A few weeks ago I wrote about the Colombian government’s sale of its share in Telefonica’s local subsidiary. My conclusion was that this was more than overdue. Now, to no one’s surprise, there is a press report that the government hopes to sell its shares to its partner.

This article in Portafolio actually does not say this in the body but screams it in the headline “Government offers to sell Colombia Telecom to Telefonica”.

There is a painful process for selling government-owned shares. The early steps are protracted and almost never result in anything but they have to be done correctly. There would even have to be an auction, in my opinion[i], although I found the draft decree on the web and it suggests the shares might be offered on the Colombian Stock Exchanges (BVC).

Not holding an auction was what caused all the problems last time. The government of the day had done a private deal with America Móvil but Colombia’s various overlapping and competing watchdogs had screamed that this was not transparent. Instead the sale had to be opened to a competition. Telefonica entered the bidding, America Móvil bid up to its original offer and dropped out when TEF raised the stakes.

Which, in this case, proved the watchdogs were right: the government got a few million dollars more in return for seriously infuriating Carlos Slim and sending a bad message to investors about doing business in Colombia. They no doubt thought that was a great deal.

But who else is likely to participate? There is not much here strategically for another operator except the opportunity to annoy Telefonica at board meetings and annual general assemblies. Sounds expensive to me just to twist TEF’s tail.

For that matter, is Telefonica going to bite? There would be several strong arguments for saying ‘No’. Firstly, it already controls the company with its 67.5% and so there is no strong strategic reason to take more. Secondly, Telefonica’s board is probably not that pleased with the Colombian government after being forced to shell out hundreds of millions of dollars to pay for assets it already owned. (Don’t ask! See you in court.). Finally, Telefonica has stated that it is an asset seller not a buyer to pay down its debt.

However, a good price might attract TEF – and also might attract a portfolio investor like a pension fund.

So is this a good price? Impossible to tell without evaluating the business plan assumptions used to create it but that does not stop me from having some ‘fun with figures’.

Press reports say that the government expects CoP$2.3T as proceeds from the sale of its 32.5% share at its minimum price of CoP$2,075.31. That implies an equity value of CoP$7.1T. The year-end 2017 report for ColTel puts its debt at CoP$6.5T for a total firm value of CoP$13.6T. Using the same 2017 report, that implies a ratio to assets of 1.05, which does not sound expensive.

According to TEF, OIBITDA for the last four quarters was €849M which, using the company’s assumed exchange rates would be CoP$1.27T implying a ratio to OIBITDA of 10.7 which does sound a bit pricey. Using the reported 2017 results from the same year-end 2017 source, the ratio drops a somewhat less expensive sounding 8.9.

The ratio to 2017 revenues is 2.72 (2.75 on trailing four-quarter revenue) but considering most of these revenues are recurring this does not sound off the wall. The company reports only mobile churn and the latest figure suggest an average customer life of (conveniently) 2.6 years. Fixed clients (which represent 39% of total revenues) are presumably longer-lived (fixed churn is not reported).

Operating Cash Flow (defined by TEF as OIBITDA-Capex) is positive so far in 2018 but negative in 2017 and over the past four quarters, presumably because of the company’s fiber deployment plans. Since the Colombian government has insisted this is merely a portfolio investment, if management has signaled high Capex for the next few years no doubt inspired it to sell its shares.

(This might also turn off a portfolio investor who will want to know when the capital calls – or debt accumulation – will stop and the dividends will start.)

Yes, the price should be set based on future cashflows but we all know that trailing ratios like these are used as a ‘quick check’ especially by Boards of Directors without the patience to plough through the details of a forward-looking business plan riddled with hard-to-assess assumptions.

The challenge for TEF or indeed any potential buyer is that this is the government’s minimum price. If no one is prepared to pay this price, the shares will go unsold. The lawyers and the bureaucrats that hang like vultures over this deal presume that the minimum price is correct for this moment in time. The investment bankers hired to do the valuation are presumed to have perfect knowledge, perfect models. This is the one-and-only truly-correct price. The government cannot decrease it just because no one shows up for the auction. If this process does not work, it will have to wait at least a year or more (politically speaking) until conditions are sufficiently different to justify a new valuation and a new price. If economic conditions are better, the price will be presumed to go up not down.

Since TEF is probably the only potential buyer – at least the only strategic buyer – the big question is what TEF thinks of the price. Presumably Telefonica management presented a multi-year business plan to its Board and the government has the slides, but the investment bank is supposed to come up with its own, independent valuation. There is no guarantee that the bank’s view is the same as Telefonica’s.

The Portafolio article says the government’s price expires on October 3^rd of this year.

To state the obvious, we will know at or before that date.

Maybe the public float will pick up the shares. Normally, retail investors do not pay too much attention to the finer points of valuation.

[i] Colombia Telecomunicaciones SAS Final Results for 2017 includes a note (1j) that refers to a modified shareholders agreement made in September 2017. Sub-numeral (i) describes a ‘put’ i.e. a requirement for Telefonica to buy all or part of the government’s shares if certain, not particularly difficult, conditions should arise. We may be in this situation and so TEF is obligated to purchase the government’s share. No press commentary has referred to this circumstance, the draft decree does not mention it at all and TEF’s 2Q18 results do not refer to it, so maybe we are not. However, a put would make this blog rather boring so let’s continue assuming that Telefonica has free choice and the auction could be competitive.

 

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