Portfolio Update

Thoughts on a few positions

DISCLAIMER: This is not investment advice. The author of this articles holds a financial interest in the shares mentioned in this article. His views may be biased or wrong and the information represented inaccurate. Please do your own research.

It has been a while since I posted and so it is time for another Portfolio Update. I made a number of changes to the portfolio and also adjusted the direction a little bit, assigning a higher weight to special situations. Here is the overview as of Friday, 03 November, compared to 01 September:

Colour Code: Solid Blue - New Positions; Light Blue - Added to existing position; Solid Orange - Full Exit; Light Orange - Reduced Position

Market View:

Over the last two months, markets felt volatile and at times choppy, but then rebounded like they did strongly last week. As I have said time and again, I have no view about the general market direction in the near-term future. Yet I note that despite higher-for-longer interest rates amid still-high inflation and fears of an earnings recession, indices are still fairly close to all-time highs. While there was some stress in some banks earlier this year, we have seen no significant rise in credit spreads nor default rates and certainly no marketwide panic or capitulation. While some people spot a generational buying opportunity whenever we are 5% down, my general sense is to try and be more on the cautious side. Note that over the past 15 or so years I have generally erred on the side of being overcautious and that may well happen again.

Accordingly, in the last couple of weeks, I have been adding positions of two kinds: (1) Companies I have looked at for some time which now have come down in price significantly so I hoped I could buy cheaply and (2) special situations with a catalyst which I hope to be somewhat uncorrelated/less correlated to the overall market. On the other hand, I exited either special situations which were resolved or lower-conviction positions. Here is the breakdown:

New positions / Additions:

Earlier this year, I started a position in Italmobiliare, a holding company with majority stakes in various Italian businesses. Once again, I orginiated this idea from the fabulous Valueandopportunity Blog . The author memyselfandi even put out a 24-page memo for free. There is also a great-quality post on the abilitato-Website which I highly recommend. Italmobiliare can be thought of as a private equity fund focused on the Italian market. They buy significant (often majority) positions in mid-sized companies and try to make grow and improve. Some of their portfolio companies like Caffe Borbone and Santa Maria Novella have grown tremendously and represent strong consumer brands. The company’s management owns a lot of shares and appears to be well-aligned with shareholders. Also, the valuations used for NAV calculation do not look aggressive and the shares trade at a sizeable discount to NAV. My main concern on Italmobiliare is about their exit strategy for their operating companies and how they allocate capital. There is a dividend in place but this time of company sometimes prioritizes empire-building over capital returns. On the other hand, management is experienced and has skin in the game.

I also added to the position in my Danish holding A&O Johansen after some weakness in the stock price. The distributor of tools and equipment for heating, plumbing, ventilations etc. currently suffers from the weak construction activity in Scandinavia (and in fact across Europe). Q3 numbers came in softer than many had anticipated and the outlook for Q4 was also weak. Still, I expect for AOJ which trade around book value, to achieve a Return on Equity in of 15% this year on a modest leverage of 1.7x EBITDA (and declining into year-end). While we may or may not have seen the bottom of the construction doom in Europe, I am convinced that over the cycle, AOJ is poised to do well, just as they have over the last decade and therefore, the current price offer an attractive entry point for an investor with a long-term horizon.

Of my new positions, Thermador is a company I have been following for some time and actually owned in the past (outside of Augustusville). I invite you to read this excellent 10y-old write-up on Valueandopportunity to familiarize yourself with the company. The business model is not unlike AO Johansen. They are a wholeseller/distributor of plumbing systems, pumps, heating systems, valves and related accessories. As for various other distributors, the economics of the business have been favourable. Thermador offers products of >800 manufacturers and its clients are DIY stores, wholesellers, commercial websites and marketplaces. Given the large number of suppliers and customers, it does not seem easy to “cut out” Thermador which has also positioned itself as a “solutions-oriented” business able to service an evolving demand. Over the years, Thermador has skillfully executed a strategy of external growth through acquisitions and is now a holding company comprising of about 15 companies.

In the last 15 years, Thermador’s Return on Equity ranged between 12 and 21 % while applying very little debt (Net Debt to EBITDA currently is about 0.4x). Over that period, revenues have grown by a factor of 3.5x. Even with a growing equity base, Thermador managed to find attractive new targets it could buy at decent prices. Given the downturn in construction activity in France and Europe, it is likely that Thermador may see a decline in revenues over the next 1-2 years and margins might be impacted. Yet, the company will likely find the growth track again. I think the cyclical environment is tough but the business is not secularly impaired or challenged. Therefore, snapping up some shares at 10x 2022 PE / 8x LTM EV/EBIT felt like a fat pitch to me.

I also started a new position in Polish Eurotel which, after selling out both TIM and Eurosnack (see below) is currently my second Polish position. Eurotel operates more than 300 retail stores for telecom and consumer electronics companies such as T-Mobile, Canal+ and Apple (“iDream). The company makes money on the sale of new products but also offers related services (brokerage, repair, B2B solutions). Some of the stores are franchised. Over the last 7 years, Eurotel have roughly doubled their revenues while keeping Groos Margins stable in the 17-18% ballpark. The business last year produced 630mm PLN in revenue on a (year-end) assets base of just 200mm PLN, half of which was equity-financed. So we have a typical trading business with low margins and high asset turnover. They do rely on their suppliers but over the years have managed to diversify (starting with T-Mobile only) - even though there is still huge concentration risk. Also, the business permits to participate in side activities (service, accessories, financing). They do need fairly little capital to grow and have a history of paying out pretty much all their earnings as dividends. 2022 was a record year with both EPS and DPS surpassing 10 PLN for the first time (helped by a one-off gain of roughly 2 PLN/share). For this year, we are on track for more 3-4 PLN/share as the customer mood has soured, some B2B clients had purchased too much inventory and financial conditions have been tightening. The company in its report also mentioned that a higher minimum wage might hamper profitability. To me, these reduction in business activity after a very strong 2022 appears cyclical rather than secular. Maybe they were overearning a bit last year and are underearning now. EPS in the maybe more normal years 2019-21 came at 4.20, 5.20 and 6.40, so maybe 6 PLN is more representative of their earnings power/dividend potential. If so, buying in around 40 PLN to me seems interesting enough.

Special Situations Bucket

As mentioned various times on this blog, having some less correlated exposure has been a good idea for a long time. Unless you are in a market which is screamingly cheap (which we are not in my view), it can be a good idea to have some event-based and/or self-liquidating postions. Over the last two months, I lost two of these as (1) the Activision/Microsoft merger was closed and I could pocket a small gain and (2) Logistec which had announced strategic alternatives earlier this year announced it would get sold to Blue Wolf Capital. I decided to sell the Logistec position shortly after the news.

Trying to refill the merger Special Situations bucket, I looked at both Merger activity and situations with an interesting legal angle. On the former, I decided to get involved in the Spirit/Jetblue merger, breaching a decade-old dogma of mine to avoid airlines. Both Companies signed a definitive merger agreement for Jetblue to buy Soirit at roughly 30 $/share which was approved by the shareholders of Spirit but soon got challenged by the US Department of Justice for being anticompetitive. Also, since the merger was announced, Spirit’s financials have deteriorated by a lot and it is clear that Jetblue would not do that deal now and is currently defending a merger it may not like. Also, if the merger falls through, the Spirit share price may well fall off a cliff. There are many more aspects to this and the best coverage I saw came from Lionel Hutz’ substack and the podcast he did with Andrew Walker. The court negotiation is currently ongoing in Boston and a decision is expected around year-end. This is far from a no-brainer but can go either way and even if the merger is permitted, Jetblue may try to pull out or renegotiate. Still given the current price of Spirit Airlines of 11.26 and a merger consideration of 30 USD, the upside is really big. From the experience of the Twitter merger, I wanted to see if I can use more options going forward and am trying this here with 20/25 Call spreads. The position may well end up a zero, which expains the small size.

Other interesting merger situations in the US include Kroger/Albertson and Amazon/iRobot (I own a tracker position which is among “Other”). A small merger I missed was Bawag/Idaho First Bank which I had on my watchlist but did not pull the trigger on and which now will go through in November.

Beyond Merger Arb, there are two legal special situations which are now in the portfolio. Burford Capital is active in the fairly novel business of litigation finance. They buy litigation claims from companies/parties who lack the resources or willingness to engage in complex, costly and lengthy legal battles and fight them out in court. There are now a number of firms in this space but Burford has been the first and biggest one and so far, their results in terms of realizsations of deployments have been excellent. Burford has also started to raise outside-money in funds, making their business accessible to other investors, reducing risk and moving toward the more capital-light model of an asset manager. Burford’s returns will depend on court decisions or settlements rather than the general economy and so I hope their results might be fairly uncorrelated to the general market. The special kicker in the Burford situation is the win they achieved against Argentina in the YPF Case . This is the biggest case Burford have fought thus far and the court assigned them an award of 6.2bn USD against Argentina, more than twice the curernt market cap of about 2.9bn USD. Nobody expects them to collect the full amount here, but even if they only get half of it, pay some fees and incentives, you basically get the entire remaining operation for free. Argentina is currently in the middle of presidential elections (with the second round taking place on 19 November) and a settlement may depend on who wins the election. Yet, if Argentina does not settle, Burford likely will have means to move their position. Overall, both the nature of the business and Argentina “kicker” make Burford a very compelling investmet case.

The final addition to the portfolio is Liquidia. This is a play on a specific legal situation, this time on patent law. In a nutshell, Liquidia is about to bring a new product on a disease called pulmonary hypertension to the market. The drug has been tested and approved, however United Therapeutics filed a lawsuit against Liquidia for patent infringement. Ever since, the launch of the new product has been delayed and in the end, may be stopped. A decent overview of the situation can be found on VIC, but also by Lionel Hutz. I will not go into details, am no lawyer and so maybe I should keep my hands off this. There is a big downside if Liquidia does not prevail in court, but from what I have been able to read, I like the odds here and the upside also appears very substantial.

Dropped positions

I already commented the exits of Activision and Logistec due to takeovers. For the other positions sold, the main driver was really the lack of conviction, in particular compared to other ideas.

For Nexpoint Diversified (NXDT), a major driver of my investment was the REIT conversions which I expected to trigger higher dividend payouts. Now, the REIT conversion went through but the dividends have not followed yet. Also, I was unhappy with the fairly intransparent reporting by the company, pushing me to give up here - despite the Trust trading at a very signidicant discount to reported NAV. I took a sizeable loss on this one.

Eurosnack, a Polish manufacturer of biscuits, had to go after I found some reports reports on the CEO having been involved in somewhat questionable activities (scam) in the past which raised my concerns about corporate governance. I have no clue if this is correct but there are so many nice companies that I do not need this risk and exited at a small gain.

RCS Mediagroup was another sale after I looked more deeply into H1 financial results which I found disappointing in terms of revenue and EBITDA development. The stock is still cheap and do may do well from here but media/newspaper has been a tough place struggling with declining revenues (I know, digital is growing). So I decided to move on from here.

Finally, Texhong was sold after posting (in my view) poor results for H1 2023. The company has quite a bit of financial leverage and even though I think they will manage to turn the ship around, I feel more comfortable with my holding in Nilorn, so exited this small position.

Conclusion

A lot has happened and I am fairly late with this catch-up. Given my cautious expectation, I feel compelled to take less direct market exposure and also keep some cash. Hopefully, the market will dive from here as I would really like to see some bargain prices to go shopping / add to some positions.

I am also planning to reduce the number of positions a bit, move more towards 20 to better concentrate the monitoring work. Finally, I aim to reduce portfolio fluctuation by - over time - owning more positions that work well and I am willing to hold for a long period.