increase. It’s simply efficient. Nonetheless, I would not be surprised to see Russia’s shaky economic standing leave traffic at Global Ports’ facilities depressed for quite a while. Assuming no recovery in trade volumes, just what level of profitability and free cash flow can Global Ports sustain?

Figuring that out requires a bit of digging. First, let’s take a look at exactly what Global Ports owns. Below is a listing of the company’s various terminals and their capacities, plus the company’s level of ownership in each.

Capture

Global Ports’ share in its Russian terminal holdings equates to 94.3% of the total throughput capacity of these terminals. That’s great, because these operations account for the lion’s share of the company’s profits. The oil terminal, Vopak EOS, is the second largest source of profit. The Finnish ports are only marginally profitable, though they are growing quickly. Global Ports very helpfully provides a high level of disclosure for each of their operating segments. The graphic below shows 2014’s segment results and Global Ports’ ratable share of profits. Though it’s impossible to tell exactly how profitable each particular Russian asset was, I’ll be using the 94.3% capacity ownership figure to estimate Global Ports’ share in profits. It’s the best I can do.

Capture

Looks like in 2014, Global Ports’ share of its segments’ EBIT was about $281 million. That’s really not so far away from the reported figures after all, but it is a difference. Now I will perform the same exercise for the first half of 2015’s figures. I’ll go a step farther and provide some pro forma net income and free cash flow figures for each segment as well. Global Ports’ financial statements have some huge one-time currency-related items and tax effects, which I’ll ignore. Instead, I’ll use the statutory tax rate for each geography.

Capture

Again, Global Ports is looking pretty good with $129 million in proportional EBIT in the first half of 2015, and $112 million in pro forma free cash flow. This is not a particularly seasonal business, so assuming no further deterioration in trade volumes, it seems likely that Global Ports will be able to post nearly $258 in annual proportional EBIT and $224 million in free cash flow in 2015.

So what do you have to pay for that kind of EBIT and free cash flow? I could compare that free cash flow with the company’s market cap and show a yield figure (hint: it is high) but I always prefer to evaluate businesses on an enterprise value basis. In order to do that, one more step remains: figuring out the company’s ratable net debt. Fortunately, the company once again provides that level of disclosure.

Capture

That wasn’t too tough. On a proportional basis, Global Ports is carrying a cool $1.11 billion of debt. That’s high, but not beyond reason for a capital intensive firm with a toll-taking business model and strong margins. In the depressed environment in which the company is operating, Global Ports has wisely decided to cease paying dividends and to devote excess cash to deleveraging. The company paid down $92 million in debt in the first half of 2015 alone. The upcoming debt maturity profile is prudently staggered, with annual principal payments through 2018 at below trailing operating cash flow.

Capture

The average interest rate on the company’s debt is 6.0%. And most importantly, virtually all of the debt is USD-denominated. I can hardly stress enough how important this is. No matter how the Russian ruble may fluctuate, Global Ports debt service requirements will remain constant and matched by USD revenues.

Now back, finally, to what we have to pay for all of this. At present, Global Ports’ market capitalization is $764 million. Add the $1.111 billion in proportional net debt and you get an enterprise value of $1.875 billion. Based on my 2015 projections, Global Ports shares trade at 7.3x current year EBIT, and a massive 29% free cash flow yield. On an unleveraged, fully-taxed basis, the free cash flow to the enterprise yield would be 14.1%.

Those are rock-bottom figures for a business with this competitive position and free cash flow profile. Seems to me that the current valuation reflects excessive pessimism and a myopic focus on near-term results. But before anyone goes out and buys shares in the morning, please read on. There are also real risks to Global Ports Investments shares.

First, there is no getting around the fact that this is a Russian business. Yes, its tax domicile is in Cyprus and it operates in USD, but substantially all the company’s major sources of income are quite literally on Russian soil. Investors in undemocratic societies with weak rule of law always run the risk that their company’s assets, or their own shares, will be “liberated” at a time and valuation not to their liking. After all, why should greedy, hegemonic Westerners profit from the labor of the Russian people? The Motherland, and all that business. It’s a real risk. I do think the involvement of a major European conglomerate (A.P. Moller-Maersk) reduces the risk of anything untoward going down, but at the end of the day, just under half of Global Ports’ shares are owned by Russian billionaires. These guys don’t exactly have a sterling reputation for treating minority interests with fairness.

Second, investing in Global Ports is placing a bet on stabilization and recovery taking place in the Russian economy. Yes, I did say that I believe that global trade has nowhere to go but up in the long run, but that doesn’t mean investors won’t feel quite a lot of pain in the meantime. Every investment one makes comes at the cost of not buying something else, and those waiting for a Russian economic recovery may find themselves waiting for a long time. Nobody really knows when or if commodities prices will bounce back, or if Putin will see fit to end his warmongering and economic sanctions will be rolled back. Things could easily get much worse before they get better.

Finally, I can see one more scenario in which Global Ports shareholders would lose out: one in which shipping volumes are stagnant or decline further, but the ruble climbs. This would reverse the cost-saving effects that Global Ports has enjoyed, and could put a serious crimp on operating margins. The ruble is actually down 13% since June 30, but it’s a volatile currency and it could easily soar. I don’t view this risk as all that likely since shipping volumes and a rising ruble are likely positively correlated, but it is real and difficult to hedge against.

Of course, none of these potential pitfalls could come to fruition, and investors buying at this price could realize a very nice return as the company deleverages and its earnings recover. I view this as the slightly more likely scenario, but I am not quite confident enough in that assessment to take the bait. Still, Global Ports will be a fun one to watch for now.

Alluvial Capital Management, LLC does not hold shares of Global Ports Investments, Plc for client accounts. Alluvial may buy or sell shares of Global Ports Investments, Plc at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

 

 

Posted in Uncategorized | 9 Comments

Keweenaw Land Association – KEWL

KeweenawLand

Today’s post concerns one of the more unusual and companies I’ve come across in my research. Keweenaw Land Association has a long and interesting history, stretching back to before the industrial revolution. During America’s great age of canal-building in the second half of the 19th century, Congress made a land grant to a company engaged in building a canal across the Keweenaw Peninsula of Michigan’s Upper Peninsula. The canal would speed travel along the southern coast of Lake Superior. Financial difficulties ensued, and the canal was not completed until 1891, 23 years after it was started. The finished canal was sold to the US government, leaving the company with 400,000 acres of wilderness in its possession. The company went through a few iterations, but was organized as a Michigan partnership in 1908. The company reached its present form in 1999, when it reorganized as a Michigan corporation.

Over the course of the twentieth century, Keweenaw did exactly what one would expect it to do with 400,000 acres of densely forested, sparsely populated land: it sold timber. The lands were heavily logged to support the war efforts during both World Wars, but the company transitioned to a modern model of forest management in the 1960s and continues to manage its forests sustainably today. Modern forestry is focused on optimizing total returns over a forest’s entire life cycle rather than maximizing current income at the expense of future harvests. Over the years, Keweenaw’s lands have produced millions in profits for their owners and will continue to do so for centuries longer.

The company also engaged in leasing its mineral rights to miners and prospectors. The Keweenaw has long been a producer of copper and other minerals, though production of copper actually peaked in 1916. Today, the region produces only token amounts of copper. Still, Keweenaw Land Association still owns the mineral rights underlying all its original lands, even those that have been sold since the founding of the company.

Today Keweenaw Land Association owns just over 167,000 acres in Northern Wisconsin and Michigan, plus the mineral rights to 402,000 acres. Nearly all the company’s land holdings are productive timber assets. The most current map of the company’s properties is below. Keweenaw’s properties are non-contiguous, but concentrated in Gogebic County.

Capture

Before I get into the value of Keweenaw’s timber assets, allow me a moment to discuss timber as an asset class. I’m a fan. I think nearly every investor can benefit from exposure to timber. It’s an ideal inflation hedge in a way that other commodities can’t be, because it has a yield. Precious metals and oil are inert. They sit in the ground until they are extracted via expensive, capital intensive processes. Mines and wells are heavily regulated and production can take months or years to scale. Timber, on the other hand, multiplies itself over time and is far easier and cheaper to harvest. Even in non-inflationary times, timber provides an on-going yield with only moderate investment by the owner. The sun and the rain are free, after all. If the prices of logs and land increase, well that’s just a return kicker.

The value of Keweenaw’s timber lands are subject to the fluctuations of timber prices, which vary in anticipation of data like housing starts. Every three years or so, the company hires a consultant to perform a valuation of its timber lands. The results for the last few surveys are presented below.

Capture

As Keweenaw is fond of pointing out, the value of the company’s timberland has grown substantially over time, compounding at 5.6% on a per-acre basis from 1998 to 2012. The value of the company’s holdings has grown through good forestry, but also through the company’s policy of selling off less productive lots for recreational and development uses and reinvesting the proceeds in more valuable timber lands. The company is able to defer taxes on these transactions by using 1031 exchanges. Unfortunately for Keweenaw, timber prices have fallen since 2012 because the anticipated increase in new home starts has taken longer than expected to materialize. When the company performs its 2015 timber valuation, I expect to see valuations somewhere between those of 2009 and 2012.

As for the company’s mineral rights, no active mining is taking place on the company’s acreage. There is a fully permitted mining site and Keweenaw has a royalty agreement with Canada’s Highland Copper. However, the prospects of Keweenaw receiving any material royalties are dim. The low price of copper has Highland Copper in a holding pattern, and most of the minerals underlying the company’s land cannot be extracted economically. Should prices for copper and silver double or triple, maybe some mining activity will occur. The company estimates its lands contain nearly three billion pounds of copper and nearly sixteen million ounces of silver. But as is, Keweenaw’s mineral rights do not represent a meaningful source of value for shareholders.

So what does it cost to buy $130-something million worth of timber, with an “out-of-the-money option” in the form of extensive mineral rights? As I type, Keweenaw has an enterprise value of just over $105 million. So right there, the entire company trades at a discount of around 20% to the value of its timber holdings, ignoring the mineral rights entirely.

In a May 2015 presentation, management touts the company’s long-term returns, showing its 20 year compounded annual return at 9.87% compared to 7.12% for the S&P 500. But this is inaccurate. The S&P 500’s total return was actually in the mid 9% range for the period. The company conveniently ignores the index’s dividends. So while Keweenaw did outperform, it was only by a slight margin. The short-term picture is much worse, however. From 2005 to 2015, Keweenaw returned only 3.54% annually, compared to over 8% for the S&P 500. Year to date, shares are down 17%.

The main reason for Keweenaw’s lackluster recent performance is timber prices. The housing boom of the mid-2000s pushed up lumber prices and with them, the value of timber-producing land. Despite a substantial rally from 2009 to 2013, lumber prices remain nearly 30% below 2006 levels. That explains the low rate of appreciation in Keweenaw’s lands since 2006. Management has been successful in controlling costs and earning higher margins from its timber sales, earning a gross profit of $46 per cord-equivalent compared to just $24 in 2010.

While management’s cost control and forest management are certainly positives, I do wish they would be more aggressive in attempting to create value for shareholders. Management seems content to harvest only a tiny portion of the company’s lands each year, and canceled shareholder dividends in 2010. There doesn’t seem to be any serious consideration of soliciting offers for the company’s holdings or failing that, taking on a modest amount of leverage in order to increase returns. For a number of years a dissident shareholder tried to persuade the company to pursue all manner of potentially lucrative actions, like undergoing a REIT conversion or exploring wind production. But each time the shareholder was rebuffed and eventually gave up.

Just recently, Keweenaw added a new member to its board of directors, a Mr. James Mai. Mr. Mai is the single largest Keweenaw shareholder at 26%, and the head of Cornwall Capital, a family office founded to manage the Mai family fortune. It’s not at all surprising that a family office would invest extensively in timber, which promises attractive long-term returns and even better, tax deferral. I expect the company will continue to operate profitably under Mr. Mai’s watchful eye.

There are more opportunistic and aggressive timber companies out there, but probably none that offers cheaper timber than Keweenaw Land. For investors looking for a long-term diversifier like timber, Keweenaw may be worth a look. Short-term results may be volatile as timber prices rise and fall, but long-term results should be solid, especially if and when inflation comes around.

Alluvial Capital Management, LLC does not hold shares of Keweenaw Land Association, Ltd. for client accounts. Alluvial may buy or sell shares of Keweenaw Land Association, Ltd. at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

Posted in Uncategorized | 11 Comments

Brief Updates: Client Letter, Conference, and More

Just a brief news post today. First, have a look at Alluvial Capital Management’s investing thoughts by reading Alluvial’s third quarter letter to clients.

Alluvial Capital Management Third Quarter 2015 Letter to Clients

In the quarter, all Alluvial strategies outpaced their benchmarks by healthy margins. Alluvial offers separately-managed accounts with a focus on micro-caps, thinly-traded securities and special situations. I welcome feedback and inquiries from potential clients or those who simply wish to shoot the breeze about Alluvial’s holdings and strategy.

Second, there is still time to register for The MicroCap Conference, taking place in Philadelphia on November 5. Plenty of interesting companies and speakers and practitioners are on the agenda. Industry groups represented include energy, pharmaceuticals, manufacturing, social media, and many more.

Finally, I was recently the subject of a detailed article written by Nadav Manham at The Private Investment Brief. The PIB profiles little-known but up-and-coming investment managers, and provides other excellent investment commentary. It’s an invaluable resource for capital allocators. I cannot share the profile here, but I highly recommend contacting Mr. Manham if you are interested in learning more about his publication.

I’ll be back later this week with another post on my favorite kind of company: old, obscure, and successful.

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Posted in Uncategorized | 5 Comments

A Trio of French Bargains

Six years into a bull market in nearly all productive assets, “traditional” value stocks are a rare breed. By traditional, I mean obvious opportunities like profitable businesses with solid balance sheets trading at very low multiples of earnings and cash flows. Most of the value opportunities still out there require some real digging to discover. However, there is one market where I still routinely find perfectly good companies trading at 4-7 times earnings: France. I am not exactly sure why so many small French companies trade at these tiny multiples. It does seem that continental investors are loathe to invest beyond large, well-known companies, and the liquidity of many French micro-caps is extremely limited. The resulting neglect may be responsible for the plethora of value opportunities. Today I’d like to present brief profiles of three of these companies.

Docks Petroles D’Ambes: DPAM

“Docks” has operated a storage terminal at the port of Bordeaux on the west coast of France since 1934. The location and function of the terminal have long been considered strategic; the RAF bombed the facility in 1944 to hamper the Nazi supply chain.

Actual mission photo. Bombers from the RAF’s No. 514 Squadron attack the oil storage depot at Bec d’Ambes on August 4, 1944.

The business model is as simple as it sounds. The company collects fees for storing hydrocarbons, plus grain and wood products. Docks links refineries with consumers in the region. Docks also owns a petroleum pipeline. Results do vary somewhat as storage volumes change, but the company is consistently profitable and carries only modest debt. Docks generates a solid return on capital, but unfortunately its opportunities for reinvestment are quite limited. More than half of Docks’ shares outstanding are owned by a larger petroleum storage company, Entrepots Petroliers Regionaux. Another 30% are owned by various refiners and pipeline companies, leaving only 12% of the shares in the public float.

Docks has a market capitalization of Eur 23 million. At a share price of Eur 235, Docks’ P/E is 7.0 and its dividend yield is 6.4%. The high dividend yield is actually a drawback for many foreign investors, because France withholds dividend payments at a 30% rate. It is unlikely that Docks Petroles d’Ambes will experience any significant earnings growth, but it could be an attractive holding for those looking for a low-risk income stream.

Installux SA: STAL

Installux manufactures metal building components. Working mostly in aluminum, the company produces pieces for use in windows, doors, awnings and many other structural elements. Installux’s results depend on the level of construction activity, and on the prices of its aluminum and steel inputs. 50% of the company’s shares are owned by CEO Christian Canty, with another 15% owned by the respected French value investing firm Amiral Gestion.

Installux is not a fast growing company, but it has managed to increase revenues and profits at a modest pace. Nearly all of the company’s revenues are earned in France. Installux’s balance sheet is strongly over-capitalized, to the point where 27% of assets are cash and the current ratio is 3.5.

Installux’s market capitalization is Eur 74 million. The P/E ratio is 9.0. But, the company carries over Eur 20 million in excess cash. Net of that cash, the company’s P/E is just 6.0. Installux shares last changed hands at Eur 244, and the company has a dividend yield of 3.3%. While Installux’s core business is profitable, stable, and efficient, future returns will be strongly influenced by the company’s use of its huge cash reserves.

Graines Voltz SA: GRVO

Graines Voltz is a grower and distributor of seeds, mainly bulk ornamental flower seeds, but also some fruit and vegetable seeds. The company sells its seeds in continental Europe, plus the Middle East and Asia. The company offers hundreds of different varieties, many suitable for mass planting in public parks and landscaping.

As an agricultural business, Graines Voltz experiences large swings in its margins. Unpredictable factors like weather, pests and disease will always influence results. But the company has managed to increase its revenues at a respectable pace, from Eur 46.4 million in 2009 to Eur 73.1 million in 2014, a growth rate of 9.5%. Earnings per share reached a record Eur 4.22 for the twelve months ended March 31, 2015, up dramatically from Eur 0.95 per share in 2009.

The company’s striking success makes its valuation that much more of a shock. At a share price of Eur 16.40 and a market capitalization of Eur 22.5 million, Grain Voltz’s P/E is just 3.9. Its price to book value ratio is 0.8. The company does carry debt, but the majority is low-cost seasonal borrowing used to finance inventory. 2014 EBIT was over six times interest expense in 2014, and greater for the trailing twelve months. Return on equity has exceeded 15% each year since 2010.

It’s possible that Graines Voltz’s results are unsustainable, the result of temporarily decreased competition or unusually benign growing conditions. But I suspect the actual causes of Graines Voltz’s extraordinarily low valuation are its tiny float and practically non-existent liquidity. As of 2013, 10% of the company’s shares are owned by American grower Ball Horticultural, another 10% for European grower Florensis, and 64% by Voltz family members and company employees. In all, only 16% of Grain Voltz shares with a market value of Eur 3.6 million are freely-floating. Average trading volume rarely exceeds a few hundred shares per day, making accumulating a worthwhile position a difficult feat.

While I view each of these companies as distinctly undervalued, please be aware that my French is rudimentary and I made heavy use of translation services in evaluating their financial statements and press releases. It is entirely possible that I have missed some important bit of information that is material to the value of these companies. As always, please do your own in-depth research if you are considering purchasing any of these stocks.

Alluvial Capital Management, LLC does not hold shares of Docks Petroles d’Ambes, Installux SA, or Graines Voltz for client accounts or those of principals. Alluvial may buy or sell shares of Docks Petroles d’Ambes, Installux SA, or Graines Voltz  at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

 

Posted in Uncategorized | 7 Comments

A Boston Real Estate Empire at a Discount – New England Realty Associates, LP: NEN

New England Realty Associates, LP is an NYSE-listed real estate partnership that trades at a 30%+ discount to a conservative estimate of asset value. “NERA” is lead by Boston real estate magnate Harold Brown. The partnership has produced exceptional returns for its partners since inception. Though the market has begun to wake up to NERA’s substantial value in recent years, the partnership remains undervalued due to its small size, limited liquidity and confusing structure.

New England Realty Associates, LP (ticker NEN) was founded in 1977 and currently owns 24 properties in and around Boston, Massachusetts. Of these properties, 17 are residential buildings, 4 are mixed use, 3 are commercial buildings and 1 property is comprised of individual units within a condo complex. as of June 30, the partnership owned 2,412 apartment units, 19 condo units and 108,043 square feet of leasable commercial space. Additionally, the company owns partial interests in another 9 properties, a mix of apartments, commercial space and a parking lot.

NERA’s properties are located in central Boston and in surrounding affluent suburbs. The partnership got its start in Allston, and four of the properties are located there.

Capture

I’ve done some poking around on various apartment rental sites, and NERA seems to target young professionals and students to fill its rentals, many of which are located in busy settings near universities. Rents seem on par with the local market, and NERA (via Hamilton Company, which manages its properties) gets good reviews as a landlord. (This may be a recent development. There is no shortage of older articles criticizing the company’s property management practices.) NERA’s properties boast occupancy rates near 100%.

Like many realty partnerships, NERA’s ownership structure is made up of multiple classes of units. NERA has two classes of limited partnership interests, Class A and Class B, plus General Partnership Units. Class A units have an 80% ownership interest, Class B unitholders own 19%, and the General Partner owns 1%. None of these units are publicly-traded. What is publicly-traded are depositary receipts that are the equivalent of 1/30th of one Class A Unit. Class A units themselves are not tradable, but may be converted into depositary receipts at a 30-to-1 ratio at any time, then traded. Because of the odd depositary receipt structure, many financial data providers do not accurately report NERA’s market capitalization or units outstanding. This lack of good data contributes to NERA’s mis-valuation.

NERA has a long history of profitable operations. The company does not always report a GAAP profit, but does produce consistent and growing funds from operations. As I’ve mentioned many times before, GAAP net income is a terrible metric for evaluating real estate companies. Non-economic expenses like depreciation and accounting for partial interests obscure actual profitability. What matters is distributable cash flows, and NERA excels at creating these. Here’s a look at the partnership’s historical results. Results are in millions and are taken from the partnership’s annual reports, without any adjustment for restatements or amendments.

Capture

NERA’s annual funds from operations have more than doubled since 2008, while gross rents rose 39%. That’s a nice result. But the truly impressive achievement is NERA’s tax efficiency. From 2008 to 2014, the partnership recorded a sum of just $5.0 million in continuing net income for its partners. Yet it produced $77.4 million in funds from operations, a very close proxy for distributable cash flow. What’s clear is that NERA’s management understands the “secret sauce” of real estate investing: leverage and depreciation. Reasonable leverage allows a partnership to control a large asset base while the associated interest expense creates a tax shield. So long as the cap rate on the assets acquired is below the cost of the associated debt, positive cash flow results. The second part of the equation is to continually add new properties to the roster, bringing in fresh depreciable assets to further shelter cash flows from taxation. Because high quality real estate tends to appreciate over time, this depreciation is merely a “phantom” expense and a valuable tax shield.

On a trailing basis, NERA produced nearly $16 million in funds from operations. This figure will almost certainly increase as rents rise and as the company continues to pay down debt. Also, the company just closed on the purchase of another rental complex, the 94 unit Captain Parker Arms in Lexington, Massachusetts. The purchase price was $31.5 million, 79% of which the company funded using its Keybank line of credit. The partnership has also begun converting the parking lot it owns into a 49,000 square foot, 48 unit apartment building. Both of these projects will contribute substantial cash in years to come.

There’s one other area where NERA excels: buying back its units. Since inception, NERA has repurchased a full 30% of its issued units. In the last twelve months, the company reduced its fully-diluted units outstanding by 1.9%, and is set to continue buying back units. In March, the board of directors approved an expansion of the unit repurchase program sufficient to repurchase an additional 13.2% of outstanding units within five years.

But what is NERA worth? The answer to the question depends on determining the proper multiple of net operating income for Boston-area apartment properties. While NERA also holds some commercial properties and condos, the vast majority of its assets are invested in apartment assets. Unsurprisingly, the average cap rate for class A Boston apartment assets is extremely low. The Boston real estate market has long been one of the tightest in the country, and cap rates reflect this. Recent transactions have been done at cap rates as low as 4%! More typical transactions have crossed in the 5% range. For anyone interested, there are a number of market reports available via a little Googling. Here’s one.

For conservatism’s sake, I’ll use a cap rate of 6%/16.7x net operating income to estimate the value of NERA’s properties. The chart below lays out the value of NERA’s fully owned properties and its stake in equity-accounted projects, net of debt.

Capture

It’s very easy to get to value of over $255 million for NERA’s properties and investments, net of debt. Using market valuations for the Boston metro yields an even higher value. The chart below shows the values of New England Realty Associates, LP depositary receipts at various cap rates.

Capture

At a 6.0% cap rate, NERA depositary receipts are worth just over $70, 48% higher than the current trading price. This value does not include the increased cash flow from the newly-acquired apartment complex, or the value to be created by developing the parking lot into a residential property. If we assign even modest value to those new assets and nudge the cap rate down just slightly, the fair value of NERA’s depositary units approaches twice the current trading price. At NERA’s current trading price, I think it’s fair to say the market is valuing the company’s holdings at a cap rate of around 7.5%, well above market cap rates.

NERA’s valuation is compelling, but potential investors must be aware of a few potential risks. First, NERA’s two largest unitholders, Harold and Ronald Brown, are quite elderly. These men together own over 40% of NERA’s units. In the not distant future, NERA may face succession challenges. NERA also holds many highly appreciated properties, and unitholders may find themselves with an large tax bill should the partnership ever be wound down for any reason. And finally, because NERA is a pass-through entity, unitholders must be sure to handle the associated tax complexity carefully, including paying state taxes to Massachusetts.

For those unconcerned by these risks, NERA could be a great way to create a portfolio of quality Boston properties at a cap rate unheard of on the ground.

Alluvial Capital Management, LLC does not hold shares of New England Realty Associates, LP for client accounts. Alluvial may buy or sell shares of New England Realty Associates, LP at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

Posted in Uncategorized | 12 Comments

The Fight for Warrnambool – WCB:ASX

Before I get into this post, I’m happy to say I’ll be a panelist at The Microcap Conference, a new conference taking place in Philadelphia on November 5. It will be a great opportunity to hear from some promising small companies, meet with company management, and network with other analysts and investors. Anyone interested can find more information at microcapconf.com.

Fair warning: my subject today is so thinly-traded that building a meaningful position is next to impossible. So, I present the situation mainly as a profile in corporate gamesmanship, of multiple competitors sparring to achieve complete control over a valuable asset. The asset in question is a real mouthful: Warrnambool Cheese and Butter Factory Company Holdings Limited.

Warrnambool-logo

“WCB” is Australia’s oldest dairy company, founded in 1888. From the very beginning, WCB was export-oriented, first sending a shipment of butter to London in 1893. The company grew by leaps and bounds in the 20th century, overcoming a disastrous fire in 1929 and forming many joint ventures and licensing agreements with major world cheese and dairy brands. Over time, the company’s footprint increased to encompass many different categories of dairy products, as well as many supply chain inputs. The company listed on the ASX in 2004.

Dairy prices can be volatile and WCB’s results are not immune, but on average the company has been profitable. Here are annual results from the company’s listing in 2004 to fiscal 2014.

Capture

Like I said. Hardly consistent, but generally profitable and moving in the right direction. Over this stretch, WCB caught the eye of other Australian dairy businesses looking to expand. WCB’s international distribution and valuable partnerships were enticing for other operators looking to achieve higher margins through increased scale and improve their market share.

The first company to propose an outright acquisition of Warrnambool was Murray Goulburn, an Australian dairy co-op. Murray Goulburn approached WCB in late 2009 but was rebuffed. The WCB board viewed the proposal as opportunistic, and to a degree it was. WCB suffered heavily amidst the global financial crisis, and 2009’s results were very poor. Though Murray Goulburn would raise its offer multiple times, they were repeatedly turned down and ultimately withdrew their offer in June, 2010. Still, they began a creeping takeover of WCB, announcing they had purchased nearly 5% of WCB’s shares in early 2010. Through continued purchases, Murray Goulburn increased its stake in WCB to just under 10% by late 2010. WCB, for its part, brought in another competitor as a substantial shareholder. Through a rights offering, Bega Cheese purchased a 15% interest in WCB.

The games would continue, with various competitors quietly building their stakes in WCB. By mid 2013, Murray Goulburn had built its ownership to 16% of WCB, and Bega held 17%. Bega was the next to attempt to acquire WCB, offering the equivalent of $5.78 in cash and Bega Cheese stock. Again, WCB’s board recommended against the offer. Finally, after nearly a year of warring press releases and attempts to rally shareholders for or against the deal, Warrnambool found itself a savior in a white knight: Saputo, Inc. The large Canadian dairy company stepped in with a superior offer of $7.00 per share, payable in cash.

However, Bega Cheese and the Murray Goulburn Co-Op were far from done. Murray Goulburn returned with a bid of $7.50 per share, while Bega Cheese maintained that its offer was superior in that it allowed WCB shareholders continued participation in an Australian dairy company. Saputo fired back with an improved offer of $8.00. Meanwhile, a previously unknown player crept in and began accumulating WCB shares in earnest. On October 29, 2013, Lion Dairy went on a massive buying spree and bought up 9.99% of WCB’s shares outstanding. Lion Dairy is a subsidiary of Japanese beverage giant Kirin Holdings. Lion Dairy had long had a partnership relationship with WCB, and now had a substantial financial investment as well.

On and on it went, with the three bidders increasing their bids in turn. Murray Goulburn’s offer would eventually reach $9.50 per share. Meanwhile, Saputo took matters into its own hands and began buying WCB shares aggressively. In the end, it was Saputo that won out. Bega Cheese capitulated and sold its holdings to Saputo and Murray Goulburn did the same. Through its various open market purchases and the takeover offer, Saputo managed to increase its ownership of WCB to 87.92%.

That might be the end of the story, were it not for Lion Dairy. One of Saputo’s explicit goals in offering to purchase WCB was to obtain a shareholding of over 90%. Saputo even offered an additional 20 cents per share if its offer succeeded in achieving 90% ownership. Why is the 90% threshold a big deal? Well, under Australian corporate law, a purchaser can force remaining shareholders to sell if the purchaser can achieve 90% ownership. Lion Dairy’s stake is now just over 10%, and it represents a blocking interest than prevents Saputo from taking full ownership of WCB. It also prevents Saputo from delisting WCB from the Australian stock exchange, forcing them to continue paying additional listing and auditors fees.

In essence, what Lion Dairy now possesses is a valuable intangible asset via its ability to prevent Saputo from fully achieving its goals. If Saputo wants to achieve complete ownership of Warrnambool, it will likely have to pay Lion Dairy (and all remaining minority shareholders) a premium for the remaining shares. The companies are not exactly adversarial at this point (witness the recent transaction where Lion Dairy sold an entire division to WCB) but Lion Dairy and Kirin Holdings are certainly aware of the strength of their position. Saputo cannot force a merger, nor can it delist WCB, nor can it directly dividend cash back to Saputo without sending 10% of it to Lion Dairy.

Perhaps Saputo will play a waiting game. If a recession rolls around, Lion may become more willing to sell its blocking interest to Saputo at a lower price. On the other hand, Lion Dairy’s asking price may only increase if WCB does well under Saputo’s ownership. Warrnambool Cheese and Butter recently traded at just under Saputo’s acquisition price. Anybody interested in aligning with Lion Dairy and taking part in the next round of corporate soap operatics might enjoy owning a few shares just for the entertainment value, with upside if WCB’s operations perform well. But purchase carefully. Warrnambool’s stock may be one of the world’s most closely-held listed companies, with a free float of less than $6 million on a market capitalization of $522 million.

Alluvial Capital Management, LLC does not hold shares of Warrnambool Cheese and Butter Factory Company Holdings Limited for client accounts. Alluvial may buy or sell shares of Warrnambool Cheese and Butter Factory Company Holdings Limited at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

 

Posted in Uncategorized | Leave a comment