A previous article I wrote discussed the case of giant French telecommunications company Orange (NYSE:ORAN), a global behemoth and the market leader in France with more than 26 million customers in that country alone. I argued that Orange could be an attractive investment, as it trades at an appealing valuation, sports a very high dividend yield and should benefit from an improvement in the European economy. However, Orange may face more headwinds in the coming quarters, as a tax liability issue needs to be solved and could result in a credit rating cut, and the CEO is currently under investigation. Therefore, it might be better to wait a few quarters before loading your portfolio with shares from Orange.
However, when it comes to the second French telecommunications group and multinational corporation Vivendi (OTCPK:VIVHY), I'm definitely more bullish. Vivendi has been trading in the US as an unsponsored ADR since January 2011, and prior to that it was a sponsored ADR (with Deutsche Bank as depositary institution). Vivendi is a giant holding company headquartered in Paris, with a long history (it was created in 1853 under the name Compagnie Générale des Eaux), and is currently focused on two major activities: media and telecommunications. On the media side, Vivendi owns (or owned until recently): French pay-channel Canal+ group (present in several European countries and in Asia), the American music corporation Universal Music Group, and the American video game company Activision Blizzard. On the telecommunications side, it owns (or owned) the second largest French telecommunications operator SFR, the Moroccan leader Maroc Telecom, and Brazilian GVT (Global Village Telecom). Vivendi also owns event ticketing companies Digitick and See Tickets, phone counseling Wengo and German video-on demand company Watchever. In short, Vivendi is diversified within the multimedia world, being present in several countries and across several activities.
Vivendi released its first-half year financial results on August 29, 2013. Even though the group's revenues were down 1.5% year-on-year (y-o-y), the earnings per share (EPS) slightly beat consensus. Moreover, the stock is rather well perceived by analysts: of the 26 analysts currently following VIVHY.PK, 6 give it a buy recommendation, 5 give an outperform, 14 give a hold, and only 1 gives an underperform recommendation (no sell). This article argues that the buy recommendations are right and Vivendi is a good stock to own now.
Several sources provided in the rest of this article are written in French only: I apologize in advance, but the information is sometimes difficult to find on English websites.
First, let's have a look at Vivendi's valuation to determine whether, on a fundamental basis, the stock is cheap or not. Here, I only consider a few valuation tools.
Is Vivendi undervalued? Morningstar thinks so: using a discounted cash flow model, the company currently estimates the fair value of Vivendi at 22 euros ($29.04). At a share price of $20.32 (at the close of August 30, 2013), that's a 43% upside potential.
A more basic valuation tool is the book value per share, currently at $21.18 (16.05 euros) based on the latest financial statement, which implies a small undervaluation for Vivendi (4%). However, if we remove the goodwill and other intangible assets, the tangible book value turns out to be negative.
First half-year EBITDA was 2,546 million euros (a y-o-y decrease of 13.7%). With a market capitalization of 20,949 million euros, and assuming the same EBITDA for the second half of 2013, this produces an EV/EBITDA ratio (where EV stands for enterprise value) of only 4.11, which is low and screams undervaluation (e.g., this article explains how companies with a EV/EBITDA ratio lower than 8 over-performed over a 20-year test period, and this article demonstrates that EV/EBITDA is one of the best predictor of the return you can expect on a stock). On a general basis, ratios lower than 5 do signal a significant undervaluation.
Finally, the first 6-month EPS is 0.64 euros ($0.845), which gives a current P/E ratio of 12.03 if we assume that the 2nd half-year results will match the 1st half-year ones. Using the reported last four quarters' EPS, we obtain an even lower P/E ratio of 9.33. Such a low ratio also signals undervaluation, especially if we compare Vivendi with US telecommunications companies (a flawed comparison, but still...). For instance, AT&T (NYSE:T) has a 12-month trailing P/E ratio of 25.9, while Verizon (NYSE:VZ) is at 86.78 (data from Yahoo Finance). In short, Vivendi appears currently undervalued on a fundamental basis.
Moreover, the dividend yield is high at 6.5% (1 euro a year), and the payout ratio stands at 78%, again assuming 2nd half-year earnings equal to the 1st half-year ones. This is higher than we would like but it is still sustainable: the dividend does not appear in danger of being cut anytime soon. It is important to notice that this payout ratio is obtained from 1st half results that exclude the contributions of Activision Blizzard and Maroc Telecom, considered as discontinued operations. Therefore, even after assets disposals (see next section) and the loss of revenues it entails, Vivendi still appears able to keep its current dividend level.
From a valuation standpoint, and with a high and probably sustainable dividend, Vivendi looks like a solid buy for any income-oriented investor. Moreover, the situation of SFR, the biggest drag on Vivendi's revenues, should improve in the near future: similar to what I wrote on Orange, the impact of the entrance of a fourth telecommunications operator on the French market (Iliad) seems to be finally stabilizing, and the worst is likely over for SFR. The further deployment of a 4G network (for instance, SFR plans to cover the entire city of Paris by year's end), a recent network sharing agreement with Bouygues Telecom (3rd French operator), and a drastic cost-cutting program should help stabilize or even increase the revenues.
On top of VIVHY.PK being undervalued, the real appeal of the stock lies in the current and upcoming asset sales. The stated goal of Vivendi's asset disposals is to reduce the debt level of the group and to try and unlock value for the shareholders. This strategy follows the arrival of Vincent Bolloré last year as the largest shareholder of Vivendi by his owning slightly more than 5% of Vivendi's capital. V. Bolloré made the quick calculation that the different parts of Vivendi are separately worth more than the whole (the holding discount), and he intends to reduce this discount as much as possible, which bodes well for shareholders.
Indeed, on July 26, 2013, Vivendi announced that it was selling 85% of its ownership of Activision Blizzard for 6.2 billion euros ($8.2 billion). Vivendi will still own 12% of Activision once the sale is finalized at the end of September. In July, Vivendi also announced that it was selling 53% of Maroc Telecom it owns for proceeds of 4.2 billion euros ($5.5 billion). On July 1, Vivendi and UMG completed, as required by French regulators, the disposal of Parlophone Label Group (which had acquired EMI) for 700 million euros ($924 million). The disposals of Maroc Telecom, Parlophone and Activision Blizzard will lower the net debt of Vivendi by about 52%. At an expected 6.5 billion euros, this debt will represent only 1.3 times the current EBITDA (using 1st half-year EBITDA and assuming a same value for the 2nd half), vs. 2.63 times the EBITDA using the net debt as of December 31, 2012. That's a significant de-leveraging.
Moreover, a part of the proceeds will most likely be distributed to shareholders as a special dividend or as a share buyback. Indeed, the asset disposals so far will generate about 11.1 billion euros, and the debt reduction will only swallow 6.9 billion euros - that means a significant amount available to shareholders. Some of the money though might be used to buy the 20% of Canal+ France that the Lagardère group owns. Vivendi appears to be re-centering its activities on the multimedia/content part, and therefore it is likely to further try to dispose of GVT in the future. Are these asset disposals positive for the group? The employees seem to think so as they recently subscribed to 148.7 million euros worth of newly issued shares.
Remaining Assets' Prospects
Among the remaining assets of Vivendi, there is the good (Canal+, UMG, and, to a lesser extent GVT) and the less good (SFR). Maroc Telecom and Activision Blizzard represented 22.3% of Vivendi's revenues for the whole year of 2012, and 40.4% of its EBITA. Therefore, after the initial asset disposals of this year (EMI, Maroc Telecom and Activision), Vivendi should roughly be left with about 77.7% of its previous revenues and 59.6% of its EBITA, and a dramatically lower debt. Moreover, the relatively lackluster results of Maroc Telecom will probably not be missed in the near future.
Let's start with the good remaining assets. Canal+ Group saw a 5.1% year-on-year increase in revenues, and an increase in its number of subscribers (about 14 million customers). UMG's revenues grew by 16.3% y-o-y. Finally, GVT's revenues are also growing, albeit by a low 3.6% y-o-y due to the depreciation of the Brazilian Real. If we look at the EBITA, the picture is less rosy, with a y-o-y decrease of 11% for Canal+ (mainly due to the decline in the French advertising market), 8.3% for UMG, and 12.1% for GVT. However, excluding restructuring and integration costs related to the recent acquisition of EMI, the EBITA of UMG was actually up by 6.2% y-o-y. And GVT's EBITDA increased slightly by 2.3% y-o-y (the difference between EBITA and EBITDA is the depreciation which is not reduced in the EBITDA value). All these companies have relatively good prospects going forward, and keep growing.
The real problem though is SFR, which still represents 47% of the group's revenues at the end of the 1st half of 2013. These 1st half results are poor, as summarized by the 11.3% y-o-y decrease in revenues. Worse, the EBITA dropped by a dramatic 36.6% y-o-y. However, following in Orange's footstep, the customer erosion of SFR seems to have finally abated: SFR actually increased its number of contract customers by 552,000 during the second quarter (and 809,000 during the first half). It currently claims 21.049 million customers. The disruptive entrance of Iliad, the 4th telecommunications operator in France, seems to have finally been fully absorbed in terms of customer numbers. Moreover, if the second quarter EBITDA fell by 16.3%, it still did better than the 24.5% drop recorded in the first quarter. These results, clearly disappointing, still show a glimmer of hope. Especially when you account for the recent announcement of a network sharing agreement between SFR and Bouygues Telecom - this will result in significant savings for both companies, by lowering maintenance costs by up to 30% and investments by about 20%. Thus, SFR should save about 200 million euros a year ($264 million). Moreover, the 4G deployment underway should result in 35% of the French population being fully covered by the end of 2013. As 4G customers pay a higher bill (higher ARPU), this should help stabilize SFR's revenues. The operator Free Mobile (subsidiary of Iliad), which destabilized the French telecommunications market and started a price war, does not currently offer 4G on its network. Therefore, the 4G offer of SFR (and Orange for that matter) will help set it apart and justify higher subscription prices. Finally, the cost-cutting plan currently underway at SFR should result in 500 million euros ($660 million) of savings by the end of 2014. Consequently, it can be argued that the worst is over, or close to being over, for SFR, and that results should improve in coming quarters. Like Orange, SFR should benefit from an improvement in European (well, French) economy. Vivendi might also list SFR next year on the French stock exchange, which would raise a significant amount of money.
A Potential Issue: The VAT on Canal+
A potential issue still unresolved is a change in the Value Added Tax (VAT) on Canal+ and other pay television channels. In the Fall of 2012, the French prime minister Jean-Marc Ayrault announced a raise in the VAT applied to Canal+ subscriptions from 7% to 10%, starting on January 1, 2014. However, on May 21, 2013, Le Figaro (a newspaper) published an article claiming that the French government might actually lower the VAT from 7% to 5% on Canal+ subscriptions. This potential good news has not yet been confirmed. An increase from 7% to 10% would result in an annual 80 million euros tax increase for Canal+. Therefore, a VAT at 5% vs. 10% would result in a 130 million euros tax difference. Since Canal+ Group is the 2nd asset of Vivendi by revenues (with 24% of the overall group's revenues), a change in VAT could have a non-negligible impact both for Canal+ and its owner.
On the basis of its undervaluation and high dividend alone, Vivendi deserves to be included in the portfolio of any income-oriented investor. When you consider the value unlocked by the current and upcoming asset disposals, the dramatic reduction in net debt of the company, the likelihood that part of the asset disposals will result in a special dividend or share repurchase, and the fact that SFR - the largest group's asset in terms of revenues - might finally see the light at the end of the tunnel (or is close to), it is hard not to conclude that Vivendi is a great stock to buy.