VMO2: Calculating The Downside - Model Update - POSITIONING

All,

Please find our expanded analysis on VMO2 here.

Note: Beta testers can check VMO2 on the portal here.

With VMO2’s bonds trading at distressed levels, we have revisited our downside scenarios to assess the protection available to bondholders if the investment case deteriorates. Our base case remains that some form of the Nexfibre/Netomnia transaction proceeds, although the final structure and economics remain uncertain. We have stress-tested the consequences of a failed transaction, the withdrawal of third-party Vendor Financing and a more challenging liquidity and leverage outlook.

Investment Rationale

  • We are initiating a 5% long position in VMO2’s 3.25% January 2031 Senior Secured Notes at 68. The 15–20 point sell-off has created an entry point at which we believe the potential upside justifies taking risk despite the weak balance sheet.

  • The Nexfibre/Netomnia transaction is the key near-term catalyst. Even approval with conditions would provide greater clarity on VMO2’s future, while the upfront cash proceeds and potential reduction in network investment could improve the credit profile. The economics remain sensitive to wholesale access fees and the number of customers ultimately migrated onto Nexfibre’s network. We are not relying on management delivering a material reduction in CAPEX to justify the investment, given the sensitivity of our DCF to terminal CAPEX assumptions.

  • Further clarity on shareholder deleveraging plans, particularly Telefónica’s commitment to reducing leverage to more sustainable levels, could also support a recovery. Current pricing reflects technical pressure and fears of a significant liability management exercise (LME), leaving scope for shareholder reassurance to improve sentiment. While Vendor Financing Notes and subordinated bonds also offer attractive potential returns, we are establishing exposure through the Senior Secured Notes first.

  • Upside: 10–20 points over six months. Approval of the Nexfibre/Netomnia deal, even with conditions, would remove a key source of uncertainty. Greater clarity on Telefónica’s deleveraging commitment and reassurance around creditor treatment could also help reverse the technical discount currently weighing on the bonds.

  • Downside: c.10 points over the next three to six months, with c.20 points in an extreme restructuring scenario. Failure of the Nexfibre deal combined with the withdrawal of non-bond-financed Vendor Financing could create a significant FY27 funding requirement and force a balance-sheet restructuring. Our downside scenario implies c.€5bn of debt write-offs, including a 12% haircut to Senior Secured lenders, although we view this as an extreme outcome.

Downside Scenarios – No Deal

  • Without the transaction proceeds, net leverage remains around 6.0x through FY28, while debt capacity recovers only gradually, from 50% of debt in FY26 to 85% in FY28. By contrast, completing the transaction and applying the proceeds to debt reduction would materially improve the outlook, with net leverage falling to 5.1x by FY28.

  • We have stress-tested two principal risks. First, failure of the Nexfibre/Netomnia transaction would remove the expected £1.1bn upfront cash proceeds and 15% stake in Nexfibre, as well as the potential benefits from lower network CAPEX and a larger fibre footprint. Although failure would not, on its own, trigger an immediate refinancing requirement, it would weaken the deleveraging outlook and remove a key catalyst for improving credit quality.

  • Second, withdrawal of third-party, non-bond-financed Vendor Financing would force VMO2 to fund a greater proportion of its network investment and equipment requirements from its own resources. With CAPEX and interest already absorbing much of operating cash flow, this would put further pressure on liquidity. We assume the affected financing is withdrawn completely by June 2027 and that these providers do not participate in any restructuring. Combined with failure of the transaction, this creates a cash funding requirement during FY27.

Recapitalisation – No-Deal Scenario

  • Under this scenario, we estimate debt capacity of c.€19bn, implying a c.€4bn debt write-off before accounting for the additional funding required to replace Vendor Financing. Including a new €1bn Super Senior Facility increases the required write-off to c.€5bn.

  • Our illustrative restructuring assumes the remaining Vendor Financing and SUNs are written down to zero, alongside a further €2.2bn haircut to Senior Secured debt, equivalent to 12% of face value. Our DCF implies an enterprise value of c.€22.3bn, or 6.4x EBITDA. After the debt write-offs and introduction of the new facility, we estimate c.€6bn of residual equity value to distribute among creditors and other stakeholders. We assume Senior Secured lenders receive 60% of the restructured equity, with the balance allocated between junior creditors, existing shareholders and new money providers.

  • These scenarios are not our base case. However, with the bonds trading at distressed levels, we believe it is important to quantify potential recoveries if the transaction fails and liquidity pressures force a restructuring.

  • Even if the Nexfibre/Netomnia deal fails, VMO2 has other potential routes to deleverage. Liberty Global previously sought to sell a 20–40% stake in VMO2’s fixed-network NetCo, potentially raising at least £1bn, but Telefónica blocked the initiative, and the project was subsequently scrapped.

Happy to discuss.

Tomas Mannion

E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk

Tomás MannionVMEDO2