Hi Paul - In order to analyse the downsize sernerio, I believe the best approach is to determine the annual sales target once the downsize is achieved. The value investor would like to buy price/sales assets at 1:1 or 2:1 and look for fair value to be reached at 5:1 to as high as 10:1; if renewed growth and new product enthusiasm (both customer and mutual fund manager) can be accomplished.
You first must adjust the price (deduct BV assets and add back debt) to reflect an adjusted "price" based on company assets (ie. cash, real estate and equity investments).
Here is the way I figure it.
I. Price to sales ratio assuming no downsize:
1) a) 1997 sales (w/ no growth) 400 million x 4 = $1.6 Billion
b) 1997 sales (w/15% growth) 1.6 x 1.15 = $1.84 Billion
2) Adjusted price : $11 - $6 (assets) = $5.00
3) Total shares outstanding 320 million
4) Sales/share a) $1.6 B/.320B = $5.00/share
b) $1.84B/.320B = $5.75/share
5) Price to Sales: a) $5.00/$5.00 = 1:1
b) $5.00/$5.75 = 0.87:1
II. Price to Sales ratio w/ Downsize
1) Assume downsized business achieves 40% sales but can maintain i) a 10% sales growth and ii) 20% sales growth. Profit margins are maintained or increase.
a) 1997 Sales w/ 10% growth = ($1.6B x 1.10)X(40%) = 704 million
b) 1997 Sales w/ 20% growth = ($1.6B x 1.20)X(40%) = 768 million
2) no change
3) no change
4) Sales/share a) 704M/320M = $2.20
b) 768M/320M = $2.40
5) Price to Sales: a) $5.00/$2.20 = 1:2.27
b) $5.00/$2.40 = 1:2.08
To summarize, a Price to Sales analysis after a downsize would achieve a higher price to sales ratio with the expectations that a higher sales growth target can be maintained going forward. If one compares other price to sales ratios for other companies in the same industry, you will find that the average ratio is much higher but a preminum is paid for perceived AND expected growth going forward. The value investor will always pay a price to sales ratio of 1:1 or less as their is significant value imputed in such a ratio.
Where is the value?
Margins and Growth -
If margins are maintained at 30%, a price to sales ratio of 1:1 assumes that three years of sales will generate profits per share equal to the share price in year one. <This is why Novell has such a great free flow cash flow number!>
Benefits of doing a downsize: Management would only want to execute a downsize if (1) they can significantly guarantee a higher growth rate going forward and (2) maintain or increase product margins. I doubt that either case would be true for Novell after any downsize.
IMO, Novell will continue with their program as detailed in (I) above and still bring value to this stock if (1) growth slows (or continues neagative but not more than 2-3 quarters) and (2) if margins are maintained at current level or even get slimmer and stablize. This would be the worst case sernerio. So SALAH is quite true, that greater value will be achieved if management can maintain or grow current sales at the rates described above.
However management must focus on sales growth, product margins and product life cycle. This is accomplished by executing a plan that overtime generates sales from several sources (like services, new product offerings etc.). They have the flexibility in the short run to reduce margins to maintain current sales levels but MUST develop additional sources of revenues from new products and services for the long term future (ie. NEST, direct customer system consulting, Internet add-on products etc)! Let's hope our management understands the factors which affect this very simple analysis.
EKS
P.S. It might be useful to compare other similiar companies Price to Sales numbers so we (Novell investors) understand how undervalued this stock really is. Other software companies include CA, MSFT, BORL, Orcle, IFMX and many others. Please post and we can review the differences in each company. |
