Last summer, the stars looked to be aligning for Denis O’Brien in his long battle to keep control of Digicel.

It was always likely that Digicel would need to divest some of its businesses in order to reduce leverage. And the Pacific business, centred on Papua New Guinea, was a prime candidate. 

Happily for Digicel and O’Brien, there was more than one bidder for the Pacific business. In May of 2020 China Mobile expressed an interest. It was then reportedly valued at $900 million.

Australia, alarmed at the prospect of a Chinese telecoms company on its doorstep, helped finance a deal with the Australian telecom Telstra in 2021. The Australians bought the Pacific business for $1.57 billion.

Back then, central banks were pumping cash into the financial system. And in those pre-inflation days, the markets were having a whale of a time. Bond investors were happy to lend money. I wrote at the time that a path had opened for O’Brien to keep full control of Digicel.

The big threshold for O’Brien was, and remains, the refinancing of $206 million debt maturing in 2023. If O’Brien is unable to refinance the bond, creditors automatically get 49 per cent of Digicel’s equity. The Pacific windfall, and a generous bond market, looked like it would be enough to refinance the 2023 bond and alleviate the stress on Digicel’s capital structure.

New mood

Since last summer, conditions have turned. The Papua New Guinean government announced it was looking for $114 million in taxes from Digicel. And the mood of bond investors has shifted abruptly. The Morgan Stanley Emerging Markets Corporate Debt Fund, which is a rough analogue for Digicel debt, is down by 9.6 per cent since September. The following chart of government bond returns from The Daily Shot shows how severely the debt markets have turned:

Last week Fitch, a ratings agency, downgraded Digicel Limited’s credit rating to CCC+ from B-. According to Fitch, debt rated CCC has “a real possibility of default”.

Fitch said Digicel is planning to use $1.05 billion of the Pacific business to repay senior secured creditors. The remaining $352 million would go towards partially repaying the troublesome 2023 note. Fitch said of the March 2023 note:

“Even if the remaining $352 million will be used to partially repay its Digicel Limited’s $925 million senior unsecured note due in March 2023, the ability of Digicel Limited to successfully refinance the balance of this debt outside of a coercive exchange remains uncertain due to deteriorating macroeconomic conditions, rising interest rates and a decrease in risk appetite.”

Up to now, Digicel has managed to keep creditors off its back through “coercive exchange” – by renegotiating and restructuring debts. But this strategy has limits. When a company restructures its debts, it swaps out plain-vanilla debt investors for teak-tough restructuring specialists. Those guys are harder to push around.

“If you rewind three years before they launched the first restructuring, they had a different investor base,” said Sul Ahmad, an analyst who previously covered Digicel at Fitch, “When you restructure, you get a different restructure base. That means the odds of litigation increase considerably. As that investor base shifts to sharp-elbowed people, at some point the costs of defaults will exceed the benefits.”

Ultimately what O’Brien is looking to do is borrow more money, and his track record of renegotiating debts is counting against him. Fitch said: “Digicel’s decision to restructure debt twice remains a constraint on the ratings. The group has a concentrated ownership and control structure along with a complex group structure that weakens both Digicel’s corporate governance and the group’s consolidated credit profile.”

None of this, you’ll note, is about Digicel’s underlying business. It’s about the supply of and demand for corporate debt. 

Fitch noted that Digicel only has one other competitor in most of its markets, and due to high barriers to entry, that’s unlikely to change. That ensures Digicel will continue to have high margins for the industry — Fitch forecasts Ebitda margins of around 40 per cent. Among nine of the world’s biggest telcos in 2020, the average Ebitda margin was 34 per cent. Fitch is forecasting that Digicel can keep Ebitda margins where they are, and that it won’t have to increase Capex much above $270-300 million per year:

“These dynamics support consistent EBITDA margins of around 40 per cent. The group’s $2.4 billion in capex since FY 2015 should ensure network competitiveness. Under these circumstances, Fitch expects the company’s competitive position to remain stable over the medium term.”

It’s essential that sales, margins and investment spending all stay stable because Digicel has a large annual interest bill. Its interest bill is forecast to be $330 million in 2023.

Digicel might not face a lot of competition, but the one thing that can go wrong for it is currency risk. Digicel owes dollars but earns in a basket of Caribbean currencies. Since the beginning of 2014, this has gone against Digicel. In that time, the dollar has appreciated against a weighted average of its trading partners by 28 per cent. 

The upshot, says Fitch in its latest ratings review of Digicel credit risk, is that “There is a low margin of safety for the company, and a default and/or default like process is a real possibility, which is reflected in the removal of the Rating Watch Positive and downgrade to ‘CCC+’ from ‘B-‘ for Digicel Limited.”