The Investment Column: A leap of faith is needed before buying Orange

Tom Stevenson
Sunday 23 October 2011 08:26

The number-crunching by analysts as yesterday's first dealings in mobile phone group Orange approached has been impressive. All sorts of arcane discounted cash flow models and comparisons of earnings multiples have been used to assess the value of the company at different risk premiums.

Depending who you talked to, the paper value of the company on flotation came out anywhere between pounds 1.5bn and pounds 3.2bn. In the end, the sale price was pounds 2.45bn and the shares shot to a 19.5 per cent premium, valuing the whole of Orange at pounds 2.9bn.

If this had been a sale of the whole company, the owners would of course have been kicking themselves at giving away so much. They could in fact have floated at a higher price, but decided against raising the ceiling of the indicative pricing range of 175p to 205p - published in the prospectus - despite early evidence that the offer would be heavily oversubscribed.

It is obvious why they were so generous: three-quarters of Orange stays with British Aerospace and Hutchison, and a healthy premium at the start is good investor relations for the long term. The marginal underpricing should be more than made up by the increase in the paper value of the rest of the stock.

The problem with valuing a stock like this is that investment appraisal is only the beginning. Orange is a latecomer to a relatively new market and it happens to have had an extremely successful year, wrongfooting Vodafone, Cellnet and Mercury One-2-One on both pricing strategy and marketing.

But with such a short track record, projections of future growth, market share, margins and customer useage are about as reliable as economists' forecasts of gross domestic product: useful as a working assumption for a Budget or a spreadsheet, but anybody who believes them needs his or her head examined.

To buy Orange requires a leap of faith as well as number-crunching. There is evidence all around that mobile telephony will have an all pervading influence on people's lives in the next century. The choice of Orange rather than Vodafone is dictated by the fact that over the next two years the company has a useful advantage: the fact that - unlike both Vodafone and Cellnet - it sells only digital phones.

Orange shares nevertheless look expensive on paper when compared with Vodafone. They will stay that way just as long as the company outperforms its bigger rivals in growth of market share.

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