Why is the stock market so keen on Bezeq?
Its share price has risen 11% in the three weeks since Teddy Sagi came aboard as an investor, even as its core business looks to be under threat.
Three weeks ago, telecoms entrepreneur Shaul Elovitch, the controlling shareholder of Bezeq, did a lightning deal: Through his Internet Gold unit, Elovitch sold some 12% of B Communications, the company through which he owns his 31% stake in Bezeq, to the billionaire Teddy Sagi at NIS 35 a share.
The price Sagi paid in the NIS 125 million transaction represented a 15% premium on B Communications’ market price on the Tel Aviv Stock Exchange and a 5% premium on the company’s net asset value.
In return, Elovitch surrendered (indirectly) a 4% stake in Bezeq. But that still puts him leagues ahead of other telecoms tycoons, like Ilan Ben-Dov, who lost control of Partner Communications, and Nochi Dankner, who is likely to lose Cellcom Israel. Elovitch is still firmly in control of Bezeq, which in turn controls Pelephone.
Moreover, Internet Gold has been enriched and now sits on NIS 292 million in cash, enough to keep the company’s bondholders at bay at least until August 2015.
“Elovitch examined various alternatives and concluded that the deal with Sagi was the least bad alternative right now,” said an investments manager who holds bonds issued by the group and asked to speak on condition of anonymity. “Internet Gold needs it. He’ll bring more cash in the future.”
The Sagi deal lowered the fear factor hovering over Internet Gold, leading to rises of as much as 11% in its Series Bet and Gimmel bonds. Today the Series Bet bonds, which have a little over one more year to maturity, trade at a yield of 8%. The Series Gimmel bonds, with about three and a half years left to maturity, trade at 12%.
Meantime, even as Bezeq’s debt has ballooned to NIS 8 billion, annual earnings of about NIS 1.8 billion are enabling the company to meets its repayment schedule. As a result, Bezeq’s bonds are trading at yields of just 3%.
Moreover, since Sagi indirectly became a shareholder in Bezeq, the company’s share price has risen 11%, bringing its year-to-date return close to a stunning 40%. Bezeq closed yesterday at NIS 5.38 a share. Shares of B Communications have performed nearly as well, gaining 26%, closing the premium that Sagi paid three weeks ago. Today, his paper profits on the deal amount to NIS 12 million, or a return of 10%.
But circumstances didn’t dictate Bezeq’s becoming the hot stock that it is. In the weeks since the Sagi deal, the news has only been bearish for the company, as the landline telephony market is being throw open to increased competition. Landline is still Bezeq’s core business, its key generator of cash flow.
Last week, the consortium building an alternative communications network over the Israel Electric Corporation’s power grid announced it had raised the equity capital required to go ahead with the project. Until then, it was not entirely clear that the investor group, led by Sweden’s ViaEuropa, would be able to pass the hurdle. Now it looks like the first homes may be connected to the high-speed fiber optic network as early as the first quarter of next year.
From Bezeq’s perspective, this is very serious competition, striking at the heart of its business and forcing it to come up with a competitive alternative. Until now, Bezeq has sought to put off such capital spending.
But on top of the threat from the ViaEuropa group, Bezeq also faces another from the Communications Ministry itself. Communications Minister Gilad Erdan has signaled that he wants to produce more competition in the fields of multichannel television and fixed-line Internet by reforming the wholesale communications market. These changes, if they go ahead, will strike at other Bezeq businesses.
Over the past week and a half, Erdan has succeeded in advancing several bills in the Knesset Economic Affairs Committee that will make it easier to force Bezeq to host rival services over its infrastructure. On the other hand, Erdan has said several times that he wants to ease the structural restrictions imposed on Bezeq, which raise it costs and make it harder for the company to compete.
The issue of structural separation was the key item when David Mizrahi, Bezeq’s chief financial officer, conducted a road show for foreign investors several weeks ago. Mizrahi traveled with bankers from UBS to New York and America’s west coast and met with major institutional investors in a campaign to convince them to buy his company’s shares.
Mizrahi estimated that removing the artificial barriers between different units of the company that do business jointly would save Bezeq close to NIS 1 billion annually in management overhead and personnel. Today, the Bezeq group employs some 17,000 people reporting to five different managements and operating under five different brand names.
Market sources believe that Mizrahi’s road show yielded results, and that three or four foreign institutions have been buying shares, causing the price to climb since Sagi acquired his stake in the company through B Communications.
Bezeq’s share price values B Communications’ stake at about NIS 4.6 billion. But against this, B Communications has debt to a consortium of lenders, led by Bank Hapoalim, Migdal Insurance and bondholders, amounting to nearly NIS 3.9 billion. After deducting for the NIS 800 million in cash the company has, its net debt stands at about NIS 3.08 billion.
Dividends for B Communications
This means that B Communications’ net asset value − after subtracting for its control premium and the value of future dividends − amounts to NIS 1.5 billion. That is 30% more than B Communication’s TASE market cap of NIS 1.15 billion, which itself reflects a big run-up since the Sagi deal. Since it has accumulated some NIS 47 million in profits, which are only expected to grow, B Communications is likely to declare a dividend, probably at the end of August, when it publishes its second-quarter financial statements. That, in turn, will boost Internet Gold’s cash holdings.
Since Elovitch bought control of Bezeq three years ago at a price of NIS 8 a share, the company has distributed dividends totaling NIS 10.3 billion. Of this, B Communications received NIS 3.5 billion, or NIS 4.20 a share. On the other hand, since the acquisition was leveraged, B Communications has also run up financing costs of about 60 agorot a share.
What it all adds up to is that the effective price B Communications − that is, Elovitch − paid for Bezeq was NIS 4.40 a share. With the stock trading at close to NIS 5.40, B Communications has earned some 20%, or NIS 844 million, from Bezeq.
These days, B Communications is working on refinancing the Hapoalim-Migdal loan, with the aim of stretching out the repayments for a longer period. Alternatively, the company might opt to issue bonds in London for longer terms.
And what about minority investors? As of the end of last March, Internet Gold’s gross financial debt, which is concentrated mainly in the Series Bet and Gimmel bonds, was NIS 1.03 billion. The Sagi deal has since reduced net financial debt to NIS 738 million. The value of its 68% stake in B Communications, its sole holding, is NIS 785 million. That being the case, Internet Gold’s net asset value − not counting the control premium or anticipated dividends − is now back in positive, but a mere NIS 50 million.
Another way analysts price holding companies like Internet Gold is via a chained NAV. That values Internet Gold’s holding according to its 21% stake in Bezeq, after discounting for its NIS 738 million in net debt and adding in the relative proportion of debt in B Communications, or NIS 2.09 billion.
Using that formula, Internet Gold has an NAV of NIS 250 million, versus a market capitalization of NIS 320 million.