TAKEStock: Show Me the Dividends
Better visibility post modified shareholders’ agreement; stock should at least be double its current market value
Telecom Egypt [ETEL]
Egypt / Telecom Services & IT
12MPT EGP22.5 (+89%)
set on 8 Jun 2021
Impact POSITIVE / Degree STRONG
Telecom Egypt [ETEL] is finally getting its money's worth from its 45% stake in Vodafone Egypt. Yesterday, ETEL and Vodafone Group [LSE: VOD] signed a modified shareholders’ agreement that defines their future relationship as the two strategic investors in Egypt's largest and most profitable mobile operator, Vodafone Egypt (VFE), come to terms with regards to key milestones. Overall, we see the impact of this as POSITIVE with a STRONG degree, where we think ETEL should be worth EGP22.5/share (+89% upside). But let’s first lay down the impact on ETEL and VOD.
What's in it for ETEL?
Disbursement of special cash dividends in 2021: Early 2021, VFE’s shareholders agreed to pay out an unusual large dividend of EGP2bn, of which ETEL's share was EGP0.9bn. As a result, ETEL decided to up its proposed DPS at the time by 50% from EGP0.50 to EGP0.75. Now, the same shareholders agreed to distribute a total of EGP10bn in the calendar year 2021, including that EGP2bn already paid out in Q1 2021. This leaves EGP8bn to be paid out through year-end, EGP3.6bn of which will be ETEL's share or EGP2.1/ETEL share. ETEL’s management indicated that this special dividend will be used to deleverage ETEL’s balance sheet which had a total debt of EGP21bn. This would further enhance ETEL’s earnings going forward on lower financing expenses.
Clear dividend policy going forward: Having had no clear dividend policy in the past, VFE now has one, which stipulates a minimum dividend payout ratio of 60% of free cash flow going forward. We believe this is much better than setting the policy as a percentage of accrual–as opposed to cash–earnings. This leaves room for VFE to provide for its capex plans before committing to shareholders’ dividends.
Enhanced minority rights: While maintaining its existing rights in the agreement, ETEL has obtained certain enhanced minority rights, including access to information about its investee, which we think makes sense given ETEL’s sizable stake in VFE. However, it remains to be seen how this could impact the competitiveness of VFE which incidentally competes with ETEL’s WE, the country’s fourth mobile operator.
What's in it for VOD?
Right to transfer shareholding in VFE within group: The modified shareholders’ agreement grants VOD the right to transfer its shareholding in VFE within its broader group of companies. Although not fully disclosed, we believe this would protect VOD from any capital gains tax resulting from such ownership transfers within the group, which makes sense if it is part of a restructuring plan.
Closer relationship with the Egyptian government: The agreement will allow VOD to continue injecting more investments in Egypt’s growing telecom sector. This will help grow the business further and provide innovative technological solutions. Also, VOD will take part with ETEL and the Egyptian government in the implementation of the state’s digitalization and financial inclusion initiatives.
More cash flow visibility: Similar to ETEL, the agreement will provide VOD with a higher level of visibility with regards to its investment in Egypt. Not only will VOD commit to more investment in Egypt, but it will also ensure a consistent flow of dividends from a subsidiary level (VFE) to the parent (VOD).
Impact on ETEL's financial KPIs
We estimated the financial impact post the modified shareholders’ agreement on ETEL’s balance sheet, income statement, and cash flow statement. As for the balance sheet, ETEL’s leverage will be reduced by 6pp from a net debt-to-total capital ratio of 34% to 28%, assuming payment of the remaining EGP8bn in special dividends. Hence, the ETEL’s balance sheet would be de-leveraged with net debt falling from EGP19.8bn to a pro forma net debt of EGP16.2bn. As for the income statement, this would save ETEL some EGP300mn in annual interest expense, which would be accretive to earnings by some EGP235mn or an EPS of EGP0.14 (+4.1% accretion). In view of VFE’s minimum payout ratio of 60% of free cash flow, we believe ETEL’s own dividend paying ability will be enhanced, which would be positive for ETEL’s shareholders. As for the cash flow statement, to gauge the potential impact on ETEL, we estimated VFE's annual free cash flow at EGP3.6bn, implying a minimum annual dividend payment of EGP2.2bn for all VFE’s shareholders, leaving ETEL with almost EGP1bn in cash per annum or EGP0.6/ETEL share.
Current Valuation
Needless to say, ETEL has been and continues to trade at very cheap multiples that are not commensurate with either its recent financial performance or strong growth profile. For instance, based on the closing price of 6 June (before the announcement), ETEL was trading at TTM EV/EBITDA (ex-VFE) and P/E of 3.25x and 3.5x, respectively. Even after the jump on 7 June (+4%), ETEL is still trading at cheap TTM EV/EBITDA (ex-VFE) and P/E of 3.32x and 3.6x. Adjusted for the additional special dividend, ETEL would be trading at even cheaper multiples of TTM EV/EBITDA (ex-VFE) and P/E of 3.0x and 3.5x, respectively. We note that such multiples do not take into account ETEL’s 44.95% stake in VFE which would otherwise suggest TTM EV/EBITDA of 1.6x (1.3x on a pro forma basis).
Our Valuation
We think ETEL’s enterprise value (excluding its 44.95% stake in VFE, which we valued at only 8.0x earnings) should be worth at least 3.0x EBITDA, which implies an enterprise value (ex-VFE) of EGP36bn. Considering pro forma debt and the VFE stake, ETEL would be worth EGP24.3/share (+103% upside). Alternatively, at a mediocre valuation of only 6.0x earnings, ETEL would be worth EGP20.7/share (+74% upside). Averaging both valuation methods, we reach a value of EGP22.5/share (+89% upside).
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Amr Hussein Elalfy, MBA, CFA
Head of Research
T +202 3300 5724