Friday, January 11, 2019

Hedge Fund Links ~ 1/11/19

The 20% a year stock picker who wishes his edge would disappear [Bloomberg]

Deal-master Debbane - the secretive fund manager behind Oprah's WeightWatchers windfall [Forbes]

Jeff Vinik plots third comeback [WSJ]

Some 2018 performance figures of prominent hedge funds including RenTec [FT]

Bridgewater ends 2018 up almost 15% [Reuters]

Greenlight down 34% in 2018 [Bloomberg]

The money managers to watch in 2019 [WSJ]

Muddy Waters up 20% in 2018 [Institutional Investor]

Harvard quietly amasses California vineyards [WSJ]

Scott Bessent is preparing for the great divergence [AFR]

Mega family offices strike Transatlantic partnership [Bloomberg]

Thursday, January 10, 2019

Notes From Sohn London Investment Conference

Below are notes from the Sohn London investment conference late last month.  Apologies for the delayed posting.  Click each link to go to that speaker's presentation.

Sohn London Investment Conference Notes 2018

Vikram Kumar (Kuvari Partners): Short Kier Group

Benoit Colas (PrimeStone Capital): Long Spirent Communications

Dureka Carrasquillo (Canada Pension Plan): Long Ferrari

Andrew Dickson (Albert Bridge Capital): Long Micro Focus

Luke Newman (Janus Henderson): Long Rolls Royce

Rachel Reutter (J O Hambro Capital UK Opportunities Fund): Long Smiths Group

Per Lekander (Lansdowne Partners): Long Carbon Credits

Maxime Franzetti (Mubadala Capital): Long Korian

Andy Brough (Schroder Investment Management): 2 Long Ideas

Bernie Ahkong (UBS O'Connor): Long Paddy Power Betfair

Vikram Kumar Short Kier Group: Sohn London Conference

We're posting up notes from the recent Sohn London investment conference.  Next up is Vikram Kumar of Kuvari Partners who presented a short of Kier Group.

Vikram Kumar's Presentation at Sohn London Conference

(Note: On the day after the conference Kier Group made an emergency rights issue of £264m and the shares fell 34%.)

Kuvari have held a short position in Kier Group since August 2017. They are currently short 0.71% of the company’s stock. They previously held a disclosed and successful short position in Carillion, the support services company that collapsed in Jan 2018.

Kier Group are in the construction and contracting business, mostly in the UK. The UK government is a big customer – infrastructure services, road maintenance and development and civil work such as schools and hospitals.  They also build residential houses and commercial buildings.

Kuvari do not like these types of businesses because they are low margin, commoditised and competitive. If government contracts cost more than anticipated to fulfill the company is liable.

Kumar called the accounting aggressive. The contract nature of the business means that income does not come in steadily but in lumps.  The contracts can be multi-month and multi-year. There is a temptation to try to smooth revenue by booking work that may have been done but not paid for. With the IFRS 15 regulation coming in Kumar believes the company will be forced to re-state some of its revenue.

With short positions, Kuvari pay great attention to working capital and particularly receivables – how quickly once you’ve invoiced your customer can you collect cash? Kumar believes that Kier’s customers are slow to acknowledge the work that has been done and slower to pay up. He believes that Kier have been booking income before customers have acknowledged work has been done.

There is a lack of cash generation in the business. According to their accounts, Kier generated £95m in cash over the last five years. Kumar believes that they have overstated that cash. Kier had to restate their full year 2017 FCF from over £100m to -£56m after pressure from regulators.

The most worrying aspect of Kier’s business is the high leverage. Kuvari estimate debt could be as high as 6.8 times, taking them well into distressed territory. Kier owns the equivalent of 68% of the equity in JVs. Kumar believes that the JV’s are being used to hide the leverage. The debt is not being consolidated. Kier also calculates leverage at a low point during the financial year and does not average it which would lead to a higher figure.

Be sure to check out the rest of the presentations from the Sohn London investment conference.

Benoit Colas Long Spirent Communications: Sohn London Conference

We're posting up notes from the recent Sohn London investment conference.  Next up is Benoit Colas of PrimeStone Capital who presented a long of Spirent Communications (LON:SPT)

Benoit Colas's Presentation at Sohn London Conference

PrimeStone have been invested in Spirent for 3 years. Spirent is a fairly complex business that designs, manufactures and tests solutions for communications equipment across a wide range of technologies.  It operates in three divisions: Network and Security - helps Nokia and Cisco test equipment; Connected Devices - tests mobile devices for Apple and Samsung; Lifecycle Service Assurance – helps Telecom Korea.

Despite being a London listed company, it creates 90% of its sales in the US and Asia Pacific. Sales have been stable for the last 10 years. Gross margin has crept up from 65% to 72% over the same period. PrimeStone was attracted by the high EBIT margin of over 20% which lasted until 2013 when they fell below 10% and then rebounded a bit. PrimeStone invested in Spirent with the belief that they could get the EBIT margin back above 20%.The company enjoys a strong and stable global market share and long-lasting relationships with customers. PrimeStone are pulling levers to bring about change at Spirent.

-    There is scope for cost reduction. In 2015, PrimeStone convinced management that they did not need to spend more on product R&D to keep up with competitors.

-    The balance sheet is strong and offers potential. The company has over $100m of cash and PrimeStone have been pushing for this money to be either distributed to shareholders or spent on share buybacks. If there was a $100m buyback the company would remain debt free.

-    There is potential to refocus the business on the most attractive parts. The weaker businesses like Connected Devices should be sold off.

Spirent trades at a discount to its US peers. Colas’ thinks the main reason for the discount is the depressed EBIT margin. As they work to get the margin back above 20% the stock price will rise.

Be sure to check out the rest of the presentations from the Sohn London investment conference.

Dureka Carrasquillo Long Ferrari: Sohn London Conference

We're posting up notes from the recent Sohn London investment conference.  Next up is Dureka Carrasquillo of Canada Pension Plan who presented a long of Ferrari (RACE).

Dureka Carrasquillo's Presentation at Sohn London Conference

In 2017 the luxury car market was valued at $570bn. Estimates suggest it will grow at about 9% for the next 5 years. Ferrari sits in the category of luxury goods that is considered an ‘experience’ and that category is projected to grow at an even higher rate.

One hallmark of a luxury goods company is it is a price maker. Carrasquillo thinks Ferrari can increase the price of their cars by about 4-7% per year. During the Marchione years prices were raised regularly.

Special cars have historically been about 2% of sales but they will become a larger part of the business.  She estimates that by 2022 special cars will represent 20% of revenues. These cars which are limited editions – often 500 cars - sell for more than $1m each and sometimes sell out on the day they go on sale. Gross margins on special cars are about 3x base cars. If the number of special cars is increased in the way that Carrasquillo predicts EBITDA margins for the whole group could increase from 33% to 38%.

Another hallmark of a luxury goods player is careful management of supply. Current product capacity is about 16,000 cars per year yet only 9000 are made. In comparison, Porsche sells 25,000 to 30,00 911s per year. Carrasquillo thinks that Ferrari could increase production to 16,000 cars per year and still sell them. Ferrari intends to launch 15 new models in the next 5 years – that’s a lot more than in the past. It takes about 40 months to produce and launch a new car.

3 potential risks to the Ferrari growth thesis:

1.    Do wealthy millennials want a Ferrari? Do they even want to drive at all? There could be a demographic timebomb for Ferrari? The Ferrari sweet spot is in the 35 to 50-year-old age range. Even though fewer millennials drive during their 20s than previous generations by age 30 they catch up.

2.    Are there enough wealthy buyers? Ferrari buyers tend to be high net worth individuals with investable assets of more than $1m – this is the starting base of an entry level Ferrari customer. Ferrari only manages to sell cars to 0.5% of this group. In the ultra-high net worth bracket they have 3.25% penetration. Carrasquillo concluded that there is a good runway for growth.

3.    Changes in consumer preference. Consumers may become more environmentally conscious? They might prefer to use autonomous cars? The most bullish forecasts suggest that EVs may become 30% of the fleet by 2030. In addition, Ferrari are aiming for 60% of their new cars to be hybrid by 2022. The hybrid cars will have higher price tags and be more profitable.

Luxury goods companies with a similar financial profile to Ferrari have an average P/E 27. If you put Ferrari on that multiple it implies 60% upside. Valuing Ferrari by its cashflows, implies a growth requirement of 3.5% per annum, yet it has been growing its top line at 10% per year for the past 20 years.

There is room for further sales. Ferrari have sold almost no cars in China. Surprisingly the embedded fleet in China is less than 500 cars.

Be sure to check out the rest of the presentations from the Sohn London investment conference.

Andrew Dickson Long Micro Focus: Sohn London Conference

We're posting up notes from the recent Sohn London investment conference.  Next up is Andrew Dickson of Albert Bridge Capital who presented a long of Micro Focus (LON:MCRO).

Andrew Dickson's Presentation at Sohn London Conference

Micro Focus is a FTSE 100 company that has an acquisitive business model. It buys mature legacy software businesses, particularly in the enterprise application software area. These are ‘melting ice cube’ businesses but the Micro Focus team have figured out a way to put them in the freezer to make them last longer. Their model is the antithesis of traditional tech investing. They find businesses that have stopped growing. They are not looking for businesses that are taking share or accelerating growth. Once they have bought a software company they try to change the culture away from growth to ‘trying to stay relevant’.

Micro Focus was founded in 1976 and listed in 2005. Until last year the stock was up 25x since 2005. In 2017 they made their biggest acquisition buying Hewlett Packard’s software businesses for $8.8bn. Digesting the HP businesses has been difficult so far. In January and March 2018 there were two profit warnings. Micro focus’s shares sold off from $20 per share to $0.9 in three days and the CEO left. Albert Bridge added to their position at that time. Since then, the company has been getting back on track but the shares are still down 40% year to date.

Dickson believes that Micro Focus’s long experience of turning around businesses will allow them to successfully integrate the HP businesses over time. In the end, they will do what they have done in the past and take businesses with 20% EBITDA margins up to 45%.

Short interest is quite high. Dickson thinks the shorts misunderstand the business. They point to the lack of top line growth when the model is all about slowing the pace of revenue deterioration. Some analysts have suggested that they need more acquisitions. The shorts also point out that the CFO is leaving after less than a year in post. Dickson thinks he is only leaving to work with a previous boss.

Currently, Micro Focus is reasonably priced at PE 9.5x. In July 2018 it announced it would sell one of its highest growth businesses, Suse, for $2.5bn. There will be a special dividend for shareholders early next year. In six months the sale will be completed and the company will still be able to produce $2 of EPS. By then it will be on a PE 7.5x, 15% FCF yield.

Be sure to check out the rest of the presentations from the Sohn London investment conference.

Luke Newman Long Rolls Royce: Sohn London Conference

We're posting up notes from the recent Sohn London investment conference.  Next up is Luke Newman of Janus Henderson who presented a long of Rolls Royce (LON:RR).

Luke Newman's Presentation at Sohn London Conference

At its heart Rolls Royce is a razor to razorblade business model – the razors - or the engines in this case - cost billions of dollars to design, deliver and install and come with an obligation to buy razorblades - service contracts - for the next 25 years. The gross margins on the service contracts are  high between 50% to 70% but the engines are sold at a loss.

The secular trends in air travel are supportive driven by increasing wealth and emerging markets. Air passenger kilometres over the last 70 years have grown at 6% CAGR. If passenger growth continues at 4.5% and assuming planes have a 25-year life, 425 new wide body planes are required every year to keep up with demand. That’s 37 new wide-bodied planes every month. The production schedules for Boeing and Airbus for next year are slated at 34 per month creating positive pricing dynamics for all participants.

Rolls Royce has the engine orders, the challenge is to execute: deliver the engines and carry out the maintenance contracts. There is also an organisational challenge. When Warren East took over as CEO he described Rolls Royce as an athlete that needs to lose weight. New management have been brought in to run finance and operations. A Cost reduction plan was announced earlier this year cutting 25% of non-engineering jobs. In addition, cash consumptive and loss making businesses have been sold. Rolls Royce has always traded on its high levels of technology and market share. Now Warren East is holding it financially accountable by setting cash flow targets of £1bn by 2020 and an increase to £1.8bn by 2023.

Over the last 20 years what was a 3-player market has become a duopoly. Pratt and Whitney took the rationale decision to concentrate on narrow body engines and ceded their market share to Rolls Royce. That did not come for free because Rolls Royce had to spend billions of dollars developing new engines to take the market share. The good news is that this year is the first year in which most of the revenue will come from the high margin aftermarket business. The company has reached a critical inflection point.

GE, the other member of the duopoly, has been in harvest mode, maintaining share and enjoying good aftermarket revenues. GE has lots of problems, but the engine business has not been one of them. GE’s engine margins have been consistently high.

There has been a correlation over the years between Rolls Royce’s share price and FCF per share.  The 2023 target of 1.8bn FCF should equate to a share price of just under 1000p per share.

Management are incentivised to grow FCF through bonus plans. To maximise their bonuses RR executives need to generate 158p of FCF in 2018, 2019 and 2020. Analyst consensus now is 117p – leaving 35% upside if the stretch targets are hit. Newman believes that Rolls Royce’s past performance is misleading analysts. He thinks they are behind in understanding just how cash generative the business has become.

Warren East bought £74K of stock in December suggesting he has faith in the way the business is performing. If Rolls Royce could execute as well as Safran and MTU their shares could go far higher.

Be sure to check out the rest of the presentations from the Sohn London investment conference.

Rachel Reutter Long Smiths Group: Sohn London Conference

We're posting up notes from the recent Sohn London investment conference.  Next up is Rachel Reutter of J O Hambro Capital UK Opportunities Fund who presented a long of Smiths Group (LON:SMIN).

Rachel Reutter's Presentation at Sohn London Conference

Perceptions of Smiths Group are stuck in the past. The management team that was appointed in 2015 has solved the pension overhang, shored up the balance sheet and now they are diverting cashflows into R&D to become market leaders in several businesses.

More recurring revenue type business is being done – 57% of revenues are from the aftermarket. Smiths has 17% operating margins. It has a diverse set of cashflows that are multi-product, multi geography, varied customers with multiple cycles.

The management are good allocators of capital. The balance sheet is strong.

Since 2015 Smiths has gone from being market leader in 60% of their businesses to 80%. The quality of the company is rising. Areas of market leadership include: airport security and particularly scanners. There are strong barriers to entry in this area because of trust and relationship issues involved in the security sector. Airmiles are set to grow at 5% per annum and the threat of terrorism seems to be ever present and becoming more sophisticated. Borders are understaffed and only 2% of containers are checked. Governments have no choice but to spend on security equipment, the underlying market is growing at 5% per year.

Other leading businesses include: John Crane, the maker of seals for the oil industry; Inclusion Systems, the maker of medical devices - 20% market share, 82% of sales are recurring.

Smiths is sensibly valued, FCF yield 6.5%, dividend 3.5%, cashflow is growing at 5% per year.

Reutter expects the medical division to be sold in the next few months. There is plenty of upside potential.

Be sure to check out the rest of the presentations from the Sohn London investment conference.

Per Lekander Long Carbon Credits: Sohn London Conference

We're posting up notes from the recent Sohn London investment conference.  Next up is Per Lekander of Lansdowne Partners who presented a long of Carbon Credits.

Per Lekander's Presentation at Sohn London Conference

Emissions credits were introduced by the EU in 2005. Companies with high emissions either had to cap them or buy credits. The carbon market will begin to go from over supply to under supply.

In 2019, new supply will be cut by 24%. The market will balance in two years. After that there will be a shortage of credits and prices will rocket.

The market is liquid and deep.

Carbon Credits are a highly regulated and synthetic market. Lekander noted the risk of political interference.

Be sure to check out the rest of the presentations from the Sohn London investment conference.

Maxime Franzetti Long Korian: Sohn London Conference

We're posting up notes from the recent Sohn London investment conference.  Next up is Maxime Franzetti of Mubadala Capital, an Abu Dhabi Sovereign Wealth Fund with over $ 20 billion of invested capital who presented a long of Korian.

Maxime Franzetti's Presentation at Sohn London Conference

Franzetti runs a concentrated book of long (usually high-quality compounders) and short positions. Korian is their largest position. They made their initial investment over two years ago.

Korian is the largest European operator of nursing homes. It has over 76,000 beds spread over 4 countries. They are No. 1 in France and Belgium and No. 2 in Italy.

The business is growing organically and margins are increasing. It’s a secular growth story with the business being able to perform well regardless of geo-political events or cyclical trends. The aging population over 80 years in Europe is set to double in the next two decades. They are well positioned to gain from the shift from public sector to private sector provision. Governments are closing public sector homes and issuing licenses to private sector providers. Korian has occupancy rates of 95%. There are barriers to entry in the form of licenses and regulatory requirements. The business is resilient and grew organically during in the financial crisis.

The business is at an inflection point. Management were replaced two years ago. The new CEO has been restructuring the business. Korian can grow the top line by 6% per year via volume, increasing prices and M&A. However, pricing is not exclusively in the hands of the business as rises are capped by law in France. The market is still fragmented with the top five players owning a small amount of the total market. There is a long runway for growth. There are economies of scale.

Korian itself has attracted interest from private equity. KKR made an offer earlier this year. Franzetti suggested that further offers could follow in the future.

Leverage is 3.2x but it is backed by real estate which is worth about half of the market cap.

Be sure to check out the rest of the presentations from the Sohn London investment conference.

Andy Brough Long Sports Direct: Sohn London Conference

We're posting up notes from the recent Sohn London investment conference.  Next up is Andy Brough of Schroder Investment Management who presented 2 longs: Sports Direct (LON:SPD) and Restaurant Group (LON:RTN).

Andy Brough's Presentation at Sohn London Conference

Long: Sports Direct

Mike Ashley is the best retailer he has come across in his 30 years of fund management. Brough likes sports retailing because there are only two quoted companies in the sector – there isn’t the high level of competition you get in general retailing. It’s profitable with gross margins between 40-48%.

Mike Ashley’s record of selling his own shares and buying back shares over the years proves he is a good capital allocator. Ashley has been a net buyer of shares recently and currently holds 65%.

Why buy Sports Direct now? It’s below the floatation price. It’s buying up other retailers on the cheap: House of Fraser (paid £90m), Evens Cycles (paid £8m - bought from Private Equity that paid £83m three years ago), Debenhams.

Brough believes that Sports Direct’s accounting is the most prudent in the FTSE 350. There are no exceptional items in the accounts. If they have a cost they take it on the chin through the P&L. As soon as stock comes into the business it’s automatically written down by 20% - it’s a way of smoothing profits.

Innovation is the key to retailing. Sports Direct’s click and collect regime has been applied to House of Fraser and has lifted the average spend per shop to £40.

Long: Restaurant Group (LON:RTN)

Restaurant Group is the largest concession operator in airports and stations in the UK.

CEO, Andy McCue, has an almost forensic-like attention to detail.  He makes good use of data to steer the business.

Restaurant Group’s shares have gone from 230p to 140p since the acquisition of Wagamama. Brough believes that Wagamama will become an excellent addition. Some Frankie’s and Benny’s restaurants will be converted into Wagamama’s. Also, underused kitchens at Frankie’s and Benny’s are being put to better use by the Gourmet Burger brand to allow home delivery by Deliveroo.

Be sure to check out the rest of the presentations from the Sohn London investment conference.

Bernie Ahkong Long Paddy Power Betfair: Sohn London Conference

We're posting up notes from the recent Sohn London investment conference.  Next up is Bernie Ahkong of UBS O'Connor who presented a long of Paddy Power Betfair (LON: PPB).

Bernie Ahkong's Presentation at Sohn London Conference

Paddy Power Betfair is an international sports betting company. It has 4 divisions: Online; Australia; Retail; US.

Ahkong’s buy case was largely based around Paddy’s ability to expand in the US. Today the US only accounts for 3% of profit. Spending on betting is far lower in the US than in the UK or Australia - largely because it has been banned. The Professional and Amateur Sports Protection Act was struck down by the Supreme Court earlier this year. It could represent a huge opportunity to expand sports betting in the US.

Paddy acquired Fanduel earlier this year. Fanduel runs fantasy league betting in the US with 7m registered customers. Only a fraction of these are active customers, though. Ahkong predicted that Paddy could take 10% market share in the US.

On the business outside the US: retail betting shops only account for 12% of Paddy’s profit – there is not as much Brexit risk as some analysts think. Regulatory headwinds in the UK are well known and priced in. The Betfair part of the business faces increased competition. It had a bad H1 but concerns that they are losing share are over stated.

Be sure to check out the rest of the presentations from the Sohn London investment conference.

Wednesday, January 9, 2019

What We're Reading ~ 1/9/19

Atomic Habits: An easy & proven way to build good habits [James Clear]

On hard choices [Seth Klarman]

Putting recent economic & market moves in perspective [Ray Dalio]

A final decision investment checklist [Value Investing World]

16 ways to measure network effects [Andreessen Horowitz]

The 2019 stock buy list [Crossing Wall Street]

Stock market investors: it's time to hear the ugly truth [MarketWatch]

The world's top 750 family businesses ranking [FamCap]

Disney's Bob Iger interview [Barrons]

On the Kentucky Bourbon resurgence [NYTimes]

Pitch on Radisson Hospitality (RADH) [Yet Another Value Blog]

A look at Cognex (CGNX) and Roku (ROKU) [RGA]

GE powered the American Century - then it burned out [WSJ]

Interview with BNSF's Matt Rose [Railway Age]

The thin line between bold and reckless [Collaborative Fund]

How China's reform transformed poor families into middle class shoppers [SCMP]

Dirty dealing in the $175 billion Amazon marketplace [The Verge]