Sometimes ideas don’t need a lot of explanation. Value is apparent and the real work comes in determining management quality, integrity, and alignment. This is one of those.
Let’s assume there is a certain investment manager who has about €350 million in assets under management. This fund manager is unconstrained and therefore has the ability to invest in almost whatever he pleases. To get a sense of the situation, we know at least nine basic things about him right off the bat:
- He has an audited public record over the past 12+ years (inclusive of the Great Financial Crisis)
- Throughout that time period, he’s compounded the value of his portfolio at over 20% per year.
- Substantially all of his worth is in the fund and he is, by far, the largest investor in the fund.
- He has recently realized some very large positions and therefore has a bit over 50% of his fund’s NAV in cash.
- His largest listed equity position in Berkshire Hathaway.
- You are able to invest in his fund and only have to pay 80% of the fund’s net asset value.
- You don’t have to pay him any performance fees nor percent of AUM expenses.
- Instead of paying out large dividends upon realizations as he has historically done, he has been consistently buying out his partners when they are willing to sell at a discount to NAV.
- He is currently in the midst of a tender offer submitted to his partners to buy back another 10% of his fund at the currently-quoted 80% of NAV.
Bavaria Industries (B8A) currently has a market cap of about €285 million. Within the business there is:
- €200 million in cash
- €139 million in securities
- €20 million worth of fully-owned subsidiary businesses (an auto seals and safety solutions business, a packaging business, and an industrial heat exchange component manufacturer)
NAV comes in at €359 million.
The business is run and controlled by its founder, Reimar Scholz. Mr. Scholz’s historical record in capital deployment has been an obvious success, he’s highly aligned, acts as a rational capital allocator, and has plenty of remaining runway.
What is Bavaria?
Up to this point, Bavaria’s business model has focused on acquiring non-core distressed industrial businesses from (mostly) European conglomerates for a symbolic €1. This may sound too good to be true, but these are bleeding businesses that most view as better off dead. The sellers (if you can call them that) in a situation like this often want the problem (business and related labor union) to just go away and are therefore happy to have it taken off their hands. After the purchase is consummated, Bavaria has a propensity to use assets like buildings, land, or equipment to raise cash and fund the ongoing losses with the idea of a 3-6 month “stem the blood-loss” turnaround. This usually involves tough labor union negotiations and massive restructuring which involves a lot of messy hands-on work requiring a very specialized skill set along the entire process.
Turnarounds are hard and historically Bavaria has had almost no success in revenue turnarounds. Bavaria has long-held the belief that there is consistent overcapacity in industrial businesses, so taking market share and growing revenue is a very tough (and costly) strategy. Therefore, nearly all the turnaround comes in margin improvements and cost restructuring. The typical deal is structured as its own legal entity with very little and preferably no recourse to Bavaria. If the purchased company cannot be saved, it’s shut down.
With that history explained, Bavaria seems to be shifting their business toward owning higher quality businesses via the public markets. Public securities now comprise a large portion of the company’s NAV, and Mr. Scholz has expressed skepticism of M&A valuation multiples and frustration toward the optimism of prospective sellers while distress remains abnormally rare in today’s world. I presume Bavaria will return to its bread and butter of distressed investing when distress and pessimism return to global markets. In the meantime, they are heading into a competitive environment in publicly traded securities – though I happen to like their current equity book (a lot).
The idea here is simple. It’s a jockey bet. We are buying Mr. Scholz’ portfolio at 80 cents on the dollar and paying nothing for future value creation. There is no moat in a private equity business of this size and I expect 100% of the return will be from ongoing execution. At today’s price, we have a €70 million cushion in case something goes terribly wrong. In past letters, Mr. Scholz has repeatedly pounded on the idea of protecting the downside above all else. If he can do that, it should be difficult to lose money over the long-term.
**This is not investment advice, nor was it ever intended to be. Simply musings. Do you own work and verify your own numbers and make your own character judgments.**