Dutch Telecom An Interesting Play According To Carlos Slim

| About: Royal KPN (KKPNY)

KPN (KKPNY.PK) is the leading telecommunications and IT service provider in The Netherlands, offering wireline and wireless telephony, internet and TV to consumers. KPN offers business customers complete telecommunications and IT solutions. KPN Corporate Market (previously known as Getronics) offers global IT services and is the Benelux market leader in the area of infrastructure and network related IT solutions. In Germany and Belgium, KPN pursues a multi-brand strategy in its mobile operations and holds number three market positions through E-Plus and BASE. KPN provides wholesale network services to third parties and operates an efficient IP-based infrastructure with global scale in international wholesale through iBasis.

KPN markets a big portfolio of quality products. Separate brands serve different target groups. Consumers in the Netherlands can choose from KPN (fixed and mobile telephony for families), Hi (mobile telephony for young people), Telfort (no-frills mobile telephony and Internet) and XS4ALL (the innovating Internet provider). The Netherlands, Germany and Belgium have the mobile telephone services of Simyo (competitively priced SIM card) and Ay Yildiz (focused on the Turkish community). BASE and E-Plus are the third mobile telephony brands in Belgium and Germany, respectively. For all their service requirements, the Dutch and international business community can rely on the KPN, Getronics, XS4ALL, Gemnet, Newtel and CSS brands. I-Basis is one of the world's largest carriers of international voice traffic.

At December 31st, 2011, KPN served 44,5 million customers, of which 36.6 million were in wireless services, 4 million in wireline voice, 2.5 million in broadband Internet and 1.4 million in TV. With 18.687 FTEs in The Netherlands (31.084 FTEs for the whole group), KPN reported full-year revenues of EUR 13.1bn and an EBITDA of EUR 5.1bn.

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Transitional year

The company goes through a difficult period and this year will be a transitional year.

KPN has transformed itself from the Dutch Telecom monopoly into a high-tech international ICT-provider. The organization has also changed from a product- to a customer-based structure to better meet the demands of clients. In 2008 KPN introduced its new strategic plan "Back to growth" in which it presented its plans to improve the results on the Dutch market and further reduce costs. The full-year 2010 and 2011 results showed that KPN has been successful in reaching its goals. In order to remain successful in the future, KPN needs to further improve the profitability of the Dutch activities. In the Netherlands, the corporate market remains under pressure due to weak economic growth. The consumer market, moreover, has deteriorated due to increased use of free data-based services (Whatsapp, Viber) to replace traditional calling/SMS, which has hurt earnings. To compensate for this, costs will have to be cut further and client propositions rolled out, which should enable KPN to supplement lost income due to data-based communication. KPN has announced an ambitious plan to reduce the workforce by another 20-25%. KPN is also investing heavily in the rollout of fiber-optics in the Netherlands, which will boost internet speed and put KPN on the technological forefront. KPN must also remain disciplined in its 'mobile international' activities in, predominantly, Germany (E-Plus) and Belgium (BASE) using its successful 'Challenger' strategy. In its latest call, KPN announced it will divest Getronics International. All in all, management still has a lot of work to do.

Key figures 2011

Revenues and
other income: €13.2 billion

Operating result: €2.5 billion

EBITDA: €5.3 billion

Free cash flow: €2.4 billion

Investments: €2.0 billion

Outlook: KPN lowered its 2012 targets and sees 2012 as a transition year for the Netherlands. It wants to stabilize its Business market share and that of Consumer wireless. The EBITDA target drops 7.5% to EUR 4.7 - 4.9bln, compared to 2011, whereas the free cash flow target drops 25% to EUR 1.6 - 1.8bln. The Capex target slightly increased to EUR 2.0 - 2.2bln. The dividend target for 2012 is reiterated at EUR 0.90 but the target for 2013 (EUR 0.95) not. 2013 dividend will depend on the performance of 2012.

Q1 2012 Results

Revenues fell 1.4% year-over-year to EUR 3.2bln against expectations of EUR 3.1bln. Net income dropped 51% to EUR 288mln, partly due to a 20% increase in capital expenditures, and missed market expectations of EUR 307mln. The operational (EBITDA) margin worsened from 39.2% to 34.6% and the free cash flow was only EUR 37mln against EUR 191mln a year earlier. KPN's debt ratio (net debt-to-EBITDA) worsened slightly to 2.4x from 2.3x, but remained within the company's target of 2.0-2.5x.

Revenues in all sections of the Netherlands showed a decrease due to the continued difficult market conditions and regulation. Mobile International reported growth in revenues of 2.7% due to a good performance in Belgium and Germany.

KPN expects group profit and cash flow to improve in the second half of 2012 as the Dutch business from than on will improve. The company will also complete its restructuring program by the end of 2013 which is two years earlier. KPN reiterated its 2012 outlook (EBITDA of EUR 4.7 - 4.9bln and EUR 0.90 dividend) and expects sustainable profit levels in the Netherlands by the end of 2012

Investment Case

America Movil ((NYSE:AMX)), owned by the world's richest man Carlos Slim, offers EUR 8 cash for KPN. With the total offer of EUR 2.6bln America Movil will increase its stake in KPN from 4.8% to 28%. AM expects to carry out the offer by the beginning of June. KPN has taken notice of the offer. The company spoke once with AM and is moderately positive about the offer.

KPN is in a transition year, but expects profit and cash flow to improve in the second half of 2012. It has plans for divestments to free up cash for investments in its home market. Having a strong and healthy shareholder from the same branch could be very helpful. In the future there could be a possibility of asset swaps (eg. E-plus and Base). American Movil has also been looking at the Southern European market and now has access via KPN's Spanish MVNO Simyo.

The stock trades with a discount and has a price-to-earnings (P/E) ratio of 8.5x expected earnings this year against versus 11.3x for the sector. KPN also has a very attractive dividend yield of 12%. Slim's strategic investment in KPN gives faith in KPN's future. A takeover in the long-run is a realistic possibility.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.