Stories
In late February, Denis O’Brien held forth a virtual event organised by the Dublin Business and Economics Society in Trinity College Dublin. The telecoms tycoon was in verbose form, lashing out at Sinn Féin, the HSE, and social media trolls, while describing Dublin as a “Zanussi washing machine” for multinational profits.
One of the more intriguing, and timely, questions was whether the 63-year-old Malta-based business would ever retire. That morning, O’Brien had sold his loss-making Communicorp group of radio stations to Bauer Media, a deal that, when combined with his retreat from INM in mid-2019, had copper-fastened his departure from Irish media. Both disposals followed his 2015 deal to sell petrol station group Topaz.
O’Brien, wearing circular glasses and a black jumper, bristled at the suggestion. “No, no, no. I will always have an interest in some business,” he said. “I may not be in as many businesses as I am now. Probably not working as hard as I am now. But in ten years’ time I will probably be in less things, and more focused.”
Eight months later, and O’Brien’s business empire is smaller still, although, in truth, arguably more stable. Last night, in a deal-driven more by geopolitics than finance, Telstra, a large Australian telco, agreed to buy the Pacific operations of O’Brien’s telecom firm Digicel for an initial $1.6 billion, with the potential for a further earn-out of $250 million over the next three years.
The deal largely is funded by the Australian government, who tempted Telstra into making a bid largely to avoid such a strategic asset falling into the hands of the Chinese state. Digicel operates in 32 markets across the Caribbean and the south Pacific. However, three markets are dominant: Haiti, Jamaica and Papua New Guinea. This deal is all about Papua New Guinea, which is located 150 kilometres from the coast of Australia and is the most rural country in the world, with only 13 per cent of the population living in towns and cities. Digicel dominates the mobile phone market there.
Amid reports that Chine Telecom, essentially an arm of the Chinese state, had made an expression of interest to Digicel, the Australian government hatched its own counterplan.
As the Australian Financial Review put it overnight: “Injecting $1.8 billion of taxpayer money to help Telstra buy Digicel Pacific is a totemic shift for a Western government to weaponise corporate power and fight back against the creeping influence of China’s Belt and Road Initiative.”
For O’Brien, the deal was opportunistic to some extent. With China and Australia duking it out for regional supremacy, O’Brien found himself sitting on infrastructure that both wanted. He was in the right place at the right time with the right asset. And, based on an analysis of the numbers, he was able to secure the right price.
But having agreed to cede equity to creditors if Digicel failed to refinance a $920 million bond that falls due in March of 2023, the deal is also highly opportune for the company and for O’Brien. The businessman has spent much of the past three years negotiating with bondholders to ease the company’s mammoth debt burden. The deal with Telstra paves a path for him to retain control of the remaining business.
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Digicel Pacific operates in six markets in the South Pacific: Papua New Guinea, Fiji, Samoa, Vanuatu, Tonga and Nauru. According to the company, it recorded sales of approximately $450 million and adjusted EBITDA of approximately $222 million for the year ended March 31, 2021.
Telecom companies are valued on earnings, but the valuation depends on whether the company is seen by the market as being high or low growth. Companies with low growth – and a of a growth story – are traditionally valued by analysts at around six times earnings, while companies in the sector with a growth story can fetch north of eight. Between purchase price and potential earn-outs, Telstra and the Australian government are paying a multiple of slightly more than eight, suggesting the top end of the range.
However, this is more down to the competing demands of Australia and China than a compelling Digicel growth story. Indeed, the lack of a compelling future growth narrative has been problematic for the company for some time, and it was a major issue in 2015 when O’Brien sought to float the company in New York (before he pulled the deal).
Potential investors in the sector are looking for rounded communications and entertainment firms. Digicel, meanwhile, saw a decline in phone calls, which are profitable, at the expense of voice over IP, which is less profitable. Based on all this, the purchase price looks on the high end of the spectrum, but not all that frothy in the event of a bidding war between China and Australia.
If the rationale for the deal for Telstra and Australia was geopolitics, then the rationale for O’Brien was debt and control.
Digicel has not confirmed what it intends to do with the $1.8 billion, but, in all likelihood, much will be directed to dealing with its debt issues. Before the Telstra deal, Digicel had a $5.5 billion debt pile. It is a massive amount of money, but it was much higher. In 2020, after three years of white-knuckle negotiations (and rescheduling of certain debt dates), it restructured its then unsustainably high-debt level of $7 billion following years of earnings decline, resulting in bondholders writing off $1.6 billion of what they are owed.
The transaction involved the creditors swapping their bonds for securities of a lesser value and has been described by credit rating agencies as a “distressed debt exchange”.
Prior to the deal, rating agencies were openly talking about default. For example, In December 2019 Sul Ahmad of Fitch, a rating agency, said:
“What we’re saying is that there’s definitely a strong likelihood of default at those levels. Because operating performance could improve between now and then – but not likely enough for the company to be able to refinance those debts at those levels.”
The April 2020 deal opened a path for O’Brien to keep full control of the company — subject to a few conditions, the biggest of which was that Digicel would refinance a $920 million bond that came due in March of 2023. If Digicel wasn’t able to refinance that bond, Digicel’s creditors would get 49 per cent of the equity of the total group.
This was not a racing certainty to happen. Several things have gone right for the company since then. First, the world’s central banks have kept the flow of money circulating in the world economy. That’s been good for bonds in general, and good news for Digicel bonds in particular, as it makes them easier to refinance. Digicel’s underlying business has performed well. Plus, foreign exchange has moved back in its direction.
It has all helped. In June, Fitch upgraded much of Digicel’s $5.5 billion debt pile from a rating that flagged a real possibility of default, although even at that new grade remains deep in so-called junk status territory, 15 rungs below its top-notch AAA rating.
For the Australian government, it made political sense to buy. For O’Brien, it made financial sense to sell.
While Fitch has concluded that Digicel is on a firmer financial footing following the debt overhaul, it cautioned: “The aggressive corporate governance that resulted in two debt restructurings in the last two years is a negative for the group’s ratings.”
In its research, Fitch said that although Digicel does not face any major debt maturities until $925 million unsecured notes fall due in March 2023, the ratings firm said that “refinancing risk for these notes will remain high”.
The Telstra deal, however, changes the tone of the conversation. In a deep dive into the proposed deal in July, Sean Keyes looked at what it would do to the company’s balance sheet based on a $2 billion deal. He wrote in July:
“Right now, Digicel has $5.55 billion of net debt, and about $930 million of Ebitda. Divide one by the other and you get a net debt to Ebitda ratio of 5.9. The South Pacific business generates 18 per cent of Digicel’s Ebitda, meaning after a sale it would have $4.06 billion of net debt and $762 million of Ebitda, for a new debt to Ebitda ratio of 5.3. It would be “modestly deleveraging”, says Sul Ahmad of Fitch. But its impact on Digicel’s creditworthiness would be bigger than just losing half a turn of leverage. It would show that Digicel is a grown-up company, serious about deleveraging, with more in its toolkit than hardcore restructuring negotiations.”
But it also leaves behind a smaller business. Indeed, much of the group’s value lay within the Pacific, something confirmed by a liquidation analysis by KPMG for Digicel before the group started negotiations with bondholders on its debt restructuring deal last year. It indicated that Digicel Pacific was the only part of the empire that would raise money in a wind-up scenario. The analysis concluded that the unit’s assets could generate up to $615.2 million in a firesale.
The KPMG report showed that Digicel Pacific’s own debt stood at $87.5 million. However, the unit was subsequently used as a guarantor for some of the notes issued by a holding company at the top of the group as part of the bond-swap transaction.
Throughout its history, O’Brien has remained the dominant shareholder in Digicel, and would even have retained majority control had the float not been aborted. The new deal removes the pressure from the 2023 refinance and limits the risk of creditors taking equity.
As Sean wrote in June:
“This deal helps because it slightly improves Digicel’s debt ratios, and as we’ve seen, makes Digicel a generally more creditworthy business. But it’s possible, if this transaction raises enough money, for O’Brien to buy out the convertible loan note. Covenants attached to the note say a $940 million secured bond and $400 million unsecured bond must be cleared before the convertible loan note, which is worth $200 million. That sums to $1.54 billion. So with $1.49 billion from a South Pacific transaction, O’Brien wouldn’t be far from clearing that most troublesome part of Digicel’s capital stack.”
As a result of this new deal, Digicel will have no operational responsibility for the Pacific operations though it said that “customary transition services will be provided by DGHL for a short period”.
It added: “There will be no change to the Digicel brand in the six markets and the current DPL management team will remain with and continue to lead the business delivering best in class telecommunications services to DPL’s valued customers in the South Pacific. To facilitate a seamless transition, Denis O’Brien will join the Board of Directors of the newly formed holding company for DPL.”
O’Brien said the sale of Digicel Pacific marked a “very successful realisation” of his group’s investment in the south Pacific region, which began in 2006.
In a joint statement, several Australian government ministers said Digicel Pacific has been a successful and growing telecommunications provider in the Pacific for the past 15 years.
“Telstra’s acquisition sends an important signal about the company’s potential and about wider business confidence in the future of the Pacific region,” they said.
For the Australian government, it made political sense to buy. For O’Brien, it made financial sense to sell. O’Brien is still a long way from retirement, but, as he foresaw in February, the scale of his business interests is receding.
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After the deal was announced Denis O’Brien joined CNBC show Worldwide Exchange on Monday to discuss the logic behind his decision to sell. O’Brien gave the interview sitting in front of a bookcase filled with photographs and business gongs as well as a framed photograph of Usain Bolt, a longtime ambassador for Digicel, breaking the 100-metre world record.
The deal O’Brien said followed a “number of unsolicited offers” for the business over the previous year and he felt it was the right time to sell. O’Brien claimed there was a “lot of growth left in the business.” As O’Brien spoke an image flashed up noting he was the “first honorary life president” of the FAI.
“The timing was right for everybody,” O’Brien told his interviewer. “The relationship with Papua New Guinea is particularly strategic because of the mining industry there. It was a meeting of minds between the government of Australia, Telstra and ourselves as the seller of the assets.”
O’Brien agreed it was unusual for a government to get so involved in a deal. But he said: “The world is changing. Some assets are becoming more strategic than others…it is a counter to China’s belt and road initiative which has been running for many years. There is a number of different factors here. The main thing here is Telstra is getting a cracking business, the Australian government also are involved, there is a lot of growth left.”
Was the deal he was asked intended to “blunt” China’s influence in the region? “It is long recognised that China has upped its influence in the Pacific region…” O’Brien replied. “This is just an extension of Australia’s role and friendship to the countries in the Pacific region.”
