Summary Thesis
Ziggo NV is the largest cable operator in the Netherlands passing c. 56% of the homes in the country. It operates in one of Europe’s most attractive cable markets characterized by oligopolistic structure, high population density, network ubiquity, wealthy population and ample opportunities for growth. In addition to strong industry tailwinds, Ziggo benefits from a growing market share, increasing penetration and ARPUs, solid cashflow generation, potential opportunities for expansion into wireless as well as an attractive valuation. Lastly, there are several shareholder-enhancing initiatives (deleveraging, special dividend, share repurchase, company sale) that could serve as catalysts for additional stock price appreciation.
Company Description
Ziggo is the largest cable operator in the Netherlands passing approximately 56% of homes in the country. The company is a provider of standard TV, digital pay TV, high-speed broadband internet and telephony services to consumers and businesses. The company offers both individual and bundled services and packages and it’s the leading provider of triple-play (“All-in-1”) offerings in the country. As of the end of the last fiscal year, the company had 4.2 mm homes passed, with 2.9mm standard TV customers (69.5% penetration), 0.9mm digital TV (21.3%), 1.3mm telephony customers (45.6%) and 1.7mm (56.9%) broadband customers. As of the last fiscal year, Ziggo had c. €1.5bn in revenues, €834mm in EBITDA (56% margin) and c. €600mm in OpFCF (40% margin). The company was formed through the merger of three different companies in 2007. It is majority-owned by two private equity players – Cinven and Warburg Pincus.
The “Bull” Story
In general, the main growth objectives of a cable operator are focused on two key metrics (i) increase “price” i.e. ARPUs; and (ii) grow “volumes” i.e. RGUs. The ARPU increases can be achieved through up-selling analogue/standard TV customers to digital pay-TV services, broadband subscribers to higher speeds and capacity or simply through ‘inflationary’ price increases. The growth of RGUs is achieved via bundling, up-selling voice and broadband services to existing TV customers. There are a number of attributes that support Ziggo’s growth objectives including:
- High homes passed penetration, lower products and services 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 as per the figures presented above. These dynamics offer significant opportunities for growth.
- Duopolistic market – limited competition: Ziggo operates in one of the most dense geographical areas in the world in terms of population where cable penetration is almost 100%. In the Netherlands, there are two cable operators with each operating in its own footprint with no overlap. The main competitor to both is the telecom incumbent KPN.
- Superior Offering and Pricing: Ziggo’s services are delivered over hybrid fiber coaxial (‘‘HFC’’) cable network, which is one of the most technically advanced in Europe. Furthermore the network is fully bi-directional and EuroDocsis 3.0 enabled which allows the company to offer download speeds of up to 120 Mbps to all homes passed and significantly speeds higher with some additional capital investment. The spectrum bandwidth capacity and speed of the network are substantially higher for TV and broadband internet services than the networks of other operators in the service area such as KPN, Tele2 and Online. The pricing in broadband and telephony is cheaper than KPN as is the “All-in-1” triple play packaging. That is why it is no surprise that the Dutch cable operators are taking nearly all the growth in the market broadband growth.
- Modest Threat of Fiber Competition from KPN: Fiber-to-the-home (FTTH) is the only network solution currently capable of providing equivalent speeds for broadband internet as those provided by Ziggo. KPN has disclosed that its fibre JV, Reggefiber, has passed 951k homes with FTTH technology, which represents about 22% of the Ziggo “homes-passed”. KPN was active in 813k of these ‘homes-passed’ and has activated 102k homes. So the threat so far is fairly modest. Furthermore, Ziggo can introduce even faster speeds (e.g. 400 Mbit/s), which will provide new challenges for the incumbent.
- Opportunities for Growth in Wireless Communications: Like other European cable companies Ziggo does not offer wireless services, however the company intends to begin offering mobile services in the near future. The plan is to leverage its fixed network and home WiFi routers, accompanied with public WiFi coverage to offer converged mobile solutions. Ziggo is currently in the process of developing a converged proposition for voice, mobile internet and video services. The company expects a cost of €100m over this period. Currently Ziggo already holds mobile licenses in the 2.6GHz spectrum band, acquired for €1m through a joint venture with UPC.
- Strong Free Cash Flow and Tax Benefits: Ziggo has one of the highest EBITDA margins in the industry (56%) and low capex intensity (target of 16% capex/sales), due to its dense and technologically advanced network. In comparison, the second Dutch cable operator UPC has EBITDA margins in the mid-40s and similar capital intensity. As a result, Ziggo generates significant operating free cash flow. Furthermore, the company has tax shields through early 2014.
- Shareholder-Enhancing Initiatives: The company currently has net debt / EBITDA ratio in the 3.5x range. Its current indenture limits the use of all the cash for shareholder enhancing initiatives and therefore the current dividend is relatively small. However, the company’s debt is callable in 2014, and it is likely that Ziggo will use its substantial cashflow to pay a special dividend, initiate a large buyback or increase the regular dividend. Lastly, Liberty Media, the parent of UPC, has expressed interest in the past in acquiring Ziggo, so a potential sale of the company can serve as and additional shareholder value enhancing catalyst.
Overall, the company’s market-leading services have contributed to the significant growth over the last few years (e.g. ‘‘triple-play subscribers’’ have increased from 29.4% in 2009 to 43.8% in 2011). These increases in turn have driven growth in RGUs and ARPUs. As a result, Ziggo blended consumer ARPU has increased from €30.42 in 2009 to € 37.34 in 2011. Given the solid market positioning, Ziggo is well-situated to likely continue such growth.
Valuation
In terms of peers, Ziggo prospects and operations are comparable to those Telenet and KDH. Currently, Ziggo trades on a 2012E c13.6x EV/OpFCF vs peers KDH and Telenet on 15.5x and 14.5x, implying 20-25% upside. On a DCF basis, assuming continued growth in the 5-7% and modest EBITDA margin expansion (c+200bp), Ziggo has upside to the € 30-35 range.
Investment Risks
- Competition from KPN – currently benign but if KPN decides to regain market share and enters a price war, the market dynamics will deteriorate
- 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
- Private equity lockups expiring in 180 day
- Limited current float.
Catalysts
- Debt Refinancing – deleveraging boosting valuation, improving credit profile and lowering borrowing costs
- Dividends – potential special or larger regular dividend
- Share buyback
- Company sale