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.

This entry was posted on Thursday, November 9th, 2006 at 10:26 pm and is filed under NZX, Telecom NZ, Yellow Pages Group (Telecom NZ). You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.