Orange: analysis of Spanish activity in light of a merger (NYSE: ORAN)

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Faced with fierce competition, European integrated telecommunications operators are now increasingly considering the M&A option to reduce operating costs, even as they invest heavily in the deployment of 5G and FTTH networks (fibre to the residence). After covering the French private company Iliad (OTCPK:ILIAY) four days ago to acquire the Italian business of Vodafone (NASDAQ:VOD), I now turn my attention to Spain where France’s Orange (ORAN) is engaged in talks to merge its Spanish subsidiary with its local rival MasMovil (OTCPK: MMBMF)according to SA News.

Given Spain’s significant contribution to Orange’s European commercial sales of 46% of the total, potential merger synergies will improve its Spanish business which suffered from a 4. 4% year-on-year in the third quarter results announced in October 2021. With the drag constituted by Spain (at -54 million euros as shown in the purple chart below), European activity suffered a shortfall of -27 million euros. There had been another similar downturn in second-quarter results when activity in Spain was down 2.7% from 2020.

Orange Q3

Orange presentation (Orange)

The group will publish its financial results for the 2021 financial year on February 17, and with this thesis, my objective is to explore the advantages of the merger for Orange, as well as to examine the obstacles that could delay a deal.

Potential Merger Benefits

For Orange, a merger would mean a rapid change in scale, strengthen its customer portfolio while reducing sales and marketing expenses. This will in turn increase operating margins and free up the cash needed to invest in next-generation mobile telephony as well as fiber optic networks. Currently, the Spanish subsidiary of Orange is the second largest operator in the country, just behind Telefonica (TEF), the incumbent operator.

From a strategic point of view, a consolidation of the telecoms market in Spain would also reduce competition and bring some moderation to the price war for which MasMovil is largely responsible after taking over the low-cost operator Yoigo in 2016 and started slashing prices.

Out loud, the telecommunications environment in Spain somewhat resembles that of Italy. The only difference is that in Italy it was Iliad which played the role of disruptor in terms of discount prices while in Spain it was MasMovil. Fierce competition has had a negative impact on service providers and explains why Orange Spain saw sales fall by 4.4% in the third quarter. As for Telefonica, faced with a high level of debt and wishing to improve its cash flow, it has undertaken major programs aimed at reducing the workforce by around 15%, which is considerable. Also, already occupying the top spot in Spain, an acquisition of a smaller competitor does not appear on the charts.

The incumbent operator also faces MasMovil as the fourth operator in Spain, but which is growing faster. Owned by a consortium made up of Cinven, KKR (KKR) and Providence, it provides broadband, fixed, mobile and TV services. As for the reasons for its success, in addition to its low-cost offerings, MasMovil has also been helped by the economic difficulties that have plagued Spain over the past five years as well as a burgeoning start-up community fostering digital communications.

Scouring the web for an independent source of Spanish mobile market share that also includes 5G, I constructed this table using subscriber numbers from Wikipedia.

Calculated from wikipedia data

Telecom market share – Spain (Wikipedia)

This table only covers mobile network operators (MNOs) and does not include fixed broadband where Telefonica leads with 38% market share, followed by Orange and Vodafone with around 20% each.

Another candidate for merger and regulation

Vodafone is another player that suffers from strong competition and low priced offers. For example, its Spanish subsidiary recorded a year-on-year sales deficit of 1.6% in its last published quarter.


Presentation Vodafone (Vodafone)

Therefore, the British company should also benefit from a merger with Spain’s fourth-largest telecom operator, and to that end it has engaged investment bankers in preliminary merger talks. For Orange, this ultimately means that it will not be quick and easy to expand its activities in Spain. At this point, it is important to point out that there have been previous merger talks between the MasMovil-Vodafone pair and even the Vodafone-Orange pair without any deal materializing.

In addition, any agreement concluded between MasMovil and Orange or Vodafone will have to obtain the approval of the Spanish regulators. To this end, the Spanish Data Protection Agency (AEPD) imposed penalties on Vodafone of 3.94 million euros, Telefónica (900,000 €), Orange (770,000 €) and MasMovil (200,000 €) . This follows a serious breach of the General Data Protection Regulation (GDPR) regarding the confidentiality/integrity of customer data in 2019. Further fines have been issued for abuse of market power and regulators will surely want to ensure that consumer interests are respected. strictly safeguarded.

However, to be realistic, they might now be more merger-friendly due to the huge amount of investment required for the latest generation of wireless technology, with Spain now focusing on digital transformation with the help of the plan. EU coronavirus recovery plan. Moreover, given the innovation lag of the old continent compared to its American and Asian counterparts, the European Union could now encourage the creation of larger players with more R&D capabilities.

Going back to the merger, it can take different forms such as the creation of a new entity with Orange holding 50% of the shares and the rest to be distributed among the owners of MasMovil. But learning from previous merger talks between Vodafone and MasMovil that were called off after reaching an advanced stage, reaching a deal may take time.

Meanwhile, a look at Orange’s price performance over the past seven days reveals that it has outperformed its UK counterpart more than twice with a performance of 2.99%, perhaps suggesting that players of the market believe that the French group is better placed to reach an agreement.

Orange SA vs Vodafone: % price change
Data by YCharts

However, Orange delivered a lackluster performance of 3.2% over the long term (one year) as shown in the table below.

Concluding with the Orange group

This underperformance is partly explained by the fact that the French telecommunications operator informed investors that its EBITDAal (profit before income tax, deductions, depreciation after leases) would not progress or would progress very slightly in 2021. It was October when the third quarter results were announced, but the company still maintained its financial targets, in terms of profits, capital expenditures and debt levels. In this case, sustained digital transformation should maintain demand for fiber broadband and 5G, thereby offsetting the effects of the coronavirus.

When it comes to valuations, with a trailing EV/EBITDA of just 4.68x, Orange is not only undervalued against its peers, but also against the communications services sector by more than 50%. Adjusting accordingly, I have a target price of $18-19 based on the current stock price of $12.3.


Peer Comparison (Seeking Alpha)

Continuing on a positive note, while obtaining an “F” on SA’s growth score, the group on the other hand obtains an “A+” on profitability. With the value strategy which is essential this year and a level of debt comparable to its peers at 133%, I consider that Orange is a reasonable purchase.

To justify my optimism, there are opportunities for monetization through the launch of his tower company (TowerCo) called Totem, comprising more than 26K towers in France and Spain in November 2021. These real estate assets can be leased to MVNOs or to other mobile service providers. . To get a sense of intrinsic value, I consider Vodafone’s Vantage Towers (OTCPK: VTWRF) which consists of 82,000 towers across Europe and boasts a market capitalization of $16.7 billion. Therefore, dividing this amount by three, Orange’s Totem could be valued at approximately $5.6 billion, which is roughly equivalent to one-sixth of Orange’s market capitalization.

On a note of warning this time, inflation hit the 4.8% mark in the Eurozone, driven by high energy prices, but here the group’s continued cost-cutting initiatives, illustrated by a reduction in CapEx of 1.0% in Q3-2021 compared to 2020 should help, unless there is an unexpected increase in FTTH related expenses which involves a lot of excavation work.

Yet, by embracing the longer-term logic, Orange is unlocking value that was previously underutilized from its vast network, and while there is some delay in merging with MasMovil, it looks increasingly likely that ‘Orange and Vodafone will continue to seek solutions to reduce the drag that their respective Spanish operations are causing on their overall finances.

Finally, for Orange, the double-digit growth it is enjoying in Africa and the Middle East should help it absorb the suffering in Spain in the fourth quarter, just as it did in the second quarter of 2021. Elsewhere, French integrator Telco is simplifying the way it offers its cheaper brands to its customers and is implementing voluntary redundancy plans for employees to save on costs.