Quicky #18 on Deutsche Telekom (decision)

I own a ‘legacy position’ in DT and thought about selling for some time. I am most certainly biased. Now that DT’s capital markets day is over, I have their new guidance to base my decision on …

This is not investment advice. Please read the disclaimer.
I own shares (economic interest) in mentioned companies.

The situation: I bought share in Deutsche Telekom in Feb 2013 and Feb 2018. I received tax-free dividends that lowered my buy-prices relevant for capital gains taxes due when realized. If I sold my position, I would roughly receive 84% of the current market value.

DT is not known for good returns. Luckily DT did not (or was not) able to sell its TMUS stake and did now merge TMUS with Sprint. DT owns 43% of TMUS and has some ITM call options for SoftBank’s TMUS stake. DT informed us to be willing to increase its stake to a majority stake (>50%) which can happen through TMUS buy-backs and/or buying more shares (i.e. from SBG). Not only returns in the US are much better than in the EU but also the political environment. Consolidation is the EU is still difficult and returns on (high) investments are daunted. DT aims for ROCE above 6.5% in 2024.

  • The telecom sector is infamous for its low returns on capital. After investing huge sums into their networks, several MNOs are in a market competing for profits with slim margin above variable costs. Further, states often hold a stake and in addition have political/regulatory power, demanding high investments.

TMUS is consolidated since SBG agreed to vote in DT’s favour. US telcos usually acquire spectrum without an expiration date, in the EU that is usually not the case. TMUS provides the bulk of DT’s group profits (adj. Ebitda AL, adj. FCF). Adjusted KPIs usually do not include (billions worth of) spectrum payments, which makes sense for sequential comparisons but can significantly overstate (normalized) valuations metrics.

This is another part of my series of Quickies on new companies.

DT’s midterm ambition should act as a good guide for expectations, based on historical achievements vs DT’s ambitions. Based on adj EPS of €1.75 in FY 2024 and a (high) payout ratio of 60% I calculate a DPS of ~€1.05 for FY’24 resulting in a dividend yield of 6% based on todays! share price (€17.50). This is not that exciting but not terribly bad either taking into account the possibility of tax-exemption. A floor of €.60 DPS underlines the defensive character of the investment. Current estimates for adj 2024 EPS are for € 1.63, below €1.75.

extract from DT’s CMD 2021 Group Strategy presentation

Any considerable upside would likely come from TMUS‘ outstanding performance (slides). But at its current valuation of $170bn Mcap + high debt load, TMUS has to deliver a very good performance to justify its current valuation of close to 40x P/E. Admittedly, TMUS demonstrated stellar growth performance over the last years, the integration of Sprint seems to be well ahead of plan, and it has the 5G pole position. As Mike Sievert, CEO of TMUS after the famous Legere, claims, the company will dominate 5G for the next decade. This might be true, but even then, the next generation (6G) will likely require high investments again and the cards are dealt anew…

If one believes in TMUS’ performance going forward, the question becomes why own it through DT? One can probably buy into TMUS (or the non-US stub) with a discount when looking at DT with a SOTP perspective. DT has a market cap of € 83 bn, and consolidated net debt of a staggering € 144 bn. It seems, that only €36.1 bn of debt are issued by Deutsche Telekom AG or guaranteed obligations. This results in a (true?) EV of € 120 bn.

DT’s TMUS stake is worth about €63bn currently, based on TMUS $179bn market cap, DT owns 43% of TMUS and current exchange rate (EURUSD 1.2180). DT’s structured (ITM) call options to buy most of SoftBank Group’s TMUS shares are worth some additional euros. DT’s other €60bn of EV get you all the rest of all the less and more desirable assets.

  • Germany – €9bn of adj. Ebitda
  • Europe – €4bn of adj. Ebitda
  • Group Development – TMNL and Towers could be spun off (at high multiples) for €18.5bn, according to slides
  • T-Systems – might have some (negative?) value
  • HQ/reconciliation – some negative value / multiple for non-allocated costs
  • Debt – € 36bn (parent & guaranteed)
  • Other – pension liabilities?

In general, I have the impression that capital allocation is below average. That DT still holds its TMUS stake is probably more luck than skill, and the threat that value created in the US gets destroyed in Europe is real. Understanding all the segments numbers is not easy, especially with all the adjustments.

I would not want to buy DT here, so an unbiased decision would likely be for selling my little ‘legacy’ DT position and deploy the capital in a better investment, soon.

One of the many biases is the endowment effect with the result that investors tend to keep investments that they would not buy at current prices. Experiments proof that we (most certainly including me) value objects differnetly, depending on the initial situation. If we own sth. (a cup) we are willing to sell at a price most likely considerably higher than we would want to buy it if we not had it. Besides buy and sell, there is also some room for a ‘hold’ decisions, but that is often not the idela decision and if we want to tackle the endowment effect it helps to think exclusively in buy or sell.

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