BEAM COMMUNICATIONS HOLDINGS LIMITED (ASX:BCC) - Beam - Getting to a valuation, page-34 - HotCopper | ASX Share Prices, Stock Market & Share Trading Forum

Originally posted by Access2020: ↑

PART 2 - Building the Profit & Loss

In the first post I detailed my key revenue assumptions and drivers for Equipment Sales and Airtime. I've set it out in a way that if you have a different view you can plug and play with your own assumptions. Remember, it's very early in the Zoleo journey and we don't have a baseline for ANZ sales, so further calibration will/may be required. Despite that I still have a high degree of confidence that this is on or very close to the mark as I've set my assumptions very conservatively.

To build out the P&L we need a view on margins and cost but we also need to understand how BCC report and what is included and excluded. For instance, BCC's gross profit margin is not clean and is factually inaccurate. Why is this? Well, let me show you why. Here's BCC's gross profit margin based on reported data. Looks fairly standard right?

The above is technically correct but if we dive into the FY2020 annual report to see what the cost of sales actually is we get this...

As you can see from the above screen shot, BCC's cost of sales ONLY INCLUDES THE COST OF SALES FOR EQUIPMENT SALES. It does not include the cost of sales of airtime revenue i.e. the carrier costs, which I highlighted in part 1. This is fairly significant and needs to be accounted for in any model.

To do this we need to account for airtime cost of sales separately. I've also reconstructed the cost of sales between Zoleo and Other Equipment, which I estimate generate gross profit margins of 15% (my estimate) and 40% (FY2020 Hardware Sales/Cost of Sales = 36%. Note: This will include some high cost of sales Zoleo produt so I've rounded it up to 40%) respectively

I break down all my numbers into half years so I can track performance regularly and look for changes. Here's the annual view, which is probably more interesting and relevant for HC'ers. The revenue numbers come directly from my table in Part 1.

It's worth noting that Airtime "revenue" is actually Airtime Gross Profit. I've accounted for carrier costs upfront so that my model is in line with how the company reports. Even if I did it differently it will still wash through but it's worth noting.

The absolute most important point to note is the sharp reduction in margins that will happen this year. This is largely a function of the high growth in Zoleo. Remember equipment sales at LOW margin are upfront. The high margin Airtime revenue lags and initially is dwarfed by equipment revenue. As a rough example, at $350 for a Zoleo it will take 8.2 months in Airtime at $42.50 ARPU to make the equivalent in revenue. This is why GP will drop sharply this year but keep trending higher in later years. Once you understand this concept your set.

Other very small things to note. I haven't accounted for JV profits or loss even though they're in BCC's P&L. BCC incurred a ~$400k loss in FY2020 from Zoleo Inc. It will probably break even this year and be profitable after that. Because it's difficult to estimate and I've set conservative parameters I've left this at $0 when the actual value will probably be a profit from FY2022 onwards. Other income represents R&D income. BCC report this slightly differently and I try to take these costs 'below the line' to get a clean EBITDA.

Finally, it's worth calling out that BCC have $1.2m in deferred tax losses. As a rough proxy the FY2021 profit will eat up all or most of that so BCC will start paying tax from FY2022.

While the above has a valuation output, it is not a valuation. I'll cover that off in Part 3 but you can see that in FY2022, based on my analysis at the closing price of today and with shares fully diluted, BCC could generate EPS of 7.7c, which would generate a PE of 4.6x.

That would also be the second consecutive year of profitability and the outlook from then would be positive, so I also expect them to start paying DIVIDENDS. They could pay them in FY2021 but again, I'm being conservative. I've applied a 25% payout ratio, which will represent a DPS of 1.9c per share or a yield on today's price of 5.5%.

It's worth noting that this business is not capital intensive. It does not manufacture products. It's essentially a working capital business with very high operating leverage. This means that there is no need for the business to sit on a pile of cash, so the capacity to have a HIGHER PAYOUT RATIO is very high. I've set it at 50% but could set it higher as my balance sheet shows cash piling up. (Note: I don't assume any M&A).

So based on FY2021 data, by my numbers I have sales roughly doubling, the business moving to profitability, and with shares fully diluted (options are out of the money until 50c) I get a PE of just 12x. I'll leave it to you to decide if that is expensive or cheap...

Oh yeah the market cap today is $23.5m and the EV about $18m when you take into account $5m being raised recently. It will not take much for this to be a multi-bagger.

PART 3 COMING SOON...

Expand

Ok, time to round this one out. Obviously valuation is driven by a set of assumptions and the valuation method that is used. I've already covered off on my assumptions that have driven my key outputs, so now it's time to turn those numbers into a valuation and then run a few sense checks to make sure it's plausible.

Firstly, it's important to pick the right valuation methodology. Most people on HC are comfortable with PEs because they're simple to understand and use, but sometimes they have their limitations as they disregard cashflow. The valuation method will and should also change depending on your industry. For instance, if you were looking at a business in Energy or Real Estate, PE just doesn't make as much sense as other alternatives.

Personally, for all the stocks I own in which I have built a financial model I typically use 2-3 methods and average out the output to get to my valuation. I find it's a good way to see if one method skews an output or not.

For BCC I've used a DCF, PE and EV/EBITDA. EV/Sales or a multiple on ARR probably isn't appropriate because there are a lot of hardware sales in the business, which are non recurring and lower margin.

Another key point that's worth pointing out is that because I classify this as a growth stock, I'm not taking a PE on FY2021 or even FY2022. My baseline year is FY2023. That has a material impact on the valuation, but because I intend to hold this for a while, unless something materially changes, it gives me an idea of what the valuation could be in 2-3 years.

1. DCF (on FY2021). Personally I think DCF is the best valuation tool but it's a bit more involved as you need to build out a whole financial model to get an idea of what the future cashflows looks like. For Beam, my key belief on this one is that because of Zoleo's high margin air time, in time, that should lead to the business becoming a much more profitable business. This is VERY positive for cashflow. The business is also relatively capital light but it's worth noting that the business amortises their development costs, which makes EBITDA look better than it is - more on that a bit later.

Using a discount rate of 10% and terminal growth of 2.5%, my implied SP is ~$1.86 using a DCF on FY2021 year end figures.

2. PE (on FY2023). As mentioned using a PE multiple is fairly straight forward. The key is justifying the right number/multiple. As I've provided my EPS in an earlier post, if you want to use another multiple you can derive your own valuation if you don't agree with mine.

I've used a 16x multiple on FY2023 EPS. Why 16x? Well BCC is presently a nano cap that is fairly lightly traded. Typically you would DISCOUNT the multiple based on these factors. In contrast, the business (based on my view), will be a fast growing and increasingly PROFITABLE one. These factors are VERY ATTRACTIVE and it's not inappropriate to see a much higher PE multiple being used. For a fast growing and increasingly profitable business you could use 25x-40x but you'd use the higher multiple on an earlier year as you're trying to account for a material step-change in growth. As I'm taking a later year where some of that growth has taken place, using a really high multiple is probably a bit too aggressive.

For me, 16x represents a 20% discount to the small ords (20x), which I think accounts for the size and liquidity of the group and provides enough conservatism for me to think it's achievable. Ultimately this is my capital so I'm generally more conservative to adjust for risk.

3. EV/EBITDA (FY2023). You'd typically see this used in telco or materials type businesses, which Beam would loosely fall into (note: Beam is grouped into Communication Equipment). I've been really conservative here and it's somewhat appropriate as BCC's EBITDA is ELEVATED because they capitalise development costs as opposed to expensing them. In other words, your spending the same money but because the accounting treatment is different, EBITDA will look different. If you don't account for this you could gross up the valuation.

In Beam's investor presentations they comp themselves against the following businesses. While many of these businesses are not direct competitors they share similar traits. I actually think SPA is the best comp. SPA has a similar market cap, operates in what I'd call a communications niche (wearables) and has a similar business model i.e. hardware (watches) plus a high margin subscription component. I know SPA very well but I'll leave that discussion for the appropriate thread.

I'm fortunate to have pretty good access to information and I can get all the broker reports that exist for the names below. I've used those as my baseline to derive my EV/EBITDA multiple - this is probably more art than science as CDA for instance is a much bigger business etc and I also need to discount BCC's multiple to account for capitalised costs.

Based on all of that I've used a 10x multiple and it's also on FY2023 for the reasons I've covered off earlier.

So my FY2023 target price is $1.81, which is the rounded average of the three methods above. That sounds VERY high relative to the present share price and it is, but the implied market cap at that level is just ~$137m, which is not overly high for a business that I think will generate ~$9m in NPAT in FY2023.

It's worth noting that once BCC starts to prove themselves and deliver, they will attract instos, broker coverage and may get into some indices. This will improve liquidity and lead to a number of re-rates and right now for investors, this can be considered the ground floor. Honestly, while it's a large numberI think there is upside in this valuation if they deliver like I think they will.

As a side note, patience will be required though as I expect margins to FALL in 1H21 before they start their ascent given low margin hardware costs will precede high margin airtime, which takes a year to earn vs upfront hardware revenue. Given this, I'm probably not expecting a rapid increase to my price target and this could disappoint some so just watch out to see how the market reacts in February. Either way, it could be a good accumulation opportunity if you have a 2+ year time horizon.

GLTAH