Qualiport

What the EMAP acquisition means

By Bruce Jackson (TMF Googly)

Kilburn, London -- Luckily, I'm not an emotional investor. Or one that worries about the day to day movements in the share prices of the companies we own in the Qualiport. Sure, we track them daily, but that is just for completeness and to give Fools an idea of how the real money portfolio is progressing. If however we didn't track the portfolio on a daily basis, I'd have no idea on whether we are winning or losing on any given day. That's not to say that we shouldn't be tracking the returns, because it is vital to know exactly how any portfolio is performing. But, ideally I'd like to do this on an annual basis.

A case in point is the movement in the Qualiport over the past 4 trading days. I don't need to tell you what a minuscule time frame this is to measure the returns of any investment. But since last Thursday, which was the highest point (in terms of value per share) for almost 4 months, the Qualiport has fallen sharply, losing 6% in value until yesterday. If I were an emotional investor, I'd be quite upset. I'd be reviewing my stock picking strategy, cursing myself, preparing to sell off the laggards as they fell yet further -- basically, working myself into a lather because the share prices of my portfolio fell.

Apart from one company, which we shall come to shortly, there was no news to report from our portfolio. Markets move up and down because... well, that's what markets do. So instead of concentrating on the movement of the share price, we should concentrate on the underlying company. Which brings me to... EMAP (EMA).

Our media company has been up to a bit of corporate activity. Yesterday, EMAP announced the takeover of The Petersen Companies Inc. (NYSE: PTN) of the US for £720m. Considering EMAP was capitalised at about £2,300m, this is a sizeable acquisition. It is no secret that EMAP were looking to expand abroad, and to do so in the largest media market in the world, the US. Only last month, when they released their interim results, did EMAP reiterate that they had established an International team to enable them to accelerate their overseas expansion. Knowing what we know now, the Petersen acquisition must have already been reasonably well progressed.

Many UK companies have failed miserably when attempting to tackle the highly competitive US market. Casualties that readily come to mind include The Body Shop International (BOS), Laura Ashley Holdings (ALY) and even Qualiport holding Marks & Spencer (MKS). There are a number of options for companies considering international expansion. They can start up directly from scratch, make a small acquisition and build from there, or go big and buy an established company. EMAP chose the third option.

As to whether they took the correct route, only time will tell. In the consumer magazine business, it is very costly and risky to launch new titles in a new market from scratch. Distribution, established management and knowledge of the local market are just some of the important things you get when you make an acquisition. This is especially so when you are entering an acknowledged competitive market such as the US.

EMAP, in their offer document, made the almost extraordinary statement that they recognise that the acquisition price for Petersen appears "full." Because of differences in accounting policies between the two companies, it is difficult to get a direct comparison on an earnings per share (EPS) basis. In fact, now that EMAP themselves have fully adopted Financial Reporting Standard 10 ("Goodwill and Intangible Assets"), a valuation based on EPS is not appropriate. Instead, and this is what we'll be focussing more and more upon in the Qualiport, both EMAP and Petersen should be valued based on the present value of all the future cash flows they produce. It is only with free cash that companies can enhance shareholder value, whether that be by share buybacks, increased dividends or acquisitions.

EMAP's aim is to increase their operating margins to 20% by the 2000. With sales growth hardly being explosive, they have managed to increase their profitability, and therefore EPS, by stretching those operating margins. You would have thought that therefore Petersen would have possibly been a company high on sales but low on margins. Gong. Again, because of the differences in accounting policies, it is difficult to make a direct comparison, but Petersen look to have operating margins that are already around the 20% mark. That doesn't leave much room for future increases. Add to that the fact that there will be very little scope for rationalisation cost cutting and you can perhaps see why EMAP say they are paying a "full" price for Petersen.

The strategy for EMAP will be to use Petersen as a launching pad into the US for some of their popular UK titles. First cab off the rank will be our top selling monthly magazine, FHM. On their recent trip to the UK, the Gardner brothers confirmed that they'd seen nothing like this publication in the US. If it's anything like as successful there as it is here, and now in Australia, EMAP could be onto a big winner. They will stick with their winning format, although obviously some of the content will have to be adapted for the American market. Nevertheless, this will now be a relatively low cost new launch.

Now the fun part. EMAP are financing the deal partly though a 1 for 5 rights issue priced at 875p. This will raise £359m, and the rest of the acquisition is being financed through new bank facilities. EMAP could have resorted to debt for the whole acquisition without overstraining their balance sheet, but the company acknowledged that this would restrict their potential for further takeovers should the opportunity arise. So, they result is a deeply discounted rights issue.

I won't go into the ins and outs of rights issues right here and now, but basically EMAP are issuing more shares at 875p, which will dilute existing shareholders' (that's us) holdings whether we take up our rights or not. Gobbledy gook? Don't worry, we'll look at this in more detail and plain English closer to the time when we have to decide whether we fork out some extra cash to purchase more shares in EMAP at 875p. With our holding of 169 shares, we'll have the opportunity to buy 33 more shares at a total cost of £288.75.

Before leaving EMAP, we had a post on the message boards about whether we intend dumping them from the Qualiport. At the moment, the answer is no. When buying them, we were impressed with the management of the company and backed them to continue their impressive growth record. Because they have suddenly made a big acquisition and the share price has fallen is no reason to dump them. Sure, EMAP are taking some risks, but companies don't get anywhere without doing that. Remember, with share options being a large part of directors' remuneration packages, it is in their best interest to maximise the valuation of the company, and the best way to do this is by growing earnings and free cash flow. We'll have a closer look at EMAP's valuation when all the offer documents come flooding through the post box.

Qualiwatch

Last Friday we said we were going to eliminate two companies from our Technology shortlist. Here goes....

Cisco (Nasdaq: CSCO) -- they say "virtually all of the information on the Internet travels across the systems of one company." They are, of course, talking about themselves. Being quite a simpleton when it comes to technology, I don't actually understand their business. I've never seen it in action, and can't reach out and touch it. I have to take Cisco's word for it that they have a monopoly on Internet traffic. To me, that's not good enough. If I don't understand Cisco's business, I've got no hope of looking at their competitors. Having seen the growth and profit margins Cisco have been able to return, you can bet your bottom dollar that competitors will be keen to get a piece of the action. Obviously the Internet is an extremely fast growing phenomenon, and that is a given. But there will be other ways to benefit from this great new medium.

Intel (Nasdaq: INTC) -- they have about 85% of the chip processor market, which is very impressive. Although they have other revenue streams apart from the chip they sell to PC makers, for the time being this is the most important part of their business. Intel are a great company with huge profit margins. They have developed faster and faster processor chips and continue to do so. Competitors struggle to make any dent in their market share, because Intel have the financial muscle and technology to put the squeeze on them. Although this is a tough decision, I am dropping them because, in the PC processor market, they effectively "only" have the ability to grow as fast as that market does. That is still a fast clip, but not as fast as a non-monopoly company in the same industry could grow, like a PC manufacturer.

And that leaves... Microsoft (Nasdaq: MSFT) and Dell Computer Corporation (Nasdaq: DELL). More about them on Friday.

With telecoms shares all the rage in the UK, we have a good discussion going about them in the Qualiport message board. Pop by and give us your opinion.

                    16/12/98 Close

               Company  Change    Bid
                 EMA    +0.30    9.95
                 IIG    +0.05    2.40 
                 MKS    -0.05    3.90
                 PIZ    -0.15    7.80 
                 RTO    +0.23    4.13
                 ULVR   +0.02    5.89

Qualiport Stocks

Last Rec'd  Total #  Company   In At   Current  Change
 19/12/97    783       RTO      2.55    4.13    62.0%
 04/11/98    245       PIZ      7.93    7.80    (1.6%)
 17/04/98    169       EMA     11.85    9.95   (16.0%)
 27/10/98    755       IIG      2.58    2.40    (7.0%)
 17/07/98    298       ULVR     6.72    5.89   (12.4%)
 11/05/98    368       MKS      5.54    3.90   (29.5%)

Last Rec'd Total # Company  In At     Value     Change
 19/12/97   783      RTO   2046.53   3233.79  1187.26
 04/11/98   245      PIZ   1966.34   1911.00   (55.34)
 17/04/98   169      EMA   2052.57   1681.55  (371.02)
 27/10/98   755      IIG   1972.64   1812.00  (160.64)
 17/07/98   298      ULVR  2052.54   1755.22  (297.32)
 11/05/98   368      MKS   2054.11   1435.20  (618.91)


Cash:                              £3,975.57
Current Total :                   £15,804.33

Total Invested:                   £16,184.62
Profit/(Loss) :                    (£ 380.29)  

Value Per Share

                   Day     Month    Year     History
Qualiport         1.88%   -1.64%   30.33%    33.27%
FTSE 100          1.32%   -1.98%    9.64%    12.15%
FTSE All Share    1.09%   -2.37%    6.37%     8.61%

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