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Chris Bailey
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Award-winning global investor who resigned from his job managing a set of funds with over US$2bn under management so he could take full advantage of the current financial market opportunities. Likes to fuse bottom-up insights with top-down macroeconomic thought. Looks at all sectors and, with a... More
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  • Telefonica - A Quick Re-Review

    I wrote an article a couple of days ago concerning a European telecoms deal associated with a majority-owned subsidiary of Telefonica (NYSE:TEF). I thought it would be useful to review Telefonica on its own, so a few thoughts on Q2/H1 numbers. All data and charts are taken from the Q2/H1 corporate presentation document released by the company.

    So what are the key numbers? As per the chart below sequentially better Q2 numbers at the revenue and cash flow lines. Using the company's preferred (and most consistently disclosed) metric of operating income before depreciation and amortisation (OIBDA) however, operating income was still down organically. Record smartphone adds = high handset subsidy payments.

    (click to enlarge)

    Geographically - and sorry this is so faint but it is kind of illuminating that it is! - but look at the huge difference between Latam (growing) and Europe (still declining high single digit percent). It is a business of contrasts still.

    Here is the first place I looked to understand the realities for Telefonica: the net debt line. If you strip out the asset sales, Treasury share sales, FX impact, spectrum payments etc the H1 free cash flow was Euro1.5bn. Annualise that and you get around a 6% free cash flow yield. That is ok. Debt as the chart shows is x2.4 obida which is workable - you would not start to worry until x3 which is a level the rating agencies are likely to look again at the company's credit rating.

    (click to enlarge)

    So there is some good and bad points but this is a little better than three or six months ago.

    So how would I value this business?

    Europe is a Euro4.8bn H1 OIBDA negative growth business. It does generate cash but Spain - due to the financial crisis - is struggling. In my previous report I valued the Dutch/Belgian European telecoms business of KPN at x6 OIBDA. Due to the economic struggles in Spain, I therefore take a further valuation discount here to x4 OIBDA. So, on an annualised basis (x2 the H1 number) that's Euro38.4bn (c. $50bn) worth of value.

    The European business of Telefonica does have other assets outside Spain. The most important of these is Telefonica Deutschland in which they have floated a minority stake onto the markets. Telefonica Deutschland does trade at a premium to this valuation at about x7 OIBDA but, don't forget, Telefonica Deutschland have just announced the E-Plus deal where, as my previous report showed, they are paying a high price. So a x4 multiple for the whole European division feels conservative.

    Latam remains a growth business although with declining margin (smartphone handsets, competition etc). It has strong market shares across the region and is the only player who could look America Movil (NYSE:AMX) in the eye. AMX trade at just under x4 OIBDA. Some investors may believe this rating should be higher but the majority owner of AMX, Carlos Slim, has had some well-publicised issues with the regulatory authorities across the region, particularly in his home market of Mexico.

    The Telefonica Latam business deserves a premium to this AMX rating. Instead of x4 we should value it at x6. Some investors may think that is slightly mean but don't forget margins are going down and the rising revenue base is having to work very hard to even offset this despite the best efforts of data etc. That gives a value here of Euro55.2bn (c. $73bn)

    Add the two together and you get Euro93.6bn (c. $123bn) and, if we look at the TEF shares today, the current EV is…Euro95bn (c. 125bn).

    I would say the market has been - for once - pretty efficient here.

    Upside lays with the operating units. Additionally watch cash flow, especially free cash flow. I think your best opportunity with this one may well come with macro volatility e.g. newsflow around Spain or regulation.

    Where would I step in? For the Euro quote low Euro9s, for the US quote low US$12s. This is a level which provides over 10% upside to the current share level and it is that sort of upside potential which I would need to buy the shares.

    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. I have no business relationship with any company whose stock is mentioned in this article.

    Tags: AMX, TEF, long-ideas
    Jul 28 3:02 AM | Link | Comment!
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