A few months ago, I suggested that Orange (ORAN) was a risky income investment despite its high-dividend yield, as the possibility of another dividend cut in the medium-term was likely. However, I wasn't expecting a dividend cut in the next few months as the company was selling non-core assets that could increase its cash flow and reduce its indebtedness, namely its joint venture in the U.K. with Deutsche Telekom (OTCQX:DTEGY) called Everything Everywhere [EE] and Orange's operation in the Dominican Republic. It recently reached an agreement with Altice to sell its Dominican Republic business for an enterprise value of $1.4 billion, and was expecting to perform the IPO of Everything Everywhere in 2014, which would help it to reduce its consolidated net debt.
Orange wants to preserve a strong financial structure and it is targeting a net debt-to-EBITDA ratio of around 2x at the year-end 2015, compared to about 2.3x expected at the end of 2013. Assuming a stable EBITDA, the leverage ratio goal implies about $6 billion of debt reduction during this period, which appears to be ambitious. Most of this reduction should come from asset disposals and the sale of its stake in EE was responsible for a large part of its debt reduction target. However, Deutsche Telekom and Orange have called off its plan to sell shares in EE, as both companies agreed to end a strategic review of the unit, which has included options such as the sale of a minority stake.
The average multiple paid over the past few months for telecom companies in deals above $1 billion was about 6.6x EBITDA, which values EE at more than $11 billion. Therefore, Orange's deleveraging target must be met organically which is of course much more demanding, especially as the French telecom market continues to be under pressure from intense competition. Orange is still heavily exposed to its domestic market accounting for more than half of its revenues.
As I discussed in my previous article, Orange's dividend appeared to be sustainable unless the company was not able to raise cash from asset disposals. Thus, the cancellation of EE's IPO increases Orange's dividend cut risk significantly, as the company is one of the telecom companies with higher debt levels in Europe and other large asset disposals are scarce within the group. Orange has also some non-core operations in Africa that it could sell, but none of them has EE's scale. In 2012, Orange's dividend was cut almost in half to €0.78 ($1.06) per share, mainly to preserve cash and increase its balance sheet strength.
As the IPO of EE is apparently disregarded, it seems tough for Orange to maintain its current dividend and reach a leverage ratio of 2x in the next two years. According to analysts' estimates, Orange's EBITDA should be about $16 billion in 2015 leading to a leverage ratio above its target, even considering the disposal of Orange Dominican Republic. A dividend cut thus looks like an alternative to reach the targeted debt ratio, or a combination of cash and new shares. Either alternative does not look like an improvement on the company's shareholder remuneration policy, so as I suggested a few months ago despite its high-dividend yield Orange does not offer a sustainable dividend for the long term and should be avoided for more risk-averse investors.