Suppliers are clear winners

The recent joint announcement by OTE and the Romanian Ministry of Communications and Information Technology (MCIT) of an agreement enabling OTE to assume a majority stake in Romtelecom should be viewed with caution, at least until all the details are finalized and become known. It may well turn out to be another disastrous adventure; or it may turn out to be the kind of growth-driver OTE is looking for. In the meantime, it looks as if Romtelecom’s suppliers are the only clear winners of the agreement, since it keeps the Romanian company afloat. OTE and MCIT announced on Friday that the two parties had agreed, subject to approval by the Romanian Cabinet and the Board of OTE, that OTE will assume majority ownership of the share capital of Romtelecom on the condition that it «pays» the equivalent of $243 million to Romtelecom in the form of cash and the conversion of debt into equity in Romtelecom, and moreover acquires a «further limited number of existing shares from MCIT, as representative of the Romanian State.» Although this deal is hard to evaluate at this time given that important details are missing, it can be safely said that this investment adds to the risk profile of OTE. By all accounts, Romtelecom, which is the incumbent fixed-telecoms operator in Romania, has seen its net debt (that is, gross debt minus cash) increase to around $450 million at the end of the first half of 2002 from about $380 million at end-2000. And its EBITDA margin has been compressed to about 23 percent at present from 25 percent at end-2001 and from 31 percent in 1999 although its revenues grew by about 6-8 percent per year during the same time period. The shrinking EBITDA margin can be easily attributed to its cost structure, which is generally regarded as inflexible, as salary costs are rising in line with the depreciation of the Romanian currency. Moreover, the company is highly inefficient, with about 120 lines per employee compared to 360 at OTE and a European average of over 400, according to Morgan Stanley estimates. It is known that the acquisition of a majority stake in Romtelecom by OTE means the Greek operator will have to consolidate the Romanian company into its financial statements. On that particular point, all analysts agree the consolidation will have a negative impact on OTE’s EBITDA margin, which is one of the highest in the European telecoms sector, at least initially. This, along with the recapitalization of Romtelecom, will also increase the group’s net debt and limit its free cash flow (EBITDA minus capital expenditures). With Romtelecom having just about 4.3 million fixed lines in service at present, there is no doubt that OTE will seek to increase that number substantially in the next three years to more than 5 million by 2005. Analysts differ, however, as to what kind of capital expenditures this will require, with some putting the total around $1.8-2.0 billion, while others put it closer to $1 billion. They say that even if OTE manages to boost Romtelecom’s EBITDA and the company’s cumulative cash flow from operations by as much as $700-800 million over the next three years, Romtelecom will still need at least $300 million in external financing and OTE, as a major shareholder, will be partly responsible for this. Things get a lot worse if one includes Cosmorom, Romtelecom’s mobile company which is not doing well, in the calculations. Analysts say Cosmorom may need some $300 to 500 million in external financing to build its network, currently covering about 55 percent of the Romanian population, in the next three years. For quite some time, analysts, fund managers and traders alike considered Hellenic Telecommunications Organization (OTE) to be a defensive stock investment, mainly due to OTE’s strong balance sheet in a sector plagued internationally by debt-laden companies. With OTE’s stock down some 40 percent since the beginning of the year, this argument seems to be losing some of its appeal, as weakness in fixed-line business hurts OTE’s profits and international investments fail to produce a tangible return to OTE’s shareholders. On the other hand, OTE still promises a hefty dividend yield on the order of 6.32 percent based on Friday’s closing price of 11.08 euros, and trades at a discount to most European incumbents on well known metrics such as P/E (price-to-earnings ratio) and EV/EBITDA (Enterprise Value to Earnings Before Interest Taxes Depreciation and Amortization). All in all, then, the acquisition of a majority stake in Romtelecom does not enhance OTE’s defensive characteristics, although it has the potential to be a profitable investment in the long term, provided Romtelecom’s management has the degrees of freedom and the ability to restructure the company and take advantage of the low penetration of fixed telephony in a market double Greece’s size. Therefore the jury is still out there, although its verdict on Romtelecom’s suppliers is clear.

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