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The Scepticist
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How it all started: Like most of you I lost a large chunk of my savings in the financial crisis of 2008-2009. During that period I was working hard to get my master degree in Biomolecular sciences. As most people I watched a lot of messages pass by on the news about the stock market and how deep... More
  • DNXCorp: Porn Has Never Been So Cheap

    1. Introduction

    In my first year as an investor I found it very appealing to invest in the basic needs of human pleasure. More specifically I'm talking about sex, drugs and gambling. In my reasoning these needs will stick. After all, they have been there for centuries! Another reason why I find these markets very appealing is the willingness to pay, meaning consumers don't spare expenses when it comes to getting excitement in their lives. This translates off course in high margins. It is relatively easily to find publicly traded stocks operating in the last two markets (drugs and gambling), e.g. alcoholic beverage companies, casino's or online betting companies. In contrast I haven't found a good company to invest in the market for sexual pleasures. Until today... Now let me introduce you to DNXCorp, a company that operates in the market of adult content.

    2. Profile

    DNXCorp is a French company created in 1999. The company is a rare pure internet player that has three main activities:

    1. Adult VOD (Video On Demand: live sex cam chatting) (86,2% of revenue)
    2. E-commerce of erotic products (sex toys, lingerie, ...) (10,8% of revenue)
    3. Web payment services & web services (3,1% of revenue)

    The company established a qualitative sober image and clearly distinguishes from shady porn sites. This strategy has successfully attracted costumers as well as partners. In fact it is an European leader in the first two activities. If you want more feeling with their "product" visit these sites to get a feel (just make sure your wife doesn't catch you).

    1. www.sexyavenue.com/ (e-commerce of erotic products)
    2. wekiss.com/ (dating site)
    3. www.edenflirt.com (erotic flirting dates)
    4. xcams.be/ (VOD services)

    3. Recent developments

    The company has grown steadily in the period 2003-2007. In 2008 the company showed explosive growth driven by the launch of its dating sites and erotic flirting dates. Since then top line results have been declining. This decline is driven by new competitors with aggressive marketing, the increasing number of sites with free content and the low entrance barriers for new players (low investments required).

    (click to enlarge)

    (Chiffre d'affaires = revenue); (Résultat opérationnel courant = EBIT); (Résultat net = net result)

    Yet, the company profits from its first mover advantage through its loyal clientele and established name. In order to oppose its declining established businesses the company continuously looks for new opportunities to diversify its activities. A recent example is the development of its web payment services. The group still has plenty of opportunities to diversify activities, e.g. mobile site/apps development and internet games market (company is in development phase). It can also extend its network in Europe (geographical expansion).

    4. Comparative analysis (key ratio's)

    I compared the company's financial ratio's with two other web companies. Meetic is a French company owning a dating site. Note that there is a takeover bid running from Match.Com. Rentabiliweb is a Belgium company specialized in web based payment services.

     

    DNXCorp

    Meetic SA

    (BEFORE BID)

    Meetic SA (AFTER BID)

    Rentabiliweb

    Share price

    18,35

    12,35

    18,66

    5,00

    Market cap (M€)

    52,01

    287,87

    434,49

    85,85

    Net CASH per share (€)

    4,93

    2,72

    2,72

    0,41

    Net cash / market cap

    26,88%

    22,02%

    14,58%

    8,20%

    P/E (2013)

    9,63

    49,74

    74,18

    14,1

    EV/EBITDA

    3,51

    6,02

    9,51

    12,6

    DIV. YIELD(%)

    9,51%

    12,19%

    8,07%

    3,00%

    Comparing P/E ratio's or price/book ratio's does not make sense in this sector because web based companies have inconsistent amortization (messes up your P/E) and a lot of intangibles (messes up book value). The best ratio for a peer analysis is the EV/EBITDA-ratio. This ratio is significantly lower for DNXCorp. Meetic's EV/EBITDA was closest, but then got pumped to 9,5x after a bid from Match.com. Based on the EV/EBITDA ratio, DNXCorp has an upward potential of 70% to get a ratio of 6,0.

    5. Discounted cash flow valuation

    I have build a conservative DCF of DNXCorp. In this valuation I assumed an annual decline of the company's EBIT (and revenue) of 4%. The company's declining profitability is expected to the aggressive competition of sites with free adult content (especially the VOD business). This is off course a pessimistic scenario.

    1. The VOD business is declining but does have a core of loyal clients
    2. Prices (and margins) in the VOD business are probably stabilizing in the next years after taking severe hits
    3. The Web payment services are accelerating in a strong pace (+57% revenue in the first year half) and could offset the company's decline in adult entertainment.
    4. It's internet games development activity is in full development
    5. Q1 and Q2 (2013) already show signs of stabilizing margins and revenue

    In summary, I left all potential for growth out of my valuation and assumed for the worst.

    I used a discount rate of 8,5%, reflecting the cost of equity and cost of capital (the company is debt free). This is composed of:

    1. a risk free rate of 2,5%
    2. a market risk premium of 6% (for a beta of 1.0)

    Note that the company's beta is only -0,13, reflecting the low volatility and risk profile of the business. Normally the market premium should be multiplied by the beta, lowering the discount rate to 3,28% (= 2,25% + 6% *0,13). The 8,5% discount rate is justified, considering it's a small cap with low liquidity (and I also tend to be very conservative in my evaluations).

    Assumptions:

    1. Revenue (X+1) = Revenue (X) * 0,98
    2. EBITDA (X+1) = EBITDA (X) * 0,96
    3. Tax rate = 33,33% * EBIT
    4. CAPEX = 800 k € yearly
    5. Amortizations & provisions = 1,1% of revenue
    6. Terminal value = 6,0 x EBITDA (2022)

    (click to enlarge)

    Market Cap

    € 52.01 M

    Value (DCF)

    € 62.739 M

    Safety Margin

    20,63%

    Shares Outstanding

    2.83 M

    Price Target

    € 22,17

    6. Tax advantage estimation

    One more driver for value... The company has a running project to transfer its business to Luxembourg. This would have an impact on the company taxes paid (33,33 % in France vs 20 % in Luxembourg). Because web services are virtual and therefore geographical location of its activities can be manipulated easily for fiscal advantage, it enables the company to alter its tax structure. In order to estimate the additional value to shareholders, I used the same EBIT-assumptions and multiplied them by 13,33% (difference in tax rate of France and Luxembourg).

    (click to enlarge)

    Market cap€ 52.01 M
    Value€ 6.22 M
    Shares Outstanding2.830 M
    Value per share€ 2,20
    Safety margin32,19%
    Price Target€ 24,29

    7. Conclusion

    The share is heavily undervalued on a comparative basis. The value was also assessed using a (conservative) DCF. The DCF concluded that the share is at least worth 22 €. The current project to transfer its capital to Luxembourg could increase value to 24 € per share. Therefore the upward potential is between 20% to 30%. This target is based on a declining business. Most likely revenue and margins will stabilize in existing markets, but the company will have to proof this during next quarters. On top the company is also developing new growth markets, which will also be contributing in the future. In the mean while, enjoy a dividend yield of approximately 10%.

    Nov 01 10:21 AM | Link | Comment!
  • Burelle SA, Most Hidden Gem On French Equity Market

    Profile and ownership structure

    Burelle SA is a French family holding company with three subsidiaries:

    1. Plastic Omnium (Ownership: 56 %)
    2. Burelle Participations (Ownership: 100 %)
    3. Sofiparc (Ownership: 100 %)

    Burelle family owns 77,85 % of outstanding shares. Surprisingly there is also one fund that holds 4,29 % of shares.

    Summary of subsidiaries:

    Plastic Omnium (POM.PA) is an industrial group active with two large divisions: Automotive division (90% of sales in 2012) and Environment division (10% of sales in 2012). The automotive division is active in fabricating structural body parts for cars (such as bumpers) and fuel systems. The environment division sells products and services for waste management and urban installations. At first sight this company lacks sexiness, but it contains all ingredients for superior investment quality. You can find the ticker here. In summary:

    1. World leader in most of their activities
    2. Technological innovation (R&D costs are 5% of sales)
    3. Playing the green card: strong focus on CO2 reduction
    4. Clean balance sheet (low debt position)
    5. Balanced client portfolio in automotive division
    6. Strong record of FCF generation (three years in a row)
    7. High exposure to emerging markets
    8. Company's automotive sales growth outperformed worldwide growth (16,7 % vs. 6,6 %)
    9. Self financed growth
    10. High return on equity (22%) supporting growth
    11. Management with a long history in the industry
    12. Company with a clean track record of profit making (2008: only year with reported losses over an existence of more than 60 years)
    13. Family held business (Burelle family)

    Sofiparc (private) is a real estate company. It owns land in Lyon and Saint-Priest and is leased to several respectable companies (such as McDonalds, Novotel and Ibis). Secondly it owns a large office building in the region of Paris that is mainly rented to Plastic Omnium.

    Burelle participations (private) invests in French companies trough equity funding, mezzanine funding and investment funds. Its goal is to generate returns in a mid-term investment horizon and to spread risk trough a large spectrum of businesses and sectors.

    Weight of subsidiaries

    Burelle SA can be approximated as an unlevered mono holding of Plastic Omnium. The other two subsidiaries have a relatively small weight in the portfolio. Burelle SA has a little more financial dept on its balance sheet then Plastic Omnium. This additional debt is related to its real estate activities (Sofiparc).

    Valuation:

    Purchasing Burelle SA stocks is purchasing Plastic Omnium stock with a considerable discount. A brief summary (based on financial report 2011 and Bloomberg) is displayed below. It can be concluded Burelle SA is cheaper on every valuation ratio. Plastic Omnium itself isn't expensive either.

     

    Plastic Omnium

    Burelle SA

    Current stock price (25/01/13)

    28.38 €

    235.00 €

    Price / Earnings

    7,69

    3,69

    Enterprise value / EBITDA

    6,93

    5,70

    Price / book

    1,88

    0,87

    Enterprise value (M €)

    2052,59

    1683,88

    EBITDA (M €)

    296,40

    295,43

    Intrinsic value of Burelle SA can be approximatly calculated as follows:

    Intrinsic Value = 15,63 * Stock price of Plastic omnium

    For every share of Burelle SA there are 15,63 shares of Plastic Omnium present in the holding. Approximation: Burelle SA is an unlevered mono holding of Plastic Omnium. Calculation above thus neglects the value of the two other subsidiaries. At current stock price of Plastic Omnium one share of Burelle has an intrinsic value of 443,47 €. This comes down to a discount of 47 %.

    Discount relative to Plastic Omnium is at its 3 years high

    One reason to believe Burelle SA share will outperform Plastic Omnium is the incredible discount in respect to its intrinsic value. I calculated discount by using the above formula and adjusting for variation in the number of Plastic Omnium stocks held:

    As you can see discount has been trending up since the bottom of 2009. Discount has been growing because Plastic Omnium 's share price rose much faster than Burelle SA's share price:

    (click to enlarge)

    Why discount is peaking now

    In my perspective there are several possible reasons why Burelle SA is discounted relative to Plastic Omnium:

    1. Holdings are always traded with a discount because of additional operational costs of a holding
    2. All communication is in French, making it inaccessible for foreign investors
    3. Slow down in West European car market puts psychological pressure on this stock
    4. A seemingly random portfolio of businesses making it a less transparent investment
    5. Burelle family seemingly doesn't care about stock price
    6. Average trading volumes are low due to lack in free float
    7. High nominal stock price
    8. Low dividend yield

    There is an obvious reason why discount is growing. That reason is the psychological effect on French investors: Western European car sales are slowing down. French population sees its home land car manufacturers (Renault and Peugot SA) swim in difficult water. This results in slicing down the number of jobs in France and social agitations. Production moving away is a common Western European trend, cfr. Belgium and Germany. All this leads to a bearish sentiment of French investors on anything related to cars. And as stated above, all communication is in French. If not for French investors, who is left to buy Burelle SA?

    Well hidden synergies between subsidiaries

    1. Sofiparc rents office space to Plastic Omnium, providing a stable income for Sofiparc.

    Sofiparc's stable income is sufficient to fully cover operational costs of the holding.

    1. Placing real estate in separate entities increases tax deductibility: restoration costs are not deductible unless real estate and enterprise are brought in separate entities.
    2. Plastic Omnium and Burelle SA split management expenses

    What could fire up stock price

    There are some hypothetical scenario's that could trigger a price increase. There is no reason to suspect the company will make such a move in the near future.

    1. Free float increases: CEO has sold a large chunk of shares in past twelve months. He could sell more as he's getting closer to retirement.
    2. Company does a stock split, causing liquidity to increase
    3. Burelle SA gets an upgrade to a larger equity market
    4. Communication to shareholders continues in English
    5. Burelle SA uses cash from dividends to buy its remaining shares off the market

    Conclusion

    A European growth stock with a p/e lower than 4 is quite unique. I've seen fraudulent Chinese micro-caps trade at less attractive multiples at this time. The company has an excellent outlook for the next four years and an outstanding history of profitability. Stock is priced brutally cheap as market clearly fails to valuate this stock properly. The purpose of being listed remains a great mystery to me. A once in a life time for investors seeking value.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Feb 14 4:57 PM | Link | 3 Comments
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