Category Archives: Deeply discounted rights issues

Quick update KPN – Sold rights & stock

Today I sold, both the KPN Shares and the rights .

All in all, I got around 2,91 EUR (1.68 for the shares, 1.23 EUR for the rights) which results in a gain of ~ 11.5% before trading cost. Quite a nice outperformance against the AEX with ~ 3.5% in the same time period.

Nevertheless, this was clearly a “bumpy ride” as the chart for the rights shows:

The optimal timing would have been to buy on the second day of the trading period. I guess this was the result of the very short time period between announcement of the terms and the start of trading.

I heard that for instance US investors were completely taken by suprise and couldn’t actively trade the rights.

Main reason for selling was that I was not sure if I want to exercise the rights and I have some other, in my opinion better ideas in the pipeline. Also I am not really optimistic about KPN in the long term.

In general, those “deeply discounted rights issues” are interesting special situations for a short term trade but have to be handled with a lot of care and patience …

Edit:
Someone asked me why I don’t show annualized returns for my single portfolio stocks. In my opinion, annualized returns for single stocks are pretty meaningless. The KPN Trade would have been an annualised 280% but what does such a number say ? As my investment strategy includes a lot of “sleeping” stocks, I think that showing annualized returns on single stock level do not provide any benefit at least not for me. Much more interesting than an annualized return per stock is the potential gap between the current price and intrinsic value.

How to raise capital – Deutsche Bank edition

In a surprise move, yesterday after the close of the stock market, Deutsche Bank announced that the increase their capital by ~2.8 bn.

For this they used the possibility of selling up to 10% of new shares without granting rights to the old shareholders.

So this would be the perfect case for the “formula” I mentioned yesterday:

Equilibrium Price = (price pre-cap raising announcement x # shares + price cap raising x # shares) / total # shares

The closing price of Deutsch Bank was 33.60 EUR. The price for the new shares 32.90 EUR. Outstanding shares were 929 mn, new shares 90 mn.

So the “Equilibrium Price” should have been:

(33.60 * 929 + 32.90 * 90)/ 1019 = 33.53 EUR per share.

Reality check: The stock actually opened around 33.50 but is now up +7.5% at ~35.40 EUR.

Learning experience:

The stock market is full of surprises. For some reason, the capital market considers it as extremely positive that Deutsche Bank increases its share count by 10%. I don’t know why.

And: Don’t rely on formulas…….

KPN rights issue: Final terms

I have covered KPN as a potential “deeply discounted risghts issue” special situation in the past.

Today, KPN announced the final terms for their rights issue (bold marks mine):

2 for 1 rights issue of 2,838,732,182 new ordinary shares at an issue price of EUR 1.06 for each ordinary share
• Issue price represents a 35.1% discount to the theoretical ex-rights price, based on the closing price of KPN’s ordinary shares on NYSE Euronext in Amsterdam at 24 April 2013
AMX has committed to subscribe for the Rights pro rata to its current participation in the issued share capital (excluding treasury shares) of 29.77%
Record Date for Offering is set at 25 April 2013 at 5.40 pm CET
Exercise Period runs from 9.00 am CET on 26 April 2013 until 3.00 pm CET on 14 May 2013• Rump Offering (if any) is expected to take place on 15 May 2013

What I find very remarkable is that there is only a very short time period between announcement of the terms and the start of the trading of the rights. Basically they announced today and trading starts tomorrow.

For the portfolio, I will start with a 1% investment as a rather “short term” special situation based on current prices of around 2.61 EUR per share. Lets wait and see how that one works out.

Severfield-Rowen – Follow up deeply discounted rights issue

A few days ago, I mentioned UK based Severfield Rowen as a potential interesting “deeply discounted rights issue” special situation.

Problem is that I don’t know much about the company. So the problem is always: How do you start looking at a new company ?

That’s when I remembered a very good post of Geoff Gannnon a few days ago:

:
I recently mentioned something in an email that I’m not sure I’ve said before on this blog. I always read the newest and oldest 10-K for a company when I start analyzing it. Reading the oldest 10-K gives you perspective.

I have to confess that normally I would start with the latest report and then work my way back, but the approach of Geoff really makes a lot of intuitive sense to me. So why not try with Severfield-Rowen ?.

The oldest annual report to be found on S-R homepage is the one from 2000.

So let’s compare some key figures from 2000 against 2011:

The difference couldn’t be bigger. In 1999/2000 we have a completely unlevered company with OK margins but very nice ROE/ROCE because of a quite efficient capital/sales ratio.

The 2011 company however looks very different. Sales have doubled, but lower margins, significant goodwill and debt including a growing pension liability reduce ROE/ROCE into low single digits.

So what happened in between ? Well of course, acquisitions:

2005: Acquisition of Atlas Ward, however this looked like rather a small fish at a bargain price

But then the big bummer:

2007: Acquisition of Fisher Engineering for a whopping 90 mn GBP

Fisher Engineering seemed to have been a Northern Ireland based company at least, the seemed to have paid partly in new shares according to this article:

Severfield-Rowen has agreed to buy AML for a total consideration of approximately £90m, of which £36.6m will be satisfied by the issue of 1,750,000 new shares at approximately 2,089 pence each with the balance in cash.

The rational given now f course sounds like a big joke, but at that time Ireland was still “hot” (for another 6 months or so:

The Fisher acquisition will extend Severfield-Rowen’s leading market position in the UK and give Severfield-Rowen a stronger presence in the growing Irish steel fabrication market.

In 2010 finally, they started a JV in India, but more on that later.

SO let’s look at 2006 vs. 2007 :

We can see in 2006 a very very healthy company with lots of net cash on the balance sheet, no goodwill nothing. In 2007, profits still went up but didn’t really compensate for the increased invested capital.

Interestingly, 2008 and 2009 were quire ok, however in 2010 S-R was hit by the “Wile E. Coyote” moment:

I spare myself the details, but i think this table is quite telling:

2007 2008 2009 2010
United Kingdom 289.6 314.6 325.4 260.5
Republic of Ireland and mainland Europe 8.9 79.5 23.2 3.6
Other countries 0.9 2 0.8 2.5

The access to the “Fast growing Irish market” for which they paid 90 mn GBP in 2007 had completely “vaporized” in 2010. I have to confess that this seems to be one of the worst timed acquisitions I have seen in my life.

interestingly enough, the still carry proudly the whole acquisition goodwill on their balance sheet. I wonder how the auditors sign this on a subsidiary without sales ?

The rights issue

Propectuses for rights issues are a very good ssource of information, the one from S-r is no exception.

Especially the following paragraph makes clear, how severe the problems are:

Severfield-Rowen will be in breach of one or more covenants under the Existing Facilities on 18 March 2013, being the date of the General Meeting. A breach of any one of such covenants would be an event of default under the Existing Facilities entitling the Group’s lenders to demand immediate repayment of all outstanding amounts and cancel the facilities. As at 14 February 2013 the Group had net financial indebtedness of £44.0 million. In the event that Shareholders’ do not vote in favour of the Resolution and the Group’s lenders demanded repayment of all outstanding amounts and cancelled the Existing Facilities on 18 March 2013, the Group would have insufficient funds to repay the amounts outstanding. The Group would then immediately need to find alternative sources of funds to replace the funds that would have been made available pursuant to the Rights Issue and the Revised Facilities. The actions that the Group would then seek to take to make up the shortfall in its funding requirements (which the Directors believe would need to be pursued simultaneously and immediately), include seeking to negotiate a new facility agreement with its lenders; seeking to obtain a sufficient amount of alternative funding from other sources; seeking to dispose of some or all of its assets or businesses; and/or seeking to find a purchaser of the entire Group. The Directors are not confident that any of the above actions will be achievable. In the event that the alternative courses of action set out above fail, the Group
ultimately may have to cease trading at that time. As a result, Shareholders could lose their investment in the Company.

So it is pretty clear: A failure to get the rights issue approved will lead to a direct insolvency of the company.

Quick valuation exercise

We have seen that the business of S-R is clearly very cyclical. At the moment, the UK and S-R are clearly at a low part of the cycle. Also, years like 2006 and 2007 will not be repeated any time soon.

Over the full 1999-2012 cycle, S-R has an average net margin of 3.7%. The exactly same average is the result of the “Normal” years, taking out 2007-2009 and 2012.

So if S-R gets back to ~300 mn GBP sales, that could result in 11.1 mn GBP normalized earnings. After the capital increase,S-R will have 290 mn shares outstanding. This results ~ 3.7 cents normalized earnings per share or a “fair value per share” after the capital increase of around 37 pence.

In order to make this interesting, the price should be definitely cheaper than that, so I would only buy below 25 pence or so.

Stock price

The rights have been split of on Tue, March 19th. The stocks are trading now around 0,37 GBP

Summary:

Looking at Severfiled-Rowen in 1999 and 2011 is like looking at two different companies. Especially the misguided acquisition in 2007 lead the company in deep trouble. However, despite the very significant decrease in the share price, S-R is still not a real bargain due to the massive dilution of the rights issue.

Only if one believes in a short term recovery of the UK economy, S-R would be a “buy” right now. So for the time being “no action”.

Deeply disounted rights issue watchlist: Severfield-Rowen Plc (ISIN GB00B27YGJ97)

UK based Severfield-Rowen is according to Bloomberg

Severfield-Rowen plc is an engineering and construction company. The Company designs, fabricates and erects structural steelwork, specialist claddings, and ancillary products. The Company also manufactures and markets a range of equipment for the meat and poultry processing industry through the subsidiary Manabo Limited. Severfield-Rowen operates primarily in the United Kingdom.

S-R came out in November with a profit warning, estimating Pre Tax profits of ~ 1mn GPB

By James Amott
Nov. 5 (Bloomberg) — Pricing pressure, protracted contractual settlements posing significant challenges, co. says in statement.
• Performances of U.K. businesses mixed
• FY pretax profit likely to be ~GBP1m
• Co. confident revamp will improve performance

Then, a little bit like in the Imtech case, the news got worse in January:

By Nadine Skoczylas
Jan. 23 (Bloomberg) — Severfield-Rowen says U.K. performance, further, “and materially,” hurt by cost overruns on 122 Leadenhall contract.
• Board intends to review current contract base, will provide update to mkt as soon as possible
• “In light of these recent developments,” board concluded that change of leadership needed to “re-establish confidence” with stakeholders
• CEO Tom Haughey standing down, leaving board with immediate effect
• Chairman John Dodds will assume role of CEO until new chief found; board “actively engaged” in search

Of course, after the CEO departure some more issues were identified and again, similar to Imtech, a capital raising was more or less dictated by the banks.

Last week then, Severfield came out with the preliminary 2012 numbers (Loss of 18.2 mn GBP) and the details of a deeply discounted rights issue.

At a current market cap of 70 mn GBPs, Severfield wants to raise ~50 mn GBP. In order to guarantee success (and to please the underwriting banks), they will issue new shares under the following conditions:

– 7 new shares for 3 old ones
– issue price 0.23 GBP (against 0.79 current price), so a discount of almost 70% !!
– the “ex date” for the subscription rights is March 19th, trading of the subscription rights will happen from March 19th to April 4th

The value of one subscription right should be at current prices:

(0.79-0.23)/((3/7)+1)=0.39 per share/subscription right.

Clearly, shareholders are not big fans of large capital increases.

The shareholders are the “who is who” of UK fund managers, the biggest are:

Prudential 13.4%
M&G 12.7%
Jo Hambro 11.3%
Aviva 10.1%
Threadneedle 6.7%

Interestingly, US Small Cap value firm Royce had built up a 3.9% stake end of last year, I guess they are not that happy now.

The stock price has been punished quite severely over the last months:

One can also see the different stages of hope and despair, especially in the last few weeks. I haven’t looked too closely at the company yet, but in my Boss model, the stock doesn’t look that bad. Interestingly, if one looks at the balance sheet, one might think that debt should not be such a problem, although they do have pension liabilities as well.

So for the time being no action, but an interesting candidate for my “deeply discounted rights issue” research.

Royal Imtech update: Higher loss & Rights issue

After last qeek’s first look at Royal Imtech, Imtech came out today with a press release:

The highlights were as follows:

Rights issue will be completely used for debt reduction
Measures to make financial structure more robust
Write-off of 150 million euro for Polish projects
Write-off of 150 million euro for German projects

So this means that the write offs are a lot higher than initially communciated. Back then, they only said “100 mn EUR in Poland”, now we are at 300 mn EUR in Poland and Germany.

In parallel they also reported a change in the CEO positon:

Gouda, the Netherlands – The Supervisory Board of Royal Imtech N.V. (IM-AE, technical services provision within and outside Europe) confirms that in good consultation and in line with the original plan, René van der Bruggen (65) has decided to retire as of 3 April 2013. He will remain a member of the Board of Management until 3 April. He will hand over as Chairman with immediate effect. Gerard van de Aast (55), who is already a member of the Board of Management, is as of now appointed CEO of Royal Imtech and Chairman of the Board of Management

So this could be an interesiting situation. The new CEO will most likely go for a “kitchen sink” approach and write off as much as possible in order to have some “cushion” in the future.

Another aspect is what they say in the first press release:

Royal Imtech N.V. (IM-AE, technical services provider in and outside Europe) announces that the company will strengthen its equity through a rights issue of 500 million euro. The proceeds of the rights issue will be completely used for debt reduction. As a result of this the balance sheet of Imtech will be reinforced

This looks like that the banks have Imtech “by the balls” and could push through the rights issue in their interest. So it is not really a surprise that the share price of Imtech dropped to a new low:

Again, as in the KPN case I would wait until the details of the rights issue are known. With a current market cap of 800 mn EUR, a 500 mn EUR rights issue will require a significant discount.

Quick KPN update

Today, KPN came out with an interesting press release regarding the capital raising activities.

In my opnion, there were 2 surprises:

Size

The capital raise to be supported by AMX will consist of a EUR 3bn rights issue and, in addition, issuance of hybrid capital instruments which are expected to receive partial equity recognition. Through this combination KPN intends to achieve the targeted EUR 4bn equity equivalent capital. The proceeds of the capital raise will be used to reduce KPN’s net debt level and to continue to invest in KPN’s operations.

In another comment I read that they are planning to issue 2 bn EUR Hybrid, bringing the total volume to 5 bn EUR. I was not sure why they were going for 4 bn before, now I am even less sure why the want to raise 5 bn. I have the feeling that I might be missing something here. The Hybrid will be much more expensive than a senior debt even at junk level.

The second surprise is the following:

AMX has committed, subject to certain conditions, to participate in the rights issue and subscribe for newly issued ordinary shares in KPN pro rata to its current participation in the total share capital of KPN. Subject to market conditions, KPN intends to issue the hybrid capital instruments during the course of 2013.

So Carlos Slim has committed to pay his share, but under some conditions. The conditions contain, among others

– 2 supervisory board seats for Carlos Slim
– a “stand still”, Slim promised not to increase his share above 30%

The second point however is then basically taken away with this point

In case of an announcement of an offer for any outstanding share capital of KPN or an offer for a material subsidiary of KPN the standstill may immediately be terminated by AMX;

So I am not sure why they negotiate a “stand still” with Slim which can be broken any second by him.

Finally the timing has shifted back into April as the extraordinary shareholder meeting has been cancelled:

The Annual General Meeting (“AGM”) has been scheduled to take place on 10 April 2013, for which a notification will follow. The matters which had been scheduled for the Extraordinary General Meeting (“EGM”) on 19 March 2013 will be included in the agenda of the AGM; the EGM scheduled for 19 March 2013 is hereby cancelled.

The market seems to have hoped that Carlos Slim would block the capital increase. This is the only explanation why the stock price fell almost 10% on this release:

Interestingly, 2 large hedgefunds (Marshall Wace, GLG) disclosed -0.6% short positions in the last few days.

So summing up:

– I even understand less why they want to raise 5 bn expensive capital
– Carlos SLim is not going away

I will stick to my initial plan and wait until the details of the rights issue are released. In between I will lean back and watch the show….

Imploding Dutch stock of the week: Royal Imtech (ISIN NL0006055329)

After KPN and TNT Express, we highly welcome another Dutch company with an imploding stock price, Royal Imtech.

The company:

Royal Imtech seems to be active mostly in everything which on can install into buildings, such as heating, securities, electrical equipments etc. although the company profile on its website sounds like a perfect score at “bullshit bingo”:

Imtech offers added value with integrated and multidisciplinary total solutions that lead to better business processes and more efficiency for customers and the customers they, in their turn, serve. Imtech also offers solutions that contribute towards a sustainable society – for example, in the areas of energy, the environment, water and traffic.

Nevertheless, until recently (November 2011) Imtech was highly coveted by analysts as “clean tech” super star , with a 100% buy rating and price targets of 30 EUR per share and more.

The problem

In beginning of February, Imtech came out with a “bombshell” press release.

Not only did they have to postpone their earnings release, but they also indicated that they have a loss of min. 100 mn EUR in their fast growing Polish business. The press release contains this “gem” of potential accounting fraud:

The Board of Management has also determined that a promissory note and pledged accounts related to the Adventure World Warsaw project – amounting to around 200 million euro – that had been recognised in the half-yearly 2012 financial statements under cash and cash equivalents must, according to IFRS, be reclassified under current financial assets. Most of this amount was recognised as an advance payment under work in progress for the four projects concerned. This advance payment was considerably higher than the incurred costs. As stated above, the advance payments have not become available to Imtech. The effect of this is incorporated in the expected write-off of at least 100 million euro

This potential fraud leads to another problem: As net cash is part of their loan covenants, the company already indicates that all of a sudden, they are now in breach with their loan covenants:

The consequence of the expected write-off will be that, when its 2012 financial statements are drawn-up, Imtech will no longer fulfil its covenants with lenders – average ratios of 3.0 maximum for net debt/EBITDA and 4.0 minimum for interest coverage. As a result Imtech will begin consultations with its lenders. Imtech has retained Rabobank as its financial advisor for these consultations.

The share price fell of course like a stone following this announcements:

One interesting aspect about Imtech is the fact that some rumours about aggressive accounting were circulating already late last year. Of course management denied all allegations at that time.

Interestingly, Imtech had already a quite high short interest at that time, almost 10% of the market cap was short at the end of the year. Thanks to the new regulations about short disclosure one could see that the “smart money” like Dan Loeb’s Third Point is short the share.

Why bother at all ?

One of the reasons I looked at Imtech is that based on many metrics, Imtech looked like a great stock and even more now at the current price levels. I am sure, Imtech will show up now on many “value screens”. Even in my BOSS model, Imtech looks quite compelling.

If we look at some measures, Imtech really looks like a great company:

EPS DIV ROE ROIC
31.12.2002 0.61 0.42 17.4% 21.9%
31.12.2003 0.57 0.36 14.5% 41.7%
31.12.2004 0.58 0.36 12.5% 17.1%
30.12.2005 0.69 0.36 18.4% 18.6%
29.12.2006 0.86 0.36 21.9% 19.5%
31.12.2007 1.17 0.36 26.4% 21.4%
31.12.2008 1.46 0.47 29.7% 18.3%
31.12.2009 1.62 0.59 28.2% 16.3%
31.12.2010 1.70 0.64 21.4% #WERT!
30.12.2011 1.72 0.65 17.3% 11.4%

One can see growing earnings, growing dividends, nice free cashflow and double digit ROIC and ROEs. So what is not to like ?

The big question

So the question is: Is Imtech a great company which has just facing a bump on its road to further success or is there a real problem with the company ?

There are some examples of great companies with similar problems, for instance Hugo Boss AG, the German luxury Group. In 2002, they detected fraud in their US subsidiary (“channel stuffing”) and had to restate their 2001 balance sheet significantly. I just found this research note from Commerzbank in 2002 where they downgraded the stock from 16 to 9 EUR per share. Looking back, this would have been the perfect entry point for Hugo Boss. The stock since then performed ~30 p.a. until now (a 15-bagger so to say) against 7.7% of the CDAX.

However with Imtech, I have some doubts due to the following reasons:

Acquisitions:
Imtech more or less looks like a typical “roll up”. On the “acquisitions” page of their homepage one can see that they have done like 10–15 acquisitions per year. With roll ups, it is very difficult to asses the reported numbers of such a company because of the large leeway available for accounting for acquisition. Even cash flows can be “massaged” quite significantly as we have seen many times before.
As a result, Imtech carries significant goodwill. This in itself is not necessarily a problem, but together with significant accounting problems, this might become a problem quite soon.

Type of fraud
As mentioned above, this fraud was not “only” about faking sales but also about faking on-balance sheet cash. As we know now, Imtech has quite tight credit covenants. So in my opinion this implies that the fraud has some connection to the whole group and is not only a result of some renegade employees in a subsidiary. Imtech seemed to have general problems with cash and fulfilling its covenants before.

Summary:

In theory, Imtech could be a great company which had bad luck with management in a subsidiary. This would be a good entry point to buy a great business at rock bottom prices.

However, at least in my opinion, the history of the company as a “roll up” as well as the type of fraud makes me cautious. So for the time being this will be just sit back and watch what is going to happen (and trying to learn more…).

Maybe if they really go the way of a big rights issue as indicated in this Bloomberg story might be an interesting entry point, but only if the issues regarding the fraud have been clarified in the meantime and the business is viable. Otherwise, the good parts of the business will most likely go to the creditors and the shareholders might get nothing (but the blues).

A few more thoughts on KPN (potential deeply discounted rights issue)

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.

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