The investment manifesto (1½/2)

You can read the first part of The investment manifesto (1/2) here.

The exclusion process

In the previous post on the investment manifesto I ended with a presentation of my margin of safety definition. The purpose of that definition is to sort out those companies that I won’t allow myself to invest in. In a sense, I use my margin of safety definition as a exclusion process. In other words, the exclusion process is a negative screen to sort out companies that I don’t think I can satisfactorily determine their downside protection. Those companies get excluded and automatically put in my too-hard-pile. Thinking about investing, at least initially, as a negative art, what you don’t want to own, is an underappreciated approach in my opinion. This is based on a belief that risk- (i.e. permanent loss of capital) control should be the main emphasis for all investors. A quote that reminds me of the importance of controlling risk is this one:

“Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.” – W. Buffett

However, a quote that in my opinion best explains the reason for the importance of risk control is this one:

Never forget the six-foot-tall man who drowned crossing the stream that was five feet deep on average. Margin for error gives you staying power and gets you through  the low spots. – H. Marks

Or as one of my favorite authors stated in his newly published book Skin in the Game:

“In order to succeed, you must first survive.” – N. Taleb

The statements and thinking above goes back to my belief that only after one has established a population of ideas with solid downside protection should one move on and start to think about their upside potential. In conclusion so far, downside protection (survival) is more important than upside potential (returns) as one starts to think about which companies to invest in. As you will see in this post, I won’t go as far as; Focus on the Downside, and Let the Upside Take Care of Itself, but almost…

The inclusion process

The population of companies that have survived the exclusion process I termed; The Liquidation Oxymoron’s in the last post. If you haven’t already figured out my reasoning for choosing this name I’ll make sure to explain it now. The companies that have survived the exclusion process all fit under the following oxymoronic statement;

They are going concerns selling below their liquidation value.

My belief is that the population of liquidation oxymoron’s creates a powerful starting point of companies to potentially invest in. The basis for that belief is that the oxymoronic statement establish that there exists a fundamental difference between consensus and value for these companies. In a recent post you can read about why I consider this difference to be the most important thing to establish and take into consideration if one strives to be a successful investor: Consensus is what you pay; the relationship between consensus and value determines what you get.

But now, let’s move on from the margin of safety and downside protection argument and take a look at my inclusion process. The positive screen if you like. I will divide the presentation for this process under three headings; 1) upside potential, 2) catalysts and 3) other factors and characteristics. Remember, the companies I look at during the inclusion process (the companies that have survived my exclusion process) are all potential investment ideas that I would be willing to invest in. More specifically, the inclusion process is about determining if I’m going to invest in company A, B or C at a certain point in time. I will come back to my reasoning for this approach of picking stocks when I present my thoughts for the buying- and selling process for the Liquidation Oxymoron portfolio.

Upside potential

As you would expect, most companies get excluded as a result of the first criteria in my margin of safety definition. That is: Selling below liquidation value (i.e. price below readily ascertainable net asset value = raNAV). The reason why I have put this criterion first is because I think the valuation aspect as it relates to downside protection is the most important one, independent of how one defines “value”, to take into consideration as an investor. Furthermore, I think the same holds true about the valuation aspect from an upside potential perspective. Again, if you are interested in my reasoning for these statements you can read more about that topic in the following post: Consensus is what you pay; the relationship between consensus and value determines what you get. 

However, the valuation aspect is far from what describes the complete picture regarding the upside potential of companies. Unlike the margin of safety definition that should be developed individually, the definition for upside potential is an universal one I would argue. The best way, in my opinion, to think about upside potential is to think of a return formula with three components. One should note that I’m by no means the inventor of this formula. For this I would like to give credit to Fred Lui at Hayden Capital and more specifically his Investor presentation and Calculating Incremental ROIC’s presentation but also John Huber at the Base Hit Investing blog and all posts on ROIIC.

What the two investors just mentioned have concluded is that the upside potential (i.e. future returns) is to be determined by the following three components (some minor adjustments done by me). I have termed this the return formula:

1. Intrinsic value compounding yield (ROIC × reinvestment rate = earnings growth)
2. Shareholder yield (stock buybacks / issuance + dividends + net borrowings)
3. Valuation yield (valuation multiple expansion / contraction)

= upside potential (i.e. future returns)

Although the return formula might seem like a manageable calculation exercise one should not be fooled into a sense security or precision. In investing, should happen ≠ will happen. Therefore, I would again like to stress the importance to only engage with the return formula once one is done with the exclusion process. Furthermore, I would like to point out that one should not cry oneself to sleep if one struggles with all the components of the return formula. For some investment ideas, the calculation of intrinsic value compounding yield will almost be impossible to calculate. Or it might be almost impossible to determine what a fair valuation multiple is for a specific investment idea. Nonetheless, those statements begs the question: Should one stay away from companies for which you can’t calculate their upside potential?

My opinion is; no, companies whose upside potential that is hard to determine should not per definition be avoided. Rather, the important aspect is the certainty of the fundamental difference between consensus and value of the company for which you are trying to calculate upside potential. For me personally, this goes back to my thinking and reasoning for the name of the Liquidation Oxymoron’s and what that name implies. Or explained in a more colorful way with the help of one of my favorite quotes in investing:

“You don’t have to know a man’s exact weight to know that he’s fat.” – B. Graham

In conclusion, I will always try to calculate upside potential based on the return formula stated above. For some investment ideas this calculation exercise will be quite thorough and detailed (e.g. HEL:SAGCV, analysis not published). For some investment ideas (e.g. NASDAQ:GIGM, analysis not published) I will more or less fall back on my assessment that the company is a Liquidation Oxymoron (i.e. makes it through the exclusion process) with high certainty in regards to the current fundamental difference between consensus and value. In conclusion, I will not exclude or rank the Liquidation Oxymoron’s population based on the outcome of their return formula calculations. Rather, I will rank the investment ideas in terms of my conviction for their upside potential, i.e. most probable upside potentialIn order to make such an assessment I have to take into consideration potential catalysts and other factors and characteristics for the Liquidation Oxymoron’s.


The circumstances for what a posteriori is determined as the catalysts is hard to determine and arrive at a priori. I’m not the first one to make this unsatisfactory conclusion as the following statement from 1955 will show:

Skärmavbild 2018-03-04 kl. 16.24.09
p. 544

Related to the statement above is his famous quote:

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” – B. Graham

Although I ascribe to the belief that value is its own catalyst there are nonetheless some circumstances and signs that I keep my eyes open for when I’m to determine my conviction for the Liquidation Oxymoron’s upside potential. Furthermore, the reason why catalysts, other than the mentioned realisation of value from Mr. Market over time, are important to take into consideration has to do with the time factor of investing. Specifically, these catalysts have the potential to unlock value in a direct and fast manner. I would argue that the time factor is an important component if one, like myself, think in terms of CAGR.

For the Liquidation Oxymoron’s I will specifically evaluate and take into consideration any signs of:

  • shareholder activism.
  • major asset sales, spinoffs or mergers plans.
  • acquisition and/or expansion plans.
  • dividend and/or share buyback plans.
  • buyout or takeover plans.
  • changes in management.

Note that what I have stated above is not to be considered an exhaustive list of catalysts. Rather, the evaluation of potential catalysts and their respective probabilities has to be done on an idea per idea basis since they will be highly individual and context dependent.

Other factors and characteristics

The factors and characteristics I will mention below are not to be considered “make it or break it” components for the investment ideas of the Liquidation Oxymoron population. Rather, they are factors and characteristics that have the potential to improve both the upside potential and the probability of upside potential. As you will see, non of these are original or special in any way but should in my opinion nevertheless be taken into consideration during the stock picking process:

  • Small market capitalisation (preferably nano or micro cap).
  • The trading of the company shares is illiquid.
  • Large insider ownership and/or insider are recent net-buyers of company shares.
  • Reasonable insider pay.
  • Famous deep value investors on the shareholder list and/or they are recent net-buyers of company shares.
  • Company has improving fundamentals (e.g. high F-score).
  • Low-level of debt or high level of debt but the company is aggressively paying down debt.
  • Company has historically paid dividends.
  • Company has historically been net-buyers of company shares.
  • Company conducts business in a stable and/or boring industry.
  • Company has been active for some time (preferably more than ten years).
  • Company shares are currently trading near historical lows.
  • The company is not a perennial Liquidation Oxymoron (i.e. the company has historically trade above raNAV).
  • A big portion of raNAV consists of cash and cash equivalents.
  • Company has hidden/undervalued asset values not reflected on the balance sheet.
  • Positive or low raNAV burn-rate.
  • Low valuation compared to operating earnings and/or free cash flow.

Again, the list above is not to be considered an exhaustive list of factors and characteristics that should be taken into consideration during the inclusion process. The ones mentioned above I usually consider but I might retract and/or add factors and characteristics to the list in the future.

The buying- and selling process

Similar to the situation for the first post on the Investment Manifesto, this one became longer than I had expected. As a result, I will save my thoughts and ideas about the selling- and buying process for the Liquidation Oxymoron portfolio for yet another post. I promise, this will be the last part in my series of post related to the Investment Manifesto.

The investment manifesto (1/2)

It’s been a while since I last posted anything here on the blog. I’m sure that this isn’t the last time I zoom out and remain silent for a while. In the end, although I’m always interested in hearing your thoughts and getting your feedback, I write for an audience of one, me. If that selfish audience is not keen on or have the time to listen the blog will be a quiet one from time to time. I hope you understand.

Nonetheless, after a long break I will try to distill the mess of thoughts that have accumulated in my head and in this case present the reason why I haven’t posted anything “portfolio related” since the mid of July.

A clean sweep

Although I haven’t posted anything you might have noticed, if you had a look at the Portfolio-page, that I sold all previous holdings during the last couple of months. In order to understand the why-question for my reason to do so I would like to start with a underappreciated Warren Buffett quote from the 1998 Berkshire shareholder letter:

Once we knew that the General Re merger would definitely take place, we asked the company to dispose of the equities that it held. (As mentioned earlier, we do not manage the Cologne Re portfolio, which includes many equities.) General Re subsequently eliminated its positions in about 250 common stocks, incurring $935 million of taxes in the process. This “clean sweep” approach reflects a basic principle that Charlie and I employ in business and investing: We don’t back into decisions. Berkshire Hathaway Shareholder letter 1998

What caused me to do a clean sweep of my previous portfolio holdings was that I came to develop a new investment manifesto. Rather than retrospectively trying to fit my previous investment decisions into the new manifesto I decided that the approach applied by Buffett and Munger would be a good and reasonable one for me as well.

One could question the rationality behind the clean sweep since the approach I had used up on till that point in time had worked out fairly well. On that note, I would like to stress that the development of a new manifesto is not a reach for more alpha or that I was dissatisfied with the track record that I had produced up on till that point in time. To the contrary, I realize that the new manifesto could possibly produce a worse outcome than a simple quant based approach. Especially in the short-term. However, at the core of my investing foundation is a firm belief if one is to be a long-term successful investor one should always focus on improving the process applied not the outcome. In other words, focus on what you can control. Over periods of time I will therefore be more than happy to look like a fool and have an audience that questions the rationality of my decisions as long as I believe that the process I apply is the correct one for me. Note that I in the previous sentence say the correct one for me not the correct one in some form of absolute sense. We will come back to this almost egocentric view of investing and its importance several times during the presentation of the manifesto.

The seeds to a new manifesto

Before presenting the process behind my new investment manifesto I would like to share the story and the circumstances that lead to its development.

At the start of the summer I decided that it was time for me to read all the Berkshire Shareholder Letters since I haven’t done so previously (you can find my extracts of wisdom from all the letters here). Defining oneself as a value investor, not having read the Berkshire letters is like being a Christian not having read the Bible. The same could be said about not having read Poor Charlie’s Almanack which I read and then re-read during the period I was reading the Berkshire letters. Having read all the Berkshire letters and Poor Charlie’s Almanack twice I could honestly say that I was on the brink of leaving the classic value investing school for the more modern value investing school. Still to this day I agree on almost all of Buffett and Munger’s points of argument as it relates to the advantages of the modern value investing school and their rational for leaving the classic school of value investing. But after countless of days thinking about a possible change I still came to the conclusion that the modern approach would be too hard for me to implement successfully.

Both Buffett and Munger are famous for the too-hard-pile analogy as it relates to individual investment ideas. I would argue that the concept can equally be applied to investment philosophies in general and their implementation. Placing an investment idea in the too-hard-pile will be a personal dependent evaluation and the same should be true for the investment philosophy too-hard-pile. I would argue, in the same way as one has to have conviction in the ideas that one invests in one has to have an even larger conviction in the philosophy that one applies. This off course has to do with the ability to “stick to your knitting” in both the good and the bad times. Not having conviction in your philosophy and your ability to successfully implement it will bring out the worst enemy of them all, you.

The investor’s chief problem – and even his worst enemy – is likely to be himself. – Benjamin Graham

Even though I was not “transformed” in the same way that Buffett once was by Munger I will without hesitation say that reading the Berkshire Shareholder Letters and Poor Charlie’s Almanack is by far the best “investments” I have made in my “investing life”. As you will see in the investment manifesto below, there are now principles at the core of it inspired by Buffett and Munger that did not exist before. These where the seeds to the new manifesto and has since then evolved into its absolute foundation. As many others do, I owe them a lot of gratitude.

Four investment principles

Sound investment principles produce generally sound investment results – Benjamin Graham

As it relates to Benjamin Graham’s quote above I would like to use the famous Munger expression:

I have nothing to add. – Charlie Munger

Therefore, I thought I would go straight to the point of presenting the four core principles of my investment manifesto (if you have read Poor Charlie’s Almanack you will recognize them):

1. Preparation. Continuously work on investment idea generation and the accumulation of mental models and worldly wisdom.

Opportunity meeting the prepared mind: that’s the game. – Charlie Munger

2. Discipline. Stay within the boundaries of the investment manifesto.

You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital. – Warren Buffett

3. Patience. Be selective and cautious in the buying- and selling process.

Resist the natural human bias to act. – Charlie Munger

4. Decisiveness. Believe in the investment manifesto and execute accordingly.

When proper circumstances present themselves, act with decisiveness and conviction. – Poor Charlie’s Almanack

Margin of safety

Beyond the four principles, but still at the heart of the manifesto, lies a focus on the concept of margin of safety, i.e. downside protection. By focus I mean that only after one has established a population of ideas with an adequate margin of safety one should move on and start to think and rank the ideas remaining in terms their possible return opportunities, i.e. upside potential.

The concept of margin of safety was first developed (as far as I know) by Benjamin Graham and David Dodd in the classic value investing book Security Analysis that was first published in 1934. However, I think most investors that are familiar with the concept relate it to the 1949 book by Graham, The Intelligent Investor, and more specifically the last chapter in that book called “Margin of safety as the Central Concept of Investment”. As most of you will know, “the margin of safety” is a wide concept and one that has been defined in a variety of ways by both Graham himself and many others since the books first publications. In my opinion, there is nothing wrong with that. To the contrary, I would say that it is both natural and needed considering the variety of investing philosophies in existence and more specifically how one defines the concepts of value and risk. However, I would argue that the margin of safety purpose is a universal one that all can ascribe to (?). In my opinion that purpose was best defined in the original text of The Intelligent Investor:

It’s available for absorbing the effect of miscalculations or worse-than-average luck. – Benjamin Graham

Based on the definition for the margin of safety purpose and with the help of little inversion we can narrow in on my definition of margin of safety. Again, note that what I present below is my definition of margin of safety not a universal one. I would strongly suggest that one goes through the same process as I present below in order to come up with a definition that is your own.

In order to make the starting point of the margin of safety definition process a little bit less vague consider the following excerpt from Poor Charlie’s Almanack:

Why should we want to play a competitive game in a field where no advantage – maybe a disadvantage – instead of in a field where we have a clear advantage?

We’ve never eliminated the difficulty of that problem. And ninety-eight percent of the time, out attitude toward the market is … [that] we’re agnostics. We don’t know. […]

We’re always looking for something where we think we have an insight which gives us a big statistical advantage. And sometimes it comes from psychology, but often it comes from something else. And we only find a few – maybe one or two a year. We have no system for having automatic good judgement on all investment decisions that can be made. Ours is totally different system.

We just look for no-brainer decisions. As Buffett and I say over and over again, we don’t leap seven-foot fences. Instead, we look for one-foot fences with big rewards on the other side. So we’ve succeeded by making the world easy for ourselves, not by solving hard problems. – Charlie Munger

In other words, your margin of safety definition process should start by focusing on what you define as “no-brainer decisions” or “one-foot fences” to hurdle over and where you believe that you have a “big statistical advantage”. The outcome of that evaluation will allow you to invest in ideas where the purpose of the margin of safety concept will likley be fulfilled. I won’t, since I can’t, go into details about the specifics of the evaluation process for me personally. This is something that has taken years to develop and where the number of inputs now are numberless. Therefore, note that what I will present below is only the end product of a long evaluation process.

My margin of safety definition

Based on my investment beliefs and my accumulated investing knowledge I have developed my margin of safety definition. The population of companies that fit into this definition I call The Liquidation Oxymorons. These will constitute the population of companies that I’m allowed to invest in, i.e. they have an adequate margin of safety:

1) Selling below liquidation value (i.e. price below readily ascertainable net asset value)

2) Proven business model (i.e. historically profitable)

3) Sound financial position (i.e. low risk of bankruptcy)

4) Shareholder friendly management (i.e non-fraudulent management with a thoughtful capital allocation track record)

If you are an old reader of the blog you will find similarities in the above definition to the investing checklist I have previously used (see for example this post about PFIN). That is true. Whats has changed is that evaluation process for each of the four criteria is now qualitative rather than quantitative. Again, if that is a rational and wise move, especially from a return perspective, remains to be seen.

Since the post became longer than I first thought I will split it up into two parts. In the next post I will present the stock picking process for which companies from the Liquidation Oxymoron population to invest in, i.e. the evaluation of upside potential and catalysts. I will also present the guidelines for the manifesto’s portfolio construction and the selling process.

Follow-up 2.0 Kingboard Copper Foil Holdings Limited

Today the announcement from the supreme court of Bermuda was made public. If you want some background to this legal process and Kingboard as a company see my earlier published checklist analysis post and follow-up & special situation analysis.

The Board wishes to update the Shareholders that the Court of Appeal of Bermuda had allowed the appeal and found in favour of the majority shareholders that have filed the appeal (the “Appellants”). A written judgment in respect of the appeal had been issued on 24 March 2017 (the “Appeal Judgment”). The judge deciding the appeal found, among other determinations, that the entry into the license agreement by the Company’s wholly-owned subsidiary, Hong Kong Copper Foil Limited, and Harvest Resource Management Limited (the “License Agreement”) was not oppressive conduct and did not unfairly prejudice the minority shareholders of the Company. It was also decided that the costs of the appeal and the court proceedings below are awarded to the Appellants.

This outcome of the legal process is not what I had expected, I must admit I’m really surprised. But when you are wrong the only thing to do is to admit that you were wrong and then review the current situation and any new facts that have been presented. So what do I do now?

The tender offer 0,40 SGD per share is still active and the intention to take the company private hasn’t changed. This morning the shares traded between 0,40 – 0,41 SGD. So the interesting question that I had to answer was: is there any upside left or should I sell today?

There might be some upside left due to the fact that the independent financial adviser has not yet commented on the 0,40 SGD buyout offer. However, because of the outcome of the court case in favor of the majority shareholder I believe there is now a much smaller chance of that review resulting in an increased buyout offer than I had predicted before. Reason being that it could earlier be argumented that the valuation of the tender offer as a premium to historical share price was a really bad staring point of valuation since Kingboards shares had traded at depressed levels because of the ongoing legal process and unfairly prejudice of minority shareholders. While I still think that historical share prices are not a relevant staring point for any valuation the premium can now arguably be seen as more “fair” than before as a court case didn’t find that minority shareholders had been mistreated (i.e less reson for the financial advisors to come up with a different valuation).

Another factor that might result in potential upside relates to the problem for majority shareholders to acquire enough shares to take the company private. So there might be an increased share offer price in order to succeed with this intention. There might even be a legal shareholder fight regarding the current buyout price being to much of a low ball offer. But again, because of the outcome of the legal process I have a hard time making an argument for this as a likely and successful outcome for minority shareholders. We also have the time factor to take into account as this can easily result in a another drawn out legal process.

To summarize and conclude, the court case announcement was both surprising and unfortunately really negative in relation to my predictions made in the special situation analysis. My main argument then was that all shareholders would likely to be bought out at the same price as the minority shareholders (‘the Pope entities’) as a result of the Bermuda court case. As a result of todays announcement we now know that my assumption and analysis was wrong and that it is now less chance of an increased buyout price. Therefore I decided to sell my entire position in Kingboard this morning at 0,405 SGD. I could of course have waited and tender my shares at 0,40 SGD at not transaction cost, but at a price of 0,405 SGD the transaction cost are already “included”. Also, selling today equals better CAGR on the investment but probably the most important factor of all; it saves me all the potential headaches that could arise with a Singapore-tender-offer in combination with a low cost focused stockbroker.

After brokerage fees and currency effects the return in Kingboard for my initial net-net position amounted to +45,7 %.

After brokerage fees and currency effects the return in Kingboard for my later initiated special situation position amounted to – 5,5 %.

Disclosure: The author doesn’t own any shares of SGX:K14 when this analysis is published.

Follow-up & special situations analysis on Kingboard Copper Foil Holdings Limited

Last Friday Kingboard Copper Foil Holdings Limited (SGX:K14) announced that Excel First Investment Limited had placed a cash tender offer at 0,40 SGD for the shares in K14. Excel First is an subsidiary to the parent company Kingboard Laminates Holdings Ltd. (listed on Hong Kong stock exchange) which is also the parent company of K14 (owns 66,01 % of K14). Before the cash tender offer was announced the shares of K14 traded at 0,34 SGD (+17,7% tender offer premium) and after the announcement the stock is trading at 0,415 SGD, I will come back to both of these facts later in the post. If you read my analysis of K14 that i published in mid January you will notice that this development was not a lightning strike from a clear blue sky. Although, I had anticipated an offer first after the result of an legal appeal in March 2017 and that company would directly make use of its then newly implemented 10 % buyback mandate. I will come back to both of these factors later in the post as well. According to the offer announcement the reason behind the offer is to delist K14 from the Singapore stock exchange. In other words, the intentions are to privatize the company (this is an important factor to take with you when reading this post).

Does K14 still pass my net-net checklist requirements?1kr50öre

Yes, I have concluded that K14 still passes my net-net checklist without any difficulties. To the contrary, since I analysed the company in January the company has published its FY report for 2016. As of this report the company is posting good revenue growth, it is still profitable on the bottom level and the company is still debt free. Also, the net current asset value (NCAV) per share has increased from 2,09 HKD to 3,02 HKD, an increase of 45% (notice that the reporting currency is HKD but the stock is traded in SGD). In relation to the share price development of 51 % since I bought my position at 0,275 SGD, the 45 % NCAV increase has translated into an P/NCAV-multiple that is almost unchanged (P/NCAV = 0,72 vs P/NCAV = 0,75x). In other words, the margin of safety in relation to NCAV is the same even though the share price has increased 51 % since I bought my position. From the checklist point of view I will therefore not be “required” to sell my position. On the other hand, I don’t want/allow myself to be an owner of a private Singapore company so lets review what options that I currently have at my disposal for closing the K14 position.

Options for closing the K14 position

The way I see it I have three options:

  1. I can tender my shares at the 0,40 SGD cash offer. With this option I won’t have any transaction costs for the sale of my position.
  2. I can sell my position at the market price of 0,415 SGD. With this option I will have transaction costs of about 1 % but I will also gain about 3,8 % above the 0,40 SGD offer.
  3. The third alternative requires me to sit tight and wait for the results of the Court of Appeal in Bermuda that takes place March 6 and 7 2017 (yesterday and today) which might result in an increased tender or buyout offer.

I believe the third option needs a more in depth explanation than option 1 and 2… Before presenting my facts and arguments for option 3 here is short sales pitch for that alternative:

In my opinon there exist a high probability that the result of the appeal will not be in favor of the holding company of K14 (the defendants/majority shareholders of K14) and that this in turn may require them to increase the cash tender offer to ~0,67 SGD if they want to take the company private. In other words, I would argue that there is a potential +61% return on the table to take advantage of. That’s not even the best part, if I’m wrong in my analysis I can still tender my shares at the 0,40 SGD cash offer (option 1) without any transaction costs and only incur a small loss of -3,8%. I think Mr Market is aware of this potential outcome and that is why the company today is selling above the cash tender offer (0,40 SGD) on the market. So obviously I have chosen option 3 (in potential combination with option 1).

Explanation for the sit-tight-and-wait-option (Nr. 3)

As I presented in the analysis in January there has been a legal process going on since 2011. I won’t go into the history of the legal process as this has in been explained in detail by the blog ThumbTackInvestor and also in the articles linked to in my earlier analysis. But in short terms the legal process i about:

Kingboard Copper Foil entered into a license agreement with Harvest Resource Management after the Petitioner (Annuity & Re Life Ltd) had vetoed the proposed general mandate for interested person transactions at the AGM of the Company on 29 April 2011.

which has resulted in that:

The Supreme Court of Bermuda found that, as the majority shareholders failed to promptly initiate negotiations with the minority shareholders with a view to resolving the impasse and take into account the interests of shareholders as a whole following the blocking of the IPT Mandate, the license agreement was a commercially prejudicial means of enabling the Company to circumvent the Petitioner’s legitimate exercise of its right to veto the IPT Mandate.

What is more important to know is that the petitioners of the legal process is the company Annuity & Life Reassurance LTD. This company is a subsidiary of Pope Investments II LLC under which another company, Pope Asset Management LLC, can also be found. The Petitioner’s holdings in K14 together with those of the two Pope entities amounted to 80,251,528 shares by July 18, 2011 according to this supreme court judgement. Its is this judgement and the findings therein that the defendants, mainly Kingboard Chemicals and Kingboard Laminates, are appealing against as I write this post (March 6 and 7). It is important to note that K14 is only a third party in this legal process, and will therefor not bear any litigation costs or liability.

In relation to the above linked supreme court judgement the consultancy firm Ernst and Young (EY) was appointed to conduct an independent review. The independent review was presented in October 2016 with the outcome that supported the supreme court judgment. This is one of the main reason why I in my earlier analysis of K14 stated that the appeal is not likely to result in favor of the defendants. What was then unknown was how the case would play out for the minority shareholders that were not appealing in court and those who hadn’t signed a form as of 7 April 2016 stating that they would like there shares to be redeemed under the same conditions as the petitioner (the Pope entities). With the current cash tender offer of 0,40 SGD  with the purpose of taking K14 private we now know a bit more. But now to the really interesting part of the whole situation.

In the cash tender offer announcement the following can be found:

Requirements for delisting:

Under Rule 1303(1) of the Listing Manual, if the Offeror succeeds in garnering acceptances exceeding 90% of the total number of Shares in issue excluding treasury Shares, thus causing the percentage of the total number of Shares in issue held in public hands to fall below 10%, the SGX-ST will suspend trading of the Shares on the SGX-ST at the close of the Offer.

In connection to this requirement for delisting we can read the same thing but from a compulsory acquisition point of view and the value of shares:

Compulsory acquisition:

  1. (a)  obtained acceptances from shareholders holding not less than 90% in value of the shares in a Bermuda-incorporated company (“Target”) whose transfer is involved (other than shares already held, at the date of the offer, by the offeror, the offeror’s subsidiaries, and nominees of the offeror or its subsidiaries)

Finally, there is the 95% ownership level which would enable them to not only take K14 private but also entitles and binds them to acquire the remaining 5 % at 0,40 SGD tender offer:

Under Section 103 of the Bermuda Companies Act, the holders of not less than 95% of the shares in a Bermuda-incorporated company (“Purchasers”) may give notice (“Section 103 Acquisition Notice”) to the remaining shareholders of the intention to acquire their shares on the terms set out in the Section 103 Acquisition Notice. When such Section 103 Acquisition Notice is given, the Purchasers will be entitled and bound to acquire the shares of the remaining shareholders on the terms set out in the Section 103 Acquisition Notice unless a remaining shareholder applies to the Court to have the Court appraise the value of such shares.

So to summarize and conclude so far, if the parent company of K14 don’t manage to acquire more than 90 % of K14 it will fail in its intentions to take the company private. This notion translates into two milliondollar questions:

  1. Can the parent company acquire more than 90 % of K14?
  2. If the parent company fails to acquire more than 90 % of K14, what will then happen?

Can the parent company acquire more than 90 % of K14?

According to the cash tender offer announcement the parent company has control, direct and indirect, over 66,01 % of K14 (se picture one below). Indirect they also have control over another 10 % if we take into account full use of the company’s buyback mandate. Finally, if the Pope entities have their 11,1 % holding redeemed, the parent company will have the control over 87,11 % of the shares in K14. In other words, the parent company is relying on the cash tender offer and that it brings in another 2,9 %. Thats is, if the parent company manage to make full use of the buyback mandate, otherwise the tender offer will have to be more successful than just 2,9%. As of the pre cash tender offer announcement there have been no signs of the buyback mandate put to use. If we make the bold assumption that the 12,618,000 shares traded yesterday (well above the average trading volume of 15,000,00 shares) were all acquired via the buyback mandate they would just have managed to vacuum up 1,7%. In other words, if we hold my bold hypothesis true for the coming days it will take at about two weeks for the company to make full use of the buyback mandate. It should be noted that I don’t think it is very likely or fair assumption but more importantly, the volume of shares traded will most likely to decrease in the following days (i.e. the portion of shares that the company can potentially acquire per day is well below 1,7%). This assumption was already obvious today when only ~1,700,000 shares have been traded (0,2 %).

So to summarize and conclude, YES the parent company can theoretically acquire more than 90 %. However, I find it not very likely given what we know today and it will most certainly not happen over a night. Instead, I would argue that the current cash tender offer (0,40 SGD) is to much of a low ball offer to give minority shareholders the incentive to sell their share at the market or to tender their shares (i.e. the company will have a hard time putting its 10 % buyback mandate to use but also in succeeding to acquire another 2,9 % via the cash tender offer). Also, the fact that the appeal and the valuation for the redemption of the Pope entities holding is not jet decided upon I believe that many minority shareholders, me included, will sit tight in the boat and wait for the outcome of the court appeal. Together this leads us into the question of; what will then happen?



Option Nr. 4 – The special situation case for K14

When I started to write this follow-up post I had not thought about the idea of acquiring more shares in K14 (this is the reason I postponed the post). However, I have come to realize that K14 has morphed into a very attractive special situation case. I have therefor increased my position in K14 under the special situations heading, not as an increased checklist net-net investment. As a result I therefor extend my earlier three options decision framework for closing the K14 position to include a fourth option. What I present below is options 4 – the special situations case for K14.

To start, I don’t believe it’s a coincidence that the cash tender offer at 0,40 SGD was announced last Friday. This belief is mainly related to the fact that the earlier mentioned appeal takes place March 6 and 7 and 2017 and that this will most likely, due to the EY report, result in favor of the petitioner (i.e the Pope entities). Also, as pointed out earlier there is still no announcement regarding the valuation at which the petitioners holding is to be redeemed at. This will most likely be announced in the connection of the appeal outcome. I would argue that the price the petitioner will be offered is well above 0,40 SGD. I would also argue that the minimum price is around 0,67 SGD since this represent the equity per share as of 31 December 2016 for K14. It might even be higher as a result of the company being profitable and debt free but also that the valuation will probably take into account loss of earnings as a result of the misconduct by the defendants.

Furthermore, one should note and be aware of that the defendants are charged under section 111. This translates into what is know as a “Class Remedy” for all shareholders. In plain English, the redemption of shares at a value jet unknown, but probably at the minimum of 0,67 SGD, is in theory not only applicable to the Pope entities and the shareholders that signed the 7 April 2016 form but in fact all minority shareholders. However, it is a bit unclear to me if the class remedy also holds true for investors that has become shareholders after the legal process started back in 2011 or not. What confuses me, as I’m not legal expert, are these two quotes that can be found in the supreme court judgment earlier referred to:

Statement from the court: “However, as I have already found above, the Petitioner is not entitled to seek relief in respect of shares in the Company purchased after the presentation of the Petition on August 3, 2011.” (p.85)

Statement from the respondents lawyer: “Mr Wong SC did not dispute the argument that section 111 is fundamentally a class remedy. In principle it seems to me that all minority shareholders must have a right to be heard at the relief stage of the present Petition.” (p.85)

However, lets say that the first quote is true and that is how the court is going to decided upon which shares get redeemed at the not jet disclosed valuation level. In that case, I would argue that this in fact doesn’t really matter for how the whole situation is going to play out for other minority shareholders like myself. I would argue that the 0,40 SGD is to much of an low ball offer to get minority shareholder exited and that the sneaky attempt by management to fool minority investors in order to attain the +90 % position needed to take the K14 private is not going to succeed, as discussed before. In other words, we may very well see an increased cash tender offer or an buyout offer at the same price as the redemption of shares for the Pope entities even though we might not legally be entitled to it. This in order for the parent company to succeed in acquiring the shares needed to delist the company and take it private, all according to its stated intentions.

Even if i’m drastically mistaken or wrong in my above probability guesstimates, reasoning and argumentation this is still an very favorable special situations bet. Reson being that at the current price of 0,415 SGD there is an estimated minimum upside of 61 % (0,67 SGD) at the same time as the downside is limited to -3,8 % (i.e. the 0,40 SGD price at which I can cash tender my shares). I think Mohnish Pabrai would would let me use the phrase “heads I win tails I don’t lose much” without to much complaints in this case.


Disclosure: The author is long SGX:K14 when this analysis is published. Also note that SGX:K14 is a micro-cap stock (173 M$ in market capitalization). The trading is illiquid.

The French regional banks – part two (2/2)

I ended the last post (part two 1/2) for the French regional banks analysis with one of my favourite quotes from Charlie Munger:

When you locate a bargain, you must ask, ‘Why me, God? Why am I the only one who could find this barging?

In this final part of the French regional banks analysis I will try to answer the above questions by inverting the last part of it. I will also take a look at the French real-estate and lending market to see if I have missed something in my earlier analysis regarding risk and uncertainty. Finally, I will try to wrap up the value investing story (post two and three) with the risk arbitrage story (post one) into an overall conclusion about the French regional banks as investment candidates. If you stick to the end of this long text you will be rewarded as the final part also includes a new catalyst that I haven’t written about before.

“Invert, always invert”

With the words of Munger borrowed from German mathematician Carl Jacobi: “Invert, always invert”, I will try to answer the last part of the question above. In other words; are there any creditable investor that have a position in the French regional banks?

I started post two with a video where monsieur François Badelon (fund manager at the Amiral Gestion fund Sextant Autour du Monde) laid out his view of the value investing case for the French regional banks. Monsieur Badelon is not alone in his positive attitude towards the French regional banks. Monsieur Louis d’Arvieu, also a fund manager at the Amiral Gestion fund Sextant Grand Large, answered and concluded in an interview in May 2015 (translated with Google)[1]:

The financial services sector was the largest at the end of March (19.8% of invested assets, compared with 11.1% at the end of 2014). How do certain values in this sector have attractive valuations in your eyes?

In this sector, we are present in certain Crédit Agricole regional caisses that we have been loyal to for years. These funds are exposed to the traditional retail banking business, are managed prudently, are inexpensive, poorly tracked, massively over-capitalized and highly discounted compared to their book value. They also pay high dividends and have very strong local market shares.

Although there is a high possibility that the two fund managers from Amiral Gestion are biased by each other’s opinions, I consider the French domestic knowledge of two highly regarded fund managers to be both insightful and trustworthy. There are also three other well-regarded French value focused investment management companies that show up on some of the shareholder lists for the regional banks, HMF finance[2], Moneta Assets Management[3] and Financière Tiepolo[4].

Now that we have established some understanding and conviction regarding the domestic funds view about the French regional banks, what about international funds and investors?

The NYSE listed American investment management company Invesco and their European Small Company fund show up on several of the regional banks shareholder lists[5]. As of November 2016 the regional banks together are the funds second largest holding[6] Also, the Belgian asset management company Value Square NV show up on several of the banks shareholder lists[7]. As of November 2016 the regional banks are Value Squares second largest holding[8]. Last but definitely not least we have Arbiter Partners, a New-York based hedge fund. Behind Arbiter Partners we find Mr Paul Isaac, a famous deep value investor and nephew of the no other than Mr Walter Schloss. If you don’t know who Paul Isaac is I highly recommend reading about him in this fantastic post from Värdebyrån (in Swedish)[9]. In an interview in the Graham & Doddsville newsletter from the spring of 2013 he lays out the value investing case of the French regional banks in detail[10]:

Our second-largest position is more esoteric. It’s in the regional affiliates of Crdit Agricole.”

So there are 13 of these non-voting shares in these various regional banks, which are decent regional banks. They have non- performing assets of 1% to 4% of assets. They usually have loan loss reserves of 70% to 150% of the non- performing assets. The tangible common equity to assets runs 8% to 15% on the outside. The ROE runs in the mid-single digits to about 10%. The efficiency ratios are around 45% to 60%.”

These are not bad regional banks, and as they have assets between $8 and $60 billion apiece, they’re also not tiny, either. You can get information on them if you speak French or can use Google Toolbar. Just go to the website of each of the regional banks. They don’t make it easy for you. You have to go through the site and find the required legal filings, and then they’ll show you the annual and trimestral reports.”

These things are trading at 25%-40% of tangible book, with somewhat depressed earnings this year, partially because of economic conditions in France, partially because of incremental taxes, and partially because of the lack of flow through of any earnings from the holding entity where they take the dividends into their income statement when they pay them.”

These entities are trading at five or six times earnings. They’re paying dividends of five to seven percent. Most of them have buyback programs. There have been buybacks of whole share classes of these entities. When they’ve occurred they’ve been at significant premiums to what these are currently trading for.

We’re getting a nice current income on the position, and there is some accretion to book value. My hope is that these things are not entirely rational for an essentially mutual institution to have outstanding indefinitely, and we may get some buybacks of whole issues. These positions are not terribly easy to buy – they typically trade between twenty thousand and a couple hundred thousand dollars a day each, so accumulating them took a long time.

To summarise and conclude. There seems to exist both a domestic and international conviction that the French regional banks are an interesting value investing case. This is not only evident from the funds mentioned ownership but also from the fact that they all actively engage in the current legal process of stressing the equality between shareholders of the regional banks[11] (i.e. the underlying reason for the risk arbitrage case of the French regional banks presented in post one).

Expanding the area of research

In the Graham & Doddsville interview Mr Isaac answers a question and points to two important areas that should be explored before I wrap this analysis up:

G&D: What is the composition of the assets at the regionals? Is it what we would expect from traditional banks?

PI: Yeah, it’s small commercial, consumer, and municipal loans. The one thing that really concerns me is if interest rates were to go up moderately, it probably would help their profitability. But if interest rates were to go up a lot, there is an inherent duration mismatch because they do some term lending, particularly to municipalities. So I think that is probably the biggest risk if you’re looking for an outlying structural risk.”

The French real-estate and lending market

When I started to get interested in the case of the French regional banks I knew very little of the French banking, real-estate and lending markets. For anyone who feels the same way and wants to acquire some insight into the French banking system I can recommend two papers: The history of banks in France [12] and the ACPR report for 2015[13]. For particular insights into the French regional banking system I can also recommend the following two papers: The French Co-operative Banking Group Model: Too Good to be True? [14] and The challenges of recent changes in French cooperative banking groups[15]. Last, for insights into both the banking and real-estate market in France and Europe I recommend reading the HYPOSTAT 2016 A review of europe’s mortgage and housing markets report.[16] In this part of the report I will use some of the knowledge gained from these reports and try to comment on Mr Isaac point that the regional banks are focused on “small commercial, consumer, and municipal loans” and that there might exist a structural risk related “if interest rates were to go up a lot

Below you will find a picture from loans outstanding for all Caisse Regionale, i.e. the regional banks in the Credit Agricolé Group (39 in total, not only the 13 that are listed on the stock market)[17]:


In the order that they are presented above each loan category represent; 59%, 4%, 20%, 9% and 8% of the total loans outstanding as of September 2016. Although the division of loans outstanding vary between the thirteen Caisse Regionale banks the above table provides a good enough picture for the average “loan structures”, i.e. focus is on home and small businesses loans. A similar conclusion can be made regarding the division of loans outstanding for the entire credit activity in France. Housing loans are the main type of loans (46%), followed by equipment loans (26%) and cash loans (15%)[18].

Before diving into the details and some macroeconomic factors related to the biggest chunk of the loans outstanding, home loans, let’s take a look at two important ratios in relation to the total loans outstanding[19]. Again, the two ratios below (impaired loans ratio and coverage ratio) are based on all 38 Caisse Regionale banks but represent a fair view of the average for the 13 regional banks as well:


Today, the impaired loans ratio for the regional banks is low. In more concrete terms, the low ratio tells us that the regional banks are not currently having any problems with their lenders ability to pay their interest and mortgage. An impaired loans ratio of 2,5% is low both on an absolute and relative level (see comparison with NPL ratio below from EBA Dashboard of 250 European banks). Also, the regional banks have a solid coverage ratio both incl and excl reserves; 103,4 % and 63,8 % respectively. From this aspect the regional banks are well protected from potential and future losses. Again, this is true both on an absolute and relative level (see coverage ratio of NPL below from EBA Dashboard of 250 European banks).


Although the above ratios are solid for the regional banks I would nonetheless like to investigate what the underlying situation for one major part of these ratios. Because 59% of the total loans outstanding is house loans I thought it be a good idea to look at some macroeconomic factors for France in relation to this figure. As I am by no means an “macro expert” I would like you take my analysis in this part with an extra grain of salt.

The French real estate-market

To start of I would go back to a statement made by Mr Paul Isaacs in the Graham & Doddsville newsletter from the spring of 2013:

These are conservatively run regional banks. France didn’t have a gigantic real- estate boom. If you don’t think the French banking system is completely imploding, these are really cheap certificates, and you are paid a fair amount while you wait.”[20]

So let us first examine how the situation has developed since 2013 when the above statement was made. In the HYPOSTAT report of the European mortgage and housing market there are graphs showcasing house price development since 2006. In the graph with countries where house prices were, in 2015, around 2006 levels, we find France[21].


A similar graph but with a longer time frame (from a different source) shows a more volatile price development than the picture above[22].


Regardless of what graph we look at I think it is fair to say that although there has been an increase in house prices since Mr Isaacs statement in 2013 there is still no signs of a “gigantic real- estate boom” in France. Nonetheless, the HYPOSTAT report does the following statement about the current trend: ”Finally, in countries where house prices have been falling in recent years such as Cyprus, France, Greece and Italy, there were signs of deceleration and of an upcoming reversal in trend.[23]

The above quote should also be put in context to another statement made in the HYPOSTAT report regarding the price development of capital cities, Paris in this case: ”In other countries such as France, the Netherlands and also the US, the country-wide HPI has not dramatically changed with respect to 2006, while their capital cities’ prices increased by between 25% and 40%, pointing to very segmented domestic markets in some instances.”[24]

So what about the outlook for the French real estate market then? I came across an article last week that mainly focused on Sweden’s real estate market but also included some information about France. The outlook for the Swedish real estate market was not positive to say the least. However, for France the European Systemic risk board (ESRB) has not issued a similar warning for the vulnerability in its real estate market[25]:


So to summarise and conclude so far. There seems be no sign of a current real estate boom in France in general, although prices are currently in an upwards trend in relation to recent years. The same statement cannot be made for the Paris real estate market where prices have increased far more than the French average. However, putting it all together there seems to be no need to worry about the outlook and stability of the French real-estate market as the ESRB declares no waring for the vulnerability. This final conclusion leads us into the quest of trying to look at other factors that supports this notion.

Real-estate lending and some other important macroeconomic factors

Price development in the real estate market is only one side of the coin that could lead to a vulnerable real estate market. The other and more interesting side, I think, is to look at how residential lending has developed over the years.

So let’s start with one important graph that in my opinion verifies the conclusion drawn by ERSB[26]:


From the above graph there doesn’t seem to be a current residential lending boom in France. More importantly I think the graph should also be viewed in relation to the earlier graph of house price increase in France since 2006 and the conclusion that there are currently no signs of a real estate boom. In other words, France doesn’t seem to have a real estate bubble financed with borrowed money. This is very good news.

Moving on to the next graph. Let’s take a look at the percentage of home owners with mortgage loan in relation to mortgage to disposable income for France and some other European countries[27]:


Again, the above graph doesn’t ring any alarming bells to my novice macroeconomic ears. France in relation to other European countries don’t have a particular high degree of home owners with a mortgage loan (an untapped revenue stream for the regional banks?). Also, the relationship between outstanding mortgage to disposable income for France is not particularly high. In other words, the underlying stability in the real-estate lending market seems to be pretty good. Both in relation to absolute and relative levels.

As I said before, I don’t consider myself a person with in-depth knowledge or analytical skills regarding macroeconomic situations and factors. However, with the presentation above I think it is fair to say that the statement about France having no gigantic real-estate boom made by Paul Isaac is still true. Considering that the regional banks total loans outstanding is made up of about 59 % home loans this is good news. In other words, investing in the banks now mean that you are not buying into a loan portfolio that is structured around historically high-priced real estate properties (i.e. low risk of overvaluation). In regards the future vulnerability of the home loans for the regional banks I think the last graph and the conclusion therefrom put in relation to the figures earlier presented for impaired loans ratio and coverage ratio for total loans outstanding provides a good margin of safety for potential negative macroeconomic developments.

What about the rest of the loan portfolio (41%) to SME businesses, farming and local authorities (municipalities etc.) then? From a macroeconomic standpoint there are both positive and negative notions that can be made. France is battling with high unemployment rate and a low GDP growth in comparison to other European countries.[28] At the same time French corporation tax is likely to be lowered in coming years from 35% to about 28% (especially if the right-wing wins the election) and the country is still the third largest economy in Europe[29]. Also, as in every other European country today the rates on French loans are at record low levels. Overall, my conclusion is that if we don’t see an explosive increase in rates I see no particular reason that the 41% of the loans outstanding should be seen as riskier than the 59% of home loans. Again, this statement in should be put in relation to the figures earlier presented for impaired loans ratio and coverage ratio for total loans outstanding and the margin of safety that appears to exist in therein.


Wrapping up the value investing and special situations story

In the good old days banking was simple, the bank would lend money to local people and businesses at a higher rate than it was deposited for, i.e. retail banking. Today the situation is a whole lot different since most banks as they have expanded wide in their field of business and geographical presence. However, as has been presented in this analysis there are still a few of these traditional local banks left. In France we find thirteen of these that are publicly traded.

As of 31 December 2015, total bank assets on a consolidated basis held by French banks, in France and abroad, amounted to EUR 7,674 billion. 83% of these assets were concentrated in the six largest French banking groups (BNP Paribas, BPCE, Crédit Agricole group, Crédit Mutuel, La Banque Postale and Société Générale)[30]. France is in other words not different than many other countries from the fact that the banking industry has an oligopoly structure. As an investor I don’t mind this at all, quite the opposite. However, you want the structure to be in “your” favour as the market share is often quite sticky in oligopoly industries, especially in the banking. If we take a look at some market share figures for mortgage issuance the picture is quite pleasant for the regional banks as it amounts to a 54,5% (i.e. mutual and cooperative banks)[31]. However, it should be noted that the Caisse Regionale banks are not the exclusive “owner” of the 54,5% whole market share cake as other branches also have regional/mutual/cooperative banks. I haven’t found any exact figures but according to a large investor in the Caisse Regionale banks that I have had the opportunity to email with (more on this later) the market share in most regions is above 50%. Considering that the Crédit Agricole group is the largest bank network in France I view this figure as plausible.


When I first started to dig into the bits and pieces of the Caisse Regionale banks it was the combination of simple retail banks with a large market share in an oligopoly structured industry selling at deep value multiples (P/B 0,3x and P/E 6x) that got me really excited. After a bit of research, I also found out that the regional banks could be viewed as a special situation case. This as a result of a buyout of Credit Agricole SA (ACA) at 1,05x P/B-multiple while excluding minority shareholders from the same deal. In the first part of my analysis of the French regional banks I presented this case and came to the conclusion that there existed a strong underlying catalyst. However, the story was highly unlikely to include a happy ending in the short to medium time horizon. Since the publication of the first part this I still my conclusion and things haven’t changed. However, this might change over the next couple of weeks since the legal process is about to start. If and when something happen I will write a follow-up post about it.

In my second and third post of the thirteen regional banks I moved on to present the value investing case of the Caisse Regionale banks. What I concluded in my second post was that the banks had continuously been profitable at the bottom line level for the last ten years. That the regional banks profitability was quite good, both in absolute and relative terms, and both from a bank efficiency ratio (53,2% average for the thirteen banks) and an ROE-ratio (5,9% average for the thirteen banks) perspective. That the regional banks financial stability was strong both in terms of absolute levels and in comparison to Basel III requirements. Finally, that the regional banks paid a dividend yield of 4,8% (average for the thirteen banks) at a non-distressed dividend pay-out ratio and a net-buyback yield of 0,8% (average for the thirteen banks). In other words, a shareholder yield of 5,7% (average for the thirteen banks). In this third and final post I concluded I was not alone in my interest of the French regional banks. I presented some well-known domestic and international value investors that have a large stake in the banks and are actively engaged in the current legal process. Finally, I found no signs that the regional banks loan portfolio was exposed to current high risk or overvaluation and that there was enough margin of safety to protect against future vulnerability in relation to worsening macroeconomic conditions.

In all of my three posts for the Caisse Regionale banks I have tried to punch a whole to the investment idea and continuously, in my opinion, failed to do so. That doesn’t mean that there exist negative factors and explanations for why these banks are selling at such low valuation multiples. Some possible explanations for the low valuation multiples (I don’t necessarily consider them negative) are the following:

  • The regional banks are quite small and illiquid. That makes them un-investable for many fund, institutions and big private investors.
  • The ownership structure is very complex and hard to get a grip of but was even more complex until just recently (see more about this in post one). This might result in that investors put the regional banks in the “too hard pile”.
  • All of regional banks financial information is in French. This makes them quite hard to analyse for a non-French speaking investor. Again this might result in that investors put the regional banks in the “too hard pile”.

In my opinion there also exist two factors that have some real weight to them for at least part of the explanation of the low valuation multiples:

  • One explanation for the low valuation multiples I think has to do with the banks limited growth opportunities. They conduct their business only at a regional level and more complex banking business is outside of their purpose and reach.
  • The second explanation for the low valuation multiples has to do with the fact that the shares publicly traded for the thirteen regional banks, CCI-certificates, are not entitled to the right of a vote (read more about this in post one). This will eliminate many institutions, funds and large investors as that don’t want or aren’t allowed to invest in these types of securities.

With the negative factors in mind I still consider the regional banks to be one of the best investment opportunities I ever laid my eyes on. In other words, the above negative factors can in my opinion not even close explain the price vs. value discrepancy (low valuation multiples) that the banks are selling for today if we take into account the positive factors earlier stated.

One last thing – a new catalyst in the horizon

In the last couple of weeks, I have had the delightful opportunity to pick the brains of monsieur Etienne Vernier over an e-mail conversation[32]. You might remember his name and articles that I linked to in the first part of the French regional banks analysis. He is a large and long-time shareholder alongside the funds earlier mentioned and is also actively engaged in the current legal process against the banks. He holds deep knowledge about the banks and I consider his insights truly valuable. Our conversation has helped me tremendously in finalizing this post. One thing really stood out from our conversation and has to be placed on top of my earlier positive facts about this investment opportunity. This has to do with his thoughts about the SACAM company, the 39 regional banks holding company, that now is the owner of ACA former ownership in the regional banks (read more about the this and the SACAM company in post one). Some of Etienne Vernier thoughts were:

CR = Caisse Regionale

 The loan to CASA are directly in the balance sheets of each 39 CR and the interests paid will be passed in expenses and diminish in their tax corporation liabilities. But the CR dividends received by SACAM will most likely be non-taxable. That makes net of taxes that dividends will be twice the interest paid or so.

Also i believe (I am not sure) that it would be absurd that SACAM repays to the CRs the dividends received by the same CRs (300 M€ in total). That would be strange. More likely, SACAM will amass that money and use it to buy CCIs on the market where they are at 0.3 of Net Assets versus 1.05 paid by SACAM. 300 M€ yearly would push the market prices up on CCIs.

After acquiring the Memorandum of Association of SACAM MUTUALISATION and 26 of the annual reports for the Caisse Regionale banks that are not listed Etienne Vernier concluded:

I consulted the 2015 annual reports of the 26 unquoted CRs in order to obtain a finer estimate of the dividends that would have received SACAM MUTUALIZATION if the deal had been in place last year. 

This resulted in a global dividend of € 297 million for SACAM and € 88 million to the CCI float of the 13 listed CRs.

PS: if they had bought the free float for 5.2 billion euros, it would have cost + – 40 M € of interest to CR to compare with +88 M € of additional dividends ….

[Etienne Vernier referring to the Memorandum of Association of SACAM MUTUALISATION]

You can see that the goal of SACAM is solely to hold, AND acquire eventually more CCA/CCis. Nothing else is specified so just one thing to do with their dividends. Buying more CCIs or at the worst sending this back to the CRs. The later alternative will improve the CR’s results but this loop would be very weird.

If you consider that SACAM yearly will receive close to 300 M€ of dividends and that the free CCI Float is around 1.800 M€, it will simply take 6 years for them to buy them all. Obviously since only 10% of the free float is dealt yearly on the stock exchange, such moves will probably push CCIs prices closer to 1.05 x their net asset values ! At the minimum, they can start doing it and this will sustain the prices and lower the cost of their holdings compared with the 1.05 they paid.

So to summarise and conclude both the value investing and the special situation case. Taking a basket approach (buying all thirteen regional banks) you are able to buy a stable +12% return (~6% ROE in an oligopoly structured industry and a growing shareholder yield of another ~6%) for a P/B multiple of 0,3x. On top of that you get the potential legal catalyst valued at 1,05x P/B for free and another free high possibility buyback catalyst in the form of the SACAM company putting its dividend money to use on the thinly traded CCI free float. In my opinion this is an investment I would make every single day with a smile on my face and one that I consider to be the closest to the Dahando investment philosophy that I have ever seen – heads I win tails I don’t lose much.

Disclosure: The author is long all thirteen regional banks (Caisse Regionale) mentioned when this analysis is published.

































The French regional banks – part two (1/2)

The story for part two

After posting part one of the French regional banks analysis a couple of weeks back I finally had the time to finish writing part two. In part one I told the risk arbitrage story of the French regional banks. What I then concluded was, even though there existed a strong underlying catalyst, that story was highly unlikely to end with a happy ending in the short to medium time horizon. Wrapping up part one I also sat the stage for the story of part two for the French regional banks when I wrote:

Next time I will present the other side and when put together with the risk arbitrage side I think a basket of French regional banks make a perfect Dhandho investment – heads I win tails I don’t lose much. So stay tuned!

If you are short of time or don’t care to read this second part of my analysis, I will for a moment leave the stage over to monsieur François Badelon (fund manager at Amiral Gestion[1]) to tell a summarized version of the story for the French regional banks that I will focus on in this part:

After listening to François Badelon I think you have figured out what part two is all about and what story I’m going to tell. Yes that’s right, I’m going to tell a classical value investing story about the French regional banks. Because of the length of text that part two has amounted to I have decided to split it up into two posts. The second post to part two will be published next week.

The numbers

In order to tell a good value investing story I think we all can agree on that we have to start with the numbers. Below you will find a summary of what I find to be the most important numbers and ratios to look at for all thirteen regional banks. If you are interested in the excel-document and want to take a closer look just send me an email at and I’m glad to share this with you.

*Note that the share prices in the excel summary represent my entry share price as of 13/10-2016. Since then the share prices for all banks have moved up a bit. To view the current share prices and the return on the regional banks since I bought them I recommend you to follow this link to my portfolio.

Price and value

For me price and value are not only cornerstones to the way I approach value investing, they are the absolute heart and starting point of my investing philosophy. I want the discrepancy between the two factors to be so evident that it feels like I get punched in the face by Mike Tyson, i.e. deep value.

In the case of the regional banks I got punched big time when I started to look at the valuation multiples. The regional banks are selling at ridiculous low multiples, both in relation to book value (average for the thirteen banks: P/B = 0,31x) and earnings for the trailing twelve months (average for the thirteen banks: P/E-ttm = 5,4x). This is also true if we look at the average earnings for the last ten years (average for the thirteen banks: P/E10 = 1,4x).


Not only are the banks cheap on an absolute basis. In relation to what banks in general are selling for around the world I conclude that the French regional banks are ridiculously cheap. It might not be the fairest comparison but two European banks that should be selling at very low multiples are Royal Bank of Scotland Group (RBS) and Deutsche Bank AG (DBK). The current P/B-multiples for those banks as of current date are 0,4x and 0,5x respectively. Regarding P/E-ttm, a comparison shows that both RBS and DBK have a negative earnings number for the last twelve months, i.e. P/E = N/A. Finally, P/E10 for RBS is still N/A since the aggregate profit is negative for the last ten years, for DBK the P/E10 multiple is 15x. We can also compare the multiples in relation to Credit Agricole SA (ACA). If you remember from my part one analysis the regional banks together own 56,7 % of ACA and until very recently ACA in return owned 25 % of each regional bank. ACA is currently selling for P/B = 0,5x, P/E = 8,8x and P/E10 = 25,7x.[2]

When I have found something that I consider to be Mike-Tyson-punched-in-the-face-cheap I move on trying to map the explanation for the discrepancy. The reason behind this is that; when something is really cheap there is often a good explanation for it. As a deep value investor I’m quite used to owning stuff that no one wants or care about and where there also exists an explanation for why this is so. What I try to do is to take advantage of these situation. Not because I necessarily disagree with the explanation but because Mr Markets has an ability to estimate the probability and/or effect of that explanation in a very biased manner. This is commonly related to the notion of loss aversion and some other well-known biases. Going forward with this analysis I will start to dive into the different parts of the banks numbers and ratios with the intention to map out the underlying explanation for the very low valuation multiples.


A typical deep value story often includes the words “negative” and “loss”. However, all thirteen French regional banks have been profitable on a net income level every single year for the last ten years (note that I haven’t checked further back in time). The same statement cannot be made for most banks in Europe (or the in world for that matter) and especially not for RBS and DBK. Taking into account the evolvement of the banking sector with increased capitol demands over the last ten years at the same time dealing with a difficult macro-economic environment in France, I find this achievement from the regional banks really impressive. On the negative however it should be noted that the annual growth rate for the top and bottom line of the regional banks is quite unimpressive  (most regional banks range in between 0-2 % CAGR for the last ten years).

When it comes to evaluating bank profitability, not only looking at which banks have showed a stable earnings and growth record, two common metrics are used. Those are bank efficiency ratio (also known as cost-to-income-ratio) and return on equity (ROE). Let’s take a look at the regional banks profitability in relation to these ratios and how they compare to other banks.

Bank efficiency ratio

The bank efficiency ratio is a measures that shows how cost efficiency a bank is. It’s a good measure to use in order to get a grip of banks quality attributes. The measure takes the bank costs (personnel, administration, depreciation, and other costs) as a percentage of the banks net banking income. In short, a lower bank efficiency ratio is better than a higher one.

Before I present the French regional banks efficiency ratios I would like to set the stage for what level of bank efficiency is to be viewed as good vs. bad. In an article published in April 2016 the bank efficiency ratio of banks worldwide was presented[3]. This might not be the fairest comparison as the ratio will naturally vary between countries, legislation and the type of banking that the bank provides. Also, the article is focused on large banks, such as ACA, DBK and RBK, not regional banks that have a focus on retail banking. Nevertheless, here is an overview:



The same article also presents the ratio for specific banks. Below I have included the table for some European banks, including the ones that earlier have been mentioned in this analysis (RBK, DBK and ACA):


Now to the French regional banks. In the picture below I have presented the efficiency ratios for each regional bank. The ratio is presented both for the 2016 half year report and for the 2015 full fiscal year.


As can be observed above, the efficiency ratio for most regional banks are really good in comparison with the largest European banks. Moreover, in relation to the bank efficiency map, where the average bank efficiency ratio for France is stated to be 65,86 %, all regional banks come out on top. The same statement is also true in comparison to the average for many other European countries presented in the article. This final line of argument can also be validated via data from the The European banking authority (EBA). The EBA has a “risk dashboard” that is regularly updated (the latest update is for Q2 2016 figures[4]). The cost to income ratio for 156 European banks is divided into three buckets (green being the best and red being the worst).


As can be observed by the latest figures, 63,8 % of the 156 banks are placed in the worst bucket with a cost to income ratio of > 60 %. Going back to the table above for the thirteen regional banks, all of them except EPA:CRAP (freaky coincidence with the ticker name!?) are placed in the yellow bucket. Note that only 26,1 % of the 156 banks can be found in the yellow bucket and 10,1 % in the green bucket. To summarize and conclude, I find profitability achievement for the regional banks from a bank efficiency ratio perspective to be quite impressive and satisfactory both on an absolute and relative scale.

Return on equity

Moving on to the other profitability measure, return on equity (ROE). When we look at this metric it is important to note that it varies quite a lot between industries. Banks is one of the industries where the metric usually is low on an absolute scale, often in the low single digit range.[5] This statement is validated from the EBA “risk dashboard” regarding the 156 European banks ROE over the period Q4 2014 – Q2 2016. For all quarters the green bucket (banks that achieve a double digit ROE) has continuously included the fewest number of banks.[6]


In the picture below I have presented the ROE for the trailing twelve month and 5-year average for each regional bank.


Of the thirteen regional banks, based on ROE-ttm, six of those are placed in the red bucket (< 6 %). The rest are placed in the yellow bucket (6-10%). If we take a look at the 5-year ROE the number of regional banks that are placed in the red bucket is lowered to five. Taking into account that the majority of the French regional banks, both on a ttm (average for the thirteen regional banks = 5,9 %) and 5-year average basis (average for the thirteen regional banks = 6,1 %), are placed in the yellow bucket I again find the results quite impressive and satisfactory both on an absolute and relative level. Although, not to the same extent as was the case for the bank efficiency ratio.

Capital allocation

Banks are known for having a shareholder friendly attitude to their capitol allocation. Typically, they have a dividend rate above most other industries and, although not that common, some also have buyback programs. I haven’t found any good article or paper covering the buybacks from banks in Europe or in the world (if you know any please let me know). But what I have found is a good summary for dividend yields of banks in both the US and Europe. Again, this might not be the fairest comparison taking into account the size and nature of the banks included. Nevertheless, the average dividend yield for the twenty banks in Europe with the highest yield is currently 5,0 %[7]. In an article from march 2016 the 16 banks US banks included had an average dividend yield of 2,4 %[8]. The same article covering US banks also include the pay-out ratio for these banks. The average pay-out ratio for the same banks amounted to 29 %. With these figures in mind I would like to present the figures for the thirteen French regional banks:


All thirteen French regional banks pay a yearly dividend to the holders of the CCI-certificates (see part one analysis for explanation of CCI and the capital structure for the regional banks). They all have done so uninterrupted for the last ten years and for most years they have also increased the dividend paid (again I haven’t checked further back in time). On top of the yearly dividend, all regional banks also have a CCI buyback program. The buyback program allows the regional banks to own CCI’s in treasury (most banks are allowed to own 10 % of the total number of CCI’s), to provide liquidity to the market (sell CCI’s back to the market that the bank has owned in its treasury) and to “cancel” CCI’s from existing.

Both in absolute terms and in relation to the figures earlier presented for the European and US banks the French regional banks looks quite appetising from a shareholder’s capital allocation perspective. With an average dividend yield of 4,8 % the thirteen banks are just short of the average for the top twenty European banks (5,0%) and well above the US banks average (2,4%). The same statement is made even stronger if we take into account the net buyback yield of the regional banks. Far from all of the regional banks have a positive net buyback yield but most importantly none have a negative yield (i.e. CCI holders doesn’t get diluted). If we add the dividend yield together with the net buyback yield, we get the shareholder yield. For all thirteen regional banks the average shareholder yield is 5,7 %. Even if I don’t have any figures from other banks to compare the shareholder yield with, I’m quite confident that the regional banks would have been on the top of such a list. One final thought is that the current pay-out ratio for the French regional banks isn’t what you would consider distressed. In other words, the regional banks have good room for continued dividend growth. In comparison to the average pay-out ratio for the US banks of 29 % the 26,2 % average for the French regional banks is also to be considered as good.

Financial stability

The banks have been under quite a lot of pressure over the last couple of years, both from legislators and politicians, to strengthen their balance sheet and to lower their risk taking. This enforcement as you all know is related to the financial crisis’s that we have witnessed and the rise of an ever increasing complexity in the banking system. The enforcement has in practical terms resulted in a regulatory framework, known as the Basel international regulatory framework for banks. I won’t go into details about framework, but I can recommend a good video presentation of the framework for those of you that are interested[9]. Two important measures of the current Basel framework (Basel III) are the CET1 ratio and LCR ratio. So let’s take a look at the ratios for the French regional banks and how they compare against the regulatory framework but also against other banks.


The CET1-ratio (common equity tier 1 ratio) measures the equity in relation to the risk weighted assets of the bank. In other words, the ratio measures a banks long term survivability and solvency in times of financial distress. The riskier the assets the more weight it will carry in the calculation, naturally cash will have the risk weight of 0%. The Basel III framework requires banks to have a CET1-raitio > 7 %. In addition, national regulators can require the banks to have an additional 0-2,5 % of capital on top of the 7 %[10].

In the risk dashboard for Q2 2016 the average CET1 ratio for 156 EU bank’s amounted to 13,5 %.[11] Explained differently, 74,1 % of the 156 banks had a CET1 ratio in the range of 11-14 % (se picture below). Only 21,6 % of the banks had a CET1 ratio above 14 %. The picture doesn’t change much if we look at the French banking sector in specific. The average CET1 ratio for the French banking sector amounted to 12,8 % according to the ACPR report for 2015.[12]


With the above requirements and the average ratios for other European banks I mind the French regional banks look really solid if we now view their CET1 ratios:


With and average CET1 ratio of 20,3 % the French regional banks are not only placed in the green bucket but they also display a high margin of safety in relation to the Basel III requirements. One again again find the results quite impressive and satisfactory both on an absolute and relative level.


The LCR-ratio (Liquidity Coverage Ratio) is measure of the banks’ ability to cover outflows of cash (net liquidity outflow over 30 days) with its “high-quality liquid assets”. In other words, it measures a banks short term survivability and solvency in times of financial distress. Currently the Basel III framework requires a LCR-ratio > 70 %. However, the LCR-ratio is increased every year up until January 2019 when the ratio of full implementation is required to be above 100 % (LCR-ratio > 70 % (2016), 80 % (2017), 90% (2018), 100% (2019)).[13]

For some reason the EBA risk dashboard doesn’t include the LCR-ratio. However, the EBA publishes a Basel III monitoring report for European banks where the ratio is included. As of the 31 december 2015 the average LCR-ratio amounted to 133,7 % and 91 % of the banks of the 227 banks in the report had an LCR-ratio above the full implementation minimum requirement (> 100%).

If we now turn to the figures for the French regional banks they are obviously a bit behind the above figures with an average LCR-ratio of 92,5 %. As of 30/6-2016 only two of the thirteen regional banks had an LCR-ratio above the full implementation requirement of 100 % (EPA:CRBP2 and EPA:CRLO). Quite many of the banks have an LCR-ratio just below the 2018 requirement (> 90%). However, one bank (EPA:CRSU) have a LCR-ratio just above the 2017 requirement (> 80%).


To summarise and conclude, all thirteen regional banks have a good LCR-ratio for 2016 and 2017 but need further improvement in coming years in order to reach the minimum requirement of full implementation of 100 % as of 2019. In other words, I find the current LCR ratios for the French regional banks on absolute level quite satisfactory but on an relative level I’m not impressed.

The SACAM transaction

As was explained in detail in part one, the regional banks (all 38 regional banks in the Crédit Agricole Group not only the thirteen publicly traded), via a new company called SACAM Mutualisation, recently bought back the ~25 % ownership that ACA had in each regional bank. The negative side of this transaction was not only that minority shareholders were excluded but also that it had a negative impact on the regional banks earnings generation and CET1 ratio. The negative impact is mainly related to the cancelation of the Switch guarantee (a 5 B€ warranty under which the regional banks charged a 9.34% interest on 5 B€ deposited with ACA since the crisis of 2008). Because of the transaction the regional banks have presented some restated ratios and numbers that I have mentioned earlier in this analysis. In order to be to provide a fair view and anlysis I thought it be good idea to present those restated figures and ratios as well:


Although the restated P/E ratios and CET1 ratios are negatively affected by this transaction the effect is not that material that it changes my former conclusions regarding the ratios (i.e average P/T-ttm = 5,9x is still ridiculously cheap and CET1 = 17 % is still way above Basel III requirements and good in comparison to other banks).

As was presented in part one the French financial market regulator (Autorité des marchés financiers, AMF) has reviewed the SACAM transaction and come to the following conclusions (Google translated from the AMF- statement):

Concerning the consequences of the transaction for the holders of CCIs, the AMF noted that the transaction will have no impact on (i) the liquidity of the CCIs, Sacam Mutualisation intending to hold long-term CCis acquired from Casa, (ii) the commitment made by the Regional Banks when listing Casa to distribute at least 30% of their result, this commitment being maintained by the said Caisses, and (iii) the remuneration of the CCIs, the Caisses Regional authorities have indicated that the remuneration for 2016 will be at least equal to that for 2015 and that their results should be increased by 2019.”

Casa = ACA
Caisses = regional banks

Similar statements have also been made by the regional banks themselves. Here is one in English from the regional bank Sud Rhone Alpes (CRSU).[14] In particular I find the first part of importance and interesting but the statement about the dividend policy and amount is of course soothing:

“The reclassification operation combined with the operating outlook for the Regional Banks therefore means that they can expect growth in aggregate net income under French accounting standards of around 10% by 2019.

Within this framework, the Crédit Agricole Regional Banks having issued CCI certificates confirm that they intend to maintain remuneration on these certificates in 2016 at least equal to that of 2015.

Furthermore, the commitment made by the Regional Banks upon the listing of Crédit Agricole S.A. to a payout rate of at least 30% will not be called into question, thereby guaranteeing the continuity of the payout policy for CCI and CCA certificates.

Finally, the SACAM company will allow the regional banks to strengthen their cohesion by pooling their results, “pay themselves” dividend instead of distributing this to ACA and take advantage of potential increase in value of themselves as good investments to a larger extent than before. To summarize and conclude, there is good and bad news with the SACAM transaction. Only time will tell if there is more or less of the other but as of current date I don’t see it to have a material negative effect on the regional banks.

Why me, God?

Based on my analysis of profitability, capital allocation, financial stability and the SACAM transaction it is hard to get clear understanding of why on earth these banks are selling for such ridiculously low valuation multiples. Nothing stands out as being the explenatory factor for the big discrepancy between price and value, both on an asset and earnings basis. When you find yourself in a situation like this I think it is a good idea to go back to Charlie Mungers famous saying:

When you locate a bargain, you must ask, ‘Why me, God? Why am I the only one who could find this barging?

In the second post of part two I will continue to paint my map of undervaluation. I will first try to answer the above questions by inverting it. I will also take a look at the current French banking and housing market and how/if that plays a role in the reason for undervaluation for the French regional banks. Finally I will wrap up the value investing story with the risk arbitrage story into a final map of undervaluation, i.e. my conclusion about the French regional banks as investment candidates.

Disclosure: The author is long all thirteen regional banks mentioned when this analysis is published.


As this will be my last post for 2016 I would like to thank you all for the feedback and comments I have received over the year. I means a lot to me that you take a part of your day to read my blog and interact with me. I wish you all a happy new year!



[2] Valuation multiples for RBS, DBK and ACA are based on data from













The French regional banks – part one

A couple of weeks back I thought to myself; what if I change my screener from searching for net-nets to instead look for really low P/B stocks. I set my screener for P/B < 0,35x (and some other quantitative measures, such as P/E < 5 and P/E10 < 5) and Voilà! there they were, French banks all over the screener!

Well this is odd I thought. I know the banking sector in Europe is not the most exciting or expensive sector (the Deutsche Bank case was at this point in time a hot news topic), but from the valuation multiples I’m seeing there must be something more to the picture. So what do you do when something looks too good to be true? You google it.

From the google search I managed to find a brilliant blogpost from a French value investor that made the whole case a lot clearer and also more interesting. The blog is called Value investing France and you should definitely check it out.[1] Before moving on with my analysis I just want to stress that I couldn’t have managed putting all the pieces together without his blogpost and further help via email. I would also like to stress that I don’t speak French and that I have used Google translate for most of my research. It is therefore possible that I have misunderstood parts of the information that this analysis relies on.

An unconventional ownership structure

Before diving into the more interesting parts of this analysis we have to start off with the ownership structure and some related details of the French regional banks analysed in this post. You will soon understand why.

For those of you that have been to France or know anything about their banking sector, you will probably recognise the name Crédit Agricole. Crédit Agricole or more correct Crédit Agricole group is a network of cooperative and regional banks. In total there are 39 regional banks in the Crédit Agricole group. The holding company of the Crédit Agricole group is listed on the Paris stock exchange under the ticker “ACA”. The 39 regional banks together own 57 % of ACA shares outstanding via a company called SAS Rue la Boétie (SAS). Until lately, ACA in return owned about 25 % in each regional bank. The structure of the Crédit Agricole group looked like this:


In this analysis I will mainly focus on the regional banks but because of the structure of the group and recent developments ACA will also be mentioned numerous times.

So what about the regional banks of Crédit Agricole group then? Well, as you probably can guess they are involved in basic and traditional local retail banking in different parts of France (se map below[2]). In other words, their focus is on household, local SME businesses and farmers. In contrast, the business model of ACA is a more complex. They engage in International banking, Financial services such as asset management and securities, insurance, consumer finance, private banking and also Corporate and Investment Banking such as offering brokerage, investment banking, structured finance and commercial banking services.[3]

map caisses regional.png

As stated earlier and showed in the picture above, there are in total 39 regional banks spread across the country. Of the total 39 banks 13 are publicly traded on the Paris stock exchange. The history behind this goes back to the early 1990’s when the banks were in need of capital and new laws made it possible for them to acquire the capital without diluting the control of the banks. It was made possible for the banks to issue two new types of shares:

  • Cooperative investment certificates (CCI’s) (Certificat coopératif d’investissement)
  • Cooperative member certificates (CCA’s) (Certificat coopératif d’associé).

The CCI’s and CCA’s differ from the regular definition of an ownership in a company (a share) on the fact that they don’t give the owner a right to vote. They do however give the holder the right to a dividend and to the net assets of the bank (shareholders’ equity)[4]. The difference between CCI’s and CCA’s is that the CCI’s are publicly traded, the CCA’ are not. Also, CCAs can only be bought and held by members of the issuing Crédit Agricole Regional Bank and its affiliated Local Banks.

A third class of ownership exist in the structure of the regional banks. This class is known as the Part Sociales (PA) and is owned by the local banks of the region but also clients of the bank. The PA is the only ownership type that gives the owner a right to vote. However, the PA is not publicly traded and has a fixed nominal value. The holders of the PA gets a small interest every year that is decided on the general annual meeting.

Here is an example of the ownership structure of one of the regional banks (Nord de France “CNF”) as of June 2016[5]:


Here is also an example, from the same regional bank, on how the dividend/interest is divided between the different shares:


As I now continue with this analysis I will be talking about the CCI’s if not otherwise stated.

Recent changes in the ownership structure

When the laws for CCI’s and CCA’s was implemented in 1987 and 1992 the anticipated outcome was that these shares were mainly going to be bought by customers of the banks.[6] What instead happened in the Crédit Agricole case was that ACA acquired a big portion. As noted earlier and observed in the ownership structure for the example of CNF above, ACA owned about 25 % in each regional bank. From this ownership ACA could consolidate a quarter of the regional banks profit into their statements at the same time take advantage of the dividend received in the development of other business lines. It also had the effect of even out the power relationship between the different parties as the regional banks owned about 57 % of ACA.

In mid-February 2016 things drastically changed for the Crédit Agricole group when operations “Eurêka” was presented. ACA announced that it was going to sell back the 25 % ownership in each regional bank to the regional banks.[7] [8] The logic behind this transaction was said to strengthen the capital structure of ACA but also to simplify the structure of the whole Crédit Agricole group.[9] The regional banks would together create a new holding company called SACAM Mutualisation (SACAM) and buy ACA ownership in each regional bank for a total price of 18 B€. The new structure would look like this:


The price of 18 B€ would be financed with a 11 B€ loan from ACA at a fixed rate of 2,15 % maturing in 10 years with an option for early repayment after four years. Another 5 B€ would be financed with the cancelation of what earlier was known as the “Switch guarantee” (see picture of earlier group structure). The Switch guarantee was a 5 B€ warranty under which the regional banks charged a 9.34% interest on 5 B€ deposited with ACA since the crisis of 2008. The remaining 2 B€ would be a pure cash payment from the regional banks. It can here be noted that the equity stake in the regional banks was valued at €16.8bn in ACA’s balance sheet at the end of 2014.[10] [11]

The new structure

So now we know the price paid by the regional banks and how the deal was structured, but what about the implications and the value of the transaction?

Implications of the transaction

Depending on what perspective you take on the transaction there will be different conclusions drawn over its implications, good and bad. Because this analysis takes a CCI owners viewpoint that is also how I will frame it.

  1. Because of the new ownership structure of the SACAM, it will not be possible for the regional banks to consolidate the earnings into their accounts (as was the case for ACA). Reason being that 39 banks will now split the ownership of those earnings. The exact details and outcome of the SACAM for each regional bank I don’t know jet.
  2. With the closing of the Switch guarantee it will have a negative effect on the income for the regional banks. It has earlier been a large source of income, about 460 M€ in total.
  3. The loan of 11 €B will give rise to a new interest expense (236,5 M€ in total). The 2,15 % fixed rate in relation to today’s interest environment and the fact that it relates to inter banking lending is in my opinion a bit high.
  4. As noted earlier, the regional banks own 57 % of ACA via SAS. A financially strengthened ACA will of course be of importance for the regional banks in the long run. At the moment this is most evident in the form of an increased dividend from ACA as a result of the simplification transaction.

Value of the transaction

One thing that stays constant and will not depend on the perspective of the transaction is the price paid in relation to the value of the regional banks. With the price of 18 B€ in relation to the net asset value of the regional banks gives us a P/B-multiple of ~1,05x paid by the regional banks.[12] [13] Most of you I guess would think this sounds like a fair multiple to pay, me included. However, what I and many others don’t think is fair is how this deal excluded minority CCI-holders from taking advantage of the same offer made to ACA. In this context it is worth noting that the thirteen publicly traded regional banks are selling for an average P/B-multiple of 0,31x on the market (see table below).

The defence association of minority shareholders (ADAM) was alerted regarding the matter and about one month later the ADAM addressed the issue to the French financial market regulator Autorité des marchés financiers (AMF).[15] The ADAM stressed in two letters to the AMF the point of equal treatment of shareholders and that a transaction involving all the CCI’s at the same price paid for ACA ownership would be less than 5 €B. It took about one month for the AMF to respond and the outcome was not positive for the minority CCI holders.[16] The AMF concluded that there was no need to implement a public take-over bid to the benefit of the minority shareholders. The AMF response (Google translated from the AMF- statement):

“The AMF noted that while stock market law is structured by the principle of equality between the holders of a category of title, this principle could not, in the current state of the texts and case law, be regarded as having a General and absolute scope which would make it possible to apply it in the absence of explicit provisions. Thus, if such provisions exist with regard to public offerings and capital reductions, the proposed transaction does not involve a mandatory public offering or cancellation of the CCI’s or the CCA’s. Moreover, CCI’s are not financial instruments subject to these provisions, but non-voting securities.”

The AMF also adressed a number of the implications that i earlier mentioned:

“Concerning the consequences of the transaction for the holders of CCIs, the AMF noted that the transaction will have no impact on (i) the liquidity of the CCIs, Sacam Mutualisation intending to hold long-term CCis acquired from Casa, (ii) the commitment made by the Regional Banks when listing Casa to distribute at least 30% of their result, this commitment being maintained by the said Caisses, and (iii) the remuneration of the CCIs, the Caisses Regional authorities have indicated that the remuneration for 2016 will be at least equal to that for 2015 and that their results should be increased by 2019.”

Casa = ACA
Caisses = regional banks

Last but not least the AMF concluded in their last section that:

“Finally, with regard to the prohibition of perpetual commitments, it is not for the AMF to decide on this point, as well as on the conditions under which holders of CCIs could apply for redemption of their securities under articles L. 231-1 et seq. Of the French Commercial Code and 19 sexies et se of the Law of 10 September 1947.”

In regards to the last statement by the AMF, ADAM is now in the process of seeking redemption for the minority CCI’s at the same level as ACA is getting paid. This was first done in a written formal request sent to each CEO of the regional banks. I haven’t managed to find any formal statements regarding the outcome, but from the information at a France investing forum this first step was declined.[17] The next step for the ADAM is legal action by taking it to the courts. [18] Again, I have found no formal news but according to the same investing forum this process has just started.[19] As I understand it, this is a process where the ADAM is helping individual CCI-owners to sue the banks. I have earlier today emailed the ADAM regarding where they stand on the matter and hopefully I will get a response that I can present in the next part of this analysis.

The French regional banks – a risk arbitrage case

There is nothing today that indicates that things are about to change (in a positive way) for the minority CCI-owners in regards to a buyout. If the legal actions don’t pay off I see no reason for the management of the regional banks to change their minds in the short term. However, if the legal actions do pay off I think there is a quite high possibility that we will see some buyout action of minority CCI’s. As noted earlier, all the public CCI’s would at the same P/B-multiple as the ACA buyout (1,05x) cost the regional banks 5 B€ on top of the 18 B€ already paid to ACA. As laid out in an article by a French investor, this would be financially possible and also quite profitable for the regional banks.[20]

In the context of framing this as a risk arbitrage situation there is also two interesting historic events. In 2009 two former publicly traded regional banks decided that they didn’t want to be public anymore. They bought back all of the certificates at P/B-multiple of 0,8x.[21] [22] The reason why I present these events is to demonstrate that there has been public buyout of CCI’s and that this, especially when recent developments are taken into account, could happen again. With the new SACAM structure I think there is an increased possibility and opportunity for the regional banks to do this, as they now can finance such transaction in collaboration.

If we take the 13 publicly traded regional banks and their average P/B-multiple of 0,31x (see table below) this can be translated into the two possible risk arbitrage outcomes:

  • The CCI’s are bought out at the same P/B-multiple (1,05x) as the ACA buyout = a possible return of 239 %.
  • The CCI’s are bought out at the same P/B-multiple (0,8x) as the 2009 buyouts = a possible return of 158 %.


Wrapping up part one

My goal with this first part of the French regional bank analysis was to set the stage for the risk arbitrage case. I think it is obvious that we have strong but highly unlikely buyout catalyst in the short to medium term horizon. However, with a longer time frame I think this probability is quite high. As will be outlined in part two of the analysis, the risk arbitrage case is only one side of the coin. Next time I will present the other side and when put together with the risk arbitrage side I think a basket of French regional banks make a perfect Dhandho investment – heads I win tails I don’t lose much. So stay tuned!

Disclosure: The author is long all thirteen regional banks mentioned when this analysis is published.

















[17] (see page 14)


[19] (see page 15)