Description
Portugal Telecom stub
Overview
This trade is not dissimilar from my last trade idea, the creation of the Norsk Hydro pure play vertically-integrated aluminium stub company resulting from the separation of the NHY oil and gas business from the aluminium business. This trade also creates a stub (a telco) at an attractive valuation resulting from the catalyst of separating away an overvalued business (cable TV/broadband unit) via a spin off.
The trade is to buy (create) the Portugual Telecom stub, ex-the spin-off of its cable/broadband business, PT Multimedia, scheduled to be spun off on November 7th, 2007 (though PT will trade ex-the PTM PL stake on October 30th, 2007). Portugal Telecom trades in Portugal under the Bloomberg ticker PTC PL and on the NYSE under the ticker PT. PT Multimedia trades in Portugal under the symbol PTM PL, but it does not trade on the NYSE, although there is an ADR in place (unsponsored, I believe). PTC PL owns 58.43% of PTM PL and will spin off its entire holding to PTC PL shareholders in a ratio of .176067 (before withholding tax, if applicable, since the spin is treated as a payment-in-kind dividend), so each holder of PTC PL will get .176067 shares of PTM PL (less 20% withholding, if applicable, so .1409 shares). It may be possible to get around the withholding tax depending on one’s tax status or by holding on swap with certain prime brokers, since certain types of holders are not subject to the withholding. The cost of the withholding tax is currently €.36 per share. So if you buy PTC PL today, you create the stub at €9.02 per share, after the cost of the w/h tax. If price for PTC PL and PTM PL remain the same from now through the October 30th ex-date, the PTC PL stub should trade ex-the spin off at €8.66. This €8.66 is my assumed entry price (math below).
I believe PTM PL, the cable TV subsidiary being spun off, is overvalued and the stub PTC PL is undervalued, so the spin off will help highlight how PTC PL is cheap. PTM PL trades at 15x 2007E EBITDA, so it’s significantly above the multiples of its European peers which trade at 10x, on average. Using last night’s closing prices, the stub is at € €8.66. This is PTC PL price of €10.46 less (PTM PL price of €10.25 x .176067 = €1.80) equals €8.66. As I’ll show below, this is an attractive valuation with a pro-forma 6.6% dividend yield (from an investment-grade telco). PTC PL has committed to pay a gross dividend of €.575 per share in 2008 and 2009, and to maintain a progressive dividend policy thereafter. The Western European (former incumbent) telecom peers I looked at, FTE FP, DTE GY, TIT IM, BT/A LN, KPN NA, SCMN VX, TEF SM, BELG BB, TKA AV, TLSN SS, and TEL NO, have an average dividend yield of 4.45%. If the PTC PL stub were to trade at the average dividend yield, it would be priced at €12.92.
Details
Portugal Telecom is Portugal’s leading telecommunications company offering fixed line, wireless, and Internet services. The company also owns a majority of leading Portuguese cable TV/broadband company, PT Multimedia Services and owns stakes in a number of international telecom companies, the biggest of which is Brazil’s Vivo. Portugal Telecom’s ordinary shares trade in Lisbon under the symbol PTC PL (on Bloomberg). There are also ADRs that trade in New York under the symbol PT. At the time of submission of this idea, the ords were at €10.46 and the ADRs were at $14.96. PTM PL was at €10.25. I use euros and the ordinary line in analysis since that’s the home currency.
PT is a complicated but very interesting story. On February 6th, 2006 PTC PL closed at €8.18. After the close Sonaecom (SNC PL) announced a €9.50 per share unsolicited cash offer. As part of its defense Portugal Tel pledged to increase cash returned to shareholders and spin off its publicly listed cable business. The battle dragged on due to a long competition review by Portuguese antitrust regulators who permitted a deal that would have resulted in an unprecedented outcome where the market went from three wireless competitors to two (Sonecom is primarily a wireless telecoms provider through its Optimus unit). A year after the takeover battle started, it was finally coming to a close in March 2007. Sonaecom bumped its offer to €10.50 per share, but failed to get enough support from PTC PL shareholders and Portugal Telecom won its independence (mainly because the price offered was too low).
As mentioned above, PTC PL’s takeover defense was built around a pledge to return cash to shareholders and spin off PTM PL. PTC PL increased its gross dividend from €.35 in 2005, to €.475 in 2006 and in 2007, and pledged to pay €.575 in 2008 and in 2009. In addition, PTC PL commenced a share buyback program beginning in April 2007. Under the buyback, PTC PL pledged to buy back €2.1 billion worth of stock in the market (a minimum of 16.5% of its equity). The buyback has to be completed by March 2008. Since beginning the buyback, PTC PL has bought back 103 million shares, or 9.13% of its outstanding shares at a cost of about €1.05 billion. So between now and March 2008 it will buy another €1.05 billion of stock. Since the price will be cheaper after stock trades ex-the spin off on October 30th, that €1.05bn should be able to buy another 122mm shares (or another 11.9% of its currently 1025.8mm outstanding shares). That’s a lot of price support in addition to the fat yield support.
Ex-the spin off, PTC PL will be composed of domestic fixed line, domestic wireless, a 50% interest in a JV (with Telefonica) controlling Vivo (VIV US on Bloomberg) which is a large Brazilian cel phone service provider, and other assets, including stakes in a number of African telecom/wireless companies and other assets.
Looking at the sum of the parts of the stub shows it is cheap, and there are a number of potential events I will outline that could prove catalysts for strong upward price movement, in addition to the imminent spin off of PTM PL.
Here are the parts:
Domestic Fixed-Line
Domestic fixed-line has 2007E EBITDA of €950mm (consensus I compiled). The best comps are Belgacom, Telecom Italia and Telia Sonera. These trade at an average of 6.7x 2007E EBITDA (versus 6.9x for the whole Western European telecom universe. This 6.7x multiple values the domestic fixed-line business at €6,365mm.
Domestic Wireless
PNM is PTC’s domestic cellular telephone unit. It has 2007E EBITDA of €670mm (consensus I compiled). The best comps are Mobistar, Vodafone and Elisa. These trade at an average of 7.4x 2007E EBITDA. This 7.4x multiple values the domestic wireless business at €4,958mm. There is potential for significant value uplift in the wireless business, which I’ll explain later.
50% stake in Brasilcel, which controls Vivo
PTC PL owns 50% of BrasilCel (with Telefonica owning the other 50%). Brasilcel owns 468.992mm ordinary shares, ticker VIVO3 BZ on Bloomberg, and 435.982mm preferred shares (really non-voting common), ticker VIVO4 BZ. The total stock market value of BrasilCel’s stake is €4.282bn, so PTC PL’s half is worth €2.141bn. This is the “look-through” value, but there is significant upside to this stake. Plus if PTC PL were to sell it, it would be completely free of capital gains tax (I confirmed this with PTC PL management). There is significant upside in the value of this stake, which I’ll explain later.
Stakes in African Wireless Telcos
PTC PL owns significant minority stakes in a number of African telcos. The companies and locations where they operate are as follows: Unitel (Angola); Medi Telecom (Morocco); MTC (Nambia); CTM (Macau); CVT (Cap Verde); and CST (Sao Tome). In August PTC entered into a transaction with a company called Helios that put a value on the business and takes advantage of Helios local management and expertise with further expansion planned. PTC grouped together the sub-Sahara stakes into a new entity called Africa Holding. Helios paid PT €125mm for a 22% stake in Africa Holdings. PT says the enterprise value Africa Holdings is €897mm so its 78% stake in Africa Holding is worth €770mm, plus it received €125mm cash from Helios, for a value of €895mm. The €897mm EB seems reasonable since it values the entity at a modest 6.8x EBITDA (Africa risk and minority stakes).
In addition to Africa Holding, PT owns a 32% stake in MediTel (Morocco) worth about €400mm plus a 28% stake in CTM (Macau) worth €160mm. The total of all this is €1,455bn.
Other Assets
PTC has stake in BSENN PL (7mm shares worth €115mm), UOL, a Brazilian ISP (UOLL4 BZ and UOLL3 BZ, worth €168mm), and a directory company (€45mm), plus a tiny stake in TEF SM (worth €4.5mm) for a total of €333mm.
Net Debt & Pension Liabilities
Excluding Vivo and PTM PL, net debt is €5,000mm, and unfunded pension liabilities are €900mm. My net debt number assumes another €500mm is spent on the share buyback between now and year end (this was with guidance from management). So the 1025.8mm current share count should drop to 967.5mm to reflect what’s in my net debt number.
Summing the above up gets: Total $mm Per Share €
Domestic fixed-line 6,365 6.58
Domestic wireless 4,958 5.12
Stake in BrasilCel/Vivo 2,141 2.21
African Telco stakes 1,455 1.50
Other Assets 333 .34
SUBTOTAL 15,251 15.76
Net Debt -5,000 -5.17
Pension Liabilities -900 -.93
Net Equity Value €9,338 €9.67
So there’s 12% immediate upside after the spin off, with the support of a share buyback of nearly 12% of the currently outstanding shares between now and March 2008, plus there’s a 6.6% dividend yield (from an investment grade company) with a progressive dividend policy.
In addition there are two potential upside catalysts:
Wireless Synergies Uplift:
As part of its attempted takeover of PTC PL, it was revealed that the huge cost savings that SNC PL would obtain were likely in the order of €2.5bn NPV. All one has to do is look at the stock price of SNC PL in the period leading up to where SNC PL almost clinched the deal. When SNC PL announced the offer its shares popped from €3.5 to €4.25 in a matter of days. When it looked like SNC PL was going to win PTC PL in mid-February 2007, its shares surged to as high as €8.09. And when it became clear they lost this unprecedented opportunity to create a duopoly, its share quickly tanked to €4.70 and have since drifted down to €3.61.
SNC PL is a majority owned subsidiary of Sonae (SON PL). SON PL is controlled by Portuguese’s richest man, a billionaire named Belmiro De Azevedo. SON PL is run like a cross between a conglomerate and a private equity firm. SON PL is always adjusting what’s in the portfolio, selling units, buying new units, making acquisitions, divestitures, etc. De Azevedo is not wedded to any unit, so I expect that someday he will consider an offer from PTC PL to buy SNC PL. SNC PL has a market cap of only €1.3bn. If PTC PL were to buy SNC PL and give €1bn of the €2.5bn of synergies to SNC PL shareholders, it could offer €6.34 per share, for a 75% premium. This price would be 16x SNC PL’s 2007E EBITDA.
The €1.5bn remaining synergies that PTC PL keeps would be worth €1.55 per share using PTC PL’s expected year-end count and €1.66 using the share count at the end of March when the buyback is concluded. So lets split the difference and call it €1.60 of upside from the eventual acquisition of SNC PL.
Sale of BrasilCel/Vivo stake to Telefonica
TEF SM owns 10.96% of PTC PL. TEF also is PTC PL’s JV partner in BrasilCel/Vivo. They jointly control 62.75% of Vivo’s equity capital and 89.35% of the voting power. When SNC PL made its hostile bid for PTC it enlisted Telefonica’s support. TEF SM turned on its JV partner and sided with Sonaecom. In turn for its support at a 10% shareholder of PTC (now 10.96% as a result of the buyback), the press reported that SNC PL was going to give Telefonica a sweetheart deal and sell Portugal Tel’s stake in BrasilCel for €2.5bn. This was when PTC’s Vivo stake was worth well below €2bn.
After the Sonaecom effort to acquire PTC failed, Telefonica was vocal about wanting to acquire PTC’s stake in BrasilCel/Vivo. Telefonica’s CEO, Cesar Alierta was quoted in the press saying how he’d love to get control of Vivo. PTC’s chairman, on the other hand, played it cool and said the stake wasn’t for sale. But I learned from sources that PTC was open to the sale, but the price would have to be right. Portugal Tell saw that the long awaited turnaround of Vivo was finally occurring and felt no need to sell out cheap. PTC could rightly demand a significant premium to the market value since its stake would give TEF SM control, and the peculiarities of the Brazilian takeover code meant TEF SM would only need to make a public bid for the ordinary shares at 80% of the price paid for the control stake, and would not even have to make a public bid for the preferreds (really non voting common). This meant TEF SM cold effectively get full control of this coveted asset simply by buying PTC’s stake (and without needing to spend a lot more for minority holders). Press heavily reported a price of €3bn being discussed when Vivo’s trading price was about 20% lower, but no deal was ever announced. I believe PTC is a seller, but the price offered would need to be impressive (around €3.5 billion for its stake). A sale at this price would bring an extra €1.40 to the valuation. And I confirmed with PTC PL that a sale of the Vivo stake would be completely free of capital gains tax because they’ve owned it for more than five years.
So to sum it up:
- Fat 6.6% dividend yield on the PTC PL stub, post spin-off, from an investment-grade telco (compared to Western European telco average dividend yield of 4.45%)
- Remaining buyback of €1.05bn worth of PTC PL stock by March 2008, which equates to nearly 12% of existing share count
- Base value of the PTC PL stub, after the spin-off of €9.67 (12% up) over implied cost of stub today of €8.66.
- Wireless Merger potential Uplift in value from synergies associated with buying Sonaecom of €1.66 per share
- Potential upside from sale of BrasilCel/Vivo stake of €1.40 per PTC share over market value of Vivo stake (tax free)
- Equals near term upside potential to €12.73 (47% up). At this price, dividend yield would be 4.5%, slightly above the Western European telco average
Catalyst
Spin off of Portugal Telecom's 58.4% stake in PT Multimedia imminently; Continuation of massive share buyback; Progressive dividend policy; Potential upside from possible acquisition of Sonaecom to create wireless duopoly and generate massive synergies; Potential sale of Vivo stake to JV partner Telefonica