Paperlinx (PPX and PXUPA)

On better news (than the previous post), the PPX AGM was held in Melbourne last week which I attended. 

PPX is one of the more talked about and controversial stocks, however I think one has to agree that at least they are making the big decisions to try and fix the business. Europe is all but done and I as understand there may be some relatively minor lease obligation residual after Germany is finished. Maybe VW can rent it to store some of their cars that no one wants to buy.

Clearly the traditional paper business in ANZA has done okay but is in structural decline. PMP, another company facing structural decline has tackled the issue by savaging costs across the board. PPX's response has been to cut out the cancerous parts and diversify into other areas such as sign & display and commercial packaging.

Diversification could go really well, or really bad as in the case of Peter Lynch's diworsification. Unfortunately I don't have any particular insight as to how well management and the new CEO will execute this strategy. With $43m in net cash (less some allowance for a potential German lease liability), they have ammunition to go buy more sign & display type businesses which in the private market ought to be no more than 4-5 EBIT. It would be a great result to see management turn the business around and navigate past an extremely difficult period.    

Corporate costs last year were $11.5m and they wouldn't provide guidance as to what these costs will be this year. To be fair, they probably in part don't know exactly themselves. If another PXUPA holder throws a legal grenade at them, PPX is responsible for the PXUPA Responsible Entity's legal fees.

In addition, there were no numbers around the Q1 update. Noting that Australia got off to a 'difficult' start (Asia stable and NZ good), it was hard not to be a little bit alarmed about the short term earnings of the business. If the old business declines faster than what they can build the new business, then the result just isn't going to be pretty in the short run. 

Finally, there is the issue of PXUPA. Management did seem genuine in their expressed desire to resolve the PXUPA issue, yet at the same time made it clear the fiduciary responsibility of the board was to PPX shareholders. So my read is that PXUPA shareholders will not be offered the farm, if any deal is made.

After the AGM, I'm just not sure with how much confidence we can value the business. If we don't know what the corporate costs are and they aren't telling us how Q1 went, then just what valuation do we use? Book value isn't going to be overly useful if the assets are in an industry declining. Crassly, if we take the $43m net cash and assume no liabilities outside of ANZA and assume last years EBIT of $14.7m will be earned again this year and also assume corporate costs reduce to $5m to produce net EBIT of $9.7m and give this an EBIT multiple of 5 (which is generous considering you can buy PMP on 4*), you get a sum of part of the parts valuation of $101m. This is even more conservative than previous valuations I have arrived at. This of course is all a bit of a stab in the dark!

Given that both PPX and PXUPA have both rallied pretty hard, the combined value of those securities is now $63.8m (PPX $22.5m and PXUPA $41.3m). So regardless of how the pie gets split between PPX and PXUPA and if you adopt a more conservative valuation because we just don't know what the numbers are, then the upside is not necessarily that big from here.

I've taken a more conservative approach and sold my PXUPA into the recent price strength and been happy with that decision. Also happy to get back in if I can get comfortable there is plenty more upside to come - I just can't see it right at the moment. If I am proven to be too conservative, then so be it.    

Kristian 

Disclosure: own PMP