On the Orient Express

When it comes to trophy assets few companies do it like Belmond. It owns hotels such as the Cipriani in Venice, Grand Hotel in St Petersburg, 21 Club in New York and operates the fabled Venice Simplon Orient Express train, amongst others. Now combine this collection of assets with an awkward shareholder structure and you have an interesting situation on your hand.

Source: Belmond

The company (originally Orient Express Hotels) was founded in the late 1970s with the acquisition of the Hotel Cipriani followed by the Orient Express. OEH was housed under a shipping company called Sea Containers founded by James Sherwood, which later filed for Chapter 11 and was forced to spin off OEH. Over the last few years the company hasn't been managed in the best possible way and there was a lot of shareholder discontent, while the liabilities side of the balance sheet began to baloon. To bring the story to the current years, the CEO resigned in 2011 for personal reasons and the board began a search for a new one. In 2012 it hired John Scott, which also marked the beginning of a turnaround of the company (profile on him in Fortune). He has a good track record in the hotel business and previously was the CEO of Rosewood Hotels, which he turned around then sold to a company belonging to HK’s New World group.

He began to restructure OEH's operations, initiate $50-70m asset sales and seek out management contracts. His team also began a rebranding effort to move away from OEH to Belmond. Apparently, most people thought that what OEH does is operate old trains between London and Venice only. With the new branding they can consolidate hotels and use it to cross sell customers. In addition, by establishing themselves as a strong hotel operator they can position the company better for management contracts. In short, the new team aims to rid the business of non-core assets, reinvest in what’s core and pay down debt. The company entered the recession with a lot of leverage (at some point over 9x EBITDA) while currently it's at a more manageable (though still high) 4x. In addition, a new board was also brought in (more on this and governance below).

All of the above was reflected in the share price which has steadily climbed from around $11 to over $15 but then 2014 came and things started to go wrong in a few markets, such as the exposure to Russia (the St Petersburg hotel is about 10% of keys) and the share price started to tumble to the $11 levels.

It’s worth noting two things here: (i) these sort of assets attract a lot of attention from suitors and (ii) an odd governance structure.

In 2007/2008 Indian Hotels (publically traded leisure arm of Tata) tried to make a run for the company when it owned over 11%. It did the same in 2012 when it had a 7% stake (you can read a good summary here from the Economist). In 2013 the bid was ultimately rejected by the board on low valuation but Indian Hotels still owns that stake. In addition to Indian Hotels, the Reuben Brothers (UK based investors, mostly involved in real estate) also own a 6% stake in Belmond. Back in pre-recession times there were rumours that they were looking to buy the company (at a $3bn valuation!).

Recently I re-read Peter Lynch’s classic “One Upon Wall Street” and he talked about trophy assets. At some point in his career he came across a company trading OTC that owned Pebble Beach with a $25m market cap. He didn’t buy the stock but Twentieth Century Fox did buy the whole company for $70m a few years later. They eventually sold assets off, starting with one piece of land that was alone worth $30m i.e. there was substantial underlying value but it needed a catalyst.

Apart from better operational performance a key catalyst would be getting rid of the current governance structure. Basically, there are class A and B shares. While it’s generally not such a big deal in this case the B shares don’t trade, instead are held by a subsidiary of the company, which also happen to carry a 10x vote vs class A shares, essentially giving control to the board / company (this is a legacy setup by the previous owner). While it enables mgmt. to act for the long term (assuming the incentives are aligned) it also makes people jittery given missteps from the old guard.

Now, what is it worth? Current market cap is $1.2bn and $1.7bn EV trading around 15x current and 14x forward EBITDA vs historical avg of 16.5x. Current EBITDA is estimated to be around $110m and mgmt. guides for $18-32m to be added by 2017 (vs 2014) from renovations / additions, increase in mgmt. fees, cross visitation etc on top of organic growth. Taking this at midpoint (and assuming no organic growth) indicates $8m increment p.a. so Belmond could be around $135m by 2017 (implied share price of $17, assuming historical multiples).

Based on the historical multiples for the various segments, the market implies around $700k/key valuation for the owned hotels. Now assuming the valuation would get back to pre-crash levels ($800-900k/key) it would imply $14-17 per share. Global trophy hotel asset transactions have been pushing $1,000k/key recently; assuming this for a second would imply valuation of $19/share. The two M&A attempts were made at average EV/EBITDA of 18-19x. Applying this on 2017 earnings gets you to similar valuation. Looking at an absolute downside, Belmond has traded at book before when things looked really bleak, which would imply $8/share.

While it appears that there is value in Belmond, keep in mind that history shows a lot examples of investors falling in love with trophy asset hoping for a greater fool, only to find their hands burnt in the process. However, I think that mgmt. has every incentive to carry on with their plan and so far they’ve made rational decisions, which (as noted above) were reflected in the share price before all the events around Russia etc kicked in.

The two key catalysts for getting to the above valuation ranges are (i) mgmt. delivering on their plan and (ii) board doing away with the shareholder structure (for those wishing for some kind of activist involvement…there is no chance). Also for the same reason M&A is unlikely for now (unless they get a $30/share offer tomorrow).

Having said all the above about the shareholder structure I do think there is hope. I’d urge you to listen to the company’s November 2014 investor day (or read the transcripts) where the topic of the shareholder structure has been debated to death. The CEO noted that this is being discussed in board meetings but actual progress has been slow to date. Let’s see. If the board would eliminate this the valuation uplift would be accelerated for sure.

Weekend reading

Graham and Doddsville Winter 2015 issue

Recent coverage of Buffett in the FT on the upcoming 50th anniversary letter: (i) article on Buffett (ii) video on Buffett and (iii) Seth Klarman on what he learned from Buffett

Forbes on Li Ka-shing's recent corporate reshuffle

Podcasts: Tom Russo on China (BeyondProxy) and Jean-Marie Eveillard (Wealthtrack)

Great interview with Jeroen Bos (5GQ)

Continued series on accounting fraud in Asia (BeyondProxy)

Mark Mobius' post on Greece

Great posts from Farnam Street on (i) decision making and (ii) influencing others

Value investing and the virtue of being lazy (undervaluedjapan)

Bruce Berkowitz's recent investor call (ValueWalk)

Investing in agriculture

Agriculture commodity (corn, soybean etc) prices took a beating last year as increased production handily outstripped demand growth. This led to an increase in stockpiles of corn and soybean, in turn pushing down prices (for instance corn reached around $5/bu at peak in 2014 spring vs low $3/bu as 2014 progressed). On the supply side there are a number of factors at play but the most important is the expansion of planted acres. Over the last decade demand for ethanol and emerging market use of crops increased substantially, which farmers met by increasing the planted area to produce more crops.

Agriculture is a “supply story” with a relatively steady growth in demand. The key driver of demand is coming from emerging markets (increasing affluence, different lifestyle, different eating habits, more protein…nothing surprising). As it is very much a weather impacted business one bad year can leave you with low production (see the drought in 2012) but higher prices, while near perfect weather and growing conditions (as witnessed over in 2014) can cause the opposite. Despite the steady demand this introduces a lot of cyclicality. While the rational move would be to cut production it’s actually quite hard and farmers are instead rotating to higher profitability crops (to soy from corn). We are looking at potentially strong production in the next growing year as well. When crop prices reached their lows last year they were near the marginal cost of production for both corn and soy in key growing regions (US and Brazil really). On a historical basis crop prices haven’t dropped below marginal cost of production for meaningful periods.

While one or two bad years are not the end of the world from a farmer income perspective as balance sheets are quite strong from previous years, farm income is going to be down this year (potentially next) thus farmers will have to make some tough choices on how to allocate capital. The key areas for the cuts are in (i) machinery (combines, tractors) (ii) rent (where land is not owned) and (iii) some chemicals (inc. fertilisers) while the areas not high on their mind to cut spending from are (i) seeds and (ii) storage.

Ag machinery is the first place most are expected to make cuts from as they have no need for replacement (fleet is actually quite young - 7 year avg. tractor age in the US vs 30 year useful life - following years of strong capex) and they also have no budget for it. On the chemicals side, farmers are expected to keep herbicide and pesticide use as these products are needed (vs nice to have) though there could be some decline in expenditure as some crops are more heavy users of chemicals than others. On the fertiliser front (NPK), depending on crop and geography, nitrogen has to be applied every year as it cannot be stored in the soil while P/K can be skipped in a year or applied only to the scientific recommendations, so there are likely to be cuts in the application of the last two.

On the other hand, seed is the last place most farmers would cut expenditure from (as they’ll keep planting on large acres) and as a result seed companies haven’t started meaningful discounting of prices either. On-land storage is important now as farmers would rather keep everything on the farm then to sell the produce at such low prices to a trader. The above is the framework I use to look at potential investments in the sector.

In the short term crop prices are expected to remain range bound given the supply picture, while lower oil prices are also not helping (positive for farmers' energy bill, not so much for ethanol and other biofuels on a relative basis). Over the long term I feel fairly confident that for instance emerging market demand for crops and various commodities will continue to be steady and that more production will be required over time (though it will remain cyclical especially as we experience increasingly odd weather patterns). However, that new production will not come online at current prices. For instance, in Brazil to bring on additional land to grow soy – of which the majority goes to China - requires at least $12/bu prices vs the below $10/bu currently.

Perhaps the best approach in taking advantage of this down cycle is via buying a basket of stocks, perhaps of the badly hit ones. Though I do think that you've to look through at least 2015 to make money as most seem to expect 2015 to be the trough. While engaging in market prediction is as useful as a glass hammer, if it doesn’t materialise there could be some serious carnage in ag names during the year. Below are a selected few that I’ve been looking at though don’t think you are in any particular rush with these names; it could get worse before the sun comes out again.

AGCO: US listed, pure-play ag company (as the name would imply) involved in everything from farm machinery, storage to farm equipment with well-diversified global sales base. Company has about $4bn market cap, $5.1bn EV and trades around 6x EV/EBITDA (NTM) and 15x P/E. The company is carrying out cost cutting measures to increase margins, which is relatively low vs peers, initiated a $500m buyback last year (to be completed early this year) and another $500m to be carried out through 2016.

CNH Industrial: The company consists of the industrial business of Fiat and CNH Global following their merger in 2013, when it went public in this reorganised state. Since then the stock is down to around $7.7 at last read (or around 40%) as it is heavily geared towards global agriculture, LatAm trucks and European construction. Current market cap around $10bn and EV of $12bn, trading at 4x EBITDA and 14x P/E. Over the last year peer Deere & Co outperformed CNH by a wide margin, likely due to it’s buyback programme. CNH does have a buyback programme in place but haven’t used it to ensure achievement of an investment grade rating. The company laid out its “strategic vision” (consultant speak for how to come out of this mess we find ourselves in) last year through 2018 – growing sales, cutting costs, improving profitability etc. It’ll be one hard long slog though you do have Sergio Marchionne as the chairman (he did surprise investors on many occasions before) and Exor controlling 40% of the votes.

Valmont: I came across this one in a recent Third Avenue shareholder letter. It's a $3bn market cap ($3.3bn EV) US listed company that makes poles, towers for utility transmission, wireless communication and lightning equipment in addition to being one of the largest players in irrigation equipment that is used in agriculture. The ag business is under pressure as described above while the utility business faces near term pressure on pricing. It's currently trading at 6x EV/EBITDA and 15x P/E and offers a 2% dividend yield.

Cresud (highly speculative): Admit it’s an odd one but just couldn’t help it. Small ($500m market cap) Buenos Aires listed company, with ADSs on the NYSE, trading at a huge discount to NAV. The company is in the production of crops, beef, milk etc as well as farmland development (where they have a good track record) - it is essentially a play on LatAm farmland (Argentina, Brazil etc). In addition via a 65% stake in IRSA it is engaged in residential and commercial real estate in Argentina. With this you are also implicitly making a bet on the outcome of the coming elections in the country. Argentina has substantial ag production, however given high export taxes and unsupportive policy it simply becomes uncompetitive. Opposition parties have indicated more favourable outlook for the ag sector simply because of its importance for the country, so that could be a positive (though take campaign promises with a large pinch of salt).

Weekend reading

A kinder, gentler activisim (DealBook)

Gates Foundation annual letter and interview on Charlie Rose

Great collection of Buffett case studies and articles on csinvesting: (i) From liquidator to operator (ii) Dempster Mill (iii) Sanborn Map (iv) See's Candies

A dozen things I've learned from Joel Greenblatt (25iq)

Preview of Mohnish Pabrai's office with Guy Spier (Manual of Ideas)

Interesting book review of 'The Tides of Capital'. Essentially an overview of the 1990s and 2008 financial crises and their impact on Asia (China RT)

Mark Mobius' post on reforms in various Asian countries and impact on small caps

Farnam Street's review of the book 'Powers of Two' on the role of partnerships

London School of Economics public lectures on corporate boards and central banking

Tom Hanks' op-ed in the NY Times on community colleges (link and post from Thomas Stanley)

Navigating the Asian investment landscape; BeyondProxy interview with Michael McGaughy of Yuan Asset (Link)

Vitaliy Katsenelson's post on Softbank (link)

Immofinanz and the tale of Russian exposure

Now for something a bit closer to home. I’ve been looking for ways to slowly start taking advantage of the current mess that’s happening in Russia and think the best approach is having a basket of securities. Immofinanz could make an interesting addition to this basket.

The company was started back in 1990 and is now one of the largest European real estate companies, listed in Vienna and Warsaw. The company has an integrated operating model of developing properties, servicing and managing, and trading as and when interesting opportunities arise (they call it the “real estate machine”…the machine).  The current portfolio consists of 470 properties with rentable area of 3.5m sqm. Their core markets are CEE/SEE (c. 70%) while the rest in Austria/Germany. Around 85% of the portfolio is in office/retail with the rest in logistics (under consideration for an eventual exit) and other non-core assets. The portfolio is very well developed, with 86% in rent generating properties and 7% each for properties under construction and pipeline. All of the above is carried at €6.8bn (€5.9bn in revenue generating assets). The average LTV on the various properties is 42%, while it’s 52% at the consolidated level with financing cost of 4%. Mgmt said they are comfortable with this level going forward (indicated 45-55% on a recent call). The below illustrates what Immofinanz owns as of October last year.

Source: Immofinanz

In addition, the company owns a 49% stake in BUWOG – collection of residential real estate assets in Germany and Austria. It was originally acquired from the Austrian government in 2004 and last April it spun-off this business to focus on core assets both geographically (mostly CEE/SEE) and segment wise (commercial). Immofinanz retains a 49% stake in the business and doesn’t consolidate it. This stake is worth around €820m currently and given the nature of the business, offers a solid dividend yield of 4-5%. Actually, part of the reason of the spin-off was to increase the yield on the overall portfolio. Prior to the spin gross running yield was 6.8% that increased to around 7.8% on Immofinanz. The company expects to be out of BUWOG in the mid-term.

Source: Immofinanz

The single largest exposure is Russia, which makes up 25% of portfolio and over 35% of the rental income, which seems to have spooked a lot of people in 2014 (Immofinanz share price down from €3 to €2 currently). The company has 6 assets in Russia, of which 5 are retail in Moscow, generating a 10% gross yield (for now). Unfortunately, the looming recession in the country is dampening consumer spending, which makes it harder for retailers to cover rent. The rent is either in USD or EUR, against which the RUB substantially devalued so as you can see retailers are hit twice. To help them out Immofinanz is offering temporary fixing of the FX on the rents for the next three months. They’ve done the same in the 08/09 crisis. A positive element for retailers (not so much for developers) is the fact that the Russian shopping centre market has one of the largest pipelines of new projects in the region, which could push down rental prices. Granted a chunk of it will be delayed/cancelled, but certainly not helping in this environment. Nevertheless, given the situation vacancy rates will likely be increasing, while rental values have already fallen thus write-offs on the Russian assets are likely forthcoming (assets currently carried at €1.7bn). It is going to be a tough 12-18 months for sure. Excluding Russia the situation is better, with attractive yields in (an artificially) low interest rate environment with more money coming into the region (e.g. Romania and Hungary) leading to increased transaction volumes.

The company has spent considerable efforts to streamline the portfolio, selling €2.7bn worth of properties over a 4 year period (mostly non-core, residential, hotels etc) with average margin of 14% over carried value, and looks to do more going forward, which should help cash flow. Immofinanz also plans €1-1.5bn of property development over the mid-term on the retail side. Currently, there is around €390m costs outstanding on development projects, mostly in Germany and Poland, in addition to €480m already spent (vs €980m fair value).

In the last financial year the company didn’t pay a dividend (in-lieu it spun off BUWOG, which pays a solid dividend). At the beginning of the year the company planned on €0.15-0.2/share dividend and buyback (8.6% yield at midpoint), however the dividend might be cancelled (for various accounting/tax reasons under Austrian law – it basically needs distributable profits), however a buyback programme will likely be maintained. The company plans to repay a financing tied to its treasury shares, cancel these (c. 9% outstanding) and launch another buyback. Personally, at this valuation I'd prefer a buyback vs dividend.

Just a word on mgmt. Back in 2008 the former CEO was ousted (later convicted for breach of trust – urge you to read around the story a bit). The current CEO – Eduard Zehetner – was brought in and did a tremendous job turning the company around, which at one point was near bankruptcy, however he will be stepping down this year.

Now for the juicy stuff (I’m including the treasury shares for the calculations, though these are in the process of being retired). The NAV of the portfolio is €4.5bn of which €3.1bn is in Eastern European/Russian assets (€0.6bn in Austria and €0.8bn for the BUWOG assets), while the market cap is €2.3bn, for a c. 50% discount. Assuming for a second that you fix the holding discount on the W. European assets at 0, BUWOG at market, the implied discount on the Eastern European assets is over 70%! I know things are bad but this is excessive.

So what about upside/downside cases. To be super bearish, if you wanted to completely write-off the E. European/Russian assets (inc. Romania, Hungary etc) you’d get to around €1.3/share but this is a very unlikely situation. Based on my estimates, downside is around €2/share (though if dividend is not paid this year and not replaced with buyback it could dip below). Upside depends on how much you believe the discount on the E. European/Russian assets would shrink. A discount of 40-50% on these implies €2.6-2.8/share, even after taking into account some write-off on the Russian assets. The key catalyst is obviously improvement in geopolitics for which you have to look through the next 12-18 months for sure. In addition, follow-on buybacks supported by asset sales would also help.

If you don’t feel comfortable owning the equity directly you could structure the trade with convertibles e.g. the 2018 maturity, 4.25% interest, put option in 2016 with full dividend protection. You’ll get exposure to both Immofinanz and BUWOG and can pick up a c. 4% yield.

Favourite blogs, websites and podcasts

I often get asked about favourite blogs, news sites, magazines, podcasts etc and thought it was worthwhile to post a selection. I've enjoyed following these sites for a long time and hopefully you'll too!

Investing/business
25iq - Tren Griffin's blog on ideas he learns from investors/entrepreneurs
Adventures in Capitalism - Harris Kupperman's blog
Apollo Asia - Claire Barnes' Asia focused, value oriented fund (recommend to check the "what's new" section)
Asia Stocks to Watch - Barron's Asia blog
BeyondBRICS - FT's emerging market blog
BeyondProxy - The Manual of Ideas blog featuring articles from value managers. They also run a podcast
Contrarian Edge - Vitaliy Katsenelson's blog
Cook and Bynum blog
Corner of Berkshire and Fairfax
Cove Street Capital blog
csinvesting - Source of case studies in investing and business
Distressed Debt Investing - Clue is in the title
Economist's Eastern Approaches blog on Eastern Europe
Fundoo Professor - Sanjay Bakshi's blog on value investing, behavioural finance and business
Investment Adventures in Emerging Markets - Mark Mobius' blog on emerging markets
Jason Zweig's investing blog
Market Folly - Daily collection of interviews, videos, articles in the world of hedge funds and value investing
Minority Report - A HK based money managers' take on investing and business
NY Times' Dealbook
Oddball Stocks - Very good blog on the topic of overlooked stocks
Old School Value - Great site run by Jae Jun
Undervalued Japan - Graham and Dodd investing in Japan
Value Buddies - Similar to VIC but focused on Asia
Value Investors Club - The illustrious
Value Investing World ... supplies my daily fix of investing and business links (run by the Boyles Asset Management guys)
Value Walk - Daily collection of interviews, videos, articles in the world of hedge funds and value investing
Vienna Capitalist - Very good blog on investing, economics etc

Non investing
Early to Rise - One of my favourite sites on personal development and generally increasing the effectiveness of your life
Farnam Street - One of the best blogs around on mental models and continuous learning
Gates Notes - Bill Gates' blog
Giveandtake - Adam Grant's blog
Levantine Musings - David Edgerly's blog on the MidEast
Mark Cuban's blog
Seth Godin's blog
Sinocism China Newsletter - Bill Bishop's daily collection of relevant Chinese news
Thomas Stanley's blog (author of the Millionaire Next Door)
Trendwatching - A consumer/retail research organisation with a great free service on up and coming trends (also region specific to Asia, Africa etc)

Podcasts
Bloomberg's Masters in Business - Interviews by Barry Ritholtz
FiveGoodQuestions - Great interviews with value investors
The Investors Podcast - Interviews and discussions about investors and entrepreneurs
James Altucher's podcast
London Real - Brian Rose's weekly interviews with very interesting people
London School of Economics' public lectures and podcasts
Opalesque TV - series of interviews with hedge fund managers
Tai Lopez podcast. He has a daily book club, which I recommend. His recent TED talk
Tim Ferriss' podcast
Wealthtrack - Consuelo Mack's interviews with money managers

Links of interest

Oldie but goodie. Lauren Templeton at the 2012 Ivey School value investing conference. Materials and link to the Sir John Templeton memo she refers are here and here

Also from the Ivey School, a 2005 talk from the late Peter Cundill

Vitaliy Katsenelson interview on Five Good Questions

Pat Dorsey at Google, discussing his book The Little Book that Builds Wealth

A dozen things I learned from Tom Murphy and Chris Dixon. Many gems in both but my favourite from the Dixon post is:
“What the smartest people do on the weekend is what everyone else will do during the week in ten years.” “Hobbies are what the smartest people spend their time on when they aren’t constrained by near-term financial goals.”

The Economist's take on Li Ka-shings corporate shuffle

Barry Ritholtz's interview (part 1) with Bill Gross

Mohnish Pabrai interview on Bloomberg

Beyond Proxy's collection of biggest mistakes investors made in their careers

The Power of Two - A great article on John Lennon and Paul McCartney

How Lego became the Apple of toys (FastCompany)