Description

Thesis

I believe an investment in ZIGGO NA will generate a minimum of +15-20% total return per year with the potential for a large special dividend and/or takeout going in the next 12-18 months.    

• Ziggo has some of the highest and most visible growth within the European Cable industry (including TNET BB, LBTYA and KD8 GR), as well as in the global TMT sector
• Management is prudently utilizing the balance sheet and FCF to leverage the returns to shareholders
• In 2014, Ziggo can call/paydown restrictive bonds that will enable the Company to substantially increase the dividend towards 100% of FCF (~10% FCF yield) and/or re-lever the balance sheet for a special dividend
• Ultimately, I believe Ziggo will be an acquisition target for either LBTYA (pre-IPO speculation) or VOD LN

Ziggo operates in one of Europe’s most attractive cable markets characterized by oligopolistic structure, high population density, network ubiquity, wealthy population and numerous growth opportunities. In addition to strong industry tailwinds, Ziggo 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.

Investment Highlights

• High homes passed/Low product penetration. Ziggo grew top-line in the past couple of years at a high single digit rate.  Despite its high percentage of home passed penetration, the company’s penetration in digital TV, telephony and high speed broadband is still relatively low – offering significant opportunities for growth
• Duopolistic market/Limited competition. Ziggo operates in one of the highest population densities in the world where cable penetration is almost 100%. In the Netherlands, there are two cable operators with each operating in its own footprint with no overlap, where the main competitor to both is the telco incumbent KPN NA
• Superior Offering/Pricing. Ziggo’s services are delivered over hybrid fiber coaxial (HFC) cable network – among the most technically advanced in Europe
• Ziggo’s network is fully bi-directional/EuroDocsis 3.0-enabled – enabling download speeds of up to 120Mbps to all homes passed and significantly higher speeds with some additional capex
• Spectrum bandwidth capacity and network speed are substantially higher for TV and broadband internet services than other operator network in the service area such as KPN, Tele2 and Online
• Broadband/telephony pricing is cheaper than KPN as is the ‘All-in-1’ triple-play packaging – should come as ZERO surprise that the Dutch cable operators account for nearly all the broadband market growth
• Wireless Opportunity. Like other Euro Cable companies, Ziggo doesn’t offer wireless services, but intends to begin offering mobile services in the future
• Ziggo plans to leverage its fixed network and home WiFi routers, accompanied with public WiFi coverage to offer converged mobile solutions
• Ziggo is currently developing a converged proposition for voice, mobile internet and video services
• Currently, Ziggo holds mobile licenses in the 2.6GHz spectrum band, acquired for €1mm through a JV with UPC
• Strong Free Cash Flow and Tax Benefits. Ziggo has one of the highest EBITDA margins in the industry (59.7%) and low capital intensity (16% capex/sales target) due to its dense technologically advanced network (vs. mid-40s EBITDA margins for UPC and similar capital intensity)
• Shareholder-friendly capital returns. Ziggo has ~3.5x leverage currently which limits the use of their FCF, resulting in a modest dividend payout (~55% FCF / ~5% dividend)
• Ziggo restrictive bonds are callable in 2014, allowing them to use its significant FCF to pay a special dividend, initiate a large buyback or increase the regular dividend.
• Liberty Media (UPC’s parent) has previously expressed interest in acquiring Ziggo (as recently as the IPO)

Description

ZIGGO NA is the largest cable operator in the Netherlands passing ~56% of homes in the country, and providing standard TV, digital pay-TV, high-speed broadband internet and telephony services to consumers and businesses.

• Operating metrics:  At Q3 2012, Ziggo had ~4.2mm homes passed, with ~2.82mm standard TV customers (69.0% penetration), ~0.95mm digital TV (33.5%), ~1.44mm telephony customers (51.1%) and ~1.73mm (61.4%) broadband customers
• Broadband penetration stands at ~61.4% of their customer base vs. ~109% VMED and ~87% UPC Austria. Ziggo is unlikely to move to 100% broadband penetration given competition and market dynamics – I do expect penetration levels to reach ~75% in the next couple of years
• Telephony penetration stands at ~51.1% (Q1 ’12) of their customer vs. ~70-110% for their Euro Cable peers.  Again, it is unlikely Ziggo gets to 100% penetration – I do expect penetration levels to reach the low-end of the peer range
• Financial metrics: At YE11, Ziggo had ~€1.5B in revenues, ~€834mm in EBITDA (56% margin) and ~€600mm in OCF (40% margin) 
• History: Ziggo was formed in 2007 through the merger of three different Dutch cable companies, and is majority-owned by private-equity firms – Cinven and Warburg Pincus

Mobile Opportunity

ZIGGO NA does not currently have a mobile telephony business at all, other than some basic reseller agreements – and is looking to invest E100mm over the next few years for the eventual introduction of this service.

Ziggo has stated it is highly unlikely they look to acquire spectrum or build out a greenfield mobile service, but would rather look to rollout a mobile virtual network operator (MVNO) model – a strategy successfully deployed by other Euro Cable operators

• Ziggo is also looking to incorporate WiFi and other network-typed functionality to add incremental value
• Though mobile may be dilutive to overall margins – it is likely to be accretive to revenues and EBITDA
• Consensus estimates ascribe little contribution from mobile – though it could show revenues (and even earnings) in 2013
• Though no formal plans have been announced – given the available options and the current infrastructure Ziggo is already building – it seems likely Ziggo pursues a hybrid MVNO network capitalizing on short-range technologies and their existing network, infrastructure and scale

Ziggo’s competition in the Dutch market comes primarily from the incumbent KPN NV (KPN NA) and two resellers that utilize KPN’s infrastructure.

• KPN’s resellers are using the KPN wireline/telephony plant – so simply can’t compete with either Ziggo or UPC’s technologically superior cable infrastructure or quality of service.
• UPC (LBTYA) is an excellent cable operator, but has ZERO overlap with Ziggo – more likely an acquirer and did look at Ziggo prior to its IPO

Industry Backdrop

• Similar to the US cable firms, Ziggo’s upgraded cable/EuroDOCSIS 3.0 plant gives them a technology-based competitive advantage against competitors, including the incumbent telco KPN NV (KPN NA) and resellers (Telefort, Tele2)
• While KPN has spent significant capital over the last several years to modernize their telephony plant, they have decided NOT to spend the capex necessary to develop a network (via FTTH) on par with Ziggo’s
• At the time, KPN maintained margins and FCF – allowing them to return a large amount of capital to shareholders
• Today, KPN simply cannot compete against cable (both Ziggo and UPC), and now must invest heavily in the network to simply catch up

KPN FTTH Network (Reggefiber)

KPN is building out a FTTH network in the Netherlands – Reggefiber – thru a JV with Reggeborgh; KPN currently owns ~41% of Reggefiber.

• Currently, the FTTH network has ~951k homes passed (13% of HHs), another 813k homes ready to be used and 102k actual customers. 
• KPN hopes to capture an incremental 300-400k customers over the next few years (6% of HHs) – these customers will come from everyone (not just cable overall), and will also include cannibalized KPN customers
• KPN should gain 60% ownership control of Reggefiber by 2014 – cash flows will still likely be negative, while any debts will be consolidated under KPN
• KPN must exercise an option to acquire 10% of Reggefiber from Reggeborgh on 12/31/12 – paying  €99mm to take its stake to 51% - but still lacking technical control
• KPN must also raise its share any outstanding shareholder loans to 51% – incurring an extra ~€40-60mm in costs (dependent on how Reggefiber is funded in '12)
• Subject to regulatory approval, KPN will likely exercise a second option to acquire a further 9% on 12/1/14 – costing €116-161mm (depending Reggefiber’s capex efficiency) – taking KPN’s stake to 60% and gaining control
• Reggeborgh retains a put option to KPN for its residual 40% stake €647mm from 1/1/17, or put the stake to KPN at ‘fair market value’ at any time in the seven years post-exercise of the second option
• Bottom Line: Consolidating Reggefiber will actually increase losses and leverage at KPN – so it is likely KP takes a more measured approach to FTTH, leading to stable pricing and revenue growth

• Competition from KPN – currently benign but if KPN decides to regain market share and enters a price war, the market dynamics will deteriorate
• KPN fiber threat – fiber-to-the-home (FTTH) is the only network solution currently capable of providing equivalent broadband speeds
• KPN disclosed its fiber JV – Reggefiber –passed 951k homes with FTTH technology, or ~ 22% of the Ziggo’s ‘homes-passed’
• KPN was active in 813k of these ‘homes-passed’ and has activated 102k homes – modest threat thus far
• Regulation – the Dutch regulator found Ziggo to have ‘significant market power’ in broadcasting services resulting in the company having to allow access to resellers temporarily; The regulator has ruled that competition has improved but some appeals are still pending
• Potential runaway costs in mobile expansion – the company has currently limited its capex outlays for wireless to c €100mm, however competitive pressures may require bigger spend
• Margin pressures: ZIGGO NA is currently aggressively investing in their brand, upgrading customers to modern set-top boxes (STB) and preparing for their mobile launch. While there is a near-term impact on margins, Ziggo should quickly realize both operational and financials as a result of these investments.
• Private equity lockups / Limited current float

Capital Returns

Potential Takeout

Prior to the IPO – there was considerable speculation of LBTYA’s purchase of Ziggo – ultimately, I believe the two sides differed on price. A merger with LBTYA would make tremendous strategic/financial sense, and would ultimately be doable from a regulatory perspective, although there may be some competition concerns.

• Through the IPO, Ziggo’s PE holders were able to realize a 7.5-8.5x current year EV/EBITDA multiples based on comparables, ‘scarcity’ of Euro Cable names and the progressive capital returns policy
• Ziggo’s PE holders also likely believed in much of the story public investors have bought into – that they could benefit from the growth outlined above, and receive a substantial amount of capital returns over the next few years
• On a pre-synergy basis, I believe LBTYA may have been willing to pay up to 10x EV/EBITDA, but given their recent acquisition and subsequent integration of KBW (a large German cable company recently acquired) – the acquisition of Ziggo would have pushed target leverage ratios to the upper bound (or beyond), as well as impacted their capital return policy
• Ultimately, I believe timing and price played a significant role for LBTYA, and public/private-equity holder could reasonably expect LBTYA to return to the negotiating table once KBW has been integrated, and the group level leverage falls – somewhere between late ’13 and 2014
• This timing would also put LBTYA in front of the potential large capital return previously outlined, and could ultimately be the catalyst for the sale of Ziggo
• While it is unlikely there is a near-term bid for ZIGGO NA, I do believe any such bid would involve substantial upside to the shares (+30-50%)

ZIGGO NA currently trades at ~8.95x ’12 EBITDA and ~8.42x’13 EBITDA – roughly inline/slight discount with its peer group (TNET BB, KD8 GR) with likely lower conservative consensus numbers, faster growth and a larger product penetration ramp. Every +0.5x EV/EBITDA of multiple expansion equals +10% to the equity as a result of leverage.

Ziggo will return approximately +5% in each of the next two years thru dividends (~55% of FCF), and will likely return near 100% of FCF (~10% FCF yield), as well as a potential special dividend or substantial buyback.  Using a base case ~18% special dividend (€4.29/share) in late 2014 (re-leveraging to 3.5x EBITDA), Ziggo will return ~35-40% of its market cap to shareholders over the next 2.5 years, not including any equity appreciation or takeout potential.

Catalyst