Orange Stock Pitch

7/27/2019 Orange Stock Pitch

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Is Orange Cheap?

By Cameron Fen

Age 22Brandeis University



Summary



Highlights

• Orange is Cheap

• P/FCF of 5

• Bad news is priced in

• Competition from Iliad (low cost carrier in France)• Relatively High Leverage

• Even if the worst case scenario plays out, Orangeis still cheaper than AT&T and Verizon

• Significant emerging market customers whencompared to AT&T and Verizon



Not a Story Stock, but Negative

News Already Priced In

• The market usually overreacts to negative

news

– P/E of stocks with negative sentiment is too low

– Backtesting, picking the 10 lowest P/E stocks

quarterly from 1986-2012 returns 17% (compared

to a market return of 10%)

• The stock has a low P/FCF because it hassomewhat high debt

– However even on a EV basis…



Enterprise Value

0

2

4

6

8

10

12

14

Orange Telefonica KPN Duetsche Telecom AT&T Verizon

E

V/

F

C

F

Company

EV/Adjusted FCF



Adjusted FCF

• FCF is better than earnings because

Maintenance Capex < Depreciation &

Amortization

– Payout ratios have been higher than 100% at

times because the available excess cash is so

much higher than earnings

• As such when using an EV ratio, have to addback interest and taxes to FCF

• All FCF numbers are Trailing Twelve Months



Background



Company Information

• Orange (originally France Telecom) provides

mobile phone and fixed line phone service (as

well as internet, TV etc.) to France, Spain,

Great Britain, Poland, Portugal, Belgium,Eastern Europe, Africa,



Competitive Advantage

• Incumbent mobile operator in France

• Highest brand loyalty, largest telecom networkin France

• Significant barriers to entry• Market shares relatively stable over the past 10-20

years

•Orange’s large size, stable market share, andsignificant barriers to entry and lower interestrate costs give it a competitive advantage



Earnings in France

• France accounts for 47% of Orange’s revenue

as well as almost 75% of FCF

• Emerging Markets account for about 0-500m

Euros in FCF

– Rest is in Britain, Spain, Belgium, Luxembourg and

Switzerland

• FCF = 5.7 Billion Euros



What the Bears See

FCF Trend

• Net income for the past 12 months = 150mm

Euro due to goodwill write down

•

Massive P/E ratio and FCF decline in 2012

2005 2006 2007 2008 2009 2010 2011 2012

7,232.00 7,131.00 8,185.00 9,710.00 9,833.00 8,421.00 8,600.00 5,725.00



Real reason for the decline in Earnings

• France’s fixed line division took a 1.5 billion

Euro hit last year because of a new value

added tax (VAT) for triple play plans

– Untapped pricing power to recover VAT, as all

competitors faced the same tax

– Iliad has already raised its Triple Play Prices

• VAT tax was responsible for around half of the2.9 billion FCF decline in 2011-2012



Earnings Decline (cont.)

• Price war with Iliad, affecting the mobile

division in France, responsible for about half

of the remaining decline

• European macro responsible for the remainder

• We will talk about Iliad later

• Political conditions in Egypt responsible for

much of the 2 billion+ goodwill write-down



French Mobile Division



Orange’s French Mobile Division

• French Mobile division earns extremely high ROE

• Mobile EBITDA = 3.3 billion euros, Mobile Capex

= .7 billion euros

• The high (EBITDA – CAPEX)/CAPEX ratio suggests

that the company has a serious competitive

advantage in France

– It is the incumbent telecom in France with areputation for the best network

– Significant barriers to entry in the mobile space



Competition

• Orange historically has had and still has

pricing power over it’s competitors

– Prices are 5 Euros higher than competitors given

same/similar service offering

• New entrant Iliad is selling phone service

below cost to take market share

– The history of a stable market share in thetelecom space suggests Iliad’s entry into this space

will be difficult



Comparing prices on same service

(Unlimited calls and txt + 3Gb data)

Iliad 19.99 unlimited/ 3GB SFR 29.99

Unlimited calls/ unlimited text/

3 GB of data

Orange

29.99

Euros

Unlimited calls/2GB

of data Bouygues 29.99

Unlimited txt/unlimited calls/

3gb data/

Orange

39.99

Euros Unlimited calls/ 4 GB of data

•

Sooner or later, Iliad is going to have to charge a pricewhich allows it to earn a profit

• Orange can charge an even higher price and earn

higher profits

• Note: Iliad has the resources to continue their price

war for a few years so one needs a longer timehorizon

• Average price of Orange’s 2GB plan and it’s 4Gb plan is

5 Euros more than SFR and Bouygues 3GB plan with

historically stable market share



Valuation of Orange

• Main takeaway: Even if Orange’s lucrative

French Mobile Division loses the price war to

Iliad and stops earning a profit, Orange is still

trading at P/FCF of around 7• This situation is extremely unlikely as, over the

long term, Iliad also needs to earn a profit

• Keep in mind Iliad is at a competitive disadvantageto Orange, so if Iliad is making a profit, Orange will

be making a larger one



Debt



Debt compared to European Peers

0

1

2

3

4

5

6

Orange Telefonica KPN Duetsche Telecom

De

b

t

/

F

C

F

Company

Debt/Adjusted FCF



Debt Compared to American Peers



The Myth of the High Debt

European Telco

• Orange’s debt is rated Aa3 by Moody’s

• Verizon after the Vodafone deal has debt

rating of Baa1

– Lower than Orange

• Verizon has an EV/adjusted FCF of 12.7

– P/adjusted FCF approx. 7

• Orange has an EV/adjusted FCF of 6.3

– P/adjusted FCF approx. 3



Lowering Leverage

• Orange is aware of it’s debt load and like manyother European Telecoms is actively trying to

sell assets and reduce the dividend to pay

down debt – Management is targeting a net debt/EBITDA ratio

of 2 by the end of 2014

•

Furthermore, macroeconomic conditions willimprove in Europe at some point

– Broadband prices could still increase over the long

term and regain the 1.5 billion euro in lost profit

due to the VAT



Debt

• Among it’s European peers, Orange has arelatively strong Debt to FCF ratio

• Even among American Peers, Orange has a lowerEV/FCF compared to Verizon

• Even if a worst case scenario where Orange’sFrench Mobile Division loses the price war withIliad and doesn’t earn a profit, Orange’s Debt/FCFand EV/FCF still in line with peers – EV/bear case FCF of 8.2 slightly below T’s EV/FCF of

10.7

– Significantly below VZ’s EV/FCF of 12.7



Markets outside of France



Poland, Spain, Great Britain

• Poland’s EBITDA – CAPEX has been relativelystable to slightly declining at around 600m eurosa year (300m belong to Orange)

–

Some of the CAPEX in Poland is probably for growth• Great Britain earnings have been around 250-

300m euros for Orange a year (50% ownership)

– Stable 33% leading market share

• Spain earned 500m euros last year – Taking share and increasing earnings in a difficult

macro condition



Macroeconomic Conditions in Europe

• Macroeconomic conditions in Europe have

been hurting Orange significantly

• However these forces are cyclical and earnings

will likely rebound in places like Poland, Spain

and even France



Emerging Markets

• Leading market share in countries like CoteD’Ivoire, Slovakia, Romania, Jordan, Egypt,Madagascar, Botswana, Senegal, Morocco,Tunisia, Iraq, Dominican Republic

• Most of these countries have robust growth inthe telecom sector as people have morepurchasing power.

• Orange does not break down earnings for thesecountries

– Earnings probably very low or negative



Analysis

• Orange has over 90 million effective mobile customers(ownership stake * number of customers) in emergingmarkets – In comparison, Orange has only 30 million mobile customers in

France and earns upwards of 2 billion euros in this segment

– Orange has #1 or #2 market share in 16 different markets, manyof which mobile penetration is significantly below 100%

• For a company trading at a multiple significantly below Tand VZ, the number of customers Orange has in developingcountries is an asset that the market has yet to assign a

value• Neither T nor VZ have any developing market customers

• Keep in mind even in the bear case, Orange has a lower multiple thatT and VZ



Valuation and Conclusion



Discounted Cash Flow

2014 2015 2016 2017 2018 Rd 3.7% Revenue 53307.4423 51708.2191 50156.972 49655.4028 49158.8487 Re 12.9% Revenue Growth -3.0% -3.0% -3.0% -1.0% -1.0% Risk Free 3.00%

Equity Risk 9.00% EBIT 6182.1 5935.0 5640.2 5585.3 5560.3 Beta 1.1 Less: Taxes 1041.4 983.6 913.8 926.3 902.6 E/V 48% Plus: D&A 7683.6 7458.5 7278.5 7231.5 7133.7 D/V 52% Less: CAPEX -5899.7 -5710.8 -5666.6 -5679.7 -5699.8 Less: Changes in NWC 31.3 -273.2 233.0 -11.7 -195.3 LTD 40181

Equity 36365 Free Cash Flow 6893.4 6972.2 6105.3 6222.5 6286.8 Discounted 6379 5971 4839 4564 4268 Weighted Debt 1.9%

Weighted Equity 6.1% Terminal Value - Terminal Growth 105906 Cash 7533.31167 WACC 8.1% PV of Terminal Value (Growth) 71895 Debt 40181 Terminal Growth 2% Enterprise Value - Terminal Growth 97917 MV Equity 65270

S/O 2631 Closing Price (as of

10/10) 13.82 Price Per

Share 25 S/O 2631.341917



Price Target

• Excluding Orange, among peers, Deutsche

Telecom has the lowest EV/Adjusted FCF

multiple of 9

• At a 9 EV multiple, the stock has a price of

$24.37

– Upside of 78%

• Still a considerably lower multiple than T and

VZ as well as any of its other European peers

Orange Stock Pitch

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