Should You Start Buying European Telecom Companies?
Now the industry's picture is changing for the best. At a time when the European economy seems to be coming back, the sector is finally consolidating and price-competition has dramatically slowed. Let's analyze my favorite two telecom plays.
The Outlook Is Finally Improving
Madrid based Telefonica is not only active in Europe but also in healthy Latin American markets, where the company generates most of its revenue and earnings. That said, the company is still struggling, partly thanks to its huge $62 billion net debt pile, which the company is reducing fast through divestitures such as its UK broadband business, 5% of China Unicom or 40% of its business in Central America.
With all of the above being said, the company is now preparing itself to be an active player in the consolidation of the European telecom market. As a matter of fact, the company is in the process of acquiring E-Plus, KPN (OTH: KKPNY)'s German subsidiary, and it could also consider buying out some of its partners in Telecom Italia, where Telefonica already owns a 10.4% stake.
I believe the on-going economic recovery and a more concentrated market will push the company's results going forward. Investors such as David Dreman or Charles Brandes seem to be thinking the same (they are long on the name). Trading at 5.1 times EBITDA, I think its a good time to start considering the stock.
A Deal Is to Be Expected
Italy's main telecom company, Telecom Italia, is controlled by Telco, a holding company that owns a 22% stake in the company. Telco, which is owned by Intesa Sanpaolo (11.6%), Mediobanca (11.6%), Assicurazioni Generali (31%) and Telefonica (46%). Most of the Italian shareholders, such as Mediobanca, would be ready to sell their stakes - they already have problems at their core industries.
Meanwhile, Telefonica seems to be weighting the possibility of buying its Italian partners out. This would further help the industry's consolidation process while making Telefonica even stronger in its core market. Nevertheless, a deal will come. If Telefonica decides not to buy its Italian partners when it decides to sell, it will surely sell its own stake. It wouldn't make sense for the Spanish former monopoly to own a non-controlling stake in Italy's biggest telecom operator. And buyers shouldn’t be hard to find. Telecom Italia is one of Europe's cheapest stocks. The company trades at 3.3 times EBITDA and generates an adjusted enterprise free cash flow yield of 11.3%, a huge discount to the sector's average. I think investors will start seeing the same rather sooner than later.
Consolidation is always good for investors (not so much for consumers). An industry with fewer players is usually an industry with less price competition and, hence, more stable revenues. As the European telecom sector consolidates and the economy ameliorates, it might be a good idea to stay long.