3U Holdings a true Ben Graham net-net stock

3U Holdings AG (UUUX.Germany)

Price: €.72 (1/29/2012)

A reader left a comment under my post on the performance of international net-net stocks and mentioned 3U Holdings AG.  It's possible most readers missed the comment since it was in French but thanks to my French/English dictionary from high school and Google Translate I was able to muddle through.  I'm glad I did because 3U Holdings is a really interesting company.  So to the commenter:

Merci de mentionner 3U Holdings, la société est intéressante et bonne valeur mais ne pas parfait.

Background

3U Holdings started off in 1997 as a German long distance carrier.  Through the years the company acquired other telecom companies and grew to service other countries in Europe.  It seems the company stayed in the wireline business with a few brief jaunts into presentation lines and SMS technology.  In 2007 the company decided they didn't want to be in the wireline operations business anymore so they outsourced operations and became an investment holding company.

Then in 2009 the company decided to change strategies again, they felt that renewable energy would be the future so they entered the solar production market.  They have a subsidiary which produces solar vacuum systems and another subsidiary that manufactures solar components.

In summary the company owns a handful of network operator codes in Germany, some SMS companies, a management consulting arm, and finally the solar components pieces.

Investment Thesis

The reason I was interested in 3U Holdings is because the stock is trading below NCAV, it's actually trading below net cash value.

Here is my net-net worksheet for the company:

The first thing that stands out is that this company is trading below net cash value, not by a lot but by a few eurocents.  The next thing I noticed is that 3U Holdings is trading below 66% of NCAV, they're trading at 63.7% of NCAV.  Ben Graham mentioned that buying a handful of securities for 2/3 or less of NCAV and selling when NAV is reached is a very profitable strategy.  The idea is to avoid concentration in just a few of these companies but instead purchase a basket of similar companies all selling below 2/3 of NCAV, 3U Holdings surely qualifies.

The company seems to be prudently selling off old wireline assets and growing their cash hoard.  As with most legacy telecom businesses revenue has been declining from the wireline segment but the renewable energy segment's growth was enough to offset the decline for now.  The company is expecting a boom in 2012 due to Germany lowering renewable rates 15%.  I believe this means that consumers will pay 15% less for energy from a renewable source which should spur growth in the renewable energy market.

What's the risk?

3U Holdings reminds me of another company I looked at recently LICT.  The issue with both of these companies is that their main business is capital intensive and sales are declining.  The good news for 3U Holdings is that they don't have any debt.  The bad news is that the wireline business is sucking up a lot of cash.

In the trailing nine months operations sopped up €11m in cash.  The company received €27m from a sale of discontinued operations but due to working capital changes and capex costs the cash balance only increased by €5m during the year.

As readers of the blog know I'm married to the concept of a margin of safety.  3U Holdings has a very strong asset margin of safety, but I'm concerned about the margin one level deeper at the operating company.  I want to see the company's operations turn cash flow positive or at least as close as possible.  If the company continues to lose money there's the potential that the cash balance could be wiped out and the asset margin disappear.

To me the biggest risk and the reason this stock is selling so low is that there isn't clarity as to whether the cash balance will remain untouched or if operations will burn through it over the course of the next few years.

So what happens next?

I have referenced in previous posts that with a net-net stock the logical thing to do would be to either liquidate or reshuffle operations so the market recognizes the value of the organization.  The reason for this is that if management continues to operate the company in a way that got them to trade below NCAV shareholders would be better off if the company just liquidated than continue down the same path as before.

The good news for 3U Holdings shareholders is that management recognizes there is a problem with the valuation and they are attempting to do something about it.  The company authorized and plans to commence a buyback of 10% of the shares outstanding.  In addition managers have purchased more shares adding to the 28% they already own.

The company also pays out a dividend and the shares currently yield 2.78%.

Summary

3U Holdings is a tough stock for me, the discount to tangible assets and cash is enticing.  I'm practicing restraint for now because the company is eating through cash.  I've been easily lured into asset discount situations in the past and then was surprised when a mildly struggling operation turned into a dire situation and ate through my margin of safety.

I think I'm going to sit on the sidelines with 3U Holdings and wait a quarter or two and watch their cash flow statements.  If the cash starts to stabilize I will probably buy a small stake.

Talk to Nate about 3U Holdings

Disclosure: No position