RR - Rolls-Royce

[TheAiGuy]

Value act increases stake:

 

http://www.londonstockexchange.com/exchange/news/market-news/market-news-detail/12589186.html

 

[KCLarkin]

Value act increases stake:

 

http://www.londonstockexchange.com/exchange/news/market-news/market-news-detail/12589186.html

 

Looking at that form, it looks like only a 0.1% increase. For some reason, they bought just enough to cross the 10% threshold.

 

In the UK, "a special meeting can be called by shareholders with a 10% voting stake." Looks like they are either preparing for a fight or trying to get negotiating leverage.

[TheAiGuy]

Value act increases stake:

 

http://www.londonstockexchange.com/exchange/news/market-news/market-news-detail/12589186.html

 

Looking at that form, it looks like only a 0.1% increase. For some reason, they bought just enough to cross the 10% threshold.

 

In the UK, "a special meeting can be called by shareholders with a 10% voting stake." Looks like they are either preparing for a fight or trying to get negotiating leverage.

 

That's just what put them over the line for the filing. They've roughly doubled their stake.

[AJDelphi]

Value act increases stake:

 

http://www.londonstockexchange.com/exchange/news/market-news/market-news-detail/12589186.html

 

Looking at that form, it looks like only a 0.1% increase. For some reason, they bought just enough to cross the 10% threshold.

 

In the UK, "a special meeting can be called by shareholders with a 10% voting stake." Looks like they are either preparing for a fight or trying to get negotiating leverage.

 

That's just what put them over the line for the filing. They've roughly doubled their stake.

 

Care to share how you know that?

[TheAiGuy]

Value act increases stake:

 

http://www.londonstockexchange.com/exchange/news/market-news/market-news-detail/12589186.html

 

Looking at that form, it looks like only a 0.1% increase. For some reason, they bought just enough to cross the 10% threshold.

 

In the UK, "a special meeting can be called by shareholders with a 10% voting stake." Looks like they are either preparing for a fight or trying to get negotiating leverage.

 

That's just what put them over the line for the filing. They've roughly doubled their stake.

 

Care to share how you know that?

 

sure:

 

http://www.ft.com/intl/cms/s/0/2806e91c-8ec4-11e5-a549-b89a1dfede9b.html#axzz3rrurJK5B

 

http://www.bloomberg.com/news/articles/2015-07-31/rolls-royce-says-activist-fund-valueact-becomes-biggest-investor

 

[KCLarkin]

That's just what put them over the line for the filing. They've roughly doubled their stake.

 

Makes sense. The last reporting trigger in July was 5% so you are correct. We just don't know when they doubled the position.

 

http://www.telegraph.co.uk/finance/newsbysector/industry/12005482/Activist-investor-ValueAct-takes-Rolls-Royce-stake-to-over-10pc.html

 

I'm not sure why they are resisting the ValueAct board seat.

 

 

[TheAiGuy]

That's just what put them over the line for the filing. They've roughly doubled their stake.

 

Makes sense. The last reporting trigger in July was 5% so you are correct. We just don't know when they doubled the position.

 

http://www.telegraph.co.uk/finance/newsbysector/industry/12005482/Activist-investor-ValueAct-takes-Rolls-Royce-stake-to-over-10pc.html

 

I'm not sure why they are resisting the ValueAct board seat.

 

Hard to say what goes on behind the scenes. Still, ValueAct could be a positive for the company without a board seat and RR is talking to them (I remember a quote along the lines of "they're [ValueAct] asking a lot of good questions" but I can remember the source)

[Guest Grey512]

I've thought a bit more about RR and decided this verges between "not attractive" and "too hard". Reasons:

 

In the short run: this may head lower. In a nutshell: RR trades at 8x EBIT; the average over the past 10 yrs was 9x EBIT. In an '08-type scenario this easily gets cut in half to 5x EBIT.  Yes, the markets do get that crazy.

 

In the long run:

- at current prices, I would rather add to PayPal or just remain in cash

- I get the sense that US-style activists are finding it tougher to execute in the UK. The culture is a little different.

- ValueAct / Ubben previously stated that they are attracted to businesses that sell some form of 'value-add' or 'process' and tend to shy away from industrials. This is a little bit close to that line. I also have not yet found any precedents of ValueAct successfully turning around a heavy industrials business of this type

- RR. went from $1.5b of net cash in 2008 to $0.5b of net debt in 2015. I have some slight doubts about how cash generative this business can be, even if all the stars line up and management engages in some 3G-style zero-based budgeting. Not all sectors are made the same. In a consumer/brand oriented environment, cost-cutting may work. In mission-critical engines & servicing? Dunno.

 

In any case: kudos to Lone Pine and whoever else was short this year. Perhaps some of you will make some money being long - good luck, just too difficult for me.

[KCLarkin]

Grey, I think this should be in the too hard pile for most, but I am not convinced by your reasoning. Especially, your thoughts on ValueAct. They do have a great track record with industrials (dresser-rand 47% CAGR, gardner denver 50% CAGR according to ValueWalk). They also got 20% CAGR out of rockwell collins, which is an aerospace company.

 

Importantly, Ubben used to be an aerospace analyst, so he knows this industry well.

 

--

Correction: Ubben used to run the fidelity aerospace fund

[Guest Grey512]

KCLarkin,

 

Thanks. Slightly embarassed - had no idea that they backed Rockwell Collins. Was under clear impression that they try to stay away from tangible products and focus on intangibles.

 

If ValueAct are really good at aerospace then that does change my views from "unattractive"/"too hard" to "too hard". For those who have invested in Rockwell Collins / other ValueAct industrial plays and are familiar with what the story was there, RR probably a great name to look into; could be my loss. It's just difficult for me to get a handle on where the value is going to be extracted here. Labor? Suppliers? Clients? Inefficient capital structure? (assuming RR does not or cannot sell the marine division at a reasonable price; cycle-wise, this is the worst time to sell that division).

[jay21]

Too hard?

 

Key drivers:

 

- Backlog durability / future deliveries

- Non Core Assets -> dispose or not?

- Productivity improvements -> benchmark to GE

 

I think you can get a good sense of those. Is there going to be inherent issues due to the migration to new models? Sure. But if you are sure of deliveries (and there is some risk there), then they are going to start generating good chunks of cash.

[TheAiGuy]

http://valuewalkposts.tumblr.com/post/133812525654/jeff-ubben-sees-value-in-rolls-royce-despite

[KCLarkin]

http://valuewalkposts.tumblr.com/post/133812525654/jeff-ubben-sees-value-in-rolls-royce-despite

 

Thanks! Pretty good summary of the thesis. This is why I consider it too hard for many:

This is where ValueAct sees value. The deteriorating fundamentals of Rolls-Royce’s non-core businesses, combined with the complex accounting in aerospace has caused analysts and investors to abandon the company, despite the robust (and improving) fundamentals of the core aerospace division.

 

It will take a couple years for those fundamentals to really shine through. I sold for the tax loss, but plan to buy back in a couple weeks.

[phil_Buffett]

http://www.gwinvestors.com/wp-content/uploads/RR-LN-Perfect-Storm-November-2015.pdf

 

update from gw Investors

 

rolls royce the perfect storm.

[rogermunibond]

Isn't it funny how the "perfect storm" which was something that Junger described as an every 50-100 years event in North Atlantic meteorological terms is used for rather more frequent business blowups.  Really funny.

 

RR wasn't a perfect storm it was a couple decades of sailing with tailwinds leading to sloth, inefficiency and complacency.  It wasn't toppled by a "perfect storm."  It was toppled by a pretty regular storm.

[fareastwarriors]

Was this posted already? Looks like Sequoia Fund added big last quarter.

 

http://www.dataroma.com/m/hist/hist.php?f=SEQUX&s=RYCEF

[TheAiGuy]

http://aviationweek.com/mro/opinion-why-aftermarket-demand-not-tracking-airline-capacity

 

[jay21]

Must watch lecture by East:

 

Anyone else have good articles/profiles on Warren and ARM?

 

Surprised this idea doesn't get more attention:

 

- Well regarded CEO

- Heavy ValueAct involvement

- Duopoly market

- Huge order book (but is it durable?)

- Low leverage

 

Lots to like on the surface but maybe too unpredictable with little visibility on future cash flows?

[Jurgis]

Must watch lecture by East:

 

Anyone else have good articles/profiles on Warren and ARM?

 

Surprised this idea doesn't get more attention:

 

- Well regarded CEO

- Heavy ValueAct involvement

- Duopoly market

- Huge order book (but is it durable?)

- Low leverage

 

Lots to like on the surface but maybe too unpredictable with little visibility on future cash flows?

 

Too hard pile:

- Accounting for long term contracts and how they will work out.

 

Possible caveats (but I did not look into them because of the "too hard"):

- CEO is well regarded, but from another industry. He may not be great/cognizant the complexities of contracts in this industry. He may mess up.

- Bad cost control?

- Price pushes from customers?

- Cyclical top?

 

 

[TheAiGuy]

Must watch lecture by East:

 

Anyone else have good articles/profiles on Warren and ARM?

 

Surprised this idea doesn't get more attention:

 

- Well regarded CEO

- Heavy ValueAct involvement

- Duopoly market

- Huge order book (but is it durable?)

- Low leverage

 

Lots to like on the surface but maybe too unpredictable with little visibility on future cash flows?

 

Too hard pile:

- Accounting for long term contracts and how they will work out.

 

Possible caveats (but I did not look into them because of the "too hard"):

- CEO is well regarded, but from another industry. He may not be great/cognizant the complexities of contracts in this industry. He may mess up.

- Bad cost control?

- Price pushes from customers?

- Cyclical top?

 

I'd also add that it could take years for the new engine programs or any operational improvements to show up in the financials. Also, it seems like there is a high likelihood for the cashflow to get worse before it gets better if they're ramping up engine sales in the near future. Then there's the issue of a low cash conversation (related) and growing intangible assets on the balance sheet (also related)? Likely dividend cut? Apparent management inability to predict near term cash flow or earnings?

 

In all honesty, we might be looking at 2018/19 before cash from service revenue is greater than the cash burn of engine sales. The accrual based earnings should turn around before that, but I'm guessing this looks like a "wait and see" type for a lot of investors.

 

That'd be my bear case, but I still think its pretty good

 

 

[KCLarkin]

If you are a value investor in a UK company, you don't want to see Woodford selling:

https://woodfordfunds.com/engine-trouble/

[ZenaidaMacroura]

If you are a value investor in a UK company, you don't want to see Woodford selling:

https://woodfordfunds.com/engine-trouble/

The replies in the comment section are scathing  :o

[Spekulatius]

I have sold my position in RR as well a short while ago, since I came to the conclusion that I don't really understand the economics of their business model too well. They are apparently running their business differently than their competitors - they are selling their engines cheaply (and possibly at a loss) , but with a maintenance contract attached that supposedly is profitable. They book a profit based on the perceived NPV of the maintenance contract. This is accrual accounting and means that cash will flow out with each engine sold, which will flow back to RR over the term of the maintenance contract (20 years or so). This means that cash flow and profits become disconnected and one needs to trust management that the accounting is correct, which is somewhat of a stretch, based on prior experience. This business model seems to be different than what competitors are doing, who apparently sell their business at a profit.

Now, we have the EU investigations into these maintenance contract and their legality, which could really throw a huge wrench into this, if these contract are going to be voided,nor even modified, I could see a huge write off in RR future.

 

All the above makes RR a fairly hard not to crack. This is not just a cyclical issue, or an issue where management has slipped up in an otherwise strong business, this is a case, where the whole business model that RR works with could be called into question, which huge implications for their balance sheet and future profitability.

 

[TheAiGuy]

Okay, so here's one way I'm thinking about valuing RR:

 

2014 Civil Aerospace (CA) revenue: 6,837 M GBP

3% growth for 2015

12% net operating margin in CA

20% Tax rate

Normalized after tax profits: 676 M GBP

 

Valuation (Annuity with 3% growth rate, 10% discount rate):

9,657 M GBP + any value for other lines of business.

 

Current market cap:

10,430 M GBP

 

 

I think it makes sense to think in terms of normalized profit around CA revenues. It's an IP based duopoly with a critical line of business and a diverse customer base, meaning it is hard for a single purchaser to dictate pricing terms or for new entrants. Structurally, sound management should be able to earn a descent profit here, and I'm calling that 12% (this is also consistent with past margins). Also, they have an order book that shows growth, so I think pricing in a small amount of growth seems reasonable to me.

 

I realize that embedded in this valuation is that you have management that can run the company reasonably profitably (its more what is the company worth under competent management vs what is the company worth now). That's an operational bet -- I've been impressed with Warren East and ValueAct so far but I can definitely understand someone else's skepticism. I'd appreciate any feedback.

[jay21]

It's imprecise in terms of valuation. It probably should be PV of backlog plus PV of legacy as the minimum value (because they will add to the backlog over time presumably). The problem is there isnt too much visibility into those CFs.

 

This is a valuable business that will exist decades from now. The question is how valuable is it? And will management doing something somewhat smart in the near term to counteract drags? Not cutting the dividend and raising debt is questionable to me. And on the call, not giving clear timelines on when this becomes FCF positive was negative because it made me think they are much more tied to the cycle than I thought, which is proving to be a little unpredictable right now.

 

It's probably a question of price and I should work a little more on valuation here. It's just how do you get a sense of CF?

 

Edit: Interestingly enough this company has turned out to be very levered to oil. If we get a rebound there, we should see some businesses come back to life.