June 14, 2007 - 7:57pm EST by
2007 2008
Price: 2.10 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 4,100 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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  • Holding Company
  • Sum Of The Parts (SOTP)


SONAE SGPS: Watershed Splitting of Portugal’s Largest Private Employer into Two Public Entities Following Management Transition, Creates Refocus on Best-in-Class Operating Assets, Driving Re-Rating of 100%+


Opportunity: Sonae SGPS (Bloomberg: SON PL) is a high quality, deeply discounted holding company that offers investors an opportunity to double their  money over the next 18 months, as it separates itself into two distinct publicly-listed entities (in the first of several deconsolidation activities likely to occur). The deconsolidation is a proactive effort to increase visibility of the underlying businesses in Sonae’s portfolio and decouple its valuation with an increasingly irrelevant static NAV methodology to cash flow based metrics that highlight the value of its many high quality, market-leading, asset-rich, and high-multiple operating businesses. Sonae offers investors the opportunity to own diversified market-leading assets while comfortably investing behind best-in-class, proven management, that have steadily compounded value at 7x-fold the rate of the Portuguese index since its IPO in 1993.  The demerger was announced earlier this year, immediately following the much publicized failure of Sonaecom’s (Sonae’s publicly-listed telecom division) bid for Portugal Telecom.  At the same time, a historic management transition of Paolo Avezedo, son of founder Belmiro Azevedo, to CEO was announced.  We believe these events will lead to material value creation as much hidden, unique asset value exists within Sonae Capital and the rump Sonae SGPS that offers portfolio optionality in Modelo Continente which was de-listed in late 2006 and Sonaecom which is subject to consolidation following regulatory clearance.


Management: Outstanding management team with high equity ownership and history of opportunistically taking advantage of markets up and downs and business trends to raise capital or withdraw companies from market in fervent pursuit of value creation. Chairman & CEO Belmiro de Azevedo (on Forbes 500 list) successfully led company during years following 1974 revolution when government seized company – he was granted his current ~50% stake in company by late banker Afonso Pinto de Malgalhaes for his success in running company during that turbulent time.


Sonae SGPS consists of a portfolio of businesses grouped into four sub-holdings: Modelo-Continente (the largest food and non-food retailer in Portugal): 2007E Revenues €3.44bn, EBITDA €288.18mm; Sonae Sierra (a 50% owned JV with UK’s Grovesnor, managing and developing shopping and leisure centers in Europe): 2007E NAV of €1.75bnE; Sonaecom (fixed and mobile telecommunications, software consultancy, newspaper) and Sonae Capital (broadly known to encompass a tail of 45+ disparate assets, including tourism assets, an insurance business, construction, transportation and venture capital).


Within Sonae SGPS, we are most excited about the main asset Modelo Continente, where fundamental cash flow metrics and real-estate backed valuation suggests value of as much as €4,369bn, or €2.18 per share, and potentially within Sonaecom (we believe on sum-of-parts the stake could be worth north of €1,400mm or €0.70 per Sonae share with further upside under acquisition scenario), where current asset mis-pricing following withdrawn bid for Portugal Telecom reflects a mis-understood management team that successfully set regulatory precedence for acquisitions in a consolidating sector subject to high anti-trust scrutiny by launching the low-probability bid.  Within Sonae Capital, we have spent considerable time on the portfolio, and are excited about multiple opportunities that could meaningfully move the needle for shareholders, including Troia (the new pre-eminent tourism assets finally being developed for Summer 2008 enterprise after years of political restriction) which we believe has the potential to be worth well north of €1.0bn or €0.50 per share for Sonae, and additionally mds (insurance brokerage), Praedium (housing development), Selfrio (cold storage), and other private equity investments such as TP, a j-v with Endesa in Wind Power, that we see potential value in aggregate of €2.5bn or an additional €1.27 per share.  In aggregate, we believe material catalysts are en route, which will revalue the shares between our base case €3.44 and our bull case €4.36 per share, representing between 69.5% and 114.8% upside.  Based on management's track-record of value creation and strategic focus on unlocking value, the exercise of valuing Sonae is simplified, as all opportunities to extract value will undoubtedly be sought. Sonae SGPS has always been opportunistic on behalf of its shareholders, looking to take advantage of market inefficiencies and eliminate the value leakage/capture the significant arbitrage between NAV-based valuation metrics that typically rely heavily on outdated book values and cash flow/earnings driven ratings applied by the market.  We would therefore weight more heavily the upside scenario (by reference, in 1996 when Sonae split the company to focus the market on differential value of modern retail and industrial assets, the shares increased 300% in 3-years).




Valuation Summary:


Base case valuation of holdings (valuation accounts for equity % ownership):

Modelo Continente: €3,628mm

Sonae Sierra: €940mm

Sonae Capital: €2,033

Sonaecom: €970mm (market price)


EV of Portfolio: €7,570mm


(-) Net Debt (€655mm) (includes NOL’s)

(-) Corporate costs (€36mm) (€6mm at 6x multiple)

Market Value: €6,880mm 

Implied share price: €3.44

Premium to current share price: 69.5%



Assuming management targets achieved valuation of holdings (valuation accounts for equity % ownership):

Modelo Continente: €4,369mm

Sonae Sierra:  €1,100mm

Sonae Capital: €2,541mm

Sonaecom: €1,400 (sum-of-parts)

EV of Portfolio: €9,410mm


(-) Net Debt (€655mm) (includes NOL’s)

(-) Corporate costs (€36mm) (€6mm at 6x multiple)

Market Value: €8,719mm

Implied share price: €4.36

Premium to current share price: 114.8%


Valuation Details:


Base case valuation of holding company equity interests suggests €3.44 target price (69.5% upside) with 18 month target price of €4.36 (114.8% upside). The below analyzes in detail the cash flow-based valuation of Sonae Capital and Sonae SGPS rump value. 


A) Sonae Capital (100% interest):


- Troia resort was acquired from bankrupt company 20+ years ago and kept undeveloped until 2005. Total invested capital is €350mm (several Analysts value Sonae Capital based on invested capital). Troia is being developed on 1057 hectares of prime beach front land to accommodate five hotels with 2,230 rooms, 650 apartments (three already built but will require refurbishment), 330 villas, five golf courses, marina, casino and congress center. The area is expected to be the 2nd largest tourist destination in tourism-dependent Portugal (appointed “project of national interest” status by government). For hotels, I assume 80% occupancy @ €200 room/day and 30% EBITDA margins and hotel peer group multiple of 12x (will likely warrant a premium multiple and higher margins as it will have lower cost base from freeloading on high-cost leisure activities already in place at “exclusive” Troia resort). For 650 tourism apartments, I assume 80% occupancy @ €325 apartment/day and 30% EBITDA margins using 10.0x multiple. For villas, I use current average selling price of pre-sells at €4,234 / sqm, 110 sqm average size of villas and 330 units. I value the golf courses at €121mm based on EV of 5 golf courses recently acquired in Portugal (average 6.17mts) for €121mm (Sonae golf courses average 6.320mts and are in more prized location). I assume conservative €7,000 / acre for remaining 617 hectares of undeveloped land (1057 – 440 = 617) based on undeveloped coastal property values in southern Portugal. I ascribe no value to two significant future development projects including a 20% stake in a 955 bed project including hotel with 300 beds and 100% stake in 3,322 beds including 360 villas and two hotels. I therefore derive value for Troia Resorts on a sum-of-parts basis well north of €1.0bn

- Contacto is civil engineering firm I value around €200mm using 1.3x 2006 sales

- TP is energy company with ownership in a 1200MW wind power plant that I value at €170mm based on a recent historical wind power transaction with implied EV/ MW of 1.41x

- mds, is largest re-insurance broker in Portugal with strong growth via acquisitions into international markets. I assume peer group multiple of 3.1x revenue multiple on €13mm in 2006 sales for mds division and 1.2x €19mm 2006 revenue for Sonae Re the groups captive reinsurer. Further upside from Brokers link which operates an international network of insurance brokers

- Various other assets to which we ascribe no value in base case including hotels, residential developments, project & facility management, health clubs, seed and risk capital, transportation services, car dealerships and energy distribution

- Using the above assumptions I derive a value for Sonae Capital between €2.0bn - €2.5bn or €1.02 - €1.27 / share




B) Modelo Continente (100% interest):

Modelo Continente (MOC) presents a relatively straight forward valuation exercise as there are numerous listed peers across Europe whose operating businesses and real-estate assets are well understood by the market, and the business compares nicely with Tesco (10.1x 2008E EBITDA) from a growth, profitability and market dominance perspective. We believe that there are no other hypermarket competitors that are substantially profitable in Portugal due to dominance of Continente's format and locations. We assume floor on valuation based on Jeronimo Martins (9.1x 2008E EBITDA), the second largest food retailer in Portugal with only ~50% of stores owned and less then half the market share of MOC.  We believe MOC will once again become well understood by retail analysts that assign full valuations to asset-rich food-retailing comparables across Europe.  After 2007, releverage or sale-leaseback can be considered, simultaneous with expiration legacy NOL balance.  We have looked at the standalone 2009 valuation of MOC assuming with and without a real-estate transaction, assuming a conservative market multiple on 2009 free cash flow (vis-a-vis continental european peers of mixed quality trading at material premiums to their local markets) and DCF and FCF Yields based on peer group metrics.  We value the real estate conservatively based on a combination of book value, regional yields and site-specific detail, and derive a valuation for Modelo of €4.37bn on a 12-month view, as compared with a €4.1bn market value for the entire holding company.  When viewed in this context, Sonae SGPS’ valuation is well underpinned, and the other impressive assets are effectively for free.  Detailed inspection of these other assets (explored in detail below) in addition to Sonae Capital, reveals another several billion of value that will aggressively be unlocked over the coming year. 



Key features:

- Has ~46% market share in Portugal in food and non-food retail

- Brief history of MOC is required to appreciate why 2007 will be a watershed year in driving growth and margin improvement and why MOC’s stock market valuation prior to delisting in late 2006 reflected a mis-understood strategic initiative by management to drive long-term value: a) Portugal government capped market penetration in food-retail at 35% in 2001 enabling foreign competition to enter market; MOC’s high penetration forced company to impetuously identify ex-Portugal markets for growth (leading to failure in Brazil venture)  b) In 2004 government revised legislation removing limits on penetration in food-retail enabling MOC to consolidate its leadership position in Portugal c) German retail giant Tengelman which now operated 20+ stores in Portugal prior to entering Portugal market stated they would require 100 stores to achieve satisfactory local scale and profitability d) Recognizing foreign competition were competing on price and depressing margins in food-retail and competitors need for scale to achieve profitability, MOC capitalized on the removal of penetration rates and redirected their focus away from high-margin, high growth non-food retail to aggressively saturate local markets in Portugal with low-margin food-retail e) With their current dominant leadership position in food-retail and strategically placed stores, competition in food-retail will likely exit Portugal knowing they will not reach sufficient scale to achieve profitability and enabling MOC to focus on their near-term growth initiatives in their high-margin, high-growth non-food retail business

- Upside from sale leaseback (2007E BV of properties ~€1.4bn). Sold unprofitable Brazil division in 2005 for ~€750mm and used proceeds to reduce debt – NOLs from Brazilian division have prevented MOC from participating in sale leaseback, however MOC currently generating strong FCF, profits and top-line growth. Management is publicly exploring sale leaseback option

- I expect margin expansion to be driven by management focus on high-growth, higher-margin non-food segment, cost reduction programs in place and leveraging economies of scale

- De-listed in late 2006 after Sonae SGPS bought out remaining stake (Sonae has history of opportunistically delisting companies prior to period of record growth/profitability in that business)

- Announced customer loyalty card initiative prior to delisting targeting ~20% penetration within year. In Q1:2007, MOC announced 90%+ penetration in customer loyalty cards and 12.2% YoY top line growth vs. 6.6% in Q1:2006

- Using the above assumptions I derive a DCF & FCF Yield based valuation for Modelo Continente between €1.81 - €2.18 / share


MOC Valuation:


Base Case:

- DCF & FCF Yield: 9.5% WACC; 9.1x terminal multiple on 2009 FCF; 6% FCF Yield

- 11-12% sales growth through 2009

- 25bps YoY EBIT margin improvement

- Capex 30bps higher then D&A

- Rental expense of 3.0% of sales from 20% real estate sales leaseback

- Value: €3,638 or €1.81 / share


Assuming management target are met (bull case):

- DCF & FCF Yield: 8.5% WACC; 10.0x terminal multiple on 2011 FCF; 5.5% FCF Yield

- 11-12% sales growth through 2011

- 35bps YoY EBIT margin improvement

- Capex 30bps higher then D&A

- Rental expense of 3.0% of sales from 70% real estate sales leaseback

- Value: €4,369 or €2.18 / share


C) Sonae Sierra (50% interest):

- I assume 5% YoY growth in sales per sqm and flat EBITDA margins (62.1%) from 2007 – 2009 to derive sales-based DCF value of €2.2bn.

- I also value based on peer group 15% premium to 2007E adjusted NAV (assume 200bps improvement in Brazil real estate yields to derive adjusted NAV and assume lowest YoY growth in four years over 2006 reported NAV of €45.8/ share. Peer group trades at 18% premium to NAV and implies real estate yields ~100-150bps lower providing cushion (and opportunity to hedge)

- Operates shopping malls in Portugal and emerging markets (2/3 of NAV currently in Portugal with management goal to derive 1/3 of NAV in Portugal in 5 years via expanding emerging markets presence)

- Generates ~7% of revenue from profit split arrangements with tenants

- I therefore ascribe value for Sonae Sierra between €0.47- €0.55 share


D) Sonaecom (52% interest):

- Base case: €970 based on publicly traded market price or €0.48 / share

- Bull case: €1,400 based on sum-of-parts or €0.70 / share

- Further upside under acquisition multiples



With increased transparency and deconsolidation pending, risk/reward is highly compelling. A downturn in real estate values will impact Sonae Sierra’s NAV and potentially Sonae Capital’s revenue from villa sales (although target customer base has high discretionary income). Sonae generally limits downside by setting up new projects/ventures to be self-financed (i.e. pre-selling villas and stake in Casino to cover required capital outlay in Troia; setting up real estate fund for Sonae Sierra expansion into emerging markets, etc). 




- Deconsolidation of Sonae Capital from Sonae SGPS (likely followed by further deconsolidation within rump); Transition of CEO to Paulo Azevedo, the market-friendly son of legendary founder Belmiro Azevedo; Potential acquisition of Sonaecom; International research coverage in H2:2007
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