Something I have long-observed is that poor investment...

Something I have long-observed is that poor investment propositions invariably become even worse investments over time and, conversely, often good investment theses tend to improve as the enterprise evolves.

TPI is a classic case of what I thought at the time to be a reasonable investment idea, offering good upside but limit downside once the company had been re-capitalised, turning into an even better investment idea down the track as the de-risking process takes hold.

At the outset when I first invested in the company some two years ago, my analysis at the time suggested I might generate a 50%, maybe 75%, return over two or three years as the company’s balance sheet healed itself.

I never thought that I would more than double my money.

However, even more surprisingly, I never thought that I would, after the stock had more than doubled, not only NOT be a seller of the business, but that I would in fact be BUYING more shares at that point, as I did after last weeks’ AGM update.

You see, as bizarre as it might sound, I think this company is an even better proposition today than it was some 24 months ago, even though its share price is 130% higher.

Why do I say that?
Because the company is at the point of being de-risked, while the valuation multiple still remains influenced by legacy – and not by the future (the market can often be lazy and negligent in that way).

The fact is that this is a fundamentally good business: it has a durable, hard-to-replicate business, that has market-leading positions and it generates significant surplus capital. The problem with it is that it had been grossly mismanaged and the in an era where corporate machismo was in vogue (i.e., pre-GFC), the then management went on a crazy, ill-disciplined spending spree, geared the balance excessively and made wealth-destroying acquisitions. But the core of it had always been a good business, which is why I have watched it for many years, waiting patiently for the distress to appear and for the market to – in its usual habit – to discard the stock right at the very wrong time, in a state of unjustified despair.

But that’s all in the past.

Let us talk about the future.

There are two major drivers of TPI’s performance over the next few months:

1. Further divestment of businesses
2. Accelerated cost reductions


Starting with the first item:

Following the sale of the Commercial Vehicles business (not a great business at all in my view) in August 2013 for a consideration of $219m (at an attractive sale multiple of almost 7x on EV/EBITDA which is a commendable outcome given expectations in certain quarters that TPI would struggle to sell that business), last week’s AGM update pointed to the potential sale of the company’s New Zealand waste management business. This business represents about $95m of EBITDA for TPI (or about 25% of TPI’s current EBITDA).

Given that New Zealand’s number 2 waste management company, Envirowaste, was sold in January this year valued at 10x EBITDA (TPI’s New Zealand waste management business is twice as big as Envirowaste), if TPI gets anything near to that number in a sale process, the company would be debt-free. (And I note that the book value of this business is around $800m, meaning that any sale price around this number would effectively be free of any capital gains tax liability, meaning that TPI would basically bank the full consideration price, net of tax)

In that case, the stock would certainly not trade at a mere 6x EV/EBITDA, which is where it trades currently.

And of course, it would mean that the company would re-commence dividends, possibly as soon as February 2014, something that would have been impossible to even consider a mere 6 months ago.


In terms of the scope and/or probability for further cost reductions, recall that TPI still has around $20m in cost outs to be booked in FY14 with a further $15m to accrue in FY15. However, given the scope for ongoing simplification of the business (this process hasn’t even started yet) it would not surprise me if the business and operational review that commenced in June 2013, and whose recommendations are currently being considered by the board, doesn’t come up with an additional $30m or $40m of cost reduction opportunities.


Accordingly, I have incorporated these two major factors into an analysis of a few potential scenarios in order to get a feel for the potential share price upside over the next 12 to 18 months.

In the interests of brevity, I will omit the details of the all calculations, but the outworkings are as follows:


Scenario 1: Ongoing cycle trough EBITDA in FY14 and FY15, no re-rating of the stock from current EV/EBITDA multiple of 6.5x
? Resulting Theoretical Share Price = $1.26/share

Scenario 2: No organic EBITDA growth, modest re-rating to 7.0x EV/EBITDA
? Resulting Theoretical Share Price = $1.40/share

Scenario 3: No organic EBITDA growth, $20m additional cost reductions, modest re-rating to 7.0x EV/EBITDA
? Resulting Theoretical Share Price = $1.50/share

Scenario 4: 5% Cyclical recovery in FY15 EBITDA, $20m additional cost reductions, modest re-rating to 7.5x EV/EBITDA
? Resulting Theoretical Share Price = $1.75/share

Scenario 5: The Bull-Case: 5% Cyclical recovery in FY15 EBITDA, $20m additional cost reductions, Sale of NZ Business for 9x EV/EBITDA, realistic re-rating to 8.5x
? Resulting Theoretical Share Price = $1.90/share


And, as is the case with all such theoretical exercises, the results are intended to be more indicative than prescriptive.

But what I have concluded is that it is by no means over for TPI’s share price outperformance.

I think the company’s management team understand perfectly well what is required to return the company’s share price to intrinsic value, and they are executing to that end ahead of the expectations that I had held over the past year or so.

Which is why, instead of selling the stock, I have been buying more.

In a world where gross undervaluation is hard to come by, TPI stands out as a bit of a rarity in terms of upside potential with limited downside risk.


Cam