ChipMOS (IMOS) Still Undervalued By At Least 40% Relative To Peers With Further Gains Possible From Growth And Margin Expansion


   Having a margin of safety is important when choosing investments. Seth Klarman, one of the all-time great value investors wrote a book about it entitled just that. So when he buys 11% of a company’s shares recently, we should take notice. That company would be ChipMOS (NASDAQ:IMOS). They are involved in the industry of outsourced semiconductor assembly and testing. What would he see in this small cap company? Let’s find out.

   I won’t go into the details of the business, and there has already been a great article on Seeking Alpha by Jaret Wilson on why it’s already an arbitrage opportunity but I’d like to present why in valuation terms it presents a great long-term investment with a large margin of safety which is critical in this environment of lofty market valuations.

   Although ChipMOS is trading near its highs, it still presents an attractive investment for several reasons.

  • It’s a bargain based on its valuation relative to peers in the industry.
  • It has a phenomenal balance sheet loaded with cash and low debt.
  • IDMs (integrated device manufacturers) are increasingly outsourcing stages of the semiconductor production process to companies like ChipMOS to shorten production cycles which should drive revenue growth.
  • ChipMOS is increasing production capacity, ramping up Capex due to expected demand from customers. Their overall utilization rate held firm at 77%, despite expanding capacity by about 17%. This shows that there is solid demand growth in this industry.

   Very rarely do we see a company that’s a value stock and at the same time growing revenue and margins like a growth stock. Now let’s look at a company comparable analysis.

Notes to Reader: ChipBond and King Yuan are denominated in Taiwan dollars. The EBITs I use are the sum of the most recent four quarters for each company. TEV or Total Enterprise Value is calculated as: Market Capitalization + Long-Term Debt – Excess Cash + Preferred Stock + Minority or Non-controlling Interests. ROIC is return on invested capital. NOPAT is net operating profit after tax or EBIT times an assumed tax rate of 35%. Invested Capital is calculated as: Total Equity + Total Liabilities – Current Liabilities – Excess Cash.

   I’d also like to note that in my analysis above I am attempting to evaluate the enterprise of ChipMOS as a whole including its subsidiaries. The EBIT numbers represent consolidated numbers and the total enterprise value calculation includes non-controlling interests so all providers of capital are included. This way we have an apples-to-apples comparison in the numerator and denominator for a ratio like EBIT/TEV. When valuing the ChipMOS Bermuda holding company itself down below I’ll attempt to back out the value of the stock by subtracting out the non-controlling interests.

   Based on a comparable analysis, we can see that ChipMOS has an EBIT/TEV ratio of 16%, or an EBIT multiple of about 6, which is far superior to any of its peers listed above. This is what makes it a bargain. The market is pricing the company at too low an EBIT multiple based on what similar companies are trading for. What could be the reasons for this? Perhaps it’s due to the fact that it’s a smaller cap stock that’s less covered by analysts than its larger peers, in addition to having their operations based in Taiwan and China, providing them with less visibility to US-based investors.

   ChipMOS also has a ROIC higher than any of the companies listed, a higher amount of cash on hand per share, and an EBIT margin of around 15%, similar to its peers listed in Taiwan.

   Now, let’s try to go through a couple valuation scenarios and come up with a conservative and a base-case value for the stock.

   Note that the book value I use is that attributable to holders of ChipMOS Bermuda.

   Note that the above valuation examples don’t include any assumptions of revenue growth or margin expansion, both of which ChipMOS is currently experiencing.

   Let’s try to make some assumptions about growth and other things to come up with where the stock could be trading over the years. These are very rough approximations that I believe to be reasonable but as with any kind of assumptions, could also turn out to be very wrong, in a good way or a bad way.

   Assumptions Used: Revenue for 2014 has been approximated based on management’s most recent guidance. Revenue then is assumed to grow at around 9%. I assume the EBIT multiple to eventually reflect companies that are similar to ChipMOS . I also assume cash remains about the same, and long-term debt is paid off at around 10% of the balance each year. Non-controlling interests I left constant over the years in addition to shares outstanding. If you would like a copy of the spreadsheet I used for the above tables to play around with the assumptions, let me know.


  • A decrease in demand for assembly and testing services for semiconductors and LCD display drivers such as that experienced in 2008 and 2009 could reduce the company’s profitability.
  • There is no guarantee that the market will adjust and price ChipMOS according to valuation ratios similar to its peers in the industry.
  • ChipMOS derived 56% of its revenue in 2013 from its top five customers so there is a decent amount of reliance on the financial health of these customers. A decrease in demand for end-products like HD TVs, mobile phones, tablets, etc, could lead to decreased demand for outsourcing services, reducing profitability for ChipMOS.


   Overall, I think ChipMOS is an under-followed company that’s a bargain based on several valuation metrics. Despite the run-up in the stock, it’s still undervalued especially compared to its peers. Currently in the midst of expanding operations due to high demand from IDMs, ChipMOS is poised to benefit from the growth in increased outsourcing of semiconductor testing and assembly.

   This is also a business with a decent-sized moat with high barriers-to-entry. The fixed costs are high to buy the proper equipment in order to assemble and test semiconductors and IDMs are very careful about who they outsource their work to. ChipMOS has been around for many years and has a good reputation.

   In addition, more people around the world are using mobile phones, tablets, and HD TVs than ever before and as wealth grows, the semiconductor industry should also see high growth. Finally, the high cash, low debt balance sheet of ChipMOS can give an investor comfort knowing there is a margin of safety here.


Is the U.S. Stock Market Currently in a Bubble? (Part 2)

Expanding on my previous post, let’s look at a few other measures that can give us an idea of the current state of market valuations.

The Ratio of Market Capitalization to GDP

In a Forbes interview, Warren Buffet described this ratio as “probably the best single measure of where valuations stand at any given moment.”  It’s simply the total market capitalization of the stock market divided by GDP.  The following chart shows how this measure has varied over the years and where it currently stands.  Below that is a chart of the S&P 500.


Market Cap / GDP Ratio, Source:


S&P 500, Source:

As we can see, this ratio is the highest its been since around the year 2000.  It suggests that market prices are rich relative to GDP at the current moment.  Of course that doesn’t mean that stock prices are ready to crash, just that investors should be cautious.

John Hussman, a stock market analyst and fund manager ( says that annual returns are driven by the following:

1.  Growth in nominal GDP

2.  The reversion in the ratio of market capitalization to GDP toward its historical norm

3.  The annual dividend yield

For a 10 year horizon, the formula can be written out as:

The historical norm of the market cap to GDP ratio has been about 0.63.  In early 2000, it hit its highest level of 1.54.  At that point, the dividend yield for the S&P 500 was 1.1%.  If we assume a generous nominal GDP growth of 6.3%, Hussman says that an estimate of the subsequent 10 year annual return could have been calculated as follows:    (1.063)(0.63/1.54)^(1/10) – 1.0 + .011 = -1.7% annually.  This means pretty much negative to flat returns for a decade.  Sure enough, the actual total return of the S&P from 2000-2010 was still negative even after bouncing back from the March 2009 lows.

Hussman then provides a valuation study for 2014.  The current market cap to GDP ratio is 1.25, about double its historical norm of 0.63.  If we assume nominal GDP gets back to a healthy growth rate of 6.3% and with an S&P dividend yield of 2%, we can estimate the following 10 year return to be:

(1.063)(0.63/1.25)^(1/10) – 1.0 + .02 = 1.3% annually

In other words, according to this, we can expect pretty anemic returns for the next decade at these levels.  Off course, if the market sells off drastically, investors getting in at better levels can expect to achieve greater returns.

The chart below from John Hussman’s website is instructive.  It shows projected 10-year return based on the formula above against the actual 10-year return that occurred.  As we can see, the two lines correlate pretty well with each other, so the formula does a pretty good job of predicting what the return will be based on current market cap / GDP and dividend yield.  Based on current stock market valuations, the chart and formula is predicting low single digit returns over the next 10 years.

Projected and Actual Returns for the S&P 500, Source:

Projected and Actual Returns for the S&P 500, Source:

Corporate Profits to GDP

Another area where we see evidence that the U.S. market may be overvalued is company profits.  The corporate profits to GDP ratio is at all time highs.  Profit margins are cyclical and mean-reverting, so they’re not likely to remain at these levels forever, unless something fundamentally has changed and companies can expect permanently high profit margins.


Corporate Profits to GDP Ratio, Source:  St. Louis Fed

Corporate Profits to GDP Ratio, Source: St. Louis Fed

The Current Market Is Still Not As Frothy as in 2000

Although valuations may be rich, we still aren’t seeing the same maniacal prices for tech stocks especially as exhibited in 2000.  From a recent BBC article, Kathleen Smith of IPO investment advisory firm Renaissance Capital says there have been 53 listings of IPOs so far in 2014 which is half what we had for the same time period during 2000.  Also, the price performance of newly-listed shares isn’t as extreme as in 2000.  In 1999, more than 100 companies saw their share price double on the first day.  In 2000 there were 80.  So far this year, there have only been 4.  (

It also seems like large-cap stocks are still reasonably priced.  Based on data from the Bespoke Investment group from a New York Times article:

In 2000, the 10 biggest stocks in the S&P 500 had an average P/E ratio of 62.6. Today, that number is only 16.1.

Today, only one stock among the largest 10 stocks has a P/E above 30: Google. (

I did a Google Trends search to see how often the term “Stock Bubble” was searched for and came up with the following chart:

"Stock Bubble" Search Interest, Source:  Google Trends

“Stock Bubble” Search Interest, Source: Google Trends

After the peak in interest in middle 2007, the years 2008 and 2009 were some of the most turbulent market periods in history.  For 2010, 2011, and 2012, we don’t see much interest in the term, until late 2013, where searches for “Stock Bubble” increased again.  Not to say that this is predictive of a market crash in any way, it was just something I found interesting to note.


Overall, I think that investors need to be cognizant of the fact that the market is valued more richly than in the past few years, especially certain sectors such as internet and biotech.  At least part of this recent bull market has been the result of easy money policies by the Fed.  Interest rates are bound to increase at some point and that will put pressure on corporate profits and stock prices.  This doesn’t mean you should dump your stocks however, especially if you have a long-term time horizon and a diversified portfolio.  If you do, then a 30% or more market correction should not scare you and will actually be an opportunity to get in at better levels.  If however, you are close to retirement, then considering moving a part of your portfolio into cash or safer assets may be a prudent strategy.

Is the U.S. Stock Market Currently in a Bubble? (Part 1)

The question of whether the U.S. stock market is currently a bubble waiting to burst or at least overvalued is a subject of much debate these days.  There are arguments that can be made supporting both opinions.  I think it’s less a question of whether the market as a whole is overvalued, but that some sectors are much more richly valued than others.  Comparing market valuation measures now to years in which we had sharp sell-offs will also be instructive.  Let’s look at evidence that can help us decide.

The S&P 500 gained 32% for investors in 2013 including dividends and the Nasdaq Composite gained 37%.  The Nasdaq Internet Index gained 63% in the 12 months ending March 6, 2014 and is currently down 17% from its peak.  The Nasdaq Biotech Index gained 86% in the 12 months ending February 27, 2014 and is currently down 17% from its peak.  Compare that to the Nasdaq in 2000, which rose 110% in the 12 months before the dot-com bubble peaked on March 10, 2000.  One of the signs of a bubble is a rapid rise in prices due to a new technology or innovation.  Internet stocks and biotechnology stocks have definitely exhibited stratospheric rises in price, so those sectors at least might qualify as being very overvalued.

Nasdaq Internet Index

Nasdaq Internet Index

Nasdaq Biotech Index

Nasdaq Biotech Index

Let’s look at some valuation metrics that will give us an idea of how richly valued the current market is.  In the first part of this post, we’ll look at the Schiller P/E.

The Schiller P/E Ratio

Looking at price alone  is one-dimensional so lets see how expensive the market is on a basis relative to earnings, a.k.a the familiar P/E ratio.  Most analysts look at P/E ratios with earnings of the past year or earnings for the next year, however this doesn’t take into account the crests and troughs of the business cycle which vary over the years.  If the economy is healthy, corporate profit margins should be higher, while if the economy is in contraction, profit margins should be lower.  The best way to compare P/E’s over the years is to take an average over several years that give us a good sample of earnings over many business cycles.  Hence we have the Schiller P/E, developed by Yale economist Robert Schiller.

The Schiller P/E uses the annual earnings of S&P 500 companies over 10 years and is adjusted for changes in the CPI to be translated to today’s dollars.  The price in the numerator of the Schiller P/E is just the current price of the S&P 500.  If you’re interested in the details, the link below provides more detail about the Schiller P/E, how it’s calculated and why it’s a superior measurement tool.

Below is a chart of the current value and history of the Schiller P/E, which right now is about 25, higher than its mean value of 16.5.  The Schiller P/E surpassed 44 during the dot-com bubble.



As some of us can remember, the markets in the late 1990’s were very skewed by the exorbitant prices of tech stocks.  However, John Hussman, stock analyst and fund manager, says that the price to revenue ratio of the median stock in the S&P 500 now is higher than it was in 2000.  (

Here’s a similar chart below from Robert Schiller’s website that shows the Schiller P/E and long-term interest rates over the years.  Notice how the P/E is the highest it’s been since 1929 during the Great Depression and the year 2000 when we had the dot-com crash.

Source:  Home Page of Robert Schiller

Source: Home Page of Robert Schiller

Does this mean that a crash is imminent?  No.  It just means that stocks aren’t as cheap as in the past.  It also shows that the low interest rate environment may have had a huge impact in the recent run up in stock prices.  Rates really have nowhere to go but up from here.  It begs the question of what will happen to stocks once the inevitable increase in rates occurs.   They’ve been held artificially low for a long time, thereby distorting asset prices.  For example, money-losing companies that should have gone out of business years ago are able to continue to obtain cheap financing at low rates to stay alive, so the market isn’t able to act naturally as a clearing mechanism.  The low rates have also encouraged and forced investors to “reach for yield”, investing in assets which are more risky and speculative for a few more basis points in potential return.

Stay tuned for part 2 of this blog post where I’ll look at some other metrics that’ll give us an idea of the current state of the market.

Investing Wisdom Takeaways from Warren Buffett’s 2013 Letter to Shareholders

Warren Buffet’s annual letter to shareholders of Berkshire Hathaway has been a treasure trove of investment wisdom since 1965.  In addition to Ben Graham’s writings, these are required reading for all value investors.  With the annual Berkshire shareholder meeting coming up on May 3rd, I thought I’d highlight some key points he makes in this year’s letter.  If you haven’t downloaded it yet, here’s the link:

WB:  “You don’t need to be an expert in order to achieve satisfactory investment returns.”

You don’t need to be a hedge fund quant in order to generate great returns over the long-run.  Stick to what you know inside your circle of competence, and if you don’t understand an investment, move on.

WB:  “Focus on the future productivity of the asset you are considering.”

You should be able to make a rough estimate of what an asset’s earnings or cash flows will be over the next few years.

WB:  “If you instead focus on the prospective price change of a contemplated purchase, you are speculating.”

Don’t speculate what the future price may be of a particular stock.  Support or resistance  or any type of technical analysis shouldn’t be a justification to invest.  Approach an investment from the standpoint of owning a piece of a business.  As Ben Graham taught Buffet:  “Price is what you pay, Value is what you get.”

WB:  “With my two small investments, I thought only of what the properties would produce and cared not at all about their daily valuations.”

How often do we stay glued to our stock quote screens obsessing over daily fluctuations in the market?  Mr. Market may be perfectly rational one day and psychotic the next.  Get away from the chaos of daily price movements, look at the big picture, and have a long-term perspective.

WB:  “Forming macro opinions or listening to the macro or market predictions of others is a waste of time.”

'And there you have it. According to our experts, the stock market will either advance, decline, or remain unchanged this year.'









This is probably my favorite piece of advice.  The world is a chaotic place and there are so many variables at play in the complex behemoth that is the global economy, that making macro predictions or listening to people making predictions about the market is a waste of time.  No one can control what goes on in the world and how the economic winds blow.  What you can control is how you allocate your capital.  Successful value investors make decisions using a bottom-up approach, analyzing each investment based on its own merits.

WB:  “Owners of stocks, however, too often let the capricious and often irrational behavior of their fellow owners cause them to behave irrationally as well.  Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits – and worse yet, important to consider acting upon their comments.”

There is a lot of noise out there about markets and the economy.  Watching CNBC or Bloomberg all day can make your head spin from all the information being spewed your direction.  It may make you feel like you need to take action, to do something, anything, in reaction to market events and opinions.  Of course banks and brokerages and trading platforms profit more when you trade actively so it’s encouraged.  However, active trading and the resulting large transaction costs will kill you.  The more you trade, the less you’ll make.

In reality, all that chatter should matter very little to how you allocate your capital.  Do your own homework and don’t blindly listen to so-called experts.


WB:  “The goal of the non-professional should not be to pick winners……but should rather be to own a cross-section of businesses that in aggregate are bound to do well.  A low cost S&P 500 index fund will achieve this goal……Following those rules, the “know nothing” investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results.  Indeed the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long term results than the knowledgeable professional who is blind to even a single weakness.”

In the end, most investors will perform better by simply staying invested in the general market.  However, there’s nothing wrong with having an opinion on certain stocks and investing in them.  Just make sure you’ve done your homework and given yourself a large margin of safety so that if you’re wrong, the financial hit won’t take you out of the game.  Overconfidence and other biases give investors false confidence in their investment decision-making capabilities.  Before making an investment, ask yourself:  “Is there a place I stumbled in my analysis or have I overlooked a hidden risk?”  Even if you’re confident, an investment in one stock should never comprise a significant portion of your net worth.

Weight Watchers (WTW): A Bargain Price in a Pricey Market Presents a Multi-Bagger Opportunity

Weight Watchers International (WTW)



  • Weight Watchers’ (WTW) current price provides an opportunity for investors to buy a brand-name, high-margin, cash-flow-rich business at a bargain price.
  • Concerns over WTW debt are overblown as company interest coverage ratio more than provides enough cash to cover interest and principal payments.
  • Management has lowered expectations and set the bar very low for this years’ earnings, therefore the market could be overly discounting the chances of a turnaround.

There have been some great articles written recently regarding Weight Watchers (WTW) stock and the favorable risk-reward profile it presents investors.  I won’t delve into all the particulars of the company and its business details so as not to repeat what others have already mentioned.  I would however, like to add my two cents briefly in a quantitative way with some number crunching to come up with an estimate of intrinsic value based on free cash flow, something that Weight Watchers has consistently been able to generate.

Weight Watchers (WTW) is the most well-known weight management services and products company in the world.  With shares down 75% from their all-time highs, investors can acquire a business with brand-name recognition along with a methodology that’s been proven to work systematically for people over the company’s 50+ year history.  Management has pretty much lowered all expectations by reducing 2014 EPS guidance by 63% from 2013 EPS.  The share price currently reflects this.  Therefore, any kind of earnings surprise or good news can give the stock a big bounce.  In other words:  “Heads:  I win a lot, Tails:  I don’t lose that much.”

Using a free cash flow model, I’ll attempt to show that even under pessimistic scenarios, patient investors have a good amount of potential upside with the current share price around $20.

Investment Positives

  • Ability to acquire a consistently cash-generative, low capital intensity business for about 4 times median free cash flow over the past 7 years. (Where free cash flow is defined as cash from operations minus capital expenditures.)  This is about a 20% free cash flow yield based on median free cash flow over the past 7 years.
  • Ability to acquire the business for 2.5 times median EBIT over past 7 years and 4.5 times expected 2014 EBIT.
  • Management considers debt reduction a priority.
  • Management expects revenues to decline at a higher rate in fiscal 2014 than that experienced in fiscal 2013.  To offset, they expect to reduce costs and support plans for future growth.
  • $150 million gross annual savings goal by end of 2014.
  •  Management expects revenue growth in 2016 and $2 billion in revenue by 2018.
  • 50% stake of large investor Artal Group can give investors confidence that there are large stakeholders that won’t stand idly by without initiating a turnaround.
  • Interest coverage ratio (EBIT/ Interest Expense) of 4.4 for 2013 and expected value of 2.0 for 2014 shows that company has sufficient cash flow to cover their interest expense.
  • WTW plans to expand into healthcare and partnerships with health plans to provide dieting and weight management solutions.  Recent offering of Weight Watchers for Diabetes has landed Orlando Health, a large not-for-profit health care network, as its first client.  Weight Watchers has been trying out its new diabetes offering in several areas around the country.
  • Spokeswoman and celebrity Jessica Simpson providing her testimony and how well Weight Watchers worked for her can lead to increasing brand popularity.

Investment Risks

  • Revenue decline may continue to accelerate faster than cost savings can be achieved.
  • Debt-service on long-term debt of $2.36 billion can become overwhelming if revenues continue to decline, resulting in less cash available to invest into the business.
  • Continuing declines in “paid-weeks” metric and meetings recruitment may be difficult to turn around.
  • Propagation and increasing popularity of free mobile weight loss apps can continue to lead to revenue declines.
  • Uncertain outcome from recent class action lawsuit filed on behalf of investors who purchased Weight Watchers common stock between February 14, 2012 and October 30, 2013 alleges that Weight Watchers misrepresented material facts and/or failed to disclose adverse facts.

Industry-Implied Free Cash Flow Valuation

WTW free cash flow for the fiscal year ended Dec 31, 2013:

Operating Cash Flow ($mm):  $323.52

Minus Capex ($mm):  $61.93

Equals Free Cash Flow ($mm):  $261.59

Divided By Average FCF Yield of Personal Services Industry:  5%

Equals Industry FCF Yield-Implied Fair Value ($mm):  $5231.80/56.4 million shares out = $92.76 per share

If we require a more stringent free cash flow yield than the industry of say 7.5%, we get a fair value of:

$261.59 / 7.5% = $3487.87/56.4 million shares out = $61.84 per share

Discounted Free Cash Flow to Equity Valuation


2014 numbers are taken from management guidance given in the fourth quarter earnings conference call.  The following years’ numbers are using assumptions I believe are reasonable and conservative.  Free cash flow to equity is defined as:

FCFE = Net Income + Depreciation/Amortization/Non-Cash-Charges – Fixed Capital Investment – Working Capital Investment + Net Borrowing

Since the value of a stock is theoretically the present value of all future cash flows available to shareholders, this is the amount that is available after all capital expenditures, interest, and principal payments are paid.  What’s leftover is money that could be paid as dividends to shareholders.

Intrinsic Value per Share based on Free Cash Flow to Equity Valuation given below:  $57.29

As can be seen, the valuation depends heavily on the company’s ability to repay debt and eventually reverse their revenue decline.

You can download the spreadsheet from the link below and play around with some of the assumptions to see how it affects intrinsic value.

WTW Valuation Excel Spreadsheet

Free Cash Flow to Equity Valuation of WTW

Free Cash Flow to Equity Valuation of WTW


The current price of Weight Watchers (WTW) stock ignores the value of the company’s brand power and cash flow generating abilities.  Management’s commitment to drastically reduce costs and pay off debt is another positive.  For patient investors that have at least a year or two horizon, WTW’s current price presents a bargain opportunity to invest in a high-margin, low capital intensity business that has proven it’s not a fad over 50 years of history.   In today’s current market of lofty stock valuations, WTW is one company where the risk-reward is skewed to the upside.

Disclosure: I am long WTW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Harvest Natural Resources (HNR): Upcoming Catalysts Provide an Opportunity for a 50% Return

Harvest Natural Resources (HNR)

Investment Thesis

Investment opportunities are sometimes found in the tucked-away, nether regions of the stock market where few analysts will take notice.  But as they say, the fishing is best where the fewest people go.  Harvest Natural Resources (HNR) is one of those stocks that present a unique opportunity.  The problem is that it’s a company that hasn’t made money in five years that’s trading below tangible book value, and who’s very ability to operate as a going concern is questionable.  So why even bother?  The reason to consider this stock is that HNR is in the midst of a sale of its share of a partnership in Venezuela and also looking to sell its assets in Gabon to interested parties.  HNR has received cash for half of the Venezuela deal.  If these transactions close successfully, the company’s net asset value alone will be over $7.00 per share, 45% higher than its recent closing price of $4.80.  The question that remains will then be:  Will management take shareholder-friendly action and return the cash to shareholders?

HNR Company Overview

HNR is an oil and natural gas exploration / development company with assets / interests in the following regions:

  • Venezuela:  Through affiliates, HNR owns a 32% interest in Petrodelta.  The majority owner is PDVSA, the Venezuelan state-owned oil and natural gas company, which exercises most of the control over Petrodelta’s operations.  PDVSA however, has been derelict in its duties, providing insufficient monetary support in capital expenditures and falling behind in payments to contractors providing services to Petrodelta.   HNR is still waiting on a $9.8 million dividend that was declared in November 2010, and is uncertain on when or whether this or any future dividends will be paid. This is due to Petrodelta’s liquidity constraints from PDVSA’s lack of monetary support.
HNR's Venezuela Properties, Source:  HNR 2012 Annual Report

HNR’s Venezuela Properties, Source: HNR 2012 Annual Report

Although Petrodelta has consistently earned a profit from 2007 to 2013, dividends of profits since 2010 have not been declared, and there’s uncertainty over whether any future dividends will be paid.  The key point:  It’s probably a bad idea for HNR to keep doing business in Venezuela!  Recently, HNR entered into an agreement to sell its interest in Venezuela for an after-tax amount of $330 million.  The first payment has been received and the next payment is expected several months from now.

  • Indonesia:  Operational activities in this region are onshore in West Sulawesi and are still in the exploration stage.

HNR's Indonesia Properties, Source:  HNR 2012 Annual Report

HNR’s Indonesia Properties, Source: HNR 2012 Annual Report
  • Gabon:  Off-shore deep-water drilling exploration is the focus here.  The first high-quality 3D seismic images are expected during the second quarter of 2014.  In September of 2013, HNR entered into negotiations with Vitol S.A. to sell HNR’s 66.67% interest in Gabon for $137 million in cash.  Net proceeds were expected to be $121.8 million after transaction costs and taxes; however HNR and Vitol S.A. were unable to reach a deal.
HNR's Gabon Properties, Source:  HNR's 2012 Annual Report

HNR’s Gabon Properties, Source: HNR’s 2012 Annual Report

  • Colombia:  HNR signed farm-out agreements with another company.  (Farm-outs are when a company assigns its oil or natural gas interest to another party for an up-front payment in addition to a percentage of the revenues)  HNR has received notices of default from its partners for failing to comply with certain terms of the farm-out agreement, and has fully impaired the costs associated with that transaction, to the tune of $2.3 million.

 Recent Insider Transactions

Date Insider





Nov 27, 2013 SPEIRS ROBERT Officer



Purchase at $3.15 per share.


Nov 27, 2013 EDMISTON JAMES A Officer



Purchase at $3.15 per share.


Nov 27, 2013 HAYNES STEPHEN C Officer



Purchase at $3.15 per share.


Nov 27, 2013 MURRAY PATRICK M Director



Purchase at $3.15 per share.


Nov 27, 2013 STINSON JOHN MICHAEL Director



Purchase at $3.15 per share.


Nov 27, 2013 CHESEBRO STEPHEN D Director



Purchase at $3.15 per share.


Source:  Yahoo Finance

As we can see, the insiders have been buying since November.

Selected Balance Sheet Data (for the quarter ended September 30, 2013) (thousands)

Total Current Assets:  $7,581

Other Assets:  $6,258

Long-Term Receivable – Equity Affiliate:  $14,947

Total Current Liabilities:  $17,262

Long-Term Debt:  $76,793

Embedded Derivative-Debt:  $3,487

Warrant Derivative Liability:  $4,757

Other Long-Term Liabilities:  $640

Total Equity:  $528,345

Stock Data

Price per Share:  $4.80

Tangible Book Value:  Total Equity – Other Assets – Long-Term Receivable = $528.345-$6.258-$14.947 = $507.14 (To be conservative, we subtract the other assets and the long-term receivable and assume they will never be recovered)

Tangible Book Value per Share = $507.14 / 45 million shares out = $11.27

Price / Tangible Book Value = $4.80 / $11.27 = 0.43

Recent Key Events / Catalysts

  • In a press release, HNR announced on Dec 16, 2013 that it entered into an agreement with Pluspetrol to sell all the company’s interests in Venezuela in two transactions totaling $400 million in cash.  The net proceeds after taxes are expected to be $122 million and $208 million.  The transaction for the first amount has already been closed.  The closing of the second transaction is still subject to approval from the government of Venezuela, and if granted should happen around mid-year.
  • Proceeds from the transaction will be used to pay down HNR’s long-term debt and the rest used for working capital.
  • In a press release dated November 19, 2013, HNR announced that it was unable to reach an agreement with Vitol S.A. for the sale of the company’s interests in offshore Gabon.
  • In a press release dated January 15, 2014, HNR announced that it completed redemption of all $79,750,000 of its outstanding 11% senior notes due 2014 plus accrued interest.


How can you value a company that doesn’t make any money?  Well, a sum-of-the-parts asset valuation is one way.

If the Venezuela transaction closes as expected, HNR will have net cash of (Balance sheet data as of 9-30-13):

$122m + $208m + Current Assets – Current Liabilities – Long-Term Debt – Embedded Derivative Debt – Warrant Derivative Liability – Other Long-Term Liabilities = $122 + $208 + $7.581 – $17.262 – $76.793 – $3.487 – $4.757 – $0.640 = $234.64m

Monthly expenses: $2m* 6 months till Venezuela deal close=$12m

Net cash per share by June 2014~ (234.64m-$12m) / 45m shares outstanding = $4.95

Their net cash will exceed their stock price by $4.95/$4.8 – 1 = 3%

If we add the valuation of their oil and gas properties according to their carrying value on the most recent balance sheet, we get the following:  $106.366m, or $106.366m / 45m shares outstanding = $2.36 per share

Then a sum-of-the-parts valuation gives us a fair value of ($4.95+$2.36) = $7.31 per share, which is about 50% higher than the current stock price of $4.80.


  • Although we have potential sum-of-the-parts valuation of $7.31 per share, in order for that value to be realized by shareholders, HNR needs to return that money back to shareholders.  If they continue with their exploration and development activities and continue to lose money, shareholder value will be destroyed.
  • The Venezuela transaction may not be approved by the Venezuelan government, thereby further hindering HNR to unlock the value of its assets and return capital to shareholders.
  • The value of HNR’s oil and gas properties as listed on their balance sheet may be overstated or they may not be able to find a buyer, particularly for their assets / interests in Gabon.  (The recent deal with Vitol S.A. fell apart.)


Overall, I think HNR is a unique investment opportunity with the above catalysts / recent developments.  The fact that it’s trading below tangible book value minimizes downside risk.  Although there are no sure things in life, the management seems confident that the Venezuela transaction will close, and it seems that they’re committed in unlocking the value of their assets for shareholders.  With HNR’s debt extinguished and with a strong, liquid balance sheet, I think this is a low-risk value investment with the embedded option for a large payoff should their remaining oil and gas properties prove valuable.

Aeropostale (ARO): A Beaten-Up Retail Stock That May Hold Opportunity for Contrarian Investors


Investment Thesis:

Aeropostale (ARO) has been among the worst-performing retail stocks of the year, down about 35% the last 52 weeks as of this writing.  This may provide an opportunity for contrarian, patient investors to acquire a stock that is relatively cheaper than its peers and among the leaders in market share among young adults aged 14-17.

I will show that shares have gotten to a point where the risk-reward trade-off is skewed to the upside, and if the company can turn things around or the teen retail environment  picks up, or if Aeropostale can adapt to the changing market environment by expanding their target audience, ARO shares will recover quite nicely.  ARO’s debt-free balance sheet and large cash balance also give us a margin of safety.

As investors, we ask ourselves: “Is this decline due to a permanent impairment in the company’s prospects for profitability, or is it a temporary one which can be reversed when the retail market picks back up again or the company adapts to changing tastes?”  I will argue for the latter argument in this article.


If you’ve been reading the news headlines, you’ll see plenty of articles talking about how fashion retailers expect weak holiday sales this year, especially the three major teen retailers, Abercrombie & Fitch, Aeropostale, and American Eagle.  There’s been a lot of bearish talk about the three “Big A’s” as they are called as you can see from the news article snapshot below.



Declining sales have forced analysts to all but write-off any kind of investment in teen retailers at this point.  Teens have “new tastes”, “the three A’s are no longer in vogue” and “teens are spending more on electronics than clothing” are just some of the things you’ll read.  While to a certain extent this might be true, I believe analysts are underestimating these retailers’ ability to quickly adapt to changing tastes and the fact that the retail industry goes through cyclical highs and lows.  I also believe that a good deal of the pessimism is already built into the stock price of ARO.  This creates a situation where any sort of good news can result in a quick turn-around of the stock price.  Now let’s look at ARO as compared to some of its peers.

Aeropostale vs. Peer Comparable Companies


  • Right away, we can see that ARO has been the worst performer over the past 52 weeks with a negative 34.73% return.
  • Aeropostale’s EV / LTM Revenue of 0.24 is cheapest among its peers, 67% less than American Eagle’s, which is next best.
  • Also notable, is ARO’s Price to Median Free Cash Flow multiple (P/FCF) of 7.44, where free cash flow is taken as the median of the past 7 years.  This is also the best value among its peers.
  • Finally, the price investors pay per dollar of sales is only $0.28 for Aeropostale, much less than any of its competitors.  (This is measured as Market Cap. / LTM Sales.)  So, with the stock price at $8.25, we are only paying 28 cents and are getting a dollar of revenue.

In terms of value, ARO seems to be a steal at this price, at least when measured against its peers.

Now let’s attempt to value the common stock of Aeropostale based on three models.

Aeropostale Intrinsic Value Estimates

Valuation Based on Tangible Book Value

  • Industry Price to Book Ratio:  2.55  (Source:, Industry:  Retail)
  • ARO Tangible Book Value per Share:  $4.32
  • Industry-Implied Fair Value of ARO:  2.55 * 4.32 = $11.01  (33.45% upside to current price of $8.25)
  • Assumed Conservative ARO Price to Book Ratio:  1.60
  • Conservative Estimate for Fair Value of ARO:  1.60 * $4.32 = $6.91  (-16.24% downside to current price of $8.25)

Valuation Based on Median Free Cash Flow of the Past 7 Years

  • Industry P / FCF Multiple:  11.13  (Source:, Industry:  Retail)
  • ARO Median FCF per Share Over Last 7 years:  $1.11
  • Industry-Implied Fair Value of ARO stock:  $1.11 * 11.13 = $12.34  (49.52% upside to current price of $8.25)
  • Assumed Conservative ARO  P / FCF Multiple:  9.0
  • Conservative Estimate for Fair Value of ARO stock:  9.0 * $1.11 = $9.98  (20.91% upside to current price of $8.25)

Valuation Based on LTM Revenue and Median EBIT Margin Over Past 7 Years

  • LTM Revenue ($M):  $2309.93
  • Median EBIT Margin Over Past 7 Years for ARO:  13.2%
  • Discounted EBIT Margin to be Conservative and Comparable to Peers over Last 7 Years:  10%
  • Normalized EBIT ($M) = $2309.93 * 10% = $230.99
  • Median EV / EBIT Multiple for ARO Over Past 5 Years:  5.22
  • Total Implied Enterprise Value for ARO ($M) = 5.22 * $230.99 = $1204.91
  • Plus Cash & Short-Term Investments ($M):  $100
  • Minus Long-Term Debt:  $0
  • Divided by Number of Shares (m):  78.49
  • Equals Fair Intrinsic Value for ARO Common Stock:  ($1204.91+$100-$0)/78.49 = $16.63  (101.52% upside to current price of $8.25)

Our three valuation measures provide estimates ranging from $6.91 to $16.63 for the intrinsic value of Aeropostale’s common stock, which is definitely skewed to the upside.

Potential Catalysts

  • The retail sales environment may not disappoint as badly as some analysts may be predicting.
  • Aeropostale may be able to adapt to “fickle” teenager’s tastes and new fads quickly.
  • Aeropostale’s stores aimed at 12-14 year old kids, called P.S. from Aeropostale are a growing chain, and over time will gain more share of that segment of the market.
  •, owned by Aeropostale, is an online women’s footwear & apparel website that is growing sales.  Despite ARO’s overall net sales decreasing by 6% in the second quarter of 2013, net sales from the e-commerce business of ARO including, increased by 22% to $39 million.  ARO’s e-commerce business may continue to become a bigger piece of the sales pie, which may stimulate an increase in ARO’s share price.
  • Sophisticated activist investors are on the scene.  Sycamore Partners has taken a nearly 8% stake in Aeropostale, calling ARO “an attractive investment.”  This makes it the third largest holder of the stock.  Communication with the company’s management and board about Aeropostale’s business and strategy may force the company to take steps that enhance shareholder value more quickly.


  • Competition from lower-cost retailers such as Forever 21, H&M, Zara, and others may continue to erode market share from Aeropostale, causing them to lower prices in order to compete, resulting in lower margins.
  • The retail environment may continue to suffer from low demand as young adults choose to spend the bulk of their money on things such as electronics.
  • High teen unemployment will result in less disposable income to spend on apparel.
  • Despite the stock reaching new lows, the lack of insider buying of Aeropostale stock is a concern.


Overall, I think Aeropostale’s stock is a good value at this level.  A good amount of the fear may already be priced into this stock, and the concerns about a weak retail environment lasting for a long time may be overblown.  The presence of activist investors taking an 8% stake in the company gives us additional confidence.  ARO’s low valuation statistics as compared to its peers, and its debt-free balance sheet and cash position also make this stock worth considering as a contrarian play.


I do not have a position in ARO, however I may initiate a position in the next 48 hours.  I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.