In a rare move, Australian-based equity analysts have admitted they made a mistake. Their cock up? Underestimating the gold mine known on this side of the Tasman as Trade Me.
Morgan Stanley's Andrew McLeod and Mark Goodridge admit in a research note entitled Trade Me … Why It Should Be Viewed as One of the Leading Internet Businesses in New Zealand/Australia that when newspaper publisher Fairfax, then led by ex-All Blacks captain David Kirk, bought the Sam Morgan founded online auction and classified business for A$670 million (NZ$720 million) in March 2006, they were critical.
They argued Fairfax had overpaid and used too much debt to help fund the deal.
"As we now approach the acquisition’s five-year anniversary, with our original expectations exceeded and strong growth set to continue, the acquisition is looking more and more astute," McLeod and Goodridge say.
"With hindsight, one aspect we underestimated was Trade Me’s ability to successfully expand and build leading positions in new categories such as online Real Estate and online Jobs. Trade Me deserves at least the same valuation multiple as its Australian peers."
"In fact, we argue there are grounds for a premium. Justified by Trade Me having a more dominant position in the overall NZ Internet market (70% of total NZ Internet traffic), a core online auction business that is absolutely dominant (95% share), plus the no. 1 market share in NZ online Auto, no. 1 in NZ online Real Estate and a close no. 2 in NZ online Job Ads."
McLeod and Goodridge note Fairfax has revealed in an investor update that Trade Me generated earnings before interest and tax (ebit) of NZ$88 million in the 2010 financial year, and they forecast an increase to NZ$102 million for the 2011 financial year.
"Thus, based on the 2006 acquisition price of NZ$720 million, after delivering a better-than-expected five-year ebit compound annual growth rate of 35%, the enterprise value/ebit multiple has reduced from 15.8x to only 7.1x."
Based on peer multiples of 15x enterprise value (the businesses' equity plus debt) to earnings before interest, tax, depreciation and amortisation (ebitda), or a price to earnings (p/e) ratio of 21x, Morgan Stanley values Trade Me today at between A$1.1 billion to A$1.3 billion. Fairfax Media's entire market value is around NZ$3.3 billion at current share prices.
"Interestingly, this implies the rest of Fairfax is trading on P/E of only 6-7x versus newspaper peers APN News & Media on 11x and West Australian Newspapers on 13x."