Tuesday, October 23, 2012

Canal+ : A Sheep in Wolf's Clothing

It’s now 6h45m a.m and my girlfriend woke me up about 40 minutes ago. She got back home from Turkey yesterday, and I just noticed that she had forgotten to adjust the clock for the 1 hour time difference. I’m not a morning person at all, but will try to make use of the extra time before work by starting a write-up on Canal+, a French media company with a very interesting structure.

Let’s get the complicated part out of the way. There are 3 separate Canal+ entities that must be distinguished before diving deeper into the valuation:
  • Canal+ Group: owned 100% by Vivendi. Canal+ Group has an 80% stake in Canal+ France. It also has other assets such as Canal+ Régie (100%), Itélé (100%), Cyfra+ (75%) and StudioCanal (100%).
  • Canal+ France: owned 80% by Vivendi and 20% by Lagardére. Canal+ France owns 48.5% of Canal+ SA. It also has other assets such as Canal+ Overseas (100%) and Canal+ Distribution (100%).
  • Canal+ SA or Societe d'Edition de Canal Plus (C+ for simplification) is the company that I’m interested in. The company offers 6 exclusive channels: Canal+ channel, Canal+ Cinéma, Canal+ Sport, Canal+ Family, Canal+ Hi-Tech and Canal+ Décalé. More details further down.

Source: Societé d'Edition de Canal Plus 2011 Annual Report

Vivendi and Lagardére, the main shareholders

Vivendi is a French multinational mass media and telecommunication company headquartered in Paris, France. The company has activities in music, television and film, publishing, telecommunications, the Internet, and video games. In 2011 Vivendi posted a profit of € 2.9bn on revenues of € 28.8bn. The market capitalization is currently € 20.8bn.

Lagardére is a French-based multinational conglomerate. The group once covered a broad range of industries but is now largely focused on the media sector, in which it is one of the world’s leading companies. The company also holds a 7.5% stake in EADS (Airbus manufacturer). In 2011 it posted a loss of € 707Mn on revenues of € 7.6bn. Lagardère’s market capitalization is currently € 2.7bn.

Back to C+

In 2000, when the current structure of C+ was set up, there was a law in France that prohibited a single shareholder (in this case Vivendi) from owning more than 49% of a TV channel that had an audience share greater than 2.5%, such as C+.

C+ is basically a shell company that allows Vivendi to overcome this law. C+ is 48.5% owned by Canal+ France (which in turn is split 80/20 between Vivendi and Lagardére), while the remaining 51.5% are float.

The structure of C+ is the following: 
  • C+ operates the Canal+ channels and is responsible for:
    • the management of the company;
    • the programming of Canal+ premium channel (and not the CanalSat channels).
  • Canal+ Distribution (100% owned by Canal+ France) is exclusively responsible for distributing and marketing the premium channel in France and receives a distribution commission in exchange. C+ enjoys guaranteed earnings from Canal+ Distribution.

A bit more color on the agreement between C+ and Canal+ Distribution: In 2000, while retaining the ownership of its subscribers, C+ gave Canal+ Distribution the exclusive commercial exploration rights of its Canal+ channels subscriber base. This enabled Canal+ Distribution the right to directly collect the subscription revenues but also shifted to it the duty of facing the entire operating & distribution expenses and marketing of its channels. In turn, Canal+ Distribution pays C+ 3.3% of the subscription revenues it collects. 

Now comes the good part, the amount to be paid to C+ has a lower and upper bound (which were set back in 2000, when the agreement was made) that grow by 2.5% each year. This feature is what makes C+ interesting, because it brings a stable and predictable top-line to C+. This contract spans for 50 years, ending on 2050, and is renewable for successive periods of 5 years.

Below is a table showing the subscription revenues and the 3.3% commission C+ is entitled to. It also shows the lower and upper limit. Notice that because the level of the 3.3% of subscriptions fell below the lower limit, C+’s pay is now set at the lower limit. 

After receiving the commission from this “lease agreement”, C+ pays taxes and distributes the majority of what is left as a dividend (now @ 5.7% yield). Notice that what is retained has accumulated over the years, and C+ is now sitting in a €138Mn pile of cash (€1.09 per share). This is roughly 23% of C+’s market capitalization.

C+'s shares are tossed around the market like a normal stock, but in my opinion they should be treated as a high quality bond, with the credit risk of Vivendi. I usually don't pay much attention to price charts, but in this case it is interesting to have a look, just to be aware of just how misunderstood the company really is.

The dark blue line is C+, the purple thinner line is the Cac40


As I am treating C+ as a bond, I used a simple DCF to value it:

As the risk here is Vivendi, I used Vivendi's Bonds and CDS to get an idea of what discount rate to use in the DCF. Vivendi's longer maturity Euro denominated bond (2021) has a yield of 2.7% and the 10 year CDS is at 200 bps. The weighted average maturity of the cash flows is 26 years (because of the weight of the final cash distribution in 2050). So by taking the 30yr Swap and adding the 10yr CDS as a proxy, I get at 4.3%. To play it safe I used a 5% discount rate.

The PV is € 935Mn or € 7.39 per share, which is +58% above today’s price of € 4.67. (Sensitivity: a change of 1% in the discount rate will change the price target by -15% / +20%; changing the cash remuneration rate has a negligible impact on the PV)

I think the assumptions above are quite conservative. If I wanted to be more aggressive I could have calculated this as a perpetuity, plug in a 100% payout, and instead of having the cash on the balance sheet back only in 2050, I could just add it up to the PV number (as if it was paid as a dividend now). If this were the case, the PV would be € 2.54bn, or about € 20 per share, yielding an upside of over 3 times. But this is way too aggressive, and I rather stick to my more conservative assumptions.

Value Unlocking Catalyst

As value unlocking catalyst, Lagardére has stated its intention to sell its 20% stake (slide 20) in Canal+ France. Further, the law that prevented Vivendi from owning 100% of C+ changed in 2008: now the minimum audience share is 8% instead of 2.5%. Canal+ has a 3.2% audience share.

Historically Vivendi tends to clean minorities up (UMG, Neuf, Jet, …). It would make sense for Vivendi to make an offer for C+ after buying the 20% stake in Canal+ France from Lagardére. .

Even with C+'s small size relative to Vivendi, the major constrain I see to this catalyst is that Vivendi may not want to acquire C+ just now, so as not to not risk being downgraded, since it is already on a negative watch.

There are also talks about breaking-up Vivendi, separating it in two: media and telecom. Although Vivendi ruled out this idea back in August, this could very well happen in the next 1-2 years. Even with this it would make sense for the resulting media conglomerate to make an offer for C+.

Final Remarks

Although this one seems quite straight forward, it took me quite a while to study. Although C+ publishes the quarterly statements in English, the all important annual report is only available in French, and Google translator isn't that reliable!

I like the bond-like characteristics of C+, the low valuation and the value unlocking catalyst. One other factor I like is the small size of C+ relative to Vivendi, which increases the likelihood of an acquisition.

Disclosure: Long Canal+ SA, and may increase my position in the coming days.

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