‘De la discussion jaillit la lumiere’ … about good discussion and foundational investments.

As stated so eloquently in our disclaimer “The Thoughtful Arbitrageur” is not an investment advisor and you should not be seeking investing advice from a blog. We are attempting to inform, sometimes amuse,and hopefully give you the benefit of our fortunate experiences. Our subject this week is Bollore Group.

Our belief is that a sound portfolio is grounded by a core of strong fundamental holdings such as Bollore. Bollore is the type of equity that can anchor a portfolio for many years. Around these investments could be an array of various strategies designed to take advantage of a particular trend. Still you must seek, and go long, keystone holdings. Just as a good wine cellar requires everyday table wines combined with the more rare harvest.

One other caveat before we move on: Our ideas may not always turn out as anticipated. Still, we believe that our thesis leading to them is always well-thought-out. A smart investor could use our concepts in three ways: Agree with it, despise it or embrace the logic and find a similar play. For example, it is akin to informing a sommelier that while you agree with his recommendation of a California Pinot Noir, you would rather choose another label. In this way, you will derive the most benefit from our private communiques.

Bollore Group was founded in 1822 and is one of the 500 largest companies in the world. The company employs over 28,000 and is listed on Euronext in Paris. It is controlled by the Bollore family and is dedicated to freight forwarding and international logistics,with a focused interest in Africa. Among its other pursuits are fuel distribution, plastics, batteries, super capacitors and electric vehicles. Bollore also manages a number of financial assets including plantations producing rubber and palm oil. Finally, the company has media, advertising and telecommunications interests. This by virtue of its 28 % stake in Havas, 29% stake in Aegis PLC,and 90% interest in Bollore Telecom, a French WiMax operator. Media, Wi-Fi and battery-powered cars are the more sensational parts of the Bollore story. Nevertheless, it is logistical services and fuel transportation, especially on the African continent, that is the raison d’ĂŞtre of Bollore. Those comprise more than 95% of its revenue base. Started in 1927, Bollore controls the largest integrated logistics network in Africa. It is present in 43 African countries, with more than 22,000 employees and 8 million-plus square meters of offices, warehouses and container yards. To say that Bollore is the heart that pumps the commercial blood throughout Africa may be an understatement. Although we love the idea of diversifying into media for the influence it affords, and electric cars as a concession to green technology, make no mistake this is a logistics play. If you agree with the notion that these folks know something about a trade that they have plied for almost 90 years, and believe in the future commercial prospects of Africa, then this is your stock.

Let’s swirl this around our glass and take a look at the overall numbers. Bollore has a quite reasonable price-to-earnings ratio in the 9 area. This compares admirably with other stocks of its kind that trade at almost double that ratio. Its price-to-book is in the 0.8 range; again, half as much as the norm. The company pays out a near 2% dividend and traded at €157.85 (about $206.21) per share as of Jan. 20, 2012. It has traded recently as high as €178 and seems to be unfairly victimized by the entire European contagion. There is quite a bit of upside. Bollore has a market capitalization near €4 billion and has a great deal of potential. You should be aware that it is very thinly traded. This is why we see it as a vastly unrecognized long-term play of the buy-and-hold category. Patience will definitely be a virtue with this investment.

We feel that given its enormous natural resources, as well as its room for growth, Africa is the financial story of the next global economic period. While Africa has experienced disturbing incidents such as the civil war in Angola, and the more recent war in Darfur, the number of armed conflicts has steadily declined. Given more prominence to political associations like the African Union, which promotes peace and advanced living conditions in the continents’ poorer countries, Africa can realize its tremendous potential. There are, of course, obvious impediments to investing in Africa, not the least of which is finding the proper vehicle. However, Bollore offers the astute investor a sensible way to enter the region.

The management story is intriguing. Through numerous holding companies, the Bollore family controls the voting power. There is certainly no agency risk in this investment, as the family’s providence is tied to your interests. Led by scion Vincent Bollore, it is leadership reminiscent of traditional European dynasties that have ruled and guided that continent for generations. Vincent Bollore has proven to be a sharp, intuitive and aggressive manager. While in some instances family leadership may be a detriment, in Bollore it is a powerful asset. He is also a comic book aficionado with an extensive collection and we like that type of whimsicality. His guidance is all the more reason to favor this pick.

Thus, our latest choice—a precious French vintage that would sit proudly in your vault: Le Group Bollore 2012 .

Au Revoir,
The Thoughtful Arbitrageur

Edward Strafaci is not an investment adviser. Nothing he writes should be construed as investment advice or an endorsement of any particular security. From time to time, a family trust with which he is associated may have positions in the securities he writes about. When it does, he will tell you. What he writes is meant to inform and in some cases to entertain and amuse. HedgeWorld’s Alternative Reality is not an investment advisory site. As a general rule you should not take investment advice from blogs, anyway. Consult a financial professional for investment advice, not a blog.

A colleague suggested that I read Daniel Kahneman’s Thinking, Fast and Slow as a way to explore the wiring of our minds regarding decision making. I was not disappointed. Kahneman is a former Nobel Laureate in Economics. His work is the progeny of other pieces, such as “Freakonomics,” which studies the human psyche and how it makes choices. Kahneman’s current best-selling book centers on the two systems that regulate our thought functions and the way we evaluate our life alternatives.

System one is mainly structured around our intuition. It is reactionary, and an amalgam of our own collective experiences, as well as what is naturally wired in us as human beings. Think of it as the brain’s RAM adjusted for “fight or flight” and modern social convention. System two is a more careful, analytical engine that allows us to give greater thought to our everyday selections. It is described as the system that basically “looks, before it leaps.” It is an arrangement of gray matter that serves as our arbiter, giving finality and concentration to our beliefs. While this may not be the first time an economist or a psychologist has written about such competing methods, Thinking, Fast and Slow serves as a tour de force that delves into the innumerable ways that we choose.

This book is essential reading for anyone, though it is especially salient for the money manager. One of the keys when making financial decisions is to eventually review one’s investments post mortem, so to speak. A work like this explores the different avenues that affect our predilections. For example, Kahneman suggests that we tend to frame our risk set based on factors such as loss aversion, more recent experiences and stereotypes or biases. In one instance, he writes about investors who tend to flock to stocks that have been in the news. He also addresses our insistence on selling “winners” while hanging on to losing investments in the hope of recouping our losses and damaged egos. Ultimately, what Kahneman advocates is a cold, hard look at our own body of work. How much of our success is due to true insight and hard work and how much is luck? After all, as we have already suggested in past articles, an approach that favors securities with real value, or arbitrage possibilities, consistently works in the long run. This discipline requires a certain degree of focused analytics and not the good fortune that trends or momentum rewards. Granted the old saw, “it is better to be lucky than smart” or “you can marry more money in an hour than you can make in a generation,” still apply. Nevertheless, it is still important to rely on a cerebral algorithm that tests assumptions, without prejudice, and adjusts for noise due to presumption.

More fascinating still, is Kahneman’s view that we set many of our choices around our own narrative. A storyline that is based on a plot we continually write for ourselves. In this way, we lend a halo effect to those options that resonate with who we want to be, or what we aspire to. We tend to overweight candidates that are attractive to us, rather than ones that are fundamentally sound. In fact, it clearly reminded me of the central premise behind Michael Lewis’ much acclaimed Moneyball. In Moneyball,baseball’s general managers and scouts preferred ballplayers that had a “pro body,” Players who compiled statistics that qualified them, yet with the additional benefit of looking like Mickey Mantle. Lewis’ protagonist, Oakland A’s general manager Billy Beane, upends this technique by using statistical analysis to choose players when drafting. His legacy is a team that saw relative triumph on a meager payroll while competing with payroll giants like the Yankees. To Kahneman’s credit, he concedes that talent and good looks should never be ignored; however, we must stick to the numbers. I apply this to the latest fascination with certain “black box” theory which has proved time and again to eventually run its course. It seems the Warren Buffets of the world win, where others do not, by considering all aspects of a trade using a strong dose of reality. In essence, that is what Thinking, Fast and Slow endorses, and I find it hard to argue with that line of reasoning.

Kahneman allows for the intangible and non-analytical, and that is what makes him special. He gives discourse on the great benefit of optimism which runs contrary to his thesis. Optimists tend to get over failure much quicker than most and is what makes them valuable entrepreneurs and creators. Optimists sometimes ignore the obvious risks. For instance, it was Edison’s insistence on trial and error that brought us the light bulb. In Thinking, Fast and Slow, we see that reality takes care of the constant concerns while optimism and originality inspire greatness.

It would be too exhaustive to explore all of the circumstances that this tome uses to describe our inner workings. Suffice to say it has been selected for many “must read” lists and justifiably so.

The journey one makes with Kahneman is that of reflection, and a contemplation of our brain’s flow chart. It definitely belongs on every serious investor’s book shelf. It should be read and re-read, and applied to our judgments, both in the financial arena and beyond. Having said that, it is also an entertaining and thought provoking read—and you may learn something, despite your inner tendencies.

Thinking, Fast and Slow, by Daniel Kahneman. Farrar, Straus and Giroux, Publisher.

One more thought….

At the risk of lavishing you, we will give you some additional food … or coffee … for thought. Another stock which has been a great performer and still has some real potential, is Starbucks (SBUX)—$47.36 last sale, as of the close 1/13/12. From a fundamental standpoint, you might shy away seeing that it sports a price-to-earnings ratio of 29 and is at an all-time high, stock price-wise. However, you cannot ignore the fact that the company’s marketing strategy during this economic crisis has been brilliant. Walk into most, if not all, of its stores and what you see is a modern day agora or town square. Starbucks produces a great product, and for a few more dollars the customer gets the illusion of pampering and exclusivity. More important is its successful foray into loyalty, or “frequent flier” cards. Combine this with a real presence in social media, and you have a sustainable growth formula that speaks to today’s economy. Of course, we will follow up on this idea. Nevertheless, we feel there is more upside here. For the faint of heart, take a look at the July Call Option Series struck at, or above the market. As for us, we will take ours plain, no sugar and go with the common.

—The Thoughtful Arbitrageur

Edward Strafaci is not an investment adviser. Nothing he writes should be construed as investment advice or an endorsement of any particular security. From time to time, a family trust with which he is associated may have positions in the securities he writes about. When it does, he will tell you. What he writes is meant to inform and in some cases to entertain and amuse. HedgeWorld’s Alternative Reality is not an investment advisory site. As a general rule you should not take investment advice from blogs, anyway. Consult a financial professional for investment advice, not a blog.

The Thesis:
It is no secret that the history of these two automotive titans has mirrored that of the country’s industrial production history. They were once global economic standard-bearers who were eventually crippled by a combination of bloated overhead, unmanageable benefit obligations and intense foreign competition. However, after the pain of a strategic bankruptcy for GM and much-needed balance sheet and organizational reform at Ford, these two former heavyweights are clearly in shape for a comeback. To that end, we view both companies as core holdings. As we implied in our introductory piece, “man does not live by straight equity investments alone”, and this idea is no different. One of the secrets to successful professional investing is to review the balance sheets and options chains, for the most efficient way to take advantage of a solid concept. We will do that here. We will also follow up on this play in future pieces until we feel that the sector is fully valued. This is the way that investors like Buffett operate, why shouldn’t you? Take a core holding and extract as much value out of it as possible using a combination of income producing and equity investments focused on a theme. Our first step is considering these companies fundamentally, let’s have at it.

The Numbers:

Much has been written about the GM bankruptcy and the Ford restructuring. However, the bottom line is that these events created dramatically competitive valuations for both of these companies. This is due to a reduction of debt and more manageable benefit liabilities, combined with a focused and greener product lineup. Price-to-Earnings ratios for Ford and GM using reasonable 2012 forward-looking estimates come in the 6x to 7x range . That compares most favorably with about 14x for the S&P, and 11.85x for the Consumer Discretionary portion of the index, and therein lies the greatest rub: With any type of reasonable growth projections, the potential is here for significant profits as well as decent down-side protection. Without getting ahead of ourselves, the potential is here for at least a double.

A nagging concern for both companies’ has been significant debt woes. Consequently, it is also important to look at their EBITDA numbers versus their Enterprise Value. In Ford’s case, it is in the 3.5 range and for GM post-bankruptcy a scant 1.7 multiple. This gives both auto makers plenty of wiggle room for debt payments while providing for future growth. We cannot ignore Ford’s $20-plus billion in cash and the restatement of a 1.7% dividend. We expect the payout to grow given the Ford family’s previous penchant for a recurring and healthy dividend. GM’s cash position stands at a solid $30-plus billion and the company has given its investors more positive guidance on its unfunded pension liabilities which has always been a sore spot for it.

Given any type of important financial metric (Price-to-Book Value, Price-to-Sales or Price-to-Cash Flow) these producers are valued more like entities in a developing country rather than the U.S. Given their strong fundamental position we see them as solid long term plays. Yet, before we fall in love with these numbers, we need to keep in mind that they are in the business of selling cars. With that in mind, let us take a look under the proverbial hood.

The Skinny (A practical look):

Turnabout is fair play, and the domestic auto makers are retaliating with some of the same tactics that were effectively used against them over the last few decades. Granted, both Ford and GM created their own bloated overhead structures. It was their failure to respond to more product-concentrated, efficient competition that caused them to lose significant market share. To that end, both producers continue to bolster and market their formidable Truck and SUV platforms which have always been their strong suit. They now hold a commanding share of the market according to the latest statistics. However, it is in the family and luxury sedan segment that both players are poised for improvement. Collectively, they sold more than 1.5 million cars last year, lagging the combined efforts of Toyota and Honda. In order to increase that share, Ford is unveiling a newly re-designed Fusion at this week’s North American International Auto Show. The design has wowed critics, and is more along the lines of European-style luxury; it can be a game changer. Along with the rest of its lineup, its current version of Fusion and the Fiesta Ford are well positioned for worldwide reach. Reports are that these cars are responsive and fun to drive, perhaps finally passing the Accord and Camry.

GM for its part will introduce a Cadillac compact model that should compare favorably with the BMW 3-Series and Mercedes C-Class vehicles. In fact, Cadillac has seen resurgence with its more youthful profile and is ready to take aim at the foreign luxury producers. Cadillac has lost out over the last few years, ranking fourth in the U.S. behind BMW, Mercedes and Lexus. With the perception of an ultimate lower cost of ownership combined with better resale value, it may finally appeal to a sophisticated clientele looking for more value and not the 70’s “Dadillac”. Finally, offerings like the Malibu have won numerous awards for buyer satisfaction in its category. Chevy’s Volt, The 2011 Motor Trend Car of the Year is ready for a breakout. GM feels that the battery problems it faced are in check and the Volt is ready to roll. Another winner for GM has been its Cruze. On the whole, Detroit has decisively gotten back in the game.

Just as important is the Detroit automakers’ push in the developing BRIC countries. GM holds a leading market share in BRIC countries and sold 2 million vehicles in the rapidly developing Chinese market. If you are looking for future growth, this is where it will come from.

The reality is, that given GM’s and Ford’s reasonable valuations and stronger balance sheets, just remaining competitive could yield significant returns as their equities reach more normal Price-to-Earnings ratios. If in fact they become more dominant, this could turn into a home run. Keep in mind that global growth concerns and rising commodity prices are an issue that may delay growth. That is a good reason to seek yield from these investments, a subject we will now address.

The Play:

Let’s start with Ford. There are a number of Ford bonds outstanding with generous yields. For instance, you can take a laddered approach by combining investments on a shorter scale with longer ones. Take the Ford Motor Credits 8s of 2016 or the 6.625s of 2017. Both issues offer yields to maturity in the 4.375% range. Combine this with a longer maturity found in the 6.375s of 2029 which pay 6.175% and are a direct obligation of Ford. A 50% split in these durations will offer a 5.375% yield with an approximate 11-year life. It should also be noted that there are many Ford issues outstanding, so the professional buyer should look around the bond showroom.

Next, you can combine your Ford bonds with some common stock, thus creating your own homemade convertible security. For every dollar invested, you can split it 60% bond and 40% equity. In this instance, you will sport a yield close to 4 % [(5.375 in the bonds x .6) + (1.7% dividend yield in the common x .4)] with 40 % of the upside in Ford. Ultimately, you can adjust this position by adding or selling the common as you see fit. We would advocate using the stock to adjust your exposure, as the cost in the trading spread of the bonds would erode your potential profits.

As a finishing touch, calls or puts can be written against the position. An example would be the June of 2012 listed call options struck at 13 for 56 cents with the common at the 11.86 level. Do this twice in a year and you have added almost 10% to your common yield, allowing yourself to be called away at the 13.5 level. Again, we will follow up on this. Nevertheless, you have enough tools and fuel for thought to make a complete investment.

Now we turn to GM. For the present, we love the GM mandatory convertible preferred B trading at 38.25 versus approximately 23 in the common. This security pays an annual dividend of $2.375 yielding 6.2% as opposed to zero in GM. Mandatory means that you must convert to common by December1, 2013, at a rate to be determined at that time using the following formula:

If GM trades at $33 or less, you get 1.5152 shares of the GM per preferred share

If GM is $39.60 or above, you get 1.2626 shares of GM per preferred share

If GM is between $33 and $39.60, the number of GM shares you get is $50 divided by the price of the GM.

What we essentially have here is the common with a short call when GM hits 33 and a long call when it reaches 39.60 yielding over 6% until late next year. In other words, you will participate in GM’s gains until $33, hit a dead zone, and participate again past $39.60 until December 2013. In return, you receive a 6.2% yield.

To sum up, we would at this time combine the above investments in a 50/50 capital split giving the investor a static yield of around 5% with some decent upside. As a long-term play, you can adjust these positions accordingly or … for the meat and potatoes crowd … just trade the common stocks of each. Again, like any good trader we will update you as we move down the highway.

In Summary:

We view both Ford and General Motors as firmly undervalued ways to participate in the next phase of the domestic economy, a period that will emphasize efficiency and competitive technology. While it may take time for the markets to recognize the value presented here, the yields offered on these investments reward your patience.

One closing thought is that a smart financier kicks the tires, so to speak, when given the chance. Get out of your office, put down the HP12 and go visit a few dealerships this weekend. Even better, spend a few dollars and rent some of the vehicles mentioned. After all, this is a long term play on America’s and hopefully the world’s fascination with two storied brands.

Happy Motoring.

—The Thoughtful Arbitrageur

Prices quoted are as of mid-day, Jan. 9.

Edward Strafaci is not an investment adviser. Nothing he writes should be construed as investment advice or an endorsement of any particular security. From time to time, a family trust with which he is associated may have positions in the securities he writes about. When it does, he will tell you. What he writes is meant to inform and in some cases to entertain and amuse. HedgeWorld’s Alternative Reality is not an investment advisory site. As a general rule you should not take investment advice from blogs, anyway. Consult a financial professional for investment advice, not a blog.

Allow me to introduce myself as a new contributor to Hedgeworld. I am a former chief investment officer and hedge fund manager who was responsible for more than $5 billion in assets. My areas of specialty included Convertible, Merger and Options Arbitrage. I also managed high-yield and high-grade fixed income, as well as various types of equity investments, both domestically and globally. I managed these products in private partnerships and mutual funds. My name is Edward Strafaci.

In this column we will not only explore ideas and make recommendations, but also learn the various complexities of investing in the arbitrage, fixed income and equity space. For too long investors have been “force fed” a diet of ideas that are long in verbiage but short in substance. What I prized most as a manager, receiving a sales call, was a concept grounded in a mathematical reality. To that end, when we present an idea, we will sometimes include a quantitative analysis that the user can accept, learn from and possibly adjust to his or her projections. In this way, even an amateur investor can eventually see the investment world through the eyes of an accomplished hedge fund manager.

On a Global and Domestic scale we will cover:

Convertible Arbitrage – Convertible securities have always been a fertile area. We will offer opportunities, as well as tutorials, on the different methods used to analyze and model these sometimes confusing but rewarding creatures.We will help you understand this hybrid and the many uses it has in the today’s portfolio.

Merger Arbitrage – Merger or takeover arbitrage has fascinated financiers since the first corporate takeover. We will thoroughly study this discipline using probability based analytics. The risks addressed will include, but not be limited to: antitrust, financing, timing and the personalities of the executives who are vital to the deal. This will be both useful to our usual audience, and occasionally to an investment banker. To understand M&A is to understand the economic underpinnings of our capitalist system, it can also add a solid non-correlated return to a portfolio.

Options Strategies – Understanding options and their inherent value lies at the heart of modern finance. It is with this in mind that we will describe and utilize options strategies as part of an overall perspective when presenting an investment choice. Options modeling affects every derivative strategy employed. Options, like medicine, can offer incredible solutions or devastating consequences. The in-depth discussion about and knowledge of the options market will play an important role in our research. When suitable,we will integrate options strategies into our advice. We will also demonstrate to the user how macro derivative valuation plays a part in many investment themes.

Equities – If there is one thing that investors like Warren Buffet know, it is that finding fundamentally undervalued securities works when seeking profits. When combined with an arbitrage play, these situations have the potential for solid profits with low downside. We believe the intersection of fairly priced equities offering arbitrage opportunities present an excellent place for one’s capital. Besides traditional fundamentals, we will also be evaluating a security’s volatility, beta, dividend policy, momentum and where it sits on the value-growth continuum. These are factors that confirm a good investment and offer a chance for proper diversification.

Fixed Income – At the end of the day, bonds are nothing more than tradable loans. We will investigate high-grade, high-yield and municipal fixed income choices. We will assess the creditworthiness of a company or country, and whether its credit rating actually reflects the yield offered. When applicable, we will also comment on the cost of credit default swaps. In this way, our core ideas will reflect what we feel is the optimal approach for capitalizing on a prospective outlay.

Ultimately we will tie these ideas to a framework that speaks to the fact that investors, as well as consultants, have to deal with the administration of an account or even a firm. From time to time we will talk about dealing with various types of sales calls, prime brokers, the administration of capital, operations and the myriad rules, regulations and tax situations. We will also include primers that review basic topics essential to Finance. For instance,the proper accounting for a return on an investment that considers expenses, taxes, present value and variance is not just thorough but essential in today’s competitive environment. Often, in the heat of battle, some of these components are ignored.

Lastly, I should mention that I have more than 30 years and billions of dollars’ worth of investing experience. Unfortunately, I encountered my own regulatory issues a number of years ago. I made a few bad choices in an otherwise good career, and it cost me. From this experience, I want to share with the readership the pitfalls of acting too cavalier when doing business. I also want to offer insight into how to avoid a potential problem. The care of your or another’s assets should be handled with extreme caution. Regulations must always be adhered to in the fullest. Sometimes what seems clever is downright wrong. It is from my error that I wish for you to learn, help detect, and avoid potential complications and trouble.

These are just some of the areas we will touch upon. We will grow and adapt our conversation to the ever-changing market place. We will sometimes be dead-on accurate, and sometimes not. However, I promise it will be a fun and rewarding journey that we will take together, in the hope of leaving no investing stone unturned.

Edward Strafaci is a principal at a web consulting/transmedia company and teaches college-level finance. He also writes a personal blog, whatasmartguy.com.