Step back and look at Fairfax Media

Recently, one of Under the Radar’s resident fund manager/columnists Andrew Brown delivered a lesson on why it’s important to step back and count the profits (and losses) in companies when you are making decisions on whether to buy, sell or hold.

It’s actually counterproductive to worry about whether your favourite stock is up or down a cent every five minutes, as you may be inclined to act on the move. Have some faith in your decisions and let the businesses do their thing.

It is interesting that this “step back” analysis of the media sector led Andrew to be lukewarm on recent outperformer Nine Entertainment (NEC) and positive on the prospects for Fairfax Media (FXJ).

CASE STUDY 1: NINE ENTERTAINMENT (NEC)

We recommended this stock in Under the Radar Report’s Issue 126 in February 2015 and since then its shares have returned 22%. In the past few months the owner of the Channel 9 network has made announcements including a share buy back and an asset sale – Nine Live (which was mainly Ticketek Australia). The company has also re-iterated its earnings guidance for FY15. What to do now?

For mine, you wouldn’t be buying Nine Entertainment at current levels, and in this market, it is always reasonable to take a profit.

CASE STUDY 2: FAIRFAX MEDIA (FXJ)

However, we see real value in the media sector in Fairfax.

Our primary reason is the market’s interest in its Domain property advertising business, which has been stoked in no small way by Fairfax’s management, who gave it a lot of attention in its investor relations. It is worth comparing this business to its closest competitor, www.realestate.com.au owner REA Group (REA).

REA trades on about 18 times current year EBITDA and 15 times some bullish forecasts of 2016. I put Domain on a discount 15 times its current year’s enterprise value to EBITDA multiple to reflect that it’s not the dominant player that REA is, and there needs to be an attraction for investors in any IPO. So based on this multiple and you can see that it is probably worth around $1.2bn in today’s market. Fairfax has a current value of equity $2.4bn and debt (basically nil) less investments (93m Macquarie Radio (MRN) shares) of around $2.3bn.

This suggests that Domain is at least half of Fairfax’s value. Subject to the tax impacts of selling all or part of “Domain”, the remaining Fairfax business should be valued at about $1.1bn and generate around $200m of declining EBITDA from its print media business.

On the “step-back” analysis, Fairfax shares are trading close to $1, which is roughly where they were a year ago. Over the past year, Fairfax has sold its radio assets to Macquarie Radio (MRN). The company now has a shareholding in Macquarie Radio of 93m shares at $1.20, which is worth about $120m. Plus it has sold another radio station to APN for about $78m.

So previously Fairfax had some illiquid assets in radio. Fast-forward to today and it has realised significant cash and a share holding in Macquarie Radio which could more easily be sold.

Secondly, Fairfax has been clearly articulating the earnings power of Domain and it has been developing this asset, which has been growing rapidly. It is clear the market will pay more for a $1 of earnings in Domain than it will for Fairfax’s core assets in newspapers.

The next key is whether Fairfax can sell part of Domain to the market via a spin off such as a share market float, or public listing (IPO). This begs the question whether you can sell anything in the current market at these full multiples. The answer to me is yes, because the market is looking for growth in a low-growth environment, and will put premium ratings on those growth companies.

This is particularly the case for growth companies, which are leveraged like Domain is to the SME market, which is what most real estate agencies are.

The recent float of MYOB (MYO) was a big success by any yardstick. This company is linked to the SME market, providing accounting software to thousands of small businesses. The company floated on the ASX earlier this month and now has an enterprise value of just over $2.5bn, which means it trades on an enterprise value to EBITDA multiple of close to 16 times, which is way above the industrial company average of about 10 to 12 times. Back when it was privatised in 2008 it was trading on an EBITDA multiple of below 7 times, so that is some uplift, which has made a lot of money for its vendor, US private equity giant Bain Capital.