I received a text recently from Dave Waters saying he was convinced France is the best place in the developed world for a value investor to hunt for bargains. Armed with a screener I went to work to proving his point. I ran a number of screens on France looking for companies trading below book value with high returns on equity, and what I've found has been interested. Interesting enough that I'd wholeheartedly agree with his statement. If you feel the well is dry in terms of investment ideas I'd recommend looking at France.
One French company that appeared in my screening result was Prodware (ALPRO.France) an IT integrator that was founded in 1989 and is listed in Paris. The company has three main business segments, business solutions, network and security solutions and integration solutions. Their business solutions division creates custom software solutions as well as proprietary solutions that they resell to clients. Network and integration solutions are implementation experts, they build networks or integrated disparate systems.
Prodware is a fairly large company with 1,500 employees spread across Europe, Africa and the Middle East. They're the leading Microsoft partner in EMEA with over 20,000 clients. The company has no operations in the US, but that's not an issue as the US IT consulting market is already saturated.
Technical consulting is a very straight-forward business model. A consulting company places a consultant at a client and bills them out at an hourly rate. The consulting company takes a large cut and pays the remainder to the consultant. As long as a consultant is billing a client both the employee and consulting company are earning money. If a client cancels a contract often a consulting company will let the employee go saving the ongoing expense.
The company screened well, it is trading for about 70% of book value and 6.5x earnings. They earned about 9% on their equity in 2013. They've had returns as high as 30% in 2004, and recently 21% in 2011. On the basis of the company's initial stats alone this had the making of a great investment. It's not often that 'good' companies trade for such a discount.
If the company's current stats weren't impressive enough then one could look at their growth. The company had €2m in equity in 2004, and in the last ten years has grown it to €95.5m for a annual growth rate of 47% a year. They've grown revenue from €22m in 2005 to €176m in 2013, an eight fold increase in the past nine years. The company's net income also followed a similar path, from almost nothing in 2005 to €7.7m in 2013.
A picture of the company's revenue is shown below:
Everything about this company seemed great when I first start to research them, their valuation, their growth, the modest executive income. Prodware seemed like a slam dunk investment. Unfortunately the veneer fell off quickly.
Prodware the company itself has a great growth story, unfortunately for investors it's a different situation. The company has financed itself in the past with convertible bonds and share issuance. At the end of 2013 they had €7m in convertible bonds outstanding, which converted would result in 798k shares being issued. This is on top of the 2m shares issued since 2011. If one looks at their equity statement it becomes clear that issuing shares isn't a one-off event, but rather something that happens yearly.
Here's a picture of the share issuance, and potential dilution from their bonds since 2012:
Technical consulting is a very straight-forward business model. A consulting company places a consultant at a client and bills them out at an hourly rate. The consulting company takes a large cut and pays the remainder to the consultant. As long as a consultant is billing a client both the employee and consulting company are earning money. If a client cancels a contract often a consulting company will let the employee go saving the ongoing expense.
The company screened well, it is trading for about 70% of book value and 6.5x earnings. They earned about 9% on their equity in 2013. They've had returns as high as 30% in 2004, and recently 21% in 2011. On the basis of the company's initial stats alone this had the making of a great investment. It's not often that 'good' companies trade for such a discount.
If the company's current stats weren't impressive enough then one could look at their growth. The company had €2m in equity in 2004, and in the last ten years has grown it to €95.5m for a annual growth rate of 47% a year. They've grown revenue from €22m in 2005 to €176m in 2013, an eight fold increase in the past nine years. The company's net income also followed a similar path, from almost nothing in 2005 to €7.7m in 2013.
A picture of the company's revenue is shown below:
Prodware the company itself has a great growth story, unfortunately for investors it's a different situation. The company has financed itself in the past with convertible bonds and share issuance. At the end of 2013 they had €7m in convertible bonds outstanding, which converted would result in 798k shares being issued. This is on top of the 2m shares issued since 2011. If one looks at their equity statement it becomes clear that issuing shares isn't a one-off event, but rather something that happens yearly.
Here's a picture of the share issuance, and potential dilution from their bonds since 2012:
Many growth companies continually re-invest for more growth, Prodware is no different. The company earned €7.7m in 2013 but generated €22m in operating cash flow. They then spent €21m on software and development costs. This should result in the company having free cash flow of €1m, except that they had debt coming due which was paid off with equity issuance. This seems to be common from what I've seen. The company generates considerable cash, but then consumes all of the cash generated for re-investment. They're left in a situation where they can't pay their financing costs and have been issuing shares.
Investors are continually being diluted by management's financing decisions. Cost control on projects appears non-existent with shortfalls being made up via equity issuance. If management were able to reign in costs and repay debt out of cash flow shareholders would be duly rewarded. For example, if the company hadn't issued shares in 2012 and 2013 their 2013 EPS would have been €1.66 per share instead of €1.09 per share. While shareholders pat their backs for the company's €1.09 in earnings they could have had 50% more if management hadn't been issuing shares. In 2006 the company had 2.8m shares outstanding, as of their last fiscal year they had 7.3m shares outstanding, and 8.4m fully diluted shares.
In 2006 the company earned €14.47 per share in revenue on a gross €46m in revenue. In 2013 the company's per share revenue was €24.30 against €176m in revenue. Revenue increased 3.8x, but on a per share basis it didn't even double. It might seem like I'm overstating the company's dilution, but to investors who are purchasing shares on an open market this is the biggest issue facing the company. If the company's revenue and earnings triple, but the company dilutes shareholders it's possible they might not see any of the gains.
The ultimate endgame for a company like Prodware is unknown, but I believe we have some hints. One of their largest investors is a venture capital firm, and venture capital loves growth. The company has been growing like a weed, and at some point maybe they'll sell out to a larger consulting firm. The venture capital backers and executives will probably do well for themselves, how shareholders will do is unknown. It seems the longer it takes for the company to sell the more shareholders will be diluted. Even though the company is experiencing great growth it's unlikely that shareholders will get to experience it themselves, which is most likely why this company is selling for such a low valuation.
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Disclosure: No position
Hi Nate,
ReplyDeleteAppreciate the shout-out. For a better French IT stock, check out Neurones. Under 7x EBIT with massive cash hoard, outstanding long-term growth and no dilution.
Dave Waters
Thanks Dave, will look at Neurones.
DeleteHi Nate,
ReplyDeleteWhat screener do you use to screen for French stocks?
Thanks
Really any screener works, FT.com, Screener.co, Bloomberg, CapIQ. Anything that has international stocks will work. I believe even Google Finance works internationally now.
DeleteThanks for the wonderful case-study on investors' share dilution, Nate. Please continue to publish such case-studies.
ReplyDeleteCheers!
Hi Nate,
ReplyDeletevery interesting study (like always ;-) ). I agree that French small caps are - even prices increased the last time - one place to find interesting investments. So I own several French stocks: Installux, TFF Group, Precia and Trilogiq. Especially Trilogiq (systems for lean management based on Kaizen) seems to me as an interesting invest at the moment. There is a big pressure on stock prices due to the much lower result 2013. I think (of couse do not know) that the down in profit is mainly related to the change of the main material from steel to graphit. I guess also 2014 will be tough due to higher costs and the start of selling the new products. But cash adjusted even on the lower profit base the cash adjusted P/E the stock is not expensive. Back to "normal" profit level, the stock is really cheap.
Some times ago MMI had made an analysis in his blog.
Kind regards
Sutje
Sutje,
DeleteThanks, I also own Installux, and Precia. I've looked at Trilogiq a few times in the past without investing. These are all great companies that are worth owning.
Nate
Hi Sutje,
ReplyDeleteI'm french and I'm impressed by your knowledge about such companies like those you own. All of them are on my watchlist since several months. If you like TFF, take a look to "oeneo", a little bit more expensive but with better hopes of growth.
By the way, don't forget to pay attention to belgium market, some small / medium caps are really interesting, for example Picanol (disclosure : I'm owner of this one) or Jensen (same profile as Precia in boring sector).
Thanks Nate for your work
Regards, Boutman
Boutman,
DeleteThanks for the comment, also thanks for the tip on Belgium! I looked at Oeneo a few times in the past, I believe I wrote about them as well. Belgium is a great market, same with the Netherlands. They're important countries in terms of history, but very overlooked currently.
Nate
In general, you can still find nice opportunities in Europe. My best idea at the moment is a portuguese stock (I'm portuguese): Toyota Caetano
ReplyDeleteHere is my initial thesis:
http://keepthesnowballrolling.blogspot.pt/2014/04/a-decent-company-875-off-its-all-time.html
and the most recent follow up:
http://keepthesnowballrolling.blogspot.pt/2014/08/toyota-caetano-2nd-quarter-preview-and.html
They will report 1H2014 results this week.
ps1: the stock is still trading around the same price I used on my initial write up
ps2: also research the stocks in the other comments, I don't own them but have read good things about almost all of them (opportunity cost is a limiting thing)
Hi Nate, why would you have thought France as being a good place to invest? The socialist government completely stifles innovation, making it very difficult if not impossible to rightsize a company, a problem which is worse, the smaller you are.
ReplyDeleteBecause of this backwards government (that has sacked the entire cabinet twice already) and the low productivity per worker, it isn't a surprise that France is quickly becoming the sick man of Europe.
On top of this, they are the only advanced European economy with falling property prices and have a population demographic that exhibits high structural unemployment as well as social unrest.
The market in which French companies operate in is a whole lot worse than most other European economies and as such, French companies rightly deserve a discount. The question is, how much is enough
Hi, nice write up.
ReplyDeletegiven your figures, the company behavior doesn't make any sense: repaying debt via equity issuance (in this ultra relaxed credit enironment), although the operating CF is impressive, is dumb and I cannot see how this helps the sponsor in any way (equity issuance costs, risk of negative newsflow from a failed transaction a.s.o. ).
It only makes sense, IMHO if the operating CF really is much lower than you believe, after all, can you be sure that those software development costs, which apparently have been capitalized, are not operating costs...
Hello Nate,
ReplyDeleteI followed a course on value investing on the site L'Investisseur Français and we actually studied that company as an example. The trap is in fact even more subtle than the share issuance process. Indeed, Prodware recognizes French tax crédits as sales, which is very aggressive. This allows them to show that their sales are growing and that they are profitable. But in fact, without those tax crédits, the core operations of the company are burning cash every year.
So in fact, Prodware is 100% dependant on the "good will" of the government. Without the sibsidies of the government, this company is likely worth 0 and, if the government stop subsidies, we can actually make a good short out of it.
Hey nate.
ReplyDeleteDo you know where can I get annual reports or financial statements for French Companies?
Thanks
Yes, Prodware makes their statements available on their site. Most French companies do.
Delete