Selecta - Cashflow and Thoughts

All,

Q4 results this morning confirm why we have been critical of Selecta for some time.

The majority of EBITDA growth stems from asset sales and at the continuously lacklustre EBITDA margin (net of gains on asset sales) of 10%, the company is merely NCF break even.

2020 Performance Drivers of E32m:

- The company has reportedly achieved synergies of E60m of its E75m package and intends to realise the final E15m over the course of next calendar year.

- FY2019 does not give full recognition to synergies achieved during the year, which could provide another E17m of EBITDA increases next year.

- Otherwise EBITDA has been quite flat and should remain so.

- Note that net CapEx in 2019 has been E15m lower than usual.

-> So including recognition of full synergies by end of 2020 and all else equal, margin might increase by 1% of sales and interest coverage might creep to 1.25x.

Bonds are trading rich:

- The bonds already price in the full synergies - admittedly the execution to date seems to have been on track.

- KKR have already equities their shareholder loan, which suggests that profit from the investment will need less tax protection than anticipated.

However, a short position is still difficult to justify here with no particular trigger in sight:

Upside / Downside:

Upside - Bonds are 2024 maturity last seen (by us) with a YTM of 5.6% somewhere around 101. If Selecta performs well (to plan) the relatively long duration could see the bonds rise some 2-3 points from current levels (same market conditions) - providing a short position with a total of ~10 points of risk (incl. 2% borrow) to trade perhaps at a 5% YTM / slightly lower YTC.

Downside - If the economic environment and European GDP (high correlation) are stalling, then the 1% priced-in net margin / CF increase are quickly eroded, given the extraordinary operating leverage (think business model exchanging OpEx for CapEx) and bondholders could be left wondering - with synergies exhausted - where interest coverage is supposed to come from. Thus if bonds were to move to say a 10% YTM by next December (maturity only 2024), they would give a short position only some 10 points return, from which to subtract the 5.6% yield and 2% borrow.

Let us know if you think the name is interesting.

Wolfgang