YCG Investments
“If you buy above average businesses at below average prices, on average, we believe you should come out ahead.” — Brian Yacktman

Vivendi: Value in Complexity

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Shares of Vivendi, a large media and telecom conglomerate in France, took a dive recently due to reduced profit expectations at their largest division, a subsequent dividend cut that resulted from this negative future outlook, and renewed concerns about a recession in Europe as sovereign debt issues continue to plague the region. In our experience, complexity, which Vivendi’s byzantine corporate structure provides in spades, plus a rapidly falling stock price, equals a great place to search for value. So, we rolled up our sleeves, attempting to first understand the six core companies that make up the conglomerate: SFR, Maroc Telecom Group, Activision Blizzard, Canal+ Group, Universal Music Group (UMG), and GVT. Here’s what we found:

SFR is the largest division by percentage of operating profit and is wholly owned by Vivendi. It is the second largest telecommunications operator in France with over 21 million subscribers and roughly a third of the mobile phone market. Recently, SFR has been plagued with negative news based on the arrival of new competitor, Iliad, which quickly garnered over 2.2 million customers and penetrated the market using a low-price strategy. This new competition has forced SFR to cut prices and is the main culprit behind the aforementioned reduced profit expectations. Fortunately for Vivendi, our research suggests that concerns regarding Iliad’s power play for market share may have been overdone. Iliad’s pricing strategy, while successful in gaining customers, has squeezed their margins so much that they are probably not earning their cost of capital, making it unlikely that they can sustain their lower prices over the long term. In addition, Iliad has recently had troubles with their service, dropping up to 50% of all calls during peak calling times last April. These issues, coupled with a look at how similar fourth player entrant scenarios have played out in other foreign markets, suggest that Iliad will not materially erode SFR’s market share.

The second largest contributor to operating profit is Maroc Telecom Group. The company is the leading telecommunications operator in Morocco with a virtually 100% market share in fixed line and Internet (ADSL) services and a market-leading nearly 50% share of mobile phone services. As a result, Maroc Telecom currently enjoys massive monopolistic margins. While margins may be negatively impacted as fixed line usage declines in favor of a more competitive mobile broadband market, Maroc’s strong share in mobile and broadband should enable it to keep cash flows relatively stable over time. Vivendi owns 53% of the company.

Next in line is a 60% stake in Activision Blizzard, the American gaming company known for its best-selling PC game, Starcraft. Currently, the company produces the ever-addictive hit PC game World of Warcraft as well as the Call of Duty video game series, which contains the best-selling game of all time. The company continues to release hit games that are not just for the video game enthusiast, but also part of a global phenomenon where large video game competitions are held. One such example is Starcraft in South Korea, where video game matches are televised and watched by millions in the country. Overall, Activision Blizzard is a stable cash cow with a strong, cash-filled balance sheet.

The fourth division is the wholly owned Canal+ Group, which has stakes in various businesses that produce and distribute premium and themed channel content in French-speaking Africa and throughout much of Europe, including the leading pay-TV service in France. In addition, Canal+ Group is looking to build its newly released CanalPlay Infinity into a dominant video streaming service, hopefully heading off any plans by Netflix to enter its market. While we’re unsure about the ultimate success of this endeavor, we view it as free call option and are happy to see that Canal+ Group is actively pursuing ways to protect and monetize its valuable content.

Universal Music Group (UMG), Vivendi’s fifth division and wholly owned, is the largest of the “Big Four” record companies with a leading market share. In the past, there has been much controversy due to widespread Internet piracy where only one in every ten songs downloaded was actually purchased. However, with the growth of legitimate music platforms like iTunes, it seems UMG and other record companies may start to see more growth in digital media downloads. Additionally, UMG has recently announced an agreement to purchase EMI, the fourth largest record company of the “Big Four,” which should help to further rationalize cost structures and pricing in the industry. As further evidence that these companies have brighter futures than their recent past would suggest, even Napster founder Sean Parker has stated that he believes the music companies to be undervalued.

Vivendi’s sixth and last core division is wholly owned Brazilian telecommunications company, GVT. As a new entrant to the Brazilian market, GVT is profitably taking market share at a fast rate. Only 18% of households have pay TV, so GVT has plenty of room to both steal market share and continue to penetrate the market space.

As for the recession concerns in Europe, when looking at Vivendi’s basket of services in Europe, it is good to note that Internet, media, and mobile services are quickly becoming non-discretionary goods in today’s world. In other words, yesterday’s luxuries are becoming today’s necessities. Such a change in the elasticity of the goods should help to insulate revenues during a recession.

Overall, our study of Vivendi uncovered a company whose business lines of telecom, media, and games are all high market share, relatively acyclical services that produce a stream of stable and probably growing cash flows. In addition, our research suggests that the troubled SFR division’s problems are likely temporary. Finally, as is so often the case, we believe that the recent precipitous drop in the stock price could serve as a catalyst to split up the company, which would greatly simplify the story and likely lead to a higher valuation for the stock. Regardless, at the bargain basement price of approximately 6x forward earnings and less than 4x earnings excluding the publicly traded Activision and Maroc Telecom stakes, and with 8% cash and 12% total dividend yields, we’re getting paid handsomely to wait. So, while we certainly agree with the old saying that there’s beauty in simplicity, we hope that Vivendi can help sow the seeds of a new aphorism: there’s profit in complexity.

Disclaimer: The specific securities identified and discussed should not be considered a recommendation to purchase or sell any particular security. Rather, this commentary is presented solely for the purpose of illustrating YCG’s investment approach. These commentaries contain our views and opinions at the time such commentaries were written and are subject to change thereafter. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. These commentaries may include “forward looking statements” which may or may not be accurate in the long-term. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable. Past performance is no guarantee of future results.

Posted by: Mike Yacktman | May 14, 2012 | Permalink

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