Description

EVENT-DRIVEN IDEA: TNET BB

DESCRIPTION

Telenet Group Holding NV (TNET BB) provides television, telephone and Internet services through a network of fiber-optic and coaxial cable, as well as mobile services using an MVNO model.  The company is the largest cable service provider in Belgian covering the Northern half (Flanders) of the country.  Liberty Global (LBTYA) is the controlling shareholder with just above 58% ownership.        

THESIS

I love investing in cable globally, I love levered equities and – for the most part – betting with John Malone has been very rewarding for shareholders. 

This is a pretty straightforward thesis:

• Bet on M&A (LBTYA)
• Bet on Malone (Tax Efficiency, Dividends and Buybacks)

I believe that TNET can provide a +25-50% return to shareholders in the next 6-18 months through a combination of buybacks, dividends and earnings growth.

Separately, I believe there is a very high likelihood that controlling shareholder LBTYA bids for the shares they do not currently own in the next 6-9 months. If LBTYA de-levers as I think they will when they buy ZIGGO NV (see my previous writeup), then TNET will be next on the agenda.  The Liberty playbook is pretty straightforward.

Note: Press reports indicate LBTYA has revived discussions to acquire Dutch broadband provider Ziggo as Malone prepares to expand his footprint in the region. Ziggo said in an e-mailed release that it is currently in discussions with Liberty Global regarding a potential offer. Liberty’s CFO said that it was still interested in acquiring Ziggo, but only at the right price.

INVESTMENT HIGHLIGHTS

1) Macro/Competitive Environment

Similar to Ziggo, TNET operates in one of Europe’s more attractive cable markets characterized by an oligopolistic structure, high population density, network ubiquity, wealthy population and numerous growth opportunities. In addition to strong industry tailwinds, Telenet benefits from a growing market share, increasing penetration and ARPUs, solid FCF generation, potential opportunities for expansion into wireless as well as an attractive valuation. 

2) High Visibility Business Model

The cable business model is one of the most attractive out there – a subscription model with high-visibility and high incremental margins once capex is completed. TNET has fully upgraded its network, and is now competing against a telephony incumbent (Belgacom) with a technological disadvantage. Belgacom has never shown any desire to compete aggressively, and I expect competitive dynamics to remain stable.

3) Capital Returns

TNET has continued its policy of high capital returns to shareholders after announcing a €7.90 dividend (May 2013), or ~20% of market cap at time of announcement. In conjunction with the extraordinary dividend, TNET announced an ordinary buyback of €50mm to purchase shares below €35.  Lastly, TNET has publicly stated a policy of returning 100% of FCF and levering up towards 4.5x net debt/EBITDA, implying an annual capital return of at least €500mm (~10% of current market cap) for the next few years.

TNET Shareholder Disbursements

• May 3, 2013:      €7.90 per share (Gross extraordinary dividend)
• May 7, 2012:      €1.00 per share (Gross dividend)
• Aug 28, 2012:     €3.25 per share (Net capital reduction)
• July 26, 2011:    €4.50 per share (Net capital reduction)
• July 28, 2010:    €2.23 per share (Net capital reduction)
• Aug 27, 2009:     €0.50 per share (Net capital reduction)
• Nov 19, 2007:    €6.00 per share (Net capital reduction)

Over the past year, capital returns totaled approximately one-third of TNET’s market cap – mostly from the dividend.  However, future returns will likely take the form of buybacks that LBTYA will not participate in. As a result, the €500mm is ~25% of the free float of minorities. 

Bottom Line: I believe TNET will likely announce a near-term tender offer upon the expiration of the restricted period (January 18, 2014) at a premium to the current share price. 

4) Solid Revenue/Earnings Growth

I estimate TNET will grow revenues and EBITDA in the +7-10% over the next few years as it leverages its 100% fully-digital cable network vs. incumbent telco provider Belgacom (BELG BB).  Though a MVNO with Mobistar (MOBB BB), TNET’s entry into mobile has also materially accelerated revenue growth and driven market share gains. Though mobile is a relatively lower margin business, the MVNO allows them to retain customers (reduce churn) at a capex-light cost. I expect EBITDA to increase with penetration increases and lower incremental marketing spend. TNET also continues to see analog-to-digital upgrades and penetration increases in broadband and telephony. Similar to the Netherlands, this is a two-player market with TNET in a stable duopoly with Belgacom. Both players are currently pushing through price increases (see below).

Telenet Price Increases

• The cable subscription fee was increased to €15.35/month. This increase was made up of:
  • A new harmonized cable underlying fee of €11.65/month across the whole footprint. Previously, different charges were applied to different geographical regions. Some customers will now pay more, but around two-thirds of customers will actually pay slightly less than before. Overall, this will not be revenue accretive for Telenet on a like-for-like basis
  • An increase in the monthly contribution for royalties from €3.18 to €3.70. This increase will be passed onto the collecting agencies, so will be EBITDA neutral.
  • Inflationary (and yearly) price increases of +1.97%. These costs are increased yearly in-line with the "rising costs of supplying and developing these services". The following prices remained unchanged: 
    • All price plans for mobile including King and Kong
    • All “price per minute” prices and options for fixed telephony.
    • Overall, these increases imply inflationary increases in headline prices. Since the market continues to increase triple-play penetration, discounts still weigh on the overall product line ARPUs. 

5) TNET: A Great Portfolio Manager’s Stock

With an investment in Telenet, you’ll get an aggressive return of capital and a potential for tender offers at a premium as LBTYA executes its playbook. The remaining minority shareholders are a committed bunch, and in the stock for the long haul – no matter how brief that may be. As a result of the ‘smart’ investor base, the stock itself exhibits very little volatility relative to stocks in the space or to global stock indices, while maintaining  its upside (though a some liquidity sacrifice at €5mm ADV).

6) Other Ways To Win

• Price Increases: Given the stability of the Belgium market, I believe we will see pricing leverage from TNET, as well as the rollout of additional high incremental margin products. I have seen this over and over in developed markets.
• Mobile: Mobile has provided real upside to revenues and customer, and will ultimately this will flow to EBITDA and FCF growth – I believe we will start seeing these benefits in 2014.
• Takeout: With LBTYA owning a 58% controlling interest, a takeout of TNET is a “when, not if” scenario. With TNET and UPC Netherlands owning significant tax assets, LBTYA needs additional assets in order to take advantage of these assets (estimated to be ~€2.5B)…and I believe Ziggo is that asset (28.5% owned by LBTYA). To be clear, I don’t expect TNET shareholders to get much of a control premium, but instead to share in the synergies and tax benefits of Liberty’s consolidation of Europe’s cable.

RISKS 

1) Competition

An increase in competition from Belgacom would disrupt the Belgian market – though they have never shown any such aggressive behavior and their fixed networks business is still growing, while mobile continues to face pricing pressures. There are no other current competitors in the market. 

The Belgian Regulator recently published the details of the wholesale pricing for cable access in Belgium. Wholesale access will be priced on “retail-minus” basis of 30% (vs. “cost-plus”) for single-play analog TV, or a combo of analog and digital TV. For dual play, it will be priced at a 23% discount (TV and broadband). Per Bloomberg, TNET will challenge the Belgian regulator's decision in a ruling expected early next year. It is likely that wholesaling the network will only become a commercial reality in late 2014/early 2015. Telenet management is confident about wholesaling cable access given there are high barriers to entry: content, relationships, set top box functionality and interface and a legacy TV base that is happy. Even the initial terms came in about as expected, while timing is now likely pushed out. Regardless, I believe the situation is “de-risked” and it is unlikely a competitor enters and makes an impact in the scope of this investment timeframe.

2) Regulatory

Expanding on the above “Competition” risk – now that the regulator has shown their cards, the proposed pricing regime does not seem like it will produce enough margin for new entrants to aggressively compete. Also, given TNET’s appeal and the process it entails – it is unlikely we see a re-seller enter the market until late 2014. I won’t even go into the technology issues that need to be overcome.

CONCLUSION 

I’ve been involved with the Euro Cable names for over a decade, and have remain confounded at how conservative analysts are with this name. Make no mistake that LBTYA controls TNET, and will be more aggressive versus peers when needed. What this has translated to for investors vs. expectations: higher dividends, more buybacks and more assertive LBTYA ownership. 

TOTAL RETURN PRICE TARGET (6-18 MONTHS): €55 - €66 (+25-50%)

Price Target Components:

• Capital Returns: TNET management have indicated they will return 100% of FCF (~€310mm in ’13 growing to ~€350mm in ’14; ~€375mm in ’15), as well as take target leverage up to LBTYA levels, or from 4.0x to 4.5x net leverage (another ~€400mm+). TNET has publicly stated support of €500mm total return over the next few years, but there could be upside of >€700mm per annum while still staying within their leverage guidelines. Given the liquidity in the stock and the recent extraordinary dividend, I believe this will likely be in the form of a tender offer at a premium to the current stock price. A tender offer to the 42% minority holders will further reduce free float. I expect an announcement with the Feb 13, 2014 earnings date.
• EBITDA Growth: TNET currently trades at ~10x ’13 EBITDA estimates. Applying a 10x multiple on my 2015 EBITDA estimate of ~€1.0B yields a one-year forward price target of ~€57/share, or ~30% higher than current levels – assuming no re-leveraging, buyback or takeout.

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