Cheap Portuguese stock Novabase with a catalyst

Novabase (NBA:PL)

Trading at €3.05 (4/20/11)

Novabase is a Portugese IT services firm that also hold subsidiaries that run a ticketing system and German direct TV, they also run a venture capital fund.  They state that their goal as a company is to make people's lives simpler and happier through the use of technology.  Novabase is a company that appeared in my list of cheap profitable stocks I posted about here, and I wanted to dig in deeper to see if this was an opportunity.

I first off need to apologize because Novabase isn't in fact a net-net as I made it out to be in the Cheap in Portugal post.  The cause of my mistake is I used the line capital shares as the number of shares, I pulled this from the annual reports.  As I dug further I realized capital shares is subscribed capital, something we don't have much of in the US because most companies issue stock with a par value of $.01.  I should also mention, I couldn't find the share count in any of the annual reports, I pulled the number of shares I use from Bloomberg and FT.com, which was 31,401,000.  While Novabase isn't as cheap as I originally thought on a asset basis I still believe they offer a relatively good value on an earnings basis, I detail why below.

What I like about Novabase is that the IT services business has a low cost of business and high margins. Novabase is in the IT services business which means they don't have to carry much inventory, and they are not a capital intensive operation, both good things from an investment viewpoint.  Novabase breaks out their segments as following:

Consulting: IT integration services, enterprise application services, business intelligence, contracting

IMS: Integration services, network infrastructure, ticketing system.

Digital TV

Venture Capital

The venture fund is partially funded by the EU ERDF regional development fund.  The ERDF is a development initiative of the EU to stimulate local regions by investing in companies in the area.  Novabase runs a venture fund that has about five investments from what I can tell.  The nice aspect of the EU as an investor is most likely the EU won't run to pull their money out at the first whiff of trouble, they are a long term investor.  Investments in the fund include home automation, telecom firm, media analysis and business intelligence, two CRM companies.

The digital TV segment is interesting, prior to 2008 the German digital TV division was consolidated along with the rest of their earnings, but in 2008 it appears they disposed of enough of the company to unconsolidate the financial statements.  This is a good development from a business perspective while the German TV division brought in a lot of revenue it wasn't really profitable, and was a drag on earnings.  For the financial statements I developed below I took out the German TV segment prior to 2008, Novabase breaks this out in their statements as well.

One thing I appreciate is that Novabase breaks out all of it's income into segments and reports on those segments.  There is a lot more detail in the annual reports, but I wanted to highlight revenue, and EBITDA by segment.

Segment	Revenue	EBITDA
Consulting	35%	49%
IMS	44%	39%
Digital TV	21%	10%
Venture Capital	1%	2%

What the breakdown by segment shows is that the Consulting and Venture Capital segments are have a much smaller cost structure than IMS and Digital TV.  The second aspect is that it shows the Venture Capital fund isn't a huge part of their business, some investors might get a bit frightened seeing a venture capital fund as part of an IT services business, but if anything it looks like a sweetener not something to worry about.  The last thing the breakdown shows is that 79% of revenue, and 88% of EBITDA comes from IT services which is their core line of business.

Highlights
-Novabase is trading at a EV/EBIT ratio of 4.23
-15% of revenue is international, the international segment is growing at 20% a year.
-The financial statements are excellent, very transparent, and available in English through the CMVM.
-Novabase has positive retained earnings, and has been consistently profitable even in this tough environment.
-The company has issued guidance for 2011 of €245m in revenue with €20-22m EBITDA, this is in line with their 2010 results.
-Novabase's balance sheet accruals ratio is 1.2% which is excellent, higher accrual ratios indicate lower quality earnings.
-ROE of 14% and ROIC of 18.3%


Catalyst
The company initiated a dividend policy in 2010 and issued their first dividend of €.308 per share which equals around a 10% yield.  The company also did a return of capital distribution of €.172 in July 2010.  The company has stated that for 2011 the dividend amount will be €.13/sh for a yield of 4.26% at current prices.  They have further stated that going forward they'll continue to pay a dividend of 30-40% of net income.  Using the 2011 guidance numbers a dividend in 2012 could be in this range:

30% of NI .125 a yield of 4%
40% of NI .1669 a yield of 5.4%

Why is it cheap?
With any stock trading at a low valuation I think it's important to examine possible reasons for the cheapness.  Here are a few reasons I identified.

-It's a very small company with a 98m euro market cap.

-The company derives most of it's revenue from Portugal which is in turmoil currently.

-The company strongly identified with it's German direct TV business which was a large drag on earnings.

-The earnings are not stellar, or growing like crazy, but they are undervalued.

-The stock is down significantly in the past year, momentum rules in the short term.

-Net income and revenue were growing nicely up to 2008 but have stagnated since.

Valuation

When I first approached this I thought it was a net-net so I put the figures into my net-net worksheet, although it isn't trading at a discount to NCAV it provides a nice read on the balance sheet.

Here is my accruals worksheet

Here is my breakdown of the income statement elements for the past five years.

To value the common if we take the .90 in cash and add earnings at a 10x multiple we get €5.  Using the more common average multiple of 15x we get €7.05.

Risks
-In 2010 the company reported the highest net profit ever, are margins at peak?
-There is significant margin shrinkage in the digital tv area of business.
-Cash flow statements aren't published, they need to be constructed by the investor.
-The company has 10.472m of debt for a approx 10% debt to equity ratio.
-The company also has lease obligations 1.67m per annum.
-Most of the business is in Portugal which has one of the lowest high school graduation rates in the EU, along with a stagnating business environment.

More Information:
Novabase website
2010 Annual report
CMVM filings
FT.com information

Disclosure: Long Novabase