Melbourne IT (MLB) & Web Central Group (WCG)

[OutToLunch]

Definitely bugg*r-all shares on offer now. This baby could become my first ten-bagger...

[OneUp]

quote:Originally posted by Damo79
I really think I could see a doubling or tripling of the current market capetalization based on rudimentary P/E ratios [8D].

Damo, I'd like to think the attraction of WCG is a little more than that.

First, I'm sure you know that EBITDA is not Earnings. The D - Depreciation (as well as the Interest and Tax) - is a very real cost for a web hosting company, mainly on servers that have a limited useful life and must be replaced reasonably frequently.

If we annualize the consolidated WCG's latest half year result, we would expect NPAT of $4.7 million. However, looking forward to this year, that would have to be adjusted downwards for the interest cost on the $11m loan WCG took out to buy WC (estimate about $1.1 million). And potentially amortzation charges on the $19.6m purchase price. All in all, I'd estimate WCG is trading at an inexpensive, but unspectaular, historic PE ratio (before amoritzation) of about 14.

The real attraction of WCG, atleast to me, lies in the economies of scale that are emerging in Web Central. If you convert EBITDA, EBIT and NPAT of the last 3 years to a percentage of revenue, some key trends will become clear.

(1) WC has increased its EBITDA margin by about 2 percentage points each half in the last 3 years. (This is the economies of scale emerging as fixed costs, like the 24/7 technical support help desk, is spread over more and more clients).
(2) Depreciation and Amortization - DA - has stayed constant at 16% of revenue.
(3) EBITDA = EBIT + DA. Because DA is a constant 16% of revenue, EBIT % has also increased at an average 2 percentage points per half; i.e. a direct one-to-one relationship with the increase in EBITDA.
(4) Because of (3), EAIT (Earnings after Tax and Interest aka NPAT) is also increasing very rapidly and should continue to do so (though possibly constrained by increased interest and amortization charges as alluded to).

I played around with an excel spreadsheet and if...
(i) WCG can average a 2 percentage points increase in EBITDA margin per half until end of FY07 (in the past three years, EBITDA % has increased from 17.9% to 28.4% - 10.5 points);
(ii) Depreciation remains at 16% (as it has done the past 3 years)
(iii) And therefore that the increase in EBITDA directly causes an increase in EBIT (increase from 1.8% to 12.7% of revenue in the past 3 years - 10.9 points).
(iv) Grow revenue at 10% per half. (In the past 3 years, revenue per half has grown from $10.5m to $19.2m.)

...then I estimate Web Central will make a NPAT of $11.7m for FY07. For argument's sake let's say FTR makes $3m NPAT in FY07. And that WCG trades at a PE of 20. If we put all these assumptions together, we get a share price of $7.00 within 3 years...and hitting my 10 bagger target within 5 years. Note that these estimates only assume that the company continues to increase EBITDA margin and revenue at the same rate of knots as in recent years. With the share price at $1.25, there is clearly a large margin of safety with WCG!

Can EBITDA and EBIT margin continue to increase? There must be a ceiling somewhere, but probably not around current margins. Rather, I think we are in NPAT takeoff stage.

A note of caution is that the NPAT result for this half may not be quite so impressive, due to interest and amortization charges. The key things to look for will be EBITDA and EBIT performance, IMO. Also, I do hope WCG does not announce a capital raising to "increase liquidity" in the company's shares. They keep doing what they're doing well and they won't need to worry about much else.

[Damo79]

Thank you for the MUCH more insightful analysis than I could currently work out myself. I'm pretty new in the sharemarket (and have only just started trying to understand fundamentals). That post was extremely helpful to me and I'll be taking those kind of considerations into account for other companies I look at. I have to admit I was using EBITDA in the P/E ratio I referred to. [:o)]

I'm still very happy with my small WCG holding, but perhaps for better reasons after that explanation.

Keep up the good work OneUp

Damo

[OneUp]

No worries Damo. WCG's one to put on the bottom drawer. From my vantage point, bid support has moved from $1.00-1.05 to $1.20-125, or up about 20% in 6 weeks. I hope this trend continues...for both our sakes

[OneUp]

I've been in contact with the company over the last few days, asking questions about whether WCG still plans to go through with a capital raising to increase liquidity, whether their cashflows are analogous to their NPAT, and most importantly whether they expect EBITDA margin to be able to increase at similar rates in the future. Unfortnately they weren't giving away much for now, going into lock-down in anticipation of the half year result, but they did promise to address my questions in the half year results announcement.

However, something useful did come out of it. For anyone who currently holds WCG shares, if you send an email to Monique Roberts (moniquer@webcentral.com.au) with the details of the name your shareholding is in or your HIN, then you will be put on a shareholder-only information distribution list.

[Damo79]

Coming along nicely under very small volumes, but about 20000 shares available at any price at all. Almost wish a few holders would decide to put theirs up for a sell just to convince some bigger investors that they can get in there. I think the lack of liquidity is a big drawback at the moment. Wonder whether a share placement might actually be a good idea, especially since they've got a bank debt to pay off.

quote:The key things to look for will be EBITDA and EBIT performance, IMO. Also, I do hope WCG does not announce a capital raising to "increase liquidity" in the company's shares. They keep doing what they're doing well and they won't need to worry about much else.

What would be the drawbacks of a capital raising, do you think, OneUp?? Is it as simple as saying that the debt is probably costing something around 10%pa, while we hope that our shares are going to return more that that?

Damo

[OneUp]

quote:
What would be the drawbacks of a capital raising, do you think, OneUp?? Is it as simple as saying that the debt is probably costing something around 10%pa, while we hope that our shares are going to return more that that?

More or less.

(1) I see no need to share my piece of the pie with others. Liquidity is a not a major issue long term - if someone wants to buy any size parcel of shares they can offer $2.00 now and get as many as they want. Hell, even I'd part with my shares if someone offered $4.00 + now .

(2) A capital raising is also likely to depress the share price short term (esp if a rights issue, not so much if a Share Purchase Plan.) If the company successfully communicated a share issue was to increase liquidity, perhaps the share price would not be adversely affected afterall.

(3) WCG has no need to issue equity - the current modest debt burden for WCG is well within its powers to service. Overall, I think an optimal capital structure for WCG involves more debt, not less, because their cashflows are overall very predictable (ie monthly billings for an essential service). So, at this stage, I would argue that equity is more expensive than debt ('yes' to your point).

A good case study on the virtues of not issuing equity to fund expansion can be seen in Michael Hill.NZX. Although that company could have expanded faster by issuing equity to fund its store rollout programme, it decided to take it slower and funded expansion by modest debt and internal cashflows. This strategy resulted in a 7 fold increase in the share price in the last decade, which is probably better than would have happened if expansion had been funded with large issues of equity. I'd also note that once upon a time MHI was quite illiquid and unsexy (people made jokes about Hill calling his company "Michael Hill International" when he had just a few stores in NZ, headquartered in the international cosmopolitan metropolis of Whangarei!). Now institutions are falling over themselves to get a piece of the action and have driven up the share price susbtantially.

On the other hand, there is a case for issuing equity if internal cashflows and prudent debt levels are insufficient to fund profitable expansion (and that this expansion opportunity if delayed would be lost). Seeing as the web hosting industry (especially the dedicated segment) is growing very rapidly and forecast to continue this may be a fair way forward.

PS: look at her fly today. Last trade $1.35, offer $1.56 (!)

[OneUp]

WCG's half year result will be announced Feb 14. I'll be having a briefing with CEO Andrew Spicer and CFO Ross Dewar later that week. If anyone has a specific question they want to me to ask, please post it here.

[Damo79]

Hehehe

I can only assume someone just bought a small amount of these 'at market' without first checking out the depth chart. There were a few thousand for sale at 1.50 or so, and not much else, and now it says last price was $1.89. Wish I'd had mine there for a sell.... Of course would have bought back once it settled.

[micro]

G'day Oneup,
I am a fellow,albeit small but happy, shareholder.
How do you manage to arrange a briefing-is it part of a presentation to one or more brokers or do you happen to be a largish holder that can command an individual briefing? Should be interesting though as apart from DiscreteInvestment ,I've never seen a broker report or shares mag write up, or on any other forum and there arent any institutional investors in there either. Agree fully that no more shares should be issued unless at an outrageously high price in the future-providing earnings are rolling along it wont take long to work off the debt.
I hope to come up with a few questions for you, but as this will be the first report with webcentral figures, it will be the first time to see where the money comes and goes although the interim might not contain all the detail the annual report will contain - there's a first question- ask them to provide a supplementary report in the event that the interim is too brief- ie rough idea of average/range of revenue per client/market share and if there are any significant competitors emerging that might hurt margins ( speaking of which, isnt it a shame that it is not 2000 now with the Ziggermeister in charge of a big cash cow-what would be WCG worth- only dreaming).Will be interesting also to see what the cash flow is like and how d&a is treated-conservative or aggressive accounting. And not to forget FTR business either- I know its the smaller part of the business now, but they keep threatening to expand products beyond the courtroom-if this is humming along well could be some good growth there also.
I like that reference to 10 bags.