Tele Columbus - Inmate Economics - Model Update
All,
Please find our updated analysis of Tele Columbus here.
Note: Beta testers can check Tele Columbus on the Beta portal here.
Are investors calculating off the right base? If you calculate your capex required to upgrade normal hotel rooms so that more travellers choose your hotel over others, you'd come up with a small number. A few extra amenities will do. However, it turns out the same is not true for convincing inmates. Once you allow inmates to choose among hotels, they will not choose based on their cell, but compared to other hotels available, and converting the prison into a competitive hotel is a larger relative capex outlay than adding a minibar and wifi.
Sounds trivial, but the generalised economics we hear thrown about that reason on ratios and averages just don't seem to apply to a hostage situation where there is more ground to be made up underneath the sheer numbers. Relative to TC's current shape, we might just need a lot more cash than shorthand economics would usually prescribe.
Investment Rationale
Although the bonds are beginning to get interesting here (still some 10 points rich), we are not taking a position. The restructuring would leave us committing likely attractive fresh cash at super sr. level, but in a business that is proving hard to grow, we would be paying for it with our own 2L exposure. Meanwhile, we don't feel confident enough to plan flipping the restructured bond pieces in the early secondary market. Especially where illiquid equity is involved in this market.
On the one hand, we are not far from committing to the name, because we have discounted it heavily and because the deal should leave the company with the fresh cash to continue funding its turnaround. On the other hand, TC is the lowest quality asset in the country and in a strategically unfavourable position. The 2023 strategy to invest in Telephony and Internet growth has failed decidedly, and all we'd be doing would be to try the same thing again. It will take quite possibly 3-5x more money than the €200m we think makes sense to throw at it in a first round, and by then today's bond exposure will at best be the equity. It's a very uncertain equity bet for which we just lack the required multi-year conviction.
On the downside, we can quite easily imagine a scenario where we'll have spent another €400m super sr. already, have seen only little growth and are asked to fund yet more capex and marketing that the business then still can't afford in debt form.
Key Conclusions
Q2 revenue came in below our expectations, irrespective of the Magdeburg disposal, a shortfall we attribute to the lack of marketing and CapEx spending that the company can no longer afford. Lost carriage on third-party networks and continued TV attrition document the failure of the 2023 recapitalisation, as the business requires another balance sheet restructuring. (Current Trading, Company, Industry)
The topline now appears to be stabilising, marking an important inflexion point, but it comes too late to resolve the capital structure. Underlying profit has held up through personnel and marketing cuts, but the business needs to return to growth to create value and cannot fund the required investment internally. (Current Trading, Driver, Model)
Three of four segments continue to shrink, with Internet the sole growth engine. The strategy is therefore to replace the declining TV base with higher-value Internet and telephony, but we are only now approaching the point where growth in these businesses can offset TV attrition. (Driver, Company)
The housing association customer base remains Tele Columbus' principal defensive advantage, with c.92% of subscribers in MDUs and exclusivity over in-building wiring (L4). However, the abolition of the Nebenkostenprivileg has removed the historic bulk-contract lock-in, while fibre overbuild by Deutsche Telekom and altnets represents the medium-term competitive threat. (Industry, Company)
Marketing spend and CapEx are currently at minimum levels while restructuring negotiations continue. The fibre rollout and business substitution therefore remain unfunded, and require fresh cash. We have modelled the current business with limited further investment and may already be somewhat optimistic; additional funding would allow faster fibre subscriber growth. (Current Trading, Model)
We previously modelled a €50m capital raise to kick things down the road, but now believe a substantially larger transaction would be required to maximise the value of the business, potentially around €200m in a first round, or more through further super senior issuance. For MSIP to provide additional capital, and assuming a day-one return requirement of at least +50%, net debt would have to be constrained to c.€600m if creditors provide half the funding. (Recap)
The bonds are c.60% covered by EV, but this does not translate into sufficient capacity to fund the required investment. Given the absence of meaningful near-term upside optionality, we do not see fresh cash accepting equity economics, making super senior capital the more likely source of new funding in a restructuring. (Valuation, Recap)
The €20m profit from the Magdeburg disposal should not obscure the underlying deterioration. We expect a comprehensive debt/equity swap by year-end, with the 2026 European cable consolidation cycle providing the relevant reference point for a potential eventual exit. (Driver, Current Trading, Industry)
Miscellaneous
The company has finally reached the inflexion point from which its Internet and Telephony business can stem the decline of tv. We are unsure if this turnaround can be continued with the low marketing and CapEx levels we are seeing now. We suspect they are too low. But it marks a milestone nonetheless.
Once stabilised, the business might be an attractive target for anyone looking to gain a foothold in German networks. TC occupies a sizeable position in a competitive market, and the customer base itself should have more value to competitors than can be realised from existing operations alone.
The restructuring negotiations are in full swing. We expect a transaction around year-end, and telecom asset prices have been falling in Europe. The Drop-Down route is fully open with no explicit sacred rights. Smaller creditors will have no direct protection from a coop that, if it turns aggressive, could strip a minority of its rights (although the supermajority lies at 90% for hard economics, those could be dealt with in a round-2 when that residual paper ranks subordinated).
The company will hardly be able to afford the interest on the new super sr. bonds. The existing debt is therefore unlikely to ever pay a cash coupon and is awaiting a significant haircut.
Delay in infrastructure and fibre investments will allow Deutsche Telekom and other players to increasingly build over TC's coax network and drive the attrition rate further.
Here to discuss this name with you,
Wolfgang
T: +44 203 744 7003
www.sarria.co.uk