Description

Emerging markets stocks and currencies have been under fire since February.  A combination of the strong dollar, trade fears, a series of high profile elections and plain old fashioned mob panic have left a number of bombed out stocks.  If you are worried about market levels in the U.S. go take a look at Brazil or Indonesia.  These markets are not without issues, but overvaluation is not one of them.

As an example, let’s take a look at a fairly simple business, Media Nusantara (MNCN) in Indonesia.  The stock is down 50% since February in local currency, with the Rupiah down double digits as well.  I’m not finding a lot of potential doubles today, but I don’t find it all hard to envision one here.

MNCN is the largest TV broadcasting company and studio in Indonesia, a country of 270 million people.  In fact it is the largest in Southeast Asia.  They operate four of the eleven free-to-air (FTA) television stations in the country.  As in the old days in the U.S., this is a business protected by government issued licences.

It is important to understand where Indonesia is on the development curve – this is not a U.S. media company.  Indonesia has a per-capita income of about $3,000.  Pay-TV is not a mass market offering.  Internet penetration is only 35%, with 65% of total advertising over FTA television.  Adoption of smartphones is well below other emerging market countries, with the majority of smartphone users still using pre-pay phones without internet access. 

Perhaps most important, 80% of Indonesians are Muslim.  The Islamic government has banned Netflix as they do not want Western programming in their country.  There’s a huge risk factor everywhere else that is simply not there in Indonesia.  Were an Indonesian OTT offering to spring up, it is important to note that MNCN doesn’t simply import western programming.  They overwhelmingly produce and own their programs.  This is the biggest studio in the country with by far the largest content library.

MNCN’s stock has fallen by 34% year-to-date in local currency, down by half since February.  Multiple factors are responsible:

1. The Indonesian economy has slowed, weakening advertising spending.

2. MNCN’s prime time ratings have slipped from a steady 34-35% to as low as 30% in some months in early-mid 2018.  The #2 player Surya Cirtra changed their programming format to compete more in MNCN’s mainstay of “sinetron”, which are like prime time soap operas.  Surya poached some of MNCN’s stars and have had initial success.  As of May, MNCN’s ratings had rebounded, but this bears watching.

3. A big reason the stock is down is that they have U.S. dollar debt.  This has been a huge issue in Turkey and South Africa, and this is a hot-button with emerging markets investors today.  The IDR has depreciated from 13,000 to the dollar at the end of 2017 to nearly 15,000 to the dollar today.  MNCN has a loan on its balance sheet of $250 million in U.S. dollars.

#3 sounds really scary (and don’t get me wrong, U.S. dollar loans can be existential risks in emerging markets companies).  But it is perfectly quantifiable.  The $250 million loan is the vast majority of MNCN’s debt, but let’s start off by pointing out the obvious.  Debt/EBIT is only 1.3x.  To quantify the currency depreciation impact, take $250 million and multiply it by a 1,500 IDR change and you get about 375 addition to their 3,400 of debt.  So debt goes from 3,400 to 3,800, EBIT coverage from 1.3 to 1.5.  Simply not a big deal.

So why are people freaking out?  First because when there is “bad” in a category that is in free fall investors don’t think, they sell.  Second, if you were a sell-side analyst who has to estimate quarterly earnings or an investor who looks at such things, this is a much more serious matter because the mark-to-market change in debt passes through the income statement.  That 375 change in debt in local currency represents over half of a quarter’s earnings and will be quite noticeable in annual earnings. 

I would rather look at this in terms of valuation – 375 is only about 2% of our estimate of intrinsic value.  [Of course it goes without saying, this business is denominated in the local currency so from a US dollar investor’s perspective goes up and down linearly with the currency rate.  Here I am just isolating the scary US dollar debt impact.]

This US dollar debt matures more than three years from now, so there is no imminent refinancing issue.  Even if there were, this would be well within investment grade.  Interest rates would step up considerably, but well within our margin of safety on earnings power.

A valuation of this company is straightforward.  We start with 2,250 of EBIT (haircut 10% for minority interest).  You will have a hard time finding a substantial media company that is not the walking dead (and even some that are) trading for less than 9x EBIT.  (Note that I am using EBIT, not EBITDA).  Thinking about a range of 9-12x EBIT gives an enterprise value of 20,250-27,000.  Less 4000 of debt (marked up to reflect the currency) gives us equity value of 16,000-22,000, or 12.50-17 per share.  Take the middle of that range, get a little help from the currency and you have a double.  The stock was just there six months ago.

Risk

The Chairman is Hary Tanoesoedibjo.  Let’s just call him Mr. T.  He is the President of Global Mediacom, the parent which owns 2/3 of the company.  It looks like cutting through all the entities he owns about 2% of the business, but appears to have more control than that ownership.  Outside of its ownership of PT Media Nusantara, Global Mediacom also owns cable, broadband and OTT assets in Indonesia.  I think it would be safe to say there are related party transactions between the companies, with Nusantara selling content to the other Global Mediacom entities.

Mr. T is Indonesian, educated in Canada.  He is a public figure in Indonesia and you’ll find pictures of him online with Trump and other bigwigs.  It took government connections to get into this business – when Indonesia’s television networks were privatized, Mr. T. bought or somehow wound up with this large franchise.

Watching ratings month to month.

The views expressed represent those of the author and do not necessarily represent the views of any other person. The information herein is obtained from public sources believed to be accurate, reliable and current as of the date of writing.  The author will not undertake to supplement, update or revise such information at a later date.  The author may hold a position in the securities discussed.

Catalyst

Investors finish selling their emerging markets positions.