Thu 05/25/2023 10:37 AM
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Relevant Document:
2022 Financial Report

Tele Columbus’ capital structure is unsustainable in the current interest rate environment given the German cable group’s poor cash generation, in Reorg’s view. The company would not be able to accommodate a higher coupon unless it right-sizes its capital structure. It is facing a €468 million outstanding term loan maturity in 2024 and a €650 million bond maturity in 2025. As a result, investors are pinning their hopes on a sizable equity injection from its shareholders United Internet and Morgan Stanley Infrastructure.

Tele Columbus said it expects a liquidity gap in the fourth quarter, which will increase in the following months. Management said the expected liquidity gap would need to be closed by the shareholders or third parties by means of liquid funds in the form of equity or debt capital. In this regard, the management board of Tele Columbus AG is in continuous talks with the supervisory board and main shareholders.

According to Reorg’s analysis, the company has general purpose senior secured debt capacity of up to €968.9 million.

Assuming a 5x EV/EBITDA multiple on a normalized EBITDA (post-IFRS 16) of €200 million, Tele Columbus’ value barely covers the secured debt comprising a €468 million outstanding senior secured term loan and the €650 million senior secured notes, or SSNs, as shown below. Hence, it is difficult to envision the company refinancing without any equity support. This also means that shareholders are out of the money, hence they are unlikely to have much bargaining power in a restructuring unless they put up cash.

Investors seem to agree that Morgan Stanley will be supportive, and at the current price of 65, yielding about 28.5%, according to Solve Advisors as of May 25, the upside from buying the bonds could outweigh the downside.

As of the end of 2022, Tele Columbus had €104.5 million of cash helped by a €75 million equity contribution in late 2022. Some investors commented that they would expect the shareholders to make an up to €500 million equity injection to pay down some of the existing debt and support a refinancing. Others suggested the company could also get a capital expenditure facility from banks to fund the rollout of its ‘fiber champion’ strategy.

Infrastructure funds usually feature a longer-term investment horizon than typical private equity funds, with five years of capital investment horizon and six to seven years of harvesting (return realization). Morgan Stanley only acquired Tele Columbus in 2021, at a consideration of 8x EBITDA and had said at that time it would support Tele Columbus in implementing the “Fiber Champion” strategy, and that the capex plan was not fully funded at close, according to an investor. In addition, forthcoming new regulation on the apportionability of cable TV costs that becomes effective from July 2024 was already in the pipeline before Morgan Stanley’s acquisition. It is expected that the regulatory change will lead to customer churn. However, we would be surprised if Morgan Stanley walked away should Tele Columbus struggle to refinance or run out of liquidity.

United Internet has been a shareholder of Tele Columbus since 2016. Investors highlighted that United Internet’s other assets like the 1&1 Telecoms network will benefit from the fiber network. An agreement in regards to the usage of the network was already signed prior to the takeover by Kublai. We note, however, that United Internet had only €47.4 million cash on the balance sheet as of March 31.

Tele Columbus is owned by Kublai, in which Morgan Stanley Infrastructure has a 60% stake and United Internet holds a 40% stake. At the time of the takeover in 2021, both shareholders said they would support the company’s “Fiber Champion” strategy, as part of which Tele Columbus plans to invest about €2 billion over a ten-year period. While the rollout of the fiber strategy will still progress, it might do so at a slower pace than initially targeted due to rising costs, some sources noted.

However, some investors said they have concerns whether both shareholders are still committed to funding the implied €200 million capex per year and support a refinancing now that the interest rate environment has changed. The shareholders have contributed about €550 million fresh equity over the 2021-2022 period.

The company said in an investor update from late April that it plans to refinance by the end of the year and is already working with advisors in regards to this. Tele Columbus has been working with Kirkland & Ellis as its long-standing legal advisor and has hired Perella to explore various options for its capital structure.

Some investors said they would value Tele Columbus at about 4x to 5x EV/EBITDA multiple, implying an enterprise value that would barely cover the group’s €468 million outstanding term loan and the €650 million SSNs, as illustrated in our scenario analysis above.

The 4x to 5x multiple compares with an average of about 5x for current public comparables, which is well below the median 7x multiple of M&A transactions in the sector over the past 10 years. Although not directly comparable to Tele Columbus, given its cable-only business focus, we note that public telecom players have a lower valuation than take-private or other private transactions, with public equity markets trading at a discount, which has resulted in a lot of consolidation and delisting transactions recently within the telecoms sector. See the trading multiples of Telecom Italia and Telenet in the industry peers table below and transaction comparables in the Appendix section.

(Click HERE to enlarge.)

On a post-IFRS 16 basis, Tele Columbus’ net leverage reaches 6.8x, above the telecom peers average of 5.1x (7.6x vs. peers’ 4.8x on a pre-IFRS 16 basis). Similarly, the group’s interest coverage ratio in 2022 amounted to 3.8x, which is below the average of its peers at 5.3x.

Due to the sizable capex plan to upgrade its network infrastructure and the long payback period of the fiber rollout strategy, Tele Columbus has been burning cash. Reorg estimates that the group spent €132 million of capex on both tangible and intangible assets in 2021 and €173.2 million in 2022 resulting in levered free cash flows after leases at negative €48.1 million in 2021 and negative €98.7 million in 2022. See historical financials in the Appendix section below.

The group states in its 2022 annual accounts that capex for 2023 will be similar to the level of the previous year. It also said that a slight overall increase in revenue and EBITDA is expected in 2023 compared to the previous year and non-recurring expenses are expected to remain at the same level.

Despite reassuring guidance from the company, its 2022 performance was disappointing, with net sales down 3.5% at €446.6 million and normalized EBITDA down 20% at €181.6 million. This was driven by investments in marketing and IT services and an 8% decline in TV revenue.

On top of that, there is a concern among investors about material regulatory risk with the change in regulation in mid-2024 when customers (building tenants) will have to be switched to individual TV service contracts (from being currently charged a fee by their building housing association, with which Tele Columbus has a contract). This could lead to high churn in the TV segment and further earnings pressure as a result.

Sources Reorg spoke to suggested potential churn rates could be as high as 50%, which would only be partially compensated by higher prices. Revenue loss in the TV segment would also be compensated by higher revenue in the internet segment as the fiber expansion progresses, sources added.

Given the poor cash generation, the group would not be able to accommodate a higher interest rate on its debt, unless it right-sizes its capital structure.

Recently, Italian technology, media and telecom group Telecom Italia, which is rated about two notches above Tele Columbus, priced a €400 million bond tap at 100.75 to yield 6.687%, which is much higher than Tele Columbus’ 3.875% rate on its SSNs. Similarly-rated bonds of French telecoms operator Altice France and Balkans-focused telecom business United Group are currently providing wider yields and we anticipate Tele Columbus may need to offer a premium to compensate investors for the group’s weak credit history and operational risks.

Assuming that a sustainable interest coverage ratio for single B rated issuers is 3x, and a normalized EBITDA is €200 million, the maximum level of interest expenses that Tele Columbus can bear is €67 million. Reorg assumes a normalized EBITDA of €200 million since management said it expects EBITDA in 2023 to be slightly above the 2022 level of €181.6 million, but €200 million is still below the group’s past seven year average EBITDA of about €230 million.

As a consequence, assuming that Tele Columbus would need to offer at least an 8% yield on new bonds and a 3x ICR, we calculate that the level of sustainable interest bearing debt for the group is in the €800 million area, a significant debt cut to the current total gross debt amount of €1.1 billion (sum of SSN and TL outstanding). An investor said that a sustainable gross leverage ratio could be around 4x and ICR at 2x, although it is difficult to estimate a run rate of normalized EBITDA for the group, given the lack of management guidance.

Investors said the company’s shareholders could use a sizable equity injection to pay down debt and refinance the rest or implement an A&E transaction combined with an equity injection to prefund capex and lower leverage.

The company could implement an extension of its term loan due October 2024, however, it is unlikely that the lenders would agree to extend beyond the maturity date of the senior secured notes due in May 2025 and, without a parallel extension of the senior secured notes, this does not buy the company much additional time.

Whilst any extension of maturity under the senior secured notes requires the consent of 90% of the outstanding principal amount of senior secured notes, European leveraged loans will typically require all lender consent, or the consent of each affected lender, for a maturity extension. In the event the company does not overcome this threshold, a non consensual route may need to be considered such as a scheme of arrangement or Part 26A restructuring plan.

We note that Tele Columbus would need to offer something to lenders in return for them giving consent to an A&E. For example, last February Altice France completed an A&E on its term loans B due 2025 and 2026 after proposing a step up in the margin to 5.5% from 3% as well as an OID of 3% on the 2025s and 2% on the 2026. Similarly, Lycra recently refinanced its €250 million 5.375% senior secured notes due 2023 with an ad hoc group of noteholders by issuing €300 million of 16% senior secured PIK notes due 2025 (issued at 20% OID), which were secured through a dropdown transaction by an additional €75 million of intellectual property not available to its existing notes.

Given the limited capacity to absorb higher cash interests, Tele Columbus could also capitalize a significant portion of the interest expenses to allow the business to recover and improve cash generation, hence any new or amended debt, if any, may feature a PIK-toggle interest rate.

Financial Overview

The group’s historical revenue to cash flow bridge is below:

Transaction Comparables

(Click HERE to enlarge.)

-- Aurelia Seidlhofer, Giulia Rusconi, Cedrick Cassin
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