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Valuation Fundamental and Relative Approaches with Investment Recommendation

Analyst Company Ticker

Angela Chiu Edge Petroleum Corp. NasdaqNM:EPEX

Brijesh Gulati Deltathree Inc. NasdaqSC:DDDC

Alan Li Tom Group HKSE:2383.HK

Chieh -Hsin Liu TiVo Inc. NasdaqNM:TIVO

Anupam Satyasheel Costco Wholesale Corp. NasdaqNM:COST

Shivanker Saxena SYMS Corp. NYSE:SYM

Valuation – Fundamental and Relative

Table of contents Page

I. Investment Recommendation ………………………………………………… 1 II. Portfolio Arrangement ………………………………………………… 4 III. Valuation Rationale ………………………………………………… 5 IV. Our Companies - Deltathree, Inc. ………………………………………………… 7 - Tivo Inc. ………………………………………………… 10 - Syms Corp. ………………………………………………… 13 - Edge Petroleum Corp. ………………………………………………… 17 - Costco Wholesale Corp, ………………………………………………… 21 - Tom Group ………………………………………………… 23


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I. INVESTMENT RECOMMENDATION Deltathree, Inc. (NasdaqSC:DDDC) Investment Recommendation: STRONG BUY Target Price $ Range: 4.00 – 6.75 Current Price: 2.95

Valuation Approach:

DCF Relative Valuation Option Valuation EVA

$5.66 $12.22 NA NA FCFF3 EV/Sales

Analyst Comments: This is the most speculative investment in our portfolio, we recommend DDDC for investors interested in participating in the burgeoning VOIP industry. Although, there are many unknowns in the marketplace, we believe the company is positioned as a partner of choice for broadband telephony deployments. Furthermore, the company is well positioned both domestically and internationally to assist in the deployment of VoIP services At present, DDDC is a strong buy because the stock does not seem to be trading on fundamentals but rather technical and momentum. TiVo Inc. (NasdaqNM:TIVO) Investment Recommendation: BUY Target Price $ Range: 6.15-7.51 Current Price: 5.63

Valuation Approach:


$6.83 $12.22 NA NA FCFF PS

Analyst Comments: After announcing strategic partnership with Comcast in March, TiVo has also been in talk with companies such as Yahoo and Google. The strategic moves as well as TiVo’s product and marketing advantages give it the potential of high growth in the next several years. Based on the fundamental analysis (DVF valuation), TiVo’s stock price has about 20% potential upside. Syms Corp (NYSE:SYM) Investment Recommendation: SELL

Target Price $ Range: $ 9.44 - $ 9.68

Current Price: $12.00 Valuation Approach:


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DCF Relative Valuation Option Valuation

EVA in

million

$9.68 $9.44 NA ($13.80)

FCFF_2 EV/EBITDA Analyst Comments: Syms has reported four years of consecutive net losses with net sales declining steadily at a CAGR of 4.4% (FY98-FY03) due to store closings. It had positive earnings of $0.14 for FY04. We estimate that fundamentals will remain weak despite efforts to lower operating expenses. It is unclear whether management has any solid rationalization plans to turn the company around in a more intense competitive retailing environment, particularly in the “off-price” segment. Syms owns approximately 62% of its store base, well above its peers in the off-price retail industry, including TJX Companies and Ross stores, who lease almost all their stores. We believe there could be significant value in the real estate and that recent speculation over offers for Sears and Toys ‘R’ Us from Vornado Realty have helped push the stock price up to just below book value. However, we do not anticipate Syms to actively sell its real estate any time soon. Our 12-month target price range is &9.68-$9.44 per share or ~7.34x FY05E EBITDA. While Syms stock price has appreciated steadily over the past twelve months, we believe this trend would reverse, given weak business fundamentals and the unlikelihood that Syms would be taken out in the near-term. Edge Petroleum Corporation (NasdaqNM:EPEX) Investment Recommendation: BUY Target Price $ Range: $23.87 – 24.66 Current Price: $14.60

Valuation Approach:

DCF Relative Valuation Option Valuation EVA in million

$23.87 $24.66 N/A $293 FCFF2 EV/EBITDA (Sector)

Analyst Comment: Our Buy recommendation is supported by both DCF and relative valuations. EPEX stock price is currently depressed due to the fluctuation of energy prices in general. However, with EPEX track record of operational success and revenue growth, the downside is limited based on our sensitivity analysis - value per share against changes in price of natural gas and EPEX market share at the end of high growth phase. Costco Whole Sale Corporation (NasdaqNM:COST) Investment Recommendation: BUY Target Price $ Range: $48.49 Current Price: $40.25


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Valuation Approach: DCF Relative Valuation Relative Valuation Option Valuation

48.49 40.40 39.98 N/A FCFF2 EV/EBITDA (Sector) EV/EBITDA (Mkt) N/A

Analyst Comment: Our BUY recommendation is supported by DCF valuation. Costco’s stock price is currently depressed because of many factors including Costco’s consistent focus on not charging customers more than 14% in gross margin; its unwillingness to charge its employees a higher contribution for health insurance but most importantly not moving to its optimal leverage. We have reasons to believe that Costco management is already working on changing these factors causing depression in the stock price. For one, it has already indicated that it is increasing employees’ share of health insurance. We also believe that Costco’s growth potential is higher than some of its rivals, because of its dynamic product mix and its willingness to experiment with new projects and products. Our relative valuation does not support our BUY recommendation but we believe that this is in part because Retail Store sector is going through a period of change and consolidation as indicated by the two big mergers (Sears-K Mart and Federated-May) in 2004. Tom Group (2383.HK) Investment Recommendation: BUY Target Price $ Range: HK$1.88 - HK$5.66 Current Price: HK$1.49

Valuation Approach:


$5.66 HK$3.51 N/A HK$281 mn FCFE_3 PE N/A

Analyst Comments Tom Group is operating in high-growth business sectors in high-growth market. The company is currently undervalued as measured by both DCF and relative valuations. We believe this delta stems from the market’s overestimating company’s revenue volatility given Tom’s historical stock performance (The Company IPO’ed in March 2000 as a dotcom and its share price declined 81% from the closing price of IPO date). The company, however, has diversified into sectors with solid growth potential using the fund it acquired through the IPO and the management has been able to demonstrate revenue growth, as further manifested in our DCF models. Furthermore, the high EVA of the company also reflects the ability of the company to create value for stockholders. Considering all the valuation approaches, we would recommend a BUY for Tom Group’s stock (2383.HK).


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II. PORTFOLIO ARRANGEMENT Our portfolio consists of four US stocks and one listed in the Hong Kong Stock Exchange. Two of our selections are experiencing high growth (DDDC & Tom Group) and the rest are experiencing relatively high growth (TiVo, Syms, Edge Petroleum & Costco). DDDC is the only company having negative earnings currently. DDDC is a provider of integrated voice-over Internet protocol (VoIP) telephony services. Its business includes the provision of Web-based and other communications services to individual consumers under iConnectHere brand name. Also, the company is a leading provider of hosted, Session Initiation Protocol(SIP)-based Voice over Protocol (VoIP) products and services. For the fiscal year ended 31/12/04, revenues rose 60% to $21.1M. TiVo is a provider of technology and services for digital video recorders (DVRs). The Company's subscription-based TiVo service is designed to improve home entertainment by providing consumers with an easy way to record, watch and control television. The TiVo service also offers the television industry a platform for advertising, content delivery and audience research. Syms Corp. is an “off-price” retailer with 37 retail stores located throughout the United States in the Northeastern and Middle Atlantic regions and in the Midwest, Southeast, and Southwest. The company offers a broad range of in-season merchandise with nationally recognized designer labels at prices lower than those generally found in department and specialty stores. However, Syms continues to under-perform relative to its peers. As other “off-price” retailers aggressively increase their store base, Syms is consistently closing stores. While Syms may be an acquisition target for retailers, particularly in the off-price segment, and the company’s real estate could be valuable, we believe the risks of Syms’ distressed fundamentals will outweigh the returns from the aforementioned, given our belief that the Syms family, with 52% ownership, would likely not sell in the near-term. As investors recognize that improbability, we expect the stock price to drop.

Edge Petroleum Corporation is an oil and natural gas company engaged in the exploration, development, acquisition and production of crude oil and natural gas properties in the United States with natural gas and natural gas liquids accounted for approximately 87% of those proved reserves. Costco Wholesale Corporation operates membership warehouses based on the concept of offering members very low prices on a limited selection of nationally branded and selected private-label products in a wide range of merchandise categories. During the fiscal year ended August 31, 2004 (fiscal 2004), Costco operated 417 warehouse clubs, of which 327 were in the United States, 63 were in Canada, 15 were in the United Kingdom, five were in Korea, three were in Taiwan and four were in Japan. In fiscal 2004, the Company operated, through a 50%-owned joint venture, of which Costco is the managing partner 24 warehouses in Mexico. Tom Group is a media company listed on the Hong Kong Stock Exchange. Besides media business (publishing and cable TV), Tom Group also invests in outdoor advertising business and mobile messaging services. The company derives its revenue from China, Taiwan, and Hong Kong (62%, 32%, and 6%) respectively. The company has been growing through acquisition and presently experiencing high-growth. The growth in revenue has been in high 20%s in the past several years.


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III. VALUATION RATIONALE To arrive at a fair value range for the companies, we have used a fundamental based cash flow valuation and one multiple relative valuation. Further, we have valued each stock based on (1) valuation of firms in their sectors and (2) valuation of firms in the entire market. We have also attempted to quantify the value of control for Syms Corp. which is operating at margins way below market averages and clearly can benefit from a change in management. The following table summarizes the valuation approaches that we used to value each company in our portfolio:

Valuation Approach DDDC TiVo Syms EPEX Costco Tom Model FCFF_3 FCFF_2 FCFE_2 FCFF_2 FCFF_2 FCFE_3 Multiple EV/Sales Price/Sales EV/EBITDA EV/EBITDA EV/EBITDA PE Option Price … … … … … …

Value of Control … … Change in margins … … …

DDDC: the high growth characteristics of this company calls for a 3-stage model, with a 4-year of high growth phase, 6-year of transition phase, and forever after 10-years of stable growth phase. Furthermore, we selected a FCFF approach to account for possible variations on the company’s financial structure and cash future generation capability. TiVo: Given the high growth characteristic, we adopted the 2 stage model where high growth period is smoothly faded into stable growth over 10 years. The FCFF model is selected to account for possible capital structure changes from state quo (1.32% including operating leases) to industry level. Syms Corp: has been losing money for some time. Hence, the management has launched some cost saving measures, like reducing advertising expenditures. However, such measures are at the cost of future growth. Therefore, though we may expect better earnings and ROE in the near future, there is not enough investment for future growth. We therefore use a 2 stage FCFE model for valuing the cash flows to the company. Syms can improve it margins drastically if the management is changed and its business strategy is revamped significantly. We have, therefore, valued control using higher operating margins and growth assumptions. However, since the company is closely held and managed and so far, has given no indication of any intention to sell, the probability of sale of business to any outside competitor (like TJX or Ross Stores) is low, at around 20%. With negligible earnings in the past 4-5 years, we believed that an EBITDA multiple would be a better multiple for comparison. While most of Syms’ competitors have some debt on their balance sheets, Syms has persisted with its no –debt policy (except operating leases), which further strengthens the case for using the EV/EBITDA multiple for relative valuation. Edge Petroleum Corp: The company currently has a debt ratio of 10% with unused debt capacity for future exploration projects. Thus, the leverage is likely to change. Like many other exploration companies, Edge Petroleum does not pay any dividend and is expected to have high reinvestment rate. As the world demand for oil & gas is on the rise, the industry is experiencing rapid growth and increase in exploration in general. Edge Petroleum also benefited from the prosperous energy market with five-year revenue growing at a geometric mean of 31.68%. Given these factors, 2-stage FCFF model and EV/EBITDA valuation approaches have been used. Costco Wholesale: The DCF valuation of Costco Wholesale is based on a two-stage FCFF model. The projected growth in demand is reflected in our assumption, as the company will experience a relatively high growth phase of 10 years by undertaking excellent projects. Costco is expected to grow at a rapid rate in the coming years and is hence expected to have relatively large capital expenditures along with many other fast growing companies in this sector. Since there is expected to be a variation of capital expenditure with the size of firms and financial leverage, EV/EBITDA is identified as the best multiple to value our Costco.


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Tom Group: The DCF model employed to valuate the fundamentals of the company is a three-stage free cash flow to equity model. In relative valuation, PE is used. The comparable companies comprises of companies in the publishing, media, and telecom services sector list in the following stock exchanges: Hong Kong, Shanghai, Shenzhen, and Taipei. We consider this appropriate because Tom Group’s business mix fluctuates from year to year.


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IV. OUR COMPANIES DDDC

Valuation by Fundamentals In valuing the company, we capitalized the operating leases and R&D expenses. We also moved DDDC’s current operating and financial performance toward industry average gradually. For example, the debt ratio in stable growth will be 25% and operating margin will improve to 33.98%. We assume that the company will be growing at 40% for first 4 years. Within 6 years this growth will gradually transition to 4%, the growth rate in stable phase. This implies compounded annual growth rate in revenues for next 10 years to be 26.71% and stable growth rate in revenues of 4% thereafter. As for discount rate, current bottom-up Beta is 2.18 using Internet telephony as comparable firms. As the company evolving toward maturity, we assume that the beta will smoothly decrease to 1.2 and debt ratio will increase from 0% to 19.18%. As a result, the cost of capital will change to 8.9% at year 10 from current level of 15.1%. Sensitivity Analysis DDDC DCF valuation is sensitive to the following critical variables

1) Compounded annual growth rate in revenues in high growth period. 2) Growth rate in stable growth period.

High growth period Growth Rate 12% 16% 20% 24% 28% 32% Value / Share 2.78 3.32 3.99 4.87 6.03 7.57 Stable growth period

Growth Rate 2% 3% 4% Value / Share 4.77 5.15 5.66


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Changes in growth rate for the high growth period result in variation of up to 172% (value/share) when considering growth rates from 12% to 32%. These scenarios bring great insight to the company’s management: if the company should consider strategies that can result on higher growth, value per share will increase substantially. We are very confident of company’s management. The company’s recent deals with Verizon and SBC remain key to our bullish thesis. We expect these deals to open doors to similar such deals with other service providers as the selection by these two partners bolsters DDDC credibility. Strategically, these deals have validated DDDC as a VoIP enabler. On the other hand, stable growth rate results in variation of around 19% (value/share) from 2% (inflation rate) to 4% (economy growth rate). Relative Valuation Sector Regression To define the comparable companies to DDDC, we looked for companies in the Internet telephony and telecom services sector. DDDC is a high growth venture with negative earnings. EV/Sales sales ratio is considered to be the most appropriate multiple. Further, we believe that the current margins have little or no correlation with expected margin. Hence, regression of EV/sales against current margins does not provide any substantial insight. In this case, we believe the firm with higher revenues growth and higher cash balances should have should have a greater chance of surviving and becoming profitable. EV/Sales = 2.81 - 0.08 ln(Rev) + 2.41 Rev Growth + 0.95 Cash/Rev

(0.80) (2.47) (2.38)

R squared 0.15

Pred. EV/Sales = 2.81 - 0.08 (3.04) + 2.41 (.60) + 0.95 (0.78)

= 4.72

Actual EV/Sales = 3.44 Stock is relatively undervalued. SECTOR SUMMARY OUTPUT

Regression Statistics

Multiple R 0.382748547

R Square 0.150818478

Adjusted R Square 0.115646924

Standard Error 2.695705347

Observations 87

ANOVA

df SS MS F Significance F

Regression 3 103.524872 34.50829 4.748742 0.004173624

Residual 83 603.1466675 7.266827

Total 86 706.6715396

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 2.816155424 0.675403398 4.147605 8.15E-05 1.465440337 4.166870512

Rev Growth 2.413574498 0.962663121 2.471247 0.015535 0.47068012 4.356468876

Cash/Rev 0.950546797 0.398740629 2.388893 0.019195 0.158991198 1.742102395

ln(Rev) -0.094757592 0.116682984 -0.81103 0.419698 -0.327182852 0.137667669


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Similarly, we ran the regression for all the companies in the market. Market Regression MARKET SUMMARY OUTPUT



R Square 0.197593647



Observations 3552

ANOVA


Regression 1 110719.7869 110719.7869 874.1922922 6.0034E-172

Residual 3550 449621.0355 126.6538128

Total 3551 560340.8224


Intercept 6.005218852 0.191181935 31.41101611 2.5558E-191 5.630381028 6.380056675

After-tax Operating Margin -1.645262498 0.055645713 -29.56674301 6.0034E-172 -1.754363382 -1.536161615 We preformed market regression using after-tax operating margin, as this should be a better representation of enterprise value. However, the market firms are priced based on the expected margins rather than current margins. This is exemplified by the negative coefficient of “after-tax operating margin”. For this reason, DDDC should not be analyzed using market regression. Summary: Company Deltathree, Inc. Multiple EV/Sales Comparables Current Multiple 3.44x Industry Multiple 2.67

Valuation Overvalued Sector Regression Point Estimate 4.72x Lower Bound (95%) 0.87 Upper Bound (95%) 8.56

Valuation Undervalued Market Regression Point Estimate - Lower Bound (95%) - Upper Bound (95%) -

Valuation - Overall recommendation based on relative valuation – undervalued.


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TIVO

Valuation by Fundamentals In valuing the company, we capitalized the operating leases and R&D expenses. We also moved TiVo’s current operating and financial performance toward industry average gradually. For example, the operating margin will improve to 19.44% and capital expenditure to 0.9 times sales. The average revenue growth rates for the past three years is 107% and we assume that the company will be growing at a compounded annual rate of 16.84% for the next 10 years before reaching the stage of stable growth of 4% thereafter. As for discount rate, current Beta of 3.225 is an observation from the company’s historical stock returns. As the company evolving toward maturity, we assume that the beta will smoothly decrease to 1.2 and debt ratio increase to 19.18%. As a result, the cost of capital will change to 8.15% at year 10 from current level of 15.93%. Sensitivity Analysis Operating margin

5% 10% 15% 20% 25% 30% 35%

Value/ Share (1.61) 1.28 4.18 7.17 10.10 13.02 15.94

Realization of high growth period growth rate

40% 60% 80% 100% 120% 140% 160%

Value/ Share 3.93 4.62 5.54 6.83 8.47 10.57 13.24 One major assumption is that TiVo will be able to imitate the 19.44% operating margin in the sector in the long run. According to the sensitivity analysis, 1% increase of the target operating margin will increase the per share value by around $0.6.


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Another factor that affects the share value is the growth rate in high growth period. For example, the assumed compounded growth rate is 16.84% now. If the company growth rate is only 80% of the expected, the share value will drop to $5.54 a share. Relative Valuation To define the comparable companies to TiVo, we looked for companies in the Cable TV sector, Entertainment Tech sector and Computer Software/ Services sector. Since TiVo has negative earnings and the current debt ratio is very close to zero, the price to sales ratio is considered to be the most appropriate multiple. TiVo is traded at 3.50 x P/S ratio, while the comparables and the market are traded at 4.14 and 3.04 x P/S ratios respectively. It seems that TiVo is undervalued compared to the comparable companies. Since TiVo’s current margin is negative, regression of price to sales ratios against current margin is not going to provide much explanatory power. Therefore, we ran the regression of pri ce to sales ratio against revenue level, revenue growth and cash balance to sales. The table below summarizes the regression output in the sector. SECTOR SUMMARY OUTPUT



R Square 0.4574968



Observations 72

ANOVA

df SS MS F Sign.F

Regression 3 368.3437 122.78123 19.114963 4.266E-09

Residual 68 436.78472 6.4233047

Total 71 805.12843

Coef. Stan. Error t Stat P-value Lower 95% Upper 95%

Intercept -0.4777908 1.7160866 -0.2784188 0.7815358 -3.9021883 2.9466067

Ln(Rev) 0.198674 0.2194283 0.9054163 0.3684418 -0.2391884 0.6365363

Rev Growth 18.216633 4.0655311 4.480751 2.925E-05 10.103992 26.329274

Cash/Rev 2.55776 0.5470372 4.67566 1.436E-05 1.4661642 3.6493557 R square = 0.4574968 Predicted PS of TiVo = -0.4778 + 0.1987 x 4.98 + 18.2166 x 20% + 2.55776 x 98.15% = 12.22 Therefore, TiVo is undervalued. Similarly, we ran the regression for all the companies in the market.


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MARKET SUMMARY OUTPUT



R Square 0.73706898



Observations 1429

ANOVA

df SS MS F Sign. F

Regression 3 63000.6993 21000.2331 1331.55745 0

Residual 1425 22473.9325 15.7711807

Total 1428 85474.6318

Coef. Stan. Error t Stat P-value Lower 95% Upper 95%

Intercept 1.52039527 0.58756312 2.58762882 0.00976211 0.36781378 2.67297677

Ln(Rev) -0.2605867 0.07013091 -3.7157188 0.00021046 -0.3981576 -0.1230158

Rev Growth 32.8388438 1.4936693 21.985351 1.7603E-92 29.9088172 35.7688704

Cash/Rev 1.41236101 0.03038267 46.4857476 7.49E-288 1.35276146 1.47196056 R square = 0.73706898 Predicted PS of TiVo = 1.5204 – 0.2605867 x 4.98 – 32.8388 x 20% + 1.4124 x 98.15% = 12.22 Summary:

Particulars TiVo

PS

Comparables 4.14

Current Multiple 3.50

Market Multiple 3.04

Valuation Undervalued

Sector Regression

Point Estimate 6.67

Lower Bound (95%) 0

Upper Bound (95%) 14.97


Market Regression

Point Estimate 8.18

Lower Bound (95%) 5.69

Upper Bound (95%) 10.66



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SYMS CORP.

Valuation by Fundamentals Our discounted cash flow analysis yields a share price of $5.27 per share, with a valuation of $83.8 million (including cash of $25.5 million – income from cash not included in FCFE). The value of control is $350 million (discussed later). To the status quo value of $5.27, we have added the value of control, adjusted for the probability of change in management, which yields a valuation of $9.68/ share for Syms. Given the fact that Syms has not been investing in any major growth opportunities (based on lower advertising expenses and pullback on capital expenditures), we do not foresee any substantial growth in future although we do expect the company to report better margins and growth in the short term because of cost cutting endeavors. In our terminal value calculation, we have therefore assumed a miniscule growth rate of 0.1%, although the growth would be higher due in the next 5 years to improved ROE. Using a market premium of 4%, 10-year treasury bond yield of 4.28%, and a beta of 0.65, we derived a Cost of Equity (Ke) of 6.86%. With a Return on Equity of around 1.8% and a Cost of Equity of 6.86%, it is clear that Syms is a money losing stock. The annual EVA for the company is -$13.80 million. In our opinion, a turnaround plan for Syms is long overdue, but unlikely in the near-term. The retailing environment has gotten more competitive yet the retailer has not revealed any strategic plans to achieve profitability and strengthen its market position. The stores continue to be clad with a dreary, black theme without any updates. For a number of years, the company has closed stores that have not been profitable at the end of its lease terms without any new openings. Despite such efforts, sales per square footage declined from $185 in FY99 to $171 in FY03. Operating profit per square footage declined from $2 in FY99 to a loss of $3 in FY03.


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The company can benefit clearly from a change in management, which would boost its ROE over the COE. The sensitivity of share value to changes in SG&A and growth rate for perpetuity is given below:

SG & A Share pr ice $5.27 25.0% 22.5% 20.0% 17.5% 15.0% 12.0%

0.10% $5.27 $9.26 $13.25 $17.25 $21.24 $26.03 0.50% $5.45 $9.65 $13.85 $18.05 $22.25 $27.28 1.00% $5.72 $10.21 $14.71 $19.20 $23.69 $29.09 2.00% $6.42 $11.68 $16.95 $22.22 $27.48 $33.80

Growth rate

3.00% $7.47 $13.92 $20.36 $26.80 $33.24 $40.97 Syms’ closest competitors are TJX Companies and Ross Stores have lower Gross Profit Margins (around 23%) but their SG&A is only 14% of sales compared to Syms’ 34% (inclusive of advertising and occupancy). If Syms can reduce its SG&A expenses, excluding advertising (which is the life blood of retailing), then the ROE, growth and share value would increase over time. The variation in ROE with changes in SG&A is analyzed in the table below:

SG&A (excluding Advertising and Occupancy) ROE 1.85% 25.0% 22.5% 20.0% 17.5% 15.0% 12.0%

2.70% 1.85% 3.46% 4.80% 5.95% 6.94% 7.95% 3.00% 1.63% 3.25% 4.62% 5.78% 6.78% 7.81% Advertising 4.00% 0.86% 2.56% 3.99% 5.21% 6.25% 7.33%

Value of control There is no debate that Syms is a poorly managed company. We also believe that with the right management, it is possible to reduce the SG&A expenditure at Syms, change the business strategy and turbo-charge the company’s growth by focused advertising efforts. In such a scenario, the company can reduce its SG&A to around 22% (inclusive of advertising and occupancy) and hike the ROE over the cost of equity to 7.30%-7.80%. If Syms could do this, the share price would be in the range of $24-$27 (SG&A-12%, Growth of 1-2% can come only with higher advertising). With gross SG&A of 22%, ROE of 7.33% and growth of 1% in perpetuity, the share value for Syms would be $27.30. We can therefore conclude that value of control for Syms is 15.9 million x ($27.32-$5.27) = $ 350 million approximately. Syms family owns 52% of the company and has been in control of the company since 1959. Given this scenario and the owners’ reluctance to sell their family, the probability of change in management is low. If take the probability of change in management as 20%, the implied share price is estimated to be = 0.80 x 5.27 + 0.20 x 27.32 = $ 9.68 EVA calculation Return on Equity in FY04 0.97% Return on Equity estimated for future 1.59% Cost of Equity 6.86% Spread -5.89% Future Spread -5.27% Book value of Equity (average) $233.8 EVA last year ($13.8) Expected EVA per annum ($12.3)


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EVA by Sector - Retail (Specialty lines) Return on Equity 13.72% Cost of Equity 9.11% Spread 4.61% Avg BV of Equity $751.2

Avg EVA per annum $34.6 Relative Valuation As has been pointed out earlier, we believe the best multiple for relative valuation is EV/EBITDA, given the fact that Syms Corp. has no debt on its balance sheet and has had negligible earnings in the last 4-5 years. We compared the current EV/EBITDA for Syms to the industry average of 7.95x EBITDA, which gives a valuation of $10.25 for the company. We also derived implied multiples for the company, based on the regressions of EV/EBITDA multiple against different variables for both comparable company in the retail sector and also the market as a whole. The results of these regressions have been described below: Sector Regression SUMMARY OUTPUT


Multiple R 0.4787

R Square 22.9%



Observations 38

ANOVA


Regression 3 225.83 75.28 3.37 0.03

Residual 34 759.71 22.34

Total 37 985.54

CoefficientsStandard

Errort Stat P-value Lower 95%

Upper

95%

Lower

95.0%

Upper

95.0%

Intercept 12.82 2.52 5.10 0.00 7.70 17.93 7.70 17.93

Eff Tax Rate (16.00) 7.16 (2.24) 0.03 (30.55) (1.46) (30.55) (1.46)

Market D/E (0.02) 0.01 (1.85) 0.07 (0.05) 0.00 (0.05) 0.00

Reinvestment Rate 1.47 0.92 1.61 0.12 (0.39) 3.34 (0.39) 3.34 Based on sector regression, the share price is estimated at $9.44. We believe on a relative basis, this is a fair value for Syms, since for relative valuation it should be compared with its sector peers.

Syms Point

estimate

Lower Bound

95%

Upper Bound

95%

Intercept 1 12.82 7.70 17.93

Eff Tax Rate 35.0% (5.60) (10.69) (0.51)

Market D/E 15.8% (0.00) (0.01) 0.00

Reinvestment Rate 8.9% 0.13 (0.03) 0.30

EV/EBITDA 7.34 NMF 17.71

Value per share 9.44 NMF 23.20


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Market Regression SUMMARY OUTPUT


Multiple R 0.14

R Square 2.1%

Adjusted R Square 1.9%


Observations 2004

ANOVA


Regression 3 433,612 144,537 14 0.00

Residual 2000 20,488,310 10,244

Total 2003 20,921,923

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 23.00 6.78 3.39 0.00 9.69 36.30 9.69 36.30

Eff Tax Rate (69.76) 15.57 (4.48) 0.00 (100.30) (39.22) (100.30) (39.22)

Expected Growth in EPS: next 5 years 44.41 20.74 2.14 0.03 3.73 85.10 3.73 85.10

3-yr Regression Beta 6.27 2.61 2.40 0.02 1.16 11.39 1.16 11.39

Syms

Point estimate

Lower Bound

95%

Upper Bound

95%

Intercept 1.00 23.00 9.69 36.30

Eff Tax Rate 35% (24.42) (35.10) (13.73)

Expected Growth in EPS: next 5 years7.22% 3.21 0.27 6.14

3-yr Regression Beta 0.64 4.01 0.74 7.29

EV/EBITDA 6 NMF 36

Value per share 7.40 NMF 47.47 Summary:

Particulars SYMS Corp

EV/EBITDA

Comparables

Current Multiple $ 12.00 (9.87x)

Industry Multiple $ 10.25 (7.95x)

Valuation Overvalued

Sector Regression

Point Estimate $9.44

Lower Bound (95%) NMF

Upper Bound (95%) $23.20


Market Regression

Point Estimate $7.40

Lower Bound (95%) NMF

Upper Bound (95%) $47.47



17

EDGE PETROLEUM CORP.

Valuation by Fundamentals The valuation of Edge Petroleum, as with other oil & gas exploration companies, varies greatly with energy prices. However, we expect long-term demand for oil and natural gas to be steadily growing due to increasing demand from emerging market like China and India. Natural gas is also in strong demand, especially in the United States. Consumption is growing at a faster rate than for any other primary source of energy, and has increased 35 percent in the last decade as natural gas is the cleaner alternatives to coal in generating electricity. The projected growth in demand is reflected in our assumption as the company will experience a relatively high growth phase of 10 years. The price of natural gas and EPEX market share at the end of high growth phase are the major determinants of the company’s revenue growth during its assumed 10-year high-growth phase. In the sensitivity analysis below, it shows how the value per share fluctuates with the two variables.

Sensitivity Analysis Stock Price Natural Gas Price ($ per Mcf)

$4.00 $4.50 $5.00 $5.50 $6.00 $6.50 $7.00 0.20% $8.59 $10.12 $11.65 $13.18 $14.71 $16.23 $17.76 0.25% $11.65 $13.56 $15.47 $17.38 $19.29 $21.20 $23.11 0.30% $14.71 $17.00 $19.29 $21.58 $23.87 $26.16 $28.46 0.35% $17.76 $20.44 $23.11 $25.78 $28.46 $31.13 $33.80 EP

EX M

arke

t Sh

are

in 1

0 yr

s

0.40% $20.82 $23.87 $26.93 $29.98 $33.04 $36.09 $39.15 * Current natural gas price is $6.67


18

Upside (%) Natural Gas Price ($ per Mcf)

$4.00 $4.50 $5.00 $5.50 $6.00 $6.50 $7.00 0.20% -70% -44% -25% -11% 1% 10% 18% 0.25% -25% -8% 6% 16% 24% 31% 37% 0.30% 1% 14% 24% 32% 39% 44% 49% 0.35% 18% 29% 37% 43% 49% 53% 57% EP

EX M

arke

t Sh

are

in 1

0 yr

s

0.40% 30% 39% 46% 51% 56% 60% 63% Relative Valuation EV/EBITDA is identified as the best multiple to value our oil & gas exploration company. With the relative large capital expenditures among companies in this industry and the variation of capital expenditure with the size of firms and financial leverage, EV/EBITDA will provide a better valuation tool for Edge Petroleum. The company’s current multiple is compared to the implied multiples generated from the regression of sector comparables1 and the market2 in the following table.

Particulars EPEX EV/EBITDA Comparables Current Multiple 3.09 Market Multiple 6.83

Valuation Undervalued Sector Regression Point Estimate 7.05 Lower Bound (95%) 14.89 Upper Bound (95%) 0.00

Valuation Undervalued Market Regression Point Estimate 9.23 Lower Bound (95%) 22.38 Upper Bound (95%) 0.00

Valuation Undervalued Using the result from sector comparables and market regression (see tables on the following page), we come up with a per share value of $24.66 and $32.64, respectively. Under both regressions, EPEX is concluded to be undervalued. Under relative approach, we set the target price at $24.66 as the historical multiples of the company are more in line with the resulting multiples from sector regression.

1 Industry comparables includes all US companies in either petroleum and/or natural gas exploration with non-negative EV/EBITDA. 2 Companies in the market regression are those with non-negative EV/EBITDA and market capitalization of over $100 million.


19

Sector Regression Result: SUMMARY OUTPUT



R Square 0.390926902



Observations 69

ANOVA


Regression 3 1087.327962 362.442654 13.9065129 4.17768E-07

Residual 65 1694.081953 26.0627993

Total 68 2781.409914


Intercept 12.49299572 1.487002855 8.40146048 5.6576E-12 9.523245981 15.4627455

LT Debt to Capital -7.436897233 3.792146599 -1.96113126 0.05415043 -15.01033688 0.13654241

Effective Tax Rate -14.44446484 3.612294256 -3.99869551 0.00016541 -21.65871455 -7.23021512

Reinvestment Rate (EBITDA) 1.951751041 0.482363136 4.04622762 0.00014075 0.988405347 2.91509673 Market Regression Results: SUMMARY OUTPUT



R Square 0.04198481



Observations 2436

ANOVA


Regression 3 396082.1813 132027.394 35.5272916 1.8174E-22

Residual 2432 9037858.136 3716.22456

Total 2435 9433940.317


Intercept 41.0524018 2.602390834 15.7748795 1.8893E-53 35.94926988 46.1555337

Reinvestment Rate -0.00840362 0.069343516 -0.1211882 0.90355199 -0.14438208 0.12757485

Effective Tax Rate -67.7666326 7.497707606 -9.03831359 3.164E-19 -82.4691862 -53.0640789

Market Debt to capital -34.0242205 6.372738865 -5.33902631 1.0211E-07 -46.52077808 -21.5276629


20

EVA Valuation3 The inputs and assumptions in the EVA valuation are consistent with the DCF valuation in the above section. EVA in each year during the 10-year high growth period is difference between after-tax operating income and the product of invested capital at the beginning of each year and weighted average cost of capital. Invested Capital in the base year is the currently combined book value of equity and debt. Subsequent invested capital for each period is the previous period invested capital plus current period net capital expenditure and change in non-cash working capital.

WACC 7.87% Terminal EVA $44 PV (EVA) $(23) Capital Invested $79 PV (Change in Capital in Yr 10) $237 Firm Value $293 EVA by Sector Natural Gas (Div.) $13,698 Petroleum (Producing) $47,307 Blended Industry .Average4 $18,068

3 The EVA valuation is based on the FCFFEVA.xls model 4 The blended industry average of EVA is 87% and 13% of the natural gas and petroleum industry, respectively, reflecting the current revenue mix of Edge Petroleum.


21

COSTCO WHOLESALE Valuation by Fundamentals The DCF valuation of Costco Wholesale is based on a two-stage FCFF model. The projected growth in demand is reflected in our assumption, as the company will experience a relatively high growth phase of 10 years by undertaking excellent projects. Costco has been growing at 8% over last five years but these years were some of the less robust years in the US economy. Wall Street estimate points to a 12% growth over next few years, we believe that Costco is capable of doing as well as that.

Relative Valuation: EV/EBITDA is identified as the best multiple to value our Costco. Since Costco is expected to grow at a rapid rate in the coming years, it is expected to have relatively large capital expenditures along with many other fast growing companies in this sector. Since there is expected to be a variation of capital expenditure with the size of firms and financial leverage, we have another good reason to believe that EV/EBITDA will provide a better valuation tool for Costco Wholesale. The company’s current multiple is compared to the implied multiples generated from the regression of sector comparables in the following table. Using the result from sector comparables and market regression (see tables on the following page), we come up with a per share value of 40.40 and 39.98, respectively. Under both regressions, Costco is concluded to be fairly valued.


22

Sector Regression Result: SUMMARY OUTPUT



R Square 0.942070964



Observations 39

ANOVA


Regression 3 11835.56404 3945.188013 189.7291715 1.05088E-21

Residual 35 727.7825511 20.79378717

Total 38 12563.34659

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 15.38505054 2.979675138 5.163331515 9.78844E-06 9.33598846 21.43411263 9.33598846 21.43411263

Reinvestment Rate 2.089533968 0.100888606 20.71129781 3.16738E-21 1.88471921 2.294348726 1.88471921 2.294348726

Eff Tax Rate -18.12737599 7.0471921 -2.572283504 0.014504964 -32.43393645 -3.820815527 -32.43393645 -3.820815527

Market Debt to Capital -9.023922748 3.919910334 -2.302073767 0.027397824 -16.98176375 -1.06608175 -16.98176375 -1.06608175 Enterprise Value /EBITDA =15.39 + 2.09Reinvestment rate - 18.13Effective tax Rate - 9.02 Market Debt to Capital Ratio Market Regression Results: Enterprise Value /EBITDA= 8.554 + 1.016 g(rev) - .150 (Tax rate) -.0664 (Debt/Capital) - 0.0188 Reinvestment Rate

Actual Market Sector

EV 16,540.0 16,387.9 16,587.1

EBITDA 1,930.00 1,930.00 1,930.00

Cash 3,790.00 3,790.00 3,790.00

EV/ EBITDA 8.5699 8.4911 8.5943

# of Shares 477.66 477.66 477.66

Market Debt 1,080.00 1,080.00 1,080.00

Market Cap 19,410.00 19,097.9 19,297.1

Per share price 40.64 39.98 40.40


23

TOM GROUP Valuation by Fundamentals The DCF model employed to valuate the fundamentals of the company is a 3-stage FCFE model. Several assumptions have been made annual growth rates in earnings, capital expenditure, depreciation, and the change in non-cash working capital as a percentage of earnings, for high growth period, transition period, and stable growth period, as illustrated in the diagram below:

Assumptions The rationale for using the three-stage model is that we believe Tom will continue to experience high-growth because it will capture the growth momentum of the Chinese media market. We assume that the high growth of 15% will sustain for 5 years and then decline linearly for 10 years until it enters stable growth. Linear declination is also built in to growth of capital expenditure, depreciation, and change in working capital as a percentage of earnings. Foreign Market Valuation The market return for Hong Kong market, 9.98%, was calculated as the geometric mean of annual returns of Hang Seng Index from 1987 to 2004. The country risk premium is obtained from the bond return spread. See table for market returns of Hang Seng Index below: Historical Returns of the Hang Seng Index


24

Date Close Market Return for the Year

31-Dec-04 14230.14 113.15%

31-Dec-03 12,575.94 134.92%

31-Dec-02 9,321.29 81.79%

31-Dec-01 11,397.21 75.50%

29-Dec-00 15,095.53 89.00%

30-Dec-99 16,962.10 168.80%

31-Dec-98 10,048.58 93.71%

31-Dec-97 10,722.80 79.71%

31-Dec-96 13,451.50 133.53%

29-Dec-95 10,073.40 122.98%

30-Dec-94 8,191.00 68.90%

31-Dec-93 11,888.40 215.67%

31-Dec-92 5,512.40 128.28%

31-Dec-91 4,297.30 142.11%

31-Dec-90 3,024.00 106.61%

29-Dec-89 2,836.60 105.55%

30-Dec-88 2,687.40 116.70%

31-Dec-87 2,302.80 89.66%

31-Dec-86 2,568.30

Geometric Mean: 109.98% Sensitivity Analysis The DCF model suggests that the stock is undervalued by 74%. We tried varying the figures for our assumptions and yield the following figures for different inputs to the DCF model Sensitivity Analysis Table Revenue Growth (High-Growth Period) 20% 20% 20% 15% 15% 15% 15% 10% 10% 10%

Capital Spending Growth Rate (High-Growth Period) 20% 20% 20% 15% 15% 15% 15% 10% 10% 10%

Depreciation Growth Rate (High-Growth Period) 20% 20% 20% 15% 15% 15% 15% 10% 10% 10%

Revenue Growth (Stable-Growth Period) 4% 3% 2% 4% 3% 2% 3% 4% 3% 2%

Capital Spending Growth Rate (Stable-Growth Period) 4% 3% 2% 4% 3% 2% 3% 4% 3% 2%

Depreciation Growth Rate (Stable-Growth Period) 4% 3% 2% 4% 3% 2% 3% 4% 3% 2%

Change in Non-Cash Working Capital / EBIT(1-t) 5% 5% 5% 5% 5% 5% 3% 5% 5% 5%

Length of High-Growth Period 5 5 5 5 5 5 5 5 5 5

Length of Transition Period 10 10 10 10 10 10 10 10 10 10

Price / Share (HK$) 8.58 7.91 7.37 6.11 5.66 5.30 5.70 4.35 4.05 3.82 Relative Valuation In relative valuation, PE is used. The comparable companies comprises of companies in the publishing, media, and telecom services sector list in the following stock exchanges: Hong Kong, Shanghai, Shenzhen, and Taipei. We consider this appropriate because Tom Group’s business mix fluctuates from year to year. Most of the comparable companies are list in Hong Kong and this is appropriate because many Hong Kong companies derive revenue from China and Taiwan as well, just like Tom Group does. The regression that yields the best fit is PE regressed over EV/EBIT. Regression has also been performed on the 50 largest listed Hong Kong companies. In both regressions, companies with negative earnings have been excluded. Details in tables below:


25

Regression on comparable firms


Multiple R 0.961

R Square 0.924 Adjusted R S quare 0.919


Observations 16

ANOVA

Df SS MS F Significance

F

Regression 1 34740.09 34740.09 171.45 3.028E-09

Residual 14 2836.61 202.61

Total 15 37576.71

Coefficients

Standard

Error t Stat P-value Lower 95% Upper 95%

Intercept 8.336 4.455 1.871 0.082 -1.219 17.890

X Variable 1 0.996 0.076 13.094 3.028E-09 0.833 1.159

Regression on 50 largest Hong Kong firms

Regression Statistics Multiple R 0.88222 R Square 0.778313 Adjusted R Square 0.772906 Standard Error 24.21639 Observations 43 ANOVA

df SS MS F Significance

F Regression 1 84414.29 84414.29 143.9453 5.4E-15 Residual 41 24043.77 586.4333 Total 42 108458.1

Coefficients Standard

Error t Stat P-value Lower 95% Upper 95%

Intercept 1.707093 4.797463 0.355832 0.72379 -7.98158 11.39577 X Variable 1 0.919305 0.076623 11.99772 5.4E-15 0.764561 1.074049


26

Based on the values obtained from the regression, we derive at the following relative valuation values (Current share price is HK$1.49)

Particulars Tom Group Implied Price

Multiple: PE HK$

Comparables

Telecom Services, Cable TV, Web Portals, Television, Publishing (Newspapers and Periodicals) companies in Hong Kong, China, and Taiwan with positive earnings

Current Multiple 6.56 Market Multiple 43.43 $9.86

Valuation Undervalued Sector Regression Point Estimate 15.44 $3.51 Lower Bound (95%) 4.72 $1.07 Upper Bound (95%) 26.16 $5.94

Valuation Undervalued Market Regression Point Estimate 8.26 $1.88 Lower Bound (95%) -2.53 ($0.57) Upper Bound (95%) 19.06 $4.33

Valuation Undervalued EVA Calculation EVA Calculation (HK$,000)

EBIT (1-t) 964,125.00$

Capital (previous year) 3,201,089.00$

ROC 30.12%

Cost of Equity 13.26%

Cost of Debt 5.31%

WACC 8.81%

EVA 281,984.42$

EVA (US$,000) 36,151.85$ Tom’s EVA is higher than the EVA in sectors it is in: Sector EVA

Cable TV -225.42

Publishing 7016.83

Telecom 4223.82

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