When you buy into a publicly traded company, the theory is that you are entitled to the discounted cash flows from the company after they meet their obligations. In reality, this is not always the case.
There are effectively two groups of people that you need to understand the incentives behind in order to see the difference between theory and reality. There is management and there is ownership. If they are one and the same, then you are fine because then management makes decisions as if they are owners. This happens for private companies owned by one individual. In the case of public companies, management sometimes loses sight of their fiduciary purpose: to increase common shareholder long term value.
In the most undervalued sector of public companies, which I'll simply call "The Phone Books," there are three companies that I've been following. They are SuperMedia, Dex One, and Yellow Media. Two of them have management that appears to be working in the best interest of their common shareholders and are fulfilling their fiduciary obligations. One of them has a management in place that is NOT making decisions as if they owned the company. I want to outline the things that I have learned from previous mistakes that will help you avoid overpaying in situations where management doesn't appear to care about you and how this affects your actual future discounted cash flows.
Let's see how their last reported quarters stack up to the one prior:
|Ticker||EBITDAAdjusted (%)Margin||Q2 ($EBITDA)M||Q1 ($EBITDA)M||/Q Q EBITDA (%)Decline||Q2 ($)MRev||Q1 ($)MRev||/Q QReve (%)Decline||Net ($)MDebt||Net / ( Q2 * EBITDA)4Debt||Debt toMarket ParRatio|
|SPMD||%41.3||$ 144||$ 148||-%2.70||$ 349||$ 363||-%3.86||$ ,1511||2.62||%56|
|DEXO||%42.2||$ 141||$ 150||-%5.74||$ 335||$ 344||-%2.87||$ ,2033||3.60||%60|
|YLO.to||%50.7||$ 145||$ 146||-%0.68||$ 286||$ 289||-%1.04||$ ,1426||2.46||%55|
SuperMedia - Extremely Undervalued With Excellent Management
I want to start with SuperMedia (SPMD). SuperMedia is presently constrained by the fact that 67.5% of their debt must be bought back at par. Frankly, this really isn't a constraint because once their debt gets low enough, the price of their debt will rise back to par value. The easiest way to prove that is to say, would their debt be trading at 100% of par if they only owed $200M? The answer is yes. The question is at what debt/ebitda ratio will this finally come to pass?
SuperMedia is doing an incredible job of enhancing shareholder value by creating instant shareholder returns through acquisitions of debt at sub-par prices. I've argued before, and I know that I feel comfortable saying that SuperMedia at some point in the next 3 years will be trading at an EBITDA valuation of around 4x. This implies that the valuation of SuperMedia is silly. This company is worth FAR more in the long run and is a gem for anyone like myself who likes to own the most undervalued companies in the world with excellent managements. At an EBITDA EV of 4x, the equity of SuperMedia is worth $793M, compared to a present $38M. That's 1900% return from here.
Dex One - Undervalued With The Best Management
Dex One (DEXO) is also closing out debt at a discount to par. Dex One, however, has proportionally more debt to EBITDA than SuperMedia but it also lacks the restrictive covenants that prevent SuperMedia from buying back more than 32.5% of their debt below par. At a 4x EBITDA multiple, again this multiple is worst case, the equity is worth $226M. Compare that to the present equity value of $60M and the upside here is 283%.
The thing about Dex One that differentiates it from these other two companies is, put simply:
- Management clearly articulates its vision going forward for Dex One.
- You have guidance with Dex One.
- Management breaks out Digital trends vs. Print trends.
Yellow Media - Undervalued With Terrible Management
I would categorize Yellow Media (YLWPF.PK) as a value trap. If you assume that management is working in your best interests, this is the most undervalued opportunity of the three. When you understand the reality of the situation and that the recapitalization plan is in all actuality "A plan to default on Yellow's equity obligations," you begin to question what value you saw here in the first place.
Yellow Media's Management has been doing the bare minimum to represent shareholders and finally has decided to throw in the cards and just screw them by presenting them an opportunity to give away 82.5% of the company even though the company is:
Current with all of its debt obligations.
Has the capacity to meet its debt obligations as they come due.
Crushing their own internal estimates and analyst estimates for both Revenue and Earnings. They beat analyst estimates by 59% on earnings in Q2.
When you have a recapitalization plan based on incredibly poor and outdated assumptions and management still supports it, that is a sign that you should question what management is thinking. Even more crazy is that their creditors are furious with this recapitalization plan because they weren't consulted!
The banks object to the restructuring, arguing that despite a challenging year ahead as debt comes due there is no need for it at the moment because the company is generating enough cash to pay its obligations as they come due.
The largest question that remains to be answered, why is the company purposely not mentioning that revenues and EBITDA only decreased 1% last quarter and instead is exaggerating the print decline by publishing YOY statistics when it appears that the rate of decline is slowing? I am referencing page 10 of 2012's Q2 MD&A.
I also want to reference Point 2 of Page 3 of the 2012 Q2 MD&A. Do these numbers look like they are coming from a company in distress?
This recapitalization effectively sets a precedent such that:
If you own a home, and you can pay your bills and are presently paying your bills and can pay all of your future bills as they come due:
Your debt holders now can take over ownership of your residence.
If you own this company, you should vote NO to the recapitalization. It is completely unfair to all stockholders. I don't understand why anyone of the Preferred C and D camp would vote YES when the outcome of voting NO is you collect a check by the end of the year for more than you can buy your shares today.
When you are hunting for extremely undervalued companies, sometimes they are undervalued for a reason. Sometimes that reason is that management is not making decisions like they own the company.
SuperMedia and Dex One both have incredibly good managements and are undervalued and I think that of the two, the most compelling value is with SuperMedia.
Yellow Media is managing the situation as if the people that own the company are the MTNs and your willingness to acquire or maintain a position in this company should be viewed from that perspective until proven otherwise. Long story short, arguing for a 4x EBITDA multiple for Yellow Media does not necessarily make sense when management doesn't appear to care who its shareholders are.
Disclosure: I am long SPMD, DEXO, YLWPF.PK.
Additional disclosure: I also represent 2.3M commons, 1.9M preferred, and $118M+ of convertible debentures for Yellow Media at the time of publication.