BBSI: Three Layers of Value
Board: Value Hounds
3 Layers of Value:
First Layer: Invested Capital / Asset Value
No growth, value of invested capital: $132 million or $19.1 per share. This is suppose to reflect the value of replicating the business today from an independent source.
This assumes no competitive advantage as measured by its ROIC relative to its cost of capital.
Second Layer: Earnings Power Value
When there is a franchise/competitive advantage then one would expect to see ROIC greater than WACC. Assuming no growth the franchise value shorthand in my view is ROIC/WACC.
Currently BBSI is expanding its ROIC as its Invested Capital requires little attention and as revenue grows, its earnings power also expands. During the past cyclical peak I calculate that in June ’05, BBSI realized a rough cut ROIC of 16.6%. We can use that for an upper-end value.
16.6%/9.2% = 1.8X. An EV/IC of 1.8X would indicate a value around $33.50
That would indicate an additional $14.40 in value based on the companies franchise earnings power over its assets without consideration for future growth. We could assume a future ROIC will generate an even higher franchise value but this is a start based on the past 9 years of results.
Third Layer: Value of Growth
The market based on current valuation of $89.70 would suggest $56.20 or 63% of the company’s share price is based on future growth expectations.
A 10-year Economic Value Add (EVA) model can provide some insight to the growth value via expectations -- but still highly subjective in terms of assumptions.
With invested capital growth likely slower than revenue growth – one has to expect ROIC to continue to expand on top of Invested Capital. To get to the current value one “could” assume 12% IC growth and ROIC expanding to 15%, 20%, and then 25% through its terminal phase. Assuming a static WACC of 9.2% -- my value comes to $89. One could slow IC growth further and expand ROIC higher (assume operating margin expands even higher.) The sky is the limit. Clearly this is where additional due diligence is helpful on estimating industry specific expectations etc.
Note that if the market is looking to a 25% ROIC that would imply a 2nd layer value closer to a EV/IC multiple of 2.7X which is $49.84 per share and future growth is $40 or ~45% of current value. Still growth is required to generate the higher value wherever that might end up at.
What would this investor do?
Clearly this is not a fat pitch in my opinion. This company should have hit my radar back in 2011 when ROIC had bottomed even in 2011 and EV/IC was at .7X and a stock price at $15. With aggressive future ROIC assumptions (relative to history) and assumptions of 45% of value based on future growth – I don't think I have a competitive advantage on knowing how this will end up so I would pass at current levels. Regardless, I am happy to see others profit from the rise in valuation.