article 3 months old

Without An NZ Sale, What’s Next For Vocus?

Australia | Apr 30 2018

Vocus Group has temporarily extended its debt covenants after withdrawing its NZ assets for sale. Will an equity raising be forthcoming?

-May be able to extract more value rather than sell assets cheaply
-Equity raising may be more likely if unable to refinance debt
-Raising debt covenants only helps if the company can naturally grow earnings

 

By Eva Brocklehurst

Vocus Group ((VOC)) has been unable to find a buyer at an appropriate price for its New Zealand assets and has withdrawn from the sale process. The company's bankers have temporarily extended covenants to 3.5x and debt is now expected to peak in the first half of FY19.

Morgans suggests, as the company is not a forced seller, it should be able to extract more value from those assets rather than selling them off cheaply. The broker had anticipated the divestment would have generated $340-450m in proceeds but had not concluded this in forecasts.

Morgans would prefer the company now use its attractive operating cash flow to de-gear the balance sheet and de-risk the business for equity holders. The broker revises capital expenditure and net debt forecasts to reflect implications of the amendment to the facility's covenant.

While the business can de-leverage via organic means, without the asset sale it does create some operating constraints and limits the flexibility for an incoming CEO, Macquarie contends, suggesting it is possible that a sale of NZ could still eventuate if subsequent higher offers are received.

Raising the covenants and refinancing the debt will buy more time for the company should it choose to re-open negotiations. Still, Macquarie is not confident this will eventuate.

Equity Raising?

The company has stated it has no intention of raising equity, noting a high likelihood of debt refinancing, but in broker opinions neither is guaranteed. The risk for shareholders, Morgans believes, relates to the free cash flow and earnings trajectory of the business, and failure to satisfactorily refinance debt could necessitate additional new equity being raised.

UBS prioritised the de-leveraging options as, firstly, selling NZ assets at an appropriate price. As this has not happened, the second option is debt relief, and the third option is to raise equity. The answer to whether the company needs to raise equity depends on new covenants that are negotiated as part of the refinancing that is due by the end of FY18.

As it stands, net debt to operating earnings (EBITDA) only falls back to 3.0x by June 30, 2019. UBS suggests, if the company cannot negotiate a lift in covenants under new facilities, an equity raising is a risk. The more probable scenario, however, is new and higher covenant limits, in which case an equity raising would be unlikely, at least in the short term.

The inability to sell its NZ assets is an incremental negative, Morgan Stanley believes, as a sale was key to de-leveraging. While the board remains comfortable about the balance sheet and has no intention to pursue equity the broker suggests this prospect cannot entirely be ruled out.

Macquarie agrees the possibility of an equity raising still exists down the track.

Outlook

Morgans suggests the catalysts to restore investor interest include the appointment of a new CEO, hopefully with strong industry experience, finalising the debt refinancing, generating free cash flow to become self funding and integrating acquisitions to stabilise earnings.

From a distressed asset perspective the stock appears interesting given its 16% operating cash flow yield, but the path to generating free cash flow is further out than the broker had anticipated. From a risk perspective, the broker's key concern relates to debt on the balance sheet relative to declining underlying operating earnings and lower return on capital versus cost of capital.

If the return on capital exceeds the cost this would create value, but as it currently stands the broker observes this is not the case. Given the complexity of the business Morgans acknowledges it is hard to extract data but estimates that on a like-for-like basis, earnings declined in FY17 and will do so again in FY18 before improving slightly in FY19.

On a more positive note, the broker notes the business consists of strong cash-generating entities with 1-15-year customer contracts and the core assets remain strong.

UBS observes a surge in debt covenants only helps in so much as the company can naturally grow earnings. Reducing leverage organically is possible if free cash flow conversion does not worsen and capital expenditure is reduced from the $180-190m expected in FY18. This forms the basis of UBS forecasts and a Neutral rating.

Macquarie concludes that with too many uncertainties surrounding the balance sheet and the tough market dynamics, it is better to stick with a Underperform rating.

FNArena's database shows two Buy ratings, four Hold and one Sell (Macquarie). The consensus target is $2.77, suggesting 16.9% upside to the last share price. Targets range from $2.35 (Deutsche Bank) to $3.50 (Citi).

Disclaimer: the writer has shares in the company.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms