Dear investor,
Another positive quarter in terms of the net asset value of our funds (+20% in the International Portfolio Another positive quarter in terms of the net asset value of our funds (+20% in the Iberian Portfolio) continuing the good progress initiated on 1 November 2020 with the approval of the first COVID-19 vaccines. We still have a long way to go, but we believe we are on the right track.
The most interesting development in the last five months is that it seems that value investing is starting to turn around the poor performance of the last few years. As we have repeated many times, we believe that the ability to generate profits is the sole determinant of long-term share prices. Finally, thanks to inflationary expectations, interest rates are starting to rise, making companies that will only gene-rate profits many years from now, or perhaps never, less attractive. Fortunately, our companies generate profits and free cash flows, and comparatively benefit from this normalisation of interest rates.
In this quarter, corporate transactions affecting underva-lued companies have intensified, with two significant takeover bids having been received, Hoegh LNG and Semapa. Both are opportunistic and below our valuation but are indicative of the value of our portfolio. Three major tran-sactions in four companies in the International Portfolio are also noteworthy. The sale by Golar of its subsidiary Hygo, which was a significant event in an important holding for us. There was also the sale of the North America division by Aryzta and the merger between International Seaways and Diamond S Shipping. In the next section we will go into these operations in depth.
Finally, we will review the investments made in Asia over the last four years, as they have added value to the funds through their relative outperformance.
CORPORATE TRANSACTIONS
During the first quarter, we had significant corporate transactions in companies with a significant weight in our portfolios, which we have grouped into two blocks:
1. Takeover bids
Hoegh ~2% of the International Portfolio
Hoegh LNG (HMLP, Financial) is one of the world's leading floating liquefied natural gas regasification infrastructure companies, in which we have ~2% of the International Portfolio inves-ted. In March the Hoegh family, main shareholder (~50%) of the company, and Morgan Stanley Infrastructure Partners, launched a delisting tender offer at NOK 23.5/share, which implied a 36% premium over the last trading price before the announcement of the takeover bid. However, we consider that this price does not reflect the com-pany's true value, and therefore decided to vote against the offer.
However, given the weight that the Hoegh family has in the shareholding, the takeover bid was approved at the extraordinary shareholders' meeting, and we are forced to sell the shares at the indicated price. Even though this is lower than our valuation, we will reinvest the money in the rest of the portfolio which has equally interesting potential.
Semapa ~9% of the Iberian portfolio
On 19 February, the Queiroz Pereira family, through its holding company (Sodim), launched a takeover bid for the 28% it does not control in Semapa (XLIS:SEM, Financial) at €11.4/share, which it subsequently raised to €12.17/share. In Cobas AM we consider the offer price to be low. By only taking into account objective issues such as the market value of Navigator (where Semapa has 69%) and the debt of Semapa, we reached a value of ~€14/share. To which we believe the following should be added: i) the value of Secil, a cement company that has obtained an average EBITDA close to €90 million in the last six years and ii) the difference between the target value of Navigator and its market value. With all this, we reached a higher value per share of € 20, far from the €12.17/share offered by Sodim.
It would not be the first takeover bid that we would not take part in because we consider that the price offered is well below our target value. From our previous stage we highlight the case of Camaieu, in which we received three takeover bids between 2006 and 2007, each one at an increasingly higher price than the previous one. We finally agreed to the third one because the price offered was close to our valuation.
2. Mergers and Acquisitions
Golar ~7%
Golar (GLNG, Financial) is one of the main operators in the liquefied natural gas value chain, owning production infrastructures and LNG carriers. Several developments in the first quarter reaffirmed that the investment assumption continues to develop well. In January the company announced the sale of Hygo, its natural gas-fired power generation infrastructure division, to New Fortress Energy (NFE), its main American competitor. At the same time, it was also announced that it was selling its stake in GMLP, owner of gas transport and regasification ships, also to NFE.
The price offered by NFE is reasonable, similar to our valuation, and this transaction will help simplify the company's structure and crystallise the underlying value of the business. Once the sale has been executed, Golar has received close to $950 million in cash and shares from NFE, while its market capitalisation is currently around $1bn. Looking at these numbers, we can conclude that the market considers the rest of the company's businesses to be worth practically zero. In our opinion, the business that Golar maintains, floating natural gas liquefaction and transport infrastructure businesses are worth far more than the share price reflects. This market inefficiency presents us with a very interesting opportunity, precisely at a time when the company's main owner and management team are more focused on executing the strategy of simplifying and crystallising the value of their assets.
Aryzta ~6%
The announcement of the sale of the North American business confirms that the change in the management team was a turning point in the history of Aryzta (XSWX:ARYN, Financial), as referred to in our letter from the third quarter of last year. This sale will allow the company to have a simpler strategy and focus on optimising the best businesses: Europe and Asia where they create the most value. Over the coming months, as there are increasing vaccina-tions in its main markets in Europe, the reopening of the economy is expected to lead to a recovery in sales and margins due to increased sales to hotels and restaurants.
International Seaways ~3% & Diamond S Shipping ~1%
On 31 March, two of our tanker companies, International Seaways (INSW, Financial) and Diamond S Shipping (DSSI, Financial) announced their merger. Following the merger the shareholders of INSW and DSSI will hold ~56% and 44% respectively of the resulting company. We consider this to be a fair deal as the swap equation is more or less in line with the value of their assets.
The deal will create the second largest US-listed company by number of tankers (more than 100), the third largest by cargo capacity and with a balanced cru-de/product mix (70/30).
We like the deal for three reasons: i) there is a complementarity of their fleets, which allows for a broader offer to their customers, while at the same time allowing for cost efficiency. In fact, cost synergies of $23 million are expected, which, capitalised at 10x, represent more than 20% of the market value of the resulting company. ii) being a share swap, it does not add financial leverage, iii) the resulting company will have a higher market capitalisation, greater liquidity, which together with the track record of the management team of INSW, should help to reduce the discount at which it trades on its net asset value relative to comparable companies.
Ultimately, we believe that all these corporate transactions will help to crystallise the value of the companies. Even takeover bids at a price below our valuation are nothing more than the recognition of the mismatch between price and value that some shareholders want to take advantage of.
ASIAN PORTFOLIO
Our presence in Asia dates back to the summer of 2008, when Mingkun Chan joined the team to be our eyes and ears there, because of China's weight in the world economy and the fact that many of our portfolio companies either had a presence there or their main competitors were Chinese.
We consider that having an analyst in Shanghai, who was initially intended to analyse subsidiaries of our companies and competitors, has been of paramount importance all these years, and most especially last year. A year in which he helped us to better understand how the pandemic was evolving and what we could expect in the West. It has also allowed us to learn first-hand about many companies and invest directly in the region, broadening our investment universe. This situation would not have been possible otherwise.
Since the launch of Cobas AM the Asian portfolio has represented on average about 13% of the International Portfolio, but due to the good performance of recent quarters, this weight at the end of March fell to around 7%, which is invested in eight companies. Companies with very good businesses (average ROCE ~39%)1, solid balance sheets (seven companies with net cash), trading at an attractive valuation (3-4x PER21)1 and all with a family as the controlling shareholder.
A clear example is LG Electronics prefered shares (XKRX:066575, Financial). We have been analysing this company for years in order to benchmark our investment in Samsung, which is also present in the mobile and household appliance businesses. The highlights of LG are that it has: i) a home appliances and OLED TV business, which generate a stable cash flow with a leading technology; ii) a loss-making mobile phone business, which, after years of studying Samsung, we consider uncompetitive; iii) finally, a Vehicle Components business that contributes a significant part of the value to General Motors' electric car. The latter provides a high growth potential even though it is still in the investment phase.
Despite the fact that LG capitalised at close to €20 billion, we believe it is not well covered by analysts. LG is cove-red by technology analysts and has long been priced at a discount compared to its technology competitors due to its poor mobile business. The market has exaggerated mobile losses, while it has underestimated the stable cash flow of the other businesses. After all, the house-hold appliance division is too "boring" a business for technology analysts/investors. This situation gave us the opportunity to buy good businesses at a discount. In addition, preferred shares trade at a significant discount (50%) to common shares, giving us an additional safety margin.
An important moment in LG's history came in 2018, when the current chairman inherited the empire due to the sudden death of his father and began to review LG's broad portfolio of businesses, with the aim of focusing on profitable businesses by exiting those in which they were not competitive.
In fact, LG recently (December 2020) announced the creation of a JV with Magna for the electric vehicle components business, and last April LG decided to exit the mobile phone business. These decisions will bring to the surface the value of LG, for which they have been applauded by the market and have appreciated by more than 100% since the announcement last December.
