Description

EI Towers is a high quality, economically insensitive tower business in Europe that has been left for dead in the recent Eurozone crisis. We believe there is very little downside at this price with the opportunity for a double over the next couple years and potentially more beyond that.  This opportunity exists due to the market it trades in (Italy), political uncertainty regarding a large new business opportunity, skepticism surrounding projected cost synergies, and a recent corporate transaction that makes the numbers messy short-term.  

EI Towers has 10+yr average contracts (with price escalators), dominant market share, and multiple catalysts.  EI Towers trades at 6x what we believe is a conservative estimate of 2013 EBITDA and 9x 2013 FCF, vs. 17-20x EBITDA for US peers and 13-15x EBITDA historically for DMT (its predecessor).  The company should eventually adopt a dividend policy similar to Mediaset, its primary shareholder, which would equate to a dividend yield of 7%+ at the current price.  Using an 11.0x EBITDA target (below its historical valuations), we believe the equity is likely worth 36.50 euros per share, or roughly a double from here.  Although not contemplated in our EBITDA estimates outlined below, we believe the potential for share price appreciation beyond this target is substantial longer-term.  If management can execute on additional synergies, win greater than 2 MUX contracts (we think 3-5 are possible), and achieve multiples closer to historicals, the stock could be worth 60+ euros by 2015 (each additional MUX represents an extra 10M of 2015 EBITDA).

cgnlm995 provided an excellent write-up on EI Towers (then DMT) in 2009 and has since posted several updates, which are definitely worth reading and present an even more bullish scenario than what we have outlined here.  Given the magnitude of the changes that have occurred since that initial write-up, we thought it useful to provide a clear picture of the opportunity as it stands today.

BUSINESS OVERVIEW:

EI Towers is the largest tower operator in Italy. There are nearly 6,000 broadcast towers in Italy.  EI Towers controls 3,200 of them, and Rai (the government owned TV station) owns 2,400. In addition to broadcasting television signals, some broadcast towers can also be fitted with telco equipment to transmit wireless signals. The process of building a new tower can take 12 years between land purchase and various local, regional, and national regulation, and is hard to get permitting for.  Outstanding contracts are about 10 years with automatic inflation escalators and nearly 100% renewal rates.  The biggest risk to contracts not being renewed is the closure of stations by customers.

EI towers derives about 80% of revenues from TV broadcasting, 11% from mobile telephony, a 7% from other (radio, wireless broadband, and utility/PA). There are secular drivers behind both of these industries that should drive meaningful growth at very high incremental margins, discussed more fully below.

CORPORATE TRANSFORMATION:

Late last year, DMT merged with Mediaset's tower assets to form EI towers.  For purposes of the merger, DMT was valued at 14x 2011 EBITDA v. 11x for EI Towers.  DMT's then CEO sold a portion of his stake at 28 euro a share in the transaction (~50% above the current market price).  As part of the deal, we believe Mediaset asked for the DMT CEO to step down, so we do not view his leaving as particularly negative. Mediaset now controls 60% of EI towers equity, with former DMT holders controlling 40%.  This merger transformed the industry from having 3 national tower companies to what we believe will become a duopoly with 2 players controlling over 85% of the market, and EIT's only competitor a relatively disinterested government owned entity that generally does not work with 3^rd parties on its tower network.

EBITDA BRIDGE FROM 75M IN 2011 TO 107M BY 2013:

FY11E Proforma EBITDA:  $75M

Multiplex wins:  $8M

Net cost synergies:   $15M

Organic growth:  $9M

Total 2013 EBITDA:  $107M

Forced DTT conversion creates new revenue opportunities ($8M of incremental EBITDA by 2013):

Italy is in the midst of completing a switch from analog to digital signals.  This conversion creates more compact signals which allow for more bandwith that can accommodate additional stations.  Stations are "multi-plexed" together.  Each MUX generally allows for 6 stations to be broadcast.  Because of the forced conversion of analog to digital, Italy should be left with 6 additional MUX once the analog to digital conversion in complete.  These MUX were supposed to be given away to broadcasters late last year, but Italy has delayed the awarding of the MUX as it considers the best use of them.  We believe that sometime this year, at least 4 MUX will be awarded to broadcasters.  We estimate that each MUX broadcast through EIT will generate an additional 6M in EBITDA for EIT 2 years out, and eventually as high as 18M/Mux (as additional stations are added and the MUX is fully utilized).  We know that Mediaset will get one MUX and that this will definitely be broadcast over EIT's towers.  Depending on how many other MUX transmission contracts EIT wins (we think 2 is easy and 3-5 possible), EIT can increase EBITDA 4-16M by 2013 off this opportunity alone.  In our numbers we give EIT credit for 2 MUX wins.  Management originally expected $6M of EBITDA per MUX in 2013, but due to the longer than expected delay in MUX being awarded we have taken a haircut to these numbers.  That said, long-term, as stations are added, we still believe that each additional MUX over time can add $18M of EBITDA.  Based on our checks in Italy, we believe the MUX will be awarded in the next 12 months. 

Expense synergies: ($15M by 2013)

There is substantial employee and infrastructure overlap between DMT and Mediaset's towers.  The tower business has regional economies of scale from a cost standpoint, such that eliminating overlapping footprint and utilizing existing employees to cover geographic areas can result in substantial cost synergies.   To put this in perspective, EIT had 1700 broadcast towers before the merger and DMT had 1500.  Despite only having that number of towers, each company had close to 100% coverage of Italy's most populous areas (as a further check, Rai has 2,400 towers and covers 99% of Italy).  Over time, EIT will be able to decommission overlapping towers, resulting in substantial cost savings from rent, maintenance contracts, and potentially personel.

Previously, DMT was servicing its towers through 3rd party maintenance contracts.  Mediaset's tower group has their own in-house maintenance personel that, post-merger, will service DMT's towers.  As DMT exits its maintenance contracts, we believe the company can generate substantial cost reductions.  This will result in further (and more immediate) cost saves.

Overall, we estimate $15M in annual cost saves by 2013, with none of these coming from headcount reductions and instead entirely from reducing 3rd party maintenance contracts and reducing tower overlap.  Long-term, we believe 40-50M of cost synergies are possible and that management sandbagged these numbers.  Management’s options have not yet priced, so there is some incentive to set the bar low here.

Organic Growth ($9M by 2013)

Inflation escalators:  EIT's contracts have built in inflation escalators.  With Feb 2012 inflation in Italy running 3.3%, this should result in predictable revenue growth regardless of economic activity (unless Italian companies start shutting down stations, which we view as unlikely).  To give you a sense of the economic resilience of revenues, DMT revenues increased 3% in 2009 and have increased about 4% YTD (as of Q3).  75% of revenues are exposed to price escalators and only ~17% of costs are exposed to inflation.

Increased mobile data usage and 4G:  EIT does have some benefit from increased data trends due to smart phones and tablets.  Italy is relatively under-penetrated today in smart phones (~50% v. 70%+ for rest of europe).  Also, 3G and 4G rollout in Italy is behind what it is in other countries.  Pre-merger, DMT derived 32% of its revenues from telco.  EIT has never tried to market its towers for telco usage, despite the fact that broadcast towers can be used to transmit telco signals.  We view this as a meaningful long-term opportunity that should have some positive contribution over the next couple years to organic growth.

Mediaset paying EI towers below market rates on their towers - this is resetting

According to Mediaset IR and EIT management, Mediaset is paying rates below market rates for the space it utilizes from EIT.  As part of a settlement with the Italian government to allow the merger to go through, EIT was forced to reprice these contracts so all their customers pay the same rate.  We are currently baking this into our organic growth assumptions and believe that the benefit here will be partially offset by lower radio revenue over time.  Others seem to believe the upside from these is substantial, so perhaps we are being overly conservative in our assumptions here.

Further EBITDA benefits not contemplated in our numbers:

Potential for 40-50M in synergies long-term:

**If management is properly incentivized and motivated, we believe the possibilities exists for 40-50M of synergies long-term (vs. 15M in our 2013 EBITDA estimate).  The biggest advantage of buying the tower assets is less the towers themselves and really buying Mediaset as a customer and eliminating the only other privately owned competitor of a national tower network. There is a relatively fixed infrastructure needed to service a national tower network, regardless of how many customers one has.  The combination of two national tower networks should result in much fewer combined personel and resources required to manage these assets than if these two were run separately.  We take some comfort from seeing one of DMT's largest shareholders (Octavian) named to the board, who we believe get the synergies possible here and will push for them to be realized.

Total EBITDA long-term of $36-90M from additional MUXs (18M per MUX) vs. $8M credited in our 2013 numbers:

The Italian Television market is 5-10 years behind the US market in its development.  Over the last 20 years, the US TV market transformed from a small number of general interest stations into a large number of smaller special interest stations.  By contrast, in Italy today, 76% of viewership is concentrated on 7 stations - this is the largest concentration in Western Europe, and speaks to the large and untapped opportunity of special interest stations to take share over time. One reason for the incredible concentration in viewership is that Berlusconi has helped to keep Italy a relatively closed TV market.   More stations seeking trasmission equals more revenue for EIT over time.  

Although the 6 MUXs in the beauty contest have been dealyed, we believe that eventually 4-6 TV MUX will be issued and that they will be awarded sometime in the next 12 months.  As the only national, private tower operator with a national network, we believe EIT could very well win all the MUX contracts ex the one MUX that RAI likely wins, which could mean 3-5 MUX contracts at a very high margin (although we have only modeled in 2).  Further, while the projected 2013 benefit to EBITDA of a new multiplex may only be 4-6M, the longer-term benefit is substantially higher as MUX owners fully utilize their newly awarded MUX with additional stations, and the eventual EBITDA opportunity of a fully utilized MUX is 18M v. the 4M we currently project in our 2013 numbers.

Dividend:

Mediaset has a history of paying nearly all its FCF out to shareholders in the form of a dividend.  We believe EIT will adopt the same policy. It is currently unclear if EIT would be restricted to dividends at EPS or at FCF.  Our understanding is that it is possible to pay out dividends in excess of EPS (contrary to a recent analyst note), provided is an excess of retained earnings available for these dividends to be paid from.  The current proforma financials do not currently break-out retained earnings . To be conservative, we assume dividends in line with EPS, which would result in a 7% yield on current prices.  If the company is able to pay out all its FCF as dividends, which they have indicated they can (and want) to do post 2013, the yield should be 10%+ at the current stock price in 2014.

VALUATION SUMMARY:  Note, these are not updated for recently reported FY11 numbers - DMT was a bit weaker and Mediaset a bit stronger but the net effect was the same.

Risks:

--Further delays in awarding of additional MUX - the MUX were supposed to be awarded at the end of 2011 and in theory could continue to be delayed or be given to telco providers instead.  Based on our checks with contacts we think these will likely be awarded by the end of the year but it is possible they fall to 2013.  There is a very tiny chance that no TV MUXs are awarded by 2013 but we view this as incredibly unlikely.  Sellside is currently giving the company no credit for potential MUX wins.

--Mediaset is 75% of revenues post-merger - any substantial shutdown of stations from Mediaset could impact EIT very negatively

--Increase in alternate means of TV transmission - If terrestrial television stations decline as more stations as more content is broadcast through satellite, cable, or via the internet, this would impact demand for EIT's tower assets.  We believe lack of cable infrastructure and high cost of satellite minimizes this risk, at least short-term. 

--Management not taking appropriate action to realize synergies and unlock value.  Mediaset has been criticized for keeping excess personel.  Also, labor laws in Italy make it difficult and costly to reduce headcount.  Although management’s synergies do not at all rely on headcount reductions, it is possible that management does not act aggressively to cut costs.  We take some comfort that Octavian is head of the compensation committee and will presumably create appropriate incentives for management to act in the interest of shareholders.

--Privatization of Rai - if Rai is privatized, they could become a more aggressive competitor to EIT.

--Former DMT CEO (or someone else) decides to roll-up smaller operators and create another DMT to compete with EIT.  This is not currently happening but if it did this would likely be a negative for the competitive environment.

Catalyst