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Chandan Dubey
Chandan Dubey
Articles (150) 

France Telecom (FTE): upsides and risks

February 11, 2012 | About:

France Telecom is the incumbent telecom operator in France and has significant exposure to Africa and the middle-east. It also owns the Orange brand. This article is mainly aimed towards an analysis of FTE and some other major telecoms with large yields which are bobbing around their 52 wk lows. Read on !

1 Key figures

Share price$14.92 (Feb 11, 2012)
No of shares2,648,858,606
State Ownership26.97% (Dec 31, 2010)
Cap$39.5 billion
EV82.91 billion (Y! Finance)
Dividend1.4 Euro (2012)
FCFEuro 7.23 billion (TTM)

2 Risks

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, 2011Dec 31, 2010
Current assets14.3415.13
Current liabilities23.5723.59
LT debt29.531.6
Total liabilities62.763.46
Interest paid1.192.05
Share based compensation414
EPS (diluted)0.731.82

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)-1,4783,8936,2007,5777,2566,8307,5717,8139,1986,4867,237

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.

2.2 Competition

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.


3 Opportunities

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 (NASDAQ:VOD) and Telefonica (NYSE: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.

4 Valuation

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).

5 Industry

Some other interesting companies in the same business trading at around their 52 wk lows are: Telefone Italia (NYSE:TI), Deutsche Teleco (DTEGY.PK), Telefonica (NYSE:TEF), AT&T (NYSE:T), Verizon (NYSE:VZ), Vodafone (NASDAQ:VOD), KPN (KPN), Vivendi (VIV.PA).

TEFTelefonica 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.
TITelephone 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.
VODFantastic 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”.
TAT&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.
VZAgain 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.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 4.1/5 (16 votes)


Praveen Chawla
Praveen Chawla premium member - 5 years ago
Good analysis. I have been buying FTE for some time. Its been a morningstar 5 star stock for some time. Like you said the highly leveraged balance sheet prevents me from backing up the truck. But below $15 adr it starts getting compelling. I also have T, TI and will consider posiitons in the rest as the whole sector (except perhaps VZ, is in value territory) as the market is chasing high beta stocks.
Cdubey - 5 years ago    Report SPAM
I am looking for a 10% drop to buy more. Will probably start making a strong position around $12. I like VOD and TEF. Need a margin of safety on VOD and debt is turning me off with TEF. Will probably not buy it.
Extramiler - 5 years ago    Report SPAM
What do you think about Deutsche Telekom?
Cdubey - 5 years ago    Report SPAM
Have to research the stock to find out their growth strategy, their brands and international exposure.

On a purely numbers basis (and a bit of digging) I have to offer following observations

  • DT has revenue of euro 62 billion and VOD has revenue of euro 56 billion (2010). The FCF in the same period is euro 4.8 billion and euro 7.17 billion respectively. This is not a one time thing. VOD has better FCF than DT.
  • DT's revenue comes from Germany, UK and US (more than 90%). These markets are low growth. DT is also looking for expansion in emerging markets but clearly VOD has a better infrastructure in place already.
  • DT has euro 12 billion in tangible equity (from Sep 30, 2011 report). The AT&T deal has fell through and probably it will be prudent to wait for the new balance sheet from the annual report. With euro 38 billion cap and 38 billion in LT debt, the EV is more than 76 billion. So, the EV/FCF stands at more than 15. Both FTE and VOD are cheaper in comparison.

I would say that VOD is a better bet. Among FTE and DT, it is hard. FTE clearly is cheaper, has larger yield but DT has a better balance sheet and a better management (32% of the shares are owned by the government but I trust German government more than the French government in terms of business).
Batbeer2 premium member - 5 years ago
>> DT has revenue of euro 62 billion and VOD has revenue of euro 56 billion (2010). The FCF in the same period is euro 4.8 billion and euro 7.17 billion respectively. This is not a one time thing. VOD has better FCF than DT.

VOD owns 45% of Verizon Wireless. The revenue is not consolidated. The dividend income, as a component of FCF, is. There was a discussion of Vodafone a while ago. At the time Vodafone was not yet collecting a dividend from Verizon Wireless.
Cdubey - 5 years ago    Report SPAM
I was not aware of this. Thank you !

I have not researched Vodafone yet. Will read your article and see if my judgement of VOD better than DT still holds.
Bill_zhang - 5 years ago    Report SPAM

Have you consider currency risk? Euro may be worth much less based on their sovereign debt crisis.
Cdubey - 5 years ago    Report SPAM
No, I have not. I don't like dollars either. In the longer term I think euro will out-perform dollar. The money printing in the US is disconcerting (so is the one in Europe, but the Europeans don't like printing too much but US loves it).

If you think Eur is worth less, buy FTE and be short Euro. But then you have to convinced that FTE is a good deal.
Batbeer2 premium member - 5 years ago
>> 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 ?

Ow.... Verizon Communications of course owns the other 55% of Verizon Wireless. That is consolidated. Verizon Wireless itself is unlevered. The balance sheet is a beauty. In other words, Verizon (without wireless) is dead. No cash. With Wireless, it is another matter.

Hint... do not confuse Verizon Communications (VZ) and Verizon Wireless (unlisted). They are two distinct companies.

The reason FCF at VZ fell off a cliff may have to do with the fact that Verizon Wireless was retiring debt (owned by VZ) at a rate of $ 15B per annum. In what I consider to be a stupid move, VZ didn't use this temporary river of cash to shore up their balance sheet.

Instead, VZ used the cash to fund a hefty dividend. The debt has now been retired in full so that option is gone. Wireless now pays a $ 15B dividend instead of retiring its debt (there is no debt left to retire). Of course, with a dividend, Vodafone gets a cut too. This eats into FCF of VZ. Permanently. I would expect FCF of VZ to now be less by roughly $ 7B (45% x $ 15B now goes to Vodafone).

VOD with a decent balance sheet and VZ with a less than decent balance sheet must come to an agreement as to what to do with their love child. This can't go on. It will stop.

Just random thoughts.
Extramiler - 5 years ago    Report SPAM
Thanks for the analysis of DT.

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