Sunday 25 September 2016

Digicel pushes the growth story as stock market flotation looms

Denis O'Brien must persuade investors he can turn Digicel from a regional mobile operator into a full service telecoms and media behemoth

Published 05/07/2015 | 02:30

Mr O’Brien named all the elected representatives on the committee in his action.
Mr O’Brien named all the elected representatives on the committee in his action.

Denis O'Brien is going to have to sell something new. For the last decade, the Digicel chief has persuaded bond market investors to lend him $6.5bn to expand his mobile phone operation in the Caribbean and Pacific.

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And it has been clearly successful. It has grown from 400,000 customers in 2002 to 13.6m now, as it island-hopped with ruthless efficiency, arriving in a new territory, targeting the incumbent telco - and taking their customers.

However the days of the easy customer wins seem to be coming to an end. Barring Ethiopia's 90 million people, there are very few virgin markets where fast- moving mobile operators like Digicel can come in and grab market share.

Digicel has announced plans for a stock market flotation, in what could be the biggest ever Irish IPO. The rationale for Digicel to float is simple. It has $6.5bn in largely US dollar denominated debt and it wants to diversify its sources of funding by tapping up stock markets.

But stock market investors are different to bond markets. Raising money simply to reduce finance costs and pare back the $6.5bn debt pile is hardly going to "wow" potential investors. Digicel is selling a strong growth story too.

Much of the narrative over the last decade has been about O'Brien replicating the success of his Esat Digifone business in the Caribbean and Pacific.

"That's what they've done all the way through the Caribbean, basically identified islands that don't have any or much competition, get in there quick. They're relatively small countries so actually the capital outlay fro a mobile network isn't enormous because you're pretty stationed and you've got it covered," according to Steven Hartley, principal analyst at Ovum.

"The incumbent isn't set up to adapt to any of that sort of competition. They just can't cope with someone like Digicel with a sophisticated marketing plan, very aggressive pricing and a network that is just far more efficient," he said.

It worked well for a decade but now it is approaching maturity. Digicel has grown at an average compound rate of 32.3pc since 2002, during which time subscribers have risen from 400,000 to 13.6m. Digicel has a 50pc plus market position in 21 of its 31 markets. Subscriber numbers grew by just 1pc. After failing to win a licence in Myanmar two years ago, new territories with millions of new customers look thin on the ground.

"They've spoken about Africa in the past. And it's taken them a long while to get any further. There's very few opportunities that fit the Digicel framework really. They tend to look for markets that haven't had competition, or if they have it's been very very minimal," Hartley added.

Digicel is also facing more serious competition than it has in the past. Traditional Caribbean rival Cable & Wireless has got its mojo back and has just spent $3bn on fast growing cable operator Columbus. Improving broadband networks have also seen the likes of Viber, WhatsApp and other instant messaging services eat into demand.

Average revenue from customers has fallen from $17.50 per month down to $15.30 last year. "Competition is very intense across most of Digicel's markets. Digicel will also be facing a rising competitive threat from a 'new' Cable & Wireless Communications since that company's recent acquisition of Columbus Communications - a very strong cable TV and undersea fibre player.

"As a result of the CWC/Columbus combination Digicel is now playing catchup to provide a full bundle of services - broadband, video and mobile," says Kevin Roe of Roe Equity Research.

In order to meet this increasing challenge head-on, Digicel is "evolving". O'Brien is transforming the company from a regional mobile operator into a multiplatform telecommunications and entertainment company.

What that really means is that Digicel is going to sell higher value products and services to its existing and new customer base.

There's a big opportunity here.

"Digicel is in the process of evolving from a pure mobile telecommunications company into a leading total communications and entertainment provider, while remaining focused on improving its competitive position in each of its markets by providing customers with access to better mobile technology, more innovative products, a superior customer experience and better value compared to Digicel's competitors," the investor documents note.

"This evolution includes the expansion of its product offerings through developing its business solutions services and entering cable TV and broadband businesses, which have lower penetration rates than the mobile business in Digicel's markets."

Around 60pc of Digicel's $2.8bn in revenues come from voice, with almost 94pc of its subscribers on prepaid deals. Smart phone usage in Digicel's markets is rising sharply, and moving its primarily prepaid voice-using customers over to more expensive data packages will lead to increased income.

Over the last three years, O'Brien has spent over $1.5bn to build up a major fibre network in the Caribbean, buying cable operators and a submarine fibre capacity which ultimately links Caribbean islands to the US.

This investment will "create a superior network infrastructure that it believes will facilitate and provide it with the capacity for future growth across mobile, cable TV and broadband and business solutions" according to the investor documents.

This is a big gamble and an expensive one, costing 43.1pc of adjusted EBITDA over the last three years. It also shows how important a role fibre plays in Digicel 2.0. Having super-fast broadband means that Digicel will also need something to pump down the wires. It has also invested heavily in content, moving into sports and entertainment programming. Digicel will look a lot like John Malone's $50bn-valued cable, mobile, TV and telephony group Liberty Global, which is now a key competitor.

Digicel has a strong brand in its markets and a very low churn rate of people leaving for other operators. O'Brien is planning to use this brand loyalty to cross-sell new products and services.

"Digicel's customer-centric approach aims at using its brand as well as its knowledge of its customers and markets to operate a service platform which Digicel calls the 'Digicel Ecosystem'," say the investor documents.

"The Digicel Ecosystem promotes customer retention and aims to drive revenue growth by capturing customers' spending on communications and entertainment across all of Digicel's businesses. It is a platform to which new products and services can be added."

Digicel is bulking up what it can show to its customers, as it grows out its sports content group SportsMax and news provider Loop - a local news and content app that is currently the most downloaded news app in the Caribbean. There are also mobile financial services through Digicel Mobile Money, Boom and Bima, which provide mobile banking and micro insurance services in various markets.

O'Brien has always been interested in leveraging his mobile brand to facilitate cash transfers. Digicel's Diaspora service allows customers to remotely top up other people's phones. It estimates that the remittance market is worth around $9bn in its core markets.

The product is performing strongly. Revenue from Diaspora rose from $26m for the year ended March 31, 2010, to $128m for the year ended March 31, 2015 - representing a compound annual growth rate of 37.5pc.

Market sources have indicated that many of Digicel's institutional bondholders, which range from Fidelity Investments, Goldman Sachs and Franklin Templeton may also be strongly supportive of an IPO with their institutional equities arms lining up for an allocation of shares.

Raising funds on stock markets will diversify Digicel's debt profile and mitigate the impact of weaker currencies in its core markets. Digicel has refinanced most of its more expensive debt at far lower interest rates and has also extended the maturities beyond 2020, which means that it doesn't have to write big cheques to repay its borrowings any time soon.

However Digicel's debt is primarily in US dollars, which means that the company is being hammered by currency fluctuations. The three main markets in which Digicel operates have seen their local currency fall against the US dollar by 8pc recently. This currency squeeze is exacerbated by the fact that Digicel's financing costs - around $600m last year - are also in US dollars.

Floating in New York, possibly in October, gives O'Brien the opportunity to raise a large amount of dollars. While the initial IPO documents have highlighted a $200m sum, this is just a box-ticking exercise rather than an actual target. Assuming that O'Brien raises $1bn from investors, he could use this to buy back some of his debt at cheaper rates.

As part of its debt profile, Digicel has a large $2bn block of bonds, maturing in 2020, with an expensive 8.25pc interest rate. O'Brien could take these out cheaply reducing his financing costs. Under the loan agreement, Digicel has an opportunity to buy this debt before September 2016, at a cheaper rate. This would be a smart play.

"Given that leverage is high, it will be helpful to be able to have equity as an alternative source of funding to debt," said Tammy Lloyd, a fixed-income analyst with Investec Asset Management in London, which holds Digicel bonds.

"It's positive and it's going to be interesting to see what it means for the longer-term strategy," she told Bloomberg.

O'Brien's timing is good. The wider telecoms, broadband and media IPO market is hugely popular amongst investors, with a raft of diverse companies - both in emerging and more mature markets - seeking to tap into investor demand. Some of these companies share characteristics with Digicel, albeit on a smaller scale.

Last month Renaissance Capital, which had been advising Rwanda's Crystal Telecom on an IPO received 2,300 applications for shares. The offering has been massively oversubscribed ahead of its flotation in mid July.

Basque broadband and telecoms firm Euskatel was also hugely oversubscribed, filling its order book for shares in just 90 minutes. The €1.3bn valued Spanish telecoms firm floated last week, with shares rising over 10pc following its debut.

Indian group Matrix, which provides voice, data and SMS services has also rolled out plans to raise money on local markets.

In New Zealand, low-cost mobile phone operator Amaysim is also planning a flotation, which could value it at about €250m.

The initial noises from the market are positive for the Digicel IPO but there's still plenty of selling to be done on the biggest ever flotation of an Irish company.

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