The next Israeli company I would like to tell you about is Generation Capital (GNRS.TA). The reason I chose GNRS is because it shows that in Israel even market leading infrastructure companies with government contracts decades into the future can trade at unreasonable prices.
GNRS is the first and, for the moment, only public infrastructure holding company in Israel. There are few (private) competitors in the Israeli infrastructure investing market, and GNRS is managing to win project after project, at amazing prices. In the next 2-3 years, after amassing a diverse infrastructure portfolio, GNRS plans to become an infrastructure REIT and distribute almost all its profits as dividend.
Since GNRS is a fund, its financials are really simple. on the asset side we have infrastructure holdings, the value of which is determined in an Annual valuation by BDO (an important point we’ll get to later). On the liability side we have a basically nothing except a small 120 M ILS bond, so to value GNRS we just need to use the value its different holdings, and we already have valuations by BDO attached to the 10Ks to help us out.
The investment thesis in GNRS can be explained very simply, but before we can get to the simple part, let’s thoroughly go through GNRS’s holdings, each of which is not only stable, but has surprising growth potential.
Energy and renewables
The first time I encountered GNRS’s activity was 2 years ago, through investing in another interesting Israeli company – Rapac (RPAC), which I still hold. The Israeli electricity market was, until recently, completely dominated by Israel Electric Corporation, (IEC) a government owned corporation.
In the last decade the government encouraged private players to enter into the electricity generation market. Also, as part of the reform in IEC, it is being forced to privatize five of its power plants, as well as encourage and assist in the building of new privately owned power plants.
And so, Rapac constructed 2 gas powered co-generation power plants in northern Israel. The EPC contractors was german company, Siemens. Unfortunately, towards the end of the plants’ construction one of Siemens’ subcontractors went bankrupt, which delayed the plants’ completion by almost a year.
Rapac felt uncomfortable with the almost 1 B ILS leverage it carried, planning for the plants to be already completed, so Rapac sought a partner to help ease the tension. There are very few players that invest in infrastructure in Israel, and at the end of 2018 GNRS made bought 50% of Rapac Energy for 90 Million ILS, an incredible bargain for GNRS. The northern plants alone are expected to conservatively generate FFO of around 80 M ILS on average in the next 5 years, and free cash flow to GNRS, after debt repayment spread over only 17 years out of atleast 40 years of expected generation of around 13 Million ILS. This means than after 17 years, the northern plants will be Free of debt and worth north of 1 Billion ILS.
After making this fantastic deal buying into Rapac Energy, GNRS wasted no time propelling RE forward. Since GNRS entered RE 2 years ago, GE won, in partnership with 2 other companies, the first power plant privatization from Israel Electric Company (IEC) – Alon Tavor. The winning bid was 1.85 Billion ILS, but the partners only paid 104 M in equity each – a total of 312 M, and the rest (~1.65B) was paid for by lenders.
I estimate the 104 m (half of which is GNRS’) of equity in the Alon Tavor plant is conservatively worth more than 500 Million ILS, and if we go by the second privatization completed since then, GE’s part in alon Tavor may even be worth 700-800 Million ILS. A 5-10 bagger in less than a year.
You can read Alon Tavor’s latest quarterly report (in english!) here. With a quarterly profit of 65 Million, you can judge for yourselves if the equity is worth more than the 312 M cost it’s written at (1/6 of which is GNRS’)
The latest deal GNRS made in the power plant business was in the height of the corona crisis. Delek Group, an Israeli energy company got into financial trouble due to the oil and gas price collapse and its high leverage. Its bonds traded at about 19% of par and it had to sell some assets, including 2 power plants. The buyer was, again, RE, which jumped on the opportunity and paid 367 Million ILS for plants that are probably worth more than 600 Million.
Separate from RE, GNRS holds 60.11% of Solegreen, A growing solar energy company trading for 227 Million ILS, after significant appreciation in the last few months. Since GNRS marks Solegreen to market, if Solegreen’s price stays constant, GNRS will recognize a profit of ~60 Million ILS by the end of the 3rd quarter.
Natural Gas Distribution
On august 2019 GNRS bought 33% of the company that holds an exclusive license to build and operate a gas distribution pipe network in southern Israel for 133 Million ILS.
The pipe network’s income has been rapidly growing rapidly in the last few years, and is expected to continue growing as more and more factories and end users are being connected.
Gas distribution profits are expected to grow double digits for years to come, replacing inefficient fuel and gas transportation by trucks.
Desalination and waste management
In recent months GNRS got into water desalination (most of Israel’s drinking water comes from desalinated sea water), and waste treatment. In 2020 GNRS already bought 2 businesses in this sector, seemingly on the cheap.
This segment is pretty new, and we don’t have its detailed financials yet. The next 10K, probably published on march, will include a detailed valuation of this segment.
What I can tell you is Israel is really falling behind in waste treatment. Knowing Generation’s management – I am guessing that as they did with power plants, they’re trying to become the only major player in the waste management business (since there really isn’t one right now – only small private companies).
GNRS holds 49% of Bon Tour LTD, that operates mini-busses, usually on long term contracts transporting students and workers.
Bon Tour generates ~50 Million ILS, not including Bon Tour’s 50% holding in bus company Metropolin. Metropolin is growing rapidly in the last few years, winning more and more bus line. Metripolin generated operating profits of 34 M and 28 M in 2018 and 2019, and is expected to generate operating profits of 39.4 M in 2020, rising to 69.4 in 2022.
GNRS’s reports include BDO’s valuation of Bon Tour, which estimates GNRS’ holdings in bon tour at 193 M ILS, Though I take issue with one specific part of the valuation – the discount yield – an important point we’ll get to soon.
GNRS’ financials and value
The best way to think about GNRS’ value is through Net Asset Value.
GNRS’ is an infrastructure fund, and basically all of its debt is on the holdings’ levels except for a 125 Million ILS bond issued 3 months ago. The bond is trading for a YTM of around 2.52%, after being issued at a yield of 3.85%. GNRS used all of the bond plus some cash to replace Rapac Energy’s (50% owned by GNRS) existing mezzanine loan with its own mezzanine loan yielding 9.5%. Considering how financially stable RE is, this seems like a great move.
This is GNRS’ latest published balance sheet – 31/3/20 (before the bond issue) in thousands of ILS:
|Cash and cash equivilants||143,799|
|Holdings in companies||789,263|
|Deferred tax liabilities||14,079|
|Total Balance Sheet||934,634|
Pay attention to the fact the only liability at the fund level (before the bond issue) was deferred tax liabilities, a liability that will probably never be paid, as GNRS intends to act an infrastructure REIT.
Regarding GNRS’ expenses – as a fund GNRS has no employees, and no offices. GNRS’ only expense (besides minimal ‘other’ expense of a few hundred thousands a quarter – probably the boards’ wages) is its ‘management fee’. GNRS’ management company is the one that pays the employees (including the management and CEO). The management fee is layered in the following way:
|Asset Value||Yearly management fee|
|Less than 550 Million||1.5%|
|More than 1,000 Million||1.0%|
GNRS’ asset value will soon exceed the 1% layer. In any case, since the management fee is basically GNRS’ entire expense, and since the management is doing an extremely good job closing deals at bargain prices.Rapac Energy’s deal alone covers the management fee for about a decade, and they just keep finding and closing great deals.
In any case, the management company contract is for 7 years, with 6 years remaining. It can be expected that when the contract ends management fees will be reduced.
The Investment Thesis
So after boring you with some background details, let’s get to the surprisingly simple investment thesis – Generation’s assets are worth much more than their balance sheet value.
So at the end on the 1st quarter the assets+deferred taxes are 948 Million. Remeber most of the assets’ value is determined in an annual valuation attached to the 10K with cash flow forecasts for every project, and the holding in Solegreen is marked to market.
So why am I saying the real asset value is much higher?
So first, Solegreen’s market price has increased by ~60 Million ILS from the end of march to today. This increase ‘already happened’ and will show up in the next quarterly reports.
Second, there are assets that do not appear on the balance sheet at all, or only appear at cost. Take the Alon Tavor plant for example, that appears at cost value of 52 Million ILS while being worth, in my opinion, at least 250 Million not counting 2 options included in the bid win to construct 2 additional plants, one being a peaker and the other an expansion of the original one.
Many of GNRS’ projects include such “options” that are not included in the valuations at all, But these are all minor compared to the main issueI have with the valuations – The discount rates used.
The politics of discount rates
Due to almost very little competition in the infrastructure sector, GNRS manages close great deals. The ‘problem’ is – GNRS doesn’t necessarily want to show the sellers and the rest of the market how great of a deal it got. That’s why they make sure, atleast in the first year or two after a deal, to keep the assets close to the purchase price. how? using artificially high discount rates.
Considering 10 year government bonds yield 0.6%, and 7 year Israel Electric Company bonds yield 0.28% (plus inflation), What discount rate would you use on a new, state of the art co-generation power plant, with set prices decades into the future, in the Israeli market in which an electricity shortage is expected as soon as 2025? 4%? 5%? BDO valuations use a discount rate of more than 10%, and since the power plants are funded mostly by ~80% debt, this drastically and artificially lowers the value. Why? because even with this high discount rate GNRS more than doubled its money on the investment, and any more than that would make everyone look bad. Let me guess that in the next few years the discount rate used will slowly get closer to a more realistic 5%, more than doubling the plants’ value on the balance sheet and increasing equity value with debt massive annual debt repayment.
Or take the transportation business – Bon Tour. What discount rate would you use for a low leverage, market leading transportation and bus business, with long term contracts with government bodies, that are not even depended on the number of passenger but on the miles driven? 4%? 7%? The valuation used a discount rate of 15.2% (!!) Why? because using a more reasonable rate would create a huge gain, too soon after the asset was purchased in 2018. The asset already doubled in value since then, and any more than that would make everyone look bad..
You see where this is going. The extremely high quality gas distribution business with long term contracts and the only alternative being gas transportation by trucks – discounted at 11%.
Summary and the next couple of years
GNRS trades for 750 Millions ILS with an equity, not including deferred taxes and updating the market price of Solegreen, of more than 1 Billion ILS.
To this we should add at least 600 Millions of assets (like Alon Tavor, with annual profits in hundreds of Millions) included at cost.
In addition, the discount rates will be lowered to a a more reasonable single digit discount rate, befitting their extremely low risk. Furthermore, in the next 2-3 years GNRS will become an infrastructure REIT, an almost ‘bond like’ sector which trades richly with yields at around 1.8%-4%. even at a 5-7% yield, I expect GNRS’ equity to increase 2X-4X in the next 2 years even without any new developments. With GNRS trading at a discount to equity (as do most stocks in the Israeli market at the moment), then even with the unjustified equity discount remaining constant I see GNRS stock at the very least doubling in the next 2 years.
Afterword: I want to use the momentum to sum up a short thesis on Rapac, which I also hold. Rapac’s half of Rapac Energy is worth at-least 600 Million ILS (not including an option for 2 additional power plants and 2 plants purchased from Delek at the height of the recent crisis), in addition to a Consulting and commerce business worth around 60 Million ILS and half of another public company, Elmor, trading for 180 Million ILS (so 50%=90 Million ILS). all this against 60 Million ILS net debt and management fees that are already included in the consulting and commerce sector results. A sum of the parts of 680 Million ILS, trading for 330 Million ILS.
I, and the fund I manage, have holdings in GNRS and Rapac.