Ann: Company update and diversification strategy, page-9

Sure. I certainly don't consider myself a font of knowledge and that's why i make plenty of mistakes.

In simple terms, if you define the four variables i mentioned, you can come up with a rough entry point for MCE as follows: EV = (E*M)/(1+R^T), where

EV = today's price/rough entry price in terms of enterprise value;
E = estimate of operating earnings (EBIT) at time T;
M = estimate of fair multiple on E;
T = hold period in years to exit;
R = required rate of return.

So, in a purely hypothetical example where you thought MCE could get back to doing $10m EBIT in three years' time, a fair EBIT multiple was 8x, and your required rate of return was at least 20% p.a., the above would solve as follows: EV = (10*8)/(1.2^3), therefore EV = $46m. Today's actual EV (market cap +/- net debt/net cash) = (45-14) = $31m, so in this hypothetical today's EV potentially represents a good entry point as it is below the $46m solve.

That isn't the full story, though, because the capital structure of the business will probably change if earnings go to $10m. MCE's net working capital position - (inventories + receivables) - (payables/progress claims) was roughly ($15m-$4m) = $11m at FY17, whereas in FY15-16 it was more like $30m, which means they'll probably have to sink all their net ~$14m cash balance into working capital if earnings grow to FY15-16 levels. So you might want to adjust today's EV for this by netting off required future working capital investment against the net cash balance. This would be a conservative approach because it effectively assumes zero operating earnings between now and exit to fund working capital growth - you're fully hitting today's EV for future working capital investment and assuming there's no ability for the business to do this in future via operating earnings generated between now and your exit period. If you wanted to be less conservative, you could do a DCF between now and exit and have earnings invested into working capital - so, maybe the business does $0m EBIT in year 1, $5m in year 2, and $10m in year 3, and you assume that entire balance ($15m) is invested into net working capital, in which case the business in year 3 would have ~$25m net working capital but would still carry today's ~$14m net cash balance.