Orange (ORAN), previously known as France Telecom, is the historical French telecommunications operator, and a telecommunications behemoth on the global stage. It is present in 33 countries (including 11 European and 21 African and Middle-Eastern ones), with a total of about 231.5 million customers served by approximately 170,000 employees. Orange covers a wide range of activities: e.g. standard ones like providing land line and mobile phone services, internet and IP television services, and also more exotic ones like installation and maintenance of underwater telecommunications cables, videoconference services, co-production of movies (in order to create content for its television services), and video-sharing services (through Dailymotion). France Telecom officially changed its name to Orange on July 1 of this year.
Like most European telecoms, Orange's share price has been decimated for the past 13 years: it remains 62% lower than 10 years ago, and a whopping 95% lower than the peak value reached in early 2000. ORAN currently trades at a P/E ratio of about 9, based on a basic EPS of 0.40 euros ($0.52) as reported for the first half of 2013 and assuming the same EPS for the second half of the year. It offers an annual dividend of 0.80 euros ($1.04), corresponding to a dividend yield of 10.8% at the share price at the close of August 2. A relatively low price combined with a high dividend should attract the eye of value-oriented investors. Moreover, with the nascent improvement in the European economy, Orange is likely a good recovery play. However, it might still be too early to load your portfolio with its shares, as we will show in this article. Orange released its financial results for the 1st half of 2013 on July 25, and as always they contain interesting data that need to be sorted out.
All of the financial results and ratios pertaining to Orange and cited in the following sections are directly obtained from the 1st half-year financial report. All of the results pertaining to Vodafone are obtained from the March 31 financial report. All of the results pertaining to Iliad are from the 1st quarter financial report. Some websites of French companies or organizations linked as sources in the following sections are available in French only.
Orange's Overview: a French Problem
During the first half of 2013, ORAN claimed 20.6 billion euros ($27.1 billion) in revenues. This is a disappointing 5.7% lower than the revenues of first half of 2012, but was roughly in line with expectations. With such revenues, Orange can be compared to Vodafone (VOD) which is the largest telecommunications operator in Europe and one of the largest in the world. Vodafone claims 403 million customers in over 50 countries, and employs 86,000 persons (incidentally, note the difference in number of employees between the two companies: Orange appears overblown). VOD's share price has been more resilient than most telecoms these recent years, even gaining 62.7% the past 10 years, and being down "only" 49% from its peak value of 2000. A major difference between the two companies is that only 15% of VOD's revenues come from its home country, the UK, while 49% of ORAN's revenues come from France. Moreover, 66.4% of ORAN's revenues originate in only 3 countries: France, Spain, and Poland. Compared to Vodafone, and also to Telefonica (TEF), Orange clearly lacks geographic diversification.
This turned out to be a major issue for Orange: despite a growing global presence (especially in Africa), ORAN remains way too dependent on its home market and on Europe in general. Orange still claims more than 26 million customers in France and a leadership role in this market. Unfortunately, the situation in the home country remains problematic. First, in January 2012, another mobile phone company joined the fray: Iliad (which fully owns the Free and Free Mobile subsidiaries) became the 4th operator to receive a 3G license in an already saturated market. The mobile phone penetration rate at the end of 1st quarter 2013 was an unpromising 112.4%. In this environment, any change in customer number is more likely than not a zero-sum game: if Iliad gains customers, the other operators must be losing some. Second, the French economy has significantly underperformed of late.
Iliad's arrival heralded lackluster financial results for the three main French operators. Iliad is a stock market darling and is currently trading at a 36.6 P/E ratio on the Parisian stock exchange. It totals 11.5 million customers, and 0.907 billion euros in revenues at the end of 1st quarter 2013. Its number of customers keeps rising, and is quickly catching up with the other telecom operators. The 2nd operator is SFR, fully owned by Vivendi (VIVHY.PK), with about 21.5 million customers. Vodafone held a significant stake in SFR until 2011, when it sold it to Vivendi: a good move in retrospect. The third operator is Bouygues Telecom with about 13.1 million customers. Both Vivendi and Bouygues are large conglomerates running other businesses that alleviated the bad results of their telecom segments.
The Iliad entrance disrupted the French telecommunications market, thanks to its extremely low-cost offers. Seen from the USA, these offers are almost unbelievable: for merely 2 euros (about $2.6) a month Free Mobile provides 2 hours of calling toward land line or mobile phone in France and the US, and unlimited texting. For 19.99 euros ($25.99) a month, you get unlimited calling, unlimited texting, and 3 Gb of data. Compare this to your monthly cell phone bill from AT&T or Verizon... French telecom companies, already suffering from the economic crisis, were ill prepared for the entrance of Iliad. Bad economy and mobile price war took a heavy toll, and the French regulatory agency for telecommunications [ARCEP] announced an overall 6.4% year-on-year decline in revenues at the end of the first quarter 2013 for all of the French telecom operators. This is roughly in line with the -7.5% change in revenues from France for Orange from 2nd quarter 2012 to 2nd quarter 2013.
To anticipate any loss of customers, Orange unveiled its own ultra low-cost brand, Sosh, at the end of 2011. The offer currently starts at 4.90 euros ($6.37) a month, also for 2 hours of calling and unlimited texting. For 9.90 euros ($12.87), you get unlimited calling and texting. Sosh may have reduced customer loss, but at the cost of significantly lower revenues. Like other European telecoms, Orange also fell victim to a flailing economy: e.g., a French unemployment rate of 10.4% and a GDP growth of -0.2% in the first quarter. Moreover, recent decisions by the French and European regulatory agencies proved equally damaging to Orange's bottom line. The latest example being the decision by Brussels to cancel roaming fees that telecom operators charge within the EU by July 2014: this good news for consumers may negatively impact Orange's profits by more than 300 million euros a year. Regulatory cuts in call prices reduced the 1st half revenues by 511 million euros. Add to this the stringent EU antitrust regulations that make it difficult for telecom operators to merge their networks or acquire other companies.
Finally, the French government owns about 27% of ORAN, which turns out to be both a blessing and a serious inconvenience. Indeed, Orange is unlikely to ever go bankrupt as the French government stake is simply too high to allow such an outcome. However, Orange is constantly at the mercy of the government's whim. This was demonstrated a few months ago when French authorities opposed the sale of 75% of Dailymotion by Orange to Yahoo. In January 2011, Orange had acquired 49% of Dailymotion, the second-largest video sharing website in the world after YouTube. In January 2013, Orange had purchased the remaining 51% of Dailymotion. Yahoo was ready to pay $200 million for a majority stake in Dailymotion, and Orange was more than willing to part with its subsidiary. Unfortunately, the government derailed the project, most likely on dubious grounds: trying to protect a French success story from an Anglophone predatory company.
First Half of 2013 Results: Less Bad Than Feared?
The first half of 2013 was actually not that bad for Orange, despite the year-on-year decrease of 5.7% in revenues. The financial report contains some good news. Indeed, since June 30, 2012, the number of mobile phone customers in France has risen by 1.5% (and +3.1% worldwide). In Spain, the number of mobile phone customers rose by 4.5%, while in Africa and Middle-East this number rose by 9.8% despite the upheavals in Egypt and Mali. During the 2nd quarter of 2013, Orange added 276,000 customers to its Sosh offer. We are far from the 201,000 lost subscribers in the six weeks following the launch of Free Mobile. In short, the French customer number erosion seems to have finally stopped.
Revenues did decrease in France by 7.5% (year-on-year growth for 2nd quarter of 2013), but they rose by 2.5% in Spain, and by 4.4% in emerging markets. For the overall group, the revenues growth was -4.8% y-o-y for the 2nd quarter. This is clearly not a good result, but is far from catastrophic. Even Vodafone saw an annual revenue drop for the year ended on March 31, 2013 of 4.2%.
The price war in France appears to be stabilizing: the mobile annual average revenues per user [ARPU], currently at 311 euros, is still expected to decrease by 12% overall in 2013, but the 2nd quarter decrease was stable compared to 1st quarter. Costs seem under control: adjusted operative expenses have decreased by 441 million euros in the first half of 2013, partly compensating for the y-o-y decrease of 1240 million euros in revenues. Finally, the first half-year EBITDA margin was 31.1%, i.e. only -1% compared to the second half of 2012. This compares favorably to the 29.9% EBITDA margin reported by Vodafone for the year ended on March 31, 2013. Orange also managed to reduce its net debt by 935 million euros compared to December 31, 2012.
Overall, it can be argued that the impact of Iliad's entrance on the French market and of the economic crisis seem to have abated. This is a rather positive development, during a time when the European economy is starting to finally show signs of life.
However, this rather positive outcome might be derailed by the recent Montreuil Administrative Court decision of July 4 stating that Orange has to pay 2.15 billion euros in tax to French authorities, following a 2005 group restructuring. This decision is a real blow to the telecom operator and Orange is appealing it at the Administrative Appeals Court of Versailles. Nevertheless, in the meantime, the tax must be paid. Two payments have already been scheduled: one was made at the end of July, and the rest is due in September. The good news is that provision for this payment had been made: payment of the tax liability was booked in 2010, and the interest was accrued. Therefore, the group results should not be affected.
Recent And Future Developments
On top of this tax litigation issue, some other recent developments are worth mentioning, as they impact the investor's decision on whether or not to purchase some shares in the company.
First, the CEO Stephane Richard was charged with fraud in June, in a case of alleged corruption involving IMF chief Christine Lagarde. Orange confirmed that he will remain the company's head while the investigation is proceeding, but in the event of a trial and if he is ever convicted, the situation could quickly take a turn for the worse. A removal of Richard might create short-term volatility in the share price, especially because he is broadly seen as a competent CEO.
Second, Orange is considering the sale of its assets in the Dominican Republic, a deal that could potentially reach $1.2 billion. This would be good news for investors as it would help reduce the group's debt (still 29.6 billion euros at the end of June) and secure the dividend. Orange already disposed of its assets in Austria in January, and is currently working on a prospective disposal in Portugal.
Thirdly, Orange confirmed that it will invest 30 million euros in Dailymotion to further develop the video-sharing company. Dailymotion's revenues reached 37 million euros in 2012, and are expected to grow to 100 million euros by 2016. Since French authorities prevented a sale of Dailymotion, Orange probably reasoned that their best course of action was to expand the video-sharing service and help increase its revenues.
Lastly, Orange and Free reached an agreement on July 25 to let the historical operator deploy optic fibers. Free had filed a complaint with French authorities to prevent Orange from rolling out its high bandwidth optical fiber network. The agreement is good for all parties. Such an optical fiber network, once operational, should help boost Orange's revenues.
Future short to mid-term developments are also of interest. First and foremost, Orange aims at further reducing (and even canceling) the impact of the French telecom price war by improving its 4G offer (see page 7 of the 1st half-year presentation): customers have proved themselves ready to pay more on their monthly bill to benefit from faster data access (the ARPU of 4G customers is about 10% higher). The 4G offer of Orange already covers 106 cities in France, compared to merely 12 cities for its closest competitor (SFR, which plans to reach 55 cities by year's end). 250,000 customers currently benefit from this 4G coverage. Orange expects to reach about 1 million customers by year's end. On July 8, it also launched a 4G offer in Spain in 6 cities, and plans to expand its offer to 15 cities by year's end. Orange also launched 4G services in the UK, Belgium, Luxembourg, etc. In the UK alone, 687,000 customers already adopted its 4G offer.
Another welcome development previously mentioned is the improvement in the European economy. For the first time since April 2011, the number of unemployed people decreased in the eurozone: in June, there were 24,000 fewer than the month before. Spain, one of the most affected countries, saw its dystopian unemployment rate slightly decrease in the 2nd quarter of 2013. The Spanish GDP growth, at -0.1%, was also better than expected in the 2nd quarter. Even in Greece the unemployment rate seems to be stabilizing. We are far from out of the woods yet, but a bottom might have been reached. Should the improvement in European economy be confirmed in the coming months, it would benefit European companies in general and Orange in particular, due to its high dependence on the European market: the weakness of years past might turn out to be a strength in a rising tide environment.
However, a potential issue facing Orange in the near term must temper this rosy outlook: its high debt ratio. Even though net debt over EBITDA was "only" 2.21 at the end of the first half of 2013 (compared to 2.03 for Vodafone at the end of March), and Orange managed to reduce its net debt compared to the end of 2012, the tax litigation issue previously mentioned mechanically raises the debt/EBITDA ratio to 2.37. This is a major problem because this level could trigger a downgrade by credit rating agencies like S&P. This helps explain why the share price dropped following the report of the first half-year financial results: investors focused on the debt level.
Another potential issue ever present is a dividend cut, which could be decided with the goal of lowering the debt level of the group. The large stake owned by the French government in Orange might actually be positive in that respect, as the government always want to see this cash inflow reduced, and Orange already cut its dividend last year. Nevertheless, an additional cut cannot be ruled out.
Conclusion: Time To Buy Or Not?
After years of share price erosion, Orange might finally see the light at the end of the tunnel. It may be premature to come back in just now, as there is a significant risk of downgrade by credit rating agencies, the future of the CEO remains uncertain, and further negative regulatory decisions by Brussels may be adopted. Moreover, on a technical level, it does not appear that the share price has found a support. However, should the nascent improvement in the European economy be confirmed in the coming months, and should credit rating agencies maintain their current ratings, Orange would then be a very good candidate to join the portfolio of dividend-oriented investors. As a company deriving most of its revenues from Europe, a welcome improvement in EU economy would trickle down to Orange's bottom line. In addition, the negative impact of the entrance of a 4th telecom operator on the French scene may finally be abated, as the number of French customers of Orange has slightly increased in the first half of the year and the further deployment of a 4G network is expected to stop the drop in ARPU. Despite the tax litigation problem, the first half of the year was not too bad for Orange and its financial report highlights some positive developments. Currently trading at a relatively low P/E ratio (which compares favorably to VOD), and sporting a high dividend, I believe ORAN may soon be ripe for the taking.