Why This Telecom Could Be Undervalued

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Seth Klarman, famed hedge fund manager of Baupost Group and author of the out-of-print Margin of Safety, recently disclosed its largest equity holding as Vivendi SA (NASDAQOTH: VIVHY.PK), with a stake worth an estimated $530 million at the time of purchase. Shares have been down, hence our interest in taking a look at why this company has Klarman so interested.

Vivendi is a global telecom and media conglomerate operating six divisions. The largest two, SFR (French telecom) and Maroc (African telecom), account for~62% of the consolidated company’s EBITDA. Both face increasing competition in their respectively geographic regions. Notably Iliad, a privately held competitor in France, has upped the ante with its new mobile offering. Vivendi also owns 60% of the gaming company Activision Blizzard (NASDAQ: ATVI), TV company, Canal+, and music industry stalwart Universal Music/EMI. Neither ATVI nor Canal+ has shown stellar performance but the music division’s recovery should help company performance. The area that we are excited about and think will drive stock performance is Brazilian telecom company, GVT. Vivendi bought GVT in 2009 for €3 billion and really Vivendi’s only growth-focused asset. Accordingly, it is the focus of our analysis.

GVT’s has a first-in-class altnet (alternative network) with a hybrid fiber-copper architecture, meaning that the fiber connects to FTTC (fiber-to-the-cabinet), FTTH (fiber-to-the-home), and some copper.  FTTC/FTTH refers to replacing the traditionally metal local loop for last mile telecom connections with optical fiber. For this division, the growth will come from geographic expansion in broadband and entry into the pay TV and broader media market. The IPTV Pay TV initiative was launched in January of this year and reached 110k customers within three months. Given GTV’s existing broadband customers, we think that management’s expectation of 400k to 500k customers by the end of this calendar year is reachable as is its projection of one million customers by year-end 2013. That amounts to approximately 20% of Vivendi’s existing broadband base. The Pay TV penetration rate in Brazil is only 18%, reportedly the lowest in South America providing GTV with a huge opportunity to capitalize on an underpenetrated market that is experiencing a rise in overall and disposable income. Sky, the market leader, currently has an advantage due to higher volumes, but GTV is aware of this and has renewed focus on accelerating volume growth in the upcoming quarters.

Vivendi’s broadband business currently touches approximately 19 million households/enterprises in 119 cities. The company is looking to aggressively increase its reach to 128 million households/enterprises in 185 cities. There are currently no plans to enter the mobile business, which we view positively at this point. The Brazilian mobile space is dominated by Telefonica Brasil (NYSE: VIV) with 30% market share and Telecom Italia (NYSE: TI) with 26% market share. Mobile is the only area in which TI has meaningful penetration and only captures 1% of the fixed phone industry compared to Telefonica Brasil’s 26% market share in the fixed phone space and 22% market in the broadband space. However, it is important to note that TI has plans to lay residential fiber broadband in Sao Paulo and Rio de Janeiro, and will thus begin to compete in the broadband/fixed phone spaces. The other big players in Brazil include Portugal Telecom (NYSE: PT) with 30% of the broadband market share and 44% of the fixed phone market share and America Movil (NYSE: AMX) with 27% of the broadband market share and 20% of the fixed phone market share. GVT has 10% of the broadband market share and 7% of the fixed phone market share. GVT identifies its advantage as higher product quality and value. The average speed of GVT’s customer base was 10.8Mbps as of year-end 2011 compared to the national average of 1.9Mbps, but its prices are comparable to competitors. The company has pointed out that it does not see its competitors investing as much on the quality front, so we believe GTV could pull ahead in additional customer acquisition by emphasizing this aspect. 

The stock looks cheap as it currently trades at multiyear lows, while offering a 9.2% FCF yield, 7.2% dividend yield, and long-term growth in the Brazilian business. It is true that there aren’t any meaningful upcoming catalysts but at ~7.0x 2012 P/E and 4.6x 2012 EV/EBITDA, we see a compelling value opportunity. Management projects revenue growth in the mid 30s, 40% EBITDA margin, and capex to the tune of R2.3 billion for GTV’s FY2012. If all goes smoothly at GTV, we are optimistic about its ability to continue to grow EBITDA, boosting the consolidated company’s financial performance. There are certainly concerns over anti-trust regulations and the competitive headwinds in the French and African telecoms businesses, but at these prices, we are comfortable establishing a position. Obviously, we don’t know exactly why Klarman likes this company. What we do know is that Klarman likes buying things cheap, and so do we (read more on Seth Klarman’s Picks).


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