Sell Ericsson and thoughts on China

Ericsson out

This has been a very interesting holding over the last six months, with my analysis and buying strategy for once working very well. I did my initial analysis (Value Hunting – Ericsson) of the company in September. The stock was then trading in the 60 SEK range and I concluded that I was wary about the negative trend since 2014. I also did a skew analysis, concluding that the stock has in the past had a history of serious negative surprises. Little did I know how timely my analysis would be when the next quarterly report was out and the stock trading down -20% on the day. I had decided to take a position sub 50 SEK and that opportunity already materialized. I took a 2% position with the plan to add further if the stock moved towards the low 40 SEK range. And so it did, the stock continued to trade down. Averaging down is in general very painful for me, it helped me a lot to have committed to this already here on the blog. So at around 43 SEK I doubled up. Again I was lucky in the sense that this was more or less the absolute bottom.

A few months later the market has started to recognize the potential for a Cisco bid. This was one of my main arguments for buying and especially adding in the stock at 43 SEK. The stock has now traded up nicely, and is now trading again in the 60 SEK range. Given that I don’t think the company outlook has changed much, the risk-reward is more or less back to where when I did my initial analysis. The medium term trend stock chart now looks better and missing out on a potential Cisco bid would obviously be very hurtful. But the stock is no bargain anymore and I choose to exit my full position on today’s close.

Thoughts on China

Currently on a business trip to Shanghai and again fascinated about how quickly things change in this city. This time the new normal is to only use Alipay and Wechat pay. We went down to the food court and my colleague had to buy the food for me because the small food stalls do not accept cash or Mastercard/Amex/Visa. You can basically only pay through your smartphone with Alipay, Wechat pay (it was also possible to use Unionpay, although nobody used it). Last time I was here cash was still accepted, it has gone so fast, Shanghai city center is going cashless! My colleagues are telling me a bit jokingly that it’s no big worry to loose your wallet, but if you loose your smartphone you are in trouble (to be able to pay). Taxis are the same thing. When I visited the city 3 years ago, finding a taxi was super easy, you could pick one up anywhere on the street. Today you could be standing next to the road for 1 hour, looking like a moron waving after taxis which are all already taken. Everyone books their taxis through their smartphone, and then obviously pays through the phone. Not armed with a smartphone loaded with all the latest Chinese services makes you lost in this ever changing city.

So if what has happened in central Shanghai is a guiding light for the country maybe China as a whole is more or less cashless in 10 years and 1.3 billion people pay their daily spending through Alipay or Wechat pay. Without taking into account the hundreds of other initiatives Alibaba and Tencent have, I could almost be willing to long these companies on only this single observation. Although just looking a tiny bit deeper, shows that Ant Financial which owns Alipay is only 33% owned by Alibaba and the market is still waiting for Ant Financial to do its anticipated IPO. Maybe the valuations already reflects this glorious future both for Alibaba/Alipay and Tencent/Wechat pay. Some reader views on this would be very welcome.

For my sport-shoe hunting, a bit disappointing to realize I won’t have time to try out any Xtep shoes, why? Because the do not have any stores in central Shanghai. They are all further out, and even often far away from subway stations. So I learned something, the tier 1 big city Chinese are already too rich to be the main potential customer group for these type of local brands, it’s all Adidas and Nike here, maybe that says something about the long-long term potential of these brands, if they do not manage to change their brand image..

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SEK bargains

The Swedish Krona (SEK) is plummeting further after the Riksbanks latest communication of a lower for longer scenario. In a fairly short period of time the Krona has gone from fairly strong to weak, particurlary to the USD which strengthen against more or less everything. In a perfect world a stock denominated in SEK, with earnings in EUR/USD should correct its stockprice to reflect the now weaker SEK. But we do not live in a perfect world, and potential bargains could exist out there.

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Winners on the weak SEK

A company which is a obvious winner on the weak SEK, has its costs in Sweden but sells all its products abroad. Good examples of such companies are Swedish pulp and paper companies. They usually source their timber/wood locally, use electricity from Sweden and has its labour costs in Sweden. Whereas the pulp is sold on the world market, with prices set in USD.

Most such companies are currently trading at high multiples at a point in time when pulp prices are at high historical levels, but i think i found an exception in the small cap lists in Sweden. The company is called Rottneros and has a somewhat troubled history ending in a rights issue in 2009. Since then they have shaped up considerably and the stock is in a nice uptrend and still trading at attractive multiples. Given the SEK plunge the operating margins are looking very nice indeed. On top of that the electricity cost is hedged, and they are rolling into lower and lower locked prices.

Risks are obviously if pulp prices on the world market plummet, I have no edge at all to predict those, but i can note that they are high from a long historic perspective.

Since Im sitting on the beach writing this i will do a more proper write up at a later time. As of close yesterday I have taken a position in Rottneros of 5% of my fund.

Ericsson

One word about Ericsson as well, the share price has continued to fall sharply and this is also a company benefiting from a weak SEK, as well as from an US investors perspective 44 SEK per share is a lot cheaper today than it was a few months ago. Im willing to continue my Value bet here and take another 2% of my fund to double up the position in Ericsson.

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Ericsson revisited

Little did I know how timely my recent analysis of Ericsson would become. It just ended up on the top of my “Value list” and because of that I decided to take a closer look (Value hunting – Ericsson). My conclusion was to buy in the 50-55 SEK range, and well, it entered and went below that in one single day. I won’t say I had any idea that this would happen, but what I can say is that I did mention the nasty downside risk Ericsson has showed in the past – and once again we experience it -20.21% on the day. The rumours of aggressive accounting must more or less be true, for this type of downturn in numbers.

Probability of bid went up

Before we had a fairly valued company, now it starts to look much more interesting to me. We will probably see lower dividends, perhaps back to the levels of 2009. But even so we still have a very healthy dividend yield of about 3.5% going forward. But to me the value is the patent portfolio and I believe Cisco gets more and more interested, the lower Ericsson falls. In my previous analysis I said that I don’t believe the majority owners would be interested to sell. On my latest flight to Asia I picked up a newspaper in the airplane which I took a photo of:

eric_bid

The article is saying that the pressure on the majority owners is increasing and there are more or less rumours that they consider selling the company. There is apparently a lot of discussions going on behind the scenes on what is the best way forward. The article continues that there is a clear resistance towards selling Ericsson, but all options are at this moment evaluated.

Reading todays articles in the Swedish press, the majority owners and the Wallenberg family particularly is heavily criticised for not taking action. The press more or less demands the Chairman (Leif Johansson – feature image in post headline) is also thrown out. So a lot is going on, and in these situations it is really painful to go in and buy.

How to value potential Cisco bid?

Let’s do a back of the envelope valuation, based on the Sum of the Parts valuation table I presented before.

SOTP 2017E EV (SEKm) 2017E EV/EBIT (x) Per Share (SEK)
Networks excl Patents 48 350 8 15
Global Services 46 973 10 14
SS excl Patents 10 471 1 3
Patents 83 940 10 26

The idea is that Cisco is interested in the Patents portfolio and are willing to pay a good premium for that – without any deeper analysis they can pay a 40% premium on the patents parts of the business. The rest of the business is slaughter and valued at 60% of previous valuations (due to the deteriorating numbers).

Networks = 15 * 0.6 = 9 SEK

Global Services = 14 * 0.6 = 8.4 SEK

SS excl Patents = 3 * 0.6 = 1.8

Patents = 26 SEK per share * 1.4 = 36.4 SEK

Total = 55.6 SEK

But the probability of a bid is not 100%, let’s say it is 40%. Then the Patents portfolio is valued at 26 SEK + 40% * (36.4-26) = 30.16 SEK

And Total valuation is = 49.36 SEK. Which is inline with today’s valuation. I think the probability of a Cisco bid over the coming 1-2 years is in the 30-40% probability range and I don’t think the rest of the business should be valued as low as my back of the envelope calculations. I don’t find the price of Ericsson to be the bargain of a lifetime but interesting enough.

No brass balls

So since I’m not born with brass balls, I won’t take a large position here. I hold 12% of my portfolio in cash and I feel comfortable with taking a 2% position in Ericsson, with the option to increase my position to full size in case we see further share price deterioration towards the low 40 range, this is when the stock starts to become seriously interesting.

 

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Value hunting – Ericsson

What stocks are “Value”?

In a number of posts (Last section hereand here) I have concluded a desire to tilt my portfolio more towards Value. Particular in Europe where Value stocks have been hammered. So a few months ago I started by asking myself, what stocks in Europe are actually considered Value? At the time I had access to an advanced Value ranking which blends simple metrics like Book to Price with more advanced ones. I ran the Stoxx 600 members through the scoring and the top 5 stocks in that ranking were:

  1. Ericsson
  2. Lufthansa
  3. Marks & Spencer
  4. Casino Guichard Perrachon
  5. Sanofi

They say Value should feel hard to invest in.. ..well they were right, that is not a list of stocks I find particularly attractive. In the future I intend to build a model which rank stocks on a blend of my own Value-metrics, but that will take some time to get in place. So I will use the advanced Value model (which I trust) and start with the list above. I don’t think I will analyse them all, but Ericsson looks interesting to me, so at least I start there.

Ericsson introduction

Ericsson is a huge company with 110 000 employees spread out over the world. Ericsson was one of the companies that was hyped during the dot-com bubble and thereafter crashed terribly and was saved thanks to strong owners (Investor and Industrivärlden) through a huge rights issue in 2002. A lot has happened since then (business model changed from phones to networks) but the company has failed to create meaningful shareholder value over the past 15 years:

eric_pricehistory

As I want to merge Value investing with Momentum, this price graph is not ideal, given the sharp negative trend Ericsson is in, but let’s look further anyway.

Business Model

It’s current business model is fairly simple to understand – they build mobile networks and everything that comes with it. The company divides its business into three parts: 1. Networks, 2. Global Services and 3. Support Solutions. Below follows more details on the units.

(more…)

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