Monday, December 04, 2006

Are we on the same (Yellow) Page?

Yellow Pages (Singapore) Ltd (SIN:Y07) (YPG SP) is the market leader in providing telephone directories and classified directory advertising in Singapore. Recently, its share price dropped like a rock following a set of poor 2Q07 results. However, at this price, Margin of Safety sees real value emerging.

Let's being with a broad review of its financials. As one would expect, the industry that Yellow Pages operate in isn't the most exciting or glamourous. This is reflected by its falling revenue since FY1998. Its recent 2Q07 numbers paint a similarly troubled picture. Compared to the previous financial year, its revenue slipped nearly 8% and net profit dropped by 17%. The lower revenue was attributed to a delay in the production of directories which led to lower distribution. Its net profit took a hit because operating expenses increased by 5% due to higher wage cost, higher provision for doubtful debts and higher training cost for sales force. However, issues such as the distribution delay are considered one-off troubles which we expect Yellow Pages to be able to turn the page on.

The ace in the hand could be the company's internet platform - Internet Yellow Pages (IYP). Currently, IYP contributes only about 4% of revenue. But with its recent initiatives to beef up its hardware and software in order to enhance its search capabilities, IYP's future contribution is likely to increase. The IYP is essentially a search engine that seeks to carve out a niche in local content. It also seeks to feature more local small and medium size enterprises. Given that this business model pits IYP head on with the search engines titans of the world such as Google and Yahoo, it is difficult to put a finger down on its potential impact on Yellow Pages' bottomline. Hence, we chose to ignore IYP in our valuation.

Yellow Pages has a 100% dividend payout policy. In FY06, it paid out S$0.085. Due to reduced profitability, its payout this year is likely to be cut to S$0.075. Given its clear dividend payout policy, the dividend discount model (DDM) will be a natural candidate to apply to this company. The following assumptions were made:

  • Dividend per share will fall by 2.5% over the next ten years;
  • A terminal growth rate in dividend of 0% was used; and
  • A discount rate of 5%.
The discount rate is justifable given the stable perating characteristic of the company. DDM gives a fair value of S$1.26.

A cross check was done using the discounted cash flow methodology. Its core business generates copious amounts of free cash flow annually. Yellow Pages current free cash flow yield is about 9%. Its cash flow per share would have been higher if not for it being masked by relatively high non cash depreciation charges. This second valuation method returns a fair value of S$1.65 using similar assumptions.

We consider the current market price of S$1.12 to be very attractive as it provides a discount ranging from 11 - 32% from its intrinsic value. We also consider the 7% yield to be attractive given the possibility of a Fed Funds rate cut in the horizon.

As it is lonely to fight against the herd, it is comforting to know that we are on the same page as a superinvestor. In early November, Third Avenue Management LLC popped up as a substantial shareholder of Yellow Pages. The Third Avenue Global Value (Master) Fund L.P. is 5.21% of the company.



Anonymous Anonymous said...

Hi Mr Market, I couldnt get how you get 1.26 for this. using those figures i came up with something close to 60 cents rather than that. would you mind showing me how you do that?

6:05 PM  
Anonymous Anonymous said...

Its an application of the Gordon model albeit a multistage variant.

For a ballpark feel, let's assume that YP were to (a) pay its reduced dividend amount for year 10 next year, and (b) pay the amount in (a) forever. In this simplified case, one would arrive at a value of $1.16.

11:19 PM  

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