As an illustration of valuation methodology we have decided to have a look at two companies that have recently listed on the Unlisted market (www.unlisted.co.nz). Unlisted provides a platform for trading shares of companies – without the same level of compliance required, and cost, as on NZX (www.nzx.com).
In August we saw the debut of two IT services companies – Synergy (www.synergy.co.nz) and Infinity (www.infinity.co.nz) – on Unlisted. Neither of the companies have yet had a share trade on Unlisted at 10 October 2006 – lack of liquidity in the market is a feature of Unlisted. Synergy (Unlisted:FSG) has a sell offer at $1.75 and no buy orders – i.e. someone is willing to sell at $1.75 a share but there are no buyers. Infinity (Unlisted:INFINITY) has buy orders at $0.40 and sell orders at $0.50. Neither company has a lot of depth – i.e. not a lot of people looking to buy or sell shares. If you were a shareholder in either of these companies – what might be an indication of value for the shares?
So what does Valuecruncher think the valuations for these two companies should be? We took only information that has been released by the companies on their websites and some assumptions that we lay-out in the valuation reports in determining our values. Copies of the valuation reports are attached to this post.
Remember that to get to the share price we start by calculating the present value of the future cash flows generated by the business – this is called the Enterprise Value. From the Enterprise Value we remove Net Debt – long-term borrowings less cash – to obtain the value of the equity in the business. We divide the Equity Value by the number of shares outstanding to get to the value per share or share price.
The information below summarises our analysis of the valuations of Synergy and Infinity.
Synergy – $11.1 million Enterprise Value and ($1.2) million Net Debt equals an Equity Value of $12.3 million and with 7.0 million shares outstanding gives a share price of $1.75.
Infinity – $22.1 million Enterprise Value and ($4.6) million Net Debt equals an Equity Value of $26.7 million and with 58.7 million shares outstanding gives a share price of $0.45.
Because both Synergy and Infinity have cash on their balance sheets and no debt – the Net Debt figures are negative and being deducted from the Enterprise Value to determine the Equity Value mean that the Equity Value is above the Enterprise Value. Our valuation reports use as comparators the comparable IT services transactions of Telecom acquiring Gen-I and Telstra acquiring Sytec. Both the Valuecruncher valuations are just below the two comparators – but are reasonable compared with these transactions.Financial advisers that work in the IT services space generally tell clients that industry transactions occur in the 2-4x EBIT valuation range. Using that as a guide (and 4x EBIT as the valuation) – would imply Synergy would have a share price of $0.94 and Infinity $0.33. Synergy has had an independent valuation report commissioned that gave a share price range between $0.50 and $1.56 – and this has been communicated as guidance to shareholders (http://www.synergy.co.nz/AboutUs/News/NewsItems/2006-08-01_Notice_to_Shareholders_Synergy_International.htm). This is below our valuation mid-point of $1.75 and the bottom end is below our NTA calculation of $0.62 per share.
We are comfortable with our valuations of both Synergy and Infinity. No trades have occurred for either company on Unlisted – Infinity has a buy offer at $0.40 and sell offer at $0.50 (Valuecruncher valuation $0.45) and Synergy has a sell offer at $1.75 (Valuecruncher valuation $1.75). The Synergy valuation advice to shareholders of between $0.50 and $1.56 is below what we think the shares are worth. The 2-4x EBIT valuation range advice (for the IT services industry) also seems low to us when applying discounted cash flow techniques. The transactions involving Telecom and Telstra in the New Zealand IT services space are slightly above the valuation levels we are getting to – there may have been some optimistic views from the acquiring parties about potential synergies available.
It is also worth noting that the EBIT margins for these businesses are in the 4-5% range – which is pretty unattractive really (Telecom NZ operates a 25-30% EBIT margin and The Warehouse currently operates at 9%). Other IT services businesses operate with higher EBIT margins – Datacom operates in the 8-9% range (http://www.datacom.co.nz/default.asp?Content_ID=430&Category=News). While Datacom may have more recurring revenues than Synergy or Infinity – we are surprised about the different levels of performance. Synergy had an EBIT margin of 4.1% and Infinity 5.5% in their last financial periods. Infinity’s Directors Report for the first half of 2006 states that while earnings are good they will be below the 5.5% EBIT level of 2005 for the 2006 year. Valuecruncher has used 5% for the EBIT margins in our valuations. However we are surprised at the low level of earnings in the IT services space. We are sure that management of both Synergy and Infinity are looking to improve financial performance.
Our valuation suggests that the buy and sell orders for Infinity are in the right general area. Our valuation of Synergy is above the guidance that the Synergy Board has given to shareholders but in line with the current sell order on Unlisted. Our valuations are sensitive to the profitability of the companies – changes in performance (positive or negative) will impact valuation levels.
We will come back and look at these companies again later – and see if financial performance does improve.