Free Mobile is moving from the first stage of the business cycle (when it achieved its easier goals) into the second stage, where growth is harder to achieve, subscriber momentum falters and investors no longer extrapolate the current run-rate, but gradually adjust their long-term expectations to more sustainable levels.
A credible mobile strategy requires much higher capex
Free Mobile’s 4G initiative has obvious flaws (in terms of coverage and frequency), but it has sparked a negative price reaction. We don’t see value creation in subsidies as subscriber gains aren’t sufficient to offset the lower EBITDA per subscriber. Free Mobile subscriber net adds could slow significantly (0.7m in 2014E vs 2.6m in 2013E), as competitors react, price differentials narrow and churn increases, given its large customer base. To cope with the expected traffic growth and stay competitive, Illiad will have to raise network investment (to EUR350-400m per year) and spectrum costs (EUR0.7-1.2bn) beyond current consensus expectations.
Bouygues unleashed hostilities
Iliad is the most at risk from Bouygues’ new offers, with its high exposure to fixed broadband (80% of EBITDA, 120% of FCF) and lower prices. We see signs of price deflation in fixed too, albeit with less intensity than in mobile, narrowing Iliad’s price discount. The cross-selling opportunity and Freebox halo effect are waning, and we expect a sharp slowdown in subscribers. FTTH levels the playing field, returns are uncertain and subscriber take-up is minimal. Iliad will need to raise capex to remain competitive long-term.
No free lunch
Iliad is probably the last partner for network sharing, takeover or consolidation. It could become marginalised, forcing it to overspend vs peers.
Reduce, TP raised from EUR135 to EUR145
We roll over our model and use lower WACC for mobile (9%) and fixed (8%) based on the recent sector rerating, but our estimates are largely unchanged. We lift our TP from EUR135 to EUR145 and reiterate our Reduce rating given the implied 17% downside. Iliad trades at 8.6x EV/EBITDA 2014E, but the ratio is distorted by its mobile unit. We estimate the implied market value of the fixed broadband unit at 7.8x EV/EBITDA 2014E. We think cable assets ex M&A trade at 8.0x and that cable merits a premium. Orange trades at 4.8x and the telecom sector at 6.0x. We estimate zero FCF generation in 2013E and –EUR60m in 2014E. Even in 2020E, the FCF yield at 7.8% would still be well below the industry average.