1 Key figures
|Share price||$14.92 (Feb 11, 2012)|
|No of shares||2,648,858,606|
|State Ownership||26.97% (Dec 31, 2010)|
|EV||82.91 billion (Y! Finance)|
|Dividend||1.4 Euro (2012)|
|FCF||Euro 7.23 billion (TTM)|
2.1 Financial situation
The following are the relevant figures from the balance sheet. We see that FTE has negative equity (not a good sign). There is nearly Euro 30 billion of LT debt. How safe is our investment here ?
|Items (in billion Euro)||June 30, 2011||Dec 31, 2010|
|Share based compensation||4||14|
On the equity perspective FTE offers a very bad balance sheet. But what about earnings. For this let us look at the FCF figures
|FCF (Eur mil)||-1,478||3,893||6,200||7,577||7,256||6,830||7,571||7,813||9,198||6,486||7,237|
Given that the telecom is a very capital intensive business (upgrading the cables for ever changing new and faster technological advances), FTE is a prodigious cash flow machine. It has consistently generated good FCF and of the order of Euro 7.2 billion per year. This is very promising. FTE has an interest coverage ratio of 3.56, which is well above the danger sign.
Let us look at the debt maturity profile of FTE.
As we see, and as the management says, FTE is trying to decrease the debt. There has been significant de-leveraging of the balance sheet. The debt profile is not too alarming until 2014 and will be well covered by the FCF it generates. I do not see a reason to worry here.
Furthermore, as the french government owns a large part of FTE (26%), I strongly doubt that FTE will have problems refinancing the maturing debts.
The market thinks that FTE’s margin will remain under-pressure because of the competition it expects in the coming quarters. A new low-cost operator Iliad will enter the french mobile market and they will significantly lower the fees for calls in France.
Given that most of the traffic of Free is channelled through the FTE network, I see FTE profiting from this anyway. Furthermore, the recent rumor suggests that Free (the Iliad srvice) has deceived the regulators claiming its network covers 27% of the population and there has been enquiry launched by the government against Iliad. Unfortunately, Free is already picking up subscribers. The current geographical figures for FTE are as follows (Sep 31, 2011)
Below we see the customer figures from 2010 and they look good
Furthermore, from the ARCEP (the regulatory authority in France for telecommunication) we also see that the market share of FTE is stabilizing.
The tele-communcations industry has suffered pricing pressures and shrinking margins in developed countries for quite some time. This is mainly due to strong regulatory environment and upstarts trying to offer cheaper services. The companies has responded with two strategies a) Aggressively cutting costs and/or b) investing in high growth emerging markets. Vodafone (VOD) and Telefonica (TEF) have significant global exposure and British Telecom has reduced costs.
Unfortunately, being state-owned FTE cannot cut costs. They have comparably large pension liabilities and the government will not allow aggressive layoffs. FTE has also missed the expansion in the growth market, also mainly due to the same reason as above. The significant shareholding by government creates a drag on its ability to jump on opportunities.
On the positive side, they do have some expanding international business. They are concentrating on the middle-east and Africa as their high growth business and this has been paying off. Moreover, FTE us the world’s largest telecom carrier and is expanding its coverage in both mobile and fixed line mature and emerging markets. The company continues to make significant capital expenditure in fiber optic network in France and enhance 2G/3G access in Africa and middle-east.
FTE is selling off many of its interests in which it does not play a majority role. This is according to the managements targets and the management wants to use these proceed to deleverage the balance sheet.
FTE is significantly undervalued. The management has pledged a dividend of Euro 1.4 for the year of 2011 and 2012. Even after a 25% french withholding tax, this is 1.12 Euro/share which on the current price of Euro 11.25 (Feb 11, 2012) is an yield of 10%. Is the dividend well covered ? With an EPS of 1.82 Euro is 2010, the payout ratio is 77% (Div Per Share/EPS). This does not really fill me with confidence, but there are two additional details which together pretty much guarantee that the dividend will not be cut at the moment. First, the management has pledges to pay it out and has not changed their stance so far. Second, the french government needs the money. This is a very profitable cash machine for them and they would like to get their hands on the dividend.
Couple this monstrous 10% dividend yield with the EV/FCF of 8.75 and you have a compelling buy. I do not want to get in the numbers as one can easily run the DCF model or the dividend discount model to see that FTE is undervalued by at least 50% (with significant margin of safety).
Some other interesting companies in the same business trading at around their 52 wk lows are: Telefone Italia (TI), Deutsche Teleco (DTEGY.PK), Telefonica (TEF), AT&T (T), Verizon (VZ), Vodafone (VOD), KPN (KPN), Vivendi (VIV.PA).
|TEF||Telefonica is the incumbent telecom operator from Spain with a fantastic growth opportunity in Latin America. Around 35% revenue comes from Spain, 40% from Latin America and 24% from the rest of Europe. The worry with TEF is its significant debt. The EV is $154 billion, LT debt Euro 54 billion and FCF Euro 7.7 billion. This is same amount of FCF as FTE with better growth but almost 2xEV. Projected yield is 9.8% and the stock is trading at its 52wk low because of the debt problems and the loss it made in the last quarter.|
|TI||Telephone Italia is the incumbent telecom opertor from Italy. It has significant exposure to Argentina, Brazil and Paraguay. It has an EV of $66 billion, yield of 6%, FCF of around Euro 3 billion and LT debt of Euro 35 billion. The EV/FCF stands at 22 which is significantly higher than what we pay for FTE. Also, the FCF figures are on a downhill since 2005 (Euro 4.8 billion and bottomed in 2009 Euro 1 billion and have now improved to Euro 3.7 billion in TTM.|
|VOD||Fantastic international exposure. It has equity interests in more than 25 countries and partner networks in more than 35. EV is $187 billion, FCF is GBp 12 billion and LT debt is GBp 29 billion. The best balance sheet around. The EV/FCF stands at 10 and is probably the best in terms of global exposure and valuation in comparison to FTE. It has GBp 87.5 billion in equity and GBp 68.5 billion in intangibles and goodwill. FTE on the other hand has negative tangible equity and hence is not a “value investment”.|
|T||AT&T is the second largest wireless career in US and does not have the significant growth opportunities as VOD or TEF. It has EV of $240 billion, FCF of $15 billion, yield of 5.9% and LT debt of $59 billion. It has $111 billion in equity and $134 billion in intangibles and goodwill. Again, not a “value investment” per se with its negative equity. Furthermore, the EV/FCF is 16 and is trading at a significant premium to FTE for example.|
|VZ||Again a US based operator with almost no global exposure. It has $45 billion LT debt, $102 billion in intangibles and goodwill and $39 billion in equity. One of the most horrible balance sheets I have seen. The yield is 5.31% and the FCF was almost $17 billion in 2010 (TTM $12.5 billion). With $148 billion EV the EV/FCF ratio stands at 8.7 according to the 2010 figure. On this metric is almost as cheap as FTE. I need to do more research to find out why the FCF went down in TTM by so much and can VZ sustain it’s FCF around $16 billion ?|
I am long FTE and will buy below $14.5 for the ADR (bought 35 shares on the last pulllback at $14.95/share). Vodafone also looks quite attractive but I want to do some research before buying some. If VOD drops below $25, I will strongly consider opening a position.