This is a past Premium recommendation and is made available for your reference. For more past trades, refer to our trade history.
Every stock has a story and every story is different. This makes analyzing some of the stocks in a way that is completely different from the “standard” analysis tools that we are used to.
Let me start by saying that this stock is not for the squeamish. I am totally confident about the investment merit of this company but the stock is going to be very volatile. If this makes you uncomfortable, allocate as little of your portfolio to this stock as you can. Perhaps even zero. That being said, the stock represents an excellent opportunity to get in the early stages of the turnaround of this company and if the company executes well, or even reasonably good enough, the stock will perform handsomely over the next year or so.
My main investment thesis for this stock being that there is a pretty good reason why the company is cheap, but as usual, the market has overdone its pessimism and the company is in a much better situation than the market gives it credit for.
Dex One Overview
In January 2010, RH Donnelley reorganized under bankruptcy protection and started afresh as Dex One (DEXO). Essentially, Dex One is a publisher of Yellow Pages, mostly for AT&T and Century Link. It publishes its directories in 28 states in US. In addition to its print business, Dex One also operates a local business directory and search site called DexKnows. In addition, it operates a Pay per click ad network called Dex Net.
The company describes itself as a marketing company that helps local businesses with their marketing programs across multiple platforms in generating leads.
The company operated 3 separate subsidiaries under the Dex One umbrella – Dex One Media East, Dex One Media West and RH Donnelley Inc. The company has been restructuring and reorganizing itself since 4Q 2010 and at the end of Sep 2011, it is now organized as RH Donnelley Corp, RH Donnelley Inc, Dex One Media, Dex One Digital (formerly known as Business.com, Dex One no longer owns business.com website) and Dex One Service.
We will not worry about the organizational structure at this point except to take a note of it. Once the restructuring is complete, it will become much clear – until than the comparables and financials by the line of business are all going to be in flux (there are a lot of inter-company transactions and adjustments, the nature of which will change until the restructuring is complete). It is easier to work on a consolidated basis and note the trends where applicable.
The Current State of the Company
The company closed out Q3 2011 with a net income of $0.44/share and expects the next quarter to perform roughly in line with Q3. The trailing earnings are as follows:
|Revenues||$ 360.10||$ 377.27||$ 391.24||$ 357.62||$ 259.23||$ 160.89|
|Reported EPS||$ 0.44||$ (12.01)||$ 1.11||$ (0.40)||$ (7.81)||$ (15.39)|
|Adjusted EPS||$ 0.44||$ 0.55||$ 0.91||$ (0.40)||$ (1.18)||$ (2.61)|
Revenues figures are in millions
In the third row, I have listed the earnings as reported by the company. In Q2, the company took a massive $801 million write down on impaired goodwill which is clearly a 1 time event (or since the company is restructuring and will have quite a few of these 1 time events). There were other write downs in 2010. As part of the restructuring, the company is on track to realize $125 million in cost savings in 2011. To come to the adjusted EPS, I have backed out the one time events along with their estimated tax consequences to get a good picture of their ongoing business.
As of Nov 17 2011 market close, the company shares are worth
- Price: $0.97/share
- Market Value: $48.67 million
Which gives it the following profit ratios
- Price to Earnings, ttm adjusted: 0.65
- Price to Earnings, next 12 month (estimated): 0.55
- Price to sales, ttm: 0.03
To summarize, the Dex One is operationally profitable and can be bought at a PE ratio of 0.65. Put it another way, a mere 2 quarters of Dex One’s profits can buy out the entire company in the market.
So why does the market treat the stock as if the company will not last another 6 months?
Ugly Balance Sheet
On the surface, the debt level is too high. And the book value is non-existent.
|Summarized Balance Sheet|
|LTD (curr & long term)||2551.736|
|Tot Curr Assets||1045.65|
|Tot Curr Liab||1080.502|
Total Equity of the company is $6.563 million. At the end of Jun 30, 2010, the company had an equity of $940.05 million. Since than, the company has written down $1.345 Billion in goodwill, down to 0, that it still carried after the bankruptcy reorganization. A quick calculation shows that the company created $411 in equity in the last 5 quarters (=6.563 – (1345-940)), or around $80 million/quarter.
Without the write downs, the equity of the company would have been around $1.35 Billion today.
Market sees the following picture:
- Revenue (ttm): $1.486 Billion
- Debt: $2.552 Billion
- Reported EPS (loss): (10.87)/share
- Equity: $0.006 Billion
And promptly believes that the debt level is too high and drives the market value down to less than $50 million.
Compare the above to the following picture:
- Revenue (ttm): $1.486 Billion
- Debt: $2.552 Billion
- Adjusted EPS (loss): 1.50/share
- Equity: $1.35 Billion
and it is easy to see that a $50 million market value is quite ridiculous.
These two pictures are essentially identical, except for writing off of the Goodwill, which is a non-cash and non operating charge and has no effect on the actual business going forward. It just had the effect of altering the EPS line and the Shareholder’s Equity line.
But the Debt is Really High, Isn’t It?
The debt is quite high, no doubt. However, Dex One is currently generating about $400 million in Free Cash Flow/year (which is after debt payments). This means that it can pay the debt off in roughly 6 years if it directs all its FCF towards debt repayment. Its current $195 million cash cushion (which is itself $3.89/share – compared to the share price of $0.97/share) should be enough working capital for the next 6 years.
This is the worse case scenario. In the best case scenario, the debt can be paid back much faster. Here is the breakdown of Dex One’s total long term debt:
|Debt Schedule||Nominal Value||Interest||Discounted Value||Discount%||Maturity||Interest/Q|
|DME Line||$ 677.40||2.80%||$ 375.97||44%||24-Oct-14||$ 4.74|
|DMW Line||$ 618.90||7%||$ 411.95||33%||24-Oct-14||$ 10.83|
|Dex One Senior||$ 300.00||12%||$ 57.00||81%||29-Jan-17||$ 9.00|
|RHDI Senior||$ 955.40||9%||$ 427.90||55%||24-Oct-14||$ 21.50|
|Total Debt||$ 2,551.70||7.22%||$ 1,272.82||50%||$ 46.07|
Except for the $300 million note, all other debt matures in Oct 2014. I want to draw your attention to the Discounted Value column. This column shows the current market value of the corresponding debt. So, for example, The RHDI senior note is currently selling in the market at 55 cents on a dollar.
Dex One is currently in the process of negotiating with their lenders to get approval to allow them to buy back part of their debt at below par. If they are able to come to an agreement, we will start seeing “write ups” on the income statement and the balance sheet and it will also be favorable to the cash flow. This will be a major catalyst in moving the stock price appreciably higher.
Estimating Intrinsic Value for DEXO
In 3 years time, when the bulk of the debt matures, in a no growth scenario Dex One will likely add another $80x3x4 = $0.96 Billion in Equity. This will bring Debt to Equity ratio to almost 1. If Dex One is able to retire some of the debt at a discount, debt/equity ratio will decline even further.
Currently Local.com trades at a 0.73 P/S and 1.02 P/B, despite making losses. A similar valuation will put Dex One at $1B in market value in 2014. This is not unreasonable for a company with $1.5 Billion in annual revenues. With approx. 50 million shares outstanding, this puts Dex One’s price 3 years from now at $20/share. It is worth noting that coming out of bankruptcy, Dex One shares traded at over $30/share in Feb 2010. The company values itself at $2.275 Billion ($45/share) assuming current cash flow for next 4.5 years and than a terminal growth rate of (1%) using a discount rate of 13.5%, so my estimate is definitely much more conservative than the company’s.
Here we have a stock that can be worth $20 in 3 years. If you demand a 15% return on your investment, you should be willing to pay up to $13 for the stock today. Add another 50% margin of safety and any price under $6.5 should be a great purchase. Of course, the stock is right now available for $1 so it is especially attractive.
No wonder Paulson & Company now own 7% of the outstanding stock.