The great Bezeq dividend bubble alert

The telecoms industry is considered a defensive investment, which means it is largely unaffected by economic slowdown and recession. Yet during this past year, this chestnut seems to have gone moldy, at least as far as telecom companies in Europe are concerned.

One after another the European telecoms have admitted falling earnings, profitability and cash flow as recession bit down in Europe and competition from new, lean telecom operators exploded.

Telecom companies in Europe tend to borrow heavily, using the money to upgrade infrastructures – and pay huge dividends to shareholders.

But during this past year the downturn in their performance and the desire to protect their blue-chip credit ratings have caused most of them to sharply reel in the dividends they pay.

In December 2012, Deutsche Telekom lopped 30% off its dividend payout ,from 0.7 euros to 0.5 euros per share. France Telecom slashed its annual dividend from 1.4 euros to 0.8 euros per share and many fear another cut looms soon because of increasing competition in the French market.

Spain’s Telefonica decided to postpone distribution of dividends for the nonce. Telecom Italia, Portugal Telecom and KPN in the Netherlands have significantly cut their dividend payments. As said, these cuts derived to a large extent from the desire to maintain their high credit ratings.

One of the most important parameters for credit rating agencies is the level of debt relative to EBITDA – short for earnings before interest, taxes, depreciation, and amortization.

The watershed that bothers the rating companies is when debt- EBITDA ratios exceed 2.5. The higher the ratio beyond that line, the greater the chance the company’s rating will go do down.

European companies like Telefonica, KPN and Telecom Italia are currently at debt-EBITDA ratios of about 2.7 to 2.8. Therefore, reducing the dividends on their part was an obvious move – first of all you look out for the creditors, then for the shareholders.

In the context of these developments, it looks as though the Israeli telecom Bezeq is living in a bubble.

Bezeq’s controlling shareholder Shaul Elovitch borrowed heavily to buy the company. Now Bezeq has to service that huge debt. In the coming year it will distribute all its profits as dividends – about a billion shekels of this will come from the company’s own equity, which the court agreed to let the company reduce by that amount.

The aggressive distribution of dividends will continue, even though in 2012 Bezeq arrived at a borderline debt level relative to EBITDA of 2.4.

The rating company Standard & Poor’s Maalot is feeling antsy about this situation and last week it downgraded Bezeq’s rating by one level to AA.

The Maalot analysts, on their decision: “In our opinion, Bezeq’s financial profile continues to be negatively affected by limited flexibility as a result of aggressive dividend policy.”

A ranking of AA is still very good. It indicates that the company’s ability to repay debt is high. However, in light of what is happening to Bezeq’s peers in Europe, it bears keeping a beady eye on this change in direction.