Pabrai Makes A Killing in FCAU

recently wrote a post about how I believed Mohnish Pabrai to be back. In it, I posited that his resurgence with only 6 major stock positions indicated a newfound confidence in his work, and improved relations with his investors.

As it relates to FCAU – Fiat Chrysler – he has a lot to be confident about.

The Back Story

On October 29, 2014, FCAU announced they would be spinning off Ferrari into a separate, publicly traded company. The spinoff would be a partial spinoff, with 10% of the ownership being a sale in an IPO and 90% being distributed to existing shareholders. On this date, the market cap of the pre-spinoff companies was $13 billion. It was during this quarter that Mohnish Pabrai loaded up, placing 30% of his fund into the stock. By the end of the following quarter, he had 42% of his fund in FCAU, or $225 million. Although I don’t think he had an average price of $13 billion – or $10 per share. I estimate it closer to $12 per share.

At the time of the IPO the following autumn, Ferrari shares traded for $10 billion.This means FCAU received $1 billion from the IPO sale, as well as $3.2 billion from debt that Ferrari took on to pay FCAU a special dividend. Combined, the Ferrari spinoff added a full $13 billion in value, which was the value of FCAU combined with Ferrari pre-spinoff.

In addition, the share price of FCAU actually increased post-spinoff, from $13 billion to $18 billion. In total, the combined $10 billion and $18 billion in Ferrari and FCAU, respectively, indicates that buyers of FCAU for $13 billion made just over 2x their money in just under 12 months.

Other Holdings

Pabrai owns a stake in Google, which I think is a fine example of growth at a discount. It’s also one of the highest quality companies in the world and has an insurmountable technological moat. I used to own this one and I would be happy to buy it again around the prices Pabrai paid for it.

Horsehead Holdings is a zinc miner and processor, which has fallen on incredibly hard cyclical times, and is raising additional money by selling more shares. The stock has dropped from the $9-11 per share that Pabrai paid and it currently trades around $2. While it is unclear how much dilution will occur, the business has a new plant that is expected to generate annual EBIDTA equal to their current market cap. Once it is fully operational – and at full capacity (which is key) – this stock will likely go from the depressed $2 price to something more in the range of $15-25. The risks associated with it being a bad business economically – low returns on capital, cyclical, commodity business, share dilution – seem to be offset by the upside here. I don’t love the company, but I am watching it closely. Pabrai isn’t often wrong and I understand what he sees here.

Posco Steel is a high-quality steel manufacturer in South Korea that has hit a cyclical depressive swing. The average free cash flow generation in the boom years of 2003-2012 were between $3-4 billion per year, and 2014’s numbers were less than $1 billion. While buying cyclically-adjusted earnings is normally a great thing to do, I worry here. China just went through an unsustainable growth period to generate those results for Posco, and with them cooling off for a few years, it seems they may not again see the same level of construction activity for awhile. At $12.5 billion, this company is trading at what may appear to be 3-5x cyclically adjusted earnings, but the value trap potential here is high. I think the cyclically adjusted earnings are much more likely to be $1.5 than $3 billion and as a result, 10x earnings for a depressed steel company doesn’t sound all that appealing to me.

The GM B warrants are another security I have owned in the past – one in which I made 3.5x my money in under 12 months. The security presents a leveraged way to bet on GM’s shares, and at current prices, is virtually free upside so long as the stock does not go down. With long-term volatility so cheap, you can get a huge advantage in betting on GM’s shares. And should the auto sector finally decide to recover to pre-recession levels (something I don’t see as incredibly likely any time soon), the warrants will earn a multiple on your money without a ton of inherent risk. If I’m not mistaken, these expire in either 2018 or 2019 so there is plenty of time for the stock to go up to ensure a safe sale.

Concluding Remarks

Overall, I love what Pabrai is invested in today. While I don’t love Posco, I think Google, the GM warrants, Horsehead, and FCAU are incredible ideas. The originality here is very apparent, as no other superinvestors that I follow own any of these names – save for Google.

 

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About Andrew Schneck

I am a value investor focused on misunderstood securities and industries, with an eye for long-term stock ownership.
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