Iliad CFO Thomas Reynaud is looking for more investment to get their bid for T-Mobile USA off the ground. Specifically, he’s led a roadshow around big financial investors looking for someone to put more equity into the deal, aiming to get the leverage ratio – debt divided by EBITDA, a measurement of risk – down to 4.5x EBITDA. However, he would do better to worry about the industrial logic of the deal, as it will take a lot of extra equity to make this transaction make sense.
The clue is in that leverage number. Our calculation puts the bid as it stands at 7.21x EBITDA, on a kitchen-sink basis including the whole of T-Mobile’s debt pile. To get down to 4.5x from there, you start by forgetting about the short-term debt, because it’s just going to get rolled over anyway. (This doesn’t sound quite as smart since the crash of 2007-8, but let’s accept it for argument’s sake.) Then you start looking at how much extra equity you might need.
Even forgetting the short-term paper, even if you get someone to put in $10bn in equity, you’re still not quite there. Things really get going when you assume some cost savings or increased revenue, the fruits of actually doing something different with the company itself. If you model $2bn of additional EBITDA, either savings or incremental revenue from operational improvements, the target of 4.5x EBITDA on their preferred measure is achievable with $2.04bn of extra equity, while it’s barely achievable at all just by throwing more money in the hat. $2bn is, as it happens, precisely the figure Iliad has pencilled in.
We’ve modelled several scenarios in the following graphic. On the top left, the chart shows how much equity Iliad and its putative partner would put in. On the top right, the chart shows how much operational gain is assumed for each scenario. The bottom left shows the leverage ratios, and the bottom right the biggest possible offer consistent with the leverage ratio for that scenario. The obvious question is “if the target is 4.5x EBITDA, and $2.04bn of extra equity is enough to get there assuming $2bn in operational gains, why does M. Reynaud want $5-6.5bn?”
The answer is plain enough. With the savings and the extra equity, Reynaud has the headroom to up his offer from $15bn to $18-19.5bn without busting the 4.5x EBITDA target – see the red or purple bars on the chart. This could be used either to offer more money per share, or else to take a bigger stake in T-Mobile. This week’s news puts the latter option in the lead, suggesting that DTAG wants Iliad to take more of its residual risk off the table.
But just look at what would be affordable – the golden bars on the chart – if he could count on twice as much uplift from operational improvements! With $4bn of additional recurring EBITDA, he could make a knockout $24bn offer without needing more than $2bn in extra equity – and if push came to shove Xavier Niel might be able to find most of that from his own pocket. This sounds like good news for the project but in fact, it just highlights its weaknesses and temptations.
Without the extreme fixed-mobile integration Free Mobile enjoys, without the regulatory and infrastructure issues that make Free’s self-financed fibre rollout possible, and with the near certainty of big spectrum and CAPEX calls in the near future, Reynaud can’t promise big gains from operations. The temptation, though, is that precisely because it’s operational gains that could transform the financials, they’ll go looking for anything that might conceivably look like a gain. Only recurring gains, and ones that can be relied on with some certainty, should be used to assess creditworthiness and operational risk, which is the point of a leverage ratio. Watch out for new numbers including one-off items like the possible sale of the $3.5bn device receivables.
This also highlights the benefits of a deal with a cableco, which really would be able to cut the costs of backhaul, make massive use of WLAN and femtocells, cross-promote aggressively, and use fixed-broadband cash flows to finance mobile, all key elements of the plan Free Mobile relied upon to drive growth like this.