In New Zealand there has been considerable debate about the increasing impact of private equity funds investing in the economy.  The recent acquisition of Telecom New Zealand’s Yellow Pages business by CCMP and the Ontario Teachers Pension Plan for NZ$2.24 billion is the most recent high profile example.

The common characteristic of these acquisitions is the use of significant amounts of very cheap debt.  The ability to obtain this debt has been a key factor in the valuations that private equity funds have been able to pay for acquisitions.

This increased private equity activity has only appeared in New Zealand over the last six to twelve months.

Just over twelve months ago there was a very high-profile transaction in the New Zealand market where the Australian media company Fairfax purchased on-line auction site Trade Me (Trade Me is New Zealand’s version of eBay) for NZ$700 million.  This price was generally greeted by the media with amazement – we thought the price looked more than reasonable.

The Trade Me sale was to an established media company while the recent acquisition of Yellow Pages was by a pure financial buyer using cheap debt.

What would a private equity buyer have potentially paid for Trade Me?

Private equity funds like certain characteristics in the businesses that they buy.  Private equity funds like: large businesses, dominant market positions, strong management teams and strong cash flows (to pay back the debt).  Yellow Pages have all of these characteristics – but so does Trade Me.

The question has been asked – does 1 Yellow Pages = 3.2x Trade Me?

We thought that was a great question – and decided to have a closer look.

This is what we did:

We took our previous valuation of Trade Me and made some amendments.  We assumed that EBITDA forecasts for the current year of NZ$45 million were met.  We then projected EBITDA at NZ$65 million for the current (2007) rising to NZ$100 million in 2009.  We then projected EBITDA growth for 10% in the next two years falling to a 3% long-term growth rate – this equals a 4% long-term growth rate in the Valuecruncher model.  We lowered our equity discount rate to 12% from the 15% we had previously used.  The Yellow Pages transaction was based on raising debt equal to 10x the forecast EBITDA ($157 million of EBITDA) for approximately NZ$1.6 billion.  For Trade Me we assumed that NZ$600 million of debt could be raised for a private equity transaction.  We assumed a cost of debt of 7.5% and a 12% cost of equity on a 50:50 debt to equity ratio (assuming a NZ$580 million debt capability – 8.9x NZ$65 million EBITDA) for a WACC of 9.75%, which we rounded up to 10%.  This WACC is probably conservative.  We used 8% in valuing the private equity transaction for Yellow Pages.

Our answer was a current valuation of Trade Me to a private equity buyer of NZ$1.16 billion.

Trade Me - Private Equity Valuation

We are not saying that Trade Me should have waited and not done the deal with Fairfax.  Decisions are made with the information that is available at the time – the potential impact of private equity on valuations of businesses such as Trade Me could not have been foreseen at the time of the transaction.  However, we do not believe that you can compare the two transactions without making the adjustments that we have.

Based on the raw numbers 1 Yellow Pages = 3.2x Trade Me.  Based on our adjusted analysis 1 Yellow Pages = 1.9x Trade Me.

Yellow Pages is a great business.  However, we see a significant number of challenges for the business moving forward.  Telecom New Zealand had an asset with significant potential on-line with Yellow Pages.  At Valuecruncher we believe that Telecom New Zealand would have struggled to achieve that potential had they retained ownership.  Telecom New Zealand probably did the right thing exiting the business – for a very good price.  We believe that on-line competition (from multiple current and potential sources) will potentially significantly disrupt the Yellow Pages business.  CCMP (one of the acquirers of Yellow Pages) brought the Singapore Yellow Pages equivalent in 2003.  Yellow Pages have announced some strategic measures it is implementing post the separation from Telecom New Zealand.  These include a revamp of the Yellow Pages website and a new physical DIY publication for the Auckland market.  We presume these activities are based on the successes that CCMP had with similar acquisitions – such as the 2003 Singapore acquisition.

Valuecruncher believes that the environment that Yellow Pages operates in is now dramatically different to 2003.  12 months ago 1 Yellow Pages might have equalled 3.2x Trade Me and today 1 Yellow Pages might equal 1.9x Trade Me.  Our bet is in 12 months time that ratio will have moved again – and not in Yellow Pages favour.  Especially if physical publications continue to be a cornerstone of the Yellow Pages strategy – the Yellow Pages acquisition requires a very good on-line strategy and flawless execution.

International News and Media’s offer (in partnership with private equity firms Providence Equity Partners and the Carlye Group) of $6.20 per share for APN has been been deemed fair and reasonable in an independent valuation report provided by Deloitte Corporate Finance (full report). Deloitte has undertaken a detailed analysis of the media industry, evaluated each of APN’s business units, considered comparable companies and transactions in an effort to determine a value for APN. Deloitte conclude their analysis by applying an arbitrary 20% premium for control to their valuation. This is a common but flawed practice that Valuecruncher has addressed previously. Aswath Damodaran from the Stern School of Business at New York University has published an excellent paper on the value of control in which he concludes “The value of control in a firm should lie in being able to run that firm differently and better. Consequently, the value of control should be greater in poorly performing firms, where the primary reason for the poor performance is the management.”. Does the control premium applied by Deloittes imply that a new management team could increase the value of APN by 20%? Interesting considering International News and Media currently own 40% of APN.

A recent essay by Paul Graham suggested Microsoft is dead or at least not the feared monster it once was. This essay sparked a wide range of responses and is clearly an emotional issue for a number of people. While Valuecruncher is passionate about valuation we try not to be emotive so we decided to see what Microsoft was worth now that it was dead. Valuecruncher valued Microsoft at $29.03 per share slightly higher than the current share price of $28.69. This equates to an EV-EBIT multiple of approximately 15 which is below comparable compnies SAP (21.7), Oracle (17) and Computer Associates (20). Although Microsoft is no longer feared it still has revenues of over $40 billion and an enterprise value of over $250 billion.

Assumptions

Cost of Capital (WACC): 10%

Terminal Growth Rate: 4%

Valuecruncher has placed a value of $28 per eBay share with a range between $22.52 and $34.05. The current share price of $33.71 is at the upper end of the Valuecruncher range.  Valuecruncher may be undervaluing eBay, as the methodology does not explicitly model the growth options available.
 
The current market price implies an enterprise value (EV) to EBIT multiple of 26.9 compared to Valuecruncher’s mid point EV-EBIT multiple of 22. It is difficult to compare eBay’s EV-EBIT multiple with other comparable companies as each has there own unique set of options.  To provide a point of reference eBay’s current market multiple is considerably lower than online companies Amazon.com (42.4), InterActiveCorp (IAC) (38.4) and Google (38.2), none of these companies are directly comparable to eBay but they all have online growth opportunities. The size of these multiples suggests the market is prepared to include a significant portion of the potential growth opportunities value into today’s price. To add a New Zealand perspective online auction site Trade Me sold for approximately 15 times forecast EBIT in early 2006. 
 
The short-term revenue growth rate of 25% and terminal growth rate of 5.8% used by Valuecruncher acknowledge the growth available to eBay. These growth rates are very aggressive but may not fully capture the potential of opportunities such as eBay’s VoIP provider Skype.
 
eBay’s ViOP provider Skype represents a significant growth opportunity but it is very difficult to model this opportunity explicitly. Skype had 171 millions users at 31 December 2006 using over 28 billion free Skype to Skype minutes. Skype out minutes totalled 4.2 billion in 2006 contributing to revenues of $195 million.
 
eBay hold a passive 25% stake in online classifieds site Craigslist which has an estimated revenue of $20 million per annum but has the traffic and untapped potential to significantly increase this. It is difficult to estimate a value of eBay’s 25% stake in Craigslist and it is definitely contributing to the difference between the Valuecruncher mid point valuation and the current market price.
 
Is eBay overpriced? The difference between the Valuecruncher mid point valuation and the current market valuation is approximately $7.5 billion. Whether eBay is overpriced (or under priced) depends on your opinion on the potential of VoIP, Skype and Craigslist.
 
Valuecruncher Assumptions
 
Valuecruncher has forecast revenues to grow at 25% over the next three years and an EBIT margin of 30%.

Terminal Growth Rate: 5.8%  
Cost of Capital (WACC): 12.5%

Valuecruncher Valuation Report - eBay  

Valuecruncher has placed a mid-point valuation of $47.12 per share with a range of $41.52 to $52.87 for the WalMart. WalMart was trading at $46.95 at the close on Friday 30 March. 

The Valuecruncher mid point valuation produces and EV-EBIT multiple of 10.5, this is slightly higher than the current trading multiple of 10.4. WalMart is currently trading at a lower EV-EBIT multiple than it’s major US competitors Target (12.0) and Costco (12.7). 

Valuecruncher has forecast short term revenue growth of 12.5% and maintained the current EBIT margin of 6%. 

Valuecruncher has used a cost of capital (WACC) of 8% for WalMart.

Long-term growth is forecast at 3.8%.    

Valuecruncher Valuation Report - WalMart