OTE BONDS

Additional dimension to yesterday’s post.

A friend friendly reminded that bonds might be safer, which is very true. OTE has issued enough of bonds - 4 issues. One may argue that if shares look good, bonds will be whole, though Mr. Market is not voting for that at the moment.

Maturity	Size, EUR	Interest	YTM	Coupon	Price of par
2016/05	900m	Annually	23.2%	4.625%	55%
2015/02	600m	Annually	36.3%	6%	56.5%
2014/08	500m	Annually	41.9%	7.25%	60.5%
2013/03	1,243m	Annually	44%	5%	69%

Just for information purposes…

Disclosure: no position.

OTE AND GREXIT

I do not know much about how devaluations work exactly but recent beating of Portugal Telecom and Hellenic Telecommunications made me curious. 

I simply took a napkin and this is what I got. All numbers are in EUR billions.

	Pre exit EUR	Exit impact	Post exit EUR
Net debt	3.35	100%	3.35
Market cap	0.71	50%	0.36
EV	4.06		3.71
Ebitda exGreece	0.40	75%	0.30
Ebitda Greece	1.20	50%	0.60
EBITDA	1.60		0.90
EV/EBITDA	2.54		4.12
Capex	0.6	75%	0.45
EV/(EBITDA - Capex)	4.06		8.23

Even at 4x EBITDA it does not look like the end of the world. 50% devaluation may sound too much because you can hear people speaking about 30% difference of labor competitiveness between south and north. It is true that significant part of OTE (this was the former ticker of Hellenic Telecommunications while it was listed on NYSE) is fixed telco and outside of Greece it is present in countries like Romania, Albania, Bulgaria (at least they must be more competitive than Greece itself), which may justify lower multiple but as I started, it does not smell anything terminal. Additionally, DTEGY.PK (Yahoo shows that it now trades at 4.7x EBITDA) has 40% of it and the state owns 10% and has 5% put at some insane price (20 EUR) (correct me if I am wrong). Communications are like food these days, so cash flows should not go away. 

Question comes to mind if you can get it cheaper - try to imagine if you would dare buying it on the day of devaluation.

FOR BEGINNERS (PART VII)

II. c) Psychological Misjudgments (Continued)

You can find List I – Here.

List II

1. Direction of Comparison. When people view a decision as one of preference, they tend to focus on positive qualities. In contrast, when asked to sell stocks, people tend to focus more on the negative qualities of each option. It is a good idea to go through your stock portfolio routinely and compare holdings to each other and to potential new ones via buying / selling lenses.

2. Extremeness Aversion. Scientifically, this refers to context of choice (and is complemented with tradeoff contrast). In practice, when you have 2 phones to choose from with price tags of $200 and $300, the distribution is approximately 50/50. However, when you add the third option with a price of $500, $300 phone wins by a wide margin (2 to 1 against the cheapest one).

3. Preferential Bias. Once people develop preferences, even small ones, they tend to view information in such a way that it supports those preferences. Everybody heard of the first impression and brand loyalty. It can become very costly. Saying is, that people hear what they want to hear.

4. Anchoring. There is a tendency we all have of latching onto an idea or fact and using it as a reference point for future decisions. Those facts can be completely irrelevant as experiments linked personal code last 2 numbers to the price one is willing to pay for a chocolate. People with high numbers overbid 60-120% those with smaller numbers. Anchors could be previous stock price, price estimate or price trend.

5. Confirmation Bias. People are almost 2 times more likely to select information confirming rather than disconfirming their prior beliefs and behaviors. Defensiveness overweight desire for accuracy in driving a preference for confirming over disconfirming information. Such cognitive dissonance leads to rejecting new facts that are contrary to original investment thesis.

6. Rationalizing. Tendency to rationalize leads to explain by an apparently rational story: a) whatever action, even irrelevant; b) whatever event, even of unclear origin; c) whatever possible sources of responsibility (external – negatives, self attribution – positives). Everyday media finds good explanations of why market went down or up. Truth is that nobody knows the truth – we can just guess.

A CURIOUS CASE OF WIRELESS & AIRLINE CARRIERS

I started to follow a story of PCS and LEAP in 2008 and watched how they went down one from $35 to $7, another from $80 to $5. They always had a pretty good sponsorship of hedge funds, which saw value in those stocks even at now unimaginable levels. Both, of course, failed on their original projections.

The story in 2008 was based on excellent situation in “existing markets” and “true profits” masked by “new [loss making] territories”. E.g. Q2 2009 LEAP’s OIBDA (their name for EBITDA) was $192m in “existing markets” and -$54m in “new territories”. Wild imagination could have assumed that once a loss making business turns into a profit, sky is the limit and annual run rate of “OIBDA” would be $900-1,000m. Fast forward a few years and as of Q1 2012 TTM adjusted OIBDA is $582m. LEAP’s story is especially sad because it turned down merger proposal with PCS back in 2007 (1 LEAP’s share would have been equal 2.75 PCS shares or LEAP now would be worth $19.25 vs. $5 current price). Although, anecdotes float that PCS stole business plan from LEAP, in reality, based on pure numbers, it would have been much better if, in exchange, LEAP had stolen business practices of PCS (now the latter’s EBITDA is 3x larger).

Somehow, I tend to identify prepaid carriers with low cost airlines (e.g. SAVE, DTG.L, ALGT): they both ride the same long term wave of a newcomer against the incumbent’s high fixed cost and slow bureaucracy. LCCs (low cost carriers) are being pursued now by ULCCs (add “ultra”), which probably will be replaced by UULCCs. This sounds almost like textile 40 years ago when new ‘looms’ were coming every year and the entire progress went straight to consumer. [Deflection: Ch. Munger is also puzzled why there is pricing discipline in one industry (my guess is that it is uncoordinated cartel) and it’s absent in another]. I think that LCTelcoC is not a goner.  They sell commodities and give more and more of everything for the same amount of money (or even less) but there is crucial difference in the industry structure (both are oligopolies, btw) – barriers to entry are much larger for telcos (money, license, spectrum). In any case, low cost carriers in both industries are doing ok.

Can They Remain Cheaper & Make Money?

The story goes that PCS/LEAP have (i) newer more efficient equipment without legacy cost, (ii) unlimited and prepaid model is inherently cheaper to operate, and (iii) prepaid is slowly eating into postpaid in the entire world. Their services are 2x less expensive than postpaid plans of major carriers. Of course, that service is not the same (there are plenty of horror stories about any LCC service on internet) but, for a price junkie like me, such things leave impression. Chart below provides good illustration (it is taken from PWC annual survey - Link). PCS & LEAP are both small carriers with revenue <$5b.

Back in 2010, I was fascinated by a slide from PCS presentation. That was the first time when I purchased it @ $5.61.

Can you imagine having price per minute, which is lower than your competitor’s cost? You must be killing them. I was puzzled all this time.

<$5b carriers clock almost 2x more minutes than the big guys. When denominator (number of unlimited minutes) increases, cost/revenue per minute are going down. I do not think that this leads to any new conclusions (big guys also have postpaid plans and I do not have the minutes for them). It is just an observation that some slides are not what they seem.

Another concerning data is that in 2011 cost per new cell site has leveled for big and small carriers. I do not have expertise to make any conclusions – I would be grateful if anybody could take a look and make sense of that. It could be that all cheapest sites are taken and it’s not technology cost only. On the other hand, depreciation per served population (POP) is still materially smaller at smaller carriers… but depreciation per average subscriber jumped in 2011 considerably (LTE). PCS and LEAP depreciation expense went up by 20% in 2011. I present this info fearing that this is the weakest link in the investment [bear] thesis but I think it is not terminal.

PCS was one of the first carriers to implement LTE, which contradicts the lowest cost provider’s modus operandi (they buy only proven technology and at a cheap price, they follow and not lead).

What Happened?

My understanding is that PCS/LEAP stumbled on a set of factors, all temporary in their nature: technological [transition of new technology to mainstream], airwaves [capacity issue – now most of smartphones are on CDMA and clogging up the system and will be fixed after cheap LTE smartphones arrive], competition [aggressive pricing from peers and incumbents], and delayed tax refunds [very relevant for prepaid segment].

Noteworthy, PCS is further advanced in LTE, which also could explain why it did worse than LEAP in Q1. LTE is faster, cheaper technology and has better spectral efficiency but is still very early in the adoption cycle [= expensive smartphones]. Smartphones use lots of data, which degrades user experience (on 2G and 3G networks). I would say, normal pains of growing and changing business.

Additionally, the incumbents cannot aggressively bid on the prepaid front because they fully depend on majority of postpaid subscribers paying $80-$100 [cannibalization risk].

Future Business

In 12-24 months, PCS and LEAP will merge, will be bought out or will post decent net subscriber addition numbers. In the frugal new normal, prepaid should continue taking from postpaid and low cost carriers taking from incumbents. I do not know if they can sustain providing cheaper service but odds are reasonable for people with a longer time horizon (for those who think that 10% pa is good enough [from 10 positions like this and fully hedged with IWO]). I like PCS more because of a lower multiple and better historical track record.

Miscellaneous Housekeeping Items

== LEAP is apparently losing “take over” or “merger” premium.

== current selloff means “no hope” for a quick deal or fix – shareholder base is changing from momentum to value. Since earning call on April 26, LEAP changed 39% of shareholders, PCS 19%, and since year end correspondingly 195% and 137%.

== nothing spectacular on short volume of PCS (might jump after May 1):

Settlement Date	Short Interest	Avg Daily Share Volume	Days To Cover
4/13/2012	7,113,455	3,598,927	1.976549
3/30/2012	3,958,263	3,596,369	1.100628
3/15/2012	3,304,612	6,087,233	1.000000
2/29/2012	4,412,210	9,979,631	1.000000
2/15/2012	3,978,746	4,656,915	1.000000
1/31/2012	3,184,186	3,745,916	1.000000
1/13/2012	4,334,154	6,876,245	1.000000
12/30/2011	3,097,568	2,994,850	1.034298

LEAP’s short interest is more impressing because of higher leverage:

Settlement Date	Short Interest	Avg Daily Share Volume	Days To Cover
4/13/2012	13,303,205	1,458,904	9.118629
3/30/2012	13,065,663	1,280,425	10.204161
3/15/2012	12,969,396	1,560,998	8.308400
2/29/2012	12,163,006	2,039,200	5.964597
2/15/2012	12,065,177	1,399,445	8.621401
1/31/2012	9,926,338	1,386,823	7.157610
1/13/2012	12,385,466	2,611,363	4.742912
12/30/2011	11,769,102	1,768,184	6.656039

== nothing to note on insider activity and ownership changes: CEO is 74 and owns many times more stock than his annual salary (5.6m shares vs. $2.5m salary)

== LEAP: debt 3.2b - cash 0.6b = 2.6b net debt + @$5 market cap 0.5b = 3.1b EV and EBITDA 0.55b = 5.5x

== PCS: debt 4.4b - cash 2.2b = 2.2b net debt + @$7 market cap 2.5b = 4.7b EV and EBITDA 1.3b = 3.6x

== combined: debt 7.6b – cash 2.8b = 4.8b + 3.0b market cap = 7.8b EV and 1.85b EBITDA = 4.2x

Disclaimer: long PCS and LEAP, 5% position each, ~10% in red at today’s level.

RANDOM MUSSINGS (ii)

Hugh Hendry issued a new piece. He is always an entertaining and highly recommended read. Especially, if his last opus was almost 2 years ago (he did not have what to say). One of the greatest contrarian thinkers at the moment.

What puzzled me is his love for “stop loss” (which also connects with my recent piece about “sell your losers and ride you winners”). I do not understand it. He gives as an example tragic death of Jesse Livermore, who was right on his macro call but market remained irrational longer than he remained solvent. Volatility killed him (by the way he was shorting the market around 1930) and his panacea could have been stop losses.

I would say that, from what I understood (disclaimer: apart of this article, I know nothing about Jesse Livermore), he was killed not by volatility but by leverage or maybe also asymmetric nature of shorting individual names.

Stop loss is a practical thing to say that I do not understand what I am doing.

If one operates with sufficient margin of safety, even considerable volatility should not scare. It is always advisable to have low expectations. You cannot time the market so that you will always buy in the lowest point. That is impossible. It should be comforting that premature accumulation is a sin of all the greatest value investors.

It takes time for intrinsic value and price to converge. I follow a general rule of 3 years (I took it from Pabrai’s “Dhandho Investor”), which should be enough for your story to play out and admit a mistake. Intrinsic value in most cases is changing slowly – definitely not like when you watch big daily plunges on the stock market.

Lehman produced many stories of 50% plunges and 200-300% recoveries in less than 3 years. I do not know how to be that smart and sell it after e.g. 20% drop, then buy back after 50% down (total) and ride it up 3 or 4x. I do not know people who bet the entire farm back in March of 2009. You are fooling yourself if you think that you will dare to move in the darkest hour.