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Trade Me's explosive growth is over, offers 'predictable' returns

Tuesday 22nd November 2011

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New Zealand’s dominant online auction site Trade Me is a “mature” business whose period of early, explosive revenue growth is over, but the company will offer attractive dividend yields, says Wellington equities research firm Woodward Partners.

“The company is reaching its mature growth phase, and we can see that in the company’s slowing revenue growth rate and its profitability margins that are beginning to settle down to more long-term levels,” said Woodward director Nick Lewis, in a research note.

“Having said that, we believe that Trade Me will still have the strongest cash flow margins of any company listed on the New Zealand Stock Exchange,” he said. “As such, most of the returns to investors will be in the form of dividend rather than capital appreciation.”

As a yield stock, Trade Me’s share price would be sensitive to rising interest rates, and its overall returns were likely to be “modest but predictable”, and driven mainly by dividends, Woodward says.

Trade Me’s owner, Fairfax Media, is offering 34 percent of the company in an initial public offering at $2.70 a share to raise $363.5 million. The IPO closes on Dec. 6, with shares scheduled to begin trading on Dec. 13 on both the New Zealand and Australian stock exchanges.

Woodward is targeting a share price over the following 12 months of $2.80, although it suggests early demand could push it higher, given expected heavy over-subscription for the issue.

On a dividend yield basis, Woodward values Trade Me at $2.52 per share, and $2.46 a share on an earnings multiple basis, using a multiple of 10.85 times. Woodward’s own valuation is $2.54 a share, based on a range of valuation approaches.

Fairfax bought Trade Me in 2006 for $750 million, including a post-sale earn-out for its founders.

Among its strengths, Woodward lists an experienced board and management team, the company’s dominant market position in all but one of its business categories, and its likely ability to raise prices, although it notes Trade Me is experiencing declining margins as the business entrenches in the New Zealand market.

Woodward also speculates that, post-float, Fairfax could seek to pump additional debt onto the Trade Me balance sheet, which it says is under-geared at 20.8 percent, with $166 million of new bank debt.

“We believe the company could readily support in the order of a further $300 million of senior and subordinated debt,” said Lewis, noting Fairfax has announced it will be seeking to reduce debt on its own books.

Lewis also warns that Trade Me may struggle to find ways to add value to its existing business, but may be tempted to undertake acquisitions because it will be accumulating around $15 million a year in cash, even with a dividend pay-out rate of 80 percent.

“Trade Me’s board and management will need to ensure the company keeps to tight financial disciplines in order to ensure shareholder value is not eroded.”

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