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Payback time is approaching for France Telecom and Deutsche Telekom. They have yet to restore the dividends they cancelled during their hard times. And they are fast running out of plausible excuses to present to their shareholders.
Investors in the French and German telecoms incumbents have had a rough ride over the past few years. Not only did the value of their shares collapse after the companies took on too much debt in the telecoms boom; they also lost their dividend income.
What's more, France Telecom and Deutsche Telekom had to tap their shareholders for extra cash to make it through the downturn.
The former needed a e9 billion rights issue and the latter a e2 billion mandatory convertible bond – essentially a deferred issue of shares.
Investors stuck by the two groups for a reason. Even though they paid silly prices to plant flags across the globe, they bought high-quality assets. Investors' bet was that dividends would flow again in the future. However, both companies have been slower to return cash to shareholders than they were to spend it.
No-one would expect them to cough up before they had stabilized their debts. But the German group has now done so. It is expected to end the year with net debt of e39 billion, equivalent to twice its ebitda. That is the bottom of the range that it is targeting for leverage. It has promised to pay an attractive dividend next year but declined to give any details.
France Telecom is admittedly in a less comfortable position.
It might take the group until the end of next year to hit the top of its target band for leverage. But the range – net debt between 1.5 and 2 times ebitda – is
conservative. The French group should be thinking carefully about its plans for next year's cashflow.
There are other reasons why these companies are under pressure to outline their payout plans. One is that the other big European telecoms groups are now paying dividends. Another is that the stock market has started rewarding companies that pay dividends with higher valuations.
A case in point is Swedish-Finnish group TeliaSonera. Its shares jumped 7% last month after it promised to pay out up to half of its net income as dividends. The group also pledged to return an additional $4 billion, or 20% of its market capitalization, to shareholders between 2005 and 2007.
This marks an important change. Until recently, investors were prepared to value telecoms companies on the basis of the cash they were throwing off. Now, tired of waiting to see the cash returned to them, they are adjusting valuations to account for this.
Consider what this means for Deutsche Telekom and France Telecom. Even though their shares are cheap on multiples of cashflow, they may remain so until they promise to hand cash back. This will colour their managements' thinking.
Of course, managements aren't always terribly keen to return cash to shareholders. The two companies were keen spenders in the past. And just because they have new management now does not mean their ambitions are entirely curtailed.
Deutsche Telekom has recently splashed out more than $2 billion on US network capacity, for instance. What's more, neither group has a position in the other's domestic mobile market. Both might leap at a chance if it arose.
Progressive dividend policy
It is against this background that shareholders are discriminating between various sorts of shareholder returns. Progressive dividend policies – payouts that grow over time in line with the business – are favoured.
That's because they mark capital discipline. Cancelling them would send a strongly negative message to investors. Share buy-backs, in contrast, are easier for companies to renege on.
This is not to say that Deutsche Telekom and France Telecom should not consider them. For one, their shares looks reasonably cheap.
Furthermore, buy-backs could address one of the problems currently depressing their shares, overhangs of government stock.
The French government announced at the start of September its intention to sell down its 50% of France Telecom's shares to 41% while the German state effectively owns 43% of Deutsche Telekom. Both states need privatization proceeds to reduce public debt.
So, rather than letting the stock swamp the market, why not let the companies take some off the governments' hands?
The effect could be quite dramatic. Assuming it held its net debt at twice ebitda, Deutsche Telekom could afford to return e22 billion of cash to shareholders, based on its 2005-07 cashflows, on Morgan Stanley estimates. That is equivalent to 36% of the market capitalization at the current share price – or almost all the government's holding. Mopping up a chunk of those shares would let Deutsche Telekom kill two birds with one stone.
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