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.

Valuecruncher was at the MORGO 2006 conference in Taupo in July.  Sam Morgan gave a great presentation on the sale of TradeMe to Fairfax – including some financial numbers.  Sam gave Valuecruncher the OK to complete a valuation and circulate it.  A copy is attached to this post.

With the numbers that Sam provided – I took a conservative approach with the valuation.  Sam disclosed that TradeMe is still growing revenues at 10% a month!  Even with my conservative assumptions I still got pretty close to the ultimate transaction value (mid-point of Valuecruncher valuation NZ$650 million compared to transaction at NZ$700 million).

There have been a number of media reports describing Sam Morgan as “lucky” for getting the deal done.  Here at Valuecruncher we wonder if he did not sell out too cheaply.  We believe that Sam deserves more credit than he has received for creating an extremely fast growing company that was also extremely profitable.

Sam also disclosed that TradeMe has approximately NZ$1 million of NTA – and then joked that 700x NTA is the new Fairfax standard for valuing acquisitions.  See previous comments on NTA – understanding the cash flows is key to understanding valuation.

View the valuation