Bottom line - As the world's richest man is learning, too much debt will find any company out
The reason we use the phrase “on average” so often on the value perspective is because the future is uncertain and plans do not always run smoothly – even if you are the richest man in the world. In Slim pickings, we highlighted how in May 2012 Carlos Slim had increased his holding in struggling Dutch telecoms group KPN from 4.8% to almost 30%. Since he bought in – at €8 (£6.97) a share – the price has fallen below €3, leaving the Mexican business magnate nursing paper losses of more than €1.7bn.
Obviously this story may still have some way to play out but, as things stand, it looks like even Slim, who initially built up his impressive investment reputation – and fortune – turning around ailing businesses, has been caught out by the fundamentals of the increasingly competitive Dutch telecoms market and the less than healthy state of KPN’s balance sheet, both of which had already caused the shares to fall to his initial €8 entry point.
Unfortunately, in the months that followed Slim upping his stake, KPN’s troubles have only intensified – for example, the auction for fourth-generation (4G) bandwidth that took place in Holland last December spun so far out of control that the bidding companies paid out more money than was spent in the equivalent UK auction, even though the Dutch population is only one-quarter the size.
As if that wasn’t enough, the Dutch government had structured the auction in such a way as to encourage a more competitive market, by reserving spectrum for a new entrant at a lower price. Separately, KPN’s business in Germany is seeing margins squeezed as it is forced to cut prices and increase promotional activity in order to keep its customers. These developments led to KPN cutting its dividend to close to nothing late last year.
Most recently came the announcement that KPN was looking to raise up to €4bn of new capital, three quarters of which will be new equity in the form of a rights issue. Slim is now faced with the prospect of having to inject yet more money into KPN, which he has said he will do in return for certain concessions, such as seats on the board.
However you slice this story, it has probably not yet turned out as Slim had hoped. Talking generally – as far be it from The Value Perspective to second-guess anyone with a near-£50bn fortune – part of the mistake investors in KPN may have made is to take for granted that the profits of a telecoms company are guaranteed to be more stable than those of other companies. KPN’s experience in Holland shows that competitive and regulatory pressures are quite capable of causing pain to Telco’s, despite their ‘defensive’ label.
People often overlook the extent to which, as it were, ‘gravity’ can exert itself on high-earning businesses so that, over time - unless there are very good reasons otherwise - competition, regulation and other forces will drag high margins, returns and earnings back down to more normal levels.
Finally, as is often the case, the fact KPN’s balance sheet was in poor shape meant the company and its investors were much less able to absorb unexpected shocks than might otherwise have been the case.
The events that have hurt KPN may or may not have been predictable but, once they happened, the company was in no position to deal with them. That is not to say it may not be able to recover to some extent but, even after its dilutive rights issue and even if things go well, it is still going to be fairly highly leveraged for some years to come. Bottom line? Debt will find you out.
Fund Manager, Equity Value
I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.
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