How much will Apple pay for TomTom?

Yesterday I set out the strategic rationale for Apple to acquire TomTom. In a nutshell 1) it helps them fix iOS maps, 2) it gives them longer-term muscle in the mapping business and 3) is a do-able deal.

Today I want to focus on the third point - how would the deal come about and how much would Apple have to pay. My key takeaways is that the deal is very do-able, but Apple will need to pay a decent premium to the current share price.

TomTom: A potted history

TomTom: Rise and Fall

Before I lay out my case I want to provide some background on TomTom. This is partly for entertainment value (its certainly been been one of the more eventful companies I've covered in my time as an equity analyst), but mainly because to understand this deal you have to understand where the founders are coming from.

TomTom began as a software shop by a bunch of former employees from Psion's Dutch arm, notably Harold Goddijn and his wife Corinne Vigreux (who still lead of the company today). The outfit - called Palmtopsoftware - originally wrote apps for Psion PDAs. I remember with some affection using their ZX Spectrum simulator on my Psion Revo back in the day (it let you play Defender of the Crown in the college library. 'nuff said). They then moved onto writing apps for Windows CE-based devices such as dictionaries and nagivation apps.

Harold's current yacht

Then engineer (and co-Psion refugee) Mark Gretton struck gold with the idea that rather than kludging their software onto Windows CE boxes, they should build their own dedicated device. This was a classic case of a dedicated appliance pioneering a new technology. TomTom happened to be at the right place at the right time, and smart enough about branding their devices to build a big lead in the market. IPO, riches and acclaim followed. Harold and Corinne bought a yacht.

Then it all went wrong.

Two things (almost) killed TomTom. First they grossly overpaid to buy Tele Atlas funded by far too much debt. Then both debt market and the satnav market crashed.

Actually buying Tele Atlas was a smart strategic move. At the time it was one of only two vendors (along with Navteq) which had a full digital map for Europe and North America (Google has since built its own third map) and thus had genuine scarcity value. And the market for a dedicated appliance matured, it made sense to diversify into higher-margin software. The fact that I am now writing about Apple wanting to buy TomTom - principally for Tele Atlas - is in some ways a vindication of the deal. Unfortunately they made the mistake of getting into a bidding war with rival Garmin which meant they ended up paying €3bn, funded by debt.

They might have survived that but then the global economic crisis hit just as the satnav market went ex-growth. With revenues from its main profit-driver falling at a 20-30% rate TomTom simply could not meet its debt covenants and the shares which had peaked at over €60 fell to less than €3. This culminating in a near-death experience and a rather messy refinancing mid-2009. To their credit Goddijn and Vigreux put their money where their mouth was, putting their personal wealth back into their company via the rights issue. They also brought on-board friendly local investors Janovo and Cyrte who put in €100m for a 10% stake. The current shareholder structure looks like this:

Since then its hardly been an easy ride. In particular Google's bombshell in October 2009 of free turn-by-turn on Android (a move finally followed by Apple this year) was the beginning of the slow death of Satnavs as a mass market proposition. Yes there remains a market for them for holidaymakers or professional users (I actually bought one this year to help navigate us on our honeymoon!), but since then Satnav revenues have declined steadily, such that TomTom no longer even tells us how many devices they have sold each quarter. To her credit CFO Marina Wyatt has done a good job defending margins and keeping the company profitable (the pressure of debt covenants does help focus the mind), but it can't have been much fun in recent years.

But at least they still have the map.

How much is TomTom worth?

There are two questions here. First how much TomTom is worth as a standalone business. Second how much is it worth to Apple.

Actually the first question doesn't matter a vast amount (I know, I know. Any value investors please leave the room now). It gives us a starting point for valuation but everyone at the table will know the real point is how much Apple is prepared to pay. For what it's worth, here's a bog-standard DCF I knocked up on TomTom's business:

Key assumptions are highlighted in blue. I'm not going to claim its a work of art, or indeed that its going to be particularly accurate. Basically IF you assume satnav declines (and therefore revenue declines) bottom out this year AND IF you assume TomTom can sustain a 10% margin then it implies a valuation price a smidge over €4 /share or about €900m for the equity (not far off the current price). . At the DCF valuation TomTom would be trading on roughly 1x EV/Sales and a 10-12.5x forward P/E multiple, consistent with a stable low-growth company. Of course that does assume that Satnavs don't die a death, and that competition doesn't crush margins - as I said its not a work of art.

This isn't particularly useful in figuring out M&A valuation - but at least it gives you a starting point for both sides.

How much is TomTom worth to Apple?

Now we get to the M&A valuation, which is much more interesting but more frustrating. I'm not going to apologise for the fact that the numbers I'm going to talk about here will have little grounding in intrinsic value or sane investment valuation. The sad fact is that most M&A is value destructive, and so the key question is not what an asset is worth but what some mug is prepared to pay for it.

The economic rationale of the deal is simple. TomTom has an asset (its digital map + associated expertise) which it is unable to fully monitise through its existing lines of business (selling satnavs and licencing the map to third parties). However plug that into Apple's front end and distribution and you can suddenly monitise that asset across hundreds of millions of iOS users. Therefore the cash generating potential of that asset is much higher for Apple than for TomTom.

That's the theory. In practice figuring out how much extra value Apple can create over the next 5... 10... 15... 50 years is anyone's guess. At the end of the day it boils down to how much the sellers reckon they can get out of Apple, and how much will make them feel good about themselves. i.e. its an exercise in psychology as much as mathematics.

As with any negotiation, what you need do is put yourself into the shoes of everyone gathered round the table.

Apple: To best honest, they don't particularly care. With $82bn of cash in the bank whatever they pay for TomTom isn't really going to ruin Tim Cook's day. I would say they won't want to pay stupid money for TomTom, and by that I would mean the demonstrably silly €2.9 - 5.7bn price tags which Tele Atlas and Navteq sold for during the last bubble. I would say those levels would be the hard lines which Apple would not want to approach.

Apart from that you can slice the valuation every which way. For example how much more would an iOS user theoretically pay to replace Apple Maps with a decent mapping app? If you assume $5 and multiply that by a 410m iOS installed base you get $2bn (but then again Google Maps is free, and its more about the value of Apple/TomTom maps to future iOS users than existing ones). How much did Apple's share price get whacked by the maps fiasco? $30bn according to some (hint: don't believe everything you read in the papers) so by that reckoning any price tag is good value (the fault in that logic, btw, is that you are making an assumption that TomTom DEFINITELY will make Apple maps as good as Google; it might not).

Another way to think about it is how much would it cost for Apple to build the map from scratch. The short answer is that it took both Tele Atlas and Navteq about $500m of capex to build their US + Western Europe maps back in the 1990s. You could undoubtedly do it for less now (for a start you could buy a TomTom to help your mapping trucks navigate the roads...). But there's a catch - it would take you several years to do this - so whats the opportunity cost of giving Google another few years to forge ahead? Tricky...

We can play these games all day. I think Apple would be willing to pay up to the €3bn level Tele Atlas went for before (they can console themselves that they're getting TomTom's other assets thrown into the deal) which gets us to €13 /share. But I'd assume they'd want to pay far less.

How much will the insiders sell for?

Janovo/Cyrte: This is the easy one. Dutch private equity houses Janovo and Cytre invested €100m in the 2009 refinancing, and hold a 10% stake in TomTom. Doing the math, that means they're currently sitting on a c15% loss on their initial investment. What would be a sensible financial return for them? I think they would want to show their investors at least a 15% CAGR return, and preferably a nice round 20%. Compounding that over three and a half years that would point to a €1.63 - €1.89bn valuation, or roughly €7.4 - €8.5 /share.

In practice though these guys are "friendly" investors for the management. If the founders take an offer they are likely to. And if the founders reject it, the deal is dead anyway.

The Founders: At the end of the day, its whether the four founders Goddijn, Vigreux, Geelen and Pauwels will take a bid. They control 48% of the equity and will have to support any acquisition given TomTom has a poison pill in place to prevent a hostile takeover.

At the very least I think they will want to see a decent return on the €4.21 /share at which they bought back into the company in the 2009 rights offering. It is important to understand the psychology behind this (which is why I gave the potted history above). The founders had nurtured their baby, seen it blossom into a giant and then seen it crash. In 2009 they had the option of walking away and let it get taken over by their debt holders, or putting their money where their mouth was and buying into the refinancing. To their credit they took the latter option, and the company is still around today. But I think the final vindication would be if they could walk away from that investment with a profit.

Another pointer would be stories about a potential de-listing which circulated earlier this year, when the shares were languishing around €3. If they were true (and, to be honest, who bloody knows?), then that would imply the insiders believed the shares were materially undervalued at that level. So what, at least €4 /share perhaps?

But its not just the money. After all in any scenario Apple would have to offer a reasonable premium to the current share price. As I said its important to remember for the founders that TomTom is their baby. So the quality of the offer is as important as the level.

By this I mean if, say, an offer came in from a private equity house which wanted to break up TomTom, fire the employees and sell off its assets it would get very short shrift.

But if an offer came from say a world-beating tech company, famously entrepeneur-led which would allow TomTom to take its navigation vision to another 410m users... Well that would be another story.

And if that gave the founders an opportunity to flourish on a bigger stage. Well...

Somewhere over the rainbow...

As I said, its as much about the psychology as the valuation.

So where have we come out at? I think Apple could pay up to €13 /share, but would want to pay less.

Janovo/Cytre would be looking at in excess of €7.4 /share. The founders would want more than €4.21 /share. The stock is currently trading at €3.86 /share. Standalone fair value (for what its worth) is probably around €4 /share (in my humble opinion).

Oh and one more piece of market nous - when you make a bid you want it to be a "knock-out bid", i.e. not a low-ball offer which makes shareholders hold out for more. In my experience a knock-out bid comes at a 30%+ premium to the share price, preferably a 40%+ premium. Yeah I know - Benjamin Graham would be turning in his grave. But Bruce Wasserstein wouldn't.

That's what they meant when they said valuation is an art, not a science.

Put a gun against my head and I'd say €5.5-8 /share, probably towards the lower half of that range. The key thing would be to get the founders on-board, at whatever price  it takes.

That's all.

Afterword: A few thoughts on deal mechanics

Timing: Given cash resources, and the fact it would be an agreed deal, I think this would be a relatively straightforward transaction. All that would be required would be a public tender for the remaining free-float. Provided there was a knock-out bid (In excess of 40%-ish to the current share price) I don't think there would be much push-back from the other shareholders. I reckon if they did this tomorrow it would easily be wrapped by end-Q1.

Counter-bids: There isn't an obvious counter-bidder out there either. Microsoft and Google already have their maps sorted out. The other big consumer ecosystem players - Facebook and Amazon - don't has as direct an interest in location-based services. I doubt the business would attract a counter-bid from a financial buyer as it already has a reasonable debt load, and has shown in the past that its model isn't amenable to high levels of gearing.

Regulatory hurdles: The only stumbling block I can think of would be regulators. On the mapping side given Nokia/Microsoft and Google are such powerful and well capitalised rivals I doubt there would be a viable challenge. If there's one thing we're not lacking in smartphones at the moment its competiton! Garmin could potentially mount a challenge on the satnav side, but given Apple has no use for the hardware busineses I think they'd be very happy to divest it. Possibly to Garmin.

Oh and by way of disclosure, no I don't hold any shares in TomTom or Apple. The forecasts (for what they're worth) are my forecasts and the opinions are my opinions. You heard it here first.