high dive with acute degree of difficulty

I want to extend a vote of thanks to Jamwolf who alerted me to the PMP investment opportunity, by way of his Discount-to-NTA argument.

Having run a quick ruler over the balance sheet and the notes to the accounts, I came to the view that even under conservative assumptions of balance sheet value monetisation, the stock was still trading at a market valuation that was around some 35c in the dollar of net balance sheet value (refer post#: 8963263).

I spent subsequent days studying the past few annual reports, in conjunction with changes in management and subsequent announcements articulating what effectively amounts to a wholesale shrinking back of the business and a monetisation of significant elements of the balance sheet in the current six months, notably in relation to property and working capital.

Thereafter, I spent some time modelling the probably capital balance for PMP for the coming few years, testing it under various scenarios, with findings as follows:


SCENARIO 1: to determine what the current market value is implying for future EBITDA

- Under this scenario I back-solve for the EBITDA in FY14 and FY15 that would result in no change in the intrinsic value of the company, i.e., at a constant EV/EBITDA multiple, as the debt is reduced, what must EBITDA do for the Market Cap to remain unchanged
- Capex has been reduced to $25m pa, compared to the long-run average of $35m pa, a reflection of the reduced scope of the business
- No re-rating of the stock from its current EV/EBITDA multiple of 2.2x
- Resulting required EBITDA changes: down 22% in FY14 and a further 8% in FY15.

In other words, the current share price is implying a 30% fall in EBITDA over the next 2 years, from FY13’s expected $69m level (the bottom of management’s $69m to $72m EBITDA guidance).

While this is not beyond the realms of possibility (given FY13 EBITDA will have fallen by about 45% since the peak of $128m in FY07), it is highly unlikely given the management remains insistent on $32m of cost reductions being brought to account this year, which will make their debut full-year benefit felt in FY14.


SCENARIO 2:
- EBITDA unchanged in FY14 and FY15 at around $69m
- Capex held at historical high level of $32m
- No re-rating of the stock from its current EV/EBITDA multiple of 2.2x
- Resulting Return = 40% pa over FY14 and FY15, or ~100% share price appreciation by 2015


SCENARIO 3:
- EBITDA unchanged in FY14 and FY15 at around $69m
- Capex has been reduced to $25m pa, compared to the long-run average of $35m pa, a reflection of the reduced scope of the business
- No re-rating of the stock from its current EV/EBITDA multiple of 2.2x
- Resulting Return = 49% pa over FY14 and FY15, ~120% appreciation in share price by 2015


SCENARIO 4:
- EBITDA unchanged in FY14 and FY15 at around $69m
- Capex has been reduced to $25m pa, compared to the long-run average of $35m pa, a reflection of the reduced scope of the business
- Modest re-rating of the stock to and EV/EBITDA multiple of 3.0x from its current EV/EBITDA multiple of 2.2x
- Resulting Return = 80% pa over FY14 and FY15, or ~220% appreciation in share price by 2015


Note:

1. This exercise is intended to be indicative, rather than prescriptive, and should not be construed as investment advice.

2. I have made no assumptions of any EBITDA improvement going forward despite the cost reduction opportunity being targeted by management. Conservativeness is, I believe, appropriately prudent given the structural challenges facing the print industry in Australia. In other words, I am basically saying they will simply have to continue running harder to stand still.

3. As can be seen, I allow little scope for re-rating under all scenarios, aiming for a modest 3x EV/EBITDA under Scenario 4. Of course, with the pending sale of property and other non-core assets, it stands to reason that as the financial risk in the company is reduced, the market should respond with some form of higher rating for the company’s earnings. For context:
a. NIBD-to-EBITDA for FY12 was 1.9x and EBITDA-Net Interest was 4.8x.
b. NIBD-EBITDA for FY15 will fall to 0.6x under Scenario 2 and 0.4x under Scenarios 3 and 4.
c. FY15 EBITDA-Net Interest will improve to 12.6x under Scenario 2 and 13.8x under Scenarios 3 and 4.

While major transformations take longer and are normally more complex than one initially imagines, and this one is particularly demanding given the backdrop of structural challenges in the print economy at the same time, this is clearly a risky proposition.

However, there is clearly also significant potential return available, and the conclusion I have come to is that the return opportunity far outweighs the risks.

About 7 or 8 years ago I had a similar “dabble” in a beaten-up printing company called Promentum, that was acquired by a New Zealand –based organisation. That exercise I recall being a long, drawn-out saga, but I made significant money in the end.

Because of this legacy association I had followed PMP for a while, but had neglected to notice just how far the market value of the company had fallen, so I thank Jamwolf for inadvertently alerting me to the stock.

I’d never expose more than one or two percent of my personal wealth to this sort of situation because the level of conviction can never be high, but the upside is very material in my opinion.

However, as I stated in my debut post on PMP, I do think that the company has at least passed a few critical inflexion points, notably:

1. The banks have given them breathing room,

2. the point of maximum pain (i.e. at which the board falls on its word and recognises that restoring value to shareholders by growing or acquiring isn't going to happen, and that the only path forward is to sell of the farm at the best achievable price) has been reached, and

3. the de facto liquidation process has started, and the good thing for PMP is that it is taking place in an environment of low, and falling, funding costs for would-be acquirers.


In a world where stocks no longer look mouth-wateringly undervalued to me, PMP certainly does.

This might be akin to doing the dive off the 10m platform by a triple somersault with two-and-ahalf turns plus pike plus reverse twist, straight into a 44 gallon drum of water, but the results - if it can be pulled off - will be spectacular.


Cam

Actually, a better analogy for investing in PMP, I think, would be riding the unicycle 50m up in the air without any safety net, while juggling some flaming torches and a powered chainsaw, but I couldn't figure a way to incorporate that into the title, so I went with the diving theme.