Not Russian Into a Sale

With France Telecom SA's finances so much in the news recently, less attention has been paid to Deutsche Telekom AG's (NYSE: DT) rather enormous debt. Unfortunately for DT's management, that doesn't mean the €64 billion hole in its balance sheet has gone away.

The German telco holds a number of stakes in Central and Eastern European (CEE) operations, the sale of which, if added together, could raise billions of euros. If it needs to raise cash from selling assets, could it sell these CEE assets instead of the much rumored sale of T-Mobile USA (but better known as VoiceStream)?

Although its debt is massive, DT's financial state is not quite in France Telecom's league. The German incumbent has around €20.9 billion in credit and liquid assets to cover the €8.5 billion in debt repayments that will fall due this year and next. However, it does have to work down the €64.2 debt bulge it had at the end of June this year to around €50 billion (around 3 times EBITDA) by the end of 2003.

Telekom said in its second-quarter results that it had arrangements in place to slim itself into the €53-€56 billion debt bracket, but that still leaves a very unsightly bit of a few billion euros.

While the rumor mill has been running hot for a while over the VoiceStream stake, another mentioned candidate for divestment has been Telekom's stake in increasingly successful Russian mobile operator Mobile TeleSystems OJSC (MTS) (NYSE: MBT).

People close to the issue have dismissed the idea of selling MTS, a company that analysts unanimously describe as a "gem." They also point out that selling assets such as MTS would not really help DT, because it would be getting a one-off lump sum and sacrificing its long-term cash flow. Better to get rid of cash-gobbling turkeys, rather than part with a golden gosling.

DT has by far the biggest overall mobile footprint in central and eastern Europe. Its mobile businesses there include:
  • a 51 percent holding in Hrvatske Telekom, of Croatia (just over 1 million subs and around 53 percent of its market);
  • 100 percent of max.mobil, in Austria (around 2 million subs, the second largest player);
  • 40.1 percent of MTS, in Russia, (over 5 million subs, market leader);
  • Radiomobil in the Czech Republic (around 3.15 million subs);
  • 59.9 percent of Matáv Group, which wholly owns mobile operator Westell Technologies Inc., based in Hungary (around 3 million subs and just over 50 percent of the market);
  • 45 percent of Polska Telefonia Cyfrowa Sp. z.o.o. (PTC) in Poland (4.24 million subs, around 36 percent of the market).

Analysts at Nomura Holdings Inc. estimate that, given current market caps, DT could, in theory, command €5 billion to €6 billion for its East European assets, including the fixed line businesses. However, they also point out that in reality it probably wouldn't quite get that. Others have noted that some of the assets could need restructuring, which would depress the prices, and there is also the minor detail of finding a buyer in the current market.

Nomura analyst Chris Alliott tells Unstrung, "There may be some venture capital groups that might consider a leveraged buyout , but I don't really think there are that many strategic buyers. Witness the difficulty encountered getting the Cesky Telecom a.s. privatization done. Perhaps the one possibility could be Swisscom AG [NYSE: SCM]."

There is also the question of whether it would make sense to sell, even if DT could get the "full" price for its CEE activities. Bob Creamer, an equity analyst with Raiffeisen Bank Polska S.A. in Warsaw, believes that the Eastern European assets are "one of the more logical strategies for DT," pointing out that they provide DT with "cash flow, which in turn gives them borrowing ability." At the end of the day, in Creamer's view, they would "only sell [these assets] in a bankruptcy situation."

However, if DT were, for whatever reason, to start to sell the shiniest CEE silver, starting with every analyst's darling, MTS, it could probably demand the current market price, plus or minus 10 percent, which would equal about $400 million for a 15 percent stake, according to Tom Adshead, a telecom analyst at investment house Troika Dialog in Moscow. Adshead adds that MTS is "doing really well… It is starting to really clean up in the regions." It had a tidy little net income of US$66.8 million in the second quarter of 2002, on revenues of $316.3 million. That was generated by 4.3 million subs, and MTS now reports over 5 million subscribers. Despite its growth, its monthly average revenue per user (ARPU) rose slightly from the first to the second quarter, to $31.

Though it is a very good business, the most likely buyer for MTS, in Adshead's view, is Sistema (failed to find Website), a Moscow-based conglomerate that already holds just under 60 percent. Adshead said he hadn't seen anything about preemptive rights in the MTS prospectus, though he adds there might well be some kind of gentlemen's agreement between DT and Sistema that excludes other bidders. Adshead suspects that life would be easier for MTS, which is listed in New York, if DT retains a controlling stake -- because the Securities and Exchange Commission (SEC) has, historically, been jumpier about potential corporate governance irregularities when it comes to purely Russian companies.

Of course, $400 million would not make much of a dent in DT's shortfall, and selling assets drip by drip in a region where there are not many buyers could be a long, painful haul. The most likely scenario, then, remains the U.S. sale scenario, most likely to Cingular Wireless. In the view of analysts at Bear Stearns & Co. Inc. in London "the possible sale of… VoiceStream is likely to be high on the list of… debt reduction scenarios."

— Ouida Taaffe, special to Unstrung
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