Telecom Argentina S.A. (ADR) or TEO as their symbol, is one of Argentina’s leading telecommunication companies. As we are aware, wireless data consumption has increased due to the rapid adoption of Smartphones and tablets. With its increasing revenues year over year for the past five years and with its ample cash, the future seems bright with Telecom Argentina. The company has initiated a long position with its solid cash flows. Telecom Argentina is the principal subsidiary of Nortel Inversora S.A., a holding company that operates out of Buenos Aires, Argentina.
Telecom Argentina Value Investing Approach
This model is prepared in a very simple and easy way to value a company, it adopts the investment style of the Father of Value Investing Benjamin Graham. The essence is that any investment should be purchased at a discount, meaning the true value should be more than the market value. Graham believed in fundamental analysis and was looking for companies with a sound balance sheet and with little debt. The basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. We calculated first the enterprise value as our first step. We believed this is important because it measures the total value of the company.
Telecom Argentina Investment in Enterprise Value
The market capitalization of Telecom Argentina was trending at a rate of 28 percent average. The enterprise value was negative during 2012 and the trailing twelve months because its cash and cash equivalent were greater than the total debt at 2640 and 3052 percent, respectively. Its total debt was 46 percent average and its cash and cash equivalent was 187 percent of the enterprise value thus, enterprise value represents only 42 percent of the market value. Buying the entire business of Telecom Argentina is purchasing 100 percent of its equity.
The takeover price of the entire business of Telecom Argentina to date, June 9, 2013, would be -$738 at -$3.75 per share, meaning zero dollars because the cash and cash equivalent are greater than the total debt. TEO had solid cash and cash equivalent in which the company had initiated its position and strength. The market price to date was $15.89 per share.
Net Current Asset Value (NCAV) Approach
Benjamin Graham developed and tested the net current asset value (NCAV) approach between 1930 and 1932. Reported that the average return, over a 30-year period, on diversified portfolios of net current asset stocks was about 20 percent. To justify this, an outside study also showed that from 1970 to 1983, an investor could have earned an average return of 29.4 percent by purchasing stocks and holding them for one year.
The table above tells us that the stock price of Telecom Argentina was overvalued because the 66 percent ratio was greater than the market price from 2008 up to the trailing twelve months. The ratio represents only 1 percent of the market price. The results further indicate that the stock price was expensive because the stock was trading above the liquidation value of Telecom Argentina.
Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation
By calculating market capitalization over the net current asset value of the company, we can determine if the stocks are trading over or undervalued. The result should be less than 1.2 ratios.
Market Capitalization / NCAV = Result (must be lesser than 1.2)
The stock price of Telecom Argentina was overvalued because the ratios exceeded the 1.2 ratios for the period 2008 up to the trailing twelve months.
A formula to be used is the Margin of Safety = Enterprise Value – Intrinsic Value. The table below shows the TEO’s historical calculation for the margin of safety.
The result of the above calculations indicates that the average margin of safety was 98 percent average. The margin of safety was high during 2012 and the trailing twelve months due to the enterprise which is negative. The average enterprise value was $6.46 while the intrinsic value was $550 average. The formula for intrinsic value was as follows:
Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)
As seen in the table above, the intrinsic value factors the earnings per share and the growth of the company. The average earning per share as per the calculations above was $10.41 and the sustainable growth rate was 22.80 percent average while the average annual growth rate was 55 percent.
The term earnings per share (EPS) represent the portion of a company’s earnings, net of taxes and preferred stock dividends, that is allocated to each share of common stock. The figure can be calculated simply by dividing net income earned in a given reporting period by the total number of shares outstanding during the same term. The formula is:
Sustainable Growth Rate
While the sustainable growth rate (SGR) shows how fast a company can grow using internally generated assets without issuing additional debt or equity. In getting the sustainable growth rate for a company, you need to know how profitable the company is as measured by its return on equity (ROE). You also need to know what percentage of a company’s earnings per share is paid out in dividends, which is called the dividend payout ratio. From there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio. For the shorter version of the process above, here’s the formula:
Sustainable growth rate = ROE x (1 – dividend-payout ratio).
The return on equity was a 30.49 percent average, while the payout ratio was 24 percent average. TEO has zero payout ratios during 2008 and 2009 because the company did not pay cash dividends during those periods to its shareholders.
There are two ways of calculating the sustainable growth rate and that is by using the relative and the average approach. The calculations above were the results of the relative approach. But to see how the two approaches differ.
As shown above, the margin of safety using the average approach has the same results as by using the relative approach. For the growth, they have only a little difference.
I have prepared a graph for us to fully understand the relationship between a price and the true value of the stock.
As we can see in the graph, the intrinsic value line or the true value line drops at a rate of 20 percent, then up by 75 percent in 2011 and remain stable during 2012 and the trailing twelve months. Comparing the trend to the revenue of TEO, its revenue reached 92 percent during 2012 and the trailing twelve months. If we will get the average of MOS from 2008 to the trailing twelve months we will get 98 percent, this represents the space in between the two lines.
Telecom Argentina Relative Valuation Methods
The relative valuation methods for valuing a stock is to compare market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.
Price to Earnings/Earning Per Share (P/E*EPS)
This valuation will determine whether the stocks are undervalued or overvalued by multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS) and comparing it to the enterprise value per share, we can determine the status of the stock price.
The stock was trading at an undervalued price because the P/E*EPS ratio was higher than the enterprise value. The P/E*EPS was 1442 percent of the enterprise value.
The other method of calculating the P/E*EPS valuation is by using the average approach. The table below will show us the difference.
The calculation above shows that the price to earnings was higher in relative approach than by using the average approach. The average price to earnings was $8.53.
The Enterprise value (EV) /Earning per Share (EPS) or (EV/EPS)
The use of this ratio is, to separate price and earnings in the enterprise value. By dividing the enterprise value of projected earnings (EPS), the result represents the price (P/E) and the difference represents the earnings (EPS).
The EV/EPS valuation indicates that the price (P/E) that was separated from the enterprise value was 15 percent average. And the remaining 85 percent represents the earnings (EPS). This might indicate that the stock was trading at an undervalued price.
Enterprise Value (EV) / Earnings before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)
This metric is used in estimating business valuation. It compares the value of the company inclusive of debt to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries. It tells us how long it would take for the earnings pay off the price of buying.
The EV/EBITDA tells us that it will take 3 years to cover the cost of buying the entire business. In other words, it will take 3 times of the cash earnings of the company to recover the purchase price.
The enterprise value was negative during 2012 and the trailing twelve months. Due to its cash and cash equivalent were greater than the total debt. Its total debt was 46 percent average and its cash and cash equivalent was 187 percent of the enterprise value. Buying the entire business of Telecom Argentina is purchasing 100 percent of its equity.
The takeover price of the entire business to date, June 9, 2013, was -$738 at -$3.75 per share. Meaning zero dollars because the cash and cash equivalent are greater than the total debt. Telecom Argentina had solid cash and cash equivalent in which the company had initiated its position and strength. The market price to date was $15.89 per share.
MC/NCAV valuation shows that the stock was overvalued. For the reason the ratio exceeded the 1.2 ratios, the average margin of safety was 98 percent average. The average earning per share was $10.41. The SGR was 22.80 percent average. The average annual growth rate was 55 percent. In addition, the return on equity was 30.49 percent average. On the other hand, the payout ratio was 24 percent average.
Furthermore, the P/E*EPS valuation indicates that the stock price was undervalued. For the reason, the enterprise value was lesser than the P/E*EPS ratio. On the other hand, the EV/EPS valuation indicates that the stock is undervalued. Because the price represents 15 percent and the earnings were 85 percent.
The EV/EBITDA tells us that it will take 3 years to recover the cost of buying the entire business. In other words, it will take 3 times of the cash earnings of the company to recover the purchase price.
Overall, it indicates that the stock price of Telecom Argentina was undervalued. The return on equity was 30 percent and the payout ratio was 24 percent. In addition, the earning per share was $10.41 average. Moreover, the company has solid cash which initiated its position and strength. Therefore, I recommend a BUY on the stock of Telecom Argentina S.A. (ADR).
Research and Written by Criselda