The lesson IM has learnt is to buy a basket of value unlocks, rather than one or two. It’s painful watching many small caps deliver excellent returns while EOH has gone from bad to worse.
In the latter half of 2020, EOH traded between R4.50 and R5 per share. The price took off in December, climbing to R8.70 before spending a couple of months consolidating between R8.10 and R9.30.
There was a significant wobbly in March, when EOH dropped to R7.30 before finding buyers. After a brief recovery back to R8.30, it’s been one-way traffic down to the current levels of about R6.50. If you enjoy roller-coasters, you can buy EOH shares instead of going to Gold Reef City.
When IM first looked at EOH at the beginning of the year, the last publicly available information was a pre-close update for the interim period. It was always going to be a risky punt but IM punted it anyway. The overall sentiment around EOH has deteriorated since then and so have the numbers.
In early July, there was bad press around the State Information Technology Agency and the possibility of EOH being blocked from public sector work. That would substantially hurt the business, so EOH moved quickly to address concerns. IM is not sure that risk has been put to bed yet.
IM’s greatest concern is the disappointing multiple achieved on the sale of the Sybrin business. With normalised earnings before interest, tax, depreciation and amortisation (ebitda) of R78m, an enterprise value (EV) of R410m was agreed for the deal. That’s only a 5.3 times EV/ebitda multiple — not a great outcome for EOH shareholders.
There are also ongoing irritations in the quality of EOH’s disclosure. For example, the Sybrin disposal was announced in June 2021 but the numbers disclosed for the business in the announcement were for the year ended June 2020.
Why not include the interim performance, to make it easier to estimate the contribution from Information Services as the remaining IP business to be sold?
To make it worse, the net profit after tax (NPAT) for Sybrin was disclosed but the segmental report only goes as low as ebitda. Businesses fighting for their lives should go the extra mile to make things clear, rather than obfuscating the numbers.
This makes it difficult to work bottom-up in trying to arrive at a value for EOH. The other approach is to go top-down, by showing what the current market cap is implying.
We know that there’s another R334m coming from Sybrin. EOH’s net cash balance has barely moved in six months, staying around the R600m mark. That implies R930m in net cash once Sybrin clears.
The R2bn debt balance hasn’t improved either in the past six months, which shows that the company is treading water at best.
Interim "core normalised ebitda" excluding the IP segment was R220m. We can hopefully safely assume R400m annualised ebitda in the underlying business. Applying a 4.5 times multiple takes us to R1.8bn EV for the core business.
If we add net cash of R930m (including the Sybrin number) and deduct debt of R2bn, we get to an equity value of about R700m. With a current market cap of R1.1bn, the remaining IP asset is thus being valued by the market at R400m.
This is extremely sensitive to the multiple we apply to the core business. For example, applying five times to the core business instead of 4.5 times changes the implied Information Services valuation from R400m to R200m.
The issue is that we don’t know how much money Information Services makes.
Syntell and Sybrin collectively generated NPAT of R77.5m in FY20. The IP segment achieved ebitda of R320m in that year, a margin of 26.4%. If we assume a 15% net profit margin, that implies R180m divisional NPAT in that year, which suggests R100m of NPAT in the entities still to be sold.
Again, this is guesswork that is being forced on the market by poor disclosure.
Assuming a six times earnings multiple, another R600m might be raised from disposals. This suggests the market cap should be around R1.3bn, an implied share price of R7.35 versus the price at the time of writing of R6.24. IM’s average in-price is R7.64, so this trade hasn’t worked out well.
Though this calculation suggests nearly 18% upside to the current share price, there’s huge uncertainty. When it comes to risky value unlocks, the potential upside needs to be worth the risk. I don’t think this is the case any longer.
The author holds shares in EOH
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