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AT&T Inc. (T), Telefonica S.A. (ADR) (TEF): Hunting for Acquisitions in the European Telecom Market

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Recently, there has been much speculation running around the market as AT&T Inc. (NYSE:T) snoops around in Europe. The company’s Chief Executive, Randall Stephenson, has been flying in and out of Europe talking to governments, regulators and CEOs for the past few months in a bid to get a feel for the market and the opportunities that AT&T Inc. (NYSE:T) may or may not have available to it.

AT&T Inc.

However, Europe is not the best place to do business right now. The continent is buckling under pressure from an ongoing recession/depression, forcing consumers to cut expenditure, and regulators are cracking down hard on excess fees and anti-competitive practices.

That said, it is not all bad news. Smartphone penetration in Europe is growing and with it the need for super-fast networks such as LTE and 4G – two areas where AT&T Inc. (NYSE:T) has a wealth of experience. Furthermore, there are still some signs of growth on the continent, for example, the telecom markets in Switzerland, Germany, the Netherlands, Sweden and the UK all remain robust. Additionally, no single telecom company is overweight in one country.

Unfortunately, even though some markets remain robust, increasing competition, regulation and price wars are taking their toll on telecom company revenues throughout the continent. Having said that, companies are not standing idle; indeed, telecom companies throughout Europe are slashing costs and dividends in an attempt to restore investors’ faith in the stocks.

This is not a short-term play, and investors who got in too soon have not been rewarded. Telefonica S.A. (ADR) (NYSE:TEF), one of Europe’s largest telecom companies, has seen its share price fall 52% in the last two years alone, and Deutsche Telekom, with operations in the relatively stable markets of the UK and Germany, has seen its stock price fall 22% in two years.

Do any companies look appealing?

There are opportunities in the market. Carlos Slim, until very recently the richest man in the world, made his first tentative steps into the European telecom market earlier this year when he acquired stakes in KPN in the Netherlands and Telekom Austria. Although both stakes have recently fallen, Slim knows what he is doing, and the longer term outlook is actually positive.

One of the best opportunities, it would appear, is in France through France Telecom SA (ADR) (NYSE:FTE), a company that has been hit hard with a double whammy of bad news recently: first the deteriorating European telecom sector and second bribery allegations against its CEO.

That said, fundamentally France Telecom SA (ADR) (NYSE:FTE) is not as distressed as it would appear. The company currently offers a 10.5% dividend yield that is well covered with cash flow:

Metric Dec 2012
Total cash from operations E10,016
Cash required for investing -E4,710
Cash available for financing E5,306
Dividends paid E3,632
Cover 1.5

Figures in euro millions

France Telecom did post a loss during the second half of last year but this was down to higher SG&A and unusual costs, which totaled E1.6 billion as the company re-structured and cut costs. Apart from this loss, the company appears to be in robust financial health; it has an E8 billion cash position, and a net debt position of E30 billion – a debt to equity level of 1.25. (A lower amount of receivables at the end of 2012 lowered the value of the company’s assets; without this adjustment debt would be 1x equity, a relatively low level for the sector.)

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