Value Ideas Blog
3U Holding AG – “a puff left”?

So, is there “a puff left” now?

In order to answer this question we need to take closer look into the structure of 3U Holding (3U). As the name suggests, 3U Holding holds a series of stakes in other companies. Benefits of this approach include synergies in terms of purchasing, facilities, legal, accounting and business administration, plus the possibility to add up profits and losses, and so save taxes. However, as blog readers have already commented rightly, the overhead costs for management and shared central functions are significant, i.e. roughly 3.5 million per year (0.10  Euro per share per year). Now, to get a clue about profitability, unfortunately the holding level reporting is of limited use. Hence, we have to take a deep dive into the details of the subsidiaries. The annual report from 2012 reveals on page 88 and following some details on the participation structure and earnings that we use as a starting point for our short analyses. Apart from three so called “joined ventures” and one minority stake, we find the following table of fully consolidated subsidiaries: 3U As we can see, 19(!) out of 25 subsidiaries make losses and only 6 earn money; 2/3 three joint ventures and the minority share lose money as well.   Obviously, management has started the typical cost cutting exercises and layoff programs, but that is more like common sense and cannot solve strategic problems. So, we ask the question: Can those businesses be profitable in the long-run?   To answer this question we cannot avoid to bother the reader with details of the main components of 3U Holding‘s investments.  

Telephony Segment

  For tax and legal reasons a series of companies have been founded, but in essence they are doing three things:
  1. Resell voice, typically via “Call-by-Call”
  2. Wholesale SMS
  3. Rent the space of 4 data centers
  Giving the fact that the transport of voice over the Internet (VoIP) in excellent quality only takes 0.064Mbit/s, the success of Skype and the like, plus the presence of flat rate tariffs, it should be clear that there is no future in reselling voice. The same holds basically true for SMS and the text message industry. Finally, renting data center space is a commodity business with low margins and big national players, e.g. Strato, that have cost advantages, because of their scale. However, long term rental contracts for data center space could be a stable income nonetheless. So, to conclude for the segment Telephony we do not expect sufficient profits in the long run.  

Services Segment (3U Dynamics, RISIMA, WeClapp)

  As 3U Dynamics has stopped operation in the meantime according to company information, we can concentrate on the remaining two.   RISIMA is a growing information security consulting, but – as with all pure “people” businesses – costs grow equally, and hence we cannot see, how RISIMA will can make a significant profit contribution in the long-run.   WeClapp offers cloud service and has incurred the biggest losses of all subsidies in 2012 (-1.884.000 Euro or -0.05 per share). Why do we believe that this is not a surprise? Firstly the cloud market is very crowded and highly competitive. Players are reaching from global brands (Amazon, Google, salesforce.com etc.), local niche players (ScopeVision) down to free open source tools like OwnCloud! Secondly, big channel partners like 1&1 and T-Systems are in strong competitive positions and thirdly customers are still reluctant to accept offers due to security concerns. Hence, we do not see how WeClapp can survive in this environment.  

Renewable Energy Segment

  EuroSun (-1.270k Euro or -0.035 per share) is building solar heating devices that are installed on roof tops and that help to produce warm water. Due to heavy subsidies for competing photovoltaic installations, the market has remained relatively small. Moreover, a mayor brand for heating systems (VIESSMANN) has grabbed the biggest share, so that we do not see any chances that EuroSun can become profitable.   Climalevel manufactures multi-functional floor coverings that provide heating, cooling and ventilation at the same time. As a patent product, which is already profitable we see interesting opportunities for profitable growth in the future!   Selfio is an online shop for do-it-yourself floor products. The main product is a floor heating system that is comparably cheap and easy to assemble. Although the online do-it-yourself market is expected to grow, competition can be expected from large DIY-stores driving down margins. Hence, the question remains, if selling the actual product through other online-channels could be a better strategy.   The next portfolio firm, which we like to consider, is the Solarpark in Adelsben. As we saw in part one of the analyses, this market is both fully protected and fully alterable by government. As the regulation stands today it will produce annual revenues of 1.7m Euro (0.05cent/share) until 2030 at relatively low operational costs. Adding back roughly 800k Euro of depreciation to the annual result reveals a nice and permanent cash flow margin.   Finally, we like to note that Immowerker, which counted for 536k of losses, has been closed in the meantime according to company information.  

Conclusion

  At the first glance 3U Holding seems to be an opportunity for value investors.  But as much we appreciate the bargain price and the high equity ratio of around 70%, we do have to acknowledge that the company is losing money – and will continues to do so!   After significant losses in 2012 of 10.6 million Euro (0.30 EUR per share) the first three quarters of 2013 have incurred more losses, i.e. 0.12 EUR per share. Therefore it does not come as a surprise that disappointed shareholders, bloggers and even an investor protection associating have heavily and publically criticized 3U for its poor performance.   From a more rational viewpoint our strategic, high-level analysis of portfolio elements suggests that the segments telephony and services cannot be sufficiently profitable in the long run. And although some parts of the renewable energy segment could be profitable, management still would need to take bold steps to restructure the portfolio and sell off assets without profitable future. At the same time it could take advantage of the excellent equity and liquidity situation and invest into more profitable assets instead.   However, from a value investing point we rather pass on “the last puff”, as non-profitable firms remain a No-Go! Here is how last week’s quote from Warren Buffet goes on:  
A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the ”bargain purchase” will make that puff all profit. Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the original “bargain” price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces – never is there just one cockroach in the kitchen. Time is the friend of the wonderful business, the enemy of the mediocre.
   So as we are here for the long run we think that it is far better for us to buy a wonderful company at a fair price than a fair company at a wonderful price.

7 Comments

  • Thank you for your post on 3U.

    As going concern your reasoning might be correct. But in this case the crucial question is whether a change in management/supervisory board will be around the corner. There is massive pressure (including legal challenges) of a large part of 3U-shareholders for change.

    Look at Dempster Mill Manufacturing Company of which Buffett gained majority control in 1961 four years after he bought the first shares (for his partnership) and 3 years after he became a board member. In this case Buffett (together with Harry Bottle at operating level) acted as the catalyst to bring market value to intrinsic value through liquidation of major parts of the company assets as well as operating measures with the final goal to sell a then profitable remaining business to someone else. You can describe his role as a liquidator of badly utilised capital to reinvest it on much better terms. This case proved to be a very profitable investment for Buffett and his partnership investors despite the long time frame. This is why he excludes the liquidator in his statement about cigar butts.

    So the crucial question is whether there will be a change in management/supervisory board to fulfil the role as a liquidator.

    • Thank you for this comment. We fully agree with your statement!

      For you information: The current CEO owns more than 25% of 3U, which allows him – due to German law – among other important things to block liquidation, see § 262 Abs. 1 Nr. 2 AktG. Moreover, the chairman of the supervisory board is a person close to him and has been elected for 5 years recently.

      So, in essence we would not expect any change soon – despite a lot of pressure from unsatisfied shareholders.

      Best,
      Daniel

      • Thank you for your quick reply (in contrast to my delayed comment hereafter).

        From a legal point of view there is obviously no imminent change of management/supervisory board. So, I fully agree with you. Main reasons, as you correctly mentioned, are the 25% of CEO Schmidt and the election of the supervisory board for additional 5 years in 2013. Also, you correctly mentioned the 5% shareholder, Mr. Thoenes, who is close to the CEO.

        As you might know, the resolutions passed in last year annual shareholder meeting was legally challenged by a shareholder and the SDK. The judge didn’t follow the arguments either and ruled that all resolutions passed in the genereal meeting are in force. Because of 3Us articles of corporation (Satzung) in conjunction with AktG § 103 and the 25% of CEO Schmidt there is no way to change the supervisory board before 2018.

        Why could 3U probably be an attractive investment case despite the assumed dismal prospects of management change?

        Firstly, there is a chance that the “dissatisfied” (I would rather call them angry) part of 3U-shareholders presents such a large part of the companys voting rights in one of the coming shareholder meetings that not only the management (as already happend in 2013) will probably not be discharged but even the supervisory board. As you might remember the actions of the supervisory board were ratified in the 2013 shareholder meeting only with the help of the 25% of CEO Schmidt, 5% of a befriended shareholder (Mr. Thoenes) and the low presence of voting rights (<50%). So, pressure on supervisory board members will probably increase further and that will usually not boost their careers. They might ask themselves what am I doing here. They risk their reputation (if they posses one) which could have an adverse effect on their main professions. So, chances are not low that one or two members of the supervisory board will sooner or later throw down and leave. That might be a chance to bring someone in with a more (minority) shareholder friendly behaviour.

        Secondly, there is a chance that the “band” between the CEO and his loyal employees, executives and supervisory board will become fragile over time due to ongoing restructurings and layoffs. There might be a disappointed ex-employee or business partner who is not that loyal anymore. That could be an open door to receive information about management practises which were probably not in line with good corporate governance.

        Thirdly, there is a chance that the increasing pressure from angry shareholders will force the management to initiate more measures including closure/disposal of lossmaking subsidiaries, layoffs, reducing holding costs etc. to bring 3U on profitable feet. You can see the announced restructuring measures taken by the management as a sign. Another sign of the defensive or even weak management behaviour is the recently announced date of the 2014 annual shareholder meeting to the end of the summer vacation season in August (2013: end of May). They might think it will reduce the presence of (angry) shareholders at the meeting. But it will in effect propel shareholders to transfer their voting right to someone, who will vote for the best interest of the minority shareholders.

        This all might create a tendency of change, which should act as a driver/catalyst to lift 3Us market value closer to liquidation value, which is not very much below equity book value. But of course teh facts are not there yet and it is difficult to assess the probabilities without knowing the many small pieces of information. Looking from a risk-reward-perspective the downside seems limited due to the market value of 3U assets, even if some years of moderate losses are discounted.

        To sum it up, risk-reward is not that bad. Especially if you find it increasingly difficult to discover other investment cases with a adequate margin of safety in todays markets. I think 3U offers a reasonable case to be an “active” value investor with limited risk.

        Thank you again for your well written analysis you did on 3U.

  • let´s see what the pressure will cause.
    Maybe there are some further things which will appear and will cause in a situation that some people will disappear from their current positions…

    It´s a really good overview which is given in this blog.

    At the end we have to reach a change in management and in the supervisory board, the problems are there.

    BR
    akionar

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