If I have been consistent on any stock during my 13 years on BNN (and the old ROB TV) – Canadian television show – it has been Thomson Corp. I remember stating even a few times, that if one picked up a dictionary and looked under the definition of dead money you will see the quote symbol for Thomson now Thomson Reuters. After hitting a high of $62 per share in 2000, Thomson has yet come close to these old highs as it’s currently languishing around the $28 mark.
Last week, Geoff Beatty was dismissed as President of the Woodbridge Company, the Thomson’s Family holding company. Speculation over the removal of Beatty was met with rumors of David Thomson’s apparent frustration over the lack of performance of Thomson Reuters Corp. share price. Apparently Beatty had championed the merger between the Canadian company Thomson Corp. and the UK’s Reuters.
As Model Price readers will come to know, if you don’t know already, big mergers rarely workout for shareholders of the acquiring company. Why? The concept we call theoretical earnings. (TE) The idea of TE is proprietary to us at Model Price, however we are happy to share this concept with anybody who is interested. This financial concept is NOT taught at any university financial course, or MBA, CFA program. By learning this concept you will be ahead of every major finance program where students are paying tens of thousands of dollars.
Back of an Envelope Calculation of Theoretical Earnings
Under Key Concepts – Theoretical Earnings, I introduce you to R and P where;
Once you calculate R and P, what you do is add R and P together. (R+P) Once this is done multiply by 2%. Take the result and divide it by shares outstanding to give you a per share amount. This result is roughly theoretical earnings (TE) per share. I say roughly because the 2% will vary, depending on other things however for the majority of cases it will work just fine.
Once you get the new balance sheet of the merged company, or you can try to do a pro forma balance sheet based on the announced details, you perform the same calculation. Compare the two calculations of TE, the merged company will usually have the higher TE. Say, the difference in the two calculated TE’s is $0.50 – before and after the merger, and the projected increase earnings from the merger is only $0.25, this will have negative consequences for our calculation of model price of the company initially. The market is very good at sniffing this mathematical relationship very quickly and usually sends the acquirer’s stock down immediately – say Freeport McMoran Copper on Thursday of last week. Post merger, managements have to drive earnings at least over the new calculated TE to derive any value or share increase at a future date. (In other words above the $0.50 increase in theoretical earnings post merger.)
Back to Thomson Reuters Corp.
Here is a chart showing the 12-month forecast in earnings for TRI and its’ calculated theoretical earnings going back to 2002.
The first observation one can make is the lack of growth in earnings for the company. For 10 years TRI has marginally boosted earnings to any degree at all.
The second observation is the calculation of TE. Notice there was a spread between TE and earnings until late in 2008, when the merged company Thomson Reuters finally issued a balance sheet. This bigger balance sheet (R+P) resulted in TE and earnings converging together. The stock price of TRI plunged with the market meltdown of 2008, recovered only to fall again as market participants tire of the lack of earnings growth. A dividend yield of 4.61% certainly helps yield hungry investors at TRI’s current stock price.
Since 2009 TE has been sloping downward, because of various write-offs taken over recent years. On the positive side at least there is a positive spread between TE and estimated earnings of the company. This is probably enough of a spread to keep the stock price where it’s currently valuated – in other words “Dead Money”, again, but with a yield!
What would make TRI’s stock price perform?
The firing of Mr. Beatty will not help Thomson Reuters in the near term. What will? Derive more earnings from the assets they have. In other words increase the EPS line on our line chart above. This will create a dynamic spread between earnings and TE thereby increasing TRI’s stock price. (Obvious you say!)
Failing this, reducing TE or R+P, by writing off poor performing assets in the short-term while reallocating assets in higher growth areas without substantially increasing TE – hard to do I know! Or allocating resources in very cheap asset categories and hopefully over time these cheap assets become fully valued – much what David Thomson’s grandfather Roy Thomson did some 60 years ago.