A bond camouflaged as stock: Societé D’Edition de Canal+ (ISIN FR0000125460) – Part 1

This is an idea a reader mailed me some time ago and originated in the Value Investor Club. The idea is freely available following this link.

A quick summary of the stock & the case:

Market Cap: 573 mn EUR
P/E 12.4
Div. Yield 5.97%
P/B 1.8

Apart from EV/EBITDA, it doesn’t look exciting, but there are some specialties which you don’t find in “ordinary” stocks:

+ the listed Canal+ stock (“SECP”) is a kind of Special Purpose Vehicle (SPV) for the Vivendi Group however only minority owned

+ it has been set up to comply with certain French regulations on ownership however those rules have been changed and in theory the structure could be dissolved

+ If I understood correctly the company basically collects the fees from subscribers and has an agreement with Canal+/Vivendi in place which requires them to pass this to another Canal+ company owned by Vivendi

+ However they have a minimum (and maximum) profit guaranteed which they retain. This minimum profit increases by 2.5% p.a.

+ the basis of the minimum profit amount is 3.3% of subscriber revenues. In 2011 revenues were 1.653 mn EUR 3.3% would have been 54.5 mn EUR. However based on the minimum amount (which increases by 2.5% p.a.) this was increased to 60 mn EUR

So far so good. The author then goes on the value the cashflow like a bond which in principle is OK:

I believe that this valuation is absurdly low. C+ shares should be properly valued as a high quality investment grade bond, with the notable adjustments that the “coupon” increases by 2.5% annually and to be conservative I will assume that the bond “matures” in 2050 with no principal payment or residual value. The valuation of C+ shares then becomes a simple discounted cash flow model with onlyreal variable being the appropriate discount rate. I believe that C+ shares are very low risk as the contractual payment of €61.7 million is less than 10% of parent company C+ Group’s total operating income in 2011. Additionally, Vivendi generated operating income of over €6 billion in 2011, so the C+ payment is very small to either entity. Vivendi’s 10 year bonds, the company’s longest maturity, have a 4.75% coupon and trade near par.

Although I’m not totally comfortable valuing C+ shares using a 4.75% discount rate (as interest rates are likely to rise), the resulting DCF value of the cash flows, starting with €40.1 million in 2012 and increasing by 2.5% annually through 2050, is €1.02 billion. Adding in the €187 million of net cash and dividing by 126.7 million shares yields a value of €9.50/share. With a 6% discount rate the value falls to €8/share and at 8% it is €6.50/share. I’ll leave it to you to decide what’s appropriate but I’m comfortable with the 6% discount rate and in any event I think it’s clear that the current share price of €4.05 is way too low – using this methodology you’d need a 14.5% discount rate to get there.

However in my opinion, this approach might be a bit too simplistic for the following reasons:

1. It doesn’t make sense for a bond valuation to assume zero final cashflow and then adding net cash to the valuation.

The cash balance is also fluctuating quite substantially over the years. In this specific situation, the shareholders do not have any direct claim to the cash. From what I understood, SECP is for instance buying the football rights for the French football league, which leads to temporarily very low cash balances.

What I would do however is that I would assume that at the end of the contract period the NAV will be still there and the “bond” will be liquidated at NAV or one can sell the stock at “NAV”.

2. Only the “operating” result is guaranteed, “financial” result and taxes are outside this guarantee

If we look at past numbers, we can see that both, financial result and taxes were quite volatile:

2011 2010 2009 2008 2007 2006 2005
Result pre 60 59 57 56 55 53 52
others           0 1
Financial 7 3 5 17 17 13 2
Charges -1 -1 -1 -1      
Taxes -17 -21 -21 -25 -25 -24 -20
Net 49 40 40 47 47 42 35
p.s. 0.39 0.32 0.32 0.37 0.37 0.33 0.28
Dvd 0.27 0.27 0.26 0.25 0.25 0.24 0.23
Payout % 69.8% 85.5% 82.4% 67.4% 67.4% 72.4% 83.3%

So it is in principle OK to use the guaranteed Pretax profit and deduct the average tax rate, but one should be aware that there are other items as well.

3. The table above also shows that the payout ratio is clearly below 100%. On average it was only 75% of the realised result and 90% of the guaranteed result after tax-

The problem with that is that an IRR calculation assumes “compounding” at the same rate as the IRR. In this case, due to the specifics mentioned above, the “compounding” on the withheld amount is only 2.5% p.a. So it is in my opinion to optimistic to assume a 100% payout ratio. I will therefore calculate with the 90% payout ratio and assume a payout at the end of the term in 2050.

4. Discount rate

On the one hand I think it is wrong to use the Vivendi yield, as Vivendi is a highly leveraged conglomerate, whereas here we “sit directly” at a very profitable asset without any additional debt.

However on the other side, we are not talking about a “senior” coupon there. At least to my knowledge, SECP could suddenly decide to stop paying dividends anytime and one might have to wait for a long time to see as cash flow.

So this looks much more like a hybrid bond or even a German participation right than a high grade senior corporate bond.

Within my investment universe, I would compare this maybe to the perpetual “Genußschein” from Bertelsmann (DE0005229942) which trades around 5.7% yield. There is also a RWE perpetual Hybrid which trades around 4.7% yield, howver there is an issuer call option priced in. So I would use those two yields as “ranges” for discounting the bond.

5. “Inflation Kicker”

Finally we have an interesting feature, which I think the author has missed. The guaranteed result the higher of 3.3% of revenues or the minimum level (which increases by 2.5% per year). At the moment, the “revenue trigger” is only at 2.8%, so the guaranteed floor is higher. However if for some reason (and inflation might be one of them…) revenues rise significantly, the guaranteed profit would rise as well.

For 2012 for example, the lower bound is 61.7 mn EUR (pre tax) which increases by 2.5% p.a. The higher bound however is 69.5 mn EUR, a nice 12.6% increae in “coupon” if revenues would increase significantly. Just for comparison reasons, sales would have to increase close to 15% to reach the upper bound this year.

Based on a back of the envelope calculation, I would “value” this “kicker” with a 0.25% “uplift”.

As the post is quite long, I will follow up with the valuation and some more thoughts asap. Sorry for the “Cliffhanger”

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