July 29, 2013 - 7:13pm EST by
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 $M): 605 EBIT 0 0
TEV ($): 1,871 TEV/EBIT 0.0x 0.0x

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  • Europe
  • Broadcast TV
  • Merger
  • Synergies


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

  • Stability of Operations and Financial Performance: One of the key factors that attracted us to ZON initially was the stability of its operations and financial performance.
    • Despite the intensity of the Global Financial Crisis and the fact that Portugal has been mired in a deep recession over the last 2 years, the Company has consistently grown its revenues and EBITDA at CAGRs of c.4% and c.7%, respectively, since its spinoff in 2007.
    • During this period, the Company also reduced costs with EBITDA margins increasing from 30.7% in 2007 to 38.8% in Q1-2013. It also cut CapEx spending by c.25% and paid Euro450mm of dividends to shareholders over the five years.
  • Leadership Position in a Consolidated Market: While the market environment in which ZON operates is not as favourable as it is for its Northern European peers there are a few positive trends.
    • Consolidated Market: The pay TV, broadband and fixed telephony markets inPortugal are basically duopolies with ZON and Portugal Telecom SGPS SA (“PT”) accounting for approximately 90% of the market in each category. The wireless market is also consolidated with three companies PT, Vodafone and the combined ZON Optimus comprising the vast majority of the domestic subscribers.

Market Shares in Portugal



ZON + Optimus

Total Share

Pay TV




Fixed Telephony












Source: The Company, May 2013

  • Stable Subscriber Base: ZON has historically been the undisputed leader in pay TV, however PT has undertaken a very aggressive marketing campaign to successfully take market share primarily among the un-penetratedhouseholds. ZON has fought back by determinedly growing its fixed / wireless telephony and broadband customer base. Net-net, the company’s total subscriber growth has been stable to slightly growing, however its Revenue Generating Unit (“RGUs”), i.e. aggregate number of services provided to its customers, has steadily expanded.
    • To the extent ZON has lost TV customers to PT, the source of such losses has come mostly from the satellite subscribers, which by definition are located in areas that ZON has no cable infrastructure. Therefore, the only region where the Company’s relative share is smaller than the incumbent’s is where it has less coverage. Furthermore, in regions where GDP per capita is higher and the Company’s network is present, ZON’s leadership relative to the incumbent has been wider.
    • ZON’s management has confirmed that the Portuguese market is more rational presently and the expectations are that market shares will stabilize around current levels.
    • Portugal’s broadband market is relatively underpenetrated (c.40%), amongst the lowest in Europe, therefore it presents opportunities for domestic growth and market share gains for both players. Domestic growth in pay TV and fixed telephony are also feasible, although prospects are less attractive due to higher penetration.
    • Less Favorable Environment: We should also mention here that, in comparison to the Benelux and Germany, where the incumbents are significantly behind the cable competition in terms of pay TV and broadband product offerings, Portugal is a more competitive market as PT is recognized as one of the most technologically advanced operators in Europe and has broad coverage. Furthermore, as mentioned earlier, Portuguese consumers are in worse shape than their Northern European peers.
  • Technological Leadership and Solid Product Offering: ZON has invested close to €1bn over the last several years to upgrade its technology and network. Its advanced product offering and high network quality are two of its competitive advantages.
    • The Company’s hybrid fibre coaxial (“HFC”) network was fully upgraded in the last three years and is the largest network in terms of coverage in Portugal, capable of supporting the expected growth in data and advanced services.
    • The company has a broad range of competitively-priced products with some of the most innovative and advanced features globally.
      • The IRIS product, a world-first of its kind, offers cloud-based 7-days recording, full convergence between TV, iPads and PCs, free APPs and many other features.
      • The Company also offers innovative broadband and voice product including unlimited fixed voice calls to 50 countries, fixed calls from anywhere using home phone number etc.
      • Launch of many new channels - some are exclusive to ZON
      • Free Wi-Fi access to 500,000 hot spots in Portugal, 7 million worldwide via ZON@FON
      • A broad-range of products that cover various price points to appeal to a wider base of customers.
  • International Expansion: ZON has actively grown its pay TV business in Angola under the ZAP brand.  The Company has formed a JV with a local partner (headed by the daughter of the Angolan President and Africa’s wealthiest woman – Isabel Santos). ZON is also expanding in Mozambique although it is currently at a much earlier stage there.
    • ZAP has the most advanced satellite-based set-top boxes in the market and is present in 10 of the largest Angolan provinces with a large distribution network.
    • It has grown its subscriber base very rapidly. In 2012 alone, the company added 155K subscribers, a 50%+ increase over the prior year while also growing average revenues per user (“ARPU”).
    • The operations are self-funding, after a small initial investment, and are generating strong cash flows.
  • Strong Management Team:We have met the management on several occasions and have been impressed by their background and achievements. There are some investors who have been disappointed by the loss of market share in pay TV over the last 3 years. They have pointed the finger to the CEO for not being aggressive enough in his retaliation.
    • However, despite the strong competition and weak economic conditions, the management has been able to grow revenues and increase margins at a solid pace.
    • Furthermore, they have been friendly to shareholders through paying out €450mm in dividends over the last five years.
    • The management does not own a large amount of shares in the company but the CEO purchased 500Kshares with personal funds upon taking on the role and currently owns about 606K shares.
    • The top management’s background is impressive with strong credentials earned at Microsoft, McKinsey and other leading global organizations.
  • Strong Benefits from the Merger with Optimus: In December of 2012, the Company announced the merger with Optimus. We believe this is transformational as it allows the combined entity to offer quadruple play products as well as realize substantial cost synergies. PT is one of the few providers in Europe that offer quadruple play (TV, broadband, fixed telephony and wireless) and ZON will be a stronger competitor as a result of the merger. 
    • In addition to significant cost synergies, estimated at €350-450mm in total, there are opportunities to take market share in the corporate segment. The latter has a market size of €2.2bn and ZON currently has only a c.13% share in this segment.
    • Furthermore there are opportunities to grow the ZON Optimus wireless subscriber base by offering bundled products and take away customers from Vodafone. The latter provides limited services outside of wireless in Portugal.
    • Furthermore there is very little overlap, only 10%, between the two companies’ subscribers thus offering cross-selling opportunities
    • The merger will also solidify ownership of Isabel do Santos in the combined entity – she is Africa’s wealthiest and most powerful woman and her backing is very beneficial.
  • Attractive Valuation and Strong Balance Sheet and Cashflows: While there are some reasons for ZON to trade at a discount to its Northern European peers, e.g. weaker macro conditions and stronger competition, we believe the magnitude of this discount is unjustified.
    • The Company currently trades at a significant discount 40-50% as compared to its European cable providers and even at a discount to European Telecoms, whose businesses face a lot more challenges. Given the substantial benefits from the merger and the Company’s opportunities for international growth, we believe this discount should be narrower.
    • ZON generates very strong FCF yields in the 14-15% range and has a solid balance sheet with less than 2x Net Debt / EBITDA vs. 3.5x and higher for the comparable companies.

Risk Factors

  • Economic Environment: The weak economic environment weighs on ZON business operations despite its defensive nature. Poor consumer confidence, decline in purchasing power and high unemployment have some adverse impact on cable operators as well. ZON’s ARPUs have declined over the last 2 years as subscribers have reduced their consumption of the highly profitable premium content products. Further deterioration in macro conditions could have an additional impact on valuation.
    • While the Company has maintained its level of subscribers, the cumulative levels of its uncollected accounts receivable has been high over the last couple of years as a result of the weaker economic conditions. However there is limited impact from this development as customers usually prepay a month in advance and if there is no payment for two months, the service gets disconnected.
    • The Company lists its exposure by counterparty. Given that a lot of its cash is held in Portuguese banks (rated BB-), its counterparty exposure is with low-rated parties. However, ZON matches assets with liabilities in terms of exposure which provides for an offsetting balance i.e. a “natural hedge”.
  • Competition: We have discussed already the competitive environment in Portugal. While a new entrant into the market is highly unlikely, a more aggressive market-share-grabbing campaign by PT or a disruptive response from Vodafone in reaction to the Optimus merger could adversely impact the market environment.
  • Legal & Regulatory: While the current regulatory market environment is benign and we don’t expect the authorities to object to the ZON Optimus merger – any incremental obstacles from the regulatory authorities, either in the form of higher tariffs or substantial merger-related concessions, could hinder the Company’s prospects. While ZON does not face any major legal liabilities, given the multiple constituents that it deals with, it could be subject to potential lawsuits.
  • “Cord Cutting”: Cable companies in the developed world have been impacted negatively by increased incidence of “cord” cutting i.e. consumer disconnecting pay TV and fixed lines to rely entirely on online-provided services. Given the competitive quad-play products that ZON provides this is a lesser issue for the Company.
  • International Operations Risk: The key growth engines for ZON are its Angolan and Mozambique operations. Any economic, currency or political disruptions in these countries will impact adversely ZON’s operations.

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)


Nov. 2007 -   Spinoff

Dec. 2012

Stock Price

9 per share

3 per share


716 mm

859 mm


220 mm

313 mm

Net Debt



Shares Outstanding



Forward EV / EBITDA



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.



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!

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.


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