Description

Millicom (TIGO: US, TIGO: SSB): US$60.07 and SEK 560

February 7, 2019

Warning: Do not buy this without doing your own work.  I / we may sell at any time.

Millicom is humming.

Millicom is a leading Latin American telco that is in the second half of a transition from a mobile prepaid voice business to a fully modernized, sustainably growing, data-centric quad play fixed and mobile company.  The market does not seem to realize how successful this transition has already been.

The stock is cheap, and the business has accelerating operations led by a tremendous CEO, Mauricio Ramos.  Since joining four years ago, Ramos and team have made a series of excellent capital allocation decisions while improving operational focus and execution across the board.  Additionally, it is clear that Millicom owns a M&A put option at prices above today’s trading levels, bounding downside.

Historically an orphaned equity, with its primary listing in Sweden despite its primary operations in LatAm, Millicom just completed a full second listing to the main US Nasdaq under the ticker TIGO (Tigo is Millicom’s dba).  Millicom stock was orphaned despite being #1 or #2 in several Latin American markets and having billions of dollars of revenue (~$6.5 billion) and market cap ($6.0 billion).

CEO Ramos is a John Malone disciple.  He currently serves on the board of Charter, and previously led Liberty Global’s LatAm business.  From my perspective, Ramos may be the most impressive of the Malone lineage cable executives. He is clear on priorities, is operationally focused, is willing to make tough decisions, and deeply understands the cable value creation model.

Trading at <5x EBITDA (proportionate) with a resilient and growing top-line, expanding margins, and an enormous high returning capital deployment opportunity in front of it, Millicom is worth much more than its trading price.  Similar, less well-positioned businesses trade several multiple turns higher. At a minimum, if you like Lilac, you should love Millicom.

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Note: The US listing is thinly traded.  Much more liquidity exists in its Swedish listing: TIGO SS.  I quote US$ stock prices for convenience.

I’m using $2.5B of 2018 pro forma EBITDA (non-proportionate), $5.1B of net debt (non-proportionate), and 100 million shares outstanding.

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Company:

Four years ago, Mauricio Ramos took over leadership of an operationally challenged mobile-first telco that had just acquired a fixed line business in Columbia, full of copper customers.  While its largest business was a voice-first mobile business in LatAm, Millicom also had a large money losing African mobile business. On the plus side, Millicom was the leading mobile operator in most of its markets, and it often ran the #2 cable business in those same markets (or no fixed business at all).  When Mauricio took over, this is approximately what the operating situation looked like:

Source: Telegeography

CEO – Mauricio Ramos:

In hedge fund world, Mauricio’s primary claim to fame may be that he is on the board of Charter, but it is his strategic leadership, operating, and capital allocation chops that impress me.  For nearly a decade - prior to his taking the reigns at Millicom - Mauricio led what is now called Liberty Latin America (aka, Lilac - ticker: LILA), but at that time was simply Liberty Global’s LatAm subsidiary.  In particular, for many years Mauricio led its increasingly high performing Chilean business (VTR), taking share and driving margins. VTR is today the crown jewel of Liberty LatAm (which has subsequently expanded via M&A to hold important positions all over the Caribbean).

At Millicom, Mauricio has surrounded himself with a revamped leadership team.  In the key leadership roles, only CFO Tim Pennington slightly pre-dates Mauricio, having been recruited from the CFO role at Cable & Wireless in early 2014, a year prior to Ramos’s hiring.  Those familiar with Lilac are likely intimately familiar with C&W…

In its short history, Lilac has been written-up five times on VIC.  Only one of those efforts directly mentions Millicom (in passing) while another has it as a semi-anonymous listing on a comp table.  This is despite Millicom being the larger, better opportunity and existing as a perfect strategic match for Lilac from an M&A perspective (Note: the VIC message boards mention Millicom several times, primarily catalyzed by Lilac’s publicly disclosed interest in Millicom, though the core write-ups do not).  Millicom is larger, cheaper, better capitalized, and growing just as fast. Sometimes I wonder what multiple Millicom would trade at if it were renamed Liberty Millicom. Lilac trades at nearly 7x NTM EBITDA, while Millicom is closer to 5x.

Upon taking the reins at Millicom, Mauricio zoomed in on a few core operating goals:

1. Operate ethically and with first world governance;

2. Invest in assets that support high speed, anywhere data transmission.  This means fiber or HFC fixed assets and 4G mobile;

3. Invest in filling its network (i.e., more customers and more usage), without sacrificing customer lifetime value;

4. Become more efficient – take cost out while improving the customer experience, re-investing savings in the network;

5. Focus only on markets and assets that are strategic and where Millicom can lead and earn a respectable return on capital (divesting anything non-core);

6. Opportunistically bolt-on strategic acquisitions.

He and his team have crushed it on all fronts, despite a very challenging operating environment (currency pain, sluggish LatAm economic growth, a rapidly declining traditional mobile voice and SMS business, inheriting a corruption scandal).

Operations:

While I have not seen it in any of their English language disclosures, per Millicom’s recent Spanish language deck for the media relating to its Cable Onda acquisition, it has moved to #1 in “Home” in all of its LatAm markets except Columbia (where it continues to build furiously).  This means that since Mauricio became CEO, he’s helped drive market share for the Home business from #2 to #1 in at least four of Millicom’s markets.

Millicom operates in difficult markets.  Just ask its competitor, Telefonica, which is suffering from poor operational execution and recently announced the exit of a number of its LatAm businesses to America Movil (Carlos Slim’s operation).  Millicom’s competition already included America Movil in several markets (dba Claro).  Claro is formidable and generally rational. Likewise, Lilac nemesis, Digicel, operates as a mobile-only competitor in a few of Millicom’s markets.

Until recently, Millicom’s core markets were Columbia, Honduras, Paraguay, Bolivia, Guatemala, and El Salvador.  In December, Millicom completed the acquisition of the leading independent cable company in Panama (Cable Onda), a perfect asset from a strategic perspective (Lilac is its primary competitor).  Millicom also has non-core African assets, which I don’t plan to extensively discuss, but will briefly touch on later.

While voice, SMS, and equipment centric mobile economics have been in dramatic decline, data-centric businesses are creating more differentiation, better economics, and deeper customer relationships.

Many of my favorite set-ups are what I call swimming ducks: at the surface, there is little to see, but beneath the surface, there is a dynamic environment temporarily being masked by the stillness at the surface.  In Millicom’s case, this was a declining legacy business and a rapidly growing data business. For a few years, the declining business was overwhelming the growth in the new business. As the legacy business became smaller and the data business grew, the dynamic began to slowly shift.  We have now come out the other side, and Millicom is growing in nearly all of its markets. That dynamic can be seen in the graphic below from Millicom’s Q3 earnings report.

If you disaggregate the LatAm business into three parts: B2C Mobile, B2C Home (i.e., cable), and B2B, you can see that Mobile was the source of negative growth.  As B2C Mobile has shifted from its analog roots (2G and 3G) to a digital future (4G+), that business has stabilized. In its April 2, 2018 report on LatAm telcos, Goldman estimated that postpaid churn is 60% lower than prepaid. Data-centric mobile as well as multi-play bundling target precisely this outcome: simultaneously growing subscription-like economics while lowering cost to serve.  At the same time, Home and B2B continue to rapidly grow. This will become more pronounced with Cable Onda included (which is primarily a Home and B2B business – deal closed Dec. 2018). Pro forma, Millicom more than 40% of its current run-rate revenue base comes from Home and less than 30% from legacy voice and SMS mobile.

Millicom is clearly a growth business, but trades today at 5x EBITDA.  This implies a stodgy, declining business with little hope of generating meaningful FCF.  We believe that lens is blind to reality.

As you can see above, Millicom is growing.  In particular, Millicom’s Home business is rapidly growing.  This is heartening, as cable subs are its most valuable / least commoditized customers.  This acceleration is primarily driven by two things: 1) sustained, large organic new builds; and 2) the near-completion of overbuilding its own old copper business (which meant a great deal of new HFC customers came at the “expense” of legacy copper customers…swimming ducks).  With this self-overbuild effort concluding and the new build operation accelerating to 1.2 million homes per year (which is world class), Home and B2B will remain robust growers. Over time, if Millicom achieves a 30% penetration rate on new builds (below its track record), that will add 360,000 HFC subs p.a.  On a base of 2.75 mm subs as of year end (ex-Panama), that’s portends a 10%+ Home subscriber growth rate for many years, while improving the competitive position for B2B and winning in an increasingly converged world.

As Home and B2B become a larger and larger share of the overall revenue pie, their growth rates will increasingly drive the overall business.  The Cable Onda acquisition increased Millicom’s number of homes connected by nearly 15% (from my estimate of 2.75 million as of December to around 3.1 million pro forma for Cable Onda).  While Mobile currently remains the largest business, Millicom is rapidly closing in on Home + B2B revenue of 50%. Within the remainder, which is essentially B2C Mobile, the higher quality “mobile data” subsegment will increasingly be a large portion of overall Mobile (with voice and SMS shrinking).  With Home growth rates >10%, B2B in the high single digits, and B2C Mobile positive low single digits, we should continue to see accelerating revenue trends. This growth will stabilize in the MSD range, as the faster growing portions become a larger and larger part of the mix.

Supporting that growth is the aforementioned large and high returning organic “build and penetrate” opportunity.  Unlike in the US and developed Europe, where passing homes often costs >$1000/home, in Millicom’s markets it costs <$100.  Even with commensurately lower ARPU, Millicom is generating >30% unlevered stabilized yields on new builds.

Millicom is passing these homes with first-world HFC/Docsis 3.0 infrastructure, creating a long monetization runway to drive those yields much higher over time.  Millicom’s infrastructure supports speeds like you can get in the US, but currently sells most customers 5-10mbps. As these economies grow, Millicom will be in the pole position to continue to serve customers’ growing needs, gradually increasing existing customers’ speeds for many years with limited incremental CapEx. This scalable infrastructure offers an incredibly bright future for market leaders with quality assets.

To understand the scope of the opportunity in front of Millicom, I’ve included penetration rates from Millicom’s recent Nasdaq listing presentation.  These are poor countries, but that also means the runway is long and the competition is less meaningful.

Millicom has been capitalizing on this by passing 1 million homes with HFC per year (probably closer to 1.2 million in 2018) and simultaneously executing a massive 4G buildout.  As of YE 2018, Millicom should have around 10mm HFC homes passed. Combined with its 4G push, Millicom’s rapidly growing data-centric customer base is much higher quality than Millicom’s legacy business of prepaid voice and SMS.

While investing heavily in growth and competitive differentiation, Millicom has simultaneously managed to drive margin enhancement.  This can be seen in the persistent YoY improvements that Mauricio and Tim have overseen. Within LatAm, Columbia has been the margin laggard, though its top-line growth rate has accelerated on the back of this margin investment.  Improvement in Columbia over the coming years will continue to drive the overall LatAm margin upward (as will blending in the Cable Onda acquisition).

You can see the recent margin evolution by market in the graphic from Millicom’s Q3 2018 earnings presentation below.  Note, these are before corporate expenses and are not proportionate:

Going forward, Millicom is guiding to accelerating top-line growth, expanding margins, and flat CapEx, implying increasing free cash flow and ample financial flexibility to continue to bolt-on acquisition opportunities that periodically arise.

Note: 2019 CapEx includes $85mm for Panama, but otherwise is like-for-like. Not adjusted for proportionate stakes.

At the recent investor day, management all but said the high end is their real expectation for the year ahead (basically barring an economic slowdown in their markets).

Proportionate Ownership:

It must be noted that Millicom has many important minority owners in its various businesses.  When one looks at KPIs, debt, revenue, profitability, and margins, the “gross” is what is reported, but the net - or “proportionate” - is what really matters.

Millicom owns:

• 80% of Panama (Cable Onda)

• 55% Guatemala

• 67% Honduras

• 50% Columbia

• 100% of all other LatAm countries

One of the “M&A” opportunities that Millicom regularly mentions as possible is buying in the minority interests of the above countries (discussed further in the M&A section below).

Capital Efficiency:

Africa:

Since Mauricio took over, Millicom has deprioritized its African assets.  Virtually all of its African operations have been for sale during the past four years.  In the meantime, the African team leadership has been given the directive to operate at CF breakeven or better (EBITDA less CapEx).  Millicom has sold most of its African businesses at multiples closer to or higher than where Millicom itself trades today (despite the LatAm assets being much higher quality).  These sales have liberated capital for reinvestment back into the core LatAm business. Today, Millicom’s remaining Africa operations are comprised of Chad, a Ghanaian JV, and Tanzania (which Millicom has partially exited).

Tower Portfolio:

In addition to exiting Africa, Millicom has monetized several of its tower portfolios to shared infrastructure operators.  This has freed a small fortune in tied up capital across a handful of transactions during the past few years.

Collectively, these African and tower divestitures have generated $800 million in proceeds, as can be seen in the below infographic from Millicom’s Nasdaq listing presentiation.

I expect Millicom will continue to opportunistically consider these types of monetizations.

Dividend:

Millicom is fairly committed to paying a significant dividend, almost certainly at the behest of its lead owner, Kinnevik.  While I would prefer that the company retain more capital allocation flexibility, the 4%+ yield is attractive ($2.64/share).  This dividend, when combined with the large organic build opportunity, likely limits Millicom’s use of buybacks.

Debt Profile:

At Sept. 30th, Millicom was at 1.8x Proportionate Net Debt / Proportionate EBITDA.  The Cable Onda acquisition elevated this to 2.5x, and Millicom will gradually bring this back down closer to 2x.  During a heavy investment phase, such as the build out Millicom is undertaking, this lower debt is implicitly required in order to continue funding its dividend.  Millicom obviously runs a much lower debt profile than Lilac, which is more like 5x (Lilac’s Net Debt / EBITDA = Millicom’s EV / EBITDA).  Despite lower debt levels, several of the other principles of the Liberty-related cable equity playbook are still at work.

Like most Liberty influenced companies, Millicom aggressively manages maturities, tries to match debt to local operations (rather than HoldCo debt), currency matches, and has a primarily fixed rate profile.  These goals are still “in process” but the direction of movement has been clear and consistent. After the recent $500mm issuance for the Cable Onda acquisition, the average maturity is around 5.3 years.

Inside Ownership:

In addition to Kinnevik’s 38% ownership, Dodge & Cox owns 11%.  Mauricio owns a good chunk of stock equal to approximately $5 million.  Four times in the past 27 months, he has purchased $500k - $1 million of stock on the open market near today’s prices (at $43 in November 2016, $56 in May 2017, $62 in August 2017, and $63 in May 2018).  Most of the purchases came after the stock fell substantially, even as clear operating improvements were becoming visible.

M&A and Valuation:

Millicom has several potential acquisition targets, none more obvious than the minority shareholders of its own operating subsidiaries (e.g. purchasing the 33% of Honduras it does not own).  Practically speaking, Millicom is the only buyer of those assets. Likewise, Millicom has in-market bolt-on acquisitions that it continues to do, generally very small cable systems but some larger opportunities as well.

Importantly, Millicom itself is a desirable M&A target, which was recently validated by Lilac’s publicly announced, albeit short lived, interest in “acquiring” Millicom.  We believe Lilac sees the same thing we see, which is that Millicom’s operational turnaround is well underway.  Millicom is now deep in replication mode for its successful organic build process. Lilac was fishing to see if it could consummate a deal before the asking price took off.  We believe Millicom rebuffed this overture based on management’s assessment that operational upside is significant, the current valuation is unreasonably low, and that Lilac paper is comparatively unattractive (both valuation and leverage).

In essence, both Millicom AND Lilac believe Millicom is the better investment, but only one of them can have it (for the time being).

As you can see in the graphic above, Lilac and Millicom have virtually zero competitive overlap, with Millicom’s recent acquisition of Cable Onda in Panama as the only meaningful conflict.  In the meantime, as Mauricio said at the recent investor day, “there could not be a more rational competitor than our competitor in Panama.”

It is not hard to imagine the blue, red, and purple all turning the same color in the future (and perhaps bolting on Altice’s high performing DR business).

It is worth noting that while Mauricio and Lilac CEO Balan Nair know each other from Mauricio’s Liberty Global days, they also both serve on the Charter board.  Despite defecting, Mauricio appears to remain in the good graces of the Malone complex.

At 5x EV/EBITDA with 2.5x turns of debt, not much has to change in how Millicom is perceived to generate explosive upside.  As the world comes to realize that Millicom’s talented management has transitioned the company to a quality top-line grower with expanding margins and declining capital intensity, it is easy to imagine a significant re-rating, which flows directly to equity owners.  In the meantime, as the business grows, Millicom shareholders stand to benefit from a levered cable equity return story overseen by an unusually talented leadership.

Millicom’s recent all cash acquisition of 80% of Cable Onda for 7.9x 2019 EBITDA (pre-synergies) stands in stark contrast to Millicom’s own trading multiple.  Lest we think that Millicom trades cheap simply because it operates in crappy markets, America Movil’s just announced acquisitions of Telefonica’s directly competitive assets in Guatemala and El Salvador was for nearly 10x 2018 EBITDA (pre-synergies).  Likewise, long-suffering Lilac shareholders know that, several years ago, it paid out the wazoo at >10x times for C&W, which, in addition to some nice cable and B2B/subsea assets, was primarily a large copper and mobile business. While we are at it, stodgy old America Movil itself trades at around 6.0x 2018.  Mexico’s Megacable trades at nearly 8.5x TTM. Goldman estimates that typical LatAm mobile M&A comps have been done at >9x trailing. I could go on. Suffice it to say that Millicom is completely ignored.  I expect this to change as its operating performance becomes increasingly undeniable.

Setting aside what others trade for, if Millicom grows EBITDA by mid- to high-single digits and de-levers back to 2.0x over a three year period (while paying a 4% dividend), it’s easy to have no sentiment change and still make 50% - 60%+ (16% - 20% p.a.).  That’s not what I’m playing for, but it’s within reach with no requirement for Mr. Market to care one iota about Millicom. That return is driven by the combo of levered equity + low multiple + growing cash flow. Re-rating provides dramatic optionality above that.

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Worries and Risks:

• Millicom operates in “exciting” countries, characterized by weak institutions and low income demographics;

• Millicom doesn’t generate substantial free cash flow, as it is currently redeploying virtually all excess cash into its organic expansion opportunities (fixed and 4G/mobile data);

• The ownership is de facto controlled by Kinnevik, which currently demands a large dividend in order to redeploy that cash into its other portfolio holdings.  I suppose this cuts both ways, but it’s restrictive of Millicom’s degrees of freedom;

• Key Man Risk: while the business would be fine if Mauricio left, I take great comfort in his leadership. I don’t believe Millicom – at it’s current scale – will be his final home. He is perfectly capable of running a leading global telco.  That said, my personal view is he views Millicom as either his platform for building the leading LatAm telco or he will sell the business. But not at these prices, and not yet;

• Corruption: shortly after Mauricio took over as CEO, Millicom self-reported a corruption issue that led to a FCPA investigation by the US DoJ (the issue predated Ramos joining the company).  Millicom was ultimately cleared of legal liability (which is an amazing outcome) as a result of its transparent, cooperative approach and installing new anti corruption procedures. However, many of these countries have operating environments that raise this risk;

• Low multiple stocks may have explosive upside from small changes in multiple, but this cuts both ways as small changes in multiple to the downside feel magnified as well.

Odds and Ends:

• Millicom owns a very large mobile payments business, Tigo Money.  It is not Johnny Come Lately, as the service is over a decade old.  Millicom does not currently attempt to meaningfully monetize Tigo Money.

• For those who love Mercado Libre’s Mercado Pago or Alibaba’s Alipay, Millicom’s management has stated that Tigo Money is the “largest mobile payment platform in Latin America”.  [I’m not sure how this is measured, so I wouldn’t put too much value in it.]

• For instance, in Paraguay, over 5% of all payments go through Millicom’s system and over half of all adults use it.  “[In Paraguay], we do more transactions than the entire financial sector. El Salvador, in Honduras, these numbers are about the same.” (Mauricio Ramos at January 2019 investor day)

• Currently, Tigo Money is primarily used as a value added service customer retention tool.  Management has said that the churn of a Tigo Money user is half that of a non-user.

• Tigo Money has more than 4 million users.  Again from Mauricio at the January 2019 investor day, “We have over 1 million [users] in El Salvador, 1 million in Honduras, over 1 million in Paraguay, we've launched in the rest of Central America, and it is an increasingly fantastic platform. The NPS on our Mobile business, on Tigo Money, is 80. I don't think Apple gets that kind of NPS, to be honest with you. It is fantastic. The churn on a Mobile subscriber is half of what the churn is on a -- on a non -- on a Tigo. So, we are monetizing our mobile financial services. But you only get that volume, you only get that level of customer satisfaction if you're willing to not be transaction-driven and price-driven on what you're charging the consumer. So, there's a quick [indiscernible] to this. The minute you want to start monetizing it, you lose all those attributes. So, for now, we're taking the strategy of this is effectively an added-value service to our platform…”

• I don’t think current Millicom management will try to turn this into a direct revenue generator, but I can imagine Millicom selling Tigo Money to or merging it with someone who will.

• Buried in the B2B business is a large data center portfolio (primarily Tier 3 DCs).  This supports the B2B business and overall network performance, but it also is theoretically a standalone high multiple business if sold.  Enterprise-focused data centers sell for 10-20x EBITDA (depending on contract quality, asset quality, market growth, scarcity value, vacancy, etc.).

• Millicom retains large tower portfolios in several geographies.  Again, these tend to be high multiple businesses.

Macro:

Catalyst

Catalysts: keep kicking ass: topline growth + margin expansion + increasing capital efficiency