price slowly showing signs of life, page-44

Here is my 2c on TGA, but I freely admit most of my limited understanding comes from reading and digesting the posts of Pioupiou and petepan.

I want to preface this post by saying that in reading The Warren Buffett Way by Robert Hagstrom, he talks about system 1 and system 2 thinking. The first being fast and simple, the second being where a slower and more cognitive process takes place. It is the latter approach that is needed to understand, digest and appreciate TGA IMO.

If you go back to 2008, operating leases account for $78 million of revenue, whereas now they account for $108 million (note 3). That is a growth of 38% and accounted for 67% of Thorn's revenue in 2008, but only 46% of their revenue in 2014. So you can see the shifting of revenue to be predominantly finance leases.

Finance lease sales revenue on the other hand have grown from $25 million to $51 million. That is a growth of 104%. But, the kicker is the interest growing from $13 million to $54 million, growth of 315%.

My assumption here is that the interest expenses are accounted for in operating leases on a straight line basis, whereas only the interest from finance leases are recognised separately - please correct me if I am wrong on this.

But, as has been detailed by Pioupiou and petepan many times before, accounting for finance leases mars the perception of NPAT from an accounting perspective. Taking this approach is too simple and doesn't give you any insight into how well TGA is operating. So I decided instead to look at the cash flow and worked on a model where rental acquisitions acquired in one year would return cash back to the business on average over the next 2 years, being in tranches of 2 lots. I used this assumption because it generally reflected the average contract length of the Radio Rentals business.

I have made the assumption that the increasing growth in finance leases and the lag between paying for the assets and receiving the money and interest back is always going to require the input of additional capital to keep up with demand, much like the banks. What seems to be a negative is paradoxically a positive. I have gone back over the last 10 years and discounted the "difference" between money spent in one year at t0, on acquiring assets, and the average cash flow generated by operations from the next 2 years at t1, t2. The last 10 years alone gives me a NPV of cash flows of $153 million.

What would be a reasonable price for earnings of $153 million over the next years? $1.5 billion using a RR of 10%.

I thought that to be conservative and ensure I haven't double counted I'd go back and halve the cash flows even though I think $153 is fairly accurate. Halving the cash flows I get a NPV of cash flows of $45 million which would give a value of $450 million and still gives a comfortable 30% margin of safety.

However, that model assumption no longer really applies with the additions of the new business units, particularly TEF which seems to be taking up a lot of cash and seemingly has a much longer contract term than the average Radio Rentals contract. But, Radio Rentals has also been increasing the average contract length and increasing interest revenue to the company as well.

I figured another way to value the business was to look at how much was spent on rental and lease (including TEF) acquisitions in the year and apply the historical ROC (return on capital) rate to the money spent knowing the last couple of years has seen $60-70 million poured into TEF without much revenue to flow back yet. So for the 2014, $102 million spent, with a ROC of 15% equates to around $15 million cash back to the company. The NPV for the next 10 years assuming 10% is $92 million, worth $920 million with a RR of 10%.

If my logic and reasoning is right, my belief is that this is a misunderstood and undervalued company.

PS. This post style is for you, Pioupiou ;-)