value and opportunity

As discussed last week, KPN might become a potentially interesting “special situation” because of its announced massive equity raising.

In any case it makes sense to look a little bit deeper into KPN, even if it would be only a “short-term” special situation invest.

Relative valuation

let’s look at some standard valuation metrics:

Name	P/B	P/E	Dvd Ind Yld	EV/EBITDA T12M	EV/MC
KONINKLIJKE KPN NV	1.88	6.47	3.81	3.80	3.79
DEUTSCHE TELEKOM AG-REG	1.46		8.04	4.28	2.22
BELGACOM SA	2.30	9.45	7.74	4.98	1.26
FRANCE TELECOM SA	0.76	5.63	17.49	3.81	2.60
BT GROUP PLC		9.78	3.26	5.02	1.41
VODAFONE GROUP PLC	1.23		5.67	8.20	1.34
TELIASONERA AB	1.72	9.51	6.56	7.28	1.35
PORTUGAL TELECOM SGPS SA-REG	1.55	17.25	15.71	5.43	3.23
SWISSCOM AG-REG	5.05	11.92	5.49	7.09	1.39
TELECOM ITALIA SPA	0.55		6.39	4.11	3.99
TELE2 AB-B SHS	2.20	13.92	6.91	5.95	1.34
TDC A/S	1.54	8.99	11.23	5.39	1.69
TELENOR ASA	2.53	41.85	4.20	5.65	1.20
TELEFONICA SA	2.19	7.37		5.29	2.41
ILIAD SA	5.04	42.03	0.27	11.09	1.14
TELEKOM AUSTRIA AG	2.53			3.75	2.39

KPN looks relatively cheap based on some metrics, especially P/E and EV/EBITDA. However we can also see that KPN is one of the TelCo companies with the highest debt loads. I used here´EV divided by market cap, but one could also use simple debt/equity ratios.

What is interesting to see is for me that despite the very weak performance of the sector, price/book is still relatively high for most of the companies. I think this is a result of the high dividends being paid by the TelCos which “eroded” book equity.

KPN history

In the case of KPN, things look a little bit different. If we look at this first set of numbers, dividends don’t’ seem to be the problem:

	EPS	DIV	BOOK Value
31.12.2002	-3.94	#N/A N/A	1.83
31.12.2003	1.11	#N/A N/A	2.90
31.12.2004	0.72	0.16	2.69
30.12.2005	0.66	0.40	2.36
29.12.2006	0.79	0.48	2.19
31.12.2007	1.42	0.52	2.51
31.12.2008	0.77	0.56	2.18
31.12.2009	1.33	0.63	2.36
31.12.2010	1.15	0.73	2.23
30.12.2011	1.06	0.81	2.05

If we exclude 2003 (which contained the losses from the 3G licence excesses), KPN paid out only ~45% of its earnings as dividends. So what happened ?

This becomes clearer if we look at the next tabel, which shows free cash flow, net debt per share and outstanding shares:

	FCF p. Share	Net debt per share	Shares outstanding
31.12.2002	1.17	4.99	2,491
31.12.2003	1.08	3.37	2,491
31.12.2004	0.91	2.90	2,410
30.12.2005	1.16	3.82	2,151
29.12.2006	1.31	4.32	2,036
31.12.2007	1.35	5.92	1,843
31.12.2008	1.21	6.32	1,714
31.12.2009	1.23	6.56	1,629
31.12.2010	1.54	7.45	1,573
30.12.2011	1.66	8.46	1,478

So we can easily see that until recently, KPN looked like the classical “anglo saxon style” shareholders dream: Fat free casflows used together with increasing debt to repurchase around 40% of their outstanding shares since 2003.

If you would take Charlie munger by his words, KPN should have been an excellent “Cannibal company”.

Looking at the stock chart, this seemed to help KPN to outperform for instance Deutsche Telekom for a long time, but now finally they both seem to have met at the bottom again:

So one lesson one can learn here is that being a “cannibal” company does not mean automatically that this will be a good investment. Based on a rough calculation, KPN had purchased around 10 bn EUR of its own shares between 2003 and 2011, nevertheless, the market cap of the company remained more or less constant over this period in time.

So looking back, this share repurchase looks rather like a debt financed liquidation than a value enhancing share buy back.

Debt profile

Having so much debt, it makes sense to look at the maturity profile of KPN.

Payments	Principal Only
Year	Amt(Mln)
2013	1,085
2014	1,400
2015	1,000
2016	1,250
2017	1,000
2019	1,046
2020	1,000
2021	1,250
2022	750
2024	700
2026	473

The table shows, that KPN has quite some debt to roll. So far they still have investment grade ratings (Baa2 from Moody’s, BBB- from S&P). Moody’s has them on negative outlook, S&P on stable.

The problem seems to be S&P. Despite having a BBB- rating on long term debt, S&P has them as “A-3” short term, which is the second worst rating available in the short term rating scale. This means effectively that KPN is shut out of short term financial markets as there are only a very small number if institutions permitted to buy such low grade paper. Even Telekom Italia still has an A-2 rating.

Especially the December S&P report clearly outlines some of the most important weaknesses of KPN. An interesting aspect is that one:

That said, the group is facing intense pressures on its domestic mobile revenues in particular, owing to the cannibalization of consumer revenues by IP-based instant messaging applications.

I have read that several times, that mobile carriers made most of their money with SMS. Now however, applications like “What’s App” are eating their lunch because they just use the internet flat fee, effectively eliminating the need to send SMS. As always, the established players were much to slow to react to this threat and I guess that now it is already to late.

KPN seemed to have identified this threat quite early and according to this article tried to increase fees for those services, but this actually resulted in a backlash called “net neutrality”. So The Netherlands and Chile are now the only 2 countries with full “net neutrality” which means the following:

The new law requires companies providing access to the Internet to treat all Internet services equally. They cannot favor their own services, nor charge extra to access a competitor’s service.

I guess this is one of the reasons why they earn higher margins in Germany as number 4 than as market leader in the Netherlands.

Another interesting point here:
If one reads the S&P anaylsis carefully, their major issue seems to be the 1.5 bn spectrum purchase which they think seems to be expensive. The big question here is:

Why does KPN target 4 bn as a capital increase although the rating agency problem seems to be a lot smaller ?

In my opnion, both the amount and the way to raise capital does not make sense. Why don’t they try to to the same as Telefonica and list a minority stake of their German business on the stock exhange ? With an EBITDA of almost 1.3 bn EUR of E-Plus in Germany, a 49% stake could easily raise 2-3 bn EUR on the basis of the Telefonica Dutschland valuation. This would be more than enough to resolve the rating issue and secure roll over of debt.

After being quite shareholder friendly over the last 8 years or so, suddenly, they don’t seem to care any more for shareholders. This is something which really worries me.

One explanation could of course be that they want to annoy or shake off Carlos Slim as large shareholder. In my opnion, this looks like the most likely reason why they behave in such a way. This howver would present exactly the short term opportunity I would be looking for. Management acting irrationally could open up an interesting sitauation, once the capital increase is being executed.

The other explanation would be that management sees a lot mor bad news coming and want to build up a cushion for big future losses. This would be bad.

Summary:

Honestly, I would not want to own KPN as a long term investment, however I will watch the situation carefully especially if they are going through with a deeply discounted issuance price. If the shareprice than will go down close to the discounted issuance price, there migth be a good “special situation” opportunity.