* Initiating with an Underperform rating and a €16.60 TP, indicating 9% potential downside: We believe Vivendi's current valuation is too high and see potential risks surrounding our forecasts for subscriber recovery at Canal+. We do not believe the market fully reflects risks around recent M&A and limited synergies between Vivendi's new investments and core assets. Our analysis indicates strong growth for Universal Music Group, but we think the market is too optimistic on UMG's valuation.
* Much to prove with Canal+ transformation: We see risks surrounding execution of the new pricing plan for Canal+'s French pay-TV business and believe there is potential downside to our forecasts if the perceived value of Canal+'s offering does not increase, particularly in light of rising competition for subscribers and content from Altice's new TV offering.
* Music is the bright spot but valuation looks demanding: Increasing adoption of paid streaming should drive growth in UMG EBITA over the long term (CSe +10% CAGR 2015-20E). However, the market-implied valuation of UMG is c.15x 2017E EV/EBITDA, too high vs other subscription businesses including professional publishers, content and pay-TV (average 10x) and European and US media valuations (average 10.9x and 10.8x, respectively).
* Risks and catalysts: Risks to our thesis include: i) Faster growth in music revenues; ii) faster transformation at Canal+; iii) potential value-enhancing M&A; and iv) a potential takeover of Canal+ or Vivendi. Catalysts include: i) the launch of Iliad's Italian mobile offering (expected Q4 2017); ii) the upcoming court case vs Mediaset; and iii) potential value-destructive M&A
* Valuation: Vivendi's 5% free cash flow yield and 23x 2017E P/E (excluding associates) look expensive vs European Media (average 6% FCF yield, 18x 2017E P/E). Our TP is based on a sum-of-the-parts including a 15% conglomerate discount to reflect the complexity of the group and uncertainty over its strategy. Our Blue Sky valuation is €21.10; our Grey Sky is €14.60.