Description

I recommend a short position in the German travel company TUI (Bloomberg: TUI.GR). TUI is an interesting story with many moving parts. To simplify the analysis, I define the company as a conglomerate consisting of an asset-intensive travel company, a container shipping company, and several non-core assets, including an eyebrow-raising steel trading business who’s profitability has gone from 12m Euros in 2003 to over 100m Euros in 2004.

Let me start by stating that the financials of TUI are difficult to dissect and that the financial reporting is vague and interpreting them, in general, is an exercise in frustration. In addition, there are numerous minority interests, cross-holdings and several divestitures that have happened over the past two years which further complicate the story. Furthermore, the CEO was formerly a banker at West LB, a German bank that until less than a month ago, held a 31% stake in TUI. In his past life, Mr. Frenzel (CEO) faced investigations (January 2003) relating to the insolvency of a German engineering company, Babcock Borsig. This summer, when TUI faced the possibility of being ejected from the DAX, there were a number of rumors floating around regarding the possible takeover of the company by US private equity companies, European hotel companies, online travel companies, my grandmother, and other venture capital investors – all of which proved to be untrue. A skeptic might argue these rumors – which began the week before August (the month during which average stock prices are calculated for inclusion / removal from the DAX) – were a bogus attempt to move the stock price up (which it successfully did). The rumors continued after August, which the same skeptic might believe was an attempt to keep the stock price high enough such that Mr. Frenzel’s friends at West LB could sell the stock above their book value of 16.50 euros.

The Tourism Division:
The largest division is a tourism division – a European tour operator. What is a European tour operator? They are a vertically-integrated travel company. They own/franchise travel agencies, they own/lease aircraft, they own/negotiate rooms at hotels – and they create packages for the leisure traveler. Again, the accounting for this division is difficult to interpret. It is a very capital intensive business. I would argue that brick-and-mortar travel agencies are challenged, low cost carriers are driving down air prices, internet bookings are taking tremendous share and hotels (particularly in their most popular destination, Spain) are overabundant. All this would lead me to believe that, over the next few years, revenues and profitability will decrease. A recently-published sell-side report indicates that on average, the packaged holiday that TUI (or Thomson in the UK) offers is significantly more expensive than a dynamically-packaged holiday when the consumer manually combines a flight and a hotel, independent of the tour provider. The two most comparable companies to TUI are Thomas Cook (50% owned by Lufthansa / 50% owned by Karstadt Quelle), which hasn’t been profitable in quite a while; and MyTravel, a UK-based company that is in restructuring mode after succumbing to significant off-balance sheet liabilities (please keep this in mind when you try to reconcile TUI’s reported EBTA vs. the cash generation of the business.)

Container Shipping Division:
Consists of Hapag-Lloyd. In my introduction, I neglected to mention that part of the bull case coming into the year was that they would IPO their container shipping division at a valuation of close to 3 billion euros. The market did not afford this type of valuation to the business and the IPO was pulled. TUI maintains that this division is worth 3 billion euros, despite the fact that the market was ascribing it a value of (what I hear was) around 1.6 – 2.0 billion euros. Perhaps the valuation reflected concerns that there is a tremendous amount of shipping capacity coming online in the next 3 years.

Central Operations:
This includes their own start-up low cost carriers, ThomsonFly and Hapag-Lloyd Express. These business lost over 60m last year and are on track to lose over 35m euros this year. This also includes the corporate overhead costs associated with running the conglomerate, as well as interest expense (note: the company incurred about 150m of interest expense in 2003 on approximately 4,100m of debt if you average the ending net debt of each quarter – implying an interest rate of less than 4%)

Non-Core Assets:
They still have some non-core logistics businesses, the steel trading businesses and some excess real estate that they intend to divest in the next 1-2 years. Indications are that these businesses are worth somewhere between 700-900m euros.

“Financials:”
I put this in quotes because these are my best estimates as to the reported profitability of each of the businesses. Please verify all financials with the company’s financial statements and press releases:

Tourism:
2002 EBTA: 226m
2003 EBTA: 208m
2004E EBTA: 373m

Container Shipping:
2002 EBTA: 121m
2003 EBTA: 253m
2004E EBTA: 410m
(I heard but cannot get written confirmation that 2000 EBTA was closer to zero)

Central Operations:
2004E loss from low cost carriers: 35m
2004E corporate expenses: 130m
2004 Interest Expense: 111 through 3 quarters

2004E Ending Net Debt (12/31): 3,000m euros

I am absolutely willing to field any questions on the financials, but will not spend much time valuing the businesses as I believe that the stock is overvalued almost any way you cut the numbers. However, here is my attempt to value the stock:

Container Shipping: Trough EBITDA: 100m euros; Peak EBITDA = 410m euros; Average EBITDA over a cycle: 255m EBITDA x 7multiple = 1,785m

Tourism: 400m LTM EBITA x 7.5 multiple = 3,000m

Non-Core Assets: 900m

Low Cost Airlines: (35m) - let’s say it’s worth zero

Central Costs = (130m) x 6 multiple (generous?) = 780m

Pension Liability = zero value

Minority Interest (40m) = let’s say this is zero also (generous)

1,785m + 3,000m + 900m – 780m = 4,905

Equity Value: 17.73 x 178m shares = 3,156m
12/31/04 estimated net debt: 3,000m
Enterprise Value: 6,156

Fair Value, Stock Price: 10.70 euros


I would also like to propose the following questions:
-- How does the company account for the 700m+ of annual operating lease expenses?
-- Why is the interest rate so low for these types of businesses?
-- Has the company engaged in sale/leaseback transactions which may show an accounting gain/profit, but not a cash one?
-- There has been approximately 650-680m euros of cash received from divestitures in the past 12 months, plus approximately 300m of EBTA from the container shipping business, plus approximately 100m from the steel trading business. Even after taking away corporate costs and interest expense, why has net debt only been reduced by 800m (pro forma to 12/31/04, using company guidance)? Has the company engaged in sale/leasebacks to inflate profitability?
-- How do you account for the significant pension liabilities (on top of the capitalized lease obligations) in valuing the company?
-- How do you account for minority interests?

I look forward to fielding your questions. I think, if nothing else, this is a very interesting company for those of us who are intrigued by the stock markets, their efficiency, and what moves stocks

Catalyst

-- Continued expansion of low cost carriers in europe
-- Continued penetration of online travel alternatives
-- increasing debt/capital lease obligations
-- detailed analysis of the cash flows of the company
-- Weakening of the container shipping cycle