ValuFocus - ValuAnalysis · ValuFocus | 3 Identifying an Economic Franchise ValuAnalysis pursues a...

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ValuFocus ValuFocus is a selection of global companies with unique

characteristics: both a sustainable and affordable franchise. We define

an economic franchise as the ability to generate, sustainably, an economic

rent (or free cash flow asset yield) above the cost of capital. It is a rare asset

in public markets, and the more sustainable and undervalued the

franchise, the rarer the asset. ValuFocus attempts to identify these

uncommon breeds.

An unassailable, sustainable and undervalued franchise is mythical,

even though the compounding effect of a franchise is almost always

underestimated. Fortunately, economic franchises are also a target for new

entrants and competitors. Occasionally, franchises do become attractively

priced as the market may overestimate an attack from competitive forces

attempting to corner the firm into giving up excess return, or from a

general, investor-induced doubt regarding the firm’s ability to sustain the

franchise. A market-wide re-appraisal of the equity risk premium (upwards)

can help as well.

We propose a typology of Franchises in Emerging, Contentious and

Core. The latter is closest to the myth described above, but is real: it

concerns solid global companies whose compounding ability is currently

underestimated by the market, in our view. Emerging Franchises concern

newer and/or largely untested business models with the early signs and

characteristics of a franchise. Contentious Franchises are franchises under

real or expected threat. Real means that the firm is in the process of giving

up some rent to competitive forces; what is contentious here is how much

it will be able to retain and sustain. Expected means that investors

themselves anticipate a rapidly fading rent.

The full map of Affordable Franchise Owners is on page 18, preceded

by a name by name rationale for their inclusion (pages 12 to 17), and a one

page note (“Running the Numbers”) on selected names from page 19. We

intend to review ValuFocus monthly, to rotate the Running the Numbers

notes, and on an ad hoc basis, expand into detailed company reports.

Issue One – 12th June 2017

Pascal Costantini (+44) 203 058 2931 | Janet Lear (+44) 203 058 2934 | Diarmid Ogilvy (+44) 203 058 2932

ValuFocus | 2

Summary

IDENTIFYING AN ECONOMIC FRANCHISE ................................................................................................................................................... 3

THE CLASSIC EARNINGS MULTIPLE-FOCUSED SELECTION PROCESS IS NOT DISCRIMINATING ENOUGH ........................................................................................ 3

FROM A MULTIPLE-FOCUS SELECTION TO FRANCHISE ANALYSIS ........................................................................................................................................... 4

VALUING AN ECONOMIC FRANCHISE ......................................................................................................................................................... 7

WONDERFUL COMPANY, UGLY PRICE ................................................................................................................................................................................ 7

MULTIPLE DEMENTIA ........................................................................................................................................................................................................ 7

THE THREE SOURCES OF VALUE… ...................................................................................................................................................................................... 8

…AT THE RIGHT PRICE ...................................................................................................................................................................................................... 9

SELECTING AN ECONOMIC FRANCHISE ..................................................................................................................................................... 10

A TOUGH SELECTION PROCESS ....................................................................................................................................................................................... 10

A TYPOLOGY OF FRANCHISE OWNERS .............................................................................................................................................................................. 10

CORE FRANCHISE – SUMMARY ......................................................................................................................................................................................... 12

EMERGING FRANCHISE – SUMMARY ................................................................................................................................................................................. 14

CONTENTIOUS FRANCHISE – SUMMARY ............................................................................................................................................................................ 16

THE FULL MAP OF VALUFOCUS’ AFFORDABLE FRANCHISE OWNERS.................................................................................................................................... 18

RUNNING THE NUMBERS (RTN) PAGES ..................................................................................................................................................... 19

GLOSSARY.................................................................................................................................................................................................... 43

DISCLAIMER ................................................................................................................................................................................................. 44

CONFLICTS OF INTEREST .......................................................................................................................................................................................... 44

ValuFocus | 3

Identifying an Economic Franchise

ValuAnalysis pursues a two-pronged approach in its investment research: a focus on the “value factor”, complemented,

“enlightened” by a myriad of other, more analytical factors: level of rent (or free cash flow asset yield), capital consumption

and intensity, competitive advantage, fade, growth etc... ValuFocus is the tip of this iceberg, i.e. a selection of companies

which we believe will deliver an attractive risk-adjusted return, among a universe of some 800 global companies.

The classic earnings multiple-focused selection process

is not discriminating enough

We will never argue against buying low and selling high multiples,

nor will we abandon the benefits of a systematic approach to

investment analysis; combined, they usually go a long way. But an

investment strategy focused solely on multiples, by definition, is

price driven before it is analytical: the market price gives the level

of the multiple, and therefore the signal (to buy or sell). Complex

issues are collapsed into a single level of multiple, which we think

is not discriminating enough.

By way of illustration, the table (right) breaks down the “PE” ratio1

of two US and two European stocks into its two sub-components,

asset multiple and asset yield2.

1 We call it “normalised economic PE” because it is calculated with corporate

economic data, such as free cash flow rather than profits, economic capital

rather than accounting book value, and averaged (“normalised”) over a cash flow

cycle.

Source: ValuAnalysis

These four companies all trade on the same “PE” ratio, which

stands at a small discount to the market. Therefore, a standard

multiple-focussed investment process would consider buying all

four of them, on the basis that they all have a higher expected

return than the market. Note, incidentally, that we see no value in

developing a cost of capital argument here. For a start, we

calculate these ratios on an unlevered basis, and believe

furthermore that global companies using a normal level of debt

all have, broadly, the same access to capital at more or less the

same cost, such that they can all be pitched against a global

2 An accounting PE ratio is the price to book multiple divided by return on equity.

Its economic version divides a net economic asset multiple by an asset yield,

called here “normalised operating free cash flow rent”, or normalised operating

FCF divided by net economic assets.

McDonald’s American

Water Works

Astra-

Zeneca

BASF

Normalised

Economic PE

26.7x 26.7x 26.6x 26.7x

Asset Multiple 3.3x 1.2x 3.4x 1.5x

Asset Yield

(norm. FCF rent)

12.4% 4.5% 12.8% 5.6%

ValuFocus | 4

expected return, which we think is between 5% and 5.5% in real

terms.

Yet disentangling the PE ratio quickly opens a Pandora’s Box.

McDonald’s and AstraZeneca enjoy a low double-digit FCF rent

clearly above the cost of capital, in line with other consumer and

pharmaceutical businesses. They own some sort of economic

franchise, or the ability to sustain a FCF asset yield above the cost

of capital, a type that we call “Franchise Owners”. BASF, the large

German chemical company, is a notch above the cost of capital,

and the US water utility is slightly under. Again, bang in line with

the fact that these last two businesses have a high capital

intensity.

If they are so different, why are they on the same PE multiple?

In effect, a simple value approach solely based on multiples

disregards all the above analytical input; the final say here lies

with the asset multiple of the firm, i.e. the valuation. So long as

the latter is adequately pitched, i.e. is commensurate with the

current return, there is no discrimination between a 12.4% rent

business and a 4.6% rent business: the valuation equalises

everything. More precisely, there is an implicit assumption of

symmetrical fade: it is assumed that both will reach the cost of

capital at the same rate, and, therefore, the initial level of return

is irrelevant and can be ignored. The limits of the approach are

conspicuous.

From a Multiple-focus Selection to Franchise Analysis

In the classic Intrinsic Value framework originally advocated by

Benjamin Graham, the value of a firm is defined as Replacement

Value (of economic assets) + Franchise Value. The latter is a

perpetuity of “Economic Profits”, defined as a level of sustainable

“Economic Rent” less the cost of capital. The actual level of the

rent, or FCF asset yield, has therefore always been identified, in

the literature, as essential to determine the value of an enterprise.

We think that it is possible and desirable to systematise its

analysis, because we believe that the discriminating nature of the

level of rent is increasing. This could be due to a rather

unconventional succession of major global events which has had

a profound and mainly positive effect on corporate profitability:

The disappearance of inflation (1981 onwards),

The emergence of a once in a century productivity revolution

(1995 onwards),

The emergence of major new economies (e.g. China),

The collapse of the real cost of debt (2008 onwards).

As bottom-up analysts, we would not wish to take a view on the

continuation or the reversal of these mega-trends, but we do have

a view on their long-term impact on corporate profitability,

sustainability and fade rates. We believe that a number of

Franchise Owners have probably benefitted from an

entrenchment of their position, thanks to a more global footprint.

On the other hand, we suspect that (surviving) lower rent

businesses are now facing a longer period of upwards

normalisation of their rent, which puts them at a disadvantage. In

short, if after all these years of rather friendly winds, they still do

ValuFocus | 5

not produce enough free cash flow, it is legitimate to wonder if

they ever will.

Taking our examples in turn, it is clear that the level of sustainable

economic rent directly influences the strategic behaviour of the

company, its capital consumption and allocation, thus indirectly

its return to shareholders:

American Water Works, an otherwise perfectly good

company, has nowhere to go for an investor. Water

distribution is, inherently, a cost of capital business, as all the

cash generation, and more, is ploughed back into the vast

economic assets. The multiple here should simply reflect the

cost of capital, which it roughly does.

BASF is in a slightly more flexible position, being less capital-

intensive and more global by nature, but the merger between

Dow Chemicals and Du Pont suggests that the industry may

need defensive moves to consolidate its returns.

McDonald’s has lived through various fortunes historically,

but, on average, has protected its level of cash return fairly

well. It could probably be considered as the most durable and

resilient of all four, and a genuine Franchise Owner.

AstraZeneca, with the highest rent, is also a Franchise Owner,

but of a different kind; it illustrates that a higher rent does not

necessarily equal a more sustainable business. Like almost

any other pharmaceutical company, AstraZeneca is facing a

vicious spiral of price pressures which has collapsed its cash

flow margin and operating cash return, as shown by the

following two charts:

ASTRAZENECA – GROSS ECONOMIC CF MARGIN AND OPERATING FCF RENT


In a context of expensive equity markets, or low risk premium, we

believe that it is particularly important to focus on such issues as

the sustainability and resilience of the rent. In the examples

above, not only the structural economic characteristics are very

different, but the future path will be too. Some will see the pharma

industry as terminally doomed or, on the contrary, at the end of a

transformation process taking it from a high margin, high volume

business to an ordinarily competitive consumer business. Some

will expect the median return of the global chemical sector to rise

after a wave of consolidation, others will consider that the

emergence of new economics will put a lid on these returns.

Elsewhere, the business model of McDonald’s will be seen as

unsustainable, given the general drive for healthier food. None of

this suggests that these four stocks should trade on the same

multiple! The level and resilience of the rent, and therefore the

emergence, sustainability or disappearance of the franchise will

be a major discriminating factor in the context of a normalisation

of the risk premium, we think.

ValuFocus | 6

As a result, ValuAnalysis believes that the most rewarding effort is

to focus on the Franchise Owners and to investigate where the

market under or over-estimates their compounding power, their

resilience, or their ability to reinvent themselves. But, as the next

section explains, not at any cost of entry.

ValuFocus | 7

Valuing an Economic Franchise

The public stock market is not overly generous; when tapped, the barrel of stocks labelled “Franchise Owners” sounds hollow.

There is, probably, more than a trickle of medium-sized companies of this kind, but for those investors in need of liquidity

and size, this quest is a struggle: Franchise Owners are in no urgent need of capital and can just as happily live in private

hands.

Wonderful Company, Ugly Price

This is, of course, an exaggeration. A number of such companies

do require some access to public markets for various reasons;

maybe because they act as an avid consolidator (i.e. consuming a

lot of capital), or maybe because the addressable market that they

covet is too vast for their own means. And, in truth, public markets

still keep some large gems in their midst, that Warren Buffett has

not yet snapped up. On our count, certainly more than, say, 150

large companies worldwide. But possibly less than double that

amount.

Like everything else rare, the inevitable corollary is that these

companies, on average, are expensive. Sometimes exorbitantly

so. Here is a random, non-exhaustive list of twenty-odd brilliant

companies, from all regions and sectors:

Keyence (Japan) Intuitive Surgical (USA) Dassault Systèmes (France)

Coloplast (Denmark) Thermo Fisher (USA) Assa Abloy (Sweden)

Rentokil (UK) Inditex (Spain) Alphabet (USA)

Reckitt Benckiser (UK) Dentsply (USA) Medtronic (USA)

William Denant (Denmark) Givaudan (Switzerland) Smith & Nephew (UK)

Stanley Black&Decker (USA) IFF (USA) Electronic Arts (USA)

SAP (Germany)

Sadly, not a single one currently trades below 38x normalized

unlevered net FCF. That’s an expected return of 2.6% per annum

(at zero growth). Objectively an expensive price tag. Do investors

actually need to care about the price of these “good to fabulous”

companies? In no more words than needed, simply “yes”. And in a

few more, below.

Multiple Dementia

Towards the end of the 1990s, Nokia was dominating the mobile

handset market; it had a global market share of 38% of what was

probably the fastest growing sector in the world: mobile

telephony. The firm had a market capitalisation of some EUR

280bn at the peak of its glory; there are still only 14 companies in

the world today with a larger market price. In the space of the

following 12 years, this market value has been reduced by 97.5%,

to ca EUR 7bn.

Between March 1997 and July 2000, we calculate that the average

ratio of Enterprise Value to unlevered last 12 months FCF was 95x,

with the lowest number over the period being 51x. Going so far

back, these multiples might be approximate, but not enough to

prevent us from labelling them “insane”. In our view, the problem

is not so much that Nokia’s management failed to foresee

ValuFocus | 8

Samsung and Apple coming after their handset division; it is that

investors did not apply a reasonable FCF multiple in anticipation

that this might happen. Forgetting to apply a “margin of safety”,

as Benjamin Graham used to call it, is a cardinal investment sin,

we think.

The Three Sources of Value…

As for ValuAnalysis, we think that our work is cut out and we see

our corporate mission:

To use our long-tested and reliable Intrinsic Value models to

identify and select those “Good to Fabulous” Franchise

Owners;

To make sure they do not carry an unjustifiable valuation risk.

To that end, we have re-engineered the standard Intrinsic Value

model, moving from the original Replacement + Franchise

formula to ValuAnalysis’ Three Sources of Value, illustrated on the

next chart (right).

Replacement Value is the economically depreciated value of net

assets, as in the original formula. We look for efficient users of

capital, growing their capital within their means. Metrics such as

Asset turn (Revenues / Assets), Asset Age / Life and Replacement

Value as a % of Enterprise Value are all important.

Franchise Value is not a perpetuity, as in the original model, but

the net present value of a market-implied fading return. We only

look at companies that can sustainably generate an economic rent

above the cost of capital (5%). Including some margin of error, this

would translate into a normalised FCF to net economic assets

(“the rent”) of 7% or above. We look at metrics such as Operating

(after maintenance CAPEX) and Net (after full CAPEX) Rent Yield,

the growth profiles of Sales and Free Cash Flow, and EBIT stability.

Ultimately, we are interested in Franchise Value as a % of

Enterprise Value.

Growth Value is calculated as a residual (market value less

replacement and franchise values), and represents the sum of the

market’s expectations of future growth and derived “abnormal”

margins. This rate of capital accumulation is also market-implied,

and also fades to a sustainable level, around GDP growth.

THE THREE SOURCES OF VALUE


ValuFocus | 9

…At the right Price

If the expected market return / cost of capital is 5%, then the

corresponding normalised operating FCF multiple should be 20x

(1/5%), at zero growth. Taking growth in capital invested into

consideration, we think that the maximum investable normalised

net FCF multiple should be in the 25x to 28x bracket. This hurdle

is relatively severe in the current market context (say the last

decade), but quite generous over a longer time frame. We have to

accept this discomfort, as ultimately, we can calculate but cannot

control, forecast or even model the equity premium that investors

choose to use. Nevertheless, this hurdle has proved particularly

effective in the past decade, as the next chart (on the right) shows.

A systematic investment in companies valued at or below 25x

normalised net FCF is able to do considerably better than buying

into the rest of the market.

RELATIVE PERFORMANCE OF PORTFOLIOS


ValuFocus | 10

Selecting an Economic Franchise

It does not take a lot out of any ValuAnalysis model to find out that Apple is a Franchise Owner. But so is Safran, the French

plane engine maker, and here stop the similarities. Not only the intrinsic characteristics of franchise ownership are diverse

(Apple’s cash rent is in the mid-40s, Safran’s is in low double digit territory), but the market assessment, and therefore the

valuation of this franchise can be dissimilar. Franchise Owners needs a typology, failing which, the same problems as buying

indiscriminately low PE companies might resurface.

A Tough Selection Process

There is more to identifying a Franchise than just observing the

level of rent, which technically has to be above the cost of capital.

Indeed, a Franchise needs to be value accretive, but sustainably

so. Furthermore, the acquisition price needs to be right and

capital consumption needs to be shareholder-friendly. We have

designed a protracted process grouped into four main areas of

our research: Franchise, Capital Consumption and Growth,

Valuation and Risk.

We look for companies with resilience and sustainability, with

metrics such as the Operating Rent Yield, the growth profiles

of Sales and Free Cash Flow, and EBIT stability. Ultimately, we

are interested in using a hurdle for Franchise Value (see page

8) as a % of Enterprise Value.

We look for efficient users of capital, preferably growing their

capital base above market levels. The amount of Revenues per

unit of Assets, Asset Age / Life and Replacement Value as a %

of Enterprise Value are all screening items.

We have explained why we consider 25x Normalised net FCF to

be an important hurdle, not to be trespassed without due

consideration. We also look for companies where the latest

Rent Yield is higher than the sector median and the Asset

multiple is lower than the sector median.

Companies with a high risk profile, whether measured by

financial debt or higher share price volatility, are either

excluded or face tougher hurdles for inclusion. We also take

into consideration the extent of Peripheral Assets as a % of

Total Assets.

A typology of Franchise Owners

Once this is completed, we identify three types of Franchises:

Core, Contentious and Emerging. All the stocks on the lists are

genuine Franchise Owners and qualify as “investable”, i.e. clearing

all or most of the hurdles above. But the probability of

sustainability of this franchise is not the same, either intrinsically

or as priced by the market.

A Core Franchise is a franchise with little dispute, both from

competitors or from investors. Coca-Cola may qualify as the

quintessential Core Franchise. Core Franchise Owners tend to

cluster between a rent of 10% and 20%, and to be at the top end

of the valuation range that we accept. The median rent of our list

ValuFocus | 11

is 12% and the median multiple is 22x. Core franchise owners are

necessary in any balanced portfolio and, by definition, the

constituents of this list are not always very surprising.

An Emerging Franchise is still, by and large, untested. It often

stems from an unusual business model (Las Vegas Sands runs

resorts in the US and Macao), or at least not mainstream

(MEDNAX). It could be a niche business which will require a lot of

transformations to become truly dominant (Amadeus), or a

genuinely emerging business (Vestas Wind Systems). Typically,

Emerging Franchises trade on similar multiples to Core, but

generate a higher rent.

A Contentious Franchise is a franchise under threat, and, as

such, a higher risk / higher reward proposition. Uncontentious

franchises are an easy call; there are quite possibly less than one

hundred such stocks in the world, and most of them are well

identified but, in the context of expensive equity markets,

demanding in terms of valuation. Unassailable franchises are

even rarer, and therefore even more expensive. Apart from these

aristocrats, a franchise is always contentious, almost by definition,

i.e. naturally disputed by new entrants, competitors, as well as

investors. In the latter case, and usually after what could be

described as a franchise accident, investors will remain in distrust

of the firm by applying a very short fade to their future cash flow

profile. A lot of such examples can be found in the pharmaceutical

industry, with the prototype being maybe Gilead. Typically, these

stocks will trade on an optically low spot multiple, certainly lower

than Core or Emerging Franchises, and the difficulty is to

determine the level and resilience of their normalised level of

return. And so, perhaps surprisingly to some, we would classify

Apple as a Contentious Franchise, whilst Safran is a Core

Franchise.

ValuFocus | 12

Core Franchise – Summary

The ten stocks below are the selected Core Affordable Franchise of our universe. They are all “buy” recommendations in that

we believe that they offer a good risk / reward and should outperform the broader market. We feature Alfa Laval, Pfizer and

Intel separately on pages 34, 36 and 38.

ValuFocus Core Affordable Franchise Owners

Norm. Rent Norm. net FCF x Comment

Microsoft 22.6% 24.3x Microsoft has started its fade some time ago: its operating cash return was 33% a decade ago, 27.6% now. This is due entirely to a clear fall in the asset turn, whilst its CF margin has been very stable over the same. Such that the only remaining question is the rate of this fade. The current 24.3x multiple is equivalent to a fade rate above 7%, way too quick by historical standards.

Alfa Laval 16.4% 20.5x See RtN on page 34 for a full Franchise Analysis.

ABB 12.0% 25.4x We think we are being conservative in our estimation of the trend (“normalised”) FCF return, which, at 12%, is some 150bp lower than the current level of rent (13.6%). The normalised net FCF multiple is 25.4x, on the cusp of our ‘value’ entry point, but we keep it in because the company is significantly better than the sector in terms of margin stability. ABB fails on our reported sales growth screening hurdle only because of the number of divestments that have been made recently.

Roche 12.0% 18.9x Roche is an interesting Core / Contentious candidate. It has significant risks in its portfolio as some CHF 20bn of revenues are under direct threat from biosimilar competition within the next three years. But this is not new news, least of all for the company. Roche also boasts the biggest potential new product launch in 2017. Meanwhile it owns three of the world’s largest drugs by revenues. The multiple reflects the challenges, we think, and does not take any positive into consideration, an ideal starting point.

Safran 10.5% 21.7x We have written a detailed note on the company in December 2016, explaining why we think that Safran’s business model of “build and service” is attractive. The shares have moved up but we still think that they belong to the Core Franchise list. The takeover of Zodiac aerospace creates noise and might be seen as distracting for management, but we don’t see this as a good enough reason to change our mind.

Nestlé 11.9% 24.2x Nestlé is producing a rent above the sector average, both on a normalized basis and today, and yet trades at a discount to the sector on asset multiple. This combination is attractive in the context of expensive equity markets, even though the normalised net FCF multiple is at the top end of what we usually consider “investable”.

ValuFocus | 13


Pfizer 12.8% 20.9x See RtN on page 36 for a full Franchise Analysis.

Kimberly Clark 8.8% 29.1x Net returns on capital remain significantly higher than both the historical average, and what is being implied by the current valuation. With less than 20% of our universe meeting our strict 'value' criterion (less than 25x free cash flow), the fact that Kimberly-Cark does so on an normalised operating basis is somewhat of a relief, rather than a reason to be terribly excited as it misses the cut on normalized net numbers (shown here), but we think the long-term positioning and franchise is still worth investigating and holding on to. It is, amazingly, the cheapest household company that we can find…

Novartis 10.2% 22.3x Novartis, like Nestlé, is probably expected to feature in a Core Franchise list, but that is not a reason to exclude it! Objectively, CF margins are steady as a rock, as is capital intensity, resulting in an equally steady profile of cash rent around 10% on a normalised basis. In the context of expensive equity markets, paying slightly more than 22x for this is not expensive. The implicit fade of 6.3% (to the cost of capital), resulting in an average rent of 7.5% over the fade period, could even be slower, in our view.

Intel 7.0% 20.6x See RtN on page 38 for a full Franchise Analysis.


ValuFocus | 14

Emerging Franchise – Summary

Emerging Affordable Franchises tend to have a higher cash return than Core, but this is not a rule and two in our list have a

relatively low rent. We rate all these stocks a “buy” and expect them to do better than the broad market, but in a perhaps

more erratic manner than Core, given the untested nature of their business model. Experian, Hoya, Vestas Wind Systems,

and Gemalto are featured separately on pages 28, 30, 32 and 34.

ValuFocus Emerging Affordable Franchise Owners


Experian 34.6% 24.0x See RtN on page 28 for a full Franchise Analysis.

Expeditors of Washington

27.3% 23.0x A good example of the service sector filling a niche role in a globalised world and, like Gemalto, a company which does not conform to the sector norm. Sales and profitability are cyclical, and margin is the biggest driver of returns. Sales growth stalled somewhat in 2016. The multiple leaves room for expansion as operational leverage should drive profits firmly on sales recovery.

Amadeus 28.9% 28.3x The equity market may have been spooked by the fading returns since the peak of 2011, whereas we think that fading returns are normal for some emerging franchises. Besides, they appear to have stabilised, which is a good sign of control of the franchise. We use a low normalised cash margin, but the share price implies a further decline in rent, at moderate levels of growth.

MEDNAX 23.4% 21.7x Another example of fast normalising returns, not unusual for an emerging franchise moving towards maturity. The market assumes that this fade of returns is going to carry on unabated, using a fade rate of nearly 8%, which is brisk. If the firm can “beat”, i.e. delay its fade for three years, we calculate an upside of c.17%. In the context of expensive equity markets, we view this as an attractive risk/reward ratio.

Hexagon 25.2% 24.4x The attraction of Hexagon has not entirely been missed by investors. The company manages to increase margins and keep asset turn high, resulting in an upward-rising rent. It seems to us that the market is sold on the growth potential of the company, with an implied average growth rate of 6% over the fading period. This makes Growth Value the largest source of Value, as per ValuAnalysis’ Three Sources of Value analysis. But arguably, Franchise Value is too low, with an implicit assumption that peak rent has been achieved. The multiple of FCF is probably a couple of points too low for this interesting company.

Hoya 13.3% 21.6x See RtN on page 30 for a full Franchise Analysis.

Vestas Wind Systems 16.4% 19.3x See RtN on page 32 for a full Franchise Analysis.

ValuFocus | 15


Las Vegas Sands 13.4% 19.7x There are maybe some doubts about the cyclicality of Las Vegas Sands’ cash margins, which are currently high, but we feel that the multiple already anticipates some retrenchment. An “asset heavy”, long duration and off the beaten tracks’ investment, at a reasonable multiple.

Gemalto 10.5% 22.6x See RtN on page 34 for a full Franchise Analysis.

VINCI 8.7% 24.2x Although VINCI has a return marginally lower than our preferred 10% benchmark, it is an attractive stock in its sector and has shown better growth in cash flow than the market median over the past 2 years. Add to this an attractive multiple, both in terms of cash flow and assets.


ValuFocus | 16

Contentious Franchise – Summary

Contentious Affordable Franchises are equally expected to outperform the broad market, and as such we rate them all as

“buy”, but expect an occasional tough ride. These franchises are under attack or suspicion. We believe, on balance, that they

are strong enough to resist both, but the probing might feel uneasy. Apple, Kone, Mylan and Qualcomm are featured

separately on pages 20, 22, 24 and 26.

ValuFocus Contentious Affordable Franchise Owners


Pandora 41.0% 16.9x Pandora is a unique investment object, and we understand why investors would be reluctant to consider an investment in this company. Yet, objectively, margins are cyclical but on a steady trend. The company uses operational leverage extremely well, as illustrated by an asset turn moving from 100% a few years ago to 200% currently. In truth, Pandora is probably an Emerging / Contentious franchise, which cumulates a lot of uncertainties reflected in the multiple. The sensitivity of the company to operational gearing is extreme, as seen recently with its first disappointing quarterly report. It would not take much for it to go the other way, with for instance the Indian market still totally untapped, or a successful turnaround of their US business. Pandora is in our Contentious Franchise list for a reason, but we think that the low multiple and the recent share price slide compensate for a lot of these uncertainties.

Cisco 21.9% 13.4x Cisco has high returns and a low cash flow multiple which looks appealing to us, reinforced by the surprising stability of cash flow margin, notwithstanding the drop in 2010. The company also has a lower asset intensity than the market as a whole. On our models, the share price discounts a steep fade of returns towards the cost of capital and we suspect this may be too pessimistic and we look for 15% upside to the shares.

McKesson 24.2% 17.1x The level of cash margin (3%...) tells investors what the underlying true business model of McKesson is: retailing. As retailing goes, this is a pretty good one, with a net economic rent in the mid-20s, something Macy’s would presumably envy. Like a retailer, the company operates on negative NWC, but carries within it some USD 15bn of inventories, exposed to price declines and therefore inventory write-down risk. The market has found a way to deal with this risk by putting the rent on a very steep fade of 12.2% per annum, averaging roughly 16% over the fade period, rather than 24.2%. If this is indeed the “new normal”, this would imply a net FCF of ca USD 1.7bn, putting the shares on a net normalised FCF multiple of 25x exactly, still an investable level, we think.

ValuFocus | 17


Kone 42.9% 19.3x See RtN on page 22 for a full Franchise Analysis.

Mylan 15.6% 22.6x See RtN on page 24 for a full Franchise Analysis.

Gilead 23.1% 10.7x We have written extensively on Gilead, and the least we can say is that timing is not our forte… The shares trade on an optically low multiple because investors price a much lower level of FCF than currently reported, due to the loss of revenues and margins on its Hepatitis C and HIV products. Even with historical trough margins as the new norm, Gilead’s multiple is 10.7x, which is not credible. A full fade analysis suggests that the market expects a collapse in growth to an average of 8% over the fading period. This looks low to us, but possible. In addition, the market is pricing a collapse of the operating FCF return to c.18%, against 33% today, approximately equivalent to a net FCF of maybe 10% (vs 23.1% today), or ca USD 3.4bn of net FCF. Thus the stock trades in fact on (strange concept for a strange situation) a “market-implied normalised” FCF multiple of less than 25x “new” normalised net FCF.

Apple 53.2% 12.2x See RtN on page 20 for a full Franchise Analysis.

Novo Nordisk 21.1% 20.3x We have written a detailed report on the company in November 2016, shortly after its major profit warning, suggesting that this might be a good entry point into this well managed business. The shares have nicely rebounded but we remain of the opinion that Novo has enough fire- power and management expertise to protect its franchise. We put it in Contentious rather than Core because investors ought to expect more such “franchise accidents” going forward, and the fade is probably steeper now than a few years ago as a result. But the multiple is attractive in the context of expensive equity markets.

Qualcomm 15.8% 21.6x See RtN on page 26 for a full Franchise Analysis.


ValuFocus | 18

The Full Map of ValuFocus’ Affordable Franchise Owners

CONTENTIOUS, CORE AND EMERGING POSITIONED BY LEVEL OF NORMALISED NET RENT AND NET FCF MULTIPLE


ValuFocus | 19

Running the Numbers (RtN) Pages

APPLE .......................................................... p. 20

KONE .......................................................... P. 22

MYLAN ....................................................... p. 24

QUALCOMM ............................................. P. 26

EXPERIAN ................................................... p. 28

HOYA ......................................................... p. 30

VESTAS WIND SYSTEMS ............................ p. 32

GEMALTO ................................................... P. 34

ALFA LAVAL ................................................ p. 36

PFIZER ......................................................... p. 38

INTEL ........................................................... p. 40

ValuFocus | 20

Growth in Capital Invested

Operating Net Operating Net Asset Growth

Last FY 55.6% 43.8% Last FY 11.1x 15.0x Est. Trend 25.0%

Normalised 66.2% 53.2% Normalised 9.8x 12.2x Last 10Y 37.7%

Mkt implied 20.0% Implied over CAP 11.9%

Free Cash Return FCF Multiple

The breakdown of assets is dominated by tangibles and capitalised intangibles: total R&D spend is c.5% of sales, capitalised over 7 years. Apple operates with USD 20bn of negative NWC,

treated by us as debt. The funding is simple, mostly equity with limited financial leverage. Growth Value is the largest source of value, but this is deceiving: this USD 342bn chunk

represents only 12 years of growth fading to global GDP (4.5%), averaging 11.9% per annum. The more "modest" Franchise Value is made of an equally precipitous fade: 13.9% per

annum, way above the 10% "terminal decline" mark.

Alongside its big tech peers, Apple's share price has had a

surge this year already, with investors presumably anticipating

a successful iPhone 8 launch, growth in its services business

and positive developments in Augmented Reality, redesigned

app store or HomePod smart speaker. But structurally,

investors are cautious and expect the party to end soon, as

vindicated by the 2016 cash margins under pressure, and an

economic rent on a long-term downward path for some years.

Strangely, some would say amazingly, the median Apple

investor is a pessimist; how else can one explain these mid-

single digit FCF ratios? This investment case is all about the

rate of normalisation of extraordinary returns. Apple is a

prototypical contentious franchise.

110 268

273 923

342 472

0

100 000

200 000

300 000

400 000

500 000

600 000

700 000

800 000

900 000

1000 000INTRINSIC VALUEFUNDING SOURCE MARKET VALUE

= negativeThe Three Sources of Value (USDm)

0

2 244

46 864

64 303

5 9435 254

0 Net =110 268

0

20 000

40 000

60 000

80 000

100 000

120 000

140 000

2.7 yrs

6.8 yrsECO AGE:

ECO LIFE:

Asset breakdown (gross - USD 124.6 bn)

150% 50%

100%

rel. to last 10Yrel. to Sector median

rel. to Market median

150% 50%

100%

150% 50%

100%

rel. to Normalisedrel. to Sector median


25.0%11.1x55.6%

Market Cap. (USDm) = 776 758

Ent. Value (USDm) = 726 511Technology Hardware and Equipment

Apple Inc. @ 154 (USD) 12 June 2017

ValuFocus List: Contentious Franchise

ValuFocus | 21

This document is provided by ValuAnalysis Limited, which is authorised and regulated by the Financial Conduct Authority (firm reference number 710908). This document is only permitted for individuals or firms who would

fall within the definition of a professional client as defined by the Financial Conduct Authority’s rules. This document does not provide personal recommendation based on your individual circumstances. By making this

information available to you, ValuAnalysis is not advising you or making any recommendation. Investments carry risk, including the risk that you will not recover the sum that you invested. The views expressed in this

document are as of the published date and based on information available at the time. ValuAnalysis does not assume any duty to update any of the information contained in this document. By viewing this document, you

confirm that you have read and accepted this disclaimer. SOURCES: Annual Reports, 10Ks, CIQ and ValuAnalysis proprietary adjustments.

Historical op. FCF Return...

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

0x 1x 2x 3x

Invest. Cycles (6.8y each)

Hist. Fut. Avg Fut.

... and Future Discounted Level

Op.FCF Return: Last 4Y: 66.2% │ Next 4Y: 43.3% (Implied)

66.2%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

'07 '09 '11 '13 '15 Norm.

Op.Rent Yld Net Rent Yld

Cash margins (first chart above) illustrate the nature of a high profile technology company: death and rebirth. In the space of a few years (2007 to 2011), Apple's margins collapsed and

recovered, a mixture of economic cycle and product development. This double-wedge effect is what the market is refusing to price continuously (see Op. Economic Profits, below),

ascribing a discount to actual Economic Profits. Margins have been stable over the last six years, but took a dip in 2016 to 33.7% as revenues took an 8% hit from primarily weaker

iPhone sales. Coupled with decreasing revenues for every $1 of economic assets expended, the OpFCF return has continued its fall from a peak in 2011 to 55.6%. And the future fading

return (fourth chart above) is a perfect continuation of this trend. There is, on top, the shadow of the company's fight with the European Commission with regard to the latter's ruling

over its Irish subsidiaries and tax structuring. But the retrospective USD 14bn potential bill is a small % of its foreign assets. More important is the potential for increase in its effective

tax rate. Inevitably, Apple will become a normal company, one day. If it is soon, it is already in the price: a 13.9% fade rate is a one way ticket to normality. If the company can manage to

slow its normalisation rate, only by a few years, let alone reinvent itself once again, the shares will re-rate by a few multiple points of FCF.

0%

10%

20%

30%

40%

50%

'07 '09 '11 '13 '15

Mrg% Norm

0%

50%

100%

150%

200%

250%

300%

350%

'07 '09 '11 '13 '15

Gross econ. CF per unit of Revenues Revenues per unit of Econ. Assets

Actual & Discounted

30718

0

20 000

40 000

60 000

80 000

'07 '09 '11 '13 '15 Norm.

EP (Op.) Discounted EP (Op.) @ 5%

Op. Economic Profits (USDm)

Fade Analysis

FRANCHISE VALUE WITH NO FADE: 888 790

FADE RATE: 13.9%

IN % OF FADING FRANCHISE VALUE: 324.5%

Selected Alternative Investments Within Same SectorCompetitive Advantage

NCR Corporation (28x, 10.6%)

Seagate Technology plc (11.6x, 13.8%)

Western Digital Corporatio (20.4x, 16.7%)

NetApp, Inc. (22.9x, 12.9%)

Samsung Electronics Co. Lt (14.3x, 7.4%)

FUJIFILM Holdings Corpora (10.2x, 5.7%)

Konica Minolta, Inc. (12.6x, 5.4%)

Samsung Electronics Co. L (14.3x, 7.4%)

Seagate Technology plc (11.6x, 13.8%)

Western Digital Corporati (20.4x, 16.7%)

Similar FCF Ret. to Apple Inc.: Similar FCF Mult. to Apple Inc.:

Economic Margin Asset Turn

ValuFocus | 22







The asset breakdown shows the light capital usage of Kone (EUR 3bn of gross capital is small for the size of its business), which explains its high cash return. Kone does operate with

negative NWC, treated as debt rather than negative asset. It expenses about 2% of revenues in R&D, which we capitalise. The company has written down about EUR 600m of gross assets

in 2012. Its IR department explains that these assets were no longer in use. The Three Sources of Value show the asset-light nature of the business, with replacement value a mere 12%

of market value. Franchise value is half the market value, due to the high starting point of cash return. This EUR 10.8bn franchise corresponds to an average FCF yield of 19,3%, fading at

a (slow) rate of 5.5% per annum. Finally, Growth Value correponds to an average growth rate of 5% exactly, in line with the past ten years.

Kone is a prototypical contentious franchise owner. Its free

cash flow rent is high (maybe flattered by a rather inexplicable

2012 gross asset write off) and thus under permanent market

suspicion, even though the market has been rerating its shares

over the past years. There is (not unduly so) suspicion around

Kone's reliance on China, a country which represents circa 30%

of its revenues. Margins are high and have been under

pressure in 2016 and to date, with a drop in Q1 2017 operating

profit. We estimate that the current valuation could withstand

a 20% fall in gross cash flow margin, but not more. There might

be suspicion around revenue recognition as well, which uses

the more complex % of competion method for long-term

projects, but it is relatively small.

2 723

10 948

9 283

0

5 000

10 000

15 000

20 000


= negativeThe Three Sources of Value (EURm)

0

410

1 446

899 2546

0 Net =2 723

0

500

1 000

1 500

2 000

2 500

3 000

3 500

3.9 yrs

9.6 yrsECO AGE:

ECO LIFE:

Asset breakdown (gross - EUR 3 bn)

150% 50%

100%



150% 50%

100%

150% 50%

100%



6.0%17.9x45.1%

Market Cap. (EURm) = 23 251

Ent. Value (EURm) = 22 943Machinery (Capital Goods)

Kone Oyj @ 44 (EUR) 12 June 2017


ValuFocus | 23

This document is provided by ValuAnalysis Limited, which is authorised and regulated by the Financial Conduct Authority (firm reference number 710908). This document is only permitted for individuals or firms who would fall

within the definition of a professional client as defined by the Financial Conduct Authority’s rules. This document does not provide personal recommendation based on your individual circumstances. By making this





0%

10%

20%

30%

40%

50%

60%

0x 1x 2x 3x 4x 5x 6x


Hist. Fut. Avg Fut.

Kone may have seen its peak cash return


Op.FCF Return: Last 4Y: 50.3% │ Next 4Y: 41% (Implied)

50.3%

0%

10%

20%

30%

40%

50%

60%

'07 '09 '11 '13 '15 Norm.


Kone is one of these businesses operating on a "new equipment + maintenance" model: as the installed base grows, so does the tail of service contracts. The cyclicality of cash margins

(first chart above) is smoothed, as a result; note the upward trend. The historical operating FCF return (third chart above) looks rather scary, and shows in its glory how much Kone has

benefitted from the Chinese boom. But why so high? Kone appears to be stingy on capital consumption and operating costs (better margins than Schindler) and a substantial beneficiary

of operational leverage. Investors are rather sceptical about the sustainability of such a level, and we agree. The right-hand chart above shows a market-implied representation of the

future fading cash profile, which suggests that Kone has seen its historical peak return. The fade rate of 5.5% p.a. is not very steep, but the cyclical nature of Kone's cash return is deeply

anticipated. Note that Kone has a 16% EBIT corporate target, which, if achieved, would easily beat these anticipations. Scepticism around the company's achievements is not recent. The

op. Economic Profits chart, below, shows that the discounted level (orange line) is best fitted to actual achievements with a 5.5% discount rate, higher than our standard 5%. If the

current cyclical downturn is not too pronounced, Kone trades on 22.3x depressed net FCF, which is not expensive in this market.

0%

10%

20%

30%

'07 '09 '11 '13 '15

Mrg% Norm

0%

50%

100%

150%

200%

250%

300%

350%

'07 '09 '11 '13 '15

This change is due to a write down of gross assets in

2012. 300% of capital intensity is in line with

competitors.


Actual & Discounted

1110

0

500

1 000

1 500

'07 '09 '11 '13 '15 Norm.

EP (Op.) Discounted EP (Op.) @ 5,5%

Op. Economic Profits (EURm)

Fade Analysis


FADE RATE: 5.5%



Atlas Copco AB (26.6x, 23.7%)

WABCO Holdings Inc. (26.1x, 14.3%)

Snap-on Incorporated (21.9x, 17.7%)

IDEX Corporation (26.2x, 28.2%)

Makita Corporation (27.7x, 7.4%)

Wärtsilä Oyj Abp (28.3x, 15.7%)

Atlas Copco AB (26.6x, 23.7%)

Schindler Holding AG (31.4x, 24.1%)


Pentair plc (28.7x, 16.3%)

Similar FCF Ret. to Kone Oyj: Similar FCF Mult. to Kone Oyj:


ValuFocus | 24







Capitalising intangible assets makes a big difference to the total asset base of this company, in common with its peer group. Note that Mylan is relatively more leveraged than the peer

group, though no liabilities are falling due until mid 2018. Our fade analysis suggests that Mylan needs to maintain returns on capital for 5 years before they fade to cost of capital

thereafter. We think this should be possible given the broad product range. Within our assumptions the split of value between franchise (driven by excess returns) and growth is very

even: management needs to maintain the profitability of the business.

Mylan has attracted negative headlines in the last six months

or so over pricing of its epi-pen product, and management was

summonded before a congressional hearing. Subsequent

press showed that the hearing raised as many questions as it

answered. We are alert to the consequent risks - hence its

inclusion in our contentious category - but feel that the

company shows enough value and stability of returns for an

investment case to be made. Normalised net returns on capital

are over 15%, a premium to the market median, and the

valuation on current net free cash flow of 25.4x is at a

significant discount to the market, which is in the 30s. We also

assume that the confusion following the intense corporate

activity of the past two years is fading away.

10 801

12 175

15 369

0

5 000

10 000

15 000

20 000

25 000

30 000

35 000

40 000



0

2 023

5 308

4 257 247103

1 577Net =10 801

0

2 000

4 000

6 000

8 000

10 000

12 000

14 000

16 000

3.8 yrs

9.6 yrsECO AGE:

ECO LIFE:


150% 50%

100%



150% 50%

100%

150% 50%

100%



7.0%19.1x17.1%


Ent. Value (USDm) = 38 340Pharmaceuticals (Pharmaceuticals, Biotechnology and Life Sciences)

Mylan N.V. @ 40 (USD) 12 June 2017


ValuFocus | 25







0%

10%

20%

30%

0x 1x 2x 3x 4x 5x


Hist. Fut. Avg Fut.



18.7%

0%

10%

20%

30%

'07 '09 '11 '13 '15 Norm.


Gross margins have improved substantially (first chart above) over the past decade or so, and this is what is helping to drive the improvement in operating rent. Note that we normalise

this CF at a relatively high level because we believe that the aquisitions of Abbott's non US business, followed by Meda have actually consolidated the level of margin. There seems to be

some sort of ability in the company to incorporate underperforming pharna assets (Meda's margins were lower than Mylan's core) and extract a higher margin, which the market is

reluctant to recognise. We agree that Mylan's intense corporate activity does not help the analysis and probably deserves a discount, but we want to keep an open mind about the

achievements. The market-implied fade profile (fourth chart above) does not seem too optimistic, in our view, with returns expected to decline towards the cost of capital without a

period of consolidation. We have modelled this with a fairly slow fade (5,3%), but not inconsistent with other comparable businesses. The operating economic profit chart (second chart

below) suggests that investors on aggregate have never been carried away by Mylan, and have only ever paid for what they see. We would not suggest it to be any other way, but this

means that, as the company should carry on producing higher economic profits, its value should carry on appreciating commensurately .

0%

10%

20%

30%

40%

'07 '09 '11 '13 '15

Mrg% Norm

0%

20%

40%

60%

80%

100%

120%

'07 '09 '11 '13 '15


Actual & Discounted

1377

- 500

0

500

1 000

1 500

2 000

'07 '09 '11 '13 '15 Norm.



Fade Analysis


FADE RATE: 5.3%



Teva Pharmaceutical Indust (17.7x, 13.6%)

Johnson & Johnson (25.4x, 13.8%)

Valeant Pharmaceuticals In (18.3x, 16.1%)

Hikma Pharmaceuticals PLC (19.3x, 13.8%)

Roche Holding AG (21.6x, 11.8%)

Merck & Co. Inc. (24.8x, 10.8%)

Shionogi & Co., Ltd. (23.4x, 12%)

Johnson & Johnson (25.4x, 13.8%)

Roche Holding AG (21.6x, 11.8%)

Santen Pharmaceutical Co. (23.2x, 10.4%)

Similar FCF Ret. to Mylan N.V.: Similar FCF Mult. to Mylan N.V.:


ValuFocus | 26







The most noticable figure on the charts above is the economic life; 5.6y is very short and indeed suggests that QUALCOMM's franchise could be blown away at the drop of a hat, but also

could re-invent itself very quickly. Unsurprisingly, the bulk of economic assets is in capitalised R&D, which is expensed in the accounts to the tune of 20% of revenues, in line with

semiconductor manufacturers. We ascribe a life of 5 years only. The Market Value is broken down fairly equally into three constituent blocks, with Franchise Value averaging a FCF rent of

8.1% over the fade period. The corresponding growth over the fade period is 5.1%.

It would be futile for us to try and second-guess what is going

to happen to QUALCOMM, with respect to its various legal

involvements. It is however a prime Contentious candidate

because its franchise is clearly under attack, and investors on

aggregate have so little faith in its sustainability that they put

the shares on an optically low double-digit multiple of FCF,

around 15x if you use unadjusted accounting data. We are

presenting here the reverse exercise: if we assume that

markets are efficient and QUALCOMM actually trades on a

sensible but mildy attractive normalised net FCF multiple, in

what kind of cash margin assumptions would we need to

believe? In short, a collapse from 42.8% to the historical all

time low of 34% in gross CF margin.

19 445

19 927

27 907

0

10 000

20 000

30 000

40 000

50 000

60 000

70 000

80 000



0 1 225

21 034

6 515284 784

253 Net =19 445

0

5 000

10 000

15 000

20 000

25 000

30 000

35 000

2.5 yrs

5.6 yrsECO AGE:

ECO LIFE:


150% 50%

100%



150% 50%

100%

150% 50%

100%



6.0%20.0x13.9%


Ent. Value (USDm) = 67 361Communications Equipment (Technology Hardware and Equipment)

QUALCOMM Inc. @ 58 (USD) 12 June 2017


ValuFocus | 27







0%

10%

20%

30%

40%

50%

60%

0x 1x 2x 3x 4x 5x


Hist. Fut. Avg Fut.



13.9%

0%

10%

20%

30%

40%

50%

60%

'07 '09 '11 '13 '15 Norm.


For a start, we can't help observing (second chart above) that QUALCOMM employs capital efficiently, increasing its asset turn from 80% a decade ago to 1.2x now, a commendable but

largely irrelevant achievement to fight its current woes. What is more interesting is "New QUALCOMM". New QUALCOMM is the fruit of two knowns and an unknown: the current market

value and a sensible but attractive multiple (we have chosen 22x normalised net FCF) on the one hand, and a new level of "normalised" FCF once the company sorts out its legal battles,

which we assume will have a structural cost. In reality, New QUALCOMM's FCF will itself stem from numerous items (margin, revenue level, investment etc...), but for clarity's sake, we

have normalised the gross CF margin only, to its previous trough, 34% (chart one above). This trickles through to the operating cash return (third chart above) and its "new" normalised

level, 13.9%. From here on, "new QUALCOMM" is assumed to live its life as a normal company, with a slight cyclical profile and a fade comparable to other major technology companies

(4.3%). In numbers, New Qualcomm generates between USD 1.3 to 1.5bn less unlevered FCF than actual QUALCOMM, to about USD 3bn (3*22x is indeed c. USD 69bn, the current EV).

This is the scenario that the current share price buys today. In the context of scarce turnaround stories and expensive equity markets, we think that the risk/reward ratio is not

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

'07 '09 '11 '13 '15

Mrg% Norm

Margins are

"normalised"

at 34% from

2014

0%

20%

40%

60%

80%

100%

120%

140%

'07 '09 '11 '13 '15


Actual & Discounted

2385

0

1 000

2 000

3 000

4 000

5 000

6 000

'07 '09 '11 '13 '15 Norm.



Fade Analysis


FADE RATE: 4.2%



Nokia Corporation (132.3x, 1.7%)

F5 Networks, Inc. (16.3x, 35.9%)

Cisco Systems, Inc. (12.4x, 27.8%)

Ericsson (19.1x, 6.2%)

Juniper Networks, Inc. (21.4x, 9.2%)

Cisco Systems, Inc. (12.4x, 27.8%)

Juniper Networks, Inc. (21.4x, 9.2%)

Harris Corporation (27.3x, 11.2%)

Ericsson (19.1x, 6.2%)

F5 Networks, Inc. (16.3x, 35.9%)

Similar FCF Ret. to Similar FCF Mult. to


ValuFocus | 28




Normalised 41.0% 34.6% Normalised 20.3x 24.0x Last 10Y -2.7%



We do not capitalise anything for Experian but consider that the bulk of its on-balance sheet intangibles (which we call "concessions") are economic in nature. Just over a third are

acquired customer relationships, software development and marketing related assets, a third is databases and the remainder capitalised software. The funding source is mostly equity,

with restrained financial leverage. The Three Sources of Value show the asset-light nature of the business, with replacement value at a mere 12% of market value. Franchise value is

almost half the market value, due to the high starting point of cash return, fading at a rate of 6.1% per annum to the cost of capital. Growth Value correponds to an average growth rate

Experian, like a typical Emerging Franchise owner, is not an

obvious bargain, even though it still trades at a discount to our

hurdle of 25x normalised net FCF, and at a significant discount,

therefore, to the market on this measure. Furthermore, its 10Y

historical asset growth appears negative, which is an oddity

due to the immaturity of the earlier returns which is making

the level of economic depreciation move around too much. In

reality Experian grows at GDP+, which is the management's

commitment. But Franchise Owner it is: the company has

leading market positions in credit data and analysis, a

substantial business in the US as well as in Europe and is at the

cornerstone of "big data" as far the consumer is concerned. An

attractivelly priced "emerger", we think.

2 729

11 394

8 879

0

5 000

10 000

15 000

20 000



0

2 003

0

870181 67

0 Net =2 729

0

500

1 000

1 500

2 000

2 500

3 000

3 500

4.4 yrs

9.7 yrsECO AGE:

ECO LIFE:


150% 50%

100%



150% 50%

100%

150% 50%

100%



4.5%18.5x43.2%


Ent. Value (USDm) = 23 005Professional Services (Commercial and Professional Services)

Experian plc @ 16 (GBP) 12 June 2017

ValuFocus List: Emerging Franchise

ValuFocus | 29







0%

10%

20%

30%

40%

50%

60%

0x 1x 2x 3x 4x 5x


Hist. Fut. Avg Fut.


Op.FCF Return: Last 4Y: 41% │ Next 4Y: 40% (Implied)

41.0%

0%

10%

20%

30%

40%

50%

60%

'07 '09 '11 '13 '15 Norm.


Cash margins (first chart above) have risen steadily since the challenging conditions endured through the financial crisis of 2008. We normalise their level towards the higher end of this

range, in the belief that growth and above all acquisitions have made these margins more resilient. Its low and slightly improving capital intensity offers some room for manoeuvre from

any margin pressure, potentially in the Consumer Services division. Experian is not about growth and we can assume that the market will get this variable right. The market-implied

average growth rate is 4.9%, in line with management's expectations. The corresponding average operating rent is 21.2%, with an average fade rate of 8.2% per annum, which is not

characteristically low (for this qualification, you need to go below 5%). Graphically (last chart above), this means that the market is implicitly expecting Experian's operating rent to wobble

around normalised levels (41.0%) for about an investment cycle, before starting a brisk plunge towards the cost of capital. Note that we have fitted a cyclical profile here as well to check

that the current valuation could withstand some volatility in the cash return, which it evidently can. If credit data is as important as generally assumed, Experian should easily be able to

control its fade better than what is implied here, and push back its peak return well into the future.

0%

10%

20%

30%

40%

50%

'07 '09 '11 '13 '15

Mrg% Norm

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

'07 '09 '11 '13 '15


Actual & Discounted

1012

0

200

400

600

800

1 000

1 200

1 400

'07 '09 '11 '13 '15 Norm.



Fade Analysis


FADE RATE: 8.2%



Robert Half International (16.9x, 24.6%)

Verisk Analytics, Inc. (37.3x, 27.4%)

Equifax Inc. (34.3x, 27.5%)

Adecco S.A. (22.6x, 24.9%)

Capita plc (18.2x, 21.6%)

Capita plc (18.2x, 21.6%)

Adecco S.A. (22.6x, 24.9%)

Randstad Holding NV (27.2x, 19.8%)

ManpowerGroup Inc. (21.9x, 16.4%)

Robert Half International (16.9x, 24.6%)

Similar FCF Ret. to Experian Similar FCF Mult. to Experian


ValuFocus | 30







Hoya is "asset heavy"; its asset breakdown does not include a lot of intangible assets, despite the fact that we capitalise circa 6.5% of revenues representing R&D costs expensed in the

accounts. The "concession assets" represent client relationship, probably connected to the optician retail business that they have. The Three Sources of Value chart show a typical

Japanese funding situation, which, despite some share buy backs, still carry a net cash position. We like the good equilibirum between the Three Sources of Value. Franchise Value is

made of a constant average operating FCF yield of 8.0% over the fading period (vs 16.1% as of last FY). The fade rate is 5.5%, which is relatively low.

Hoya, like Olympus or Santen among others, belongs to this

"new" type of Japanese companies successfully leveraging an

average legacy business into a more attractive bunch of assets.

"Life care" now represents two thirds of Hoya's assets, and is

driving the group. This is one of the reasons, we think, for the

re-rating of the shares. In the context of expensive equity

markets, and despite its share price at a quasi-all-time-high, we

think that the company is not expensively valued; the share

price anticipates the cyclical nature of the residual

semiconductor-related business. Because Hoya is moving away

from it, normalised returns are probably higher, today, than

our calculated 12.8%, and 22.4x normalised net FCF looks

acceptable. A cheaper alternative to Essilor, in summary.

666 846

614 924

585 398

0

500 000

1000 000

1500 000

2000 000


= negativeThe Three Sources of Value (JPYm)

0 5 711

223 078

501 5284 901 0

101 952 Net =666 846

0

100 000

200 000

300 000

400 000

500 000

600 000

700 000

800 000

900 000

5.0 yrs

11.7 yrsECO AGE:

ECO LIFE:

Asset breakdown (gross - JPY 837.2 bn)

150% 50%

100%



150% 50%

100%

150% 50%

100%



5.0%16.3x16.1%

Market Cap. (JPYm) = 2113 172

Ent. Value (JPYm) = 1866 188Healthcare Equipment and Supplies (Healthcare Equipment and Services)

Hoya Corp. @ 5685 (JPY) 12 June 2017


ValuFocus | 31







0%

10%

20%

0x 1x 2x 3x 4x 5x 6x


Hist. Fut. Avg Fut.



12.8%

0%

10%

20%

'07 '09 '11 '13 '15 Norm.


It is difficult to judge exactly Hoya's future cyclical profile, as the group evolves, but we can assume that it will be slightly less pronounced that historically, thanks to the growth of the life-

science businesses. The calculated normal level of gross economic CF margin (first chart above) is at the higher end of the historical range, but because Hoya is changing its asset mix, we

are not forcing a lower normalised level. Yet, there is no disputing that margins are currently high, and for the same reason, so is the operating FCF return, third chart above. The merit

of these shares are in the valuation, we think. Most comparable companies trade on multiples of net FCF in the mid 30x, when Hoya trades on 22.4x. This discount can be put in context

on the implicit future profile of operating FCF return, fourth chart above. We are able to fit the current valuation with a marked cyclical profile, including a peak return not far from

current levels. If Hoya's management are able to execute their programme reasonably well, the future profile should be more benign than implied by current aggregate investor

sentiment. On balance, this implicit profile is an invitation to disregard the current high level of margin and put some faith in the valuation.

0%

10%

20%

30%

40%

'07 '09 '11 '13 '15

Mrg% Norm

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

'07 '09 '11 '13 '15


Actual & Discounted

60527

0

20 000

40 000

60 000

80 000

'07 '09 '11 '13 '15 Norm.


Op. Economic Profits (JPYm)

Fade Analysis


FADE RATE: 5.5%



DENTSPLY SIRONA Inc. (35.6x, 13.7%)

Hologic Inc. (31.3x, 17.9%)

Varian Medical Systems, In (25.6x, 17.1%)

Essilor International SA (34.8x, 15.9%)

Medtronic plc (38.3x, 12.5%)

Essilor International SA (34.8x, 15.9%)

Hologic Inc. (31.3x, 17.9%)

Varian Medical Systems, I (25.6x, 17.1%)

ResMed Inc. (31.6x, 17.4%)

Elekta AB (34.9x, 17.8%)

Similar FCF Ret. to Hoya Corp.: Similar FCF Mult. to Hoya Corp.:


ValuFocus | 32







The breakdown of gross assets shows a balance between tangible and intangible assets. We capitalise 2.5% of revenues expensed by the company, representing its R&D effort. In

addition, the company carries some "concession assets" representing mainly "completed development projects" and software. Vestas keeps a large amount of cash on balance sheet, of

which a small amount is restricted; non-interest bearing liabilities include, among others, warranties. Franchise Value is the largest source of value, equivalent to an average rent of 9.8%

over the fade period. The fade rate of 7.4% is not "fast" but not at the low end either, which would be closer to 5%. Growth should be GDP+ and is priced like this, too.

Vestas is a prime Emerging Franchise business. "Emerging"

because of the business in which it competes, and also

because only a few years ago (pre 2014), the company was in

losses, prior to launching its "Profitable Growth Strategy"

initiative. Vestas also displays some typical Emerging Franchise

characteristics, notably the volatility of key economic variables

such as rent or asset turn. The accounting of Vestas is intricate:

the company hedges its large US exposure (over one third of

revenues), co-invests in certain of its clients' projects and

receives pre-payments from others. None of this is

overwhelming but might demand a discount for some. Yet in

the context of expensive equity markets, a sub-20 multiple of

normalised net FCF appears attractive.

6 228

7 603

6 035

0

5 000

10 000

15 000

20 000



0767

2 134

3 690166 442

874Net =6 228

0

1 000

2 000

3 000

4 000

5 000

6 000

7 000

8 000

9 000

3.6 yrs

8.6 yrsECO AGE:

ECO LIFE:


150% 50%

100%



150% 50%

100%

150% 50%

100%



6.0%16.4x17.7%


Ent. Value (USDm) = 19 887Electrical Equipment (Capital Goods)

Vestas Wind Systems @ 610 (DKK) 12 June 2017

ValuFocus List: Emerging Franchise

ValuFocus | 33







-20%

-10%

0%

10%

20%

30%

0x 1x 2x 3x


Hist. Fut. Avg Fut.

Next peak return could easily match the

previous one, due to a better revenue mix.



16.3%

-20%

-10%

0%

10%

20%

30%

'07 '09 '11 '13 '15 Norm.


We have normalised Vestas' cash margin at 17% for the past three years, given some uncertainty on the cyclicality of this now structurally profitable business. Thus the last three years of

charts 1 and 3, above, are normalised levels rather than the real achievement of the company, which is higher. Apart from its unusual aesthetics, the asset turn chart does not yield much

information. What we like about the company is that it is a "build and service" model. The margins on the service part are about 200 bp higher, and as the installed park grows and ages,

the service portion should increase, too. This is why we are very comfortable with the future (fading) peak return of the company matching the historical peak return of 20%, before the

structural fade starts. Vestas is the world's largest manufacturer of wind turbines with a global footprint. This ought to give it a noticeable competitive advantage, which it should be able

to leverage in order to manage its level of economic franchise. The market-implied USD 7.6bn Franchise Value is based on a decidedly fading path, falling from high double digit to high

single digit in the space of a couple of investment cycles. We feel that this might be at the more conservative end, especially since Growth Value is also fairly undemanding, implying a

5.2% average growth rate.

0%

10%

20%

30%

'07 '09 '11 '13 '15

Mrg% Norm

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

'07 '09 '11 '13 '15


Actual & Discounted

679

-1 500

-1 000

- 500

0

500

1 000

1 500

'07 '09 '11 '13 '15 Norm.



Fade Analysis


FADE RATE: 7.4%



Schneider Electric SE (28.3x, 11%)

ABB Ltd. (24.5x, 13.1%)

Hubbell Inc. (21.7x, 15.2%)

Sensata Technologies Holdi (26.9x, 15.3%)

Legrand SA (36x, 11.3%)

Ametek Inc. (25.2x, 22.4%)

Hubbell Inc. (21.7x, 15.2%)

Emerson Electric Co. (20.7x, 20.3%)

ABB Ltd. (24.5x, 13.1%)

Sensata Technologies Hold (26.9x, 15.3%)

Similar FCF Ret. to Vestas Similar FCF Mult. to Vestas


ValuFocus | 34







The different structure of Gemalto compared to its peers is illustrated with the relatively low proportion of off-balance sheet intangible assets that we need to capitalise: tangible assets

and working capital are over 50% of the invested capital, compared to nearer 80% for, say, Oracle. Gemalto is "asset heavy" and more of an industrial company, which explains its

relatively low level of rent. The market-implied franchise value is EUR 1,7bn, corresponding to an average FCF yield of 8,4%, with a fade of 7,8%, which is a bit sharp. this company is still

building up its franchise and we don't see the reason to expect such a fast normalisation of its returns.

Gemalto is perhaps a slight oddity in the Software & Services

sector in terms of its profile of returns as its products are more

niche than those of the behemoths. In our view, this is an

opportunity given the structual respositioning being

undertaken. It could be wrong to write the company off as a

payment card business, and when the acquisition of 3M's

Identity Management Business closes in the near future,

Gemalto will be a market-leader in this space. The move

towards services (currently arond one third of revenues) will

also help to boost the margin, if executed correctly.

2 260

1 641

1 230

0

1 000

2 000

3 000

4 000

5 000


= negativeThe Three Sources of Value (EURm)

0

237

989

1 230111

39

439 Net =2 260

0

500

1 000

1 500

2 000

2 500

3 000

3 500

3.5 yrs

8.2 yrsECO AGE:

ECO LIFE:

Asset breakdown (gross - EUR 3 bn)

150% 50%

100%



150% 50%

100%

150% 50%

100%



5.5%14.0x14.5%

Market Cap. (EURm) = 4 672

Ent. Value (EURm) = 5 140Software (Software and Services)

Gemalto NV @ 52 (EUR) 12 June 2017


ValuFocus | 35







0%

10%

20%

0x 1x 2x 3x 4x


Hist. Fut. Avg Fut.



10.3%

0%

10%

20%

'07 '09 '11 '13 '15 Norm.


The improvement in margin (left hand chart above) has offset the declining asset turn (second chart) and the operating FCF return is on the up (third chart above). This latter chart is

optically misleading, in that it suggests a sharp increase but the absolute level, in the low double digits, is still quite modest and could easily expand. Ingenico, for instance, has a rent of

double that level, in the low 20s (Gemalto is classified as "software" in the main indices, which is not entirely accurate). We suspect that Gemalto's cash rent is cyclical, and we have built

its market-implied future profile with a cyclical bent. We also suspect that investors in aggregate are unsure about the sustainability of the latest level of return, and so we have fitted-in a

peak margin assumption. The result is, in our view, a very conservative future profile, suggesting an inability to sustain a franchise. This is not the impression that we have. Gemalto is

making acquisitions in promising areas (it missed the acquisition of Morpho, though) and its competitors vary between the segments and are spread across the auto, technology

hardware, retail, media and mobile telecom sectors, which we see as an advanage to consolidate its competitive position and manage its fade. Gemalto was, historically, overpriced as

the operating Economic Profits chart (second below) shows, but this largely undue premium has disappeared.

0%

10%

20%

30%

'07 '09 '11 '13 '15

Mrg% Norm

125%

130%

135%

140%

145%

150%

155%

160%

165%

'07 '09 '11 '13 '15


Actual & Discounted

149

- 50

0

50

100

150

200

250

'07 '09 '11 '13 '15 Norm.


Op. Economic Profits (EURm)

Fade Analysis


FADE RATE: 7.8%



Activision Blizzard, Inc. (26.6x, 26.7%)

Oracle Corporation (16.9x, 29.7%)

Citrix Systems, Inc. (20.8x, 16.5%)

SAP SE (34x, 18.4%)

Constellation Software Inc (36.2x, 19.5%)

Check Point Software Tech (19.8x, 69.9%)

CA, Inc. (16.8x, 26.5%)

Citrix Systems, Inc. (20.8x, 16.5%)

Oracle Corporation (16.9x, 29.7%)

Sage Group plc (26.5x, 31.2%)

Similar FCF Ret. to Gemalto Similar FCF Mult. to Gemalto


ValuFocus | 36







Alfa Laval is asset "heavy", in that the bulk of its capital employed is absorbed in tangible assets. We identify about SEK 3.3bn of concession assets to be included in economic capital,

which represent trademarks and patents. The firm only expenses about 2.5% of revenues in R&D, which we capitalise. The liability breakdown of Market Value shows a modest but

noticeable level of financial leverage, which we prefer to a full equity funding. The SEK 35bn Franchise corresponds to an average 8.8% operating rent (op.FCF to net assets) over the

fading period. The fade rate is 4.6%, which is objectively low but not for a 130 year-old firm with entrenched market positions in areas of strategic importance (food, pharma, energy or

Alfa Laval has been running the same business, mostly

profitably for 130 years; this sustainability is the quintessence

of a core franchise owner. We are surprised that the market is

not more enthusiastic about its shares, which are trading on

22.3x last reported net FCF. Considering the steadiness of the

firm and the context of expensive equity markets, this is

almost cheap. We are not quite sure what spooks investors.

Yes, the firm is a consolidator, thus acquisitive and not afraid

of leveraging (modestly) its balance sheet. Yes, the firm is

involved in certain cyclical businesses, and yes, trend growth is

not that high. But it is a remarkable compounder and its rent

level is in a sweet spot: high enough to support investments,

not high enough to attract too many aggressive competitors.

27 420

34 760

31 324

0

10 000

20 000

30 000

40 000

50 000

60 000

70 000

80 000

90 000


= negativeThe Three Sources of Value (SEKm)

03 330

6 140

17 1941 842 2

5 126Net =27 420

0

5 000

10 000

15 000

20 000

25 000

30 000

35 000

40 000

5.3 yrs

12.5 yrsECO AGE:

ECO LIFE:

Asset breakdown (gross - SEK 33.6 bn)

150% 50%

100%



150% 50%

100%

150% 50%

100%



4.5%20.7x15.5%

Market Cap. (SEKm) = 73 069

Ent. Value (SEKm) = 93 480Machinery (Capital Goods)

Alfa Laval AB @ 172 (SEK) 12 June 2017

ValuFocus List: Core Franchise

ValuFocus | 37







0%

10%

20%

30%

40%

0x 1x 2x 3x 4x 5x


Hist. Fut. Avg Fut.

The market prices Alfa Laval as if it had seen

the peak of its return, which is typical of the

undervaluation of a true compounder.


Op.FCF Return: Last 4Y: 17% │ Next 4Y: 15.6% (Implied)

17.0%

0%

10%

20%

30%

40%

'07 '09 '11 '13 '15 Norm.


Alfa Laval is probably more cyclical than some people think, and less cyclical than the charts above suggest. There is a real exposure to the investment cycle, and order books can be

reported in free-fall at the trough. But the firm has historically exhibited a good anticipation and management of the business cycle, and the large (positive) wobble in 2009 is a

misleading representation, as this was in fact a tough year for revenues and order intake, more than compensated by an aggressive NWC management. Overall, we believe that our

normalised gross cash flow margin of 17.5% (first chart) is representative of the mid-cycle profitability of the firm. Note that asset intensity is high and on the rise; a decade ago, Alfa Laval

was able to turn over 1.6x its assets per annum, a figure that has declined to 1.2x only. Overall, we think that Alfa's normalised rent is around 17%. The way in which Alfa Laval's

valuation can be expressed in a fade (fourth chart above) is typical of a compounder: the market assumes that peak returns will not be seen again. Despite that fact that a 4,6% fade rate

is slow, the pre-reversion period (before the fade starts, i.e. before the firm needs to give up some excess return to competitors or clients) is only 5.5 years and probably too short. Given

the market shares that Alfa Laval controls (30% world-wide in two of its three divisions), this pre-fade period could just as well run into decades.

0%

10%

20%

30%

'07 '09 '11 '13 '15

Mrg% Norm

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

'07 '09 '11 '13 '15


Actual & Discounted

3279

0

1 000

2 000

3 000

4 000

5 000

'07 '09 '11 '13 '15 Norm.


Op. Economic Profits (SEKm)

Fade Analysis


FADE RATE: 4.6%



Pentair plc (28.7x, 16.3%)



Wärtsilä Oyj Abp (28.3x, 15.7%)

Fanuc Corporation (29.4x, 13.1%)

IDEX Corporation (26.2x, 28.2%)

Dover Corporation (24.6x, 16.8%)


Illinois Tool Works Inc. (27.7x, 22.5%)


Similar FCF Ret. to Alfa Laval Similar FCF Mult. to Alfa Laval


ValuFocus | 38







Nothing out of the ordinary on the asset breakdown; we capitalise 20% of revenues expended for R&D to create a USD 88bn gross value. Note that if we capitalised, say, only15% of

revenues over just 8 years (perhaps with the argument that generics consume less capital), this would not materially change the rent or the FCF multiple. However, it would reduce the

replacement value by about USD 27bn, and the implicit fade would need to change to compensate. The current figure of 8,4% would come down to 6,9%, and the average implied return

would move up from 8,9% to 10,2%. These figures remain well within investable levels, in our view.

Three pharmaceutical stocks make it into our core franchise

list, and a few more in the contentious one. Price pressures are

a well-documented phenomenon, as is the shortening of asset

lives. Yet it remains that the stocks were expected to almost

disappear from the planet a few years ago, and half a decade

later, we find that 1- their ability to sustain and protect their

franchise is not that damaged, 2- they have adapted to the

new world (45% of Pfizer's revenues are in generic medecines

today) and 3- their valuation is still attractive, especially in the

context of expensive equity markets. Compare Johnson &

Johnson to Pfizer: it has a similar rent (13,6% vs 12,8%) but

trades on 5 points high multiple (26x vs 20,9x). Compare P&G

to Pfizer: 9,6% rent on 29,5x...

100 115

95 455

70 753

0

50 000

100 000

150 000

200 000

250 000



0 7 371

88 323

31 4351 330 2 275 107 Net =100 115

0

20 000

40 000

60 000

80 000

100 000

120 000

140 000

4.6 yrs

11.3 yrsECO AGE:

ECO LIFE:

Asset breakdown (gross - USD 130,8 bn)

150% 50%

100%



150% 50%

100%

150% 50%

100%



6.0%16.4x14.9%


Ent. Value (USDm) = 265 820Pharmaceuticals (Pharmaceuticals, Biotechnology and Life Sciences)

Pfizer Inc. @ 33 (USD) 12 June 2017


ValuFocus | 39







0%

10%

20%

30%

0x 1x 2x 3x

Invest. Cycles (11,3y each)

Hist. Fut. Avg Fut.


Op.FCF Return: Last 4Y: 14,8% │ Next 4Y: 14,9% (Implied)

14.8%

0%

10%

20%

30%

'07 '09 '11 '13 '15 Norm.


The gross CF margin chart (first chart above) shows that, despite some volatility, nothing much has been altered in terms of margins. Our calculated normalised level of 46,3% looks very

accurate and in no need of change. So much for the oft-mentioned upheaval of the industry. Capital intensity (second chart above) is high and unchanged, too, which results, expectedly,

in a fairly constant operating rent. This makes the interpretation of the implicit future level (fourth chart above) fairly simple; investors in aggregate expect this state of affairs to carry on

for a few more years, before returns start their journey downwards to the cost of capital. This is not an unreasonable view, but it is a cautious view. This company has experienced a sea

change of its competitive landscape over the past decade, only to end up exactly where it started, in terms of margins, capital intensity and returns. We are all in favour of past

experience not being a guide etc..., but this resilience is poorly priced by the market, which is not expecting to see another such decade going forward. In the context of high uncertainty

on corporate profits, we would have expected proven resilience in a difficult environment to command a premium, not a discount.

0%

10%

20%

30%

40%

50%

60%

'07 '09 '11 '13 '15

Mrg% Norm

0%

10%

20%

30%

40%

50%

60%

70%

'07 '09 '11 '13 '15


Actual & Discounted

8345

0

5 000

10 000

15 000

'07 '09 '11 '13 '15 Norm.



Fade Analysis


FADE RATE: 8.4%



Mylan N.V. (19,5x, 14,3%)

Teva Pharmaceutical Indust (17,7x, 13,6%)

Astellas Pharma, Inc. (12,3x, 11,7%)

Valeant Pharmaceuticals In (18,3x, 16,1%)

Roche Holding AG (21,6x, 11,8%)

Hikma Pharmaceuticals PLC (19,3x, 13,8%)

Valeant Pharmaceuticals I (18,3x, 16,1%)

Novo Nordisk A/S (18,7x, 22%)

Mylan N.V. (19,5x, 14,3%)

Teva Pharmaceutical Indus (17,7x, 13,6%)

Similar FCF Ret. to Pfizer Inc.: Similar FCF Mult. to Pfizer Inc.:


ValuFocus | 40







The gross asset breakdown shows Intel as the behemoth that it is: almost USD 100bn of capital tied in tangible fixed assets. We estimate that Intel also uses slightly more than USD 70bn

of intangible capital. The company reports that 20% of revenues are ploughed into R&D each year, which need to be capitalised. The Three Sources of value chart suggests that perhaps

we should not include Intel in our Core list: it hardly has any franchise... But the reason is, partly, that we calculate a market-implied franchise, and Intel is at the cheap end of the current

market spectrum. With a fade rate more in line with Intel's status and market position (we suggest 6%), the Franchise Value would be worth twice as much.

The main reason not to buy Intel's shares is that cyclical

companies are preferably bought at the trough, and the last

trough was in 2009... Despite this unhelpful timing, investors

who can ride the cycle should be interested. We deal with

Intel's cyclicality by normalising its CF margin and therefore

cash return. Taking a simple average of peak (ca 15%) and

trough (ca 7%) operating cash return would suggest a

normalised level around 11%. We are using 9.4%, which yields

a normalised op.FCF multiple of 15.6x only, inexpensive in the

context of the current equity markets. In figures, this is

equilavent to about USD 11.3bn of op.FCF, in line with reported

numbers. The net FCF multiple, which we prefer, is 20.8x, again

at a noticeable discount to the (expensive?) market.

121 424

27 475

23 523

0

20 000

40 000

60 000

80 000

100 000

120 000

140 000

160 000

180 000



0 4 652

70 282

98 432978 1 072

4 338 Net =121 424

0

20 000

40 000

60 000

80 000

100 000

120 000

140 000

160 000

180 000

200 000

3.9 yrs

9.1 yrsECO AGE:

ECO LIFE:


150% 50%

100%



150% 50%

100%

150% 50%

100%



6.0%14.5x8.6%


Ent. Value (USDm) = 172 144Semiconductors and Semiconductor Equipment

Intel Corp. @ 36 (USD) 12 June 2017


ValuFocus | 41







0%

10%

20%

0x 1x 2x 3x 4x


Hist. Fut. Avg Fut.


Op.FCF Return: Last 4Y: 9.4% │ Next 4Y: 6% (Implied)

9.4%

0%

10%

20%

'07 '09 '11 '13 '15 Norm.


The latter half (from 2011 onwards) of the first chart, above, is not Intel's real gross CF margin, but our estimate of its normalised, or mid-cycle, level: 48%. For comparisons, the

corresponding real margin is 51.2% as of last reported. Similarly, the operating FCF return (third chart above) is based on the same normalised margin from 2011 onwards, which means

that the return simply follows Intel's capital intensity. On this subject, we note that Intel is not managing to hold on to its historical turn of ca 55% (second chart above) and is now turning

over 47% of its net assets, which is a low number, showing the substantial capital intensity of the semiconductor sector. These adjustments notwithstanding, it is not too much of a

stretch to assume that 9.4% is representative of Intel's normalised operating FCF asset yield (remember that a simple arithmetic peak to trough average suggests 11%). In this case, the

implicit fade profile (fourth chart above) is undemanding, to say the least. The fade is a steep 10.5%, past the 10% "terminal decline" mark. In less technical terms, the average operating

cash return over this fade period is 6.3%. Furthermore, note that it is possible, within the constraints of the current valuation, to fit an immediate new trough (to 4.2%) one year out. We

have to conclude that the new cycle is already priced in. What we can't say is if bad momentum, when it comes, can crush this value.

0%

10%

20%

30%

40%

50%

60%

'07 '09 '11 '13 '15

Mrg% Norm

0%

10%

20%

30%

40%

50%

60%

70%

'07 '09 '11 '13 '15


Actual & Discounted

2599

0

2 000

4 000

6 000

8 000

10 000

'07 '09 '11 '13 '15 Norm.



Fade Analysis


FADE RATE: 10.5%



NVIDIA Corporation (70.7x, 12.5%)

Marvell Technology Group L (60.7x, 3.7%)

Tokyo Electron Limited (48x, 9.8%)

Infineon Technologies AG (70.1x, 2.8%)

Microchip Technology Inc. (32.5x, 14%)

Analog Devices, Inc. (26.9x, 17%)

Xilinx Inc. (25.6x, 19.4%)

KLA-Tencor Corporation (21.9x, 18.2%)

Texas Instruments Inc. (23.5x, 22.8%)

Applied Materials, Inc. (27.2x, 14.2%)

Similar FCF Ret. to Intel Corp.: Similar FCF Mult. to Intel Corp.:


ValuFocus | 42

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ValuFocus | 43

GLOSSARY

Competitive Advantage Period (CAP) The period during which a firm can generate a return (see Rent) above the cost of capital.

Economic Profits Cash profits or Free Cash Flow minus the notional cost of capital.

Excess Return The level of return above the cost of capital.

Fade The rate of normalisation of the competitive position of the firm, defined as its level of Rent and

growth rate. By construction, an excess return cannot be assumed to be perpetual, and the market

always assumes an eventual normalisation towards the cost of capital.

Franchise Value One of the three sources of value, defined as the net present value of a firm’s sustainable level of

Economic Profits over its Competitive Advantage Period.

Gross economic Capital (GeC) The sum of all operating capital used by the firm pre-depreciation, including all tangible assets,

capitalised intangible assets and operating leases, Other Long Term Assets (OLTA) and concession

assets.

Growth Value One of the three sources of value, defined as the residual of: Market Value minus Replacement

Value and Franchise Value.

Intrinsic Value The sustainable value of a firm, defined as Replacement Value plus Franchise Value.

Net economic Capital (NeC) The depreciated value of GeC, according to the principles of economic depreciation.

Net Free Cash Flow Gross cash flow minus all capital spending.

Operating Free Cash Flow Gross cash flow minus maintenance capital spending.

Rent or Rent Yield The ratio of FCF over Net economic Capital. We refer to it as “asset yield” or “cash return” as well.

Replacement Value One of the three sources of value, equal to Net economic Capital.

Residual Income Model A valuation framework defining the price of an asset as the net (depreciated) value of this

asset plus the net present value of its sustainable level of economic profits.

ValuFocus | 44

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ValuFocus | 45

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ValuFocus | 46


ValuFocus | 47


VALUFOCUS

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