Vivendi: Universal Music Group Deal Highlights Undervaluation

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About: Vivendi SA (VIVEF), VIVHY, Includes: TCEHY, TCTZF
by: Mark Ashton
Summary

Vivendi is selling a 10% stake (with an additional 10% option) in UMG to Tencent at an implied €30B valuation.

The sale will help unlock liquidity and allows Vivendi to build on its strategic partnership with Tencent to expand further into China.

The market may not be attributing sufficient value to the post-money Vivendi valuation.

Vivendi (OTCPK:VIVEF) owns 100% of Universal Music Group (UMG), with the unit contributing ~40% to revenue and ~70% to Vivendi’s value. While UMG already has strong traction in the US and Europe, the Chinese market remains a relatively untapped opportunity expected to drive further growth over the next few years. In that regard, the Tencent (OTCPK:TCEHY) deal couldn’t have come at a better time.

Vivendi already has a commercial partnership with Tencent, and this deal aligns Tencent’s success in China to UMG’s.

The bonus is that Vivendi received a valuation boost for its UMG stake, and post deal, will be left with at least a 30% stake which could be re-valued at the proposed deal’s valuation or even higher (accounting for Tencent’s strategic value). The risks associated with deal seem low. The valuation boost following Tencent's acquisition of the minority stake will be highly value accretive to existing shareholders with Vivendi shares looking very investable right now.

Tencent to acquire a minority stake in UMG

Vivendi announced that it had entered preliminary negotiations with China’s Tencent to sell a 10% stake in Universal Music Group (UMG) at a valuation of €30B. The stake also comes with a call option to acquire an additional 10% within a year of deal completion at a similar valuation. The deal is subject to the due diligence of UMG and legal/government approvals.

The deal is in line with Vivendi’s earlier stated intention to offload 50% of its stake in UMG to several minority shareholders, which also would bring strategic benefits/synergies on the table. Though the current sale is just 10%, with a possibility to go up to 20% within a year, we believe this is a good start.

Tencent is a diversified Chinese behemoth with interests in music, media, social media, and new technology companies with a consolidated user base of about 900M. It has its music services in China such as QQ Music, WeSing and Kuwo Music.

In 2017, Tencent and Vivendi also entered a commercial partnership to distribute UMG’s music in China via its streaming platforms. With this stake sale, Vivendi gets to build on to its existing relationship with a strong strategic partner to help it expand into China. And with China on the cusp of massive consumption growth driven by the rise of its middle class, I feel it's a matter of time before the Chinese music streaming industry catches up with its global peers. With Tencent's backing, Vivendi will benefit from an expanded reach in China given Tencent's vast user base.

The announcement also stated that Vivendi and Tencent are exploring other areas of strategic commercial cooperation. These are likely to involve further developing music studios and artists in China, as well as to open further avenues to sell UMG’s music assets in China.

On the financial side, it's helpful to look at a few aspects around the use of proceeds, valuation, and percentage stake sold in the current transaction.

Vivendi is likely to use the proceeds from the UMG sale to repurchase shares or drive further M&A activity. The valuation uplift and the capital return plans should help unlock value for current shareholders.

Tencent has valued UMG at €30B, in line with the €20-40B range estimated by various analysts. On a standalone basis, this seems like a fair valuation given the strategic benefits. The sale has also, in my opinion, set a floor for the price of the remaining 40% stake.

With Vivendi only divesting 10% (and potentially, an additional 10% via Tencent's call option), management will have its work cut out to find good strategic partners to take on the remaining 40% stake.

In sum, the deal is a positive one for the company and should help unlock some near-term value for the Vivendi group upon completion. The longer-term benefits are immense - through a continued strategic partnership with Tencent, Vivendi will gain access to the burgeoning Chinese market in a relatively inexpensive way.

Valuation

As of the Aug. 9 market close, Vivendi had a share price of €25 with an enterprise value of €35B. Assuming ~20x EV/EBITA on €0.9B of FY18 EBITA, that implies €18B of EV (~50%) was derived from UMG on a trailing basis.

With the Tencent acquisition pegging UMG’s equity value at €30B and Vivendi retaining a 90% stake, UMG’s contribution to Vivendi’s market cap will now be €27B (30x90%). But with Vivendi’s market cap at ~€30.3B (based on the Aug 9 share price) this implies the market is attributing only ~€3-4B to the Vivendi "rump" despite its valuable asset portfolio (Canal+, Havas, quoted and non-quoted investment stakes).

Possible reasons for valuation discount include regulatory risks associated with the deal completion. But given the size of the sale (10% stake), it seems unlikely to me that regulators will step in. In the likely event the Tencent sale goes through, however, and the company follows through on share repurchases, Vivendi should re-rate.

Conclusion

The Tencent deal comes at an opportune time, and the stars seem to be aligning for Vivendi. Entry into a fast-growing Chinese market, strategic support of Tencent, and a good valuation (€30B equity value) make this deal a lucrative one.

There may be some regulatory risk associated with the deal the getting completed, and the market certainly seems to think so, but the probability of a minority stake sale getting canceled by regulators seems unlikely at best. Owing to its good prospects and an attractive valuation, Vivendi shares look like a good buy.

Disclosure: I/we 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.