Milking A French Cash Cow

In my previous article I wrote about Telefonica’s (TEF) debt load and implications for its dividend. Today I want to look at a company which I believe could be an alternative investment opportunity to Telefonica. Ladies and gentlemen this company is Vivendi (VIVHY.PK).

Why should you be interested in Vivendi? Let’s say that if you are interested in Telefonica you are an income oriented investor. Vivendi currently yields 8.7%, its dividend is well covered and the company plans to increase it next year.

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Do I have your attention now?

Overview

Vivendi is a company with colorful history spanning three centuries. After some time of soul-searching at the beginning of this century it reinvented itself as a media and telecommunication company.

Its core holdings are:

• SFR (French telecommunication company)
• Canal+ Group (premium pay-tv channel)
• Activision/Blizzard (publisher of computer games)
• Maroc Telecom (telecommunication company in Morocco, Gabon, Mauretania, Burkina Faso and Mali)
• GVT (telecommunication company in Brazil)
• Universal Music Group (music content company)

The real gem among Vivendi’s holdings is SFR, which brings in the most revenue and free cash flow. This summer, Vivendi bought 44% of SFR which it didn’t own. As a consequence, the free cash flow will increase by ~440M EUR. This also means there will be a dividend hike in 2012 (already promised by the management). I estimate the next dividend to be between 1.5 to 1.6 EUR/share or equivalent amount in USD per ADR.

Other holdings are doing also very well.

Maroc telecom is sporting an incredible EBITA margin. It will bring nice profit to Vivendi’s coffer despite unrest in the North Africa this summer. Growth in sub-Saharan Africa looks promising.

GVT is a fast growing telecommunication provider in Brasil. This year should be its first FCF-positive year. Vivendi spent large amount of capex in previous years to expand GVT’s coverage in main Brazilian cities. This paid off as GVT is the technological leader in Brazil and its revenue is up 53% in H1.

Activision/Blizzard (ATVI) is going to have a phenomenal year. With the release of new Call of Duty and Diablo 3 games this Christmas, EBITA is expected to grow more than 30%.

Canal+ Group is growing and expanding in countries like Poland, Vietnam or French overseas territories. Vivendi still doesn’t own 20% of Canal+ France but resisted urges to overpay for the shares owned by competing Lagardere group. This is very positive and shows management’s financial discipline.

Universal Music Group has the lowest EBITA margin and is the black sheep of Vivendi family. But it is still a profitable business (albeit not much).

Past performance

All these companies brought Vivendi 28.9B EUR in revenues and 8.6B EUR in cash flow last year. And it wasn’t an exceptional year if you look at past performance.

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Just by looking at this chart you would never know there was any financial crisis in the past few years. Vivendi kept on earning more money like a well-oiled engine. Its gross margin has been around 50%, operating margin around 30% and free cash flow margin has been north of 10% for the last seven years. This cash cow could give you at least 10 cents in cash from every dollar (or euro) it earns.

Dividend analysis

Companies usually don’t pay out all their free cash flow to shareholders. They need to repay their debt, make acquisitions or retain cash for future. I must say that I prefer companies that pay dividends to companies that return cash to shareholders via buybacks. Dividend is real cash in my pocket which I can use for whatever I want. Buyback is supposed to increase share price but shareholders must sell their shares to realize this value. Often, buybacks mask share dilution or are simply ineffective (e.g. Lexmark spent amount equal to their market capitalization on buybacks during last 10 years only to have its share price sink by ~40%).

When I look at Vivendi I see a company that pays out significant amount of its free cash flow as dividend. It grew its dividend by 8% annually for last six years. Payout stagnated from 2009 to 2010 but is expected to rise again by 10% in 2012. Vivendi pays out 55% of its free cash flow which means that it has enough room for future increases. The official dividend policy says that Vivendi has to pay out at least 50% of adjusted net income. Shares yield 8.7% at the moment.

One thing to notice in the previous chart is the significant drop in FCF in 2010. It is not because of extraordinary capex but because Vivendi paid almost 1,2B EUR more in taxes than in 2009. I think this will become a new normal for Vivendi. Despite that dividend is safe and well covered.

Debt profile

Debt will be the cause of Telefonica’s future debt cut. How does Vivendi’s debt profile look like?

Vivendi kept its debt well balanced during last seven years. There is a sudden jump during the first half year of 2011. Total net debt at the end of first half year was 14B EUR. This jump has been caused by acquisition of SFR minority stake from Vodafone (VOD). According to my calculations, total debt/equity ratio should now be around 0.75. The acquisition was an important step forward to consolidation of Vivendi’s holdings and should pay off in future.

Maturity profile after SFR acquisition is:

Maturity	2012	2013	2014	2015	after 2016
Amount [mil. EUR]	1,892	4,267	4,823	1,500	2,446

Will Vivendi be able to handle this debt? The economic average term of debt is 3.8 years. Vivendi had around 1.4B EUR of free cash after paying dividends last year. It should have 440M EUR more next year (thanks SFR!). With enough free cash to make debt payments, debt/equity ratio of 0.75, S&P credit rating of BBB and average debt maturity 2 years shorter than Telefonica (Telefonica has average debt maturity of 6 years) I can easily answer “YES”. Vivendi will be able to roll over and repay its current debt without problems.

Risks

Not to touch any macroeconomic risks, I will mention only those issues I am cautious about.

The first is entry of a new low-cost telecommunication operator into French market - Illiad. Illiad should start to offer its services at the end of this year and could possibly cause margins compression or steal some revenue from SFR. It is almost certain that SFR will bring in less cash after Illiad enters French market. How much less has yet to be seen.

The second issue is Vivendi’s debt. I generally despise debt and prefer companies without it. Vivendi’s current debt is manageable. But there is always a risk that management will launch some ill-conceived acquisition propelled by debt. At the moment, Vivendi is said to be interested in Polish TV network TVN and in music publisher EMI. I don’t like the first and hate the second acquisition. UMG is in the same industry as EMI and has the lowest EBITA margin from all holdings. Wasting more money on business with lowest margin has little sense in my opinion.

Conclusion

Vivendi really is a French cash cow giving its shareholders generous dividends. It is not going to run out of milk thanks to its strong position in western markets and rapidly growing presence in emerging markets. It is a focused company with strong identity and good management. I believe in its successful future and made it the biggest holding in my portfolio. Let’s hope European troubles continue and I can buy more and cheaper Vivendi shares.

If you want to know more about Vivendi, I recommend you to read Lonely Value Investor’s article about Vivendi’s valuation.

Disclosure: I am long TEF, VOD, VIVHY.PK.