Wednesday, July 15, 2009

TTS - dodgy analysis

A short mea culpa before I go on. I bought TTS (13July09) on the back of some dated analysis and a, potentially, good looking chart. After running through the numbers I don’t think TTS is great value above $2.60. Still like the management. Just the broad numbers don’t suggest terrific upside from there without a meaningful win on some of the bids they are likely to lodge. Anyways, its all grist to the mill…on with where I have got to.

I subscribe to the theory – if the value isn’t obvious, or at least readily understood, then it’s probably missing. This is particularly true of financial models. I have been guilty of trying to build the million-variable model in my youth. No more.

So to a quick summary of my views on TTS. I’m going to simply extrapolate the Dec 08 half yearly result. I know there is some seasonality in their business – but for these purposes a straight line from the latest numbers will suffice.

My current take on TTS splits the overall business in two – 1) there are the steady state operations (Tatts Lotteries, Unitab, and MaxGaming) and 2) the run-off and growth potential (Tatts Pokies, the international operations and upcoming local opportunities).

In valuing the business I therefore assume there is a core business that is pretty easy to get a broad grip on. Take the following for example,

Dec-08 EBIT
Unitab 71.3
Lotteries 46.5
MaxGaming 20.3
H/O costs -17.0
Group EBIT 121.1
Annualised 242.2

EBITmultiple 8 10 12 14
Valuation 1938 2422 2906 3391

You could argue the group EBIT is conservative – given it includes the corporate costs associated with Pokies as well – but this is an impressionist portrait.

Take your pick which EBIT multiple is appropriate for a business like TTS. From my perspective, I reckon 10 to 12 times would probably work (equivalent to P/E of around 15x). Gaming businesses typically command a reasonably high multiple (CWN trades in a P/E range of 15 to 20). On the flip side, state governments have been a tad unfriendly of late – so there should be compensation for the heightened regulatory risk.

Okay, that’s the ‘core operations’. How about the rest?

I think we can ignore the international for the moment. There is potential there – but nothing has come of this as yet and they have been at it a while. Let’s value these at zero then.

That gets us to the Tatts Pokies business. Let’s assume that the EBIT of $116m for the Dec08 half is replicated across the remaining term of the licence (6 half years). And let’s also assume that TTS is successful in extracting $600m from the government per the original licence agreement (the IPO prospectus assumed $598m). PV these back (I’ve assumed 7% - no particular reason, seems like a healthy premium to the risk free rate) and voila, you get a present value of $1,100m.

Finally, TTS had net debt of $734m at balance date. Capex of ~$45m was running just below depreciation of ~$50m – let’s assume it’s a wash.

So what have we got:

Core business $2,400 $2,900

Tatts pokies $1,100 $1,100

Less debt $ 730 $ 730

Market value $2,770 $3,270

Or, given 1,270m shares on issue, a share price between $2.20 and $2.60.

Conclusion – This analysis is clearly rough. It’s also probably conservative. And it doesn’t take into account upside from TTS winning new business – something I think the management is very capable of doing. But on the face of it, if I want to own TTS, better off waiting for a retest of the lows. I sold out of the position today.

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