Telecom - Foreign Industry

By: Steve Rubis

Industry: Telecommunications – Foreign
Number of Companies: 30
Market Capitalization for Companies in Universe: $572.4B
Market Capitalization for all Foreign Telecoms: $681B

The Telecommunications – Foreign Industry trades at fair value, due in large part to brisk M&A activity during the past year. Despite numerous deals, there seems to be a few undervalued take out targets. In our opinion, there are numerous factors which should help unlock the value of the undervalued securities in this industry.

Catalysts / Problems Facing the Telecom – Foreign Industry:

1.) Mergers and Acquisitions Activity: Morningstar.com provides an enlightening outlook for the Telecom - Foreign Industry. These companies generate significant cash flow, despite large debt positions. Secondly, due to government regulations and margin pressures, M&A provides the best access to growth.
Article: Morningstar Outlook on Foreign Telecom

2.) Telecom Italia Bids: AT&T and Mexican firm America Movil offered 2.82 Euros per share for the parent holding company of Telecom Italia. This price sparked a bidding war, as France Telecom recently expressed interest in the telecom as well.
Article: Telecom Italia Bid

3.) China's Infrastucture: Siemens and Nokia believe that sales growth will double and continue to be strong in the future. It seems that due to the 2008 Olympics in Beijing, that China needs to upgrade much of its infrastructure. The recent runs in China Netcom and China Telecom Group validate this theory.
Article: Siemens and Nokia's Outlook on China

4.) Geo-Political Risks: investing in any foreign entities often involves geo-political risk. Many of the undervalued Foreign Telecoms are located in South America: Brazil and Venezuela. Venezuela’s Hugo Chavez is prone to nationalization of any valuable industry, hence share prices are depressed.

5.) Speculative / Unfavorable Capitalization Structures: a major draw back to the Telecom – Foreign Industry is its capital intensive nature. The majority of the stocks in this industry have large debt burdens, which is cause for alarm.

The chart below reviews the metrics which characterize the Telecom – Foreign Industry as a whole.

Table 1: Telecommunications – Foreign Industry Metrics Compared to the NASDAQ



The metrics above are in-line with the overall market and reflect the numerous M&A deals over the past year. Numerous stocks within the industry have shown significant price appreciation due to M&A activities.

Furthermore, the Price to EBITDA (Earnings Before Interest, Taxes, Depreciation, Amortization) and Enterprise Value to EBITDA ratios suggest that M&A activity will continue. These ratios are quite low in comparison to most industries. Secondly, these stocks offer a strong Return on Equity as well as a decent Return on Assets. Problems occur for investors who rely on Discounted Cash Flow valuations because of an exorbitant Price to Free Cash Flow ratio. Lastly, the industry does not offer much safety in terms of the Fed Model. Earnings Yields are not significantly above the current Risk Free Rate.

Table 2: Telecommunications – Foreign Industry Average Per Share Values



The per share values above confirm our thesis that the industry trades at fair value. A roughly 11% discount is hardly cause for celebration. Nevertheless, there are a few stocks which seem quite attractive because of the catalysts identified at the beginning of the article. Here is the list:

Undervalued:
1.) Brasil Telecom Participacoes (BRP)
2.) China Netcom Group (CN)
3.) KT Corp ADS (KTC)
4.) Nippon Telephone and Telegraph (NTT)
5.) Telenor ASA (TELN)
6.) Tele Norte Lest (TNE)
7.) Compania Anom Venezuela (VNT)

Moderately Undervalued:
1.) France Telecom (FTE)
2.) British Telecom (BT)
3.) China Telecom Corp. (CHA)
The companies on the undervalued list, with the exception of VNT, seem poised for further growth. Despite large capitalizations, each one seems to have good prospects for the future.

*Note: we did not use the Altman Z Score discussion in the article. At the time of writing, we encountered difficulty compiling the data. This was due to currency conversions and stale data.
**Note: the author of this article cannot be held responsible for any monies gained or lost based on this presentation. This presentation identifies certain stocks to be attractive based on data from Yahoo!Finance. Further due diligence is needed before purchasing any stock mentioned.

McLean, Bethany, and Peter Elkind, The Smartest Guys in the Room, Penguin Books, New York, 2004.

Enron Epitomizes All That Is Wrong With Corporate America: Greed, Arrogance, and Charlatanism

By: Steve Rubis

Corporate America at the turn of the new Millennium faced numerous scandals. These scandals involved both individuals and entire corporations. The Smartest Guys in the Room is a catchy title that epitomizes the Enron story. The majority of Enron employees believed that they were the smartest in the room. McLean and Elkin use their investigative journalism as a point of departure in order to generate a true financial history. Descriptions of interpersonal dynamics, corporate culture, and audit complacency provide more than a history of Enron’s demise. Smartest Guys in the Room exposes Corporate America of the new Millennium for what it is: greedy, arrogant, and unaccountable.

The authors illustrate how intellectual hubris served as a catalyst for Enron’s demise. McLean and Elkind attempt to describe the history of the Enron Corporation. These authors begin with the company’s humble beginnings in the 1980’s. McLean and Elkind give readers an in-depth, often overly detailed, description of the rise and fall of Enron. They describe in great detail the interpersonal relationship of the major players: Ken Lay, Jeffrey Skilling, Rebecca Mark, Andrew Fastow, et al. The book serves as the pre-eminent source on how Enron fell. The interviews, myriad sources, and minute detail create an anatomical map of Enron. Readers who seek to learn every last detail about Enron should start with McLean and Elkind.

McLean and Elkind provide a simple account of the history of Enron. The authors attempt a metamorphosis of their financial journalism into a financial history. Their financial history attempts to retell the development, growth and demise of one of America’s most innovative corporations. Their goal is to detail the shenanigans so that the reader can develop a better understanding of the Enron debacle. Primary sources serve as the foundation of their account, which started with the author’s own investigative journalism.

Smartest Guys in the Room is a clever title since it summarizes the entire book. Enron Corporation hired the best and brightest and offered these employees a blank check. The corporation encouraged employees to push the envelope to ensure that profit targets were achieved. McLean and Elkind illustrate this arrogant corporate culture as the recapture the personal dynamics of management. Andrew Fastow and Jeffrey Skilling epitomize the intellectual arrogance and charlatanism of Enron. Fastow and Skilling pushed the envelope beyond reason using financial games as well as belittling to ensure Enron’s prominent reputation.

McLean and Elkind offer an authoritative source for future historians. Any future researchers interested in corporate scandals or Enron should start with this history. While cumbersome at times due to immense detail, the book give the best account of the Enron story. Smartest Guys in the Room is complimented by its much less dense cousin 24 Days: How Two Wall Street Journal Reporters Uncovered the Lies that Destroyed Faith in Corporate America by Rebecca Smith and John Emshwiller.

Work Experience Gives Best Insight into the Value of an MBA Program

By: Steve Rubis

The plethora of MBA programs leaves prospective students with headaches when trying to make a decision as to which school one should attend. A few months ago, we wrote an article stating that we would like to put forth a new rubric for ranking MBA programs. In order to do so, it is necessary to understand what characteristics are most important to a ranking structure. Most MBA Admissions Officers and Ranking Organizations focus their discussion on statistical metrics, i.e. GMAT, Diversity, Salary. The problem is that the statistical metrics overlook the most important aspect of MBA programs: student work experience. Previous work experience drives the growth and career changes that most MBA students seek. We believe that student work experience separates the truly great schools from the rest of the pack.

Certainly, statistical metrics allow prospective students to compare numerous schooling options. Statistics create a common base for analysis which allows prospective students to analyze their diverse options. The problem is that statistics make the specific school in question look good. Analyzing different admissions standards and statistics offers no value to the consumer. The metrics that Admissions Officers and Ranking Organizations use offer data on an educational experience and it offers no data on results. Statistical analysis fails to illuminate what return prospective students will receive from their educational experience.

In our humble opinion, analyzing the resumes of current students for previous work experience and internships offers the greatest insight to an MBA programs value. Perusing current student’s resumes offers an insight to the level of intelligence and work abilities. The prospective student can easily compare his or her resume to the current student population. Within minutes, the prospective can accurately decide whether or not he or she will benefit from the program in question.

An illustration of our statements above will provide clarity. There are two schools: School A and School B. The student’s backgrounds are as follows:

Work Experience:
School A: small firms, no corporations
School B: Fortune 500 and many corporations
School C: Prominent Fortune 500 corporations

Salary Range:
School A: under $50,000
School B: between $50,000 and $60,000
School C: above $50,000

For most prospective students the reasons for attaining an MBA are higher salary, better jobs, and career change. The above scenario illustrates why looking at work experience is essential. If I make $50,000 and have worked for prominent corporations, I will not benefit from attending a school where the students experience is below my previous experiences.

This illustrates how work experience is the most essential aspect of an MBA program. Students are able to get better jobs and affect career changes because of the network built while at school. If a prospective student wants to obtain a position at a prominent Fortune 500 and has strong work experience the student should go to School B. Our test student would not benefit from School A because the student populace does not offer a useful network. If the student went to School C, he or she would fail because the student populace is at a more developed position career wise.

Student work experience answers two analytical questions: (1) can your candidacy and acceptance make the school better; and, (2) can attending the school in question help your career goals. We think that this analysis offers the best value and takes the least amount of time for prospective students to employ. After all, the prospective student’s telos is to obtain a better job, not just a fun and expensive experience.

Rubis Hybrid Valuation of Avatar Holdings

By: Steve Rubis

At Stock Research, equity valuation is the center of our investment analysis. An article we wrote a few weeks back discussed the problems of equity valuation. Currently, analysts calculate a myriad of values and then compare them to validate, or develop a fair value range. The problem is that this method seems to value a component of the company rather than the entire entity. It is our belief that investors should seek to evaluate a company as a whole, and this entails a valuation that adds assets, equity and net income together. These are the three most important components when generating share holder value of any successful company.

Let us now present the hybrid valuation of Avatar Holdings. The process involves calculating the Weighted Average Cost of Capital; generating the Returns on Assets, Equity and Net Income each for five years in the future; then discounting them to the present; adding the values, and then determining a per share value.


Table 1: Rubis Hybrid Value Inputs



The first input is the Weighted Average Cost of Capital, since it will provide our discount rate for our expected returns on Assets, Equity, and Net Income. Readers should pay special attention to the outstanding Returns on Assets and Equity that AVTR provides. In order to proceed, investors must question whether these rates are sustainable. We believe that given the current climate for the Residential Construction Industry, the rates are not sustainable. Therefore, there is a five percent reduction in Asset growth per year, an eight percent decline in Equity, and a three percent decline in Net Income growth as well. These adjustments should create a more realistic picture of AVTR’s future (This approach is also quite conservative).

Table 2: Asset, Equity and Net Income Cash Flows for 5 Years



Above, we estimate the expected returns on Assets, Equity, and Net Income. These three components seem to be the most important value generators for any publicly traded company. It is our view, that adding these three cash flows is more illustrative than a typical Discounted Cash Flow (DCF) valuation.

Table 3: Per Share Hybrid Valuation of Avatar Holdings (AVTR)



The values in the chart above reflect the strong Returns on Assets and Equity provided by AVTR. The problem is that according to this analysis, investors are paying more for the assets than the true earnings power of the business. This begs the question, does the per share value calculated above accurately reflect the fair value of AVTR? We say yes given our calculations in our comparative analysis of Avatar Holdings and WCI Communities. That being said, it seems reasonable for investors to be suspect of the above valuation.

Nevertheless, the Rubis Hybrid Valuation seems to provide an interesting illustration of company value. At the same time, much work is needed on developing this valuation method.

*The author cannot be held responsible for any monies gained or lost through trades made based upon our analysis. This analysis and valuation is for informational and educational purposes.