* The war is not over yet
The environment is likely to remain extremely challenging for French telecom operators, with 4G having been launched without the premium we expected and a broadband price war threatening to break out. Meanwhile, the (low) valuation aberration has disappeared after Bouygues’ great share price performance of 2013. Its risk/reward profile has become more balanced. We downgrade to Hold.
* 4G opportunity missed
4G is now a reality and the opportunity to recreate value via a premium over 3G did not materialise. Iliad’s announcement in early December (despite not having a network) that it would offer 4G without a premium triggered a chain reaction as a result of which all players are now offering 4G at no premium and relying exclusively on higher data utilisation to achieve, in the long run, ARPU increases. We think an historic opportunity has been missed.
* The arena for a new price war: broadband
Bouygues is declaring war on Iliad in broadband. The move makes sense to us, because fixed represents the totality of Iliad’s cash flow generation and this offensive strategy seems the only way to disrupt its strategy in mobile. Although the move is rational and in theory at a limited cost (given Bouygues’ small presence in fixed, every euro lost generates a 4-5x bigger loss at Iliad), this is not good news short-term (there will be an intense war before peace breaks out, we believe).
* Valuation no longer an aberration
Bouygues’ share price had an excellent performance in 2013, deserved in our view by several achievements: halting the EBITDA deterioration, obtaining the refarming of the 1800MHz band, successfully launching 4G and initiating negotiations on a RAN-sharing agreement with SFR. As a result, a key argument that we had when rating the stock as a top pick at the end of 2012 based on a 7x P/E has now disappeared at 14x P/E.
* Risk/reward profile not clear-cut: downgrade to Hold
The conclusion of the arguments above is to downgrade our rating from Buy to Hold. We believe Bouygues knows what it is doing and has the financial means to lead and win this battle against Iliad, but in the short term things are likely to get worse (results under pressure) before they get better (normalisation of French telecom environment). The risk/reward profile is not good enough. We prefer to observe the battle from the sidelines.