Description
I recommend to short SBBMY (Local - Bovespa – ticker: SUBA3) due to overvaluation, increased competition and potential overhang due next year secondary offer to be made by venture capitalists. This stock went up almost 200% since the IPO seven months ago, and the IBOVESPA Index is up YTD 50% in US Dollars and 28% in local currency. The GDS is for qualified investors (144A), but there is plenty liquidity in the local market, and any investor could borrow the shares locally. There is an investor relations website in English so you can get more info on the company, and the address is: http://www.submarino.com.br/ir/ . The company agreed to Bovespa (New Market status) rules that oblige them to issue financial statements in US GAAP or IFRS GAAP and give to minority shareholders tag-along rights. Each GDS (ticker: SBBMY) is equivalent to 2 local shares (Bloomberg ticker: SUBA3 BZ).
BACKGROUND
Submarino is a pure e-retailer that sells around 24 products categories in Brazil, from books/CDs to TV sets and stoves. It is comparable to Amazon. It is the first or the second largest e-retailer in the country, the other one is Americanas.com which is a subsidiary of Lojas Americanas S.A. (Bloomberg Ticker: LAME 4 BZ). The company was founded at the top of the Internet boom (1999) by private equity investors:
- GP Investimentos: 21.1%
- Thomas H. Lee Putnam Ventures: 6.3%
- Others: 5.5%
Total: 32.9%
which are planning to do a third offering of their entire remaining stake in the company in order to take advantage of the enormous liquidity that is chasing investments in Emerging Markets. I am generally suspicious of such moves by insiders, because they have the timing on their side, so when they decide to sell is because they think that the price is very good for them and there is no money left on the table.
It is important to emphasize that the controlling shareholders of Lojas Americanas are also the founders of GP Investimentos which is the main shareholder of Submarino. Therefore with the planned Submarino’s secondary stock offering the owners of Americanas.com (Lojas Americanas) are free to increase competition to Submarino.
Submarino’s management minimizes the impact of the competition and the potential competition threat poised by Americanas.com is not addressed, nor the competition from local shopping search engines such as www.buscape.com.br and www.bondfaro.com.br.
VALUATION
1) DCF
The valuation of the company done by CSFB, which was IPO’s book runner, using DCF was $ 21.80 (per GDS) based on terminal value growth of 5%, which is well above the average growth of the Brazilian economy. Besides that, if we reduce the terminal value’s growth expectation to 3% we reach a value of $ 19.00. Usually investment bankers and private equity guys are not conservative on valuation when they are exiting/selling an investment.
2) Comparable Transaction
Last August, Americanas.com bought another e-retailer called Shoptime which was also owned indirectly by GP Investimentos (56%) and TV Globo S.A. (44%). The acquisition cost was R$114.6 million – an alternative retailer that runs two main format, each representing about 50% of revenues: the Shoptime TV home shopping channel that runs on cable/satellite TV, with 24h exclusive programming of product offerings, and an online store (www.shoptime.com.br) that has similar offering to that available at Americanas.com, in addition to catalogue sales.
The target company (Shoptime) has net sales of R$ 108.7 million for the nine months of 2005 and my forecast is net sales of R$ 147.2 million for the all year. The Ebitda is not meaningful. Besides that, this company has a tax loss carry forward of R$ 50.3 million, but I considered a value of R$ 30 million. Therefore the price paid for the operation was close to R$ 85 million and that correspond to EV/ Sales multiple of 58%.
The consensus estimated 2005’s sales for Submarino is US$ 415 million; therefore using the multiple calculated above (58% on net sales) we get a value for the company of US$ 241 million plus net cash position of US$ 22 million. So the GDS ‘value is US$ 11.50, and the IPO price was around US$ 17. Maybe my appraisal based on Shoptime transaction is not fair because Submarino is a better company than its peer. Even if I add a premium for quality, let’s say 50%, then the multiple on sales will be 87%, the company is still very expensive, an appraised value of US$ 17.25 per GDS against a market price of US$ 38. Based on the Ebitda for 2005 the company is trading at multiple of 38x Ev/Ebitda.
SHORT SELLER’S RISK
The herd mentality fueled by an enormous liquidity which is chasing a few investment opportunities in emerging markets. Therefore the company could become more expensive and hurt the short-sellers.
In order to minimize that, I suggest a pair trading, which is to be Long LAME 4 and Short SBBMY (or SUBA 3).
POSITIVES ASPECTS FOR SHORTING
- The lock up period for doing another secondary offer expires in March/2006, so there is an overhang for the stock.
- Competition is becoming fierce because company’s marketing expenses in the 3Q05 increased more than expected by investors.
- I believe that after next year secondary offer, Americanas.com will be much more aggressive on competing with Submarino. Besides that, Lojas Americanas (local ticker: LAME 4, the parent company of Americanas.com) has more brand recognition by consumers than Submarino and has more financial resources for a fight.
- The controlling shareholders of Lojas Americanas, through Cia. Brasileira de Varejo Ltd. ( a private company) , controlled by Jorge Paulo Lehmann and partners Marcel Telles and Lojas Americanas’ Chairman Carlos Alberto Sicupira, bought on November 22, 12.6 million shares of LAME 4, valued in US$ 315 million, increasing significantly their stake in the company from 7.3 % of non-voting shares to 26%. Remember that Lojas is increasing its presence in the e-commerce by buying Shoptime. The three guys mentioned above founded GP Investimentos, which owns 21.1% of Submarino, and they are one of the shrewder investors in Brazil. So they invested more money in LAME 4 recently than the value of their stake in Submarino – US$ 185 million (21.1% stake) - owned through GP Investimentos ( a private equity fund manager), and I estimate that only 20% (US$ 37 million) of it belongs to them and the remaining are from the limited partners of the private equity fund.
- Next year in October will happen presidential elections in Brazil and this mean some turbulence and local currency could depreciate against the US Dollar.
- Due to strength of the local currency, the retailers (bricks and e-commerce) of consumer electronics are increasing their sales, so the expected growth is very dependent on this segment and any reversal in the situation either hurt margins or slowdown growth.
Catalyst
- Increasing competition will hurt Submarino’s margins, mainly from Americanas.com;
- Investors recognize that the company is overvalued and there are cheaper plays in the Brazilian retail sector;
- Stock overhang due to planned secondary offer;
- Local currency depreciates due election turbulence which affects stock price and the business growth;
- The level of USA’s interest rates could dampen the liquidity that is soaking the Emerging Markets, and companies similar to Submarino will suffer.