Liberty Global plc [LBTYA: NASDAQ] – Market cap as of March 10th $18.36bn

Sunrise Communications Group AG [SRCG: SW] – Market cap as of March 10th CHF3.41bn ($3.41bn)

Introduction

On February 27, 2019, Liberty Global, the biggest international TV and broadband internet company, agreed to the sale of its Swiss business – UPC Switzerland – to Sunrise, the largest non-state-owned telecommunications company based in Switzerland, for a price of $6.3bn. The deal marks the end of Liberty Global’s restructuring process– although the regulatory approval of a parallel transaction with Vodafone signed in May 2018 is still pending. The company is cashing out from the slowly growing Swiss market with an amount equal to 4x its initial investment.

About Liberty Global

Operating in 10 European countries under the brands of Virgin Media, Unitymedia, Telenet and, up to transaction completion, UPC Switzerland, Liberty Global has nowadays become one of the world’s largest international TV and broadband companies. It offers a bundle of services that includes cable and internet and media digital platforms.

The company offers a wide product portfolio encompassing all aspects of connectivity, with activities branching into 4 main product lines: i) superfast broadband speeds, offered via a combination of fiber and coaxial cable; ii) intuitive in and outdoor Wi-Fi and other connectivity solutions; iii) mobile services and iv) TV boxes. Launched in the UK and now taking on Europe and LATAM, TV box is a platform combining the most advanced and flexible technologies – it allows to record 6 shows at once and to watch them in 4K Ultra HD Ready – with popular content such as Billions and Game of Thrones, relying on $2bn invested yearly and high-profile partnerships with the likes of Netflix to share content. In addition, the company owns 50% of VodafoneZiggo, a joint venture providing video, broadband Internet, fixed-line telephony and mobile services to residential and business customers in the Netherlands, valued – via equity method – $3.8bn at the end of FY2018.

Liberty Global’s network provides its services to 44.5m households and connects 21.2m customers subscribing to 44.7m – of which 6.4m mobile subscribers and 12m Wi-Fi access points – digital services. Company’s continuing operations reported a 2.2% YoY growth in revenues – settling at approx. $12bn in absolute value – for the year ended December 31st, 2018. When looking at their geographical breakdown, it is worth highlighting how the Swiss market is the only one reporting a slow-down, -2.9% YoY. Operating income jumped by 10.3% vis-à-vis previous year, reaching $839.1m. This performance improvement is the consequence of a broader reorganization program aimed at decreasing management layers and increasing efficiency across both central and local operations through asset disposals. Simplifying group structure making it more intelligible was thought to be the solution to unlock value for the shareholders of a company which during the previous 3 years was punished by the market precisely due to its inefficient structural complexity. Moreover, the restructuring process was needed in light of the company’s desire to move towards fixed-mobile convergence in Europe. In fact, recent M&A activity has been oriented towards becoming able to bundle together fixed-line and mobile services. Net earnings attributable to Liberty Global shareholders were $725.3m (-73.9% YoY). In spite of its magnitude, the change reported by Liberty Global’s net income is however not so meaningful because of extraordinary expenses carried out by the company during the last year that created year on year comparability issues.

About Sunrise

Born in 1997 as a brand launched by British Telecom and Tele Danmark, Sunrise only took one year to become a leader in the Swiss telecommunications market, a role that it will maintain until today. 2010 was a key moment in Sunrise’s history as it marked the entrance in the company’s equity of CVC Capital Partners. CVC acquired Sunrise for CHF3.3bn and started a phase of expansion characterized by the launch of several partnerships and new offers both for mobiles and landlines. The PE fund partially exited the investment – as of 2015 year-end, its stake in the company was reduced to 25.27% from approx. 90% – recurring to an IPO that valued the company at CHF3.1bn, with an IPO price of CHF 76 per share. At the time, Sunrise’s IPO was the biggest on the Swiss Stock Exchange since 2006 and it captured the interest of many institutional investors, leading to a 5m shares upsize of the base offering. The following year, CVC finalized its exit, selling its stake to Freenet, the largest network-independent provider of mobile telecommunications services in Germany. Nowadays, under Freenet’s control, Sunrise has become the largest non-state-owned telecommunication provider across the country, leveraging on a strongly integrated network and one of the most competitive mobile networks nationwide.

Sunrise’s current business model of the company builds up on 4 main segments: i) Smart TV, an HD quality, multiscreen platform allowing customers to watch more than 270 channels; ii) Internet, a fiber optic network with 1 Gb/s upload and download speed; iii) Mobile, offering mobile rate plans and representing 67.7% of FY 2018 revenues and iv) Landline, offering home packages.

Sunrise’s financial performance – specified according to a fixed 1$/CHF exchange rate – for the year ended December 31st, 2018, shows little revenue growth, with a 1.2% YoY increase to reach CHF1.9bn. On the other hand, company’s operational performance remained flat for the year, as Adj. EBITDA settled at CHF595m (-1.1% YoY) besides a positive trend was recorded in Q4 2018 in light of increased mobile postpaid subscribers (+8.5% YoY). Net income attributable to Sunrise shareholders grew by 47.5% over the year to an amount of CHF35m. The magnitude of the increase is however influenced by the fact that the company reported very low levels of net income for the previous year.

Industry Overview

The last few years have seen a rise in the trend of consolidation within the telecom market. Nevertheless, this hastening trend has seen much opposition from European antitrust authorities which have been able to block deals such as Three and O2’s £10.5bn merger back in 2016. Three, a CK Hutchison company, which offers mobile services has been one of the companies aggressively pushing for consolidation. In the same year as their O2 merger was blocked, the company completed a €20bn merger with the Italian subsidiary of Veon (an Amsterdam based cable and internet company previously known as Vimplecom) creating Wind Tre.

Much of this trend towards consolidation has to do with excessively low prices offered by telecom providers due to high competition, squeezing profit margins. In France, a raging price war among leading providers has left the sector bruised, heightening positive sentiment within the industry regarding M&A activity to ease competitive pressure. The French market saw its first steps towards consolidation in 2014 with the acquisition of SFR, France’s second-largest telecom operator, by Numericable, Altice’s French subsidiary, for a deal valued at €17bn.

As with the rest of Europe, one other market characterized by high levels of segmentation is the mobile Swiss market which is effectively dominated by three large network operators, Swisscom, Sunrise and Salt who held 58.1, 25.2 and 16.7 percent of the market in 2017 respectively along smaller mobile virtual network operators (MVNOs) that tend to local communities. Although the market is relatively more concentrated as it is mostly covered by the state-controlled operator Swisscom, further trends of consolidations are beginning to pick up with the sale of Liberty Global’s Swiss assets to Sunrise for a deal valued at $6.3bn.

Traditionally, the European telecom market has been very fragmented, unlike its American and Chinese counterparts, while tough anti-trust rules and difficult integration between former monopolistic providers have proved to be barriers to consolidation. This is even more apparent when taking Europe’s average revenue per user (ARPU) into consideration, which is a third of that of the US and half of Japan’s. Although it is also crucial to highlight the popularity of “broadband bundles” in the US, plans which encompass TV and phone packages, and their higher prices compared to European alternatives. Taking into account the rising costs of investments into infrastructure and technology needed to upgrade networks, consolidation within the European telecom market seems to be inevitable for survival within the industry.

Deal structure

On the 27th of February 2019, Liberty Global plc entered into a binding agreement to sell its Swiss operations, UPC Switzerland, to Sunrise Commmunications Group AG for a transaction value of $6.3bn. The enterprise value represents a 10x multiple of UPC Switzerland’s currently estimated 2019 adjusted segment operating cash flows. The deal is being through two channels: Sunrise will assume the group’s existing senior secured notes and associated derivatives and certain other debt items for a value equal to approximately $3.7bn and will pay the remaining $2.6bn to Liberty Global in cash, attributing an equity value of the same amount to UPC Switzerland.

Deal rationale

Labelled “Project Capri”, this $6.3bn deal constitutes a further step in the consolidation of the European telecommunications industry. Hailed as a great opportunity for Liberty, the spin-off at issue is still raising concerns among the buyers’ shareholders.

From Liberty Global PLC’s standpoint, as emphasized by Redburn’s analyst Steve Malcolm, the transaction is supposed to be “a great deal for the company’s shareholders, who would get cashed out completely from Liberty’s shrinking Swiss unit”. As a matter of fact, UPC has experienced a 32,500 units reduction in customer base during Q4 2018, due to poor performance in Switzerland and Belgium. By selling the troublesome unit, Liberty would consequently wipe out all the connected business risks.

Moreover, through the sale, Liberty would stick to its CEO Michael Thomas Fries’ plans to restore normal cash levels. Indeed, despite recording the abovementioned 2.2% increase in revenues for the year ended in 2018, and higher operating profit figures compared with the previous fiscal period, the company has recorded unscheduled $2bn expenses in the last few years, building an impressive and worrisome debt burden. This deep indebtedness, as high as 6.13 times EBITDA, persuaded S&P to downgrade the company’s creditworthiness to the junk category (BB) in May 2018. In order to face this phase of distress, Mr Fries has announced a 20% cut in Capex for 2019 yet declining any potential cut back on spending for Project Lightning (consisting in a network upgrade in the UK). Together with the new roof for Capex, UPC sale will bring the company some fresh air, in line with the other recent transactions that Liberty has closed. Indeed, the European cable company has undertaken several transactions of this sort in recent times, explicitly pursuing a policy aimed at cashing-in investments. Having this goal in mind, Liberty has agreed in May 2018 to sell the German and Eastern European assets to Vodafone for about $18bn, confident that the antitrust watchdog would approve the transaction. Furthermore, the corporation has sold the Austrian business to Deutsche Telekom last year, also merging its Dutch cable business with Vodafone mobile business in the Netherlands to create VodafoneZiggo. In addition, Liberty is now selling its DTH Satellite TV operations to M7 Group, for a $180m in enterprise value. Through these transactions, the company is trying to restore both its historical normal cash position, and a more solid credit score. 

To better understand the big picture, it is also worth mentioning Liberty’s owner John Malone’s point of view when it comes to corporate investments in Europe. Creatively nicknamed “cable cowboy” for his role in consolidating the cable industry, he is slowly trying to leave the European soil, because of the tougher and tougher intervention of European antitrust regulators in all M&A transactions. Those watchdogs, according to him, will keep on preventing value creation in the years to come, to the detriment of potential growth also in the cable industry, which is instead “screaming for consolidations, exactly like in Latin America”, he said. Investors already had the feeling that he was running away from the Continent, due to the several aforementioned sale transactions, which Liberty has undertaken in recent times. However, as Mr Fries declared, “UPC spin-off is meant to be the last step of the company’s rebalancing”, bringing Liberty’s cash-in phase to an end.

From Sunrise’s standpoint, instead, the transaction was conceived as a way to create additional value, exploiting UPC’s 1.1m TV customers and 138,000 mobile phone clients in Switzerland. The resulting synergy could be quantified in CHF2.8bn, according to a Jefferies’ analyst. Despite the undeniable value creation, one of the company’s major shareholders, i.e. the previously mentioned German telecommunications and web content provider Freenet, is still firmly opposing the transaction. In its CEO Ingo Arnold’s words, “With the agreed-upon terms and conditions, Liberty would not share any risk”, making the deal somehow imbalanced. However, it would be very hard for Freenet, accounting for just 25% of Sunrise voting rights, to be a deal breaker considering the additional value derived from the synergies. However, Sunrise’s BoD will undoubtedly face significant difficulties in persuading at least 50.1% shareholders to approve the massive funding needed for the acquisition, through the issuance of new share rights. As a matter of fact, those CHF4.1bn needed constitute about 130% current Sunrise’s market capitalization (CHF3.35bn as at March 1st, 2019).

Finally, it is worth highlighting that the deal at issue was also structured as a way for the two involved parties to generate a respectable competitor to Swisscom, which can nowadays boast a 60% market share in Switzerland. A transaction of this sort has been rumoured for several years, yet usually identifying Liberty as a potential buyer, rather than a seller. And indeed, last year, Liberty and Sunrise started negotiating a merger, but the talks eventually have not come to a proper agreement. The UPC sale appears therefore as the actualization of the long-awaited consolidation path, which will bring about a new strong competitor for Swisscom in the Swiss marketplace.

Market Reaction

In line with expectations, investors hailed the sale from Liberty with a slight enthusiasm, despite the uncertainties around the deal. Indeed, Liberty Global’s shares have been experiencing a positive trend in the aftermath of the transaction, growing from $25.36 (closing price on February 25th), to $26.35 (closing price on February 28th, 2019).

Sunrise’s stock price, instead, has undergone the opposite path, closing at CHF81.35 on February 25th, and at CHF74.40 on February 28th. The reason behind this pessimistic reaction is rather straightforwardly to be found in the rising concerns from both existing and new shareholders about the CHF4.1bn rights issue, which Sunrise is about to sell on the market. As pointed out above, the issuance actually amounts at 130% current market cap, and some shareholders and analysts are still doubtful about the value creation following the acquisition.

Advisors

The rights issue has been fully underwritten by banks, with Deutsche Bank and UBS co-coordinating and advising Sunrise Communication Group AG, and Morgan Stanley acting as a joint book runner. Credit Suisse, JPMorgan and Liontree, instead, advised Liberty Global PLC.


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