We have written about the Yellow pages here and here. Some of our commentary has been picked up by leading New Zealand business publications.
NBR Yellow Pages Sale
But it appears our valuation was wrong. The rumours in the market were that it took NZ$2.1 billion to make the short-list and the four finalists are all private equity players. Our valuation was NZ$1.1 billion – that is a long way short of NZ$2.1 billion.
Here at Valuecruncher we back our analysis – and when we are that far out we want to know why.
Our valuation was based on Yellow Pages Group as a standalone entity – normal valuation procedure. Often in a sale process an acquirer in the same industry can come in and extract synergies (either revenue and/or costs) and be able to pay a higher price than outsiders by paying away some of these synergies in the process. We discussed this in a post about 42 Below. In the Yellow Pages example the logical party with the ability to exploit synergies in the directories business in the Australasia region is Telstra with the Sensis business. Then Telstra came out with an amazing statement when they did not make the final short-list saying in-effect that the price was too high and the bidders are paying too much. So we can take it that the synergies were not enough to secure the asset.
Are the remaining private equity players paying too much – as Telstra suggest? The remaining bidders are a very successful group that have a track record of generating wealth in the private equity business. How can these funds pay this amount (with the expectations of significant returns) when the typical logic says it is too high?
This has been bugging me – I don’t like being this far out on valuations. I like to think it isn’t typical.
Two things drive value – cash flows and the discount rate applied to those cash flows.
I started by looking at the cash flows of the business. Do the private equity funds provide the expertise for the Yellow Pages Group to increase the cash generated by the business. I concluded no – the EBIT margins of 50% are at the top of the international comparator range. Private equity funds have brought in operational expertise over the last couple of years but this isn’t likely to bring insights on new strategies for Yellow Pages Group – private equity funds like Clayton Dubilier & Rice have Jack Welch (ex-GE CEO) where what the Yellow Pages Group buyers need is a Sam Morgan. I don’t believe that Sam Morgan is going to start work for the ultimate acquirer of the Yellow Pages Group – but it is the only way that cash flows are likely to be increased. I stick with my conclusion – no; the cash flows are not the answer.
The discount rate – has to be here somewhere and if it isn’t the cash flows… This is where things get interesting. In my prior analysis I started with a 15% discount rate and moved to a 12% rate. Then I found this. For those that can’t be bothered following the link – it is a Bloomberg piece about the rates private equity funds are able to borrow at and the amounts of debt available. The numbers are crazy – private equity funds are able to borrow startling amounts of cash for each transaction at very low rates. The Bloomberg piece states 2.25% above LIBOR (London Inter-Bank Offer Rate – basically the rate banks will lend to each other). The LIBOR rate today is 5.30%. 2.25% above that is 7.55% and the borrowers will be able to take the tax benefit (at say 33%) to give a post-tax borrowing rate of 5.1%. If we assume the equity portion of the discount rate is 15% – reflecting the variability of the cash flows of the asset (rough estimate rather than science – but probably pretty close). If we then assume a 75:25 debt equity split (5.1%x75% + 15%x25%) we have a weighted average cost of capital (WACC) for the private equity buyers of 7.6% – we will round it up to 8%. If we put that into the Valuecruncher valuation model from last time – all cash flow assumptions remain constant and we simply substitute 8% for the 12% discount rate we used. We come up with a valuation of NZ$2.47 billion.
Yellow Pages Valuation – Private Equity
Telstra’s WACC is 10%. Placing Telstra’s WACC into the model produces a valuation of NZ$1.78 billion – NZ$690 million short of the private equity valuation. Potential synergies extracted from the Yellow Pages Group by Telstra obviously would not close that gap. That is why Telstra exited. Others could pay more.
The ultimate reason the price has gone so high is that there is an unprecedented amount of cheap debt available to fund these types of private equity acquisitions. Is this cheap debt a sustainable on-going condition? Too hard to call – but if a big private equity transaction goes bad and some big lenders lose significant capital things may change. For now private equity buyers can finance certain acquisitions (Yellow Pages Group is an example – a combination of size and stable cash flows) with very cheap debt. This gives them a big advantage over potential strategic acquirers (i.e. Telstra’s Sensis with Yellow Pages Group).
What does this all suggest about the final price paid by one of the remaining buyers? Hard to say – my valuation is based on some broad estimates. The specifics of the funding arrangements available to each private equity fund will be different. It will probably come down to the group that decides they really want the asset and are prepared to go the distance to get it. The individuals involved are pretty competitive types – so that could be interesting.
That said – this is a deal about leveraging the existing cash flows. I would not expect the ultimate owner of these assets to be investing significantly in new services – i.e. developing an effective on-line strategy for Yellow Pages Group. Expect more of the same in regards service from the Yellow Pages in the New Zealand market over the next few years.
There are certainly questions about the strategic wisdom of Telecom selling the Yellow Pages Group. But the choice of timing – with the cheap debt available to private equity funds – means that the result to Telecom will be a good one financially.
And that is how in my opinion private equity buyers can pay in the region of NZ$2.1+ billion for the Yellow Pages Group.