Sohn Foundation 2019 London Review

Activism, ESG and accounting analysis

Hamlin Lovell
Originally published in the January 2020 issue

The eighth annual Sohn London Investment Conference showcased seven long ideas, four short ideas, and a regional strategy, from ten fund managers and one business school student, who won the third Sohn London Investment Idea Contest.

Activist longs 

Trian Fund Management LP owns over £900m of stock in plumbing distributor, Ferguson. Trian Partner and Senior Analyst, Brian Baldwin, argues that it is misunderstood and undervalued, but should get re-rated when it relists in the US. The firm gets 80% of its sales from branches, which are relatively insulated from e-commerce because Amazon cannot supply components as quickly in a business that requires speed and reliability. Around 75% of sales relate to repairs, maintenance and improvement (RMI), which are less cyclical. End customers are contractors, who are less price sensitive since labour costs typically make up 75% of total costs. 

A repricing of carbon exposures is likely and EU emissions trading is already putting a price on carbon.

Ferguson has been growing revenues by around nine and a half per cent per year (seven and a half per cent organic, two per cent M&A), which is three to four per cent on average faster than the market, through both organic growth and acquisitions. Its return on invested capital is 23% with gross margins and EBITDA margins both growing. The US market is structurally very different from the UK market (where the company still trades under its former name, Wolseley). The more fragmented US market offers much higher revenues per branch, margins 800 basis points higher, and faster revenue growth than the UK market, where clients are more consolidated. Ferguson’s valuation (an EV2020/EBITDA ratio of c 10.4x) is closer to a UK plumbing distributor at an average of 8.3x than a US specialty RMI distributor, which could command a multiple as high as 17.2x. That would increase Ferguson’s share price to more than 100 from 67. Yet sell side analysts predominantly based in Europe view Ferguson through the prism of its UK business even though North America contributes 95% of EBITDA. There is minimal US analyst coverage, and the lower liquidity associated with the UK listing also contributes to a lower valuation. A demerger of UK operations, making the US CEO group CEO, and a review of the listing structure could prompt a re-rating. Other UK companies that relisted on the UK market, such as Invesco, Signet Jewelers and Randgold Resources, saw valuation uplifts.

SpringOwl Asset Management LLC Managing Partner, Jason Ader, is an activist with extensive experience in gaming, including turnarounds such as Las Vegas Sands in the US, in Europe and The Stars Group in Canada. His contrarian, constructivist approach applies a private equity mindset to investing in public companies. He typically identifies the worst performers over a one, three and five-year basis, and then works with management and other shareholders to try and unlock value. SpringOwl owns just under five per cent of Playtech, which trades at a deep discount to peers on revenue and EBITDA multiples: it is valued at around five times cashflow while rivals trade at 15 times, and Ader views it as the most undervalued gaming company in the world. Playtech already has a market share as high as 30% to 70% in some segments and is growing its share of the dynamic global online gaming market. The acquisitions of Italy’s Snaitech could add as much as 40% to EBITDA. The US market – where Ader has been licensed in New Jersey, Nevada and Pennsylvania before – could be a game changer, as large as the UK and Europe combined. Meanwhile, Playtech could exit non-core assets, including its financials business, TradeTech; excess land, such as Milan racetrack, and its Asian business, which might be worth five times more than the value analysts currently judge. Severing ties with founder, Teddy Sagi, could also help the stock to re-rate and a special shareholder meeting should align management compensation with shareholder value incentives. Playtech could be accretive to an acquirer such as Aristocrat, IGT or Scientific Games and Ader wouldn’t rule out private equity buyers who would take private, clean up, and sell at a higher price to one of the strategic buyers.

Hospitality conglomerate discount 

CIAM is most famous for activism, but is not an activist per se. The manager invests in a selection of special situations and merger arbitrage deals, including some companies where it supports management strategy and does not anticipate becoming activist. This sleeve includes some firms that could become private equity bid targets. CIAM co-founder, Catherine Berjal, explained how private equity firms cannot charge fees on uninvested capital, and public to private deals have made up 30% of global M&A in 2019. Hospitality conglomerate, Accor, could be an attractive PE target. It is mainly present in Europe and emerging markets, which are at a later stage of the revenue per room cycle. In the hands of a private equity owner, Accor could sell assets such as its luxury franchises and non-core external stakes in Orbis, AccorInvest and Huazhu that would allow for a return of capital. As much as 35% of the market cap could be monetised, and there are many other value drivers: focusing on the mid-scale and economy segment would de-risk the business and raise margins. The private equity owner could also reposition Accor’s brand portfolio by phasing out outdated brands and expanding new ones. Accor’s share price has lagged the sector over the last five years, and now trades at an average discount of 28% to peers such as Marriott, Hilton, Intercontinental, Hyatt, and Choice. Stripping out assets shows that Accor’s valuation has an EV/EBITDA as low as 10.5 when competitors are around 13.5. Accor could double its EBITDA to €1.2bn by 2022. The company has above average cash generation. Overall, Berjal sees 50% upside: she expects a private equity firm could pay €60 per share and still generate a double-digit IRR. CIAM is a great fit for Sohn Conferences, as the manager donates 25% of its annual performance fees to charities dedicated to improving children’s health and education across the world.

Telecoms refinancing and re-rating 

Pieter Taselaar, Founding Partner and Portfolio Manager of Lucerne Capital Management, was introduced by Exane Director and Global Head of Sales, Dina Geha. Lucerne, which was founded in 2000, seeks out inefficiencies in European mid-caps and views Altice NV as having multiple value drivers that could triple the share price in 18 months. The fundamental backdrop is strong as mobile ARPU is now growing after a five-year price war and churn rates are dropping. Of Altice’s €35bn enterprise value, only €6bn is equity so there is huge optionality in the equity. The first phase of re-rating could come from refinancing over €15bn of callable debt, possibly reducing interest costs by as much as €500m per year and raising the free cash flow yield from 8% to 20%. The second phase could see both organic deleveraging and disposals of multiple non-core assets, including fibre to home infrastructure and towers in France and Portugal, deleverage the firm by at least one turn of EBITDA. Then a sum of the parts valuation, applying a typical infrastructure multiple of 15-20 times to the EBITDA emanating from infrastructure assets, could result in further valuation upside versus the six times multiple applying to telecom services assets.


Media is further through digitisation and disruption than other sectors and has adapted well to Amazon and Google with 83% of books now ebooks.

Digital, audiobooks and subscription growth drivers for publishing 

In 1994 Bloomsbury Publishing was the first PE investment for Allianz Global Investors CIO of Global Equities, Lucy Macdonald, and she still likes the stock. Media is further through digitisation and disruption than other sectors and has adapted well to Amazon and Google with 83% of books now ebooks. Audiobooks are another lever of growth, reaching well beyond the traditional market of pre-schoolers and the visually impaired. Academic and professional books are another important growth driver, which offers higher margins. Meanwhile Harry Potter demonstrates impressive longevity, remaining in bestseller lists 22 years after first being published, and four illustrated editions are being released. Bloomsbury Digital Resources is growing B2B digital revenue and recurring subscription revenues – from the Churchill, National Theatre, and Shakespeare archives – are 49% of digital revenues. The dividend yield is three per cent and has historically grown by six per cent per year.

Medical devices, epilepsy and depression

Medical device maker, LivaNova, was formed in 2015 through a merger of Italy’s Sorin and Cyberonics of the US. Bodenholm’s Per Johansson judges that the base business is undervalued at a PE of c 20 versus 35 for peers, and negative value is ascribed to its pipeline. The company has warned on profits due to delays around VNS (Vagus Nerve Stimulation), its neuromodulation nerve treatment for drug-resistant epilepsy patients. Bodenholm has a constructive view on the drug’s prospects after interviewing US neurologists. If it achieved just five per cent penetration of the epilepsy market the drug might generate $2bn of revenues. The real game changer could come if the drug can also be used as a VNS Therapy System for treatment-resistant depression patients; there are 13.8m US patients with an MDD 9 major depressive disorder. The treatment may also have other applications (heart failure and sleep apnea), and the company could also become a takeover target at some stage.

A fintech on a single digit PE

Odey Asset Management LLP partner and portfolio manager, James Hanbury, believes that fintech company Plus500 is deeply undervalued relative to competitors such as IG Group and CMC. The firm’s market-leading platform hosts c $2trn trading volume a year from c 300,000 customers and has generated average EBITDA margins of 58% and average return on equity of 117% in the three years from 2016 to 2018. Since raising $22m at its IPO in 2013, the company has returned c $850m to shareholders and still has over $300m of cash on the balance sheet. Plus500 competes on the basis of tighter spreads and offers negative balance protection to all traders (not only to retail customers as required by EU rules). Plus500 has a quintessential fintech culture, and in 2018 had revenues per employee of c £1.5m, which is four or five times higher than rivals, as well as non-marketing costs per customer of £221, which is 85-90% lower than rivals. Even so, Plus500 regularly appears towards the top end of the short interest league tables, due to concerns including new regulations and risk management. Hanbury argues that tougher regulations are a positive longer-term factor that will raise barriers to entry and are already driving weaker players out of the industry. On risk management, unlike some rivals, Plus500 does not hedge positions but does limit position sizes and has a hit rate of 85% in terms of winning days, with no impact from key events such as the Swiss franc unpegging that caused large losses for some peers. The company is rolling out a global expansion plan potentially including new licenses in Japan, the US, Hong Kong and Canada. Its PE ratio of around five times is deeply discounted, and a PE ratio of 20 would roughly quadruple the current share price. Plus500 has migrated from AIM to a full LSE listing.

ESG: sulphur regulations and shipping rates

Tamas Eisenberger, Portfolio Manager at Europe-focused long/short equity fund, Sikra Capital, is a fundamental stock-picker who had a profitable 2018. He has identified ISO 2020 fuel regulations as impacting on several industries including shipping. Currently, a single cruise liner can spew out as much sulphur as millions of cars in just one year but limits on sulphur from January 1, 2020, are now forcing 90% of the global fleet to run on compliant fuel, or install scrubbers that allow continuing use of high sulphur fuel. The spread between high and low sulphur fuel oil has already blown out to the point where the difference could add $10,000 per day to a ship’s running costs. The implications are that: some ships may have to slow speeds to use less fuel; uneconomic old vessels may need to be scrapped or retrofitted with scrubbers; there may be delays in doing this; new fuel blends may cause problems for some engines, and ports could become congested. The net impact is that shipping rates, which have already started to recover from an eleven-year bear market, could jump and stay high for an extended period. Eisenberger has identified Star Bulk Carriers as offering strong gearing to rising shipping rates: it has a young, compliant fleet, all fitted with scrubbers, and 100% spot rate coverage with no rates fixed forward, which means it should fully capitalise on a spike in rates. The firm trades at a 40% discount to NAV and if shipping rates hit $30,000 per day, it could have a 100% free cash flow yield at its current share price. Scorpio Tankers is another firm with strong gearing to spot rates. 

ESG: pricing a growing carbon footprint 

Air Products has advanced c 40% in 2019, riding the wave that has lifted quality defensive stocks. The sector tends to outperform industrials when the ISM reading peaks, and its relative PE ratio is now near an all-time high. But Arnaud Langlois of Lombard Odier is not making a top down call on the sector. He has formed a stock-specific short thesis, partly based on ESG considerations. Between 2018 and 2023, Air Products is planning c $17bn of investments primarily into synthetic gas projects that its much larger competitors, Air Liquide and Linde, have spurned, due to country risk, concentration risk, customer and joint venture risks, not to mention environmental commitments that include water quality and reducing carbon dioxide intensity. The Air Products projects would generate twice as much C02 as a coal-fired gas plant, possibly raising Air Products’ C02 footprint as high as 100 million tonnes by 2025, according to proprietary research. Air Products already has one of the most carbon intensive business models in the S&P 500. Meanwhile other companies, such as utilities transitioning to renewables, are targeting reductions – or even carbon neutrality. A repricing of carbon exposures is likely and EU emissions trading is already putting a price on carbon. The Air Products annual report even flags up the risk of legislation on greenhouse gases, but the sell side is complacent about this.

Shorts inspired by aggressive accounting 

Bodenholm’s Johansson sees 50% downside for Koenig & Bauer, primarily based on its less conservative accounting. The banknote printing press manufacturer has lost its monopoly, faces competition from Japan’s Komori, and may see revenues shrink over the next 18 months. Its EBIT margins are inflated by capitalising R&D and other operating expenses, writing up intangibles, releasing balance sheet cookie jars and other non-recurring items that in total made up 60% of 2018 earnings. Management are incentivised to maximize EBIT margins, which are moving in the opposite direction of free cash flow – the company has been burning cash since 2015. Reported EBIT margins of 7.1% could be closer to 2.8% according to Bodenholm’s estimates, which also means that its true leverage could be as high as eight times on Bodenholm’s definition. Valuing projected 2020 EBIT using the current EV/EBIT multiple suggests downside of at least 50%. Bodenholm Capital has publicly disclosed a short position of 2.76% of Koenig and Bauer’s market capitalisation as of December 2019.

The Sohn Idea Contest is judged by Stuart Roden, former Chairman of Lansdowne Partners; Bill Ackman, CEO and Portfolio Manager of Pershing Square Capital Management LP; Reade Griffith, CIO of Polygon’s European Event Driven fund and a co-founder of Tetragon, and Elif Aktug, hedge fund manager of the Agora Fund at Pictet Asset Management (who has featured in The Hedge Fund Journal’s 50 Leading Women in Hedge Funds report). Together they selected Wharton School student, A J Lahouaoula, whose winning idea was to contend that luxury goods marketplace, The RealReal, is overvalued versus numerous peers. The business model of connecting buyers and sellers, authenticating and shipping goods, also has a much smaller market size – of perhaps $17bn – than the $200bn they assert. The addressable market is much lower since only 33% of luxury goods are listed on resale marketplaces, whereas their market size estimate would imply 85% penetration. Moreover, both gross margins and potential improvement thereof via operational leverage are overstated. Beyond this, accounting is aggressive in capitalising R&D costs and expenses. A threat to the business model is lawsuits in relation to authentication. 

Makuria’s Mans Larsson perceives 75% downside in Swedish supermarket franchise operator, ICA, based on a seven per cent free cash flow yield valuation. The company has declining sales volume (after stripping out inflation) and store footprints, and poor cash conversion. Offline competition is already hotting up in Sweden, with Lidl making headway, and may soon begin in the Baltics in 2020 and 2021. Meanwhile, the Swedish grocery market is fast moving online, and the online business is essentially cannibalising the stores. Disclosure on franchisees is poor at the ICA level but can be ascertained from their individual tax filings. These reveal that a handful of large, maxi store, out of town formats are responsible for the majority of earnings. If franchisee profitability is down, ICA may have to lower its own fees to franchisees just as Spain’s Dia did. ICA’s dividend already exceeds cash generation, and depreciation policy is aggressive in applying a period more typical for buildings to capex. A lot of free cash flow generation comes from non-operating items, such as networking capital and reverse factoring. Yet ICA is one of the most expensive retailers in developed markets, trading on 25 times accounting earnings (or 60 times cash earnings).

Children’s Cancer Research  

Sohn Conference Foundation events have raised over $85m over the past 20 years. The flagship New York City event, and others held in Australia, Brazil, Canada, Geneva, Hong Kong, India, London, Monaco, San Francisco and Tel Aviv, raise money for local charities, hospitals and research. The London event raised money for organisations including Cancer Research UK, whose Paediatric Lead, Dr Sheona Scales, pointed out that around one in 500 children below the age of 14 get cancer. Of these, 82% survive 5 years or more and 18% die; there are 230 deaths per year. Leukaemia, lymphomas, brain and spinal tumours are the largest causes of death while certain cancers, such as eye cancer, show survival rates near 100%. Advances in radiotherapy and chemotherapy have aided survival rates, but there are long term side effects – such as neurological damage, developmental problems and hearing loss. For super-rare cancers, the number of cases with each sub-type is so small that international cooperation is needed for clinical trials, and to this end the UK is uniting with 13 other countries.

Merger Arbitrage in the Middle East

Fadi Arbid, Founding Partner and CIO of Amwal Capital Partners, finds that the Middle East can provide attractive merger arbitrage spreads, so long as stock borrow can be obtained. The market is relatively retail driven. Though Saudi retail investors own just 26% of the Saudi market they account for 62% of average daily trading volumes. This is a proxy for MENA markets for which there is limited research coverage. One trade saw local HSBC subsidiary, SABB (Saudi British Bank) buy Alawwal. Even four days before the deal closed, the spread was as wide as four per cent, having been between 10% and 13% after regulatory and AGM approvals and as high as 25% eight months earlier, after it was first announced. Another merger arbitrage trade saw MENA’s largest bank, Kuwait Finance House, buying AUB, which has dual listings in Kuwait and Bahrain. The deal was intended to boost return on equity for the acquirer. Multiple regulatory approvals were needed, from regulators in Kuwait, Bahrain, Egypt and Turkey. Yet even after some of these approvals had been obtained, the spread remained as wide as 10% while the annual cost of stock borrow was around four per cent.