In November 2006 – Telecom New Zealand ($TEL.NZ) announced plans to sell their directory business in a competitive process. Analysts placed a range of values between NZ$1.5 billion to NZ$2.2 billion. I ran some numbers and came up with a NZ$850 million valuation – using Yell Group ($YELL) in the UK as a comparator. In my analysis I wrote the following paragraph:

I believe these numbers (NZ$1.5-2.2 billion) are fantasy.  The top of our valuation – based on sensitivities – is NZ$1.1 billion.  Using the current 13.8x Yell multiple gives a valuation of NZ$1.21 billion.

As a result of some discussions I revised the analysis 24 hours later with some more aggressive assumptions. My updated valuation was NZ$1.10 billion with a range of NZ$867 million to NZ$1.36 billion.

But hey – there was a fully-fledged private equity boom going on. What did I know.

In early 2007 to get to the short-list of potential acquirers for the Telecom New Zealand directory business required a NZ$2.1 billion bid. I wrote yet another piece – with the following excerpts:

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.

and

This has been bugging me – I don’t like being this far out on valuations.  I like to think it isn’t typical.

Then I proceeded to explain the bid valuation as best I could (summary – really cheap debt).

In March 2007 with the closing of the sale to CCMP I noted:

Valuecruncher believes the result is an excellent one for Telecom.

Since 2007 it hasn’t been an easy time for owners of highly leveraged directory assets. Debt isn’t as cheap as it was (check out this Bloomberg piece from February 2007 – the world has changed). Another strange thing – people are also using this internet thing where they previously relied on services like directories. That means there is pressure on key directory revenue streams (like advertising).

There is a long piece in the New Zealand media today (Sunday Star Times written by Tim Hunter) about the challenges facing the directory business – now called Yellow Pages Group. It quotes a number of unnamed sources using Yell Group ($YELL) in the UK as a valuation comparator (“Yell in the UK has just restructured and trades at seven times earnings“). With Yellow Pages Group having EBITDA of around NZ$130 million – that places an enterprise value on Yellow Pages Group of “NZ$750-$800 million“. Note the article has senior debt holders being owed NZ$1.2 billion – ouch. The article is a good piece of analysis by Tim Hunter.

Our Valuecruncher interactive analyst report for Yell Group backs up this analysis (have a play with the DCF tab as well). A 6.3x EV/EBITDA multiple for Yell Group and a NZ$130 million EBITDA gives an enterprise value for Yellow Pages Group of NZ$819 million. Enterprise value is the value of the whole business (equity and debt).

Hold on – isn’t that just about where I started?

Lesson: Do robust analysis and run the numbers – and back that (even in the middle of a private equity boom).

It has been a tough and challenging 2010 for Telecom New Zealand ($TEL.NZ) – New Zealand’s largest listed company. $TEL.NZ is trading close to a 52-week low at NZ$2.24. There has been widespread outages on their mobile XT network and yesterday a group of New Zealand entrepreneurs (including Valuecruncher investor Lance Wiggs) announced a new international broadband initiative to complete with the Southern Cross Cable Network (of which $TEL.NZ is the largest shareholder). Time to look at some valuation numbers – where is $TEL.NZ coming out?

Valuecruncher Interactive Analyst Report For $TEL.NZ

Discounted Cash Flow Valuation

We have completed a discounted cash flow valuation using our interactive tools (there is a “discounted cash flow analysis” link just under the company name on the company page). We have populated our model with a mixture of consensus analyst estimates and Valuecruncher estimates. Our analysis produces a valuation of NZ$2.70 for $TEL.NZ – 20.5% above the current share price. We see $TEL.NZ undervalued at the moment. But how about compared to a peer group?

Comparator Analysis

I am going to look at only one of the metrics we use at Valuecruncher – EV/EBITDA. Enterprise Value (EV) is simply market capitalization plus net debt [long-term borrowings less cash]. We use EV to capture the impact of debt and cash on a company’s balance sheet – market capitalization doesn’t capture different capital structures when comparing companies. EV/EBITDA shows how a dollar of profit (measured in as Earnings Before Interest Taxes Depreciation and Amortization) is being valued by the market against the comparator set.

On an EV/EBITDA basis $TEL.NZ is trading at 3.7x ($TEL.NZ is being valued at 3.7x last year’s profit at the EBITDA line). A dollar of $TEL.NZ EBITDA is worth less than a dollar of $T, $VZ, $VOD.O or $TLS.AX EBITDA. $TEL.NZ is a smaller scale but broadly similar business – $VOD.O is perhaps an outlier.

If we raise the $TEL.NZ EV/EBITDA multiple to the average of $T, $VZ and $TLS.AX (4.7x) then this gives a share price of NZ$3.17 – 41.5% above the current share price. This valuation is in line with our DCF analysis – but even higher.

Summary

Based on our DCF valuation – $TEL.NZ looks undervalued. Looking at some comparators – the market is valuing $TEL.NZ lower compared to the peer group. $TEL.NZ looks cheap at current prices – even with the challenges the business is facing.

Disclosure: no positions.

We tend to get some complaints when we write about New Zealand-based issues. This post is one of those New Zealand focused ones. Feel free to skip it if that isn’t what you are interested in.

Dear NZX

We like your work – we really do. The relevance and professionalism of the New Zealand share market has improved by an order of magnitude over the last ten years.

But we also love the quote from Il Gattopardo (The Leopard) – “If we want things to stay as they are, things will have to change”

We know you get that – for New Zealand to remain competitive we need stronger capital markets. The Capital Market Development (CMD) Taskforce has some good thinking – which needs the political support to implement. However, looking at the majority of suggestions – they are 20^th century solutions. Do they need implementing – absolutely. But for a small market like New Zealand we need to be looking at different solutions as well – what works in a big market doesn’t necessarily work here. We need to be looking at more innovative solutions – and again, I do think you get this. Adding Rod Drury to the NZX board is a step in the right direction.

We are in the broad equity research space – and we were disappointed by sections of the CMD Taskforce report. The CMD report (from page 69) outlines a situation where there is limited traditional equity research coverage of smaller listed companies. The CMD report offers solutions including public and private funding of additional equity research (supplied by traditional research providers) – because that is what other markets are doing. There is discussion about a “small levy on trades” (page 70).

Really. That is the best solution we have got. New Zealand is a very small market – quoting the CMD report:

“INFINZ data show that 30 stocks are covered by all six major New Zealand brokerages, and a further 37 stocks are covered by some of those firms. There are 47 (41 percent) NZX companies without any analyst coverage at all, and a further 15 have only one or two analysts covering them. There is generally no coverage of small stocks, and no coverage of the companies on the smaller exchanges, the NZAX or Unlisted.”

“All six major New Zealand brokerages”. Unless the plan is to make a significant investment in research (more than one analyst per company) – and that doesn’t seem possible – why are we bothering? The traditional large market research model doesn’t seem to be relevant here. Never mind that most traditional research reports are virtually impossible for the average retail investor to comprehend – anecdotally the consumption of research reports by retail investors in New Zealand is low. NZX knows where retail investor education is in New Zealand – the large electronic ticker going around the NZX Centre in Wellington uses full company names and the share price not ticker codes and the share price. That is the right thing for NZX to do by the way – but it shows how far we have to go.

Why not start with a plan to provide base financial information and valuation resources for the market? Let’s initially make information and tools available – how people use them is the next step. NZX.com is the logical home for those resources.

There will be traditional coverage where the market deems it worthwhile – the largest companies on the NZX only. For the rest not covered by traditional research (in fact for all of the NZX companies) NZX should be following Jeff Jarvis’ rule from What Would Google Do – “do what you do best and link to the rest”.

Most investors in New Zealand go to the NZX website for information on listed companies. NZX has added news feeds from Fairfax to encourage more engagement – but where is the financial information and analysis? NZX should make base financial information and valuation resources available. NZX.com is in a position to be the default portal for listed company information in New Zealand. There are options available to NZX where other parties are providing free access to information and tools to fill the current gaps on NZX.com.

Example 1 – Reuters

It isn’t well known – but the free Reuters website has good coverage of NZX listed companies. We can use New Zealand’s largest listed company Telecom New Zealand ($TEL.NZ) as an example.

For New Zealand companies all you need to add is a “.nz” suffix to the ticker code and there is a quantity of quality free information. The information is comprehensive – and in a single location. Using $TEL.NZ as an example – consensus analyst estimates, historical financial statements, charts and even paid research options. It isn’t only the large NZX companies – for example Xero ($XRO.NZ) even though they have no analyst coverage.

Example 2 – Valuecruncher

At Valuecruncher we provide interactive valuation tools for listed companies. This already includes 156 companies on the NZX. These are comparator based tools. Using $TEL.NZ as the example again.

Valuecruncher Interactive Analyst Report For Telecom New Zealand ($TEL.NZ)

Our algorithms choose the peer group from an international selection. But you can change the peers to a New Zealand focused group. The tools are interactive.

Disclosure: Yes – one of the solutions is Valuecruncher. In case there is any doubt – that is the company associated with this blog.

NZX – do what you do best and link to the rest. What would Google do? Google Finance uses links to Reuters for deeper data.  NZX.com can be the default financial information and valuation resources location for New Zealand as a first step to a potentially bigger future. It is time to look for specific solutions for this market – not simply copying the actions of larger markets.

Regards,

Mark Clare

Valuecruncher CEO

The Capital Markets Development Taskforce currently reviewing the New Zealand financial markets released am interim report this week. Media reports have focused on a range of issues – one of which is a lack of analyst coverage.

From page 14 of the interim report:

“Work commissioned for the taskforce has found that there is no analyst research is available on 42% of the companies listed on the NZX, and a further 13% of companies have only one or two analysts covering them.”

We would disagree with that assessment. Here at Valuecruncher we cover 156 companies listed on the NZX. This is more than 42% of the companies on the NZSX. We have valuation tools available for companies from Telecom New Zealand ($TEL.NZ) to Xero ($XRO.NZ).

Telecom New Zealand ($TEL.NZ) – Valuecruncher Interactive Analyst Report

Xero ($XRO.NZ) – Valuecruncher Interactive Analyst Report

Now our reports are not the “typical” analyst reports. But we would argue that the current analyst model looks broken – the current model is too expensive and produces research reports that are complex and hard for retail investors to consume. Those are some of the reasons that there is a lack of traditional analyst coverage in markets like New Zealand.

We believe that equity research will change moving forward and while we may not yet know what the final solution looks like – it will be different to what has gone previously. Parties like the The Capital Markets Development Taskforce should be looking at different more innovative solutions and how those can be encouraged.

Clay Shirky – “That is what real revolutions are like. The old stuff gets broken faster than the new stuff is put in its place. The importance of any given experiment isn’t apparent at the moment it appears; big changes stall, small changes spread.”

Financial markets need experiments. For small markets like New Zealand – these are vital.

New Zealand’s largest company Telecom New Zealand (TEL.NZ) closed yesterday at NZ$2.23 – TEL.NZ’s lowest closing price since the early 1990’s.  We decided to have a look at TEL.NZ with the Valuecruncher interactive tool to place an estimate on the intrinsic value of the company using a discounted cash flow valuation.

Valuecruncher valuation model of TEL.NZ with interactive assumptions

Valuecruncher produces a valuation of NZ$2.41 for TEL.NZ.  This is a current valuation (an estimate of intrinsic value) not a target price.  This valuation is 8.1% above the current share price of NZ$2.23.

Assumptions

In 2008 (June balance date) TEL.NZ had revenues of NZ$5.673 billion and an EBITD margin (profits) of 32.15%.  Reuters aggregates 10 analysts covering TEL.NZ and these have mean estimates of 2009 and 2010 revenues of NZ$5.668 and NZ$5.652 billion respectively.  For this analysis we have used revenues of NZ$5.65 billion in 2009, NZ$5.65 billion in 2010 and NZ$5.70 billion in 2011.  We have forecast EBITDA margins falling from 31.5% in 2009 to 30.5% in 2011.  We have estimated capital expenditure of NZ$1.25 billion in 2009 to a long-term (terminal) number of NZ$1.05 billion.  All of these assumptions can be amended in the Valuecruncher on-line valuation model to adjust the valuation.

Other Model Assumptions:

Discount Rate: 9.5%.  PwC in their New Zealand cost of capital report calculates TEL.NZ WACC at 9.6%.

Terminal Growth Rate: 2.0%.  The New Zealand economy has grown at an average rate of 2.6% over the last five-years.  We see TEL.NZ growing more slowly than the New Zealand economy moving forward.

Our analysis incorporates the cash and debt on the TEL.NZ balance sheet – Valuecruncher calculates a net debt number.

Based on our analysis and assumptions the current share price looks a slight discount to intrinsic value.  Play with our assumptions – what does your analysis say?

Disclosure: None

Valuecruncher has a database of over 1,000 companies on major international exchanges. You can explore, create and share valuations for any of these companies.

Telecom Corporation of New Zealand (TEL) is New Zealand’s largest company (by market capitalisation). TEL is facing a range of challenges in the New Zealand market as it begins to operate in a more open regulatory environment. We decided to have a look at the company using the Valuecruncher interactive tool.

TEL Valuation

Our assumptions of revenues for the next three years are NZ$5.625 billion in 2008 decreasing to NZ$5.575 billion in 2010. We have projected EBITDA margins decreasing from 33.5% in 2008 to 31.5% in 2010.

We have used a terminal growth rate of 1%. Our view is that TEL will start to see modest growth post 2010 and 1% is a reasonable estimate. This assumption has a significant impact on the valuation. If you believe TEL has better future prospects – this will positively impact the valuation.

We have used a WACC (discount rate) of 10 %. The WACC (discount rate) has a material impact on a discounted cash flow valuation (as does the terminal growth rate). PricewaterhouseCoopers December 2007 cost of capital report gives TEL a calculated WACC of 11.3%. In our opinion this is too high. In 2004 PricewaterhouseCoopers calculated a TEL WACC between 9.8% and 10.5% (with 10.1% as the point estimate). In our opinion this 2004 analysis appears more reasonable. The December 2007 cost of capital report gives a New Zealand market WACC of 10.3% – TEL having a WACC 1% higher seems wrong.

We used a terminal capital expenditure number of NZ$750 million. In our opinion capital expenditure should stabilise around this number.

TEL Valuation

Our analysis incorporates the cash and debt on the TEL balance sheet – Valuecruncher calculates a net debt number.

Our analysis gives a valuation of NZ$3.40 which is 8.85% below the current share price of NZ$3.73.

Based on our analysis, TEL shares look expensive. Our key assumptions are around terminal growth and WACC (discount rate). Play with our assumptions – what does your analysis say?

Valuecruncher has a database of over 1,000 companies on major international exchanges. You can explore, create and share valuations for any of these companies.