Tuesday 20 November 2018

Digicel buys some time, but is it enough as hard choices loom?

Denis O'Brien's Digicel has bought itself a few weeks of extra time, but tough decisions lie ahead for the telecoms giant. Fearghal O'Connor reports

Digicel brand ambassador Usain Bolt
Digicel brand ambassador Usain Bolt

When Denis O'Brien sensationally pulled the long-awaited initial public offering (IPO) of Digicel shares at the 11th hour in October 2015 he was robust in his defence of the decision. "Why would you sell your front garden when you know it's worth a lot of money and why would you sell at a discount?" he told CNBC.

But not a whole lot has gone the telecommunication company's way since then and a posse of bondholders who are owed billions by the company are now camped on Digicel's front lawn, refusing to budge.

Last week, lawyers representing bondholders who hold 60pc of the company's most imminent unsecured debt rejected a proposal by the company to swap $2bn of bonds due for repayment in 2020 for new securities due in 2022. The deal would have also included a swap of $1bn of bonds due in 2022 for debt that would instead be repaid in 2024. Digicel, which provides telecommunications services in 31 markets across the Caribbean, Central America, and Oceania regions, extended the deadlines for creditors to accept its offer to October 19.

"Constructive discussions" continue with the bondholders, said the company.

Opinions are divided as to what this means for Digicel's future. Some sources spoken to by this newspaper believe it gives the company the time and space to strike a deal with the bondholders, allowing it to gets its balance sheet in order and concentrate on growing revenues.

Others believe the bondholders' tough stance marks another step on a road that will end with O'Brien having to take some very tough decisions if Digicel is to survive in its current form and under its current ownership structure.

Debt

Digicel has one key problem: debt. To build out its extensive mobile networks it has borrowed a whopping $6.8bn (€5.86bn). $2bn (€1.72bn) of that is due to be repaid in September 2020 and a further $1.2bn (€1bn) will be due a year later. After the company suffered a number of setbacks - many not of its own making - the yield on that debt shot up over recent months, forcing it to make its surprise proposal to swap its bonds.

One knowledgeable source remains optimistic that this process can still end in a deal.

"There is a bit of cat and mouse going on here between the company and its bondholders," he said. "It was always anticipated that there would be 'over and back' on this process around what the bondholders want and to what extent the company can accommodate those asks," he said. Ultimately, the bondholders - made up of a group of major financial institutions and investment houses - will seek an enhancement of the terms of the debt in their favour, he agreed.

"But," he said, "given the level of debt, there is only a finite amount of wriggle room the company has."

But what happens if the company runs out of that wriggle room without an agreement to refinance the debt due to be repaid in two years' time?

Many analysts believe such an outcome will force Digicel to embark upon an aggressive programme of asset sales beyond what it is currently undertaking, a divestment from some of its markets and, perhaps most significantly for O'Brien, a drive to bring in substantial amounts of new equity into the business.

Indeed, ratings agency Moodys has said it considers the exchange offer as a distressed exchange, which is a default under its definition - a definition which is likely to have not found approval at Digicel headquarters given that it proposed a par for par debt exchange.

Nevertheless, a second ratings agency, Fitch, also downgraded Digicel's debt. Chicago-based Fitch analyst Sul Ahmed believes that with bondholders rejecting the company's Plan A, Digicel now needs to look to at least a Plan B and a Plan C. As part of this, O'Brien, Ahmed believes, will likely need to both put more money into Digicel himself and ramp up asset sales by Digicel. This, said the analyst, must happen regardless of whether the debt exchange deal can be successfully agreed with bondholders next month or not.

Nevertheless, Ahmed remains relatively upbeat about Digicel's ability to come through the current storm, pointing to the company's new chief executive Alexander Matuschka's history of turning around companies.

"And they have made some very serious investments in their network capabilities over the last number of years, along with their investments in the South Pacific and in Papua New Guinea," said Ahmed. "So I do think there is meaningful opportunity for them to increase their margins and their profitability using more organic measures. But ultimately, with their liquidity issues and their leverage issues they are going to have to make aggressive moves on selling assets or ponying up additional equity. That was our base case before and now that the bondholders have rejected this offer it is even doubly so."

Infrastructure

There are, of course, good reasons as to why a company such as Digicel would have such high levels of debt. Installing high-tech telecommunications infrastructure is not cheap, not least across a range of island nations in a poor and sometimes troubled part of the world.

And like others in the sector, Digicel has been forced to change rapidly in recent years. Right across the mobile phone sector, operators have struggled to keep pace with the displacement of once lucrative calls and texts by the arrival of free calling and texting apps powered by the growth in mobile data. For its part, Digicel has made great efforts to reinvent itself from an infrastructure utility company to a more fully-fledged digital content and entertainment provider. It reduced its headcount to become more lean and invested $2.4bn (€2bn) over the last four years, largely on new cell towers and fibre to allow it offer customers access to high speed 4G data services.

"The company took a 'build it and they will come' attitude," said one market source.

But luck was not on Digicel's side. Most dramatically, a number of its key markets were hit by two massive hurricanes, Maria and Irma, which both left a trail of destruction.

"Although they were insured for those events it did mean that the growth and adoption of the new technology they had put in place in certain markets just couldn't really happen."

At the same time, a Chinese telecom equipment group Digicel hired to upgrade its networks was forced to suspend operations as it faced US sanctions because of its own business dealings with Iran. That issue was soon resolved without major impact. Far more damaging though was the strengthening US dollar, which meant many of the emerging market currencies that Digicel deals in had weakened.

And there was another problem, this time self- inflicted. Having put the new technology in place, the company optimistically told the markets it would see a big uptick in revenues as customers signed up to new data packages. But that didn't happen and Digicel later had to admit it had over-priced its data packages and traditional phone customers were not transitioning across to the new offerings as quickly as it thought they would.

The wobble coincided with a more challenged environment for emerging market bonds in general so Digicel suddenly found itself on the wrong end of market sentiment. Its bonds shot up and the company moved to sell off some assets - such as mobile phone towers - in order to raise money to plug the gap.

"All of the elements for Digicel to transform into a modern 4G provider are now in place -the build-out of infrastructure, the adoption by clients of new handsets and the right price for data plans. What the company now needs is time to monetise all that," said a source.

Management had hoped to buy more time for this uptick in 4G data driven earnings revenues to take hold by pushing out the bond maturities by two years.

"That would benefit all stakeholders - customers, shareholders and bondholders," said the source, arguing that it remains the right course of action for the company.

But is Digicel's current predicament down to bad luck or a bad business plan? That question divides the opinion of market sources spoken to by this newspaper.

As part of the company's transition efforts, in October 2015, O'Brien had prepared the company for an IPO but pulled out of it at the last moment, disappointing the markets. Some market sources argue that, at the time, it was the right move given the environment.

"They were in very good company. Ardagh also pulled back and there were a whole slew of others. Look at the trading in Vodafone in that time to see the challenges that faced some of the listed mobile phone operators."

So far in 2018 to date, Vodafone's share price has halved, for example.

But Ardagh, of course, did return to the markets two years later and successfully carried out its IPO. Digicel chose not to.

In that time, O'Brien has found himself caught up in the completely separate but ongoing corporate drama at Independent News & Media, the publisher of this and other newspaper titles, and where he is the largest shareholder. Some analysts believe the arrival of High Court-appointed inspectors at a company in which he is a major shareholder does not help his overall cause and only emboldens bondholders to play hardball with the Irish billionaire.

Others point out that, in the unsentimental world of high finance, the two issues are completely unrelated and that bondholders would merely look to their own interest in whatever business is immediately to hand.

Ahmed has seen no evidence of any such impact on sentiment towards Digicel from the INM situation. "In none of the talks we have had with investors in the US or in London that has never really come up so I view it as a separate issue," he said.

Bloody nose

Those who remain optimistic about Digicel's future argue that the company is fundamentally sound and believe it will either agree an enhanced deal with its bondholders next month or find another way to deal with its debt mountain.

"Will it be a bloody nose if a deal does not happen with the bondholders? Yes, probably," said a knowledgeable source. "But it should be remembered that this debt is still two years from maturing and a full range of options still exist to deal with it in the meantime over and above these proposals. On three or four occasions they have advised the markets that they felt they were turning a corner and always something unpredictable has come up. But they have done a lot of the right things and, at this stage, you could argue that they are due a break."

But others are withering in their assessment of what has brought Digicel to its current impasse, blaming Denis O'Brien's decision to pull the IPO rather than bad luck.

"A bad business plan, definitely," said one market source. "Other factors have been unlucky in terms of timing but there was always a likelihood that one or other of these things would happen. The biggest mistake though was backing out of the IPO because they couldn't get the price they wanted. That sealed the fate of the company. If they had gone for the IPO it would mean they could now sell more shares and there would be a way out. They've bitten off their nose to spite their face because they believed the company was worth more money than it was and that mistake has led to where we currently are."

It would appear that at least some of the company's bondholders agree. So, if bondholders reject the company's Plan A next month, where next?

Ahmed believes Plans B and C - to sell assets and bringing in additional equity - are very achievable, not least because Digicel has very attractive assets across Latin America and the Caribbean that could be sold and good margins that could attract in additional equity partners. But, he said, time is of the essence and the next 12 months "will be absolutely critical."

Indeed, the company itself has already embarked on a programme of asset sales. On Friday it announced a sale and leaseback agreement for a number of its towers in Jamaica that is expected to raise $90m (€77.6m). The deal follows a series of announcements of similar scale asset sales.

Revenue growth continues too. On Thursday the company announced that it had been awarded the contract to build a high-tech fibre network in the Caribbean nations of Saint Lucia, Grenada and Saint Vincent & the Grenadines, in a deal believed to be worth in the high tens of millions of dollars.

But the jury remains out.

"Their network investments haven't quite paid off as rapidly as we thought," said Ahmed. "They are the number one player in almost all of their markets and they still have options to get leverage back down," he said.

But, he warned, "if we don't see progress being made on that in the next year that would be a red flag for us."

Are the bondholders in whose hands the future of the company is held prepared to even be that patient? That will become clearer over the coming month.

 

Digicel: by the numbers

Revenue: Total revenues declined by 6pc to $565m (¤486m) in the first quarter. Data revenues stabilised after “tariff rebalancing actions”. Data usage was up 55pc on prior year quarter with smartphone penetration rising from 51pc to 56pc. Subscriber numbers rose 1pc to 14.2m.

Earnings: First quarter ebitda was 2pc lower at $249m (¤214m).

Debts: Digicel owes $6.7bn (¤5.7bn), with its next major maturity in September 2020. It has said that it “remains on track” to reduce leverage by ‘one turn’ by end of March 2019 — in other words to about $5.7bn (¤4.9bn).

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