We have had a good response to our first Stock Of The Week.

Rakon ($RAK.NZ) has has had a torrid time. $RAK.NZ has been as high as NZ$4.22 in the last year and at NZ$1.03 is just above the 52-week low of NZ$1.00 from yesterday.

In late October Valuecruncher put a valuation of NZ$1.99 on $RAK.NZ with the share price at NZ$1.82. With $RAK.NZ now trading 43% below that share price - it was time to revisit the valuation.

In asking you what you thought - we got some really interesting responses. We had valuations ranging from NZ$3.61 to NZ$0.92.

It appears the reason that the price of $RAK.NZ dropped so sharply was the realease of the latest half-year results and guidance on expected future results. This presentation (especially slide 3) gives a good summary of how $RAK.NZ views the near future. This is worse than most comentators expected.

Factoring in this information - what did your analysis say?

Revenue: Our original valuation had revenues rising from NZ$210 million in 2009 to NZ$315 million in 2011. The view from the valuations this week is that looks overly optimistic now. Sam had revenues rising from NZ$160 million in 2009 to NZ$225 million in 2011. Isambard had revenues rising from NZ$140 million in 2009 to NZ$200 million in 2011. Jamess (with the NZ$3.61 valuation) had revenues of NZ$169 million in 2009 rising to NZ$240 million in 2011.

Our Revised Take: Revenues rising from NZ$155 million in 2009 to NZ$225 million in 2011. Interestingly Reuters has the five analysts covering $RAK.NZ giving mean estimates of 2009 and 2010 revenues of NZ$201 million and NZ$257 million respectively (with a low estimate of 2009 of NZ$175 million). You are more pessimistic - and so are we.

Profitability: Our original valuation assumed a flat 15% EBITDA margin. Hmmm - probably not looking at the latest information. We had a range of opinions on profitability (EBITDA margin). Isambard was negative in 2009 rising to 15% in 2011. Tiger was 12% in 2009 rising to 18% in 2011. Sam was 8% in 2009 rising to 12% in 2011.

Our Revised Take: A wide range to consider there. We think 2009 is going to look pretty rough (not negative) but something like an 8% EBITDA margin. 2010 is going to be better at around 11% . This will rise to around 14% in 2011 - still not the 15% we previously projected.

Discount Rate: We have done a post explaining about discount rates and it is a good place to start when thinking about them. PWC issues a cost of capital report for New Zealand that lists discount rates (in the form of WACC). PWC calculates the NZ market WACC at 9.5% - and that feels “about right”. You would expect to see WACC’s (discount rates) as low as 7% for an energy utility and as high as 15% for a research/intellectual property company like Genesis ($GEN.NZ). Within that range - where do you put $RAK.NZ? We used 11% with our previous valuation. Sam uses 12%.

Our Revised Take: 12%. As the post says - “a combination of science and art“.

Terminal Growth Rate: Again we have a post on terminal growth rates. It is a hard concept to get your head around - beyond year three what sort of growth should we be forecasting? The terminal growth post has the following table that is a good guide:

If we calculate the year three growth (using revenues) - in our case: NZ$190 million growing to NZ$225 million. That is a year three growth rate of 18.4%. We need to extend the table - but assuming we use 15% year three growth and assume that the stable on-going growth rate for $RAK.NZ is 4% (assuming the company will long-term grow faster than the New Zealand economy - that averaged 2.6% over the last five-years). This gives a terminal growth rate of 5.0%.

Our Revised Take: 5.0%.

If we bring all of these revised assumptions together we get a new valuation for $RAK.NZ of NZ$1.24 - 24% above the 52-week low of NZ$1.00.

Updated Valuecruncher valuation model of $RAK.NZ with interactive assumptions

$RAK.NZ are already reacting to their challenging situation.

Thank you for your analysis.

This week we want to try something new. We want to put some analysis in your hands this week. We are going to try a new feature on the blog - “Stock Of The Week“.

This is how it will work. We are going to identify a stock on Monday (today), provide some information around that stock (but not a valuation) and ask the readers of this blog to complete valuations of the company (using the Valuecruncher valuation tool). On Friday we will look at all the valuations completed for the company and provide our take on the valuation of the company.

Remember - you can be completely anonymous with the analysis. We won’t be making fun of any valuations - we want to hear what people think. We are keen to tap the wisdom of the crowd.

If you are looking for a quick tutorial on how to complete a valuation - here is an example using Microsoft.

Stock Of The Week

We have decided to start with a New Zealand stock this week. Rakon ($RAK.NZ) is a New Zealand-based designer and manufacturer of high-performance frequency control technology. Valuecruncher completed a valuation of the company at the end of October.

Since we completed our valuation the stock has dropped 39% on the back of rough financial results and guidance on future potential financial performance. We thought it was time to get some thoughts from you on what could happen next - and what that means for valuation.

Resources To Assist

Our valuation from the end of October is a good starting point. It gives a view of $RAK.NZ using information from analysts at that time. It is a solid starting point for inputs like discount rates, terminal growth rates and tax. Since that valuation $RAK.NZ has released information about their last six-months of performance and expectations moving forward. This presentation (especially slide 3) gives a good summary of where the company is at today. Some of this information could certainly feed into a new valuation. Finally here is the media take on the $RAK result.

So what do you think? Does the current share price of NZ$1.11 mean the shares look overvalued, undervalued or about right? Complete a valuation - and write some comments on your assumptions. At the end of this week we will review the view of the crowd and add our take.

As always the starting point is the $RAK.NZ company page - Here.

Last week Rakon announced its annual results for the 2007 year and issued their revenue and EBITDA  forecasts for 2008. Rakon’s revenues exceeded the projections in last year’s prospectus by 17% reaching $106.2 million and producing $20.3 million EBITDA (31% higher than the prospectus forecast). Rakon has forecast revenues growing to $200 - $220 million in 2008 and EBITDA increasing to $32 - $38 million. Based on the latest Rakon guidance figures and Valuecruncher’s analysis we have placed a mid-point valuation on Rakon of $5.38 per share with a range from $3.67 to $6.31. Rakon was trading at $5.50 per share at the time of this valuation.

Two key points arise from this valuation.

1. Why is the valuation range so wide?

2. Why has Valuecruncher’s valuation increased so dramatically from the January 2007 mid-point estimate of $2.59 per share?

Valuation Range

The width of the Valuecruncher valuation range reflects the scenario analysis used by Valuecruncher. Because there are limited relevant publicly listed comparable companies for Rakon and the high phase the company is currently going through Valuecruncher constructed two scenarios to looking at the impact of lower than projected EBIT growth and alternative cost of capital assumptions. If short-term EBIT growth is only 80% of the projected levels the valuation drops to $4.22 per share.

Increased Valuation

The increase in the Valuecruncher valuation from January is a direct result of revised revenue projections. The January valuation projected revenue of approximately $100 million for 2007 growing to $156 million in 2009. These projections are significantly lower than the Rakon forecast for 2008 of $200 - $220 million.

Assumptions

Valuecruncher has assumed that revenues will grow to $350 million in 2010, with EBITDA increasing to $85 million 2010, these projections reflect a compound annual growth rate of 49% and 67% respectively. The terminal growth rate is set at 6% representing expected ongoing high growth rates in 2011 and 2012. The cost of capital of 13% reflects the risk associated with the projected growth.

Key Uncertainties

Capital Expenditure

Rakon has recently increased capacity, acquired the frequency control products division of C-Mac MicroTechnology, these developments have contributed to increased production capacity. Rakon has announced it is investigating developing additional manufacturing facilities in China. To facilitiate the projected growth Rakon will need to further expand capacity. Whether the Rakon do this through acquisitions, partnerships or new factories they will require capital expenditure. Valuecruncher has forecast capital expendiutre of $15 million, $10 million and $10 million in 2008, 2009 and 2010 respectively. Higher levels of capital expenditure may be required to produce the growth projected.

Growth

Over the last two years Rakon’s growth has been impressive and they are expecting to double revenues in 2008. The increased revenue in 2007 was driven increased revenues from the Asian market, to reach the projected revenues Rakon will need strong growth from the US and European markets. The recent acquisition also diversifies Rakon’s product range.

Rakon’s share price appears to be fully reflecting the growth potential of the company but based on the performance over the last 12 months the company appears to be doing everything right. Rakon have an enterprise value of approximately $700 million, revenues of over $100 million, projected to double in the next month and over 50% of the global GPS market. Rakon is a true New Zeland success story. We need more. 

Rakon Valuation Report

Rakon represents an interesting case for Valuecruncher. It is hard to say where Rakon will position itself in its respective market in the next few years. From what can be taken from the 2007 interim report, it seems that at least in the short-term, Rakon will concentrate on it’s current product lines (in quartz crystal technologies with emphasis on GPS systems), rather than branch out into completely new products.

Valuecruncher values each Rakon share at $2.59 with a range between $1.85 and $3.44. The current share price stands at $3.66, outside of Valuecruncher’s valuation range.

Key Assumptions

Revenue Growth

Revenue growth for Rakon was 41.98% in the 04/05 period and 4.13% in the 05/06 period, which represented unusually low growth. From the figures presented in the 2007 interim report, it can be assumed that revenues for 2007 will be around $100 million, representing a growth rate of 40% in the 06/07 periods. We have also assumed revenue growth to be 30% in the 07/08 period and 20% in the 08/09 period, following the trend that revenue growth will remain high but continually decrease over the next few periods.

EBIT Margin

EBIT margins have grown steadily from 6.03% in 2004 to 11.61% in 2006. If we assume that Rakon will continue to concentrate on the development of their existing products, it is likely that EBIT margins will continue to rise. We have forecasted these to continue to grow to 15%, 20% and 25% in the next three years.

Terminal Growth

Terminal growth is expected to be 3%

Discount Rate (WACC)

The discount rate used in this analysis is 13%.

Commentary

It comes as no surprise that the value we have come up with is under the current share price. The assumptions we have put in place restrict Rakon to expand only in their current product lines. Since the release of Rakon onto the stock exchange there has been much hype about this stock, with most of it being justified by possible growths in the industry that the company belongs to. However, we have valued Rakon on its current core business. Perhaps the market is valuing Rakon with more growth opportunities than we are? Based on our valuation and the current market price, the value that the market places on these ‘extra’ growth opportunities is $114 million (the difference between the market cap and our valuation). It will be interesting to see what happens to the share price in the next six months.

Rakon Valuation