The art of being earnings accretive

November 28, 2019

by Rob Zdravevski

 

I just love the deal made by Bernard Arnault and LVMH in buying Tiffany.

The sales pitch LVMH gave Tiffany was;

  • a 32% premium to its previous close (the price was revised upwards, twice)
  • An all cash deal from the world’s largest luxury brand house with a market cap of $200 billion run and controlled by the world’s 2nd or 3rd richest individual.
  • and we are “offering Tiffany time and money”, to get away from the burden of quarterly reporting spare Tiffany from the demands of quarterly reporting and invest over the long term.

LVMH’s chief financial officer Jean-Jacques Guiony went further on to say, “We expect to bring Tiffany time and capital, which are two things that aren’t easy to get when you’re quarterly reporting to the stock market”.

In essence, the deal is basically a “private equity” style acquisition conducted by a publicly listed company.

“The deal underlines the growing firepower of LVMH, which generated €46.8bn in sales and €5.5bn in free cash flow last year. After its shares rose 60 per cent this year, it now has a market value of more than €200bn”, the Financial Times commented.

LVMH will not issue or use its own stock to pay for the acquisition.

Instead, they will issue their own LVMH debt to pay for Tiffany’s. With their A+ credit rating, LVMH will be able to more or less be its own price maker of the coupon rather than market dictating so.

Companies often offer their stock to pay for acquisitions when they believe they can use their inflated and expensive shares as currency.

In LVMH’s case, it’s the opposite. This tells me so many things about management’s opinion of the company’s prospects.

They’re not using their stock as its too valuable to give away to Tiffany shareholders. Why give away something of value when debt (cash) is cheap? Why dilute the equity holders?

It’s a very clever and logical decision.

Interestingly, LVMH had already prepared and submitted a “Base Prospectus” in July 2019 for issuance of debt notes for an amount up to EUR 20 billion.

Tiffany’s US$16.6bn purchase price will equal EUR 18.3 billon and if they add advisor fees of let’s say EUR 400 million and they’ll close it for under EUR 19 billion.

They should likely offer 5 year paper with a coupon of 0.50%, which is a generous 90 basis points above the EUR 5 year Euro Government bonds (which are currently trading at negative 0.40%) and LVMH could possibly even rank the debt as unsubordinated.

Of Tiffany’s $4.2 billion revenue, they tend to produce (a normalised “undisturbed”) free cash flow amounting $300 million annually.

So, EUR 19 billion debt will cost LVMH EUR 95 million in interest per annum which easily covered by Tiffany’s free cash flow, let alone that LVMH have said that they expect the TIffany’s acquisition to become earnings accretive to the tune of EUR 500 – 600 million by 2020. That’s operating profit, not cash flow and we are talking about a year away.

Bien joué Monsieur Arnault

Ignore the noise & be patient

As an investor, do you find yourself “jumping at shadows” with the smallest hint of (real or perceived) bad news?

Are you truly as much of a longer term investor, which you say you are? I implore my clients to really think about this question. If not, it’s best that you cut yourself some slack & confusion , by admitting that you are a speculator.

Major equity markets have staged a wonderful rally with most of them re-visiting their levels of last August or October. If you focused on hunting for bargains and overreactions, you would have used the months of November and December to add to your portfolio.

Some “shadow jumpers”, “Trump deflectors” and “trade war worriers” may have riddled themselves with worry or worse yet, panic, which may have resulted in a poorly thought out decision to sell your securities during this time. It takes time for investments to mature.

Once the analysis and thesis is developed, formed and capital deployed, it doesn’t mean that the “payoff” occurs within the time it takes to run a horse race.

And through the period of the thesis being proved and confirmed, there will be volatility and pricing hijinks. Interestingly, the price action of the indices below are suggesting new long term trends are being confirmed.

 

No alt text provided for this image

 

No alt text provided for this image

 

No alt text provided for this image

 

No alt text provided for this image

Understanding Volatility

Courtesy of: Visual Capitalist

“>http://<div style=”clear:both”><a href=”https://www.visualcapitalist.com/5-lessons-about-volatility-to-learn-from-the-history-of-markets/”><img src=”https://2oqz471sa19h3vbwa53m33yj-wpengine.netdna-ssl.com/wp-content/uploads/2019/02/volatility-history-infographic.jpg&#8221; border=”0″ />

Courtesy of: Visual Capitalist

You are missing out if you only invest in Australian equities

The overwhelming bia and perhaps “comfort” which Australian investors exhibit and seek by either solely or heavily investing in their domestic equity market has proved to be a substandard strategy over the past 20 years.

Larger, developed markets have outperformed the ASX 200 over this greater period of time.

My anecdotal experience whilst being an Australian domiciled stockbroker who focused and specialised in “overseas” equities, from investors who shunned international securities included them telling me that “at last they can drive by and ‘touch’ the company” which they are invested in, or some may have justified their strategy by convincing themselves they could conduct their research more easily by knowing the Australian company better.

I find these type of justifications quite weak and poorly founded.

It’s highly unlikely that an investor in BHP has researched or visited all or most of their sites, offices and operations located in Australia and the same would be the case if one analysed a power, supermarket or healthcare business.

Interestingly, Australians probably use more products and services from overseas corporations than they care to admit.

Whether its Google, Ford, Facebook, Dropbox, Sony, Bayer, Siemens, Netflix etcetera, etcetera……

I fear, that the government “sponsored” or “promoted” programs of negative gearing, franking dividend credits and perpetual money flow into superannuation will continue to allow “local” only biased Australian investors to continue doing themselves an investing disservice for decades to come.

 

It’s time to look at emerging markets again

I think the developed equity world is not cheap, while emerging markets are. For those hunting GDP growth, take a look at this infographic from http://www.visualcapitalist.com

It leads me to ask, how will you position your portfolio for the next 10-15 years?

 

Chart: The World's Largest 10 Economies in 2030

Not owning Aussie banks has saved you money

For 5 years I have advised clients to steer clear of owning shares in Australian banks.

Telling people when to sell, avoid or hide, not only saves & protects their capital but isn’t displayed in their annual summary of portfolio returns.

Such analysis and advice is unquantifiable yet it has proven to be invaluable.

It remains a difficult concept to explain to prospective clients.

Here are the 5 year price charts of CBA & NAB.

 

Don’t own a home, own businesses

This chart sourced from visualcapitalist.com shows the percentage of assets that people of differing “wealth brackets” tend to favour.

It may prove the theory that wealthier people allocate their money to assets and businesses whilst others tend to spend their money on “stuff”.

Also interesting is the significant weighting of money that the primary residence and vehicles categories account for amongst the first couple “wealth” bands.

This could prove why conversations around motor vehicle (sales, servicing, repairs, parts, insurance) and real estate (buying, selling, renting, furnishing, maintaining) are so prominent in our daily lives.

These two assets (or liabilities) are also enormous revenue raisers for governments. Just think of the registration fees, stamp duties, fuel excises, luxury car tax to mention a few.

I’d like to think that this data could provide the basis for our cultural and government propaganda surrounding the great dream of buying a house. For, if we believe in the “dream”, we’ll take out a notable mortgage to acquire a home and this will require us to stay in the workforce in order to service our debt, all in while, we are paying taxes and providing the labour force for the businesses which the wealthier bands of citizens own.

Maybe my conspiracy theory for the month.

Either way, I think the chart below is quite interesting.

 

%d bloggers like this: