2013 | 2014 | ||||||
Price: | 4.10 | EPS | $0.00 | $0.00 | |||
Shares Out. (in M): | 309 | P/E | 0.0x | 0.0x | |||
Market Cap (in $M): | 1,266 | P/FCF | 0.0x | 0.0x | |||
Net Debt (in $M): | 605 | EBIT | 0 | 0 | |||
TEV (in $M): | 1,871 | TEV/EBIT | 0.0x | 0.0x |
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We believe that ZON Multimedia - the leading Cable company in Portugal is an attractive long investment.
The investment idea presented in this case study capitalizes on the incessant human need for entertainment, in particular affordable entertainment. Television, along with its “younger cousin” – the Internet, do provide affordable entertainment and as such are present in most households in the developed world, even in countries that are facing dire economic conditions. Indeed, looking through the performance of cable companies during recent recessions, one can see convincing evidence that people hold on to their pay TV and broadband subscriptions despite rising unemployment and declining confidence.
We have been attracted to the European Cable industry, which despite operating in the epicentre of recent global economic earthquakes, has demonstrated enviable stability and growth. In addition to the human desire for affordable entertainment, there have been several drivers behind this strong performance: (i) relatively low penetration and limited quality free TV options, (ii) inadequate internet connectivity provided by most Telecom incumbents, (iii) discounted bundled services (iv) VOIP fixed telephony. These factors have allowed cable companies to grow their respective subscriber bases and increase their revenues. Indeed, the sector has offered one of the few domestic growth stories within continentalEuropeover the last 3 years.
ZON Multimedia – Servicos de Telecomunicacoes e Multimedia, SGPS, SA (“ZON” or the “Company”) is the leading cable provider inPortugaloffering cable and satellite pay TV, broadband connectivity, fixed telephony and, in limited cases, wireless telephony. In addition, the Company is engaged in film distribution and cinema management inPortugaland is the leading satellite pay TV provider inAngolathrough a local joint venture. In comparison to its European cable peers, ZON boasts some of the most advanced technology and leading product offering. However, it also operates in an environment that is less favourable than its peers. This is due to two factors - 1) the Portuguese economy is among the worst impacted from the crisis and 2) the incumbent, Portugal Telecom, is a very strong competitor, unlike most of the telecom operators inNorthern Europe. These two factors have depressed the valuation of ZON, with its shares currently trading at a 40-50% discount compared to cable providers in the Benelux, UK and Germany.
It is our firm view that the magnitude of this discount is not justified, the rationale for which we will debate throughout this paper. Our confidence is supported by the transformational corporate transaction that the Company is engaged in at the moment. ZON is in the process of merging with Optimus SGPS SA (“Optimus”), the third wireless operator in the country, a deal expected to be finalized by the end of the third quarter of 2013. This merger brings significant cost benefits to the combined entity – €350-400mm as per management’s guidance – and additional upside in the form of revenue synergies and market share gains. Summing it all up, ZON offers a stable, yet attractively-valued, business that generates strong free cash flows, has a solid balance sheet, offers opportunities for growth both domestically and, especially, internationally and provides for significant cost synergies stemming from a recent transformational merger. Hence we are recommending an investment in ZON.
What We Like About ZON
Market Shares in Portugal
Market |
PT |
ZON + Optimus |
Total Share |
Pay TV |
39.2% |
51.4% |
90.6% |
Fixed Telephony |
50.9% |
38.0% |
88.9% |
Broadband |
51.3% |
37.3% |
88.6% |
Wireless |
42.6% |
22.1% |
64.7% |
Source: The Company, May 2013
Risk Factors
Investor Sentiment and Valuation Analysis
Investor Sentiment
ZON was spun off from PT into an independent entity in November 2007. Since then revenues and EBITDA have decidedly gone up. This achievement has occurred almost entirely through organic growth as ZON did very little net asset purchases in the last 5 years. However, during that period the shares and the multiples have deflated. That certainly frustrates all of ZON’s stakeholders and perhaps is partly the rationale for doing this transformational transaction.
Prior to the flaring of the PIIGS debacle, ZON traded in line or higher than its European peers. Since the summer of 2011, a wide valuation discount has developed. The following chart summarizes the massive de-rating that the Company has endured since its early days:
Comparison of ZON – Current to 2007 Spinoff (In Euros)
Metric |
Nov. 2007 - Spinoff |
Dec. 2012 |
Stock Price |
9 per share |
3 per share |
Revenues |
716 mm |
859 mm |
EBITDA |
220 mm |
313 mm |
Net Debt |
197 |
605 |
Shares Outstanding |
309 |
309 |
Forward EV / EBITDA |
12.5x |
5x |
Source: Bloomberg
Granted, ZON came out initially at 12.5x EV/EBITDA, which was perhaps too rich of a premium to other European and US cable operators at the time. However, it feels like the multiples’ pendulum has swung too far post the crisis.
ZON’s stock price has been on a steady decline since its spin-off and reached an all-time low last summer of €2. Since then the stock has recovered crossing the €3 mark post the announcement of the merger. ZON has outperformed PT this year as buy-side sentiment is improving. The short interest in the Company’s level I ADRs has also declined from last Fall – although given its illiquidity it is perhaps not a very accurate indicator.
The sell-side sentiment is still mixed. At the end of last year approximately 30% of the analysts recommended positively the stock – the current percentage is slightly higher at c.50%.
Current Sell Side Stock Price Recommendations
Buys 52.9% 9
Holds 41.9% 7
Sells 5.9% 1
12M Target Price €4.17
Source: Bloomberg:
We believe few members of the sell-side community are giving full credit to the benefits of the merger at present and are waiting for the macro picture to clear out and the merger to close before they become more aggressive with their recommendations. For long-term value investors like us this creates an opportunity.
Valuation Analysis
We have valued the Company on a combined basis. The merger with Optimus is a key catalyst in this investment story and we feel confident that it will materialize in the coming months. The sell-side has not developed full combined pro forma estimates and therefore there is no good basis for comparison. We have built our model based on guidance from management and taking into account the macro environment.
In our base case we have assumed flat subscriber and ARPU growth over the next three years with minimal margin leverage as recent cost cutting takes effect. We have assumed moderate, compared to recent precedent, growth in Angola along with margin expansion as the subscriber base there grows. We feel that these estimates are relatively conservative and reflect our findings from discussions with management.
In determining our target prices we have relied mostly on EV/EBITDA multiples as well as Free Cash Flow yields both relative to history and other peers. We have also looked at EV/ subscriber metrics but those are perhaps somewhat less relevant due to the different profitability profile and product composition.
Target Price Ranges
Our valuation analysis has taken our assumptions developed throughout the case study and multiple ranges to arrive at our price targets. We have developed three scenarios – Base, Bull and Bear and a fourth one called a “Recession/External Shock” case.
Bull Case: Our bull case is predicated on small subscriber and ARPU growth and moderate margin leverage. We also assume a multiple rerating from the current 4.7x 1-year forward pro-forma EV/ EBITDA multiple to 6x. Our 2015 “Bull” price target is €7.84.
Base Case:
Our base case is predicated on flat subscriber and ARPU growth and minimal margin leverage. We also assume some modest multiple rerating to 5.5x. Our 2015 “Base” price target is €5.77.
Bear Case: Our bear case is predicated on negative subscriber and ARPU growth and no margin leverage. We also assume no multiple rerating and lower synergies than guidance. Our 2015 “Bear” price target is €3.95.
Recession Case: In our recession case we have assumed significant subscriber and ARPU declines (-5%, each) as well as no margin leverage and much lower synergies (40% of management guidance) at bottom valuation. We also assume further multiple deterioration (4.5x) in deriving our average “recession” price target of €2.67.
Summarizing all three “normal” cases and assigning probabilities to each we get to a weighted average price of €5.81 in 2-3 years, in line with our base case.
Conclusions
There are a number of factors that have attracted our attention to ZON. Despite operating in a challenging environment, it has demonstrated enviable stability in its operations. The Company’s international operations provide for an exciting area of growth while its recently announced merger with Optimus offers substantial cost and revenue synergies. ZON trades at a very attractive valuation, a significant discount to its peers. We firmly believe this is unjustified.
Disclosure: We, or affiliates we advise, have currently a position in ZON and we may trade in it without further disclosure. Do you own work as we don't guarantee the accuracy of this work!
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