Selecta - Outlook - Positioning

All,

Please find our unchanged analysis here. 

We have been meaning to put this trade on for a while. One of you had the idea about a month ago and we like it, but we weren’t going to spill the beans before that fund had time to put it on. We think it's the right trade fundamentally and while there are some risks in the short term, we are also expecting some tailwinds this year, before we are expecting a normalisation in the following two years.

Investment Rationale:

- Ahead of the results later this week we have sold our position in the SSNs @ 98.125c/€, worth 4.2% of NAV. We bought these back in March last year and they have done well. 

- We have kept our 2% of NAV position in the 2LNs for now, yielding just shy of 15% to maturity.

- We have added another 2.7% of NAV to our existing 1.3% of NAV position in the Prefs at 52c/€. Liquidity wasn’t super fantastic, so we’ve had to pay up a bit.

- Our total position size will therefore reduce from 7.6% to 6%, but the risk weighting will be significantly increased. We will also be earning more PIK than cash and there will be less pull-to-par into maturity.

Pref Shares:

- Maturity in 2026 does not automatically constitute an event of default, but merely a threat to KKR of conversion into 100% equity, where the KKR portion of the Prefs receives non-voting shares. 

- At the current valuation and if Selecta needs fresh cash in such a transaction (cannot refinance the SSNs and 2LNs, then we see the Prefs as worthless. The large x-holdings in the structure will likely prefer to convert the 2LNs into 100% of the equity and the small prefs might struggle to double down and inject what would soon be more cash than they paid for their instruments in the first place. 

- However, we see more upside in these instruments primarily on account of the positive cash flow development we are forecasting. As flagged before, we think the Paris Olympics this year should give the company an extra shot in the arm. 

KKR:

- We have not always been a fan of Selecta. For a long time, the sponsor has been pursuing the wrong strategy with Selecta. The quest for world domination has cost dearly and the pie proves too big to swallow. 

- Current management, however, has turned the wheel and Selecta is on the path to producing cash flow. 

- Vending machines are generally an attractive cashflow business - until one goes after market share (or someone else does). 

- We therefore do not see KKR giving up the company or handing over the keys any time soon - not for the puny little SSN-Prefs, not with tighter rates, not right when the company is turning around.

Gross Margin:

- Fundamentally, the company has some €50m of annual Gross Margin to catch up on. This would come in the form of higher sales prices relative to a slowing of food/coffee inflation. 

- We have been observing a slowdown of food inflation and in some areas (Grocer staples - not directly related to Selecta) even deflation. 

- Meanwhile, wages should continue to catch up with events throughout Europe. 

- In the short term, we are somewhat concerned that the strike actions roiling rail and aerospace across Europe will affect Selecta’s figures in the first half of 2024. But we are inclined to see through those.

Here to discuss,

Wolfgang