Is it Time to Consider a European Telecom Provider?

Is it Time to Consider a European Telecom Provider?

The Verizon buyout of Vodafone Group's minority stake looks a win for both parties. Verizon acquires full ownership of its leading U.S. wireless business and Vodafone gets about $130 billion in cash and stock. But the transaction also suggests that the British company might be expecting better returns elsewhere. Vodafone and other telecom giants have been increasingly looking to Europe. It may benefit individual investors to look there as well.

The European market is inhospitable but active
The European telecom market is not a very friendly place to operate. Increased competition and government regulation hobbles profitability in a fairly saturated market. But as tough as the environment is, Europe still seems a popular area for telecom deal making.

Mexican billionaire Carlos Slim's America Movil recently made a $9.6 billion bid for the 70% of KPN, a Dutch telecom company, that it does not already own. Slim is trying to topple an earlier $11 billion offer from Spanish telecom leader Telefonica for KPN's key asset, Germany's E-Plus. America Movil isn't the only company looking to raise its presence in Europe. Top U.S. wireless operator AT&T has been reported to be looking for an acquisition on the continent and Vodafone recently outbid Liberty Global, a company controlled by American media mogul John Malone, with a nearly $10 billion offer to win Kabel Deutschland, the biggest cable TV operator in Germany.

European telecom companies to watch
Given that these telecom giants find European markets attractive, individual investors may also want to consider investing in the sector. Some prominent firms include:

Telecom Italia Group is a fixed and mobile telecom company with most of its operations in domestic Italy, which generates about 60% of revenues. Brazil and Argentina properties account for the remaining 40%. Though the company operates in a tough environment with a heavy debt load, it also looks amenable to some sort of partnership to help ease its burdens.

Last December, Telecom Italia turned down separate offers of investment and a combination of wireless assets due to valuation differences. Though those discussions fizzled, Italia still looks inclined to make an arrangement. In a move to possibly ease government concerns, the company recently said it is planning to spin-off its fixed-line assets into a new company with some ownership going to a state lender. Fixed- line assets are considered strategic by the Italian government and such a proposal could offer the company more flexibility in dealing their mobile business.

The company should get some interest given its valuation. The stock, using a cash earnings times a capitalization multiplier valuation, seems to be trading at less than a 3.0 times multiple based upon cash earnings of around $6.0 billion and profit margin of 17.2% on sales of $35.0 billion. While it's probably reasonable to give some discount to Italia given the company's weak first half results, where revenues fell a steep 7%, the possibility of a beneficial partnership might make the current cut overly pessimistic.

Orange , formerly France Telecom, is another leading European telecom provider. Over 50% of the company's sales are from the domestic French market with the rest spread out over the rest of Europe, the Middle East and Africa. High regulatory burdens and increased competition in Orange's markets have lead to significant price cuts, lower revenues, and reduced profits. Sales dropped 4.5% in the first half of 2013 and operating income fell a dreadful 11%.

In spite of these headwinds, the company has made some gains. A focus on commercial business helped revive mobile growth in France and Spain with total year-on-year subscribers increasing 3.1%. The company is also expanding its broadband capabilities to lure in lucrative high-data use customers. It has begun rolling out improved 4G LTE mobile networks in many of its major markets and "Fiber to the Home" fixed broadband in both France and Spain.

Though not thought a major deal target nor a significant acquirer, the current market valuation on Orange may generate some attention. Trading at less than a 4.0 times multiple, based on sales of $52.7 billion and cash earnings of around $7.5 billion at a margin of 14.2%, the shares could lift on any signs of business stabilization or additional success in the company's growth initiatives.

Vodafone is another European telecom to watch. The company has some substantial operations outside the U.S. Its Northern & Central European markets account for about 47% of the company's $66 billion in sales. Businesses in Africa, Asia and the Middle East and Southern Europe generate the rest. Vodafone is also looking toward broadband growth to offset its lagging mobile markets, where revenues dropped 3.5% in the latest quarter.

The acquisition of Germany's largest cable TV company is its most noticeable move in building out broadband but Vodafone is also looking at a major investment plan called "Project Spring" to develop high-capacity data service across Europe and the emerging markets. After the Verizon deal closes, Vodafone will be left with roughly $30 billion to invest. This cash horde provides the company a lot of resources and options to improve its network.

Vodafone shares might look most intriguing after the U.S. assets are divested. Given the company's remaining businesses look to deliver revenue of around $66.0 billion and cash earnings of near $9.5 billion at a profit margin of 14.4%, its reasonable to expect the residual "stub" shares could be worth something in the $10 area assuming a slightly optimistic 5 times multiple.

It looks like many large telecom operators see attractive opportunities in the European market. As they seem willing to drop billions of dollars into the region, individual investors might want to consider the area as well. Though the operating environment isn't very friendly, companies like Telecom Italia have been making adaptive moves. Moves that, if successful, could offer noticeable upside for those discounted European telecom shares.

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Bob Chandler has a long position in Telecom Italia (ADR). The Motley Fool recommends Orange (ADR) and Vodafone. The Motley Fool owns shares of Orange (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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