Groupe Cofidur: Simple Value or Corporate Governance Time Bomb?

Groupe Cofidur is a French electronics contract manufacturer that has low valuation multiples, strong balance sheet and good profitability. At first sight the case seems pretty simple:

Valuation multiples:

Valuation

Financials

As seen from the table, the company is profitable, has high ROIC and there is no clear trend down on revenues or profits:

Income statement

The business produced lot of FCFF over last five years (16,7 MEUR), especially compared to market cap (14,7 MEUR) and EV (13,8 MEUR):

FCFF stement

The FCFF was used mainly to pay down debt:

FCFF use

The aggressive debt payment has changed Cofidur’s balance sheet quite dramatically to net cash positive:

Balance sheet

As there is no clear trend up or down in the business, the last five year average profit might be good predictor of the next five year’s average profit. If so, then valuation at about book value seems realistic, because the ROIC>WACC.

Assuming rerating of the valuation multiple from the current P/B 0,7 to P/B 1, and the current profit level, the IRRs would be more than satisfactory in up to five-year time frame:

Forecast

If the multiple would rerate in one year the IRR would be 60 %, and if it would take five years IRR would still be 17 %.

Time is friend of the wonderful company but valuation of the mediocre. In Cofidur’s case, the problem from return perspective would start only if the rerating would take more than say six years.

The IRR forecast is based on assumption that the future profits stays at the current profit level and that the management uses the subsequent cash flows on NPV+ projects and respects minority shareholders. Is there reason to believe otherwise?

Business

Biggest sources of trouble in electronics subcontracting are customer and product concentration. These especially in case of fast products cycle products like consumer electronics.

Cofidur attributes 41 % of revenues to “industrial and professional” sector, 37 % to “LED” sector, 24 % to “aerospace and defense” sector and 18 % to “after sales service” but there is no details of exact products or customers.

chiffres-2016-anglais

It’s difficult to say anything conclusive of the potential customer and product risk based on the data available. The price below NCAV implies quite a lot of pessimism towards Cofidur’s future so watching this case from Nordics as non-French and non-French speaking person raises serious questions what I might be missing?

From the data it can be inferred that Cofidur is likelly to have at least three customers in three different sectors, but it could also be more given the variety of “extensive experience” the company sites:

a) Aerospace and defense sector: calculators, guidance systems, munitions and missiles

b) “High volume” industrial and service sector: digital set-top boxes, broadband modems, payment terminals and gaming terminals

No more than three customers would risky but one would be even worse. For example Finnish electronics subcontractor Elqotech went bankrupt having served only Nokia, while other Finnish subcontractor like Scanfill has survived for decades with more diversified customer base.

Is there contracts coming to end or customers moving their production from France to lower cost countries, that locals living near the manufacturing plants (which are probably close to the main customers) would know?

One might speculate that the aerospace and defense related products are more complex and longer product life cycles and thus that the customer relationships are more deep and longer term in nature than in the “industrial and professional sector”, which probably refers to the simpler and shorter product cycle “high volume” set-top-boxes and modems.

One might be also totally wrong and all contracts end tomorrow. But since the company has been in business 30-50 years (there are mixed data at the website) perhaps the conclusion is that the company knows how to manage product and customer risk.

The answer to the product and customer risk is quite impossible to know with my available resources, and it might be insider information anyway, but as seen from the IRR table earlier, if the risks won’t materialize, and the business continues to hum along at the historical pace, the returns should be quite satisfactory.

And good thing for portfolio investors is that if the company doesn’t diversify its risks the investors can do it by himself.

Management

As there is no evidence of the business dying soon (at least I don’t have it), and the balance sheet is strong, the only potential problem left is the management.

Cofidur’s main owner is EMS finance with more than 50 % of the shares.

EMS had about 11 % ownership but became the 50%+ owner in 2009 during take-over attempt by Eolane Group, after first declining the take-over offer and then using their “right of first refusal” option in shareholder agreement with the other two big owners at the time (ESCA and Calyon), who did accept the take-over offer:

Since then, Cofidur’s capital allocation seem to have been quite savvy:

2011 Bought back 8 % of own shares @ EUR 160 /share (vs EUR 380 / share market price and 556 BPS today) in big block trade

2011: Sale subsidiary Techci which was loss making in 2009 and breaking even in 2010

2011/2012: Closure of one factory in subsidiary Cofidur PM which had about 3,6 MEUR net loss in 2010 (vs. ~2 MEUR net profit for Cofidur in 2016)

2013: Buyback of 2,5 MEUR par value convertible bonds @ 1,3 MEUR (almost 50 % discount)

2011-2016 reduction of debt by 13 MEUR

+ paid dividends every year

As a result, Cofidur turned around and started to make a profit, it only has subs that have more or less always been profitable (at least back to 2009, last year I checked), it has net cash position and significantly reduced share count (purchased at bargain prices).

There are few negatives though:

1) Last year management reverse splitted the shares so that each 200 shares became 1 share.

If I did understand this correctly, if you didn’t have the full amount of shares the broker automatically sold the non-full amount to the market.

Basically it was thus possible that you lose some value, especially for small investors.

And the reason for the potentially bad deal for minorities was bonkers; desplit because “high volatility of the stock” and to “stabilize the long-term ownership” of the company????

2. The era before EMS became the main owner and the old main owners (Caylon and ESCA) left (2001-2009) is really hairy including at least accusations of looting the company by somebody and issuance of LOT of warrants and other complex transactions for someone else, where EMS seem to have been involved somehow (EMS people seem to have been in management roles of Cofidur from at least early 2000s).

The French is so difficult that I cannot get my head around if the transactions were fair for minorities.

While the last nine years has been good for shareholders and the dividend payment implies that minorities get to share the fruits too, I would not be comfortable in taking big position in a stock if there would ever had been clearly unfair activities conducted by the controllig shareholders.

If there were problem though, I wouldn’t think the current owners would have left all 20 year old documents (annual reports and stock exchange releases) for everybody to read today, so they seem to be OK what’s in there.

Conclusion

Cofidur is profitable, dividend paying company selling under 5xEBIT and below NCAV and 0,7x BV. If stock rerates to P/B 1 in few years IRR will be satisfactory.

The problems are customer concentration and potentially, but not verified, corporate governance problem. The first you can diversify but the latter you would preferably avoid.

Currently I’m long the stock with 3,7 % position but feel that with my portfolio size it’s too trivial to matter. While having the “starter” position, I’m trying translate the 2001-2009 finacial reports to find out the history of the current main owner.

If I get green light I would be willing to at least double up the position but potentially even go up to 10 %. If I blow up before that, at least it was good practice for my first French class I’m having (half way through).

Disclosure: Long Cofidur with 3,7 % position

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4 thoughts on “Groupe Cofidur: Simple Value or Corporate Governance Time Bomb?

  1. Great in-depth analysis, thanks! Not much to add, if they cont. to generate cash it has to go somewhere (let’s hope 2017-1 was due to seasonality). Did you find anything about off-balance leasing? They don’t seem to own their factories according to my “French” :-)

    Liked by 1 person

    • Hi, the operating leases are on my checklist but seem to have forgotten to check it, ups. Substance over process lol, but I have read all the notes and don’t remember mentions of operating leases. The alternext reporting is not very strict though. I let you know if I come up with more information.

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  2. Thank you for a very interesting read.

    I bought around 370 for the quantitative reasons you also mention (below NCAV, Enterprise Multiple< 5, paying dividend and satisfactory growth in shareholder's equity over the years. I hadn't done qualitative analysis so thanks for providing that! Makes me a bit more worried than I was about the position.

    My idea was to hold until NCAV (currently 470-ish I reckon). The stock has traded close to NCAV as recent as January 2017 and before in 2015 (it closed the year close to NCAV). As far as book value … my first impression was this stock hadn't traded at full tangible book since 2008 (as far as I went back) so that didn't seem very likely to me but on closer inspection I guess it trade at (what was at the time its) book value during a brief price spike in April 2014. Still I'm not sure I would count on this getting all the way to book within a reasonable time frame. If they continue to grow book at 10% a year while we are waiting maybe you have a point.

    Do you have a special reason for anticipating (hoping?) a close between price and book rather than the more likely appreciation of price to NCAV?

    Regarding the debt, what do you expect them to do given that debt is now below 20% of assets. Build up a large cash reserve, increase dividend, something else? Reducing the debt to zero would only raise their WACC at this point without much further benefit or am I missing something?

    Thanks again for an interesting article.

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    • Yeah, I agree with your thinking.

      I don’t have special reason to believe the stock reaches book value, other than in private transactions that would probably be the minimum any transaction would occur. So the value is there, but capital allocation and low dividends and possible corporate governance problems keep the price low, currently,

      Re the debt/cash, I don’t have specific expectations for it. Typically when cash starts to be big part of the value there is some kind of corporate action, acquisitions or special dividends.

      The acquisition card is interesting because in essence “over capitalized” balance sheets (i.e. big cash positions) has embedded “hidden earnings power” as the cash (+ potential new debt) would be converted to productive assets.

      But if the cash is just left there then it’s just unproductive asset which of course deserves discounted valuation.

      In netnet prices there is implied assumption that the corporate assets are not and will not be in productive use and thus the discounts.

      On surface it always seems plausible assumption, but statistics show that on avarage that’s poor assumption with netnets.

      The problem with netnets is that you really don’t know in which ones are the good ones and thus you must go with diversification so the (few?) random good ones’ performance can more than offset the underperformance of the random bad ones.

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