2021 | 2022 | ||||||
Price: | 32.00 | EPS | 0 | 0 | |||
Shares Out. (in M): | 114 | P/E | 0 | 0 | |||
Market Cap (in $M): | 4,439 | P/FCF | 0 | 0 | |||
Net Debt (in $M): | 6,214 | EBIT | 0 | 0 | |||
TEV (in $M): | 10,682 | TEV/EBIT | 0 | 0 |
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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:
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:
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:
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 1st 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
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.
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