Description

Buy TNET BB Equity

Trades ~$4mm / day

TNET was previously written up by cross310 on 1/4/14. We refer you to his good work on the name and recommend you read that first. We will skip the background info that he covers. What has changed since then:

1)      Fundamentals have improved, the business has grown

2)      TNET has acquired BASE and now has a converged offering with strong synergy potential

3)      The share price is the same, and valuation is significantly more compelling

4)      We’re less bullish on the prospects of LBTYA taking out TNET minority holders out in the near-term

Introduction / Positioning

Raise your hand if you’ve read Cable Cowboy. Ok, glad we got that out of the way.

On the one hand, the track record and monopolistic qualities of cable companies speak for themselves. On the other hand, there are lots of cable assets out there with mediocre (LBTYA, CHTR, CMCSA) to lousy (CVC, SJR, CABO) fundamentals (pricing trends, RGU growth, margins), but still commanding premium valuations. Combine this with strategic questions surrounding mobile, programming costs, regulatory challenges (a perennial industry woe), fiber competition, and, in some cases, “elevated” leverage, and it can be challenging to get excited about investing in many cable companies.

Thesis

TNET is a cable company worth being excited about. TNET has strong fundamentals in a rational and now converged market. We are excited about the BASE acquisition, and think that it will continue to drive further fundamental improvements in the business alongside a substantial synergy opportunity. On top of all of this, TNET trades at a discount to many peers at 6.5x 2018E EBITDA & 12% 2017E FCF yield.

We’re not huge fans of Malone/LBO math (because it basically works at any share price), but for those who are interested – MSD topline growth drives HSD EBITDA growth, decreased capital intensity and leverage drives low teens FCF growth, kickers from share buybacks and re-levering the biz + current 12% FCF yield, and it’s not hard to see a mid-20s IRR in the medium-term on this investment.

Or the multiple could contract and you could get obliterated (see: LBTYA). We clearly don’t think that this is likely over a reasonable time-horizon.

Insert plug on capital allocation, John Malone, etc.

We are not betting on the takeout that cross310 wrote up, and would love to ride the business as-is. There is a material probability that takeout occurs down the line, but we think that LBTYA is focused on leverage and other uses of its FCF right now.

Fundamentals

The fundamentals at TNET are strong, especially compared to peers. Cross310 covers a lot of the high-level aspects of the Belgium market.

Industry

Belgacom’s Proximus is the incumbent telco, leaning on its national copper footprint throughout the country. Unlike other EU incumbents, Proximus has made minimal fiber investment, which means that Proximus can only offer a maximum of 100 Mbps internet speed. TNET and other cable operators have been investing to reach 1 Gbps speeds, so cable operates in a duopoly with a superior product offering.

The mobile market has historically been weaker, with BASE driving more competition as a challenger, but is improving. BASE has 25% market share, Belgacom’s Proximus 45%, and Orange’s Mobistar 35%. BASE was struggling to compete without a converged offering (which KPN has been very successful with in its home Netherlands) which drove KPN’s decision to sell the asset. I expect increased convergence to drive further rationality in the mobile market.

Total industry ARPU / RGU is in the EUR 30 range, which is lower than other developed markets and provides room to run with price increases.

Company Specific Trends

TNET’s footprint passes 2.9mm homes in Flanders and Brussels regions. The population of Belgium is 11.2mm with 4.6mm households, for reference. Within the footprint TNET has 83% video (football is big), 53% internet, and 41% voice penetration.

• RGU growth moderate (1 – 2%) and should slow over time

• Tailwinds are a converged offering and superior product compared to copper

• Headwinds are the new cost minus 18% wholesaling agreement, which should drive some customers to wholesalers

• Pricing trends positive (2% “inflation” escalators + other usage-based pricing increases), low price base to start from; should continue in an even more rational market

• Converged market driving decreased churn, removes a lot of strategic questions

• Moving to 1 Gbps internet offering on current investment plan, should be able to reduce capex afterwards

• Additional cable acquisition opportunities with large synergies

• Not sure if VOO or Numericable are sellers

• Key Headwinds: cash taxes and regulation

• The company has not been a cash tax payer for several years, but started paying in 1Q 2015, unclear how this will progress

• Because of the fixed duopoly, regulators have decided to force wholesale agreements. Prices for wholesale regulation are not announced yet, but preliminarily looks like the offer will be retail minus 18% for double-play

• Retail minus 18% does a few things – 1) doesn’t incentivize price cutting from incumbents, 2) doesn’t provide much of a margin to drive massive growth from new entrants, especially with the back-end investment needed to enter the business

• At the end of the day, retail minus is very delicate, so this situation deserves monitoring

Valuation

We are above the street on FCF, largely driven by higher EBITDA. We don’t think that analysts are projecting the full run-rate synergies and also think the cash tax burden and capex spend will be lower than expected. The company has a pretty good spreadsheet with consensus estimates on its website.

To be clear: we don’t view our different numbers as the key “edge” here. We think the investment is compelling even if you just look at some of the smarter sellside numbers.

Risks

Three things worth keeping in mind.

1. At the end of the day, LBTYA probably wants the other 43%. We get nervous that there could be a temporary fall in the share price and that LBTYA could take out the minorities on the cheap

1. LBTYA tried to buy TNET’s other 49% in 2012 at a 14% premium (EUR 35); this offer received pushback from TNET’s board and independent valuation committee

1. http://www.libertyglobal.com/pdf/press-release/10-29-final-lgi-release-tnet.pdf

2. Ultimately, only 8% of the holders of TNET tendered their shares to LBTYA

3. Current Valuation metrics are significantly cheaper than those at the time of this proposed deal (see press release above)

2. Need 95% of shares to initiate a squeeze-out under Belgium law

3. We would appreciate any other insights that people have on this corporate governance dynamic

2. Regulators, cost-minus wholesaling, definitely worth monitoring

3. Illiquidity, could get trapped in the stock as TNET buys back shares

1. This could also result in widening gaps to intrinsic value as larger investors lose interest

Catalyst

It would be nice to chug along with share buybacks, special dividends, and underlying growth for many years.