My debut purchase of TPI shares was at the same time as the 50cps re-capitalisation exercise around this time two years ago.
At the time I calculated the margin of safety to be sufficient enough to justify investing in the company.
It occurred to me that the deep under-valuation at the time would ultimately deliver pricing of the stock towards is intrinsic value, especially since the debt reduction focus articulated by management would see rapid “re-equitisation” of the Enterprise Value of the company
[“Re-Equitisation”: when, assuming a constant EV/EBITDA multiple, Net Borrowings reduce and the Equity value rises to fill the space vacated by Net Debt in the Enterprise Value formula].
I find it a useful exercise to review cases like this, when the theory has translated into practice.
To demonstrate this let’s take a look at the numbers:
In FY2011, TPI had the following key financial metrics:
EBITDA = $425m
Net Interest = $177m
NPAT = $44m
Net Interest Bearing Debt = $1.56bn
Shares on Issue = 1.077bn
Share Price = $0.50
Market Cap = $540m
i.e., Enterprise Value = $2.1bn
And therefore, valuation-wise:
EV/EBITDA = $2.1bn/$425m = 4.9x
And solvency metrics:
NIBD/EBITDA = $1.56bn/$425m = 3.7x
EBITDA/Net Interest = $$425m/$177m = 2.4x
Clearly, this was a heavily-indebted business, and the financial risks were obviously part of the explanation as to why the stock was valued at less than 5x EV/EBITDA
Immediately after the $250m capital raising that occurred in November 2011, the metrics were changed to the following:
Net Interest Bearing Debt = $1.31bn
Shares on Issue = 1.579bn
Share Price = $0.50
Market Cap = $790m
i.e., Enterprise Value = $2.1bn
And therefore, valuation-wise, nothing had changed (since at that point all that had happened is that a debt for equity swap had taken place):
So EV/EBITDA = $2.1bn/$425m = 4.9x (as before).
But solvency metrics had improved somewhat:
NIBD/EBITDA = $1.31bn/$425m = 3.1x
EBITDA/Net Interest = $$425m/(177m less $25m) = 2.8x (pro forma basis, assuming interest expense falls by $250m @ 10% borrowing cost, i.e., $25m)
So, the capital raising at the time was a relatively modest one, in the context of the EV of the company, and its impact on the solvency metrics is relatively limited. (NIBD/EBITDA falls by 0.6x and EBITDA-to-Net Interest rises by 0.4x.)
But let’s look at what happens in the subsequent two years:
By 2013, surplus cash flow as well as the sale of under-earning assets, results in the following salient financials:
Net Interest Bearing Debt = $978m (down from $1.31bn after the capital raising)
EBITDA = $412m (EBITDA lower due to sale of several businesses)
Net Interest = $116m (lower due to lower net debt)
NPAT = $68m (higher due to lower interest expense, despite lower EBITDA)
Now, assuming that the EV/EBITDA multiple remained unchanged over time at 4.9x, as it had been in 2011 (we’ll later in this missive take a look at what the EV rating actually did), then we can solve for the implied Market Capitalisation and the resulting share price as follows:
EV/EBITDA = 4.9x
=> EV/$412m = 4.9x
=> EV = $2.0bn
So, Market Cap = EV less NIBD = $2.0bn less $978m = $1.026bn
Shares on Issue = 1.579bn
=> Share Price = Market Cap divided by Shares on issue = $1.026bn divided by 1.579bn = $0.65
In other words, following simple debt reduction, the “re-equitisation” alone of the EV (i.e., excluding any change in the valuation multiple) results in a $0.65 share price, up from $0.50 in 2011.
That’s 30% share price appreciation.
And note that return is delivered despite EBITDA having fallen.
Now let’s take a closer look at what happens to the solvency metrics:
For 2013:
NIBD/EBITDA = $978m/$412m = 2.4x (Recall that the 2011 figure was 3.7x)
EBITDA-to-Net Interest = $412m/$116m = 3.5x (2011 = 2.4x)
So clearly, this company’s debt situation – while not completely out of the woods yet – is in far better shape than two years ago.
The financial risk is clearly diminishing with time.
And as one of the axioms that pertain to the valuation of securities dictates: the less risk, the higher the valuation.
And we see this in the rating of the stock, which – at the current share price of $1.07/share – translates into a Market Cap of $1.69bn, and EV of $2.67bn, and therefore an EV/EBITDA multiple of 6.5x. (up from 4.9x, recall, in 2011 at the start of the process).
So, at $1.07/share vs the purchase price of $0.50/share... that’s a total return of some 115% in two years.
I think this is a great case study of “re-equitisation” theory being realised in practice.
And don’t forget – and this I think is a very significant lesson to value investors – this excellent share price performance was delivered even though the macroeconomic backdrop for the company over the past two years was simply horrible, and even brought about a few profit warnings and numerous downgrades by analysts. And the exit of the CEO.
Such is the power of “re-equitisation”.
As the EV continues to “re-equitise” over the next two years, and as the stock continues to be re-rated on the reducing financial risk, I believe the stock will continue performing well for shareholders.
Prudent Investing!
Cam
- Forums
- ASX - By Stock
- "re-equitisation" theory in practice
My debut purchase of TPI shares was at the same time as the...
-
- There are more pages in this discussion • 3 more messages in this thread...
You’re viewing a single post only. To view the entire thread just sign in or Join Now (FREE)
Featured News
Add TPI (ASX) to my watchlist
Currently unlisted public company.
The Watchlist
FHE
FRONTIER ENERGY LIMITED
Adam Kiley, CEO
Adam Kiley
CEO
SPONSORED BY The Market Online