A Small Cap That Pays You To Wait
One of our largest holdings in the TBF Small Cap Value Growth Fund is a company with a market cap of $170M that reported a profit of $27M in CY2016 and paid a dividend of $18M. The business does not have a lot of debt on the balance sheet and based on our forecasts is set to grow earnings this year. We estimate the company is trading on 6x PE for CY2017 and a dividend yield of 12%. The stock is still under the radar with only one broker covering it, yet it is the leading player in its industry. With a sustainable 12% yield we feel that we are getting paid to sit and wait for the market to wake up and re rate the stock. Find out more.
NZME (NZM) demerged from APN News & Media (HT1) on June 2016 and is listed on the ASX and NZX. NZM is a publishing and media business that operates some of New Zealand’s most recognized publishing, radio and digital brands focusing on news, sports and entertainment.
NZM’s publishing division consists of 6 regional daily newspapers, 23 community newspapers and includes The NZ Herald which is the number 1 read national paper with over 1.3M readership. The radio division operates 9 stations across NZ with Newstalk ZB, again the number 1 radio station in the country. The radio division has a 38% audience share and reaches more than 1.4M listeners. The digital division operates the digital brands across the company and also an ecommerce business (Grabone), which promotes daily deals in NZ.
Print accounted for 59% of CY16 revenues (with a 6% decline in revenue in CY16), Radio and Experiential accounted for 28% of revenue (with a 4% decline in revenue in CY16) and Digital & E-commerce accounting for 13% of revenue (growing at 9%). The company noted that across 2H CY16 declines in Print moderated and Radio assets stabilized due to various initiatives. This year we expect digital revenues strong growth to continue, and the radio assets to resume growing while offsetting the decline in revenues of the print division.
The company reports on a calendar year basis and provided results for CY16 back in February. In NZD, on a pro-forma continuing operations basis, the company generated revenue of NZD $407M, EBITDA of $72M, and EPS of 14.2 cps. Our investment in NZM is a straight up value play. There remains significant upside opportunity if the company can return the declining print division to growth or stabilize the decline. We expect further cost cutting to help maintain margins.
Unlike Australia, NZ has no dominant online players in Property or Auto classifieds apart from Trademe (TME) and Autotrader. NZM portals are currently in the top 3 for Property and Autos and so it has the potential to replicate the success of Domain and Carsales online Australian businesses in the NZ market. If this was the case, the upside is multiples of the current share price. The current valuation afforded by the market, in our view, ascribes a low probability to such scenario.
Fairfax NZ Merger
Significant upside risk is also present if a proposed merger with Farifax’s (FXJ) New Zealand assets is ultimately approved. The proposed transaction would see NZM acquiring additional trading revenue in the order of NZD $350M and EBITDA of $60M in exchange for a cash payment and 41% of the enlarged groups equity to FXJ. There would be an opportunity to recognize considerable cost synergies from the expanded group cost base.
Whilst the NZ Commerce Commission has currently blocked the deal, both companies are having one last go at appealing the decision with the high courts. We expect a resolution by the end of the calendar year, but see a favorable outcome as highly unlikely now. We think the current share price factors a zero probability of the merger succeeding.
If the deal is miraculously overturned, we see substantial upside in the share price. Synergies between the two companies have been quantified in the order of $35M - $55M. If the deal does not proceed then we think the current business remains undervalued in any event. In fact, we almost prefer the deal not to go ahead, and rather then giving too much equity to FXJ holders, we believe NZM can gain further market share organically from FXJ, as they continue to be distracted with the divestment of their Domain division in Australia.
What is NZM worth?
Based on CY17 estimates NZM trades on a 6x PE, 3.5x EV/EBITDA multiple, and a 12% dividend yield. There are a couple of ways to value NZM. On an income basis the yield of 12% is very attractive in an environment where a term deposit these days pays circa 4% pa.
We see media assets in general as fairly resilient in the long term, especially radio assets, and we believe digital growth will offset over time the decline in print revenues. The company has a strong balance sheet and free cash flow generation, and therefore we view the current dividend yield as sustainable for the long term. On a yield base valuation, we think the stock should trade on an estimated 8% yield, which values the business at $1.35.
Another way we can value NZM is to look at its most comparable peers and what they are trading on. Southern Cross Radio (SXL) trades on a PE of 11x and an EV/EBITDA of 8x. Fairfax (FXJ) trades on PE of 16x and EV/EBITDA of 8.5x. Macquarie Radio (MRN) trades on PE of 12x and EV/EBITDA of 7x. Applying a blended average of these to NZM and we get a valuation of $1.70.
Anyway we look at it, NZM is very cheap. Keep in mind that the market will take time to re rate the stock as investors will need to see some confirmation of earnings stability and growth. In the meantime, we are sitting, waiting and getting paid.
3 stocks mentioned
Head of Australian Equities for TAMIM Asset Management. Previously Founder & Portfolio Manager of the TBF Small Cap Value Growth Fund. Ron has responsibility for research, company analysis, portfolio construction for the TAMIM All Cap Portfolios.