Description

Summary

Telenet is Belgium’s largest cable operator. Pessimism in the European telecom sector has weighed on the stock and the market overly focused on near-term earnings variability rather than normalized/sustainable cash flow. Valuation appears attractive on free cash flow (12-14% yield), dividend yield (~8.5%), and relative to the sector. M&A optionality exists through the majority shareholder.

Investment Thesis

The investment thesis rests on the following:

• Attractive valuation based on 2021 and normalized cash flow estimates – Market valuations appear attractive on an absolute and relative basis at ~8.5% dividend yield, enterprise value / normalized earnings yield of 8.5%-11.5% based on reasonably conservative assumptions (see Valuation section below)
• Numerous possibilities for shareholders to realize cashflow (dividends, share buybacks, debt reduction) – Annual dividend floor of €2.75 per share (8.5% dividend yield at €32 per share) was recently reaffirmed by management. Medium-term debt reduction is also feasible and would lower current leverage towards other sector comps, potentially supporting multiples closer to less levered Scandinavian peers such as Elisa and Tele2.
• Potential for takeover well above current levels ­– Liberty Media owns 58% of Telenet and may seek to consolidate / tender for minority shareholders’ stake. Historical M&A has historically been ~10x EV/EBITDA (€70 implied share price). Liberty attempted to buy out other shareholders in 2012 at a 14% premium (€35) but the offer was contested by the board and an independent valuation committee. Only 8% of shareholders tendered their shares, suggesting renewed attempts would be at higher premiums.

The opposing / bear case view is underpinned by long-standing (justified) pessimism over the European telco space generally. Lackluster equity free cash flow generation in recent years and perennial forecasts of lower future capex have weighted on investor sentiment; fiber capex for European telecos generally is still unlikely to fall until the late-2020s. Europe has also historically faced challenging regulatory regimes. Expected improvements in free cash flow through equity could allow regulators to become more even more punitive and/or allow for new entrant operators. Telenet’s strong position in Belgium combined with stable, substantial margin of safety at recent trading levels, and consistent FCF delivery of >€400 mn pa offsets these risks. The well-covered dividend floor also supports shareholder returns at recent trading levels.

Company overview

Telenet has plenty of sell-side coverage so I will keep discussion of the business' operations brief. Write-ups from glgb913 in 2016 and cross310 in 2014 provide more background on the company. 

Telenet Group Holding (Telenet) is Belgium's largest cable operator. The company provides broadband services in Belgium and Luxembourg. Telenet Group also provides voice, data, and Internet services for businesses under its Telenet Solutions brand. Liberty Global owns nearly 58% of the company. The company reports results by cable subscription, mobile subscriptions, and business services/other:

• Cable subscription (56% of FY2020 revenues):  Telenet generated €655mn revenue from Broadband internet, €559mn from Video sales and €225mn from fixed line. Overall cable subscription revenues are likely to be stable for the foreseeable future with broadband growing 1.5-2.0% for a year or two before flattening, video sales declining slowly (less than 50bps per year) and fixed line declining more rapidly (~2.0-3.0% per annum).
• Mobile subscriptions (18% of FY2020 revenues): Telenet generated €451mn from mobile subscriptions. Low single digits % growth is likely in the mobile.
• Business services and Other (27% of FY2020 revenues): Business services are expected to generate 2.0-3.0% growth over the medium term.

Financial analysis

Liquidity & financial leverage– Telenet has higher leverage relative to the sector average at ~4x net debt to EBITDA. The debt profile is attractive, however, with no near-term maturities. Short-term debt as percentage of total outstanding has risen in recent years but remains below 10% of total debt. ~30% of pre-tax income is allocated towards interest payments, which is undoubtedly high but should be manageable given Telenet operational stability (stress tested in 2020) and free cash flow after interest payments; EBITDA less capex was over 5x greater than 2020 interest expenses.

Recent earnings (Q1 2021) – The company added 9,000 net new broadband internet users in Q1 2021, 18,700 net new FMC customers and customer ARPU up 3% yoy in Q1 2021. Growth was positive despite a tough, pre-covid comparison with rebased subscription revenue was up 1% and adjusted EBITDA up 4% despite a 27% net profit decline. Other highlights include:

•          Q1 2021 revenue of €645.9 million, -1% yoy  reflecting a 9% decrease in other revenue
•          Net profit of €112.5 million in Q1 2021, -27% yoy, due to higher income taxes
•          Q1 2021 Adjusted EBITDA increased almost 4% yoy driven by significantly lower direct costs as our Q1 2020 direct costs reflected the accelerated write-down of broadcasting rights due to the global COVID-19 pandemic
•          Operating Free Cash Flow of €201.9 million in Q1 2021, +15% yoy, mainly driven by substantially lower investments in Q1 2021
•          Adjusted Free Cash Flow grew 49% yoy in Q1 2021 to €124.0 million, driven by lower cash interest and derivative expenses following refinancings in 2020

Earnings outlook – Management reiterated guidance in Q1 2021 with up to 1% revenue growth in revenues and 1-2% growth in EBITDA during 2021. Free cash flow is estimated between €420 and €440 million for FY 2021. The company expects to deliver on the lower end of their 2018-2021 operating free cash flow growth targets of 6.5-8.0% during 2021. The annual dividend floor of €2.75 per share was reaffirmed (€300mn aggregate).

Telenet's outlook for both a return to top-line growth and adj. EBITDA growth (1-2%) is supportive relative to sector growth and peers. Consistent delivery of €400mn FCF is likely achievable. As mentioned, the company is highly levered relative to the sector (3.5-4.0x) but has an attractive debt profile with no significant maturities until 2026 and significant free cash flow generation after interest payments (~€400mn). Management outlook for 2021 consists of revenues €2,573mn (+1%), EBITDA €1,346mn (+1-2%), operating FCF of €826mn (-1%), FCF €420-440mn. Cash capex was EUR475mn in 2020 and €432 in 2019mn.

Normalized earnings / free cash flow – Normalized free cash flow is likely between €775mn (€2,500mn revenue @53% EBITDA margins and €550mn capex) and €1,050mn (€2,700mn revenue @53.5% EBITDA margins and €400mn capex) over the next three to four years.

Valuation

Market implied valuation – Market valuations appear attractive at ~8.5% dividend yield, 8.5%-11.5% normalized earnings yield based on the wide range above.

NPV is a reasonable approach to valuing Telenet given recent operational and earnings stability. Backing out the implied discount rate based on reasonable assumptions suggests substantial market pessimism. At the current share price, the market implied discount rate is in the high-teens (17-18%) assuming 10x exit multiples and base case forward operating assumptions (53-54% EBITDA margin, 21-23% depreciation as % of sales, €500-575mn of capex per annum, declining revenue in fixed line & video, two years of ~1.5% growth in broadband sales).  Telenet’s Euro-denominated 1^st lien secured notes due 2028 currently yield ~2%, for comparison.

Absolute valuation – The same operating assumptions above valued at 10% discount rate and 10x exit yield by 2024 suggest values of ~€55 per share (+70% above recent share price). 7-8% discount rate would suggest low-to-mid €60 per share (2x recent levels) and are arguably fair given the return on capital, and prospects for moderate revenue growth. Historical M&A in the sector has been ~10x EBITDA would imply valuations above €70 per share (>2.3x recent share price).

Relative valuation – Telenet is trading at 11% 2021E FCF yield versus 7% for the sector. Euskaltel in Spain offers the best comparable from an avg. ROIC and net leverage (~4x) perspective; Euskaltel trades at 5.5-6.0% free cash flow yield. Valuing Telenet using 7% free cash flow yield would suggest instrinsic value of €50-85 per share.

Risks

The Belgium regulator could introduce more burdensome regulator, new entrants or other competitive pressure could dampen medium-term earnings, increase in long-term financing costs would dampen levered free cash flow

Catalyst

Potential for tender (Liberty owns 58%) or takeover. Infrastructure monetization could also be a catalyst. According to press reports, there will be a renewed process to sell Voo (cable operator in Wallonia) which Telenet could acquire; analysts estimate synergies of €50-80mn pa.