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A Great Company at a Graham Price – Gigaset AG

June 14, 2012 | About:
Within the value-investing community, it is no secret that Gigaset (AQU) is cheap. What is not readily understood is that the addressable market of the company has been expanding at double-digit rates.

Value and price

The company has 50 million shares outstanding. Shares change hands on the Frankfurt Stock Exchange. Code: GGS, ISIN: DE0005156004 at €1.55 apiece for a market cap of €80 million. Americans can try the thinly traded OTC market.

As of March, Gigaset had €40 million of cash and no debt worth mentioning. In 2011, the company earned roughly €20 million before tax.

From an owner's perspective, that’s a 50% yield after adjusting for excess cash.


Business and Competition

Gigaset Communications was established in 2008. That year, Arques Industries bought 80% of Siemens' home and office communication division. Siemens was in deep trouble at the time.

In the '80s, analogue cordless phones began to reach Europe from the Far East. After a few years, it was realized that if you did it digitally, this would result in:

- Less crackle and interference

- More phones within a small space

- Security against eavesdroping

- The ability to move throughout buildings by 'handing over' between base stations

It was decided by the European Telecommunications Standards Institute that a new standard would be developed – DECT.

In 1992, the first domestic cordless DECT phone, the Gigaset 900, was launched. The Gigaset range of products evolved to become the industry leader. By 1997, Siemens had sold 10 million DECT gigasets. That number has now grown to 150 million.

Today, the market for handsets (DECT and other) is roughly 100 million units. By revenue, Vtech and Gigaset each have a share of 30%. By unit volume, Vtech (after the acquisition of AT&T's division) leads. They sell 45 million handsets. From this, Vtech generates revenue of $700 million (they sell other stuff too). Vtech's gross margin comes in at 30%.

Gigaset sells about 15 million handsets. Gigaset too generates revenue of $700 million (€500 million). At Gigaset, gross margins are higher – 45%.

Panasonic and Philips also compete in the space.

In recent years, DECT volumes were driven by the displacement of 900 Mhz analogue and 2.4GHz/5.8GHz digital handsets in the U.S. The U.S. adopted the DECT standard in 2005. Since then, the market for DECT handsets has grown. India is in the late stages of adopting DECT and China is thinking about it. There are quite a few homes with phones there too.

35024_1339659869RjkK.png

That’s an interesting opportunity for a company that is:

- 100% focused on this particular market (no one else is)

- Universally regarded as the premium brand within the space

- By far the most profitable player

- Currently selling 15 million units in a 100 million-unit market.

Gigaset doesn’t try to sell you your first handset. The company is more interested in selling you the last one you’ll own. Yes, some of their models are well suited for senior citizens but that is not the point here. Gigaset designs and manufactures handsets to the highest possible standard. It is common for customers (including myself) to go looking for an identical replacement for a handset they and their family have been using for a decade or more.

It is a slow but profitable model for growth. Like Porsche, Loewe AG and for that matter Apple, the products will not win each and every “objective” consumer test. They win where it counts: customer satisfaction. It shows.

35024_1339624795e098.png

You don't get better by being bigger, you get bigger by being better - Buffett.

Technology and Innovation

DECT has survived two decades of innovation because it is tied to the 1.9 Ghz frequency. The reverse is true as well. If you want to use that frequency you have to comply to the DECT standard.

It so happens 1.9 Ghz is just right for penetrating brick walls with enough information to get high-quality digital audio (better than old-school 900 Mhz). 5.4 Ghz Wifi can carry more information (more than you would need for clear audio) but it requires a lot of energy. This is a fundamental problem for an elegant cordless device.

A typical example of the Gigaset approach to innovation is the L410 clip. This is a tiny handset lacking some important features. You can't even punch in a phone number. All you can do is accept calls. The audio quality is great. The small battery lasts a week. Bluetooth doesn’t have the range and Wifi will eat your battery before lunch.

35024_1339624297SfGU.png

At $50, this is a high-margin product. In addition, once you have a couple of these in your house, your next base-station is probably going to have a Gigaset logo.

Whereas Vtech, Panasonic and Philips have several lines of business to occupy their attention, Gigaset is focused on DECT. The others are not going to get a major upgrade in the perception of their brands without upgrading their entire product line. Meanwhile, because of their high market share and superior gross margin, Gigaset AG can afford to spend more on innovation than anyone else within the space. That is precisely what they are doing.

Management

Peter Löw is the man in charge. He sits on the supervisory board and owns 1.8 million shares.

As of this year, there is a fresh new executive board. This requires some explanation.

Prior to 2011, the company we know today as Gigaset AG was called Arques Industries. Arques, founded by Löw, was a publicly traded firm that focused on the acquisition and the active restructuring of companies in transitional situations.

Dr. Löw retired in 2007 with an impeccable record. Two years later, Arques found itself in a frozen credit market holding a dozen unrelated and unprofitable businesses. Management had a choice. Liquidate before or after bankruptcy. They chose the former.

As management began to sell off the portfolio, the founder returned as head of the supervisory board to rescue the hidden gem from the rubble – Gigaset. The CEO promptly resigned. A new CEO, Maik Brockman, resolves the remaining issues with Siemens and buys the remaining stake (20%) from that company. Arques is subsequently renamed Gigaset AG. Maik specializes in restructuring businesses.

In January of this year, Maik handed the reins to Charles Fränkl. Fränkl is a CEO with significant experience in wireless technology. Maik is still on the executive team along with a newly promoted young CFO, Alexander Blum.

The supervisory board, with six members including Löw, meets almost monthly. Members are paid about €20,000. They get the cash only after the shareholders have approved their performance at the next annual meeting. Some, like vice chairman Professor Judis, have spent most of this money buying shares.

The three executives, including the CEO, get paid about €150,000 annually depending in part on the stock price.

Peter Löw and Alexander Blum own 1.8 million and 35,000 shares, respectively. This means the CFO spent a significant chunk of his income buying shares.

Specific Risk

DSP group supplies a significant portion of the world's DECT chipsets. Should there be a problem or price hike, the impact would be significant. This would be worse for manufacturers with lower margins.

75% of Gigaset AG’s revenue comes from Europe. A frozen housing market and/or depressed economy is not good for a company selling premium DECT handsets. For foreign shareholders, a decline of the euro would result in a lower earnings in real terms. This can be hedged out.

Gigaset could spend its hoard of cash in a dumb way.

Catalysts

This week, at the annual meeting, management of Gigaset AG proposed a plan to buy back shares.

The industry is consolidating. At current prices, Gigaset is a takeover target.

Why is this cheap?

The stock is European. All bets are off. People in Europe have historically been willing to pay about one day's wages for a Gigaset handset. Gigaset sells roughly 15 million handsets. At a 10% net margin, I guess the owner of Gigaset AG rakes in the equivalent 7500 times the annual income of an average European. Regardless of currency.

2011 was the first full year of “clean” operational numbers. Gigaset was a restructure within a restructure. Both the operating business and parent holding company have been restructured recently. The current financial performance of the business is obscured by its former self. Investors don't have a nice series of ten-year numbers to plug into their favorite spreadsheet.

Investors generally associate the market for DECT handsets with fixed-line phone utilization. Contrary to popular belief, this has no direct bearing on the number of DECT handsets sold. Modern handsets use IP for their upstream connection. It’s called VoIP.

Hubris/impatience. One investor who bought the stock after doing some work on it, subsequently spoke with the CFO. The investor tried to explain that this was a commodity business more akin to selling vacuum cleaners than ipads. The company should quit spending on R&D and start buying back shares. Dr. Alexander Blum, the CFO of a company with half a billion in revenue and a triple digit margin spread to the nearest competitor, patiently listened but didn't seem "to get it". I leave it as an exercise to the reader to find out in what field Dr. Blum got his degree.

The investor/analyst/writer concluded this was a case of inferior management and sold in disgust. That's the same CFO who spent a huge chunk of his income buying shares and who, this week, announced the company will be buying back shares after resolving the last of the issues with former parent Siemens.



Read more:

Gigaset financial reports

DECT forum

Gigaset in the US

Vtech

Good work over at aboveaverageodds.com

Professional analyst Marie Therese Grübner explaining why it's worth €9. It was trading at €4.

DECT versus Wifi.

India

Try finding DECT in Panasonic's annual report

What is DECT?

Disclosure

This is not a recommendation to buy or sell anything. I had no position in any of the stocks mentioned at the time of writing.

Any and all questions welcome as usual.


P.S. It just occurred to me that this one probably scores well on Phil Fisher's 15 point checklist.

About the author:

batbeer2
I define intrinsic value as the price I would gladly pay to own the business outright. With current management in place. For most stocks, that value is 0. As of September 2012, I'm the author of the monthly Buffett-Munger Best Bargains Newsletter. I can be reached at fvandenbroek AT gurufocus DOT com

Visit batbeer2's Website


Rating: 3.7/5 (27 votes)

Comments

Cornelius Chan
Cornelius Chan - 2 years ago
Thank you for this interesting research. Could you kindly explain why the company has lost money the past 3 years (given that you have stated it is coming out of restructuring)? I am getting my numbers from here.

Thanks again.

batbeer2
Batbeer2 premium member - 2 years ago
Hi C.W.R.

That's not a bad place to get numbers from. Having said that....

1) The fact is, they haven't lost money in the past three years. They were profitable in 2011. For revenue and earnings, that year is missing from FT's overview. For some reason, they did graph the cashflow of 2011.

2) In 2008, they had about a dozen businesses, one of which was Gigaset. They've divested the unprofitable operations leaving just Gigaset. At FT, you can see revenue and assets go down. Peter Lynch would say they were dediworsifying.

3) They took impairment charges on some of the businesses before they were divested.

Since Löw returned, EPS has steadily improved. Now it's positive. That is a neat trick given the prevailing headwinds in Europe.
Figurenzauberer
Figurenzauberer - 2 years ago
Hello,

As a long term user of Gigaset products I know the company quite well.

What is not expressed in the analysis is that Gigaset has great fundamental problems:

Their new products have significantly lower accepance than the old ones which were (until 2011) still sold under the SIEMENS brand! Furthermore there are NO significant switching costs for the customers.

Finally management is very poor at capital allocation which is a big problem given the fact, that they have no clear organic business growth.

I believe therefore that problems are arising quickly given the fact, that their organic business has rather poor economics. Currently EBITDA margins are already coming down from 14 to 9 percent.

S.Seiler

batbeer2
Batbeer2 premium member - 2 years ago
Hi Figurenzauberer.

Reasonable people can look at the same facts and disagree.

I believe there's evidence for the following:

- This is the most profitable company in the space.

- There is significant room to grow unit volume.

- They are spending more on R&D than anyone else.

I'm not making any predictions here, just listing facts.

"Management is very poor at capital allocation" strikes me more as an opinion. Nothing wrong with that, but where's the evidence? The CEO started in january. The other guys on the executive team played an important role in turning this from a money-losing conglomerate into a profitable pure-play in a very tough economic enviroment. Not to mention the great record of Peter Löw.

-EDIT-

Yes there are no switching costs. The same could be said of diapers, safety razors, ipads and newspapers. Meanwhile, people stick with the Gigaset brand for many years :o)
batbeer2
Batbeer2 premium member - 2 years ago
>> Their new products have significantly lower accepance than the old ones which were (until 2011) still sold under the SIEMENS brand!

I just did some scuttlebutt on eBay to find out the market value of DECT handsets today. It seems the Gigaset brand is worth something.

Just search using the terms "DECT Gigaset", "DECT Siemens", "DECT Gigaset - Siemens", "DECT Vtech", "DECT Panasonic" and "DECT Philips".
swnyc2
Swnyc2 - 1 year ago
Batbeer2,

I'd be most interested if you had any new thoughts on this one?

The stock price has continued to go down substantially since you wrote the article about 1 year ago.

Did you make a mistake in your analysis / assumptions?

Or, do you think there is still an opportunity here?

Regards,

batbeer2
Batbeer2 premium member - 1 year ago
Hi Swync2,

Yes and yes :o)

I underestimated the impact of the housing market on Gigaset's sales. A mistake.

I think there is an opportunity here.

I plan to do an update on on QUAD and KWK this month.

Maybe I'll do an update on this one too. Alternatively I may write about Natuzzi. That's tied to housing too and has more exposure to the US. The stock has been left for dead though.
swnyc2
Swnyc2 - 1 year ago
Batbeer2,

FYI, I was at Best Buy today and I happened to look at the cordless phones.

They caught my eye becuase they were right by the entrance and because I had recently read your review on Gigaset.

Best Buy was displaying phones from Panasonic, Vtec, Uniden, and AT&T, but no Gigaset.

So, I decided to look on-line.

Of the 410 cordless phone models sold by Best Buy, only 5 are Gigaset.

Furthermore, if you sort by popularity, Gigaset doesn't even make it into the top 50 most popular phones on their website (or on Amazon's website for that matter).

Perhaps, the company's reputation and market share in the U.S. may not be representative of Europe? Or, perhaps Gigaset is for the elite and not the masses?

I don't want to quibble, but it makes me wonder if they are the "universally regarded as the premium brand within the space."

Perhaps the market has changed?

As usual, your thoughts would be most appreciated!

Regards,

batbeer2
Batbeer2 premium member - 1 year ago
Hi all,

I now consider this idea a mistake.

I did an autopsy here.

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