Digicel: EM Bonds – Time To Buy?Guest Post
Denis O’Brien, Ireland’s richest native ($4.3bln) is the 94% owner of Digicel Group. Digicel Group offers telecommunications (wireless, cable, and business services) media and entertainment services to 14 million subscribers in 32 markets, primarily in the Caribbean and Central America. Largest markets; Haiti (16% revenues), Jamaica (16%), Papua New Guinea (13%), Trinidad & Tobago (6%).
Digicel bonds have been the worst performing emerging market bonds of 2018, losing 30% of their value year-to-date.
The strengthening US dollar had been a big factor and analysts expect the effect to be ongoing, lessening top line revenues by as much as $220mm and EBITDAR by approx. $100mm per annum. A full 95% of Digicel’s debt is US dollar denominated whereas 50% of revenues are either USD or from markets where the currency is pegged to the US dollar.
DLLTD 8.25% 9/30/2020 RegS. Issue size; $2bln. Maturity 9/30/2020 (2.05 years) sub 2 year duration. Net leverage 7.0x (up from 6.4x prior year). Recent price $69.76, current yield 11.83%, yield to maturity 39.33%. Fitch downgrade 8/24/2020 to B-, neg. outlook. It remains to be seen what the bond market reaction will be to Fitch’s downgrade of Friday past, but I suspect it will be muted. Bond CUSIP USG27631AD56.
Digicel Group Limited (DGL) debt, of which there is $3bln total outstanding is structurally subordinate to $3.7bln of debt held in 2 other Digicel entities, 2.3bln in senior unsecured Digicel Limited debt and $1.4bln in senior unsecured terms loans/revolver at DIFL (Digicel International Finance Limited).
Potential sources of refinancing:
The market is anxiously awaiting the game plan from Mr. O’Brien on the refinancing of the DLLTD 8.25%’s of 2020. The fact that the market is trading at the current level of distress (i.e. sub $70.00) may offer opportunities for restructuring Digicel. Given the large issue size of $2bln, a successful tender for the bonds at $80.00 could save Digicel $400mm. XTract Research recently released a report eluding to this possibility, but as I understand it no price indication has been proposed. One potential value catalyst noted in the XTract report (I have only seen an exerpt) is rolling in the assets of the currently unencumbered Digicel Pacific Limited entity.
-It is possible that $1.2-1.3bln of additional secured debt could be raised related Digicel entities.
-Denis O’Brien has eluded to the possibility of an equity infusion in the past. When Digicel was “rolling in clover” as they say, Mr. O’Brien took out $1.1bln in dividends from Digicel, the bulk ($950mm) in the form of a special dividend. This action (an equity infusion) would be in keeping with O’Brien’s plans to eventually IPO Digicel. Denis last attempted the IPO route in 3Q 2015, but it is doubtful he will try again before 2H2019 when leverage can be brought down to a more manageable level of 5.7x. Fitch and the other rating agencies note there is a lot to like in the competitive positioning of Digicel which operates largely in duopoly markets boasting a market share of 50% in many (not to mention 40% margins). What the rating agencies are more concerned with is the liquidity situation of the group with $158mm in cash/near cash versus an annual interest expense of $456mm, approaching 50% of EBITDA (Note: IF Digicel were a US company their interest expense would only be partially tax deductible as the 2017 Tax Cuts and Job Act caps/limits the tax deductibility of interest to 30% of EBITDA).
-Asset sales. Digicel recently effected a sale/lease back on their cell phone towers which helps at the margin, but with net proceeds < $100mm the effect is minimal in the grand scheme of things. Beyond the 450 towers covered by the sale/leaseback details have been scant of the other $400mm O’Brien has eluded to (i.e. $500mm total asset sale program).Perhaps more important is getting capex back to 14-15% of FCF from the recent highs of 21% due to heady network investments.
-Cost cutting. No further meaningful cuts are achievable as 25% of the group work force was retrenched in 2017.
Value comps: EV/EBITDA; C&W (bought Liberty) 11.2x, Columbia (bought) 9.6x, AT&T (T) 8.5x, American Mogul (AMX) 5.3x, Telefonica (TEF) 5.4x, T-Mobile (TMUS) 6.2x, Orange (ORAN) 5.6x = avg. 7.4X.
The DLLTD 8.25%’s 2020 have traded as low as $62.90 in 2018. The minimum lot size for the bond issue profiled is $200k (par value), hence if one were to buy the bond at $70.00, the initial investment would be $140,000 (plus accrued interest of almost $7k), qualifying as a substantial investment for an account sized at $5mm (i.e. 3% of invested capital). Too much single name risk for me, $100k par value is more typical. JP Morgan’s EM bond ETF, ticker EMB would offer similar exposure for individual investors with more modest account size. The ETF has $13.6bln in AUM with a dividend yield of 4.62% and a ytd -5.13% return in 2018.
Digicel (B2, neg. outlook). A total return >35% is attractive, especially when compared with the paltry 7.7% yield on longer duration single B3, neg. outlook credits like TESLA (i.e. TSLA 5.3% August 2025 bonds last traded at $87.20 to yield 7.7%) which carry much higher interest rate risk (TSLA’s 5.8 year duration versus sub 2.0 year for Digicel). Tesla’s current EBITDA is -326.2mm (analysts estimate $3.2bln in EBITDA for 2019) hence a potential double headwind of EV subsidy cessation and loss of interest deductibility. Shorting TSLA is too expensive and foolhardy, but you don’t have to own it for certain.
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Safe trading. JCG
Article by Firehorsecaper, iBankCoin