Tuesday, June 17, 2014

Neustar Is A Compelling Long-Term Deep Value Play

Summary

Neustar shares have been battered by negative rumors and headlines.
A high-upside and low-downside creates a unique investment opportunity.
Neustar is a compelling long-term deep value play.
Neustar (NYSE:NSR) is a company that has been troubled by a barrage of rumors concerning its ability to retain its Number Portability and Administration Center (NPAC) contract, which represents around 50% of revenue. The stock price has fallen by nearly 50% in the past 6 months and short interest is at 31.40% as of May 30th, 2014 (Yahoo! Finance). Due to the unique situation of Neustar, I have attempted to calculate a fair market value for the price of Neustar shares. My results and conclusion are below.
Assuming a 2% growth rate, at a price of $24.35, this implies a WACC of 19.93%, and assuming industry averages, an equity required rate of return of 23.02%. For me, as an equity investor, this is more than an acceptable rate of return, considering current yields and market sentiment. Of course, this is assuming Neustar wins the contract and continues to service the NPAC.
Assuming a 2% growth rate, an industry average WACC, and the current price per shares of $24.35 implies FCFF of just $1.37/shares, which represents a loss of 67.87% of FCFF.
Let's assume an absolute worst case scenario of a loss of 75% of cash flow. This means forecasted FCFF of just $1.07 per share. If we assume a 2% growth rate, and an industry average WACC of 7.76%, we arrive at a price per shares of $18.95. This gives us a downside of ~20% and an upside of nearly 100% (assuming a contract win and continuing FCFF).
Keep in mind that with a minimal forecasted growth rate of 2% in perpetuity, these are all extremely conservative estimates, as Neustar's other sectors are still growing at around 10%. In this case, we can't apply a simple FCFF growth model, as the short-term growth rate is too high and it would be foolish to assume that the 10% growth rate continues in perpetuity. Let us perform a (grossly) simple calculation and assume all earnings figures are reduced by 50%. We can then apply the Information Services industry average multiples for EV/Sales of 4.05, EV/EBITDA of 14.48, EV/EBIT of 20.62, and Price/Book of 5.10 to calculate prices of $17.96, $26.93, $24.93, and $24.89, respectively. With an equal weight to each multiple, we get a price of $23.67. Thus on a relative basis, the entire price of losing the NPAC contract appears to have been priced into the stock.
Neustar is a great deep value play that has minimal downside and very large upside. On both a worse case scenario FCFF and an industry-relative basis, Neustar appears to be fairly - perhaps even slightly under-priced. Furthermore, in 2013, the company repurchased $285.3 mm in shares, representing 9% of shares outstanding. Cheap debt helps, but this shows unwavering commitment by management to the operations of the company. To take advantage of this situation, I would recommend purchasing call options, or even going long the stock if you have a long time horizon.
Of course, the market is unpredictable and the stock price could fall further in the short term. But with all of the rumors and headlines in the past couple of months, any potential bad news has already been priced in.
Please see my work below. All figures come from the Neustar investor relations website which can be found here: http://www.neustar.biz/about-us/investor-relations
Industry Averages - Information Services
Cost of equity: 8.73%
Pre-Tax cost of debt: 4.54%
WACC: 7.76%
Market debt/Capital: 16.06%
Tax Rate: 17.0%
Neustar FCFF 1Q2014
2014 annual FCFF = Adjusted NI + Interest (1-T)+ Depreciation - WCInc - FCInv
= 238,000+19,460.57+27,460-13,853-13,634=257,613.57
257,613.57/60.23mm shares = $4.28 FCFF
Disclosure: The author is long NSR. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

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