Case | HBS Case Collection | November 2004 (Revised July 2005)
Messier's Reign at Vivendi Universal
by Rakesh Khurana, Vincent Dessain and Daniela Beyersdorfer
Focuses on a crisis in the board at Vivendi. Highlights the difficulties that arise when dramatic pressure from outside the boardroom affects boardroom dynamics. In this case, there are two events. The first is an unexpectedly large financial loss and a pending cash flow crisis that forces Vivendi's directors to deal with the issue of dismissing their CEO. Whatever they decide, their actions will be scrutinized by the press and investors and will likely be revisited in a legal environment. The second is the board diagnosing its role in the financial crisis by approving a series of costly acquisitions in recent years that led to the crisis.
Keywords: Corporate Governance; Crisis Management; History; Cash Flow; Acquisition; Performance; Telecommunications Industry; Media and Broadcasting Industry;
IT IS no secret that Vivendi Universal, a once high-flying media and telecoms group based in France, is facing a serious financial crunch. Last week, at a tense meeting in New York, its board debated how to tackle the firm's euro19 billion ($17.9 billion) of debts and reverse the slide in a share price that has fallen from a peak of euro141 in March 2000 to only around euro30 now. Successive credit downgrades have reduced Vivendi's debt virtually to junk status.
Almost the only good news for Vivendi in recent weeks was the announcement on May 30th by Standard & Poor's (S&P), a credit-rating agency, that it no longer fears that a further downgrade could trigger a catastrophic slide towards bankruptcy. That came after Vivendi managed to persuade its banks to delete clauses from its credit agreements that allow lenders to demand immediate repayment if the rating falls below an agreed level.
Despite that slight relief, Jean-Marie Messier, Vivendi's chairman and chief executive, is fighting for his job. He has considered selling a big part of Vivendi's 63%-owned environmental arm, along with several other businesses, to raise much-needed cash for his media and telecoms arms and stabilise Vivendi's finances.
However, the group's financial position appears to be much worse than is currently believed by most analysts. As the analysis below will show, Vivendi's profits are far weaker than is generally understood, and it will struggle to avoid being crushed by a debt mountain that already threatens the dividend. Vivendi chooses to highlight a number that gives a misleading impression of its profits, thus grossly flattering a key financial ratio that underpins its credit rating. Moreover, despite a euro12.6 billion writedown in the value of firms it has acquired in the past two years, Vivendi still puts optimistic values on several assets, especially its near-bankrupt pay-TV business. Vivendi could even face the prospect of a break-up that would pit its shareholders against its bankers.
From sewerage to Seagram
A look at Vivendi's recent history helps to shed light on its byzantine finances. In the mid-1990s Mr Messier used a French water utility as the launching-pad for a series of deals to create a presence in the telecoms and media industries. In 2000 the original utility, called Vivendi Environnement, was partially floated, with Vivendi retaining majority ownership and control.
By then Mr Messier had built a global media operation. Using highly priced shares as an acquisition currency, he paid euro12.5 billion for control of Canal Plus, a pay-TV group, and spent euro32.6 billion to acquire Seagram, owner of Universal, one of the world's leading film and music brands. Integrated with Vivendi's existing telecoms and media businesses, this became the core of the new group.
Vivendi made a further flurry of deals last year and has continued to mutate in recent months. One result of this activity is that the group is highly complex. Its recently published 2001 accounts and regulatory filings have provided perhaps the first set of numbers that make possible a proper analysis of its financial health.
The perils of ebitda
At the centre of this analysis is a measure known as ebitda (earnings before interest, tax, depreciation and amortisation). For most investors, ebitda is synonymous with cashflow, a view that few companies discourage. But ebitda is an inadequate guide to cashflow because it takes no account of a firm's capital spending and gives no indication of how much profit is actually turned into cash—as opposed to, say, remaining tied up as receivables.
Despite its shortcomings, ebitda now plays a central role in the work of analysts and rating agencies. S&P, for example, uses the ratio of ebitda to a company's debt as one of the principal factors in determining its ratings. These ratings in turn affect what interest rate the company pays on its debt, and also how much capital markets and banks are willing to lend to it.
Vivendi and other big groups are enthusiastic users of ebitda because it gives a flattering picture of performance. Indeed, Vivendi defends its presentation. “We are transparent enough that the market and analysts can make their calculations the way they want to,” says Guillaume Hannezo, the chief financial officer. The company even bases its bonus schemes for top management on ebitda. This explains why Mr Messier's total pay last year was an impressive euro5.12m, despite the fact that Vivendi announced France's biggest-ever corporate loss of euro13.6 billion.
In Vivendi's case there are special reasons why the ebitda number is misleading. The main one is the group's practice of fully consolidating the profits of some companies in which it is a minority shareholder. For instance, Vivendi includes in its profits all of the ebitda of Cegetel, a telecoms group that owns 80% of SFR, France's second-biggest mobile operator. As Vivendi owns only 44% of Cegetel, its true share of SFR's ebitda ought to be 35%. Vivendi justifies counting all of SFR's ebitda because it has board and management control of Cegetel.
The effect on its stated ebitda is dramatic (see table 1). Last year, Vivendi reported ebitda of euro5.04 billion, of which telecoms accounted for euro2.31 billion. Give Vivendi only 35% of SFR's earnings, however, and that telecoms figure falls to euro807m. Vivendi's true ebitda was therefore only around euro3.5 billion, and its debt/ebitda ratio was 5.1, far worse than the 3.8 under Vivendi's own accounting.
Only near-bankrupt companies show ratios as large as 5, so The Economist asked S&P why it accepts Vivendi's full consolidation of Cegetel's earnings. The rating agency says it is assuming that later this year Vivendi will buy out some of the other owners, taking greater control of Cegetel's cashflow for itself. S&P admits that its overall rating on Vivendi is qualitative rather than purely quantitative.
There is another way to demonstrate the weakness of ebitda as a tool for assessing Vivendi. Last year the company says it produced free cashflow (ie, ebitda minus capital expenditure and holding-company costs, adjusted for earnings not turned into cash) of euro2 billion. Of that, euro1.5 billion came from the telecoms businesses (see table 2). However, free cashflow based on Vivendi's actual stakes in its various holdings was a far more modest euro800m, barely enough to cover an estimated euro700m of interest charges on Vivendi's debts, let alone the euro1.2 billion dividend and related taxes it paid in 2001.
This raises a question: where did Vivendi find the money for its dividend? The answer lies deep in its accounts. For the past two years, Vivendi has raided special reserves tucked away in the balance sheet of its holding company. Once such reserves have been used up, the company must either cut its dividend, because it has nothing left to distribute, or it must bring up sufficient earnings from its subsidiaries to cover a payment.
It does not help Vivendi that it is subject to a special tax levied on French firms that distribute dividends out of overseas profits or special reserves. During 2001, this levy cost the company euro213m. This year Vivendi will have to stump up another euro337m. If this tax persists, Mr Hannezo says that Vivendi intends to reduce the dividend. That prospect is unlikely to reassure investors.
Vivendi's gigantic loss for last year included a euro12.6 billion writedown in the value of assets bought during its acquisition binge. By far the biggest writedown was a euro6 billion charge against the value of Canal Plus, the group's pay-TV operation.
Only two years ago Vivendi paid an astonishing euro12.5 billion to buy the 51% of Canal Plus that it did not already own. At that time, Canal Plus was loss-making and had around euro2.8 billion of debt, so it seems Vivendi paid a frothy price to begin with. Since then, conditions for pay-TV companies in Europe have become much tougher; several, including KirchPayTV and ITV Digital, have gone bust.
The writedown of Canal Plus leaves it worth euro6.5 billion on Vivendi's books. But is it really worth that much? Last year Canal Plus made an operating loss of euro374m and drained euro500m of cash from Vivendi. Most of the problem is attributable to its Telepiu subsidiary in Italy. Were it not for the support of its parent, Canal Plus would probably have gone bust. It is possible that Vivendi's auditors will ask for a further writedown when the group closes its half-year books at the end of June.
To maintain Vivendi's credibility in financial markets Mr Messier has said that he will significantly reduce its debts, bringing its debt/ebitda ratio to 3 by the end of this year. He has also said that he expects ebitda to reach euro6 billion, which implies a total debt of euro18 billion.
Can Vivendi's targets be taken on trust? One striking episode suggests that investors should be sceptical. On September 25th last year, Vivendi announced that it intended to cancel around 3% of its share capital by purchasing 33m shares for cash in the open market. The implication was that it had plenty of financial slack and thought its shares were undervalued.
However, the 33m shares were never cancelled as promised. In December Vivendi used 32m shares as part-payment for the entertainment businesses of USA Networks, an American company, saying these were the shares that were to have been cancelled. But in early January, Vivendi changed tack again, dumping 55m previously purchased shares back on to the stockmarket and raising euro3.25 billion of cash. The share dealings indicate an urgent need to raise cash, an observation supported by the fact that, just before the end of last year, Vivendi abruptly sold 9% of its stake in Vivendi Environnement, bringing in euro1.2 billion.
Vivendi further surprised investors in March by properly disclosing for the first time commitments it had made to buy its own shares at prices well above the current level. Mr Hannezo confirms that Vivendi is using cash each month to buy out these “put options”. The options carry a potential financial risk of euro600m.
Liabilities such as these, as well as pressure from credit-rating agencies, have led to an overhaul of Vivendi's balance sheet. In recent months the company has raced to reduce its reliance on short-term debt, particularly commercial paper that it could no longer place in the market. It has renegotiated or extended its credit lines with its banks, especially those with Société Générale, its main lender. In March Vivendi raised a new euro3 billion medium-term facility, and in April it sold part of its publishing business to raise a further euro1 billion.
Despite all this activity, Mr Hannezo says that Vivendi's debt was little changed at the end of May, at around euro19 billion. However, says S&P, the company's efforts mean that the likelihood of a short-term liquidity squeeze has diminished. S&P's latest estimate is that Vivendi has euro2 billion-3 billion of debt to repay in the rest of this year, and a similar sum in 2003.
Nonetheless, most analysts appear too sanguine about Vivendi's ability to wriggle its way to safety, in part because they accept its flattering ebitda numbers. Mr Messier and his team might yet slip up. To see how, first consider S&P's assumption that Vivendi will gradually take full ownership of Cegetel, perhaps beginning later this year with the purchase of a 26% stake held by British Telecom. S&P describes this outcome as a key “rating support”.
But BT is unlikely to accept Vivendi's sagging shares even in partial payment. That means that Vivendi will have to take on yet more debt. It is difficult to put an exact price on BT's stake in Cegetel, but around euro4 billion is plausible. Because it already fully consolidates Cegetel, Vivendi will get no boost to its earnings.
Other, more extreme scenarios contain similar traps. If Vivendi were forced into a strategic retreat from telecoms by selling its stake in Cegetel, the euro6 billion or so it might raise would have to be used to pay back the euro16 billion of debt that is now in the central holding company. That would leave a still formidable debt, with only the media assets to support it.
A further problem concerns Vivendi's 63% stake in Vivendi Environnement, currently worth euro7.2 billion. After the board meeting in New York on May 29th, Vivendi became uncharacteristically silent about its plans for this stake, having previously suggested that it might be sold. As The Economist went to press, there were rumours that Vivendi might soon announce its intention to reduce its holding, raising around euro2.3 billion, thereby losing control.
But Vivendi Environnement has troubles of its own. It has debts of euro16 billion and its share price has tumbled, from more than euro50 to below the euro34 level at which it was floated two years ago. Top managers want a capital increase to shore up the balance sheet and have been openly critical of Mr Messier, who in the past has failed to inform them before talking to journalists about his plans.
All of which suggests that there is no easy way out for Vivendi Universal. On one side, it must reduce its debts and it may have to write down the value of its overvalued assets further. On the other, it faces having to cut dividends and borrow more to buy its way out of trouble. In the meantime, it remains worryingly dependent on the markets' continued acceptance of its dubious financial ratios.
Were investors to lose faith in the company's assumptions and numbers, its share price would come under renewed pressure. Simmering boardroom tensions would almost certainly boil over. Mr Messier might then learn a painful history lesson: it is one thing to build an empire, quite another to make it endure.
This article appeared in the Business section of the print edition