Valuecruncher has placed a value on Pumpkin Patch of $3.89 per share with a range of $2.46 to $5.55, compared with the current share price of $4.25.

Revenue Growth

Because of Pumpkin Patch’s unstable revenues growth we have taken fairly conservative estimates of future growth.  Revenues growth has been decreasing from 27.28% in the 04/05 period to 11.09% in the 05/06 period.  The revenues growth for the 06/07, 07/08, and 08/09 periods has been estimated to be 10%, 9% and 8% respectively, converging closer to the comparator Hallenstein Glasson Group’s current revenues growth of 7.13%.

EBIT Margin

The EBIT margins for Pumpkin Patch have been increasing steadily from 6.40% (2003) to 14.47% (2006) and with its current expansion in all four of the markets it is present it (NZ, AUS, UK and US), it is likely that these EBIT margins will continue to grow. For this reason we have used an EBIT margins of 15%, 16%, and 17% for the next 3 periods.

Discount Rate (WACC)

The discount rate that has been applied in the analysis is 10.5%, in line with discount rate for Hallenstein Glasson Group, as given in the PwC Cost of Capital Report.

Terminal Growth

The terminal growth is assumed to be 3%.

Commentary

The higher EV/EBIT multiple can be explained by the larger number of growth opportunities from Pumpkin Patch. As they continually expand into the UK and US markets, whilst growing the number if stores they operate in Australia and New Zealand, we believe that Pumpkin Patch have more opportunities to grow when compared with New Zealand comparators Hallenstein Glasson or Postie Plus.

Pumpkin Patch Valuation

Valuecruncher has placed a value on Telecom of $4.47 with a range of $3.71 to $5.26 - driven primarily by revenue and EBIT margin sensitivities. This is slightly below Telecom’s current trading price of $4.50.

Yesterday, 28 November 2006, Parliament’s finance and select committee released the telecommunications amendment bill, recommending that Telecom separate into three operational business units: fixed network services, wholesale, and retail. The regulations surrounding the unbundling of Telecom’s bitstream service were also included in the amendment with recommendations that Telecom face limited competition only three years after the implementation of the Bill. In other words, Telecom will be facing full exposure to competition in the first three years of unbundling their network. So what does this mean for Telecom?

Using the Valuecruncher model, we have come up with a value range for Telecom. For this analysis we have used figures from pre-2006, that is, starting at 2005. The annual figures from the 2006 annual report were not, in our opinion, representative of the long-term nature of Telecom’s operation.

The key assumptions are outlined as follows:

Revenue Growth

Revenues grow at 3% p.a. This is down on the growth seen in the 03/04 and 04/05 periods of 3.80% and 7.72%, respectively, but is in line with the forecasted terminal growth of 3%. This assumption is based on Telecom’s ‘utility-like’ characteristics, which suggest that its long-term growth will follow the economy’s average long-term growth. Under the conditions set in the Telecommunications Amendment Bill, it is unlikely that Telecom will see revenues growth above 3%.

EBIT Margins

EBIT has been projected to decrease by a total of 25% over the next three periods (2006, 2007, and 2008). Under increased competition and regulatory intervention it is likely that Telecom will face increasing pressure on their margins. In 2005, Telecom’s EBIT margins were 28.3% of revenues. We have forecasted these to decrease to 25%, 22% and 19.5% over the next three years.

Discount Rate (WACC)

The discount rate used in the analysis is 11.0%.

Telecom NZ Valuation 29 November 2006

Valuecruncher has placed a value of US$29.63 with a range of US$23.19 to US$36.87. We believe that Yahoo is currently under-valued with its current share price of US$26.72.

Key Assumptions

Revenue Growth

Revenue growth for Yahoo! has been slowing over the past 2 years with growth of 120.0% for the 03/04 period and 47.1% for the 04/05 period. From the available data we have assumed the revenue growth for the 05/06 period to be 35% and the growth in the periods 06/07 and 07/08 to be 25% and 15%, respectively.

EBIT Margins

EBIT margins have been growing over the past three years, ranging from 24% in 2003 to 48% in 2005. However, we believe that the EBIT margin will decline to around 35%, similar to the comparator Google Inc. for this reason, the EBIT margin in 2006 is assumed to be 45%, declining each year by 5% to give EBIT margins in 2007 and 2008 of 40% and 35%, respectively.

Terminal Growth

Terminal growth has been estimated to be 6%.  This maybe too aggressive – we are giving Yahoo! credit for the option set that they hold in the internet sector (which is arguably a broader option set than Google).  If the terminal growth rate drops to 4% then our valuation mid-point drops to US$22.99 – below the current US$26.72 share price.

WACC

WACC has been estimated to be 12%.

Yahoo! Valuation

Valuecruncher has placed a value on Google of US$325.01 per share with a range of US$257.01 and $402.31. Currently Google is trading at US$509. We believe that the stock is over-valued and appears priced for perfection.  The market appears to be valuing the continuation of the current businesses success and placing value on the options the company has generated.

Key Assumptions

Revenue Growth

Although revenue growth has been high for Google over the past three annual periods, with growths of 117.56% and 92.48% in the periods of 03/04 and 04/05, respectively, we forecast the growth of Google to be slowing down. For the current valuation, growth for the 05/06 periods have been estimated at 80%, declining to 60% and 40% for the periods 06/07 and 07/08, which corresponds to a decrease in revenue growth by 20% per year.

EBIT Margins

EBIT margins over the past three years have ranged from 24% in 2003 to 35% in 2005. For 2006, the EBIT margins have been maintained between 35-40%. For the purpose of this valuation we have used EBIT margins of 35%.

Terminal Growth

Terminal growth has been estimated to be 6%.

WACC

WACC has been estimated to be 12%

Google Valuation

Aswath Damodaran - a well know finance academic and author - has a valuation of Google on his site.  His valuation (completed in September 2006) is below our value at US$217 a share.

A core part of the Valuecruncher valuation is a discounted cash flow (DCF) model.  In corporate finance, at its most theoretical level, value is a DCF calculation.  Note I did not say “price”.  Price is what a willing buyer and willing seller will exchange an asset for – the market value.

Without a market price for an asset (i.e. a company) the basic starting point for determining the valuation of the asset should be a DCF.

The point of this post is not to give a complex example of how a DCF model is constructed.  I want to focus on the conceptual understanding of what a DCF is.  Understand the conceptual basis of the DCF model and if you require one – get someone like us to do the math.

The basis of the DCF model is that something is “worth” the present value of the cash flows (post-tax cash flows) that the asset produces into the future – all the way into the future.  There is a method called a terminal value calculation to value the cash flows into perpetuity.

Key to understanding the DCF model is recognising that a dollar received today is worth more than a dollar received in the future.  How far into the future matters as does the uncertainty or variability of the future cash flow.  The financial equivalent of “a bird in hand is worth two in the bush”.

There are only two components to the DCF model – size of cash flows and the discount rate (that reflects the variability of the cash flows).

The cash flows are easy to comprehend – the higher the post-tax cash flows the better.  This is the easiest to understand and the most important.

The discount rate is less intuitive but takes into account two main components – the opportunity cost of waiting to receive the cash and the variability of the cash flows.  The opportunity cost component is the option of using the cash in another (usually risk-free) manner (i.e. investing in Government bonds).  The variability component is being rewarded for risks associated with the cash flows associated with the asset.  For example – an investment in a company has the potential to lose the cash invested or produce returns higher than risk-free Government bonds.  For assuming this risk (around the variability of the cash flows) – investors should be rewarded.  The lower the variability of cash flows the lower the discount rate – which for the same cash flows means a higher value.

To increase the value of an asset (i.e. a company) therefore requires only one of two things:

1. Increase the cash flows produced; or

2. Reduce the variability of these cash flows.  For example – find a way to make future years cash flows (after-tax profits less capital expenditures) more certain (i.e. contracted sales or recurring revenue streams).

Understanding these points is the basis for understanding the DCF model.

We have had a lot of discussion around the valuation we did of Telecom New Zealand’s Yellow Pages Group (Yellow Pages).  Based on some of this discussion we have decided to revisit some of the assumptions and see where we come out - see if there is a change.

Key assumptions

In our valuation we have used a 15% discount rate – basically we ignored the ability of Yellow Pages to assume debt.  This is probably an oversight.  Yellow Pages produces a lot of cash.  Any owner could use this cash flow to repay substantial debt – which would lower the WACC (discount rate) we have used.  15% is probably too high and around 10% (Telecom New Zealand’s WACC) is probably too low – we have used 12%.

In our valuation we used 20% growth – based on the compound annual growth rate Yell has achieved over the last five years.  Yell has achieved this growth primarily through acquisitions.  Acquisitions are probably not available to Yellow Pages.  Any acquisition probably isn’t going to deliver the 20% annual growth that Yell achieved by entering the United States then Spanish markets.  We hear that Yellow Pages will hit the NZ$300 million revenue mark this year (NZ$250 million last year) and then a figure of 5-8% annual growth is more realistic.  We have used NZ$300 million for 2007 and then 7% growth to 2009 and kept the 3% terminal growth.

EBIT margins – how much revenue is pre-tax cash?  Several parties have suggested that the Sensis EBIT margins are a better reflection of Yellow Pages margins than Yell.  The opinion is that 50% EBIT margins are closer to the mark than the 28% achieved at Yell and the 35% we used.  I struggle on this one – 50% EBIT margins are achievable, but that is an exceptional business.  Yell has achieved 30% EBIT margins and is, we believe, a very good case study for Yellow Pages.  To see how it plays out however we have used 50% EBIT margins.

Making those changes produces a Valuecruncher valuation for Yellow Pages of NZ$1.38 billion with a range NZ$1.11 to NZ$1.66 billion – based on sensitivities around revenue growth and EBIT margins.  This is 11.0x 2006 EBIT (assuming 50% EBIT margins).

Revised Valuecruncher Yellow Pages Valuation

This is where the NZ$1.5+ billion figure has come from.  To get above this level requires removing significant costs or new revenue streams (potentially on-line).  We still believe NZ$2.2 billion is fantasy – but we can see where NZ$1.4-1.6 billion comes from.

At Valuecruncher we don’t believe 50% EBIT margins are achievable – for a standalone Yellow Pages business.  The highest that we feel comfortable with is 40%.  Yell is at 28% - Ebay has ~40% margins.  At 40% EBIT margins the Valuecruncher result is – NZ$1.10 billion with a range NZ$867 million to NZ$1.36 billion – based on sensitivities around revenue growth and EBIT margins.  This is 11.0x 2006 EBIT (assuming 40% EBIT margins).

Our previous valuation of NZ$897 million may be low.  We can see how the NZ$1.5+ billion figure has been obtained.  However – we can’t get to 50% EBIT margins required by these numbers.  At Valuecruncher the best we will assume is 40%.  At 40% with the various amendments the valuation is NZ$1.10 billion.

Valuecruncher Valuation – NZ$1.10 billion with a range of NZ$867 million to NZ$1.36 billion.  If Telecom New Zealand can get above that – they will have done well.

On 3 November Telecom New Zealand announced their first quarter result and that they would be running a competitive process for selling their directory business – Yellow Pages Group (Yellow Pages).

Analysts have placed values on the Yellow Pages business of between NZ$1.5 billion and NZ$2.2 billion.

We decided to have a look and see what sort of valuation we would place on Yellow Pages.

Yell Group

Before we get to Yellow Pages here in New Zealand – it is worth having a quick look at Yell Group (Yell) in the UK.  Yell was the directories business owned by BT (British Telecom) that was sold to private equity firms in 2001 and then listed on the London Stock Exchange (LSE) in 2003.  This is a pretty good case study of what might happen with Yellow Pages here in New Zealand.

Some details:

BT sold the business in 2001 for GBP2.14 billion – that year the business had EBIT of approximately GBP220 million (normalised EBITDA of GBP245 million for the year ended 31 March 2002 and we have assumed GBP25 million of depreciation and amortisation – 31 March 2006 EBITDA of GBP503 million with GBP54 million of depreciation and amortisation).  This equates to an Enterprise Value (EV)/EBIT multiple of 9.7x.  At the time of the sale the business was operating 25% EBIT margins – revenues of GBP865 million and EBIT of approximately GBP220 million.

Over the next five years to 31 March 2006 Yell increased revenues at a compound annual growth rate of 17% and adjusted EBITDA (for abnormal items) at 20%.  For the year ended 31 March 2006 Yell had revenues of GBP1.62 billion and EBIT of GBP449 million – 28% EBIT margin.  96% of these revenues in 2006 were derived from selling advertising in printed classified directories.

It is worth noting that Australian Telco Telstra’s wholly owned directories business – Sensis – has EBIT margins approaching 50%.  Sensis is however not an independent company.

Significant parts of Yell’s growth had been achieved by acquisitions in the United States (now reptresenting over half the 2006 EBIT).  In July 2006 Yell completed the acquisition of Spain’s primary directory business (not included in any of the financial or staff numbers used in this analysis - but incorporated in the current share price).

Yell had 11,500 employees at 31 March 2006 so derived GBP141,000 of revenue per employee.  This converts to NZ$403,000 at 0.35.

Today Yell trades on an EV/EBIT multiple of 13.8x.

Yellow Pages in New Zealand

This is what we know:

Yellow Pages last year had approximately NZ$250 million of revenues with approximately 600 people.  For the first three months of the current financial year revenues grew by 11.3% against the prior period last year to NZ$69 million.  This equates on a run rate basis to approximately NZ$276 million this year of revenues.

Our valuation approach

We started with the NZ$250 million of revenues for last year.  We have assumed that there is scope for considerable growth over the next three years and used 20% annual growth from 2007-9.  The current period has growth of 11.3% so far – we are saying that Yellow Pages can do better than that over the next three years.  We don’t specifically value growth options (i.e. new electronic services) – remember 96% of Yell’s revenues are still print based advertising.  But this growth rate implies some new revenue streams – the same large acquisitions made by Yell internationally are not available to Yellow Pages (in our opinion).  We use a 3% terminal growth rate post-2009.

We have looked at Yell’s 28% EBIT margin and Sensis’s nearly 50% margin and used 35% as an EBIT margin.  We think Yellow Pages can do better than Yell but that Sensis’s EBIT margins are inflated by not being a fully independent company.

With 600 employees – Yellow Pages derives NZ$458,000 of revenues per employee.  This is comparable with Yell’s NZ$403,000 per employee and further justifies our slightly higher EBIT margin.

Our answer

A copy of our valuation is included below.  We produce a mid-point valuation of NZ$897 million – well below the NZ$1.5-2.2 billion being suggested.  We come out at an historic EV/EBIT multiple of 10.3x – compared to Yell’s 9.7x when the business was originally sold and 13.8x today.  It should also be noted the Yell share price has risen 19% since late June 2006 on the successful acquisition of the Spanish directory assets – the market views Yell as a higher value owner of the assets.  This has inflated the current multiple – prior to the acquisition the multiple was 11.9x.  We have used the 13.8x multiple in our analysis – but it does include expected growth in the newly acquired Spanish assets.

To get to the NZ$1.5 billion valuation with our assumptions requires 45% compound annual growth to 2009.  Which will be very hard without major innovation or significant acquisitions – where will the acquisitions come from?  This is a 17.5x historic EV/EBIT multiple and a 14.3x forecast EV/EBIT multiple (assuming 35% EBIT margins and 20% revenue growth this year).  To get to NZ$2.2 billion is 65% compound annual growth and 25.4x historic EV/EBIT multiple and 21.0x forecast EV/EBIT multiple.  TradeMe was bought by Fairfax for 26.9x historic EV/EBIT and 15.6x forecast EV/EBIT.

I believe these numbers (NZ$1.5-2.2 billion) are fantasy.  The top of our valuation – based on sensitivities – is NZ1.1 billion.  Using the current 13.8x Yell multiple gives a valuation of NZ$1.21 billion.

There are some serious strategic questions about actually selling Yellow Pages – BT ultimately stared another directories business after selling Yell.  BT originally sold Yell because of severe debt issues after buying 3G mobile spectrum – Telecom New Zealand has no such pressures.

At Valuecruncher we don’t believe that Telecom New Zealand will achieve the sale price currently being discussed in the market – NZ$1.5 billion+.  An acquirer paying NZ$1.5 billion+ would need to extract some significant synergies and be prepared to pay for them in the sale process.  Our number is around NZ$900 million.  We will watch the process with great interest.

TEL Yellow Pages Group Valuation