Thank you for writing on Neustar. As an investor who has been following the company for some time, I thought you demonstrated a good deal of knowledge on the situation. However, I'd question a few of the arguments made in the article.
Although I question some of the points, I appreciate you sharing your thoughts, and I contribute my own in the spirit of a thoughtful discussion.
Points in Question:
"Management has proven to be a savvy capital allocator repurchasing nearly a third of the shares over the last five years"
I'm not sure a management team deserves the label "savvy capital allocator" when they repurchase nearly $800mm worth of stock since 2010 at an average price of $37 when the stock currently trades at $29. They would have proved to be much, much savvier capital allocators had they instead simply invested that $800mm in an S&P 500 Index Fund.
"It is hard to believe that shaving a few extra bps, while jeopardizing service, quality, efficiency and reliability, is the main objective of telcos' management team"
The discussion of NPAC costs is simply no longer relevant. Yes, NPAC costs comprise a small share of overall carrier costs. Yes, this might theoretically give carriers pause about the risk/reward tradeoff of switching. But carriers have already made their decision, as noted at the 3/27 NANC meeting-a decision that Neustar clearly believes is unfavorable. So that horse has left the barn.
How do we know that Neustar is displeased? The company, which once promoted the NAPM as having "exactly the right incentives to insure the best value" (10/18/2012 FCC letter), suddenly began changing their tone in January 2014. They now state that the "the NAPM's refusal to solicit additional proposals is unjustified and contrary to the public interest" (3/7/2014 FCC letter) and, "in hindsight" the NAPM was an inappropriate body to administer the RFP in the first place (FCC letters on Feb 12, Feb 25, and Mar 20). Neustar is now asking the FCC to intervene and force NAPM to amend the RFP, effectively throwing out the last 18 months of the bidding process that the FCC itself instituted to promote competition (way back in 2010).
Isn't "the bad news already priced in?"
Let's use your figures and take a slightly different angle on valuation. Since one of our value-investing heroes, Charlie Munger, has great disdain for "EBITDA", suggesting that anytime we see it we should instead insert "bulls**t". Let's make it more palatable for him and use EBITDA less capex when comparing Neustar to Verisign.
You assume that Neustar's non-NPAC 2013 Adjusted EBITDA figure is $110mm. Total capex for Neustar is about $50mm. If we assign half of that to NPAC, that leaves $25mm for the non-NPAC businesses. The result is $85mm of 2013 Adjusted EBITDA minus capex. If we grow this at your assumed 12% annual rate, then these assets will generate $95mm of expected EBITDA minus capex in 2014. Verisign is trading at 10.8x 2014e EBITDA minus capex. If we are a bit more aggressive then you and award the full 10.8 multiple to Neustar, then the value of these assets is $1,030mm.
Again, using your numbers, the NPAC business generates $284mm of EBITDA. When we subtract the $25mm of capex and tax effect this by 35%, the resultant free cash flow is almost $170mm. Let's give Neustar 2 more full years of this, so that's worth $340mm. (Yes, we're not growing it per their NPAC price escalators, but neither are we discounting the future cash flows and we're giving them a full 24 months of cash flows instead of the remaining contracted 18 months.)
So, we have non-NPAC assets worth $1,030 and the NPAC worth $340mm against net debt of $385mm. With 61mm (basic) shares outstanding, that suggests the equity is worth $16 per share. That's 45% below the current stock price of $29, so I'm not sure that the stock really prices in the loss of the NPAC contract. Alternatively, what does $29 per share imply on the value of those non-NPAC assets? 19x EBITDA minus capex, which would represent a 75% premium to Verisign.
One other approach to valuation….
Let's assume for simplicity that the after-tax free cash flow of the NPAC business ($340mm per above) balances off the net debt ($385mm) and what remains is the non-NPAC businesses. Again, let's use your $110mm of EBITDA and $25mm of capex. That translates into pre-tax earnings of $85mm or per share earnings after tax (35% rate) of $55mm. On 61mm shares outstanding, that's $0.90 of per share earnings. Again, I'm not sure that I'd go so far as to say that with the stock trading at $29 (or 32x this earnings figure) that a NPAC contract loss has been baked into the stock price.