Description

Summary Thesis

Lilac has been written up numerous times on VIC and has had a pretty active message board historically. There has not been as much of a discussion on the company as of late however (save for LimitedDownside’s post in April last year and a couple messages there). We thought it could be valuable to share our perspective, focusing on some of the more recent developments, and hopefully restart a dialogue among members that are still following.

We calculate the EV for Lilac today at ~$11.5b (pro forma for the completion of the Telefonica Costa Rica asset) and that 2020 pro forma proportionate EBITDA excluding synergies (for AT&T Puerto Rico and TEF CR) is ~$1.70b and including synergies is ~$1.78b; the create today is therefore ~6.8x / ~6.5x. We think the company can reach $1.90-1.95b in EBITDA by 2024 and ~$400m in FCF, in large part just driven by a COVID recovery in C&W and VTR, but also through the successful execution of synergies at PR and CR and the continued strong performance of the Liberty Cablevision fixed asset in PR. At ~7.7x EBITDA / 6.5% levered FCF yield, that would translate into ~$6.1b equity value or ~$23 per share; adding in the ~$900m of PF cash today and the additional ~$1.2b we estimate the company will generate in 2021-2024 gets you an additional $8 per share, for an all in value of $31, about a 2.2x from today or 24% IRR thru YE 2024. We find that very attractive in this market, and think there is potential upside from (1) multiple expansion given increased infrastructure PE money flowing into telecom assets (in particular residential telecom assets and now also in Lat Am…see Brazil and Chile) and (2) the value Lilac can create with the >$2b cash at their disposal, either through accretive M&A or share buybacks.

Below we will go through our views of each segment and where we forecast profitability and FCF going forward, and then we will finish with valuation.

Segment Discussion

Cable & Wireless (40-45% of PF EBITDA):

C&W is still the largest segment for Lilac, although less now given the AT&T PR and TEF CR acquisitions. C&W had a very challenging 2020, as the COVID impact caused sharp declines in prepaid mobile and B2B. The team did manage cost here very well (EBITDA margin % flat yoy despite the 8% revenue drop), and the fixed resi numbers were encouraging, with broadband penetration up ~200 bps yoy and fixed resi revenue up yoy.

In the next several years, we should see the COVID impact normalize as lockdowns in the Caribbean/Central America are lifted and tourism gradually returns. There are also the “problem markets” i.e. Panama and Bahamas (although only 49% owned by C&W keep in mind, so proportionate impact not as much). Tough to make a call here on timing, but we would just point out a couple things. Mgmt recently separated the Panama unit apart from the rest of C&W, so they will directly report up to Lilac. The increased visibility/scrutiny indicates to us that they are serious and very focused on fixing the underperformance of this market (with mgmt in that market taking more direct ownership of the numbers). In addition, it appears that the market is finally cleared for consolidation, and now is just a game of chicken between Digicel and who of the 3 other players (Lilac, TIGO and AMX) will buy them. Imagine some of the 3 are just waiting Digicel out if Digicel is asking for too much on valuation; eventually Digicel will likely sell even at a reduced price, as they will need the cash for deleveraging. For Bahamas, it seemed like C&W was communicating somewhat stable numbers there pre-COVID. Even if there is still some share to lose, we think they are likely pretty close to a market equilibrium at this point.

Apart from those markets, the competition backdrop seems okay. We have heard that Digicel is being rational on price in both the mobile and the fixed resi market. They will continue to attack B2B and C&W is somewhat exposed there as the incumbent telco with legacy products, but that takes investment dollars from Digicel so will be more gradual given their financial position. And in the meantime, C&W can continue to overbuild its copper plant with fiber, to the benefit of both its resi fixed and SMB B2B business. The subsea/networks business also showed good growth in 2020 (more on that later in valuation).

So overall, C&W feels alright. We don’t think you need to make heroic assumptions here – we have proportionate EBITDA in 2024 around $800m, still below your 2019 level of $810m, and FCF of ~$150m, just a bit below 2019 levels of ~$160m. You can still grow broadband as continue to do new builds and fiber overbuilds and take some on price. The fiber build should help B2B as well. Mobile will likely continued to be pressured, but maybe not as much if Panama consolidation happens. FX will continue to be a drag. Then you have the slow COVID recovery. And would also point out that we think there is still room for cost takeout here, with the potential for a couple hundred bps of margin improvement.

VTR / Cabletica (~25% of PF EBITDA):

Just when you thought Lilac was stabilizing C&W and Puerto Rico was well positioned, VTR becomes the “troubled” asset. Part of this is network issues they experienced as a result of COVID: major traffic spikes overwhelmed their network (which was not prepared for that level of activity), which then caused network performance issues for their broadband/video customers, which led to increased service calls that overwhelmed their support staff / technicians, which ended with increased churn. VTR was a cable machine for years…I see positive broadband net adds every quarter all the way back to 2015 (and I’m sure the streak started well before that). But in Q3 and Q4 this year, the company lost ~30k broadband subscribers each quarter and net adds turned negative for the year. Now, mgmt has said that they made the necessary capacity investment in the network, and increased resources for customer service support, so this self-inflicted issue is close to being fixed – they point to declining service calls and truck rolls towards the end of 2020 and positive net adds in January of this year on their Q4 call. That seems all well and good to us, but there is another issue…

Fiber. A lot of fiber coming into the Chilean market. There are small overbuilders here and there, but the big one is now Telefonica, the telco incumbent in the market. They recently sold a 60% stake in their fiber wholesale network to KKR, and there are plans to increase the fiber homes passed from 2m today to 3.5m by 2023. So as VTR, the market leader in broadband today with ~40% of total broadband subs, you are now facing the prospect of KKR/TEF overbuild 25% of the market with fiber (1.5m homes on 6m total homes in Chile).

Not a great set up. But that is part of the reason why the opportunity likely exists in Lilac today. If you go a level deeper, we think you can make reasonable assumptions to get to an outcome where VTR is okay. First, we assume that KKR/TEF take ~12% of total subs over a 4 year period, which is a combination of them growing their penetration on their existing 2m fiber homes and ramping penetration on the 1.5m new fiber builds. So where does that share come from? Well, unlike more traditional fixed markets where there is a duopoly between cable and the incumbent telco, Chile has a wide variety of providers (some clearly overbuilds, others not as clear if they just built to where VTR or TEF is not present today). Claro overbuilt Santiago area with HFC and we think has 10-15% of total bb subs. There is still a DSL (i.e. copper) share, we think around 10-12% (most of which is probably Telefonica and part of the homes they are overbuilding with fiber). Then there are other players (Entel, other smaller overbuilders) with another ~15% of total subs. This is all to say that, KKR/TEF broadband subscriber growth from their fiber overbuild will not proportionately come out of VTR’s share. There is also the dynamic of VTR new builds, as they only pass ~3.7m homes out of the total 6m homes in Chile today. One of the more surprising things on the Q4 call / 2021 guidance was how much Lilac is ramping new builds in Chile this year – ~10% growth in homes passed vs historically in LSD-MSD % range. In addition, the total broadband penetration in Chile today is around 60% (compared to mid to high 80% range in the US), so we think there should be some continued growth there. So for us, we think VTR will see declining % penetration on their homes passed, but still increase their total broadband subscribers as they build out to new homes and the market grows in aggregate.

As a result, we have VTR / Cabletica EBITDA pre TEF CR acquisition, reaching ~$445m in 2024, only slightly above the 2019 level of $434m (with VTR EBITDA in 2024 flat to 2019 and the growth from Cabletica fixed business). Layering in TEF CR fully synergized (with some additional topline improvement and margin expansion, given we think TEF probably didn’t manage the asset that well), we get to total VTR/Cabletica EBITDA of ~$535m in 2024. On FCF, we think there will be ~$110m contribution from this asset in 2024.

Puerto Rico (30-35% PF EBITDA):

Liberty Cablevision (fixed asset in PR) had an incredible year in 2020, with EBITDA up ~9% yoy (excluding the impact of AT&T PR in Nov & Dec). The broadband business in particular is booming: revenues up ~17% on the back of strong subscriber growth, with penetrations increasing from ~32% to ~38%. It is likely that COVID pulled forward some of this broadband demand, but we view a gradual increase in penetrations up to the low 40% range over the next 4 years as reasonable. You are competing against AMX here with a copper DSL product. Longer term there is a risk that Claro does a fiber overbuild, but it seems like they have their hands full currently with fibering their major markets like Mexico and Brazil. Now, AMX could sell the asset to another player who invests with a fiber overbuild thesis. But then you are going up against what will be a dominant converged player in Liberty. Possible, and certainly a risk, but one that we are not overly worried about at this stage. So your penetration increase can come on the back of continued share gain from an inferior product as well as overall increase in market penetration for fixed broadband (we have seen estimates that PR fixed broadband penetration is only around 50% today). There are some other puts and takes for voice and B2B, but broadband is the main driver here. So we think the fixed asset can grow EBITDA to ~$250-260m in 2024 from ~$220m today.

On AT&T PR, the recent numbers look pretty good, ahead of where Liberty marketed the deal back in 2019. It’s a 3 player market now with Liberty and T-Mobile fighting for #1/2 position and Claro #3 (Liberty has ~1m mobile subs on a ~3m population). AT&T subscriber split is 75% postpaid (so much better than traditional EM wireless). But like most Lat Am wireless markets, it is pretty well penetrated. We don’t assume any revenue growth for the mobile business. Down the line, the converged offering might allow Liberty to take share on mobile (with just 25% of their fixed subs on an AT&T plan today), but that will take some time to implement. So we assume that your ~$320m EBITDA in wireless today grows to ~$400m, with most of the increase from the realization of ~$70m synergies.

Putting fixed and mobile together gives us ~$650m of EBITDA in 2024 and around $200m of free cash flow.

Valuation

We approach valuation using a sum of the parts. Going through each segment:

C&W:

We further split this out between resi fixed, resi mobile, B2B incumbent and subsea / Lat Am B2B. On resi fixed, you are 2/3 cable or fiber and 1/3 DSL today. That should continue to get better. And the market penetrations for broadband are still low in these countries. But you still have some legacy voice owing to you being the incumbent telco. And there is FX exposure. So we think a 7-7.5x EBITDA multiple is appropriate here. On resi mobile, you are the subscale player here (to Digicel mostly) in a lot of your markets. Most are duopolies, which is good, but your small market share is likely resulting in lower EBITDA margins and therefore FCF conversion is not great. These markets are also mostly prepaid (and same FX exposures). We value it at 4x EBITDA, which is more in line with EM mobile assets in competitive markets. Mgmt has recently attempted to highlight the “networks” business they have in C&W, which is not only the already disclosed subsea asset, but also (1) a portion of terrestrial fiber in Central and South America that is mostly sold on a wholesale basis (i.e. not part of actively managing a network for a large enterprise, but selling capacity to another telco) and (2) the intercompany subsea revenue. The company is trying to shed light on this asset given the activity from infra PE funds in telecom as of late. Their precise game plan for unlocking this value is still TBD, but we think they could eventually get credit here with a higher multiple. Ufinet is a Lat Am terrestrial fiber player that was acquired for a low teens EBITDA multiple a couple years ago. And while subsea valuations vary widely based on the market/route, recent rumors suggest Telefonica was looking to sell its subsea asset for ~10x EBITDA. We value this subsea/networks piece of C&W at 8.5x EBITDA, but feel there is upside risk here. Finally you have the remaining B2B “incumbent” business, where you serve SMEs and Enterprise customers. Some of this business is likely good (migrated to next gen solutions), but there is also a lot of legacy business here from you being the incumbent telco (i.e. copper voice products). We value this at a 7x EBITDA multiple. So blended together, we get to a low 7x EBITDA multiple for C&W.

VTR / Cabletica:

VTR is the bulk of EBITDA for this segment (~80%) so will focus on that here. We would have been much more bullish on VTR in the past, but the current competitive backdrop is tricky. The volatility of the peso recently is also a reminder that there is FX risk here, despite Chile being one of the more mature/well managed Lat Am countries. We value this segment at 7.5x EBITDA. The positives are that you are mostly a fixed resi cable asset in relatively good countries, with room for increasing broadband penetrations in the market as a whole. But there is still FX exposure and the fiber competition is threatening.

We would also add that the headline EBITDA multiple KKR / TEF transacted at for the Chile fiber asset (~18x), could provide some upside risk to the multiple of VTR here. That was a wholesale network deal, so not directly comparable to VTR, but if you do the math on splitting VTR into an infra co and retail co at the same economics, it implies the blended multiple for VTR could be closer to high single digits. At this point we don’t ascribe any of that to our valuation today, but is something we would be watching closely.

Puerto Rico:

We are a bit more aggressive on our Puerto Rico multiple, using 8.5x EBITDA, but feel it is justified for several reasons. You are the dominant cable broadband provider in a country that still has a lot of room for increasing broadband penetration. You are competing against copper DSL, and there does not appear to be any near term threat of a fiber overbuild. And you are in a dollarized market. Given where the US cable players trade today, I think a ~10x EBITDA multiple on the fixed asset is defensible, and this is ~40% of PR EBITDA. For wireless, 60% of EBITDA, you are in a 3 player market with somewhat balanced share (at least between you and T-Mobile) that is mostly postpaid and again, in a dollarized economy. This might be closer to a 7.5x EBITDA multiple. That gets you to 8.5x blended. Would also point out that the fixed asset had best in class EBITDA margins, close to 50%. AT&T PR will bring this down, but we still think mid 40% is attainable. So your FCF conversion is very good and helps justify the higher multiple.

Lilac total:

Putting it all together, and adding in some corporate costs to EBITDA and FCF, we get to $1.90-1.95b of EBITDA and ~$400m of FCF in 2024. The blended EBITDA multiple comes out to ~7.7x and implies a ~6.5% levered FCF yield / ~$23 per share (with share count PF for convert). Separately adding in the ~$900m cash on B/S today and the ~$1.2b FCF generation thru 2024 is another ~$8 per share, for a total value of ~$31. From $14 today that would be a 2.2x, or ~24% IRR thru YE 2024. We like that risk in today’s market, especially for a company like Lilac where a lot of the main value drivers are in the broadband businesses, and in markets where the penetrations of broadband are low compared to developed markets. We think there could be upside risk to multiples given the increased activity of infra PE funds investing in telecom assets (and now EM telecom assets too). And we think Lilac could create additional value thru the >$2b in cash they have at their disposal, either through M&A or share buybacks.

Catalyst

Growth, multiple expansion, M&A or buybacks