Wednesday, April 30, 2014

Gevelot's hidden value is exposed

Almost two years ago to the date I wrote about Gevelot (ALGEV.Paris), a small French industrial company.  I was attracted to the stock because they were a two-pillar stock, a company where earning power supported book value.  Two pillar stocks are especially attractive when the company is trading below book value.  In the past two years the company has slowly drifted higher until Monday when shares jumped 43%.  When I searched for a reason behind the jump in share prices I stumbled on Gevelot's hidden asset, a subsidiary's minority investment in an associate.

The company has three European subsidiaries that each have different areas of focus: extrusion, pumps, auto parts.  The company's extrusion division generates the most revenue at €109.7m, with pumps generating €89.4m and auto parts €14.1m.

The company reported their 2013 results in a press release, and released their annual report yesterday.  They recovered from a net loss in 2012 to earning a profit of €6.26 p/s in 2013.  The company is in great shape financially, they have little debt, and book value grew to €133m this year.  The company is still undervalued trading with an €86m market cap.  They also repurchased about 1,000 shares of their own stock, an extreme rarity in France.

If this were all there'd be nothing to post about.  It would be a cheap French company whose results are improving with a share price climbing towards fair value.  What makes Gevelot interesting is a paragraph included at the end of their 2013 results press release.  The company reported that their PCM subsidiary owned a 45% stake in a Canadian company named Kudu.  Kudu received a buyout offer for $250m, or €161m.  This offer valued Gevelot's stake at €72m, more than the market cap of the entire company at the time.

Instead of accepting the buyout offer the subsidiary rejected it and offered to purchase the 55% of the company they didn't already own for €94m giving them 100% control of Kudu.  The company continues in their release they once they own 100% of the company they intend to sell it to a third-party.  I find this last thing the most curious, why would Gevelot buy 55% of Kudu to flip it?

The Kudu stake was valued on Gevelot's balance sheet for €10m as an unconsolidated investment.  In 2012 Kudu generated €1m in net income, but in 2013 it generated €20m from €153m in sales.  Whatever Kudu is doing to sell pumps in Canada is apparently working, although Gevelot was about to be left out.  Kudu terminated their contract with Gevelot starting April 30th.  Gevelot noted in their annual report that they expect earnings to be much lower in 2014 as a result of this relationship.  It's no wonder that they decided to purchase the 55% of Kudu that they didn't own, it ensures that they have a distributor for their parts in the fast growing Canadian market.

When looking at the Kudu buyout with last years numbers it appeared like Gevelot overpaid.  When viewing the acquisition with the 2013 numbers it looks like they got a deal.  They paid €90m for €11m in earnings (55% * €20m, they already owned 45% of the earnings or €9m).  In total their cost for the Kudu investment will be about €100m, or 5x earnings.  If they can sell it for €160m they can flip this for a quick €60m.

My first inclination after the price jump was to sell my shares for a gain, making 100% in two years is an excellent investment.  But after digging into their press release and looking through the annual report I'm now inclined to sit still.  What looked like a foolish investment now looks savvy given how Kudu performed in 2013.  A criticism is that maybe the 2013 numbers are a cyclical high or a fluke and won't be repeated.  My response would be that Gevelot's management has a lot more insight into the situation compared to investors.  Investors only have financial statements to work from but the company can talk to Kudu's management and assess the viability of the market.

With the acquisition of Kudu complete Gevelot will be able to consolidate their financials.  If they were able to consolidate in 2013 the company would have earned €28.40 p/s.  Even with a 50% price increase the shares still appear cheap.

They aren't only cheap on an earnings basis, they're still cheap at the asset level as well.  The company has a book value of €133m, or €146 per share using Kudu's stated cost.  If we value the pre-transaction Kudu stake at the offer value then their book value increased to €226 p/s.  This is more than double today's price.  Fully consolidated it appears that Gevelot will continue to be a two pillar stock with €28 p/s in earnings and a book value around €226 p/s.  Earnings at 8-10x give credence to the company's book value.

Even if Gevelot isn't able to sell the company to a third-party for a quick gain this transaction is very accretive for shareholders.  Sometimes a company has a hidden asset shareholders don't even know existed as was the case with Kudu.

For those interested here is their press release
Here is the latest annual report
(Both in French)

Disclosure: Long ALGEV

11 comments:

  1. but if they flip Kudu, won't they once again lose their distribution in Canada?

    ReplyDelete
    Replies
    1. Mike,

      That was my thought as well, unless they stipulate a new contract as part of the sale. That's my guess for what they'll do, they will ensure that the buyer is friendly and they have an attractive distribution deal.

      Nate

      Delete
  2. If they're so sure they can re-sell Kudu for more, why wouldn't that end buyer just circumvent the middleman and buy it now?

    ReplyDelete
    Replies
    1. Maybe they couldn't buy it without Gevelot's approval. Their 45% could block a sale.

      Delete
  3. Excellent blog!

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    ReplyDelete
  4. An interesting situation. I'd be inclined to sell. I respect your point of view that management know more about the situation than we do, but equally management have career risk. They may need to own the distributor to keep enjoying jobs that they like, even if it's not in the best interests of shareholders.

    Would you buy these shares today, if you'd just come across them? Perhaps not?

    Just food for thought. Like your blog btw, and admire your whole esoteric approach!

    ReplyDelete
  5. Great article. Interesting in that hidden assets can be found in big NYSE stocks too. Take Corning Glass (GLW), they own 50% of Dow Corning, a $6 billion sales company, while Dow Chemical (DOW) owns the other 50%. Nobody seems to talk about it, or notice, but why doesn't anyone put pressure on GLW to sell or spin-off their ownership - at least ask Dow if interested???? Even if GLW could get one times sales, they would have over 10% in market cap value, pre-tax. Because it would be a control situation, maybe Dow would pay more if interested. Instead, there is this hidden asset simply paying dividends to the 2 owners. It's all there in the GLW 10-K towards the back. Dow Corning shows high capital expenditures pre-2013, then cap ex below depreciation and amort in 2013 - very interesting. Dow Corning announced their Q1 2014 earnings and showed a big increase too. Sometimes hidden assets are right there in front of you, but the stock of the holder of the asset may not be cheap enough.......yet!

    ReplyDelete
  6. Some of statements not true. i.e. kudu didnt act to cutoff first but it occurred other way around

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    Replies
    1. Do you mind elaborating? So Gevelot cut off Kudu? If so why did they then acquire them?

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    2. both partners couldnt agree since shareholders also used to be competitors. So, one side (whose decided to cutoff first) did want to kill other. Meantime, they made money too..

      Delete
  7. Seems like they indeed flipped Kudu: http://www.reuters.com/finance/stocks/ALGEV.PA/key-developments/article/2996860

    Question now becomes what they do with all the cash...

    ReplyDelete