Description

VimpelCom has been hemorrhaging its natural shareholder base over the last two years. Company specific issues took an already bleak macro environment for Eastern European telecoms and brought VIP into the pit of investor pessimism within the space. A debt building acquisition spree beginning in 2010, a leverage related dividend cut in early 2014, a swath of bribery allegation headlines throughout 2015 and into 2016, a $795 million FCPA fine in early 2016, and a recent large shareholder semi-forced sale have decimated VimpelCom’s market valuation. What has not gone south for the Company is its ability to generate massive amounts of cash flow; unexpected macro headwinds and company specific issues leaves us as opportunistic buyers of geographically diversified telecom operations at just 4.1x TTM consolidated ebitda (~7.1x TTM ebitda less capex). 

We believe VimpelCom is as cheap as it is not due to legitamte fundamental concern, rather the market misunderstands the implications of VIP’s Italian JV transaction, values it as if it is a pure-play Russian telecom operator (even though Russia only accounts for 33% of its total EBITDA), scoffs at the triviality of its dividend, and has been scared off by unpalatable headlines.

Setup / Why is this Cheap?:

• VimpelCom has been bombarded with problem after problem ever since going on an acquisition spree to expand its operations into Europe in late 2010. 

• VimpelCom announced a surprise dividend cut in January of 2014. After paying out $1.3bn in 2012 and $2.2bn in 2013 ($1.4bn special div), the Company dropped the payout to just $60.5m over debt coverage concerns and the stock fell about 12% on the news.

• In November of 2015, the CEO at the time was arrested for corruption charges related to bribes sent to the daughter of the President of Uzbekistan. At the same time, the Company set aside a $900m provision for potential fines stemming from the bribery allegations.

• After struggling for control of the company and wanting to distance itself from the bribery charges, Telenor, a 33% stakeholder, announced its intentions to sell its stake in Vimpelcom, describing the Company as a “problematic asset.”

• In February of 2016, the DOJ eventually fined VimpelCom $795m for violations of the FCPA in relation to bribes sent to aid the Company’s position in Uzbekistan.

• More recently, on September 1^st, EU regulators approved the merger of VimpelCom’s Italian business with Italian telecom, 3 Italia. 

• On September 12^th, VimpelCom announced the pricing of the Telenor partial stake sale (about 8.1% of VimpelCom O/S shares) at $3.50. Shares fell about 7.5% on the news – (even though this is not a dilutive sale, it served to double the free float to 20%).

Why Own This Now?

1.  On top of the company specific issues listed above, the regions in which VimpelCom operates have seen their economies whittle through 2015 and into 2016 – particularly Russia. This has caused a significant amount of currency exchange losses in addition to currency adjusted top-line pressure. It is unlikely the Company will continue to face a rapidly appreciating USD paired with eastern european economic deterioration (we think the effect was mainly due to a rout in oil prices), but the important insight here is that VimpelCom has mostly traded in line with Russian peers (whose economy has seen the worst of the macro headwinds) even though the Company only does about 33% of its business there an on EBITDA basis. This over-correlation to Russian peers may have been aided by the transfer of the Italian business into the assets held for sale line – segregating about a third of EBITDA from consolidated EBITDA (possibly misleading a quick glance at the actual exposure to Russia).  

2.  While the Company originally cut its dividend in the beginning of 2014 as it struggled under the weight of its debt load, they have continued a very low payout (vastly underpaying vs peers) – a result of the $795m FCPA fine straining an already over-leveraged entity. We believe certain investors, especially in the telecom space, heed too much on dividend payouts – the relative difference is significant given VimpelCom pays only ~1% annual dividend where peers like Rostelecom and Megafon have yields of >7%. The Company has stated it will look to reinstate a more appropriate dividend in Q1’17 which should bring in new investor enthusiasm.

3.  As of 3Q'16 reporting, the Company was still in the in the process of merging its Italian assets into a JV with CK Hutchison (the operator of Italian telecom 3 Italia). Due to this, the Company had placed its whole Italian business into the assets held for sale bucket on its balance sheet – deconsolidating earnings from ongoing operations. The JV which will house the Italian business is taking on EUR$9.8bn of debt from VimpelCom but is not taking on any debt from the 3 Italia business (in fact 3 Italia brings on EUR$200m of cash). This transaction should not only be accretive due to projected deal synergies, but also because it serves to materially delever VimpelCom’s balance sheet. As of November 6th, this transaction has been completed. 

4.  The JV transaction will serve to materrially aid the company's over-levered capital structure and should allow VimpelCom better leeway in restructuring its existing obligations.

5.  Extremely attractive valuation: The Company earned ~$3.6bn in TTM EBITDA on its ex. Italy business (with de-escalating capex requirements, now about 17% of revenue, or $1.5bn run-rate). At the same time, the ebitda attributable to VIP shareholders from the Italian is esxpected to be about $1.3bn in 2017. On a consolidated basis, accounting for the net debt of the Italian JV attributable to VimpelCom pro-forma for the transaction, VimpelCom trades at just 4.1x ebitda (~7.1x ebitda less capex) and is again experiencing organic revenue growth in most regions (big exception is Russia).

6.  We see multiple ways to win in that we trade at a lower valuation than Russian peers yet have significantly better operating regions (Italy, Pakistan, and Ukraine all recently boasted >5% organic top-line growth and have more developed infrastructure in place to handle higher margin data servicing plans). We see VimpelCom's valuation correcting near term on the dividend reinstation and success in Italy; long term we are jovial owners of this operation base with likely future secular tailwinds and de-emphasis by investors on the Russian piece of the business. 

Potential Risks:

We do not have a differentiated view by any means on the economic vitality of Eastern Europe, we do not think however the current valuation of VIP is justified in the absence of a severe and immediate continued economic downturn in the regions in which VIP operates. We could be wrong on this view, while we believe little risk lies at this valuation, upside would not easily be concieved in this event. 

In connection with the approval of this merger transaction, French telecom operator Iliad agreed to become the fourth mobile phone operator in Italy. Illiad is known for its low pricing and extreme competitive nature.  The current CEO has dealt with Illiad before at SFR which gives us some comfort.  

Catalyst

The Company expects to re-instate its more appropriate dividend in the beginning of 2017 (much like the drums in a jazz song, a dividend is needed to give investors something to grasp onto).  

As the dust settles after a series of turbulent macro shocks, company specific detriments, and the Telenor stake sale, a natural shareholder base should return as the earnings power of the Company is realized (and possible multiple re-rate as investors discount their Russian anxiety).