Confession time, as promised last week.
My largest mistakes in terms of what EGP share price might now have been are probably acts of omission, things I knew I should buy but didn’t. I will disregard those to talk instead about my worst 2014 act of commission, something I shouldn’t have done, but did (bearing in mind there is still 5 weeks left for something even more regrettable…)
The biggest act of commission of 2014 was selling Dicker Data shares earlier in the year. My reasons for selling the first block now appear unsound. My view of intrinsic valuation had grown to a point that the market valuation approximately matched valuation, which is a perfectly sound reason to sell; also the holding had grown to a larger portion of the portfolio than intended. It was, however, an acquisition around the time of the sale that was the major trigger for selling. Primarily, because the metrics for the sale were not set out. In hindsight, a little patience would have served us better.
In my (quite unscientific) view, probably 5 out of 10 (major) acquisitions destroy value for the shareholders of the company making the acquisition. Around 3 or 3.5 in 10 cause neither benefit nor harm and the remaining 1.5 or 2 out of 10 cause the intrinsic valuation of the acquiring firm to rise somewhat.
Included in that 15 or 20% of ‘value adding’ acquisitions, perhaps 15 or 20% in turn of those are truly company transforming acquisitions. So working back my rough math above, something like 1 in about 30 acquisitions cause the value of the acquiring to make a large, positive valuation step change. The Dicker Data acquisition of Express Data on April 1st this year was such an acquisition in my view.
My big mistake was selling out before I gave management a chance to explain what the acquisition would do for the company. This was because the first announcement about the acquisition set out no metrics for the sale. The revenue, profitability, rationale and most importantly purchase price were all absent from the original announcement. As I set out above, given my view that very few acquisitions add value, absent some criteria to make the assessment for myself, I sold some shares as the intrinsic value excluding the acquisition was very close to the price.
Now the reason the vast majority of our holdings have substantial ‘insider ownership’ is because I like the alignment that gives the management with the shareholders (provided those insiders have a history of acting in minority shareholders best interests). Dicker at the time of the acquisition was one of the most concentrated insider ownership situations imaginable with more than 93% held by the directors. Professional managers’ (i.e. not founder-managers) interests are sometimes aligned very differently to their shareholders. Managing a larger business usually means a larger salary, even if the ‘Earnings per Share’ of the newly enlarged business does not grow. Owner managers care more about growing earnings and dividends on a ‘per share’ basis, not diluting their stake.
The big mistake? I should have factored the alignment David Dicker and Fiona Brown had with us as shareholders to do the right thing with the acquisition. The vast majority of their respective wealth is tied up in Dicker Data. A serious misstep with a poor acquisition would hit them a lot harder than it was ever going to hit minor shareholders. The assumption should have been in the positive, and despite what I maintain was insufficient disclosure initially around the acquisition, with owner managers, it must be remembered their primary concern is usually with running the business well rather than explaining strategy to their shareholders.
Because of decent new capital inflows in March, June and September, despite the meaningful price rise in Dicker Data shares, their proportion of total EGP fund assets had shrunk. I have rectified my sale mistake and purchased further shares, EGP now own 170,000 DDR shares and we are likely to participate in the DRP until share price gets closer to the newly rebased intrinsic valuation.
Intrinsic valuation is a slippery beast, but I will try to give you some idea of how I am thinking about Dicker Data currently. Absent the acquisition, FY15 for Dicker would likely have held revenues near $500m and NPAT around $11 or 12m or maybe a little more, with an intrinsic valuation something around $1.30 to $1.50 per share range with a relatively challenging organic growth profile ahead.
The first quarter announcement flagged revenue for Q1 of the combined business of $263m. Q1 is the slowest quarter in the industry, so you can reasonably expect them to at least quadruple that figure, so expect at a minimum FY2015 revenue of $1,050m with a very good result being something like $1,200m in revenues. When the acquisition was made, Dicker dropped the distribution rights for Apple products as the margins were unsatisfactory. Between the removal of this low margin revenue and the substantial removal of costs through consolidating onto the company owned Kurnell hub, expect gross margins to return to something approaching the pre-merger figure of 7%. Pre-tax margins are historically near 3%, though additional volumes/scale could potentially improve this somewhat due to the inherent operating leverage in the business. There are little over $3m in ‘one-off’ costs that will impact FY15 profits, but unlike many companies, these can be genuinely viewed as one-off as the redundancies are paid and leases closed out.
For the sake of conservatism, using the low end of revenue guidance, I would be surprised if PBT doesn’t exceed the $30m the business has guided for by at least 5-10%. I am expecting PBT of at least $31.5 – $33.0m in FY2015 before integration costs. This is an underlying NPAT of a little over $22m. In FY16, I expect revenue exceeding $1.2b with PBT in the low to mid $40m range and NPAT in the order of $30m plus.
The share-base is currently 128.5m. Management indicate they expect to issue about $50m in new equity in the next 12 months to extinguish the majority of debt taken on for the $65m ED acquisition. The first $20m or so will come from paying out 100% of earnings via the quarterly dividend and near full take-up of the DRP. I will assume this equity will be issued at an average price of about $1.80 per share, or about 11.1m shares. They have indicated they expect to issue shares at no less than $2 per share for the final circa $30m after the full-year results are announced in 2015. If the earnings figures are anything like I’ve posited above, I can’t imagine they will have an issue with that sort of pricing, so that would be another 15m shares @ $2. This would mean they would have about 154.6m shares on issue for the FY16 year, with manageable debt of around $50m. If they earn the NPAT of $30m as I have set out above, this would amount to 19.4 cps of FY16 earnings. After delivering this, I would expect they will be able to at least trade at a multiple close to the broader market (given the quantum of earnings growth, they would justify an above market multiple, but conservative is better) of circa 14x. 14 times 19.4cps is a valuation of about $2.72 per share valuation based on my expectation of FY2016 results.
The foregoing could be a slightly rosy view of how things unfold, but the wonderful thing with Dicker is that they pay out 100% of earnings, so you will get well paid even if the performance is at the lower end of expectations.
I attended the AGM for Dicker a couple of weeks back and to hear management tell it, underperformance seems unlikely. The scope for extracting that most elusive of acquisition benefits (the synergy) seems enormous. You can tell by the fact the low-margin revenue foregone with the decision not to stock Apple products has virtually all been replaced in Q1 that some of the ‘cross-selling’ synergies are already being partially exploited. Furthermore, once the acquisition is properly bedded down, the ability to exploit an underserved New Zealand market in FY16 will ensure that scope for future organic growth has been created by the acquisitive growth.
I am very excited by the prospects of Dicker as the benefits of the acquisition start to become obvious to the market. I think the prospects of the business will be largely uncorrelated with the broader share-market performance over the next 18 months or 2 years as information trickles out about the earnings improvements the acquisition has engendered in the business.
I remain as always reluctant to pinpoint an intrinsic valuation at this point in time (for there are still execution risks ahead), but I can tell you I will be participating EGP’s shares in the DRP all the way into the early $2 range and depending on the level of new fund inflows we receive in the December investor intake, if prices stay well below $2, I will happily increase our stake to as much as 15% of the EGP share portfolio – Tony Hansen 28/11/2014
|
|
Apr 1st 2011 |
Jul 1st 2014 |
Current Price |
Current Period |
Since Inception |
|
EGP Fund No. 1 |
1.00000 |
1.56145 |
1.55538*1 |
(0.56%) |
69.37%*2 |
|
35632.05 |
45991.23 |
46187.80 |
0.43% |
29.62% |
EGP Fund No. 1 Pty Ltd. Down by 0.56%, trailing the benchmark by 0.99% since July 1st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 69.37%, leading the benchmark by 39.75% all-time (April 1st 2011).
*1 after 31May 2013 dividend of 2.333 cents per share plus 1.000 cent per share Franking Credit & 31 May 2014 Dividend of 7.000 cents per share plus 3.000 cent per share Franking Credit
*2 calculated based on dividends reinvested
