How to analyse a new float or IPO.
There has been a bit of action on the IPO front over the past few months. Sixteen stocks have been added to the main board of the ASX, as set out below with their actual listing date.
I thought it might be a worthwhile task to run the ruler over them and see if any are potential investment candidates among the newcomers.
Let’s start our exercise at the more speculative end of the investment spectrum. I don’t gamble with money, so let’s eliminate those that are involved in exploration activities given their high risk/high reward dynamics. There are 12 exploration businesses among this group. I will leave these to others who are more suitably qualified in working out whether any opportunities exist here and whether they will find something before their cash runs out.
Of those remaining, well-known NZ website Trade Me and RXP Services are involved broadly in the IT space, Alliance Aviation is involved in mining services and finally Chorus, another NZ company, specialises in Telecommunications. These are the four businesses we will focus on. A brief review of these follows.
Alliance Airlines (AQZ)
I will start with a sector I know well – airlines. A capital intensive industry with lots of competition rarely makes for wonderful business economics (Qantas, Virgin) and despite Alliance operating in a niche market of fly-in, fly-out operations for the mining sector, my view remains the same: I will never invest a dollar into this sector.
Alliance has grown quickly since its formation in late 2002. From nothing, to a fleet of 20 Fokker 100 and Fokker 70LR jets as well as five Fokker 50 turboprops with established, long-term, profitable blue-chip relationships with BHP Billiton, Santos, Incitec Pivot, and Newcrest. That’s an outstanding achievement by management. A distinguishing feature is that approximately 75% of Alliance’s 2010-11 revenue was subject to medium to long-term contracts – recurring revenues.
No matter. Any airline cannot escape competition or its high level of ongoing capital requirements. And for a niche space, four other competitors (Cobham, Network aviation, Qantaslink, Skywest) appear to be a handful in terms of the prices they can charge, competition for future contracts (especially when 44% of 2010-11 revenue was from one client, BHP), ongoing operating margins and future market share gains.
A total 47.6% of Alliance’s forecast for 2011-12 EBITDA will be consumed on refurbishments, maintenance, rotables, new aircraft and property, plant and equipment. This leaves just over 50% to pay taxes, interest and for working capital requirements. And once all is paid for, only a little will be left over for future dividends, buybacks, etc. It is not surprising, therefore, that the prospectus does not forecast a dividend to be paid in 2012.
Despite a pro-forma forecast of $18.1 million NPAT, or 20.1¢ earnings per share, and the shares trading below what the business may be worth, if you ever see me buying an airline, please put me in a straitjacket.
RXP Services (RXP)
Unfortunately, this business has a very, very short history and no real track record. It was formed in October 2010, just 15 months ago, with the purpose of establishing an information & communications technology (ICT) business with a focus on medium/large enterprises and the government.
The founders have done this, but with one drawback. Rather than building a business organically, the purpose of the float was mainly to raise funds to acquire two unlisted businesses in Vanguard and Indigo Pacific. The rollup of these has seen RXP service capabilities expand overnight from nothing into a broad range of management, business and ICT consulting, delivery and support services.
With a number of already listed ICT businesses already competing for market share – SMX, CSG, OKN, many of which have had a chequered operating history as listed entities – the space appears to be a little crowded. I can’t see how RXP will differentiate a commodity product offering.
And turning to its financials, despite the consolidated accounts in the prospectus showing how the businesses may have looked had Vanguard and Indigo been owned in the past, they weren’t; what we see is what would have been a profitable little businesses. But as we have little to go on as to how they will actually function together going forward under new stewardship, we will watch this one from the sidelines for now.
Chorus (CNU)
Chorus is a spin-out from Telecom New Zealand. It is New Zealand’s largest telecommunications utility company, a technical way to describe a business that builds, maintains and repairs existing phone and broadband lines.
Following the demerger, Chorus is a business whose sole focus is on bringing fibre within reach to as many New Zealanders as possible – kind of like our own NBN Co., but not run by the government, even if it has been chosen by the Crown to build NZ’s ultra-fast broadband (UFB) network to 830,000 urban premises, as well as extend fibre further into rural New Zealand through the Rural Broadband Initiative (RBI) by the end of 2019.
Having so far deployed some 2500 kilometres of fibre optic cable, upgraded hundreds of local telephone exchanges with new broadband equipment and installed or upgraded about 3600 roadside cabinets, a target of 20,000 kilometres of fibre optic cable to deliver ultra-fast broadband will probably be met. Management’s recent experience in rolling-out ADSL2+ broadband is coming in very handy and helping to build New Zealand’s fibre future.
There are some obvious tailwinds here, with the long-term nature of this contract and ratings agency Moody’s has assigned Chorus a Baa2, stable issuer and senior unsecured rating. A rating similar to Bulgaria and Kraft foods.
Look under the hood, however, and you can see that about $NZ1.7 billion of net interest bearing debt was outstanding as at December 2011, all current. On just $NZ422 million of equity, it appears that Telecom New Zealand may have also let go of some unwanted baggage in the de-merger.
While 2011 cash flows appear to be well managed and interest payments well covered, I can’t help but be reminded of another infrastructure asset in Asiano when it was demerged from Toll holdings in 2007. It too was saddled with a large debt burden and at the end of its first trading day; Asciano had a market capitalisation of $7 billion. Today it is $4.5 billion.
Trade Me (TME)
Last but not least is the well-known NZ website Trade Me. Similar to eBay international, Trade Me is now dual-listed on both the New Zealand and Australian Stock Exchange.
While this is another spin-off, Fairfax Media Limited (ASX:FFX, SQR B3) has retained a shareholding of 66% – generally a good sign.
On one reading this might be the pick of the recent floats. The business has an moderately geared balance sheet, produces a significant amount of free cash with low levels of ongoing capital expenditure now that the website is mature and has a history of earnings growth which any shareholder, and that includes Fairfax, would be truly happy with. On top of this, with Fairfax retaining a material level of ownership in the business, they are still highly incentivised to continue promoting the website via its vast media network.
On another reading Fairfax paid $750mill for Trade Me (TME) and have just sold 34% of it for $363.5 mill or a total ‘value’ of $1.07Bln. This will help them justify the carrying value on their own balance sheet. Further, since 2007 TradeMe has made net profits totalling $276mill, the bulk of which has been taken out as dividends. So FFX have made an IRR of about 17% per annum. Given FFX have set up the company with market cap of about $1 billion, equity of $631 mill ($721 mill goodwill and therefore negative NTA) and debt of $164 mill, the expected return on equity is just over 10 per cent means FFX have got a return that you might not.
Posted by Roger Montgomery, Value.able and Skaffold author and Fund Manager, 6 February 2012.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Rainsford
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Hi Roger
Thanks for your comments re TME. The Skaffold numbers for equity and debt appear different to those you mention (and I agree wth ) in the blog?.
LukeS
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Hi Roger,
We live in exciting times. There are some clever people out there. I always laugh when I see “This time it’s different” type of stories. However, as we stand back and observe traditional retail, it seems things just might be different this time.
This short video shows how Tesco is competing in Korea. It is one of those “Of course” ideas. Simple, brilliant.
I am often late to the party so if this is old news to everyone why wasn’t I told?
http://www.youtube.com/watch?v=o9zcs1dg8qo
It put a whole new slant on having a Woolies store on Town Hall Station.
LukeS
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A few days have passed since I watched this video. We sell stuff that can be easily adapted to this idea. So I went for a walk around town. There are people waiting everywhere. Waiting for a bus, taxi, train, to finish a coffee, conversation, smoke. What a gorgeous direct sales method. Every movie, play or concert should have the ability to take a booking right there at the bus stop. I am very excited.
Matthew Smith
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Did anyone happen to invest in Lemarne Corporation Limited??
There are still a few cigar butts lying around worth taking a puff or three….
30 June 2011 Financials
• Mkt Cap was $3.4m or $0.40
• Revenue $54m
• NPAT $3.7m – 6.7% margin
• Op Cash Flow – $4.3m
• FCF of $3.5m – 100%
Valuation
• Net-Net Working Capital – $27.9m & Net Cash – $13m
• P/E of 5x – $18.5m
• FCF discounted at 15% – $23.3m
Roger Montgomery
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Skaffold valuation 27c and has been declining every year since 2007. I didn’t like it in 1992 and still don’t.
Matthew Smith
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What about a discussion/post on fixed income securities??
At the end of the day Graham & Dodd wrote two versions of a fantastic book titled “Security Analysis” and not “Equity Analysis”
In fact the majority of the book is written about investing in fixed income securities.
Just a different line of thought for everyone…there are so many good titles for the post like, “Why you should go into Debt”……hehehehe
If people are not interested that is fine with me.
Paul Rehill
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How to analyse a new float or IPO. How about how to not bother analysing a new float or IPO, unless your Roger of course. Most of us would be better off checking ourselves if we try to. Graham recommended excluding securities that don’t have a 10 year track record of producing profits and Buffett follows this rule so that is a better starting point for most of us. Others also have a four year profit track record criteria. Perhaps a balance between the two could be struck to reduce portfolio risk. It takes a great deal of discipline to cast aside IPOs and say to yourself, I might be missing out on a ten bagger here, but I also might shoot myself in the foot with this new speculative stock or “speculative investment” unless I watch it like a hawk, and even then it still might not work out. I’d prefer to look in the rear view mirror for some past evidence of profitability and management actions that suggest they are interested in increasing shareholder wealth. If time is the friend of the wonderful business, enemy of the mediocre, I’d rather cast all IPOs aside.
Regards Paul
Roger Montgomery
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Too simplistic Paul. Some companies that list/IPO have been in business for ten years or more. They are not new at all. Collins Foods is an example (I republish my original pre-listing article on it below and as you can see, there’s plenty of information with which to make a decision even though its an IPO…) There is a track record there. Buffett also buys new issues – lots and lots of them. Indeed some new issues are issued only to him. SO don’t be too simplistic or tentative about new floats. Just read and think…
PORTFOLIO POINT: A sneak peek at Collins Food Group ahead of its IPO offers an intriguing view for investors.
As a parent I’ve never been much of a fan of fast food but I do know that many of the strong brands in this sector command enormous market share.
But I’m not here today to give you a lesson in nutrition; what I want to talk about is the opportunity to invest in the future success of KFC in Australia through the $238 million initial public offering of Collins Food Group.
The KFC brand is owned by US-based and listed Yum! Brands. Owning a strong brand is one of the best competitive advantages money cannot buy.
The value of this competitive advantage is reflected in the returns on equity, gross margins and pre-tax profit margins Yum! Brands generates of 66.2%, 33.6% and 14.3% respectively for the most recent 12-month period.
Amongst 47 listed restaurants in the United States, Yum is number two by return on equity and 17th among 790 listed services companies by the same measure. There are indeed very high returns to be made from leveraging a great brand like KFC and selling franchises.
Being the franchisee, on the other hand, is rarely as lucrative and the forthcoming listing of Australia’s largest KFC franchisee – Collins Foods Limited (CKF) – will demonstrate this to investors.
Collins has 119 KFC stores (117 of them in Queensland), along with 26 Sizzler restaurants in Western Australia, NSW and Queensland, and it’s the franchisor of maybe 60 Sizzlers in Asia.
The price point of these restaurants will inevitably have fund managers – who are participating in this week’s bookbuild – referring to Collins as a “defensive” investment. But as I have previously indicated, the only defensive investment is a brilliant one; mediocre companies need not apply.
To begin with it is important to note that Pacific Equity Partners (PEP) – the private equity firm behind REDgroup, the parent company of Angus & Robertson and Borders now under administration – will be exiting its stake completely.
Perhaps more interestingly, the existing management team is cashing in, too. Managing director Kevin Perkins will reduce his holding from over 20 per cent to about 8% and the rest of management will reduce their holding, too.
When Pacific Equity Partners paid $US210 million in September 2005 (the $US6.92 a share was a 42% premium to the then traded price of $US4.92) for Worldwide Retail Concepts, the US publicly listed company that is now Collins Foods, management then co-invested with a 48% stake. According to all reports, management will now retain just 10%. In other words, management is selling 80% of its holdings into this float.
If PEP bought the company in 2005 alongside management who owned 48%, and you buy in 2011 with management owning just 10%, do you think the deal has a whiff of fried chicken to it?
During the privatisation, PEP and the management were arguably similarly incentivised but when you buy Collins Food Group’s from PEP in the IPO, you will not have the same committed management.
And when PEP bought Worldwide Retail Concepts in 2005, the company operated, joint ventured or franchised 302 Sizzler restaurants (with 28 in Australia), 112 KFC sites (111 in Queensland) and it also owned 22 sites of the US “quick casual” or family value restaurant chain Pat & Oscars.
Worldwide Restaurant Concepts reported revenues of $US347.2 million in the year to April 30, 2004 ($A444 million at the then exchange rate of US78¢) and 70% was generated in Australia. All this for $US210 million ($A269 million).
According to reports, you are being asked to pay $A230–278 million ($US244–295 million) for 119 KFC outlets, 26 Sizzlers and around 55 franchised Sizzlers in Asia. I am not sure if the IPO company will offer a stake in the other 220 Sizzlers but I can tell you the Pat & Oscars chain was sold to management in 2009 after another buyer in 2007 failed to secure funding.
Oh, what doesn’t Google know!
Same-store sales growth has been positive while in the care of PEP and Collins Foods, and is forecast to hit $430 million in 2012, according to one report, but it is the growth in earnings since the purchase in 2005 that has been spectacular.
For the year to April 30, 2004, Worldwide Restaurant Concepts earned just $4 million. In 2011 that number might be closer to $25 million for Collins Foods and it is probably for all this hard work that management want to cash in their 38%.
Despite this wonderful growth in profits, the best estimate of intrinsic value I can give you is $2.55. This represents the low end of the expected range of possible prices at which you might be entitled to any shares.
But before you jump in like a headless chicken, remember two things: management are taking their cream; and the franchisor always makes more money than the franchisee. Just look at Yum! Brands’ return on equity and compare it to Collins Food Group’s when we see it.
Finally, it’s always interesting to follow the cash account, which can give an alternative picture of the company’s position before and after its float. For those who have access to the prospectus have a look at the pro forma cash balance prior to the float.
Let’s presume it is close to $50 million. That cash balance will first increase by the proceeds of the float – say $250 million – but any debt repayment will see the account decline again.
Then you need to look carefully. If there is a further drawdown (because all the proceeds were used to reduce debt) it will see the account restored but then payments to vendors and reimbursing costs associated with the float will result in a starting cash balance that may be a lot less than it was before any float was contemplated.
If this is indeed the scenario – and it would not be one without precedent – the drawdown would have effectively funded the payment to vendors and costs. If there is no further drawdown or refinancing, there could be no payment to the vendors including management.
The prospectus will be out shortly. The last float we looked here at Value.able was MACA at $1 and we suggested participation for those lucky enough to have been offered shares.
MACA shares now trade at $2.35, after being as high as $2.96, trouncing the return of the other floats we reviewed, Myer and QR National. Will Collins Food Group be an addition to the Value.able portfolio? There’s a greater chance that my kids will be regulars at a KFC restaurant.
Andrew
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I steer clear of IPO’s but for different reasons. For starters, some companies have got quite a fair bit of history behind them before listing as Roger stated above.
My problem with IPO’s is that more often than not the aim is to get the best (highest) price from the listing for the sellers, this is especially true if it is the listing of a company owned by a private equity business looking to exit their stake completley.
How many years have we been hearing about facebook launching, nine was rumoured to of being floated last year but market sentiment canged that. Myer was far too expensive when it was listed. The list goes on.
This may be a very general rule as i know some have been listed at a significant premium but i believe these are the exceptions rather than the rules.
Roger Montgomery
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And then you get floats like The Reject Shop…
Parag
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Not to mention other great ones of recent times like SWL, MCE, EAX, MACA, GR Engineering…