Business discussion
The decline in revenue has almost stabilized. There has been good growth in subscribers. The total subscribers grew by 8%, mainly in the middle-east and Africa. Some of the details are lifted from the press release here and show that FTE has been expanding and upgrading its network. Given the capital intensive business that it is in, this is hardly surprising and we were well aware of this when we covered the company before (France Telecom: Upsides and Risks)The year was negatively affected by the partial pass-through of the VAT increase that took place on 1 January 2011 in France (-0.2 point) and by the situation in Egypt and Côte d’Ivoire (-0.1 point). Restated EBITDA also included the impact of regulatory measures estimated at -227 million euros in 2011.
Investment in networks, representing 55% of the Group’s CAPEX, rose 2%, in particular due to:In view of the continuing review of its portfolio FTE is planning to make the following changes
- increased investment in mobile networks by most European countries as the equipment upgrade programme to improve service quality and reduce costs was implemented;
- accelerated deployment of 3G mobile networks in Africa;
- investment in submarine cables in Africa (ACE) and in the Indian Ocean (LION2);
- growth of fibre optics (FTTH) in France.
- On 23 December 2011 it announced that it had signed an agreement to sell 100% of Orange Switzerland based on an EV of 1.6 billion euros, corresponding to 6.5 times the subsidiary’s estimated EBITDA in 2011.
- On 3 February 2012, the group announced to sell its 35% interest in Orange Austria for around 70 million euros.
The Swiss market (as well as Europe) has been very competitive with almost no pricing power. The number of new customers are shrinking, while the regulations are tightening. Last year, Orange tried to merge with Sunrise to compete better with Swisscom, the incumbent operator in Switzerland. This was blocked by the regulatory authorities on the grounds of loss of competitiveness in the mobile market.
With increasingly stringent regulations, a higher tax burden, more intensive competitive pressure in its home turf by the arrival of fourth mobile operator and deteriorating macro-economic indicators, the group expects the EBITDA-CAPEX to drop to 8 billion euros from 9 billion euros this year. The group aims to preserve the net debt/EBITDA ratio of around 2 in the medium term.
The group will propose an interim dividend of 0.6 euros for the fiscal year 2012 in september 2012.
Dividend
FTE reaffirmed a dividend of Euro 1.4 for 2011. A balance of Euro 0.8 will be paid on 13 June 2012.The group has decided to align its shareholder remuneration policy with operating cash flow generation. The group expects a OCF of 8 billion euro in 2012 and plans to pay 40-45% of that as dividend. Assuming that FTE is spot on the target with its OCF, investors will likely see Euro 1.2 dividend for 2013, which is a 17% hair-cut on the dividend.
In numbers
Let us discuss the numbers now. We will look at the income statement, the balance sheet and a valuation update to see if the current under-performance of FTE is a buying opportunity.
Income statement
| Item (in mEuro ) | 2011 | 2010 | 2009 |
| Revenue | 45,277 | 45,503 | 44,845 |
| D&A | 6,735 | 6,461 | 6,234 |
| Op Income | 7,948 | 7,562 | 7,650 |
| Cost of debt | 2,066 | 2,117 | 2,232 |
| Income from continuing operations | 3828 | 3807 | 3202 |
| EPS continuing op | 1.46 | 1.43 | 1.06 |
The income statement does not seem out of ordinary. The revenue has decreased a bit but was according to the forecast. The EPS from continuing operations improved and so did the income. Let us now look at the balance sheet.
| Item (in mEuro) | 2011 | 2010 | 2009 |
| Cash and equivalents | 8,044 | 4,428 | 3,805 |
| Total Current Assets | 18,535 | 15,130 | 13,452 |
| Goodwill | 27,340 | 29,033 | 27,797 |
| Intangibles | 11,343 | 11,302 | 9,953 |
| Total non-current assets | 75,531 | 79,146 | 69,194 |
| Equity | 29,592 | 31,549 | 29,577 |
| Employee benefits | 1,688 | 1,826 | 1,223 |
| LT financial liabilities | 34,192 | 33,792 | 31,116 |
| Total liabilities | 39,279 | 39,136 | 36,060 |
| Total current liabilities | 26,172 | 23,591 | 22,093 |
The group targets to have (Net financial debt)/EBITDA of about 2 in the medium term. This metric is 2.09 at the moment and was 1.95 last year. The indebtness of the group has increased from 31,840 mEuros to 32,331 mEuros in 2011. This is not a significant increase and will only be worrying if it continues. As I discussed in my previous article on FTE, the indebtness of the company is manageable and given the large stake of the French, it will not have much trouble getting finances. The only thing we need to make sure is that it remains a good FCF generator so that it can cover the interest expenses. From the income statement we see that that the cost of debt (or interest expense) is around 2 billion euros. With a net income of 3.8 billion euros, the interest coverage ratio is less than 2 now. This is a bit low and a doubling of the interest rate will severely effect the profitability of the company.
Valuation update
| 2011 | 2010 | 2009 | |
| # shares | 2,648 | 2,648 | 2,648 |
| FCF (mEuro) | 7,237 | 6,486 | 9,198 |
To be safe, let us do an EV like calculation with total liability instead of just the debt. We see that this is 62.8 billion Euro. For a consistent FCF generator like FTE, the DCF calculation is a good valuation tool. Using it, we see that the EV is less than 8.67xFCF.
| Share price (Euro) | 11.14 |
| Cap (mEuro) | +29,525 |
| Total Liability | +39,279 |
| Minority interest | +2,019 |
| Cash | -8,044 |
| Total | 62,779 |
If you are comfortable with the debt and an interest coverage ratio of 2, FTE is undervalued on several metrics to its counterparts like Telefonica (TEF), Telecom Italia (TI), Deutsch Telekom (DTEGY) and AT&T (T). A price below euro 11 is a very good price to pay for this monsterous dividend yielder and a very good FCF generator.
