Royal Kpn N.V.: Likely 9.5% ROI With Limited Downside

Sep.25.13 | About: Royal KPN (KKPNY)

Royal Kpn N.V. (OTCPK:KKPNY) is the incumbent telecom operator of the Netherlands. Carlos Slim's America Movil, S.A.B. de C.V. ADR (NASDAQ:AMOV) recently bid 2.4 euro per share to gain control of the company - it already controlled about 30%.

However this bid is blocked - for the time being - by an independent foundation. After looking for an English source I found this article in the Financial Times:

The foundation said it considered the €2.40 a share offer hostile and would not allow it to go through until the two sides had engaged in deeper negotiations.

The bid effectively puts a ceiling on the stock price. After all the deal could go through.

However AFTER the bid was made, two pieces of important positive news have come out: The bid for a piece of KPN by Télefonica (NYSE:TEF) called E-plus was raised to 500 million euros. It was confirmed by the Dutch Tax Authorities that the sale of these assets would enable KPN to book a €3.7bn tax shield.

This is positive because:

-Carlos Slim's América Móvil group can raise its bid with a good reason.

-The value of the good news might not be entirely reflected in the stock price because of the possibility of the deal going through at the current bid.

-The positive news make it unlikely the stock will fall back all the way to its price before América Móvil made its bid. The bid is about 20% higher as the stock price - € 2 per share - before the latest good news came out.

So what's the upside here?

The upside I'm most interested in here is short term in nature. This is a situation where I want to take advantage of the possibility of a raised bid while being protected on the downside.

Analysts agree that the tax credit and increased sell price gained by the E-plus sale are worth between € 0.20 euros - € 0.34 euros per share.

Santander values the sale of E-plus at € 0.35 per share and an unnamed Hedge Fund values the sale of E-plus at € 0.20 per share.

The current price of a share is € 2.38, A higher bid - some analysts think the foundation is mainly out to get a higher price - of between € 0.20 - € 0.35 would come down to an average gain of 13-14%.

This return is most likely to materialize in months rather than years and even on the low end of the spectrum the annualized returns would be great enough for this to be a good bet - even if it doesn't always work out.

What downside are we looking at?

América Móvil has threatened to withdraw its bid if the foundation doesn't remove its roadblocks. This is not unfathomable as there have also been rumors - denied by AMX - that Slim wanted to acquire KPN to get access to the E-plus assets.

Before the bid the stock was trading at € 2. Factoring in the E-plus deal using a range of estimates the stock would be worth € 2.27, down from the current € 2.38 that would mean a loss of about 5%.

Furthermore I'm inclined to feel good about the downside as the stock's valuation is not lofty to begin with. EV/Ebitda is at 4.2 and low compared to many of its peers. Not necessarily a great sign but it does indicate KPN is trading in the low range of industry valuation levels.

(Click to enlarge)

KKPNY EV / EBITDA TTM data by YCharts


It's great to find a situation where the upside is about three times as large as the downside. However the frequencies with which events transpire determines if the investment will have an average positive return greater than that of the broader market.

Given AMX interest in KPN over a longer period of time and the average price it paid for shares of the company I think the likelihood of them raising the bid is about 50%.

There is the possibility of the bid going through at € 2.4 which I think is fairly unlikely given the foundations concerns and the sale of E-plus. However there are discussion about the legality of the foundation blocking the sale. AMX could take the matter to an European court. I'm putting the likelihood of the deal going through at 10%.

That leaves a 40% possibility of the deal not going through and shares of KPN dropping. Most likely to levels like before the bid but adjusted for the sale of E-plus.

Event Frequency Share Price
Bid Raised 50% +13.5%
Bid Withdrawn 40% - 5%
Bid Accepted 10% 0%
Click to enlarge

If this is anywhere near correct the average return on this investment would be 9.5%

Different outcomes have different time frames but I expect all outcomes to materialize in less than one year. It's possible things will play out quite quickly. The average ROI will handily beat the S&P 500 and I like the risk profile of the deal.

KPN's shares currently trade at € 2.38 on the Amsterdam Exchange or $ 3.15 in New York.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.