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Autopsy of Gigaset AG

June 11, 2013 | About:
The stock of Gigaset AG has been cut in half since I wrote about the company last year. That in itself doesn’t mean much to me. Since I operate under the assumption that the market is at least sometimes wrong, I can’t logically conclude that a 50% price drop constitutes a mistake per se.

In other words, unless you believe there is no such thing as a stock trading at a 75% discount to intrinsic value, you cannot logically conclude an analysis is wrong simply because the stock drops 50% after you’ve identified it as a bargain.

So if a 50% drop isn’t a mistake, what is?

According to the American Heritage® Dictionary of the English Language, a mistake is:

An error or blunder in action, opinion or judgment.

Thefreedictionary.com is somewhat more helpful. They point out some causes:

An error or fault resulting from defective judgment, deficient knowledge, or carelessness.

What was my thesis for Gigaset AG?

I wrote:

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.

Twelve months later, the company is sitting on €30 million of cash. The bad news is that they took on €30 million of debt to maintain that cash balance. Gigaset AG did not generate €20 million of owner earnings. They burnt through €40 million instead.

That is not sustainable. Gigaset AG is in dire straits.

Was this knowable?

I don’t know. I don’t think so but it's crystal clear that I was willing to bet serious money against this result. I misjudged the risk. What’s worse, the information was there. I was careless.

Like before, Gigaset dominates the European market. Not only did they gain market share in 2012, they did it with even higher gross margin (now 50%). Basically, they sold more phones at higher prices than the competition. In short, the business performed precisely as I expected…. and lost a lot of money. Ouch.

The problem is that selling phones is tied to the housing market. The European housing market in 2012 was not unlike the U.S. housing market in 2010. Frozen. I’ve watched this movie before. I’ve been tracking Natuzzi for years. Natuzzi has superior gross margin, good brand recognition and not enough revenue to cover costs. This has led to a long string of losses.

Gigaset went down with the European housing market exactly like Natuzzi tanked with the US's housing market. As was pointed out by forum members, Gigaset is a long way away from gaining the market recognition abroad that it has in Europe. The growth in the U.S. and Asia hasn’t come close to offsetting the decline at home.

To add insult to injury, the man at the helm, Peter Löw, has left the bridge.

35024_1370959510o1gT.jpg

Lessons learned

When analyzing a company with superior gross margin, check how this trickles down to the bottom line (efficiency). With superior gross margin a company should also have superior net margin. If not, the company may be “bloated.”

In any case, the higher cost structure must be accounted for. Are the costs fixed (pensions) or variable (advertising)? Is the company investing heavily for growth?

Had I taken the time to analyse the efficiency of Gigaset AG, I would have seen that the gross margin of 50% was not making its way to the bottom. My estimate of earnings (pre-tax) was € 20 million. This means net margin was coming in at less than 4%. Vtech's net margin is almost three times as high on much lower gross margin. As it turns out, faced with some headwinds, Gigaset is struggling to cut costs. For now, they are failing. In a year, they've burnt more cash than their market cap. That's certainly not the case at Vtech.

The numbers were in front of me. I ignored them. An unforced error.

Read more:Current financials.

Peter Löw resigns.

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: 4.1/5 (16 votes)

Comments

Nicolas73
Nicolas73 premium member - 1 year ago
Hi Batbeer,

don't blame yourself for this.

i really appreciate your intellectual honesty, and

also your wonderful insights, like PNL (I bought it

after reading your article and I'm keen of it,)

Perhaps I should repay your precious hint with

an analysis on a italian company :)

Nicola
cdubey
Cdubey premium member - 1 year ago
@Batbeer2: A good checklist item, at the very least.
batbeer2
Batbeer2 premium member - 1 year ago
>> Perhaps I should repay your precious hint with an analysis on a italian company :)

I would appreciate any thoughts on:

- Buzzi Unicem

- FIAT industrial

- Brembo

and of course Natuzzi.

For Buzzi I've had a tough time getting some background info about the quality of management.

@Chandan

Yes.
AlbertaSunwapta
AlbertaSunwapta - 1 year ago
Very, very well put! (Quote below) I love your rational thinking! I'm always amazed to see comments on a value investing site rating a manager's stock picking and hedging ability by short- and medium-term market and portfolio price movements. That said, we all know "Markets can remain irrational longer than..."

"Since I operate under the assumption that the market is at least sometimes wrong, I can’t logically conclude that a 50% price drop constitutes a mistake per se.

In other words, unless you believe there is no such thing as a stock trading at a 75% discount to intrinsic value, you cannot logically conclude an analysis is wrong simply because the stock drops 50% after you’ve identified it as a bargain."
Nicolas73
Nicolas73 premium member - 1 year ago
Well,

I'll be quick.

Fiat Industrial/ Fiat were a wonderful buy before the split, they traded @ the equivalent of 8€ togheter!

now I think the business of FI is good, but the debt is too high to provide a margin of safety.

Buzzi has really thin margins, with the Europe business still suffering from weakness and competition, and Mexico and Russian and US branches the only profitables.

the management is basically the Buzzi family, with a presence in this market of over a century

brembo is one of my favourites, it has had a wonderful growth still propelled by the growing asian market and a great market share position protected, in my opinion, by a durable moat

sorry for Natuzzi, the only knowledge I have of this company is the softness of my mother's sofà :)

ciao!
batbeer2
Batbeer2 premium member - 1 year ago
@ Nicolas73

Thanks!
coryashpt
Coryashpt premium member - 1 year ago
We can learn so much by learning from the mistakes of others. Thanks for this article. This site would be better with more such as this. Here's to better investing.
swnyc2
Swnyc2 - 1 year ago
Batbeer2,

I really enjoy reading your articles and think it's great that you critically revisit your prior posts. I wish other authors would do this more. A lot could be learned.

My knowledge of accounting is weak, so it's not so easy for me to understand how you could have prospectively predicted the fact that Gigaset would do so poorly over the past year. However, I wonder if there is possibly another lesson to be learned?

I've noticed that many of the companies you analyze have very negative market sentiment. Some examples could include COCO, AHC, PNLYY, QUAD, and KWK.

I understand, you are looking for exceptional value, so it's not surprising that you analyze companies with low valuations, and many of these will have negative market sentiment.

But, I can't help but think about something I believe Warren Buffet said. Paraphrasing from memory, he said that he would prefer to purchase stock in a wonderful company at a fair price, rather than purchase stock in a fair company at a wonderful price. I believe the reasoning behind this is that over the long term, the share price of a wonderful company often appreciates by much more than the share price of a fair company, even if shares in the fair company were originally purchased at a greater discount. This may also have to do with the margin of safety being higher in a wonderful company due to its invariably larger moat.

Looking at Gigaset,I wonder if it is worth considering whether in your original post, would you have considered it a "wonderful" company?

Finding wonderful companies selling incredibly cheaply is almost impossible. It certainly is a lot harder than finding fair companies that are selling incredibly cheaply.

However, there may be some wonderful companies that are not recognized by the market as such and which are selling closer to fair value. The margin of safety for buying stock in these companies could still meet your threshold, and may be less likely to lead to negative returns.

Just a thought.....

Please leave your comment:


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