Saturday, March 11, 2006

Brian Gaynor: Let's hear it for the Trade Me genius

Sam Morgan of Trade Me is a genius, he should be appointed to the board of Contact Energy and every other New Zealand company that is vulnerable to a takeover from Australian or other offshore interests.

Morgan is the first controlling shareholder of a $500 million-plus company to obtain a full value since Peter Masfen sold Montana Wines nearly five years ago.

And $700 million is a great price when you considered that Capital Properties, which has an extensive property portfolio in Wellington, is going to the AMP for $358 million, Ports of Auckland was sold for $848 million and the NZX, which has been around for nearly 150 years, has a market value of just over $100 million.

Morgan started Trade Me in August 1999 with capital of 150,000 $1 shares. Subsequently, 44,730 new shares were issued and these $1 shares are worth $3595 each under the Fairfax offer.

Morgan, the largest of the 12 shareholders, will receive $227 million while the smallest investor will realise $6.5 million.

If Morgan invests his proceeds in 90-day bank bills, he will receive interest of $46,800 a day at present interest rates. Not bad for a 30-year-old less than seven years after he started the internet auction company.

One of the more fascinating aspects of the transaction has been the widespread comment in New Zealand financial and media circles that Fairfax may have paid too much.

Why should we be concerned that Fairfax may have paid too much for Trade Me? Were the Australians worried that Telecom might have overpaid for AAPT or The Warehouse was too optimistic when it bought Clint's Crazy Bargains and Silly Solly's?

Purchasers always face risks when they pay a full price for acquisitions. Northern Hemisphere academic studies show that a large percentage of acquisitions do not succeed because over-confident managers pay too much and they don't achieve the synergies they anticipated.

That is what should happen. Why should existing shareholders eliminate a purchaser's risk by selling at less than maximum value?

Unfortunately we are used to selling assets at low prices and virtually eliminating the acquirer's risk. Thus we are surprised when an offeror takes a big risk and pays maximum price for one of our companies.

We first started selling assets cheaply in the late 1980s through the Government asset sale process.

Postbank was sold to the ANZ Bank for $665 million in a tender process, and the second-highest bidder was Sir Michael Fay and David Richwhite at a third of that price. The two New Zealanders were convinced their bid would be successful because the perception of value in New Zealand was that $200 million-plus was fair.

Postbank proved to be an excellent purchase for ANZ Bank.

Telecom was sold for $4.25 billion in 1990 and, seven years later, it was worth more than $15 billion.

In 1992, the Bank of New Zealand was sold to National Australia Bank for $1.5 billion and is now worth an estimated $8 billion.

Tranz Rail was sold for $328 million in 1993 and the price was so low that the purchasers made a complete mess of the company and still walked away with vast profits.

Subsequently, we have sold a large number of companies in the media, forestry, energy, food and beverage sectors. Most of these sales were at such low prices that the acquirers carried minimal risk and made huge profits from their investments.

The 2003 sale of Independent Newspapers' publishing assets, which included The Dominion Post, The Press (Christchurch), Sunday Star-Times and Sunday News, to Fairfax is another example of a low-priced sale.

The sale price of $1.188 billion was largely based on an ebitda (earnings before interest, tax, depreciation and amortisation) forecast of $137.1 million for the June 2004 year, whereas the outcome was $165.5 million or 20.7 per cent above forecast (the June 2005 year ebitda soared to $190.9 million).

But the important point is that the sale price was based on a forecast ebitda multiple of 8.7, whereas earlier transactions in New Zealand had gone through at an average forecast ebitda multiple of 10.5 and Australian, United Kingdom/Irish and North American newspaper acquisitions at average forecast multiples of 11.4, 12.6 and 11.2 respectively.

The average forecast ebitda multiple for listed Australian newspaper stocks, excluding any premium for control, was 9.9.

Why do we sell our assets at much lower multiples than overseas when many of our companies face little competition and have the potential to achieve very high operating margins? (In the June 2002 year, Fairfax's Australian publishing operations had an ebitda margin of 22.2 per cent and INL 21.9 per cent. In 2005, the Australian publishing activities had an ebitda margin of 25.1 per cent and New Zealand 33.6 per cent.)

Grant Samuel, the independent expert, concluded that the $1.188 billion offer for INL's publishing assets was "fair" although it didn't define what it meant by "fair". It noted that the proposed transaction was not the result of a competitive tender process, and it was difficult to conclude that the Fairfax offer represented the maximum price achievable.

Surely the objective of every director and shareholder is to achieve the maximum price, and if the independent expert states it cannot be sure that the offer represents maximum value then the bid should be rejected?

Maybe one of the reasons that Fairfax is paying a full price for Trade Me is because it bought INL's publishing assets so cheaply.

Other reasons include the high ebitda margins achieved by internet companies and the huge ebitda multiples they trade on. If chief executive David Kirk can convince investors that Fairfax is more of an internet organisation, then it will trade on a much higher ebitda multiple.

Internet companies achieve much higher ebitda margins. The ebitda margin of eBay is 43.1 per cent, Google 37.8 per cent and Yahoo 40.7 per cent.

By comparison Gannett, publisher of USA Today, has an ebitda of 30.6 per cent, the New York Times 16.6 per cent and Time Warner 17.1 per cent.

As the accompanying table shows, old media companies trade on much lower ebitda multiples than internet stocks. This is the reason why it is much more rewarding to establish a successful internet company than a big-selling magazine or newspaper.

But the long-established Dominion Post, Sydney Morning Herald (Fairfax), New Zealand Herald (APN) and New York Times are predictable and stable, whereas the internet is far more competitive and risky.

Time Warner merged with the internet giant American Online (AOL) in 2001 and this is still the world's biggest corporate deal.

The merger has been an abysmal failure, with the group reporting a loss of US$99 billion ($153.4 billion) in 2002, mainly due to the write-down of goodwill associated with the merger.

Kirk is taking a big risk and he won't want to repeat the Time Warner/AOL experience.

We should applaud Kirk's ambitious goals and willingness to pay top dollar to achieve his objectives.

But more importantly, we should congratulate Morgan for finally convincing the Australians to pay full value for one of our companies.

Although Trade Me is being sold on a lower forecast ebitda multiple than eBay, Google or Yahoo, these three companies have worldwide operations, whereas Morgan's will remain New Zealand-focused. In this regard, Trade Me is more similar to the old media companies than the three US-based internet giants.

Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Management.

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