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Don't Buy The Big 3; Look at Quebecor Instead
With the Freedom Mobile acquisition looming, it's a very interesting time for the company
Note: your author is STILL on holidays, because he’s a
lazy bastard retired guy and going on holidays is what retired guys do. Some numbers may be slightly out of date.
I can’t be the only person who ignored Quebecor Inc. (TSX:QBR.A)(TSX:QBR.B) for years thinking it was a second-rate Quebec telecom, right?
There’s a powerful investing axiom I learned a few years ago that seldom steers me wrong. Rather than buy the upstart at a cheaper valuation, why not just buy the leader?
Quebecor fits squarely into that situation. The company competes with BCE (and to a lesser extent Rogers and Telus) in virtually every part of its business. Sure, it holds its own, but if you’re looking for exposure to the telecom sector, just buy BCE. That’s what everyone else does. Why look for half-assed exposure?
Aside: after my Dream Office post a couple weeks ago, people asked why I don’t just buy Dream Unlimited instead, which owns Dream Office shares as well as a bunch of other stuff. It’s just like I said above. Go for the full exposure if you want to bet on something. Lazy investors aren’t going to research the pros and cons of Dream Unlimited versus Dream Office. They’re just going to buy Dream Office.
Then, a few months ago, things changed for Quebecor. The company announced it was going to acquire Freedom Mobile from Shaw, as part of Shaw’s efforts to satisfy regulators as part of being acquired by Rogers. Then, literally minutes before I started typing this, it was announced a last-ditch effort by regulators to send the deal back to the Competition Tribunal failed.
To put it in English, now the only thing standing in the way of the Rogers/Shaw deal going through is a parliamentary committee. And with Shaw shares trading at less than a 1% spread compared to the deal price, the market is viewing the last step as merely a formality.
Quebecor’s pending acquisition of Freedom Mobile looks to be a winner, bought at a bargain price after Shaw was forced to sell. Besides, who else was going to buy those subscribers? Telus and BCE can’t, since it’s likely such a deal wouldn’t be approved. Rogers couldn’t, since selling Freedom was a condition to get the deal approved. That leaves Quebecor, maybe Cogeco, or a completely unrelated third party. Quebecor was in the driver’s seat and acted accordingly.
More on the Freedom deal later. First, a short history of Quebecor and what the company looks like today.
It all started in 1950, when Quebecor’s founder Pierre Peladeau got a tip from his then-girlfriend, telling him a struggling neighborhood weekly paper was up for sale. He borrowed $1,500 from his mother, purchased the paper, and the empire was born.
And, most importantly, he eventually married the girlfriend.
Then, in 1964, Peladeau took advantage of a strike at La Presse to launch Le Journal de Montreal, which burst on the scene for about a week and a half before La Presse solved its labour issues. But Peladeau pressed on and, eventually, his paper started turning a profit. La Presse is now the largest newspaper in Quebec.
The company, officially named Quebecor in 1965, continued to expand in print media, buying papers and magazines across Quebec. It became one of the world’s largest printers, eventually listing that part of the business on the TSX as Quebecor World. These assets eventually went through bankruptcy protection, then were acquired by a Wisconsin-based printer. That printer was eventually acquired by Transcontinental.
After Peladeau’s death in 1999, his son Pierre Karl took over. He immediately set out to transition the company to the 21st century. It acquired Videotron, a leading cable company, back in 2000. The acquisition was largely financed by a big investment from Quebec’s pension giant the Caisse de Depot, an equity stake Quebecor finally bought out in 2018.
The company’s next big foray was its expansion into the wireless business, which started in 2006 but really started to take off after 2010. Quebecers were happy to get their wireless services from the local operator and bundle it with cable, internet, and home phone. These days the wireless division has 1.7M subscribers.
Finally, like BCE and Rogers, Quebecor next diversified into the media business. It took over management of Quebec City’s new arena. It launched TVA Sports, which is the NHL’s official French-language broadcaster in Canada. It bought two Quebec Major Junior hockey franchises. And it acquired Gestev, which produces sporting and cultural events. Quebecor has also been pressuring the NHL for a new franchise in Quebec City, although those efforts haven’t worked out so far.
Today the company is divided into three segments. Telecom is by far the largest, reporting TTM revenue of $3.7B. Media generated about $750M in the same period, with Sports and Entertainment bringing up the rear with $190M in revenue.
As you can see, the Media and Sports divisions aren’t nearly as profitable as telecom. Its pretty obvious where the crown jewels are.
Let’s talk about the wireless division, since that’s the real reason we’re here. Quebecor built its network in Quebec from scratch, investing approximately $1B in spectrum in 2008-10. It focused on Quebec’s major centers, delivered a good service at a decent price, targeted existing wireline customers, and slowly gained customers and market share. Incumbent wireless carriers responded by lowering prices, and this extra competition has translated into lower wireless prices in Quebec.
But then, in 2013-14, Quebecor started buying spectrum in B.C., Alberta, and Ontario, spectrum made available by the federal government to entice a fourth national wireless player to enter the market. Quebecor purchased the spectrum and then almost immediately started telling investors it had no intention of starting a fourth carrier from scratch. That spectrum was ultimately sold to Shaw, after it acquired Wind Mobile, and Rogers, for a tidy profit.
Quebecor did something similar in 2021, paying some $830M to acquire spectrum across Canada. This new spectrum covers most Canadian provinces with an emphasis on Ontario, Alberta, B.C., and, interestingly, Manitoba. It was widely speculated Quebecor bought this spectrum to add to its network should it acquire Freedom Mobile.
The Freedom deal
Next, let’s talk about the Freedom Mobile acquisition, which I think will end up being a slam dunk for Quebecor.
There were other players in the sweepstakes — like Explornet or Global Live, with the latter clogging up my Twitter feed with sponsored tweets about buying Freedom — but they were never real players. Quebecor made the most sense, and once Rogers and Shaw did their token due diligence there was only one buyer remaining.
Back when Shaw first bought Wind and was posting solid subscriber growth numbers, I’d see Shaw suggested as a way for investors to buy a telecom with actual wireless subscriber growth. But one quick look at the financials and there was an obvious flaw. Shaw was cutting price to get market share, and that was reflected in margins. The big three telecoms consistently delivered 40%+ EBITDA margins. Shaw’s EBITDA margins on its wireless side were closer to 20%, although they have improved steadily over the years. Shaw’s recently released 2022 annual report puts adjusted EBITDA at $485M and EBITDA margins at 37.5%.
I think Quebecor can improve these margins over time to more align with the 50%+ EBITDA margins it currently enjoys from its existing telecom business.
The deal itself is straightforward. For $2.85B (which includes assumption of various retail leases), Quebecor acquired all Freedom’s customers, spectrum licenses, network infrastructure, and retail locations. The total cash out the door will be a hair over $2B.
As part of the deal Quebecor also signed a long-term deal with Rogers to provide roaming for Freedom customers, eliminating a huge issue that hampered Freedom’s growth as it struggled to acquire spectrum outside of major Canadian cities.
Here’s why I think Quebecor got a good deal. Firstly, the price was just 7.1x trailing EBITDA, which I think is an extremely attractive valuation. Back in 2015 when Shaw acquired Wind (it was renamed Freedom Mobile in 2017), it paid $1.6B for a company that earned $65M in EBITDA. That’s a 24x EV/EBITDA multiple.
The other reason I like this deal by the time you add up all the spectrum purchases, the retail network, and the amount paid for Wind originally, Shaw invested some $5B into the wireless business. Yes, some of that $5B was likely squandered as Shaw learned the business, but I like the idea of Quebecor buying assets on the cheap.
This deal is also right in Quebecor’s wheelhouse. Not only has the company built up a wireless operator from scratch before, but it went up against local incumbents and won. It can create synergies by whacking a bunch of Freedom employees and transferring those operations back to Quebec.
I also think Quebecor can increase Freedom’s profitability. Backing out the purchase price of $2.05B at 7.1x EBITDA, we get Freedom’s EBITDA at approximately $300M, not the adjusted EBITDA figure of $485M I posted earlier. That translates into a 23% EBITDA margin.
Let’s be a little conservative and assume Quebecor’s wireless business enjoys 45% EBITDA margins and is bringing down the rest of the telecom part of the business. Freedom Mobile did $1.29B in 2022 revenue, growing at high single digits per year. Meaning, I see something like this potentially happening.
There’s two ways this Freedom acquisition can be a big winner. Quebecor can do its magic and increase the profitability of these wireless customers. Or Quebecor offers something compelling and droves of customers leave the incumbents and switch. Either thing happening could very well be the catalyst needed to send Quebecor shares higher.
Quebecor’s valuation is also attractive
I’ve already demonstrated why I like the Freedom deal, even if the market doesn’t particularly like it. Hey, I get it. There’s execution risk there.
Now let’s talk about the legacy business, which is also attractive. At least from a valuation perspective.
Over the last 12 months, Quebecor earned $617M on just over $4.5B in revenue. That works out to $2.54 per share, or about 12x trailing earnings.
To put that into perspective, here are its competitors’ trailing P/E ratios:
Analysts are expecting the bottom line to increase to $2.91 per share in 2023, putting shares at just 10.7x forward earnings. Take analyst expectations with a grain of salt, obviously, but the fact remains Quebecor offers unique mixture of value and growth its competitors can’t, even if analyst estimates for 2023 are a little aggressive.
Quebecor is even cheaper from a price-to-free cash flow perspective as it milks earnings from its legacy wireline businesses. Trailing 12-month free cash flow was $843M. Total market cap of both classes of shares is $7.3B. That gives us a price-to-free cash flow ratio of just 8.6x.
I think Quebecor re-rates at approximately 15x net income when it proves to the market it can successfully integrate Freedom. That gives me a target price of approximately $45 per share in 2024. That’s around 50% upside compared to today. Shares could go potentially higher if Freedom really starts to gain share from competitors, too.
There’s more. The company is buying back what it views as undervalued shares, authorizing the repurchase of 1M class A shares and 6M class B shares in 2023. 2022’s share repurchase plan was pretty much fully utilized as the company eliminated some 6M shares, or a little under 3% of the total float.
Quebecor also pays a $0.30 per share quarterly dividend ($1.20 annually), a payout that has increased substantially over the last few years. Back in 2013, the company paid a mere $0.05 per share annual dividend. It started raising the payout in 2015 and hasn’t missed a year since. It has a payout ratio of just over 40% of next year’s earnings, which is much lower than any of its competitors. I’d guess investors can expect 7-10% dividend raises for the foreseeable future.
There’s a certain amount of risk Quebecor’s legacy assets end up being worth nothing, but I like these assets. Quebecor does bundling better than its competitors. It has various French media assets that its competitors can’t replicate, like Vrai, a French language streaming service. I’d worry more about BCE’s assets in Quebec more than I’d worry about Quebecor’s.
The bottom line
It will take some work by Pierre Karl Peladeau and his team to both successfully integrate Freedom and then prove to the market the company is a legit fourth player in wireless, but I think their chances are relatively good. And if they do drop the ball a little Quebecor’s low valuation should help to soften the blow.
Plus I really like Quebecor’s dividend profile here. Shares currently yield 3.8% with the potential for high single-digit percentage increases for a while, especially if the company can improve Freedom’s EBITDA margins and get it really adding to the bottom line.
Ultimately, Quebecor is a Canadian telecom that has a much cheaper valuation than the big 3, plus better growth potential. It, as a minimum, holds its own in Quebec, which I think is a pretty solid moat. It generates higher EBITDA margins than its peers, too. This is a good business that should get more exposure as it integrates Freedom, which should lead to good things.
Disclosure: author is long Quebecor Inc.