French telcos: a gap too large to bridge
• No Orange/BTel deal - M&A likely off the table for now. Obligation to cohabit could reduce promos
• Social and execution risk angles known, valuation /state position likely hurdles. Next trigger: Bouygues fails to restructure
• Recent gains likely to vanish, Orange to be less hit due to weaker stock perf, lack of dilutive deal and solid fundamentals
* Orange / Bouygues Tel talks collapse opens new era
Despite opportunities, we believe France is set to remain on the side lines of the consolidation wave hitting most of Europe. The current market equilibrium will likely remain precarious with Orange regaining momentum but not properly monetizing high speeds, Bouygues and Iliad so far not generating much FCF, and NUM-SFR underperforming operationally. Some of the “tactical” promotions may not be renewed as all four operators need to improve their economics on the current market structure, but this is by no means guaranteed, and in our view will determine to a degree the outlook for French telco stocks in the remainder of 2016. We expect broad based price pressure on Monday with Orange somewhat less impacted. Going forward we continue to like Buy rated Orange and Iliad vs Neutral-rated NUM and Bouygues.
* Reasons for failure: State + valuation likely main hurdle
Despite some concerns in the market, Orange has not compromised, and in our view has walked away from a deal that would not have created sufficient shareholder value. Bouygues claims some of its core criteria could not be met and cited 1) employee protection, 2) the level of Bouygues’ stake in Orange and related governance, 3) execution
risk, and 4) B-Tel’s valuation. We believe issue (1) was manageable by Orange, while (3) was known by Bouygues to a degree before engaging with Orange. This leaves the stake, governance and price as the main hurdles, in addition to execution risk linked to clauses imposed by some parties. The press (Les Echos) relayed Economy's minister Macron's efforts to limit Bouygues' influence on Orange by increasing Orange's valuation in the deal (up to €19), preventing Bouygues from increasing its stake for seven years and cancelling Bouygues’ double voting rights for ten years, even if sold to a third party.
* Stock implications: back the solid fundamental stories
We expect heavy turbulence on Monday with all four French telco stocks having outperformed the sector significantly since early December when news of talks first came out. Post the end of week adjustments, NUM had outperformed the sector by 23.7%, Iliad 17.5%, Bouygues 13.5% and Orange 9.6%. We believe positioning in the deal will play a key role, and would expect the stocks to give up most of this outperformance in the absence of significant change in fundamentals. Orange should be somewhat more immune, with the company avoiding a potentially value dilutive deal, and valuation providing solid support at current levels.