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Seems like the company has performed rather poorly over the last two years.

 

Ruane Cunniff was a big holder for a while and talked about the poor corporate governance and diversification strategy in their latest annual letter:

http://www.sequoiafund.com/Reports/Annual/Ann14.pdf

 

It seems like they have a great jet engine/civil aviation business and it could be possible that the market is not properly valuing the company at this point as a result of its "conglomerate" structure. 

 

RR also recently won some new contracts with Emirates:

 

Rolls-Royce wins $9.2B order from Emirates for Trent 900 engines, support Rolls-Royce (RYCEY) has won its largest ever order, worth $9.2B, to provide Trent 900 engines and TotalCare service support to Emirates. The engines will power 50 Airbus (EADSY) A380 aircraft that will enter service from 2016.

 

 

With the recent CEO change, wanted to see if anyone had any thoughts on the company going forward / any insights on the new CEO / current valuation?

 

http://www.bloomberg.com/news/articles/2015-04-22/rolls-royce-names-east-as-new-ceo-amid-investor-discontent

 

 

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We looked at it and like the basic thesis - RR sells engines up front at low to no margin and then picks it up over the life of the engine via total care contracts. They have a good investor day presentation on the total care contract.

 

Unfortunately, we couldn't get a good feel for the future cash flows they will generate from the total care agreements.

 

If someone has figure out the exact economics would love to learn from your research

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I believe it's a pretty big position for Sequoia Fund and they compared it a bit to Precision Castparts in a letter to investors I seem to recall. I took a look at RR when it was lower than today but the business was too complex for me to come up with much of a valuation range (I'm still very much a rookie).

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I remember RR was mentioned in longleaf partner's recent letter. They said the change in CEO was by the board to aggressively push EPS up. The new CEO wasn't good and decided to expand into marine engines sector. I can't totally remember that though. You can look it up and see if it helps.

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[Delayed] Rolls-Royce Holdings  RR.    Rolls-Royce Trent 700 Worth $930m Selected By IAFC

2015-07-20 07:02:18.810 GMT

 

 

 

  Rolls-Royce Holdings (RR.) - Rolls-Royce Trent 700 Worth $930m Selected By

  IAFC

 

RNS Number : 4344T

Rolls-Royce Holdings plc

20 July 2015

 

                                                                  20 July 2015

 

ROLLS-ROYCE TRENT 700 ENGINES WORTH $930M SELECTED BY INTERNATIONAL AIRFINANCE

                                CORPORATION

 

 

 

Rolls-Royce has been selected by International AirFinance Corporation (IAFC) to provide Trent 700 engines, worth $930m, for 20 Airbus A330 Regional aircraft.

 

The Trent 700 is the clear market leader on the A330 with more than 60 per cent of new orders over the last three years. The Trent 700 now accounts for

90 per cent of A330 freighters in service and on order

 

Moulay Omar Alaoui, International AirFinance Corporation, President and CEO,

said: "We selected the Trent 700 as the best solution in terms of economics and reliability."

 

Eric Schulz, Rolls-Royce, President - Civil Large Engines, said: "We welcome our customer's confidence in the Trent 700 as the best solution for fuel burn, emissions and noise performance as well as delivering unrivalled reliability for Middle East operations."

 

More than 1,500 Trent 700s are now in service or on firm order, making it the largest in-service Trent engine.

 

About Rolls-Royce Holdings plc

 

1.  This Original Equipment order will result in an increase in the Group's order book of $930m, in accordance with Group accounting policy and is linked to the TotalCare® order announced today. The value of the contract is consistent with the disclosures set out in the recent market update issued by Rolls-Royce Holdings plc on 6 July 2015.

 

2.  Rolls-Royce's vision is to create better power for a changing world via two main business divisions, Aerospace and Land & Sea. These business divisions address markets with two strong technology platforms, gas turbines and reciprocating engines. Aerospace comprises Civil Aerospace and Defence Aerospace. Land & Sea comprises Marine, Nuclear and Power Systems.

 

3.  Rolls-Royce has customers in more than 120 countries, comprising more than 380 airlines and leasing customers, 160 armed forces, 4,000 marine customers including 70 navies, and more than 5,000 power and nuclear customers.

 

4.  Our business is focused on the 4Cs:

 

·      Customer - placing the customer at the heart of our business

 

·      Concentration - deciding where to grow and where not to

 

·      Cost - continually looking to increase efficiency

 

·      Cash - improving financial performance.

 

 

5.  Annual underlying revenue was £14.6 billion in 2014, around half of which came from the provision of aftermarket services. The firm and announced order book stood at £73.7 billion at the end of 2014.

 

6.  In 2014, Rolls-Royce invested £1.2 billion on research and development.

We also support a global network of 31 University Technology Centres, which position Rolls-Royce engineers at the forefront of scientific research.

 

7.  Rolls-Royce employs over 54,000 people in more than 50 countries. Over

15,500 of these are engineers.

 

8.  The Group has a strong commitment to apprentice and graduate recruitment and to further developing employee skills. In 2014 we employed 354 graduates and 357 apprentices through our worldwide training programmes. Globally we have over 1,000 Rolls-Royce STEM ambassadors who are actively involved in education programmes and activities; we have set ourselves a target to reach 6 million people through our STEM outreach activities by 2020.

 

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It is really hard to understand the profitability here.

http://www.rolls-royce.com/news/press-releases/yr-2015/pr-29-07-2015-rr-signs-580m-totalcare-engine-support-agreement-with-vietname-airlines.aspx

 

340M Pounds for 14 engines. That's 24 M per engine. Assuming a 20% profit margin, it will be 4.8 M per engine profit. How long is this total care contract? 10 years? 20 years? That can change the valuation drastically. Does anyone know?

 

Assuming it is 10 years contract. Each year it will make 0.48 Million pounds per engine. There are 1500 engines sold. So that's 740 Million pounds per year profit. Giving it a 10 PE, and we get 7.4 Bn valuation. Today's market cap is 13 bn.

 

Is my assumption reasonable? Of course they have other lines of businesses, but not that profitable. It puzzle me as to why the author claims it is way undervalued.

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It is really hard to understand the profitability here.

http://www.rolls-royce.com/news/press-releases/yr-2015/pr-29-07-2015-rr-signs-580m-totalcare-engine-support-agreement-with-vietname-airlines.aspx

 

340M Pounds for 14 engines. That's 24 M per engine. Assuming a 20% profit margin, it will be 4.8 M per engine profit. How long is this total care contract? 10 years? 20 years? That can change the valuation drastically. Does anyone know?

 

Assuming it is 10 years contract. Each year it will make 0.48 Million pounds per engine. There are 1500 engines sold. So that's 740 Million pounds per year profit. Giving it a 10 PE, and we get 7.4 Bn valuation. Today's market cap is 13 bn.

 

Is my assumption reasonable? Of course they have other lines of businesses, but not that profitable. It puzzle me as to why the author claims it is way undervalued.

 

I asked the article's author about totalcare revenue recognition today, he wrote:

"The company does not provide much detail on how revenue is recognized from TotalCare agreements. Given that, it is hard to give you an answer."

 

On the subject of pricing, he goes more into it in his previous article:

http://seekingalpha.com/article/3266845-rolls-royce-the-goose-has-laid-the-golden-engine

 

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It is really hard to understand the profitability here.

http://www.rolls-royce.com/news/press-releases/yr-2015/pr-29-07-2015-rr-signs-580m-totalcare-engine-support-agreement-with-vietname-airlines.aspx

 

340M Pounds for 14 engines. That's 24 M per engine. Assuming a 20% profit margin, it will be 4.8 M per engine profit. How long is this total care contract? 10 years? 20 years? That can change the valuation drastically. Does anyone know?

 

Assuming it is 10 years contract. Each year it will make 0.48 Million pounds per engine. There are 1500 engines sold. So that's 740 Million pounds per year profit. Giving it a 10 PE, and we get 7.4 Bn valuation. Today's market cap is 13 bn.

 

Is my assumption reasonable? Of course they have other lines of businesses, but not that profitable. It puzzle me as to why the author claims it is way undervalued.

 

I asked the article's author about totalcare revenue recognition today, he wrote:

"The company does not provide much detail on how revenue is recognized from TotalCare agreements. Given that, it is hard to give you an answer."

 

On the subject of pricing, he goes more into it in his previous article:

http://seekingalpha.com/article/3266845-rolls-royce-the-goose-has-laid-the-golden-engine

 

If it is hard to give the answer, then why can he comfortably claim RR is undervalued? Isn't totalCare contracts the major reason to invest in this annuity like business?

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It is really hard to understand the profitability here.

http://www.rolls-royce.com/news/press-releases/yr-2015/pr-29-07-2015-rr-signs-580m-totalcare-engine-support-agreement-with-vietname-airlines.aspx

 

340M Pounds for 14 engines. That's 24 M per engine. Assuming a 20% profit margin, it will be 4.8 M per engine profit. How long is this total care contract? 10 years? 20 years? That can change the valuation drastically. Does anyone know?

 

Assuming it is 10 years contract. Each year it will make 0.48 Million pounds per engine. There are 1500 engines sold. So that's 740 Million pounds per year profit. Giving it a 10 PE, and we get 7.4 Bn valuation. Today's market cap is 13 bn.

 

Is my assumption reasonable? Of course they have other lines of businesses, but not that profitable. It puzzle me as to why the author claims it is way undervalued.

 

I asked the article's author about totalcare revenue recognition today, he wrote:

"The company does not provide much detail on how revenue is recognized from TotalCare agreements. Given that, it is hard to give you an answer."

 

On the subject of pricing, he goes more into it in his previous article:

http://seekingalpha.com/article/3266845-rolls-royce-the-goose-has-laid-the-golden-engine

 

If it is hard to give the answer, then why can he comfortably claim RR is undervalued? Isn't totalCare contracts the major reason to invest in this annuity like business?

 

 

I think this presentation regarding TotalCare accounting answers your questions, I'm surprised the author hasn't referred me to it:

http://www.rolls-royce.com/~/media/Files/R/Rolls-Royce/documents/investors/results/presentations-and-briefings/2014-investor-briefing-totalcare-accounting-mark-morris-tcm92-57736.pdf

 

 

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340M Pounds for 14 engines. That's 24 M per engine. Assuming a 20% profit margin, it will be 4.8 M per engine profit. How long is this total care contract? 10 years? 20 years? That can change the valuation drastically. Does anyone know?

 

Assuming it is 10 years contract. Each year it will make 0.48 Million pounds per engine. There are 1500 engines sold. So that's 740 Million pounds per year profit. Giving it a 10 PE, and we get 7.4 Bn valuation. Today's market cap is 13 bn.

 

Are you not ignoring the engine business itself. The profits from selling more engines and long term contracts on those ?

 

Regards

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340M Pounds for 14 engines. That's 24 M per engine. Assuming a 20% profit margin, it will be 4.8 M per engine profit. How long is this total care contract? 10 years? 20 years? That can change the valuation drastically. Does anyone know?

 

Assuming it is 10 years contract. Each year it will make 0.48 Million pounds per engine. There are 1500 engines sold. So that's 740 Million pounds per year profit. Giving it a 10 PE, and we get 7.4 Bn valuation. Today's market cap is 13 bn.

 

Are you not ignoring the engine business itself. The profits from selling more engines and long term contracts on those ?

 

Regards

 

The whole point of this total care business is to sell engines at breakeven/loss in order to get longer term annuity like profits from engine maintenance.

The SA author just replied to me and said the totalcare contracts are usually as long as the engine's life span, which means 20-50 years, not the 10 year assumption in my previous calculation. Therefore assuming 20 years and 1500 Trent 700 engines, the net income per year is only 340 million, so that's just a 3.4 bn worth business.

 

If you think 1500 engines are too small and they will quickly succeed and sell many more, please let me know your estimate on the Trent 700 engine counts in 3 years. Do you think that can become 6000? Even if so, that's just worth 3.4*4 = 13.6 bn, exactly today's market cap.

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I digged a bit deeper into the previous years' financial statements between 2009 and 2014, when the old CEO running the totalCare business liked a lot by Sequoia was still there and I thought they would have been gushing tons of free cash flows each year.

However, what I saw was this:

1. Every single year's depreciation+amortization cost is much less (about 50% less) than the "addition of intangible assets" + "addition of PPE" in its consolidated cash flow statement.

2. Each year's FCF, which I defined as OCF minus ("addition of intangible assets" + "addition of PPE"), is only about half that of the OCF, and the amount is around 0.3-0.5 bn per year. Very small amount indeed.

 

Given that, I would not figure out why it is even worth today's 13 bn market cap.

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I digged a bit deeper into the previous years' financial statements between 2009 and 2014, when the old CEO running the totalCare business liked a lot by Sequoia was still there and I thought they would have been gushing tons of free cash flows each year.

However, what I saw was this:

1. Every single year's depreciation+amortization cost is much less (about 50% less) than the "addition of intangible assets" + "addition of PPE" in its consolidated cash flow statement.

2. Each year's FCF, which I defined as OCF minus ("addition of intangible assets" + "addition of PPE"), is only about half that of the OCF, and the amount is around 0.3-0.5 bn per year. Very small amount indeed.

 

Given that, I would not figure out why it is even worth today's 13 bn market cap.

 

The thesis of lack of FCF is that we are going through a "super-cycle". RR (and GE) both have one-a-lifetime huge backlog of orders and are investing heavily to increase their production capacities.

 

http://finance.yahoo.com/news/aerospace-climbs-supercycle-204300442.html

 

The difficulty with RR is how to figure out its normalise FCF. I'm still pondering on this...

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(BN) Rolls-Royce Says Activist Fund ValueAct Becomes Biggest Inv estor

 

+------------------------------------------------------------------------------+

 

Rolls-Royce Says Activist Fund ValueAct Becomes Biggest Investor

2015-07-31 14:46:25.279 GMT

 

 

By Andrea Rothman

    (Bloomberg) -- Rolls-Royce Holdings Plc said that ValueAct Capital Management has amassed a 5.44 percent stake, a move that makes the activist hedge fund run by Jeffrey Ubben the engine- makers biggest investor, according to Bloomberg data.

    San Francisco-based ValueAct manages more than $18 billion and has helped influence the direction of companies including Microsoft Corp., Sara Lee Corp., Adobe Systems Inc., Valeant Pharmaceuticals International Inc. and Motorola Solutions Inc.

    Rolls-Royce’s disclosure comes with new Chief Executive Officer Warren East only four weeks into the job after his predecessor stood down following a series of profit revisions.

East has already halted a share buyback to preserve dwindling cash reserves as he seeks to clean up operations.

    “We welcome any investor who recognizes the long-term value of our business,” Rolls-Royce said in a statement. “We have frequent communication with all of our shareholders and meet with major investors on a regular basis. We look forward to engaging with ValueAct, just as we do with all investors.”

Activist funds generally acquire equity stakes in public companies and seek to pressure management and directors for changes that boost shareholder returns. ValueAct has served on at least 38 public company boards and typically seeks influence behind the scenes, often with a directorship.

 

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