Monthly Letter July 2018

July Sector Comments

Madrague had a good month in July: +1.15% which takes the year to date figure to +2.67%. Sectors of note in July:

Telecom: +1.01%

Long positions in Veon, KPN and Hellenic Telecom were the main contributors. Veon announced in the beginning of July their intention to sell their 50% stake in their Italian JV Wind Tre to Hutchison. We believe it is a step in the right direction and that it also shows that management is willing to create shareholder value through strategically correct decisions. After the announcement S&P upgraded the credit rating for the company and Goldman Sachs upgraded their equity recommendation to buy with a price target c50% above where it traded before the announcement. Even at GS target price, Veon would be at roughly 40% discount to the European telecom sector. This is way too much even for a Russian company with its headquarter in Holland and with a US listing. KPN reported their q2 figures towards the end of the month. The numbers surprised positively with the new management surprising on the upside. KPN also announced that they will redeem their EUR 1.1bn hybrid bond in the 3rd quarter. This will on the face of it increase their net debt by 10% (the hybrid is only captured by 50% within net debt vs. cash 100%), but on the positive side it will increase free cash flow by 6% as the cash used to redeem the hybrid earns zero interest thanks to the manipulation of the cost of money. We increased our long position in KPN, kept our Veon position unchanged and decreased our exposure to Hellenic Telecom.

Pharma: +0.5%

This is a very small sector for us which we rarely write about. We are not looking for exposure to the pharmaceutical segment, but rather to the medical technology and medical services segment within the sector. In July our long position in Capio performed really well as Ramsay General de Sante made a bid for Capio. The bid, which was at SEK 48.5, would give Capio a valuation of EV/EBITDA 8.8x which would become 7.5x post synergies (if realized). We thought this was a bit of a cheeky bid, Capio rejected it and the market immediately priced Capio c9% above the bid price. Capio had previously announced that they had received interest in their French operation so we guess Ramsay took the chance to bid for a cheap asset. Capio has been clear that they want to pursue the Nordic opportunities further which means that a divestiture of France and Germany has been in the cards. As for a lot of the industries nowadays internet is changing the primary care market. Capio is looking to be a big player in the nascent, but fast growing on-line doctor appointment market. We believe that Capio should have a good possibility to become a market leader given they have a lot of doctors tied up in the primary care centres. There should be an opportunity to leverage those doctors in their on-line push as well. With Mikael Wolf as chairman of the board the company has a management that is focused on creating shareholder value. We remain shareholders and expect management will be able to attract a better offer or be in charge of a company valued at a higher multiple.

Financials: +0.5%

Our short in Avanza and our long position in Banco Santander were the main contributors. Avanza is a good company that has managed to attract an ownership base that perceive Avanza to be a platform company with capital light growth. We disagree and 2018 will be the third year in a row with falling profits. The company was started with the promise of always being the cheapest when it comes to executing stock trades. As competition has intensified their mantra has changed: price is not everything, customers are willing to pay for good service. Anyone recognise the voice of the incumbent banks 10 years ago? With the change in management last year we however recognise that they are on a strategically better path, but earnings growth and valuation does not stack up. Banco Santander delivered a good set of second quarter result, but the stock had quite a muted reaction to our mind. The stock is down c12% with earnings estimate for 2018 down c3%. This is not a staggering number as the bank sector has been one of the worst sectors in Europe in 2018. We covered a small part of our short in Avanza and remained long in Santander.

Capital Goods: +0.4%

Our short position in Assa Abloy and our long position in SKF were the best performers in July. Assa Abloy came out with a profit warning in the beginning of July where they took goodwill impairments and non-cash write-down due to challenges in their Chinese operations. Their Chinese business has now declined 3 years in a row. This does not match with a company trading at an expected 16 times EV/EBITDA for the current year. The premium rating should continue to melt. SKF reported a good set of Q2 numbers where they beat consensus on an EBIT level with 6%. The company is trading at a slight discount to historical average whereas the sector is a 19% premium. Apart from some intramonth fine-tuning of our exposure both positions were left unchanged.

Business Service: -1.2%

Our best sector year to date had a bit of a perfect storm in July. Our long positions in Playtech and Ryanair together with our short position in Evolution Gaming were the main sources of poor performance. Playtech issued a profit warning that shaved c18% off their EBITDA for 2018 and the stock was down 29% for the month. The Asian operation is experiencing severe price pressure and we recognise that visibility is lower than what we previously thought. Taking that into consideration together with single digit p/e multiple on a company that we believe will be debt free by the end of 2019 is simply too cheap. We increased our position slightly in July. We increased our position slightly in Ryanair while we closed our short position in Evolution Gaming. We marginally increased our gross exposure from 154% to 155% in July. We decreased our net exposure slightly from 50% to 48%. Our option protection shows the same characteristics as always, i.e. a gap move down 5-10% and we would have zero net exposure to the equity markets.

As always, you are more than welcome to contact us should you have any comments or questions on our investments or the views expressed in this letter.

Lars Frånstedt

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