Friday 31 August 2012

Randstad (RAND NA) ... put-ting away for a rainy day

Hays (HAS, mkt cap £969m) reported its full year numbers yesterday. As expected, the outlook appears cloudy and so it opened around 70p/shr, or 9% down. I closed my short in Hays and long in Michael Page (MPI, mkt cap £1.0bn) (see link). I may have jumped the gun. Hays could go lower. But then I’d made 11% on my HAS short, lost 3% on my MPI long and I’d been short HAS by a factor of 2 to long MPI on 1.That seemed a good return in just over a week.

What I reckon should go lower on the back of Hays’ outlook statement is Adecco (ADEN VX, mkt cap CHF8.0bn) and Randstad (RAND NA, mkt cap €4.4bn); the world’s 1st and 2nd largest recruitment companies, respectively. So I looked at the prices of puts in RAND.

If fundamentals were fully at play, I can see both ADEN and RAND steadily falling as we get closer to 2013. The market is expecting 12% EPS growth for RAND in 2013, rising to 17% growth in 2014, paying a P/E of 10.5x for those 2013E earnings. That seems optimistic to me and predicated on another dollop of new money. Trying to work out what central bankers will do makes second guessing where this market will be by year’s end pretty tough. If the ECB President Draghi gets his way then the market could get a shove higher. However, if BUBA President Weidmann keeps resisting, then it’s difficult to see what props euro land up against the weak fundamentals.

Either way, looking at the RAND puts, I was amazed. December puts in Randstad seem proper value. With the shares trading today at €25.5, December puts with a €20 strike could be bought for c. 35 €cents. RAND found a floor as low as €9.35 in the big bout of chaos we had in 2008/09. If Draghi fails to deliver, economic data remains weak and chaos reigns again, then that €9-10 level could be revisited before year end. In that event, a €20 strike costing 35 €cents, delivers me €10-11; or c. 30x my money. That seems to be astonishing odds and I can’t understand why they’re so high. Maybe the potential for euro weakness lessens the return? Even so, I still reckon it’s staggering value. So I tucked away some puts for a rainy day.


Randstad share price
Randstad valuation, 2013E P/E and EV/EBITDA
Randstad consensus 2013E earnings momentum
Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog. 

Tuesday 28 August 2012

Capita (CPI) … it’s very bouncy

I’ve shorted Capita.

I had a look back over the notes I’d made when Capita announced an equity raise in April last. Its share price fell by 18% in the weeks that followed from its pre-announcement price. It’s since bounced back by 18%. It’s very bouncy.
My main concerns then and now are as follows:
  1. April’s cash call came shortly after it arranged a new £285m 2 year loan in February 2012. On my maths, that tallies up to a raise of c. £562m from its banks and shareholders during H1.
  2. Prior to its equity raise, Capita had suggested that it would likely reduce its acquisition spend during 2012, relative to previous years. Indeed it acknowledged this in the accompanying statement to its equity raise. It subsequently concluded that the “current acquisition environment continues to offer a rare opportunity to broaden its business”. That seems to me to be a bit of a “flip-flop” approach.
  3. In its equity raise statement, Capita also suggested that “its clients value Capita partly because of its financial strength.” This would be reflected through keeping its net debt to EBITDA level within its targeted range of 2-2.5x (2011: 2.5x). However, in the light of the company spending £1.3bn on acquisitions since 2005, and £733m since Jan 2010, a more welcome outturn would be to see these acquisitions begin to provide a greater input into the reduction of net debt, as opposed to a cash call. I note that my estimate of its free cash flow shows it has not risen since 2009 (in fact it seemed to have halved in 2011 – see below), while the net debt to EBITDA ratio has risen. To me it appears as though prior acquisitions have not helped with the group’s financial strength. So I don’t see why further acquisitions should do either.
  4. Total annual spend on acquisitions has been increasing while the valuations attached to those acquisitions appear to have remained high and the margins bought appear to be getting lower. On my estimates, acquisition spend has been c. £175m, £181m, £311m, £341m in the years 2008-11, while (again on my estimates) the average EBITA margins of the acquired businesses has fallen from low double digits in 2008, to single digits in 2011. Further, despite lower margins associated with acquisitions and the difficult trading backdrop across the market, valuations paid appear to have remained relatively sticky at c. 9x EBITA.
  5. Its net debt has risen from £258m in 2005, to £1.33bn in 2011. This declined to £1,201m in June 2012; however, excluding April’s cash call, net debt would have risen to £1,477m. Meanwhile, on my estimates, CPI’s free cash flow more or less stalled in 2008-10, at £209m, £239m, £240m, and then halved to £121m in 2011.
  6. The Deferred Annual Bonus Plan criteria appear to have been steadily falling. In 2009 the criteria for 33% to 100% vesting was for the company’s EPS growth to fall in the range of RPI + 6% pa up to RPI +16% pa. In 2010, this was brought down to a range of RPI + 4% pa to RPI + 14% pa. In 2011, this was again brought down to a range of RPI + 4% pa to RPI + 12% pa. Over the past two years the upper boundary for vesting has fallen from RPI + 16% to RPI + 12%. That is against the grain of management’s rhetoric on record pipelines.  
  7. Operating lease commitments rose significantly in 2011. Future minimum rentals payable under non-cancellable operating leases rose from £265m in 2010 to £379m in 2011; by 43%.
So for the reasons above, I have gone short.
Capita share price
Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog.

Wednesday 22 August 2012

Hays (HAS) vs. Michael Page (MPI) ... a gap has opened

Yesterday I shorted Hays (HAS) and went long Michael Page (MPI) at a ratio of 2:1. As I can’t see a hiring frenzy on the horizon and both stocks don’t appear cheap, I fully expect both to go down. But I reckon that Hays is not as good a business as Page and has more downside as a result. On the other hand, if the monetary authorities provide another dose of money salts to perk up the risky assets, then Page should blitz upwards while Hays may take a jauntier stroll. The charts show this all better in pictures than I can say in words ...

Hays vs Michael Page

Hays share price
 
Michael Page share price
Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog. 

Experian (EXPN) ... a lot of acquisitions, capex and director selling ...

I have a short position in Experian. I have shorted the shares for the following reasons:
  1. Despite having spent $4.5bn on acquisitions since 2006, I reckon its organic and acquisitive revenue growth for the past six years appears somewhat lacklustre.
  2. Margins have improved dramatically, but the group’s capex as a percentage of sales has also risen sharply and has significantly diverged from the rate of its competitor, Equifax.
  3. Experian has spent a considerable amount on acquisitions since 2006. As far as I can infer, they have been very expensive.
  4. I consider its balance sheet to be weak. Ex-goodwill and intangibles the business has net liabilities of $2.8bn. 
  5. The shares appear expensive and consensus has significantly downgraded its future EPS estimate over recent months.
  6. Management have bought £200k of stock during the past two years as compared to £42m of sales.

What does Experian do?

Experian is a credit and marketing services company. The company retains databases on persons and businesses to provide credit scoring/checking and monitoring to then sell to businesses and consumers.

Revenue and margins

Experian’s revenue increased from $3,064m to $4,487m during the period 2006-12; representing a CAGR in revenue of 6.6%. However, during this period the group has also spent c. $4.5bn on acquisitions. Experian’s accounts suggest that at the point of acquisition, the bought businesses were generating a combined c. $1.4bn in full year revenue. Certain parts of the business were also disposed of during this period, totalling c. $1.5bn, and c. $695m of associated revenue looks to have been lost through these disposals. I reckon that means about $720m of revenue has been gained from net acquisitions since 2006, or roughly half of the group’s total revenue gain. Given that the total CAGR in revenue was 6.6%, and net acquisitions have contributed half to the revenue gain, it doesn’t seem like the core business has been growing that strongly; maybe keeping pace with inflation. 




What has increased strongly over recent years is the group’s EBITDA margin. My estimate is that the group’s EBITDA margin has risen from 26.7% in 2009, to 33.1% in 2012. I would add that I have ignored the adjustments the group makes under its so-called “Benchmark” approach. Management’s performance and remuneration is set against this “Benchmark” measure. I find this odd as under this measure, while reported PBT totalled $600m, $656m and $689m in 2010, 2011 and 2012 respectively, Benchmark PBT was reported to be, 42%, 40% and 64% higher at $854m, $920m and $1,128m respectively. Others may choose to ignore these adjustments as “one-off”, but they don’t appear particularly “one-off” to me.

While the EBITDA margin has risen strongly, so has the level of capex as a percentage of sales. In 2006, the group spent $62m on the purchase of property, plant and equipment, and an additional $150m on the purchase of other intangibles (databases, internal use and generated software). This equated to 6.9% of sales in 2006. It rose to 8.5% of sales in 2008 and fell back to 8.1% in 2010. It averaged 7.8% through the period 2006-10. By 2012, the group spent $84m on the purchase of property, plant and equipment and $369m on the purchase of other intangibles. Capex as a percentage of sales had risen to over 10%.

A competitor of Experian is the US based company Equifax (EFX, mkt cap $5.5bn). This is a broadly similar although smaller business to Experian.

While Experian’s capex totalled 10.3% of sales in 2012, Equifax’s is expected (Bloomberg consensus) to be at 3.5% of its sales (down from 3.8% of sales in 2011). Figure 6, and the chart below shows the path of each company’s capex as a % of sales.






Acquisitions

When looking at the group’s acquisition expenditure and trying to estimate valuations paid, I came across this, which I found to be fairly amusing on one of Experian’s acquisitions.
In 2007, Experian sued a US based company called Mighty Net for trademark infringement. At the time, The President of Experian's Consumer Direct segment, Ty Taylor, was reported to have said "We believe it is important to not only protect our intellectual property, but also to protect consumers against such companies [Mighty Net]." My emphasis added.
In 2010, Experian bought Mighty Net for $208m.

Experian’s accounts detail what the group’s acquisitions provided in revenue from date of acquisition to its financial year end and the acquired businesses revenue generated from Experian’s financial year beginning to date of acquisition. From this it is possible to get an estimate of what I think the acquired businesses generated in revenue for an entire financial year. This is detailed in figure 9, below. 


Experian spent $4,520m in cash on acquisitions during 2006-12 and it appears that bought revenue totalled $1,512m at the various points of acquisition. This equated to 3x sales. On a profit after tax (PAT) level, the group also details what the acquisitions provided from date of acquisition to financial year end. Using the ratio of revenue reported from point of acquisition to financial year end and revenue reported from financial year beginning to date of acquisition, it is possible to get a proxy for what full year PAT may have been. I estimate this to have totalled $139m for the group’s acquisitions in the years they were purchased. I have then assumed that the tax rate was 28% to determine what a likely profit before tax (PBT) would have been. I estimate this to have totalled $193m that the acquisitions collectively achieved in the years they were purchased. On this basis, Experian appears to have paid $4,520m for companies which were collectively achieving $193m in PBT at the time of acquisition; or 23.4x PBT. I reckon that is expensive. I have also added a row to estimate what potential EBITDA may have been were a 28% margin to have been achieved against the acquired revenues. This would have totalled $423m and imply a price paid of 10.7x EBITDA. Again this seems expensive. 


Balance sheet

Having spent a significant amount on acquisitions, the bulk of this has been included in Experian’s balance sheet as goodwill. Given that the sector is typically tangible asset light, balance sheets stuffed with intangible assets are not out of the ordinary, but even so. Excluding goodwill and other intangibles would leave Experian’s balance sheet with net liabilities of $2.8bn. This compares to reported net assets of $2.9bn and a market cap of $15.6bn.

Lots of selling

Management has lobbed out a sizeable number of shares over recent years. In total the directors have sold £42m of stock since June 2010 and bought £0.2m. Some of this is to satisfy tax on option entitlements, but even so. £200k out of £42m is not much of a token gesture. 


Valuation

The shares trade on 18.7x current year earnings, falling to 16.7x 2014 earnings. On an EV/EBITDA basis the company is valued at 11x current year EBITDA, falling to 10x 2014 EBITDA. It pays a prospective dividend yielding 2.2%, and has c. $1.9bn of net debt. This is not a cheap stock either on a relative basis or by its historic average.

Experian 2013 consensus valuation 

It would also appear that it continues to receive downgrades to analyst consensus earnings estimates. Just since May, its 2013 EPS estimate has been cut but c. 19%, while the shares have rallied c. 10% during the same period.
Experian 2013 consensus earnings momentum

So for the above reasons, I have shorted the stock.

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog.

Trinity Mirror (TNI) ... who's the best value of them all?

I have a long position in Trinity Mirror. I started buying at 38p and continued to hoover them up until they hit 26p. A lot of hoovering went on. TNI is about the best value stock I’ve seen for a long time. I’m long the shares for the following reasons:
  1. Superb cash generation. TNI generated £94m in operating cash in 2011. During its half year to July 2012, it generated a further £57m. This compares to a market cap of £107m.
  2. Net debt has been reduced by £197m since January 2009, to £181m in July 2012. At that rate the group will be debt free by 2014/15.
  3. Bid speculation cropped up a few months back and I suspect that hasn’t gone away.
  4. It’s ridiculously cheap. The shares trade on a consensus 2013 P/E multiple of 1.7x and price/cash flow multiple of 1.5x. This year’s free cash flow yield is likely to be c. 61%.
  5. New management. David Grigson took over as Chairman in May. He has form.

Cash, cash and more cash

Despite TNI’s revenue having fallen by £225m (23%) during 2007-11, TNI chucks off cash by the bucket load. Since January 2008, the group has generated £461m of operating cash. That’s 4.3x its current market cap of £107m. By way of comparison, during the same period, the FTSE 250 company, MITIE (MTO), has generated marginally less in operating cash. However MITIE has a market cap of £1bn.

Where the concern lies for TNI is in its gearing, pension deficit and the outlook for newspapers.

At the end of 2008, TNI had £378m in net debt; equivalent to 3x EBITDA. Net debt is now £181m, as at the end of June 2012; equivalent to 1.3x EBITDA. Even accounting for a further decline in revenue going forward, TNI is likely to be debt free by 2014-15. As I expect newspapers to still be around for at least another decade (although circulations may have more than halved), the group is likely to be capable of generating c. £50m in free cash flow pa until 2022. After discounting, I reckon that’s worth more than its £106m market cap. Probably at least four times as much. It’s worth bearing in mind that when debt free, it will also be free of its net interest cost. In 2011, net interest alone was equivalent to 5p/shr. At today’s price that would be equivalent to a 12% dividend yield.

Pension deficit

The group does have a sizeable pension deficit of £210m (down from £230m in Dec 2011). However, TNI has structured a deal with the pension trustees to limit overpayments into the pension fund at £10m pa over the next three years. Prior to this, the group had paid an average of c. £38m pa into the pension fund. This will help to allow the debt to decline. Moreover, the group also retains land and property assets on its balance sheet, valued at £177m. There may be an opportunity to transfer these assets to the pension to help offset the pension deficit.

New management and the outlook for newspapers

David Grigson took over as Chairman in May 2012. He has previous in that he helped to steer Reuters back on course, which culminated in its merger with Thomson in 2008. He was quick to transition the former CEO, Sly Bailey, out of the picture and is currently looking for a new CEO.

I fully expect newspaper circulations to more than halve over the next decade and margins to decline. But even so, I reckon at 42p/shr, TNI still appears to present incredible value.

So for the reasons above, I may add to my long.

TNI share price

TNI 2013 consensus valuation

TNI 2013 consensus earnings momentum
Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog.