Friday, February 1, 2019

How Do You Value A Company With Negative Terminal Growth Rate (APTT Case Study)

Most valuations' case study tends to focus on companies that are exhibiting positive growth rate in their earnings or cashflow over the next 5 years.

They project the running cashflow rate by forecasting them over the next five years then discount them to the present value using a predetermined wacc rate.

The alternative is to use the Gordon Growth Model to identify the company's terminal growth rate then have them discounted back over the present value using the same method.

The terminal value of a company is a rough approximation of its future value at some date beyond which specific cash flows cannot be estimated.

Example of a Gordon Growth Model using Terminal Growth Rate
If you are a sell-side analyst working in a large corporation, it makes sense that you want to be covering stories that exhibits a potential strong turnaround or earnings growth as these exciting stories will entice investors to come and put their money in it.

If you are an investor, it usually also make sense wanting to put your money in companies that are exhibiting some sort of growth potential in their business. After all, the idea of all these investment is to ultimately grow your wealth so most people would look at a strong companies to get stronger over time.

Again, there is no conceptual reason to believe why terminal growth rate can be negative in the long run. It's akin to cancer cells that are spreading and the only real value at the end of the day is its liquidity value.

While there are enough reasons to justify a negative earnings short term, which likely is due to competition because of new entries, regulation changes or life cyclical nature of the industry itself, a longer negative terminal rate indicates that they will become obsolete over time, most likely due to the ever changing landscape and the world we live in today because of new technological disruptions.

As investors, what matters at the end of the day is how much returns you are able to get out from your investment.

APTT Case Study

APTT is a good case study because of what had happened since the past few years.

In fact, this is a company which I managed to take advantage of last year before the clear impending cut of their unsustainable payout.

Their businesses are clearly in a sunset downturn with high capex maintenance and reinvestment required to maintain their TV cable network and providers. In this new age of Netflix and other online media streams, it will be very difficult to maintain both subscribers and the ARPU rate.

To attract more subscribers, they may have to reduce the ARPU since there are plenty of sunk costs invested and this becomes a vicious cycle over time.

Their broadband business is so far the saving grace for them but they would have to spend approximately $17m a year in capex just to maintain them.

Overall, they had to spend around $65m in capex which was unsustainable in the past because of poor net free cash flow after paying out dividends but one which is arguably sustainable with higher net free cash flow in the future.



With the sustainability question now answered, the question then remains if the business will go obsolete in the next 11 years.

If the answer is not, then this might be an opportunity for an investor, of course depending on valuations too.

The reason why I chose 11 years is because at 1.2 cents dividends and current share price hovering at 13 cents, it gives a dividend yield to investors of about 9.2%, which translates to about 8 years break-even if we use the rule of 72 compounding.

$65m capex which translates to a $188m ebitda for full year with about $90m of free cash flow generated each year means they are generating a very damn high fcf yield and internal return. The only downside from here is the terminal growth can quickly go negative much quicker than we expect and suddenly things will not look so rosy. An 14% xirr means that the terminal growth needs to go down higher than that in order for the company to go bust faster than it can return to investors.

While it is clear that the company's terminal growth rate is likely to go negative from here, their high yield and sustainability of the payout ensures that they can kick this down the road for longer time. If any case, it is likely that the business might just survive the 8 years break-even point and there's liquidation value out of it should they decide to just keep their $14m to $17m maintenance capex and not do anything else thereafter.

I am keeping this in my watchlist and I think this stock has the potential to return decently over the next few years given how they have dropped so much since the last time they cut the dividends, though the upside is likely to be capped due to the impending negative terminal growth rate.

Management has also not a good track record from the days of the spin-off from MIIF.

Thanks for reading.

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3 comments:

  1. Hi Brian, thanks for the write up on APTT...appreciate. How I wish I have some of your sharp investment acumen....saw that you can even make money out of APTT when its price plumment and build up such impressive portfolio size.

    I used to hold this from the MIIF days. But unfortunately, the financial results keep dropping albeit management keep coming out every quarter to say signs of stabilising soon. While the current cable TV will decline over time due to OTT and rampant piracy issues, think cable TV will still have demand and a place and will not be obsolete totally.

    Just like the 5G rollout, it will actually directly impact earnings from 5G packages on offer by telcoms for internet but at the same time, 5G base stations connection by telcoms using APTT existing infrastructure will offset it...just that not sure net impact of which will be more. This makes valuation very difficult.

    With regard to your last point on the management track record, personally, I think that APTT should start looking for new folks to join their Board of Directors to challenge and change the status quos as well as to look for other business ideas.

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  2. Hi Blade Knight

    Many thanks for your kind comment.

    I've actually read up your piece on APTT and it's very well written thoughts, and I have shared it too with my friends who are interested to learn more about the company.

    I agree, it won't go obsolete that fast. In fact, I think they'll do up a bundle the way Starhub and Singtel are doing with their bundle package for their paytv along with the broadband. I wonder if APTT will go the same route on this though as it will require a much higher capex than what they are paying today but with a much better sustainable retention of customers.

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