What are SGH Shares Worth ?

At the moment the brokers are all over the place on valuation / price targets for SGH.
So here's my two bobs worth.

If you are buying, it's all about future earnings (not the NTA backing -given all the intangibles on the balance sheet).

The 2016 year EBITDA guidance is $205M, up about $75m over 2015, ($90 more, if the normalised figure is used as the base). The assumption is most of the increase comes from SGS, the business bought from Quindell.

EBITDA of $205M would probably give a 2016 NPBT of about $135M to $140M, after taking out similar interest and depreciation as was incurred last year, plus say allowing an extra $40M in financing costs etc for the extra $600M of debt that's now in the balance sheet.

NPBT of say $137.5M would mean a NPAT figure of a bit over $100M for 2016, or 28 cents or 29 cents per share.

On that basis, if you buy the shares for $1, it's the buy of year.

But (there's always a "but"), the market, and in particular the institutions, obviously have their doubts about the $205M EBITDA figure. The reasons aren't hard to find.

1. The announcement that group operating cash flow for FH 2016 would be $30M to $40M negative. That's roughly a $50 to $60M negative turnaround from 2015 if you use the previous full year figures as a base. If the Aus and UK law firms are earning their normal cash flow, it must mean that SGS is heavily cash flow negative currently.

The institutions would probably like to know how the $205M EBITDA guidance reconciles with the minus $30M to $40 FH cash flow. Is there a cash flow "hockey stick" at the end of the year ? Is there going to be a big jump in the work in progress on the balance sheet, taken to profit? Are trade receivables blowing out? etc etc Currently we are all in the dark.

2. Quindell was required to restate its accounts after SGH bought the SGS business from them. Prior to the purchase Quindell had its earnings as GBP86M. So the analysts all did their advice on the basis that SGH was paying a certain multiple of those earnings. After the UK regulatory authorities went into Quindell my understanding is that the accounts show a loss of more than GBP130M for 2014.

3. SGH paid about $1,300M for SGS, including about $1,000M for goodwill. That's hard to justify if it's not adding to group earnings from day one.

4. At the end of the day, the SGH directors may not have the final say in what their work in progress figure will be at the end of the 2016 FY. If, just for arguments sake, the new auditors come in and say they want a more conservative valuation method, and tell SGH to knock $100M off the WIP figure, that would mean NPBT (using my figures above) of $35 to $40M, not $135 to $140M, if the accounting treatment of WIP stays the same. That would be earnings of more like 7 or 8 cents per share after tax.
NOTE this is just conjecture on my part - I have no idea how SGH does its WIP valuation and whether it would be regarded as conservative or not, or what an auditors view would be. I'm just saying that SGH directors may not have the final say in the profit figure.

5. Longer term, the UK regulatory changes may not be good news for SGS.

Just my opinion, but currently SGH are not doing a great job of explaining to the market what's going on. And the institutions reaction to that, and the fact SGH was going to drop out of the top 100, explains why the price fell off the cliff at the end of November.

Until the information gaps are filled in, I suppose the brokers valuations / price targets are going to stay all over the place.

Disclosure: I'm not long or short in SGH. If I was long, I'd probably be holding.