Tele Columbus - Initiation
All,
Please find our initiation on Tele Columbus here.
TC faces structural decline in its TV business which is likely to accelerate from mid-2024 when a new law abolishing bulk contracts comes into effect. Moreover, TC's capex has historically been above industry norms and it isn't clear what portion of this is attributable to maintenance spend, which makes valuing the existing business very challenging. Indeed it's plausible that TC's capex needs are structurally high (on a % of sales basis). With leverage above 7x (before "non-recurring" items), FCF already negative before its planned fiber rollout, and EBITDA to potentially decline further, more equity would be needed to enable a refi of its existing debt (let alone the fiber rollout). It isn't a given shareholders will continue to support the business without significant haircuts applied to TC's existing debt. Ultimately, to justify a long position in the bonds we would want to create TC at the EV of the existing business (notwithstanding upside risk from more equity support and value-add from the fiber rollout), and we're not convinced this is the case at the current bond price.
Investment considerations:
- We won't be taking a long or short position in the bonds.
- To justify a long we would want to create the company at the EV of the existing business (ex fiber rollout), notwithstanding the possibility of more equity support and value-add from the fiber rollout; and we're not convinced this is the case at the current bond price as we're unable to determine maintenance capex requirements for the existing network (potentially structurally high in view of TC's historical capex levels being above industry norms)
- Moreover, the structural decline in TV revenues will likely accelerate from mid-2024 (owing to a new German law abolishing bulk contracts which account for c.70% of TC's TV RGUs)
- TC is also facing margin headwinds from rising direct and indirect costs which there is limited visibility on.
- From an event-risk standpoint, the case for further shareholder support isn't obvious (at least not without significant haircuts applied to TC's existing debt).
- On the short side, the aforementioned valuation uncertainty, along with the potential for further shareholder support, makes shorting the bonds in the 60s also unattractive.
New German law will likely accelerate structural decline in TC's TV business
- Cable TV subs have been in decline in Germany since 2017, driven by cord-cutting/OTT substitution; and it seems likely that the decline in TC's TV business lags real-time demand due to bulk-contract lock-in.
- Growth in TC's broadband revenues should provide at least partial offset given still low broadband penetration in TC's network, however, the trajectory/upside from broadband penetration gains is still uncertain.
- A new German law abolishing bulk contracts with HAs (which account for c.70% of TC's TV RGUs) means from mid 2024 bulk contracts will need to be replaced by individual contracts directly with tenants which tenants will be free to decline (whereas under bulk contracts, HAs pass on the cost of basic cable TV to tenants regardless of usage).
- This will likely accelerate the decline in TC's TV business from mid-2024.
Fiber roll-out capex plan requires funding
- TC plans to spend c.€2bn over 2021-2030 on upgrading its network to connect c.2m homes with FTTB/FTTH as part of the company's "Fiber Champion" strategy; TC has stated it also intends to spend c.€1bn in other capex items (it isn't clear whether this is additional; we assume it represents a baseline maintenance spend, but it's possible the entire c.€3bn is additional).
- Broadband subs will be served with fibre on a wholesale as well as retail basis.
- Currently, TC's broadband penetration is low at c.27% of two-way upgraded homes, which TC aims to drive higher through said fiber rollout.
- Without these additional investments, TC also risks potentially losing share to the upgraded networks of its competitors (e.g. Vodafone, Deutsche Telekom) to the extent they target TC's footprint.
Significant valuation uncertainty
- TC's capex spend has been above industry norms (on a % of sales basis) in recent years; it isn't clear how much of this is discretionary spend vs. maintenance, which makes the task of valuing TC's existing business (before its fiber rollout) very challenging.
- It's plausible TC's capex is structurally high and the EV of the existing business below the create at the current bond price.
Case for shareholder support (upside event risk) is highly uncertain
- The case for further shareholder support (upside event risk) is naturally determined by the value of the business in its current form and the ROI opportunity from the fiber rollout while taking into account any potential for equity value creation via discounted debt purchases/haircuts if any (the price of which would not necessarily be above current debt trading levels).
- The recent c.€75m equity injection is suggestive of continued MSIP/UI commitment, but a much larger equity contribution will be needed and this isn't a given (at least not without significant discounts applied to the debt).
Team Sarria