Telecom – Foreign’s Undervalued Opportunities

By: Steve Rubis and Louis Entsminger

The Telecom – Foreign Industry offers significant investment opportunities. We feel that there are numerous companies that are undervalued when compared to the rest of the industry. Mergers and acquisitions activity will provide the significant catalyst for unlocking value.

Below, is our competitive analysis of the Telecom – Foreign Industry. The stocks selected for comparison are those listed as undervalued in our Telecom – Foreign Industry analysis article posted on Friday, April 6, 2007.

Table 1: Undervalued Foreign Telecommunication Stocks


The table above illustrates that four stocks exceed our required threshold for margin of safety. Each stock has a margin of safety greater than $20 per share. We think that these companies are attractively priced. These stocks offer significant discounts from fair value at current prices.

Table 2: Telecom – Foreign Industry Stock Universe


The stocks highlighted in green represent the stocks which offer the greatest margin of safety. This spreadsheet serves as the initial filter for our analysis. Stocks that appear undervalued on this sheet are then selected for further research.

The most significant opportunities exist in South America, specifically Brazil and Venezuela, and Asia, which includes China, Japan, and Korea.

Table 3: Comparative Analysis of Take Out Values


Industry metrics for Price to EBITDA and EV to EBITDA suggest that the industry will continue to experience strong M&A activity. The industry as a whole trades at very low ratios, which makes the Telecom – Foreign Industry ripe for consolidation and private equity investors.

Table 4: Comparative Relative Multiple Values


Each opportunity offers investors significant safety in terms of book values. The ratios suggest that the selected stocks are attractive. Table three illustrates that each stock has significant room for price appreciation in terms of price to sales, earnings, and book value.

Table 5: Comparison of Enterprise Values


Table four gives investors a sense of what it will cost to re-create each company from scratch. This provides an interesting signal to mergers and acquisitions and private equity investors. Investors are better off buying shares of these respective firms because their share prices sell for less that what it would cost to re-create each business.

Table 6: Comparative Earnings Power Value and Weighted Average Cost of Capital


Despite large debt positions, each company seemingly enjoys a very low weighted average cost of capital. The respective WACC’s range from 3.56% to 24.54%, which begs the question: are these values reliable? In our estimation, the answer is yes. The reason that these companies enjoy such low WACC values is because of their geographic locations. They have an advantage in that debt is sometimes cheaper in foreign countries, and tax credits generate a greater tax shield benefit. Given that the WACC costs are reasonable, the earnings power values are valid as well.

Table 7: Comparison of Earnings Power Value and Reproduction Value


Four of the selected companies pass our first extreme value test: does earnings power value exceed reproduction value. This provides investors a strong margin of safety, since this shows that the earnings are worth more than the assets. This validates our reproduction values and further validates our margin of safety calculations.

Sources: Yahoo!Finance as well as Value Investing and Beyond by Greenwald, et al.

*Note: the authors cannot be held responsible for any gains or losses incurred from trades based on this article. Investors should read articles and annual reports before acting on any data presented herein.

**At the time of writing and publishing the author owns 19 shares of BRP.

The Equity Valuation Problem

By: Steve Rubis

Benjamin Graham once stated, “Stock Analysts stand between a mathematician and an Orator.” Equity analysis in general is too subjective and imprecise. Analysts rely on calculating numerous values in order to validate a fair value target. In reality, analysts should seek an equation that will determine fair value by adding an earnings component, asset component, and equity component to determine fair value.

Academics as well as professionals often describe equity investing as art rather than science. The reason that equity research is more art than science is due to the lack of a single infallible valuation technique. Researchers, investors, and academics have yet to develop a single valuation metric or calculation that correctly assesses a company’s fair value. Currently, Discounted Cash Flow analysis seems to be de rigeur. The problem is that DCF is highly subjective in assumptions and prone to rosy projections. It is our hope that our analysis will offer a new valuation metric which more accurately determines value. Equity valuation should generate a combined value of earnings power plus asset value. On the contrary, current principles seek to corroborate or triangulate by comparing a range of results from disparate valuation methodologies.

Equities analysis is an art because there is no set rubric for corroborating, developing, or assessing a firm’s value. Certainly, there are orthodox methods such as DCF or relative analysis; however, these calculations do not always yield meaningful results. The main problem driving the subjectivity of equity valuation comes from future projections. Most analysts rely on projections of future earnings or cash flow to determine a fair value of a firm. These analysts are often prone to blue sky projections. Most financial statement models seem to assume that growth is constant; for the most part analysts project that the firm’s earnings or cash flows will constantly rise and seldom include the possibility of an earnings miss or decline.

Furthermore, we believe that cash flows are too volatile and disparate to attain an objective fair value. Our view is that the Statement of Cash Flows should be used to validate the Balance Sheet and Income Statement rather than for equity valuation. We feel this way because as many have written before us, DCF valuations rely heavily on uncertain future projections and derive the majority of fair value from the terminal cash flow (Greenwald, et al.). In our view, cash flows are not the best indicator of a company’s true value.

The second glaring problem with equity valuation is that no valuation technique successfully combines both earnings and assets. Most will argue that DCF calculations meet this challenge; DCF only indirectly meets the challenge stated above. Analysts seem to triangulate or corroborate valuations in order to determine a fair value for a specific firm. For instance, we use a combination of Take Out Values based on EBITDA, Relative Analysis, Earnings Power Value as proposed by Bruce Greenwald, and a proxy for Reproduction Value as proposed by Bruce Greenwald. Academia also follows this approach, which is illustrated by the outstanding research done by Tulane’s Burkenroad Reports. While this triangulation or corroboration method seems to work, we believe that there must be a better way of determining fair value.

We propose that analysts should use a hybrid valuation technique that discounts assets, equity, and earnings. These three components are the primary determinants of a company’s fair value. In other words, each component adds to the overall company value and should be added together to get fair value. Generally accepted practices involve analyzing each component in a vacuum in which the analyst compares / corroborates the values in order to determine fair value. Our hybrid looks at a five year time horizon and discounts the cash gains generated by Return on Assets, Return on Equity and EPS.

Table 1: Hybrid Valuation Variable Inputs


Table 1 illustrates the variables necessary to carry out the hybrid valuation. Central to the calculation is determining the Weighted Average Cost of Capital (WACC). The second step is to discount the gains on assets, equity and net income for the five year period.

Table 2: Gains on Assets, Equity and Net Income for Five Year Period


The hybrid valuation grows assets, equity and net income by their respective growth rates. Next, the method discounts the gains generated by the respective growth rates by the WACC. Lastly, the values are summed and divided by the number of shares outstanding.

Table 3:Hybrid Valuation of Lockheed Martin


The difficulty with equity analysis is that there is no scientifically proven valuation method. Investors are limited to methodologies that treat earnings and assets as mutually exclusive entities. Any buyer or evaluator of business should seek to determine a fair value based in concert with said variables. Otherwise, analysts and investors run the risk of leaving possible gains on the table.