Virgin Media O2 – Building
All,
Please find our updated analysis here.
Sarria | VMEDO2 - Live Discussion
Thu, 6th March, 3 pm UK time | 10 am EST
Virgin Media O2 (VMO2) has stabilised its subscriber base through higher marketing spend and discounts. This friction with customers will persist into 2025 as CPI rises in 2024 are passed on via higher prices. The friction is present for VMO2’s Fixed (including broadband) and Mobile business. Investment in Fibre remains a necessary drag on cash flow. VMO2, the hybrid coaxial-fibre network cannot provide the speeds that customers demand and the company is investing in fibre within its network and arranging to be an anchor tenant for the Nexfibre network being built by Liberty/Telefonica and Infravia. Increasingly VMO2 is moving away from owning its network infrastructure and capitalising that business separately. It will mean greater layering of the SSNs but there is no step change in risks so far.
Investment Rationale:
- There is no specific event here. VMO2 is a collection of mature businesses, which are all facing long-term changes in consumer habits. The $/€ SUNs yield over 8.5%, if they were to fall in price we would have another look. Even now, they are a decent place to park money. At c£800m, there is enough paper to build a position. As part of a £22bn debt stack, Liberty/Telefonica will not let this sliver of debt dictate VMO2's future.
- To get above 8% we would have to look at the 8-year paper. There is no catalyst for the bonds to widen, however, if we saw them out beyond 10%, we would get involved and buy the SUNs.
- Liberty/Telefonica are managing Leverage at the higher end of their 4x – 5x EBITA leverage target. This is a model that market participants have become comfortable with. It is calculated using the last two quarters annualised with non-recurring expenses excluded. It is currently <4x. You buy VMo2 for operational stability not deleveraging, and the shareholders have shown restraint when cash flow needs to be directed into the business. The expected distributions to shareholders will be £350m - £400m (around half of last year's figure.
The SSNs will be layered as the VMO2 part disposes of Net Co:
- The existing network is being partly sold to outside investors and around £2bn of debt will move from into the Net Co company. This will be structurally senior to the Senior Secured debt, including the SSNs.
- Bids of £1bn for a 40% stake have been reported but the deal has not closed yet. VMO2 will pay a rental fee for access to the network. We expect infrastructure investors will be interested and we may be conservative on the level of debt that will be included.
- Net Co will remain inside the Restricted group perimeter, but in the event of a future restructuring retaining access to the network will be complicated; although we cannot see why it would be denied.
- VMO2 has upgraded over 4.4m of its homes passed to FTTP; the company will spend another £2bn in 2025 to further increase the amount of fibre in its network. It is not yet clear whether that debt will be incurred at the Net Co level or moved down into Net Co later.
Nexfibre will expand VMO2’s reach, along with everyone else:
- We estimate Nexfibre now passes 2m homes and intends to build out between 5m and 7m homes in the next couple of years.
- The Nexfibre network is not an overbuild of VMO2’s existing network and will allow VMO@ to extend its coverage and expand its clients.
- Access is not exclusive and Nexfibre can take on other customers. With BT Openreach also building FTTP and FTTH there is the danger of overcapacity in the future with new entrants being able to enter and cherry-pick customers. There is no sign of this yet, but broadband ARPU may well come under some of the pricing pressures seen by Mobile operators in the past.
VMO2 is slowly exiting its Towers JV:
- CTIL is a JV originally between Vodafone and VMO2. It holds the tower infrastructure for the mobile business.
- VMO2 has reduced its stake to 25% with sales to two different infrastructure investors and we estimate the equity value of its remaining 25% at £500m.
- VMO2 pays for access to the network and will continue to do so.
- The rollout of VMO2’s 5G network continues with 75% of the population now covered. The merger of Vodafone and 3 will lead to an auction of spectrum, and VMO2 will be a bidder.
In time, VMO2 will need to deal with changing consumer behaviour:
- Consumers are changing how they consume TV, moving from cable boxes to streaming apps, to using 5G compatible smartphones. VMO2 is involved in all of these markets. Pay-TV has mainly been about wholesaling content from SKY at low margins. The change to consuming TV via streaming will impact the number of subscribers to Pay TV and therefore revenue, but the impact on EBITDA contribution will be much smaller. With a fixed and mobile network, VM02 is well placed to continue to earn subscription revenue as customers need online access to Subscription Video on Demand (SVOD).
- Competition in broadband will grow as new entrants take advantage of the ability to buy capacity in fibre networks wholesale. However, this competition will take time to emerge. VMO2 cannot be complacent. SKY has the same number of subscribers as VMO2, despite not owning its own Network.
Free Cash flow after interest will be flat in 2025, but will rise in 2026:
- We expect capex at the top end of the £bn - £2.2bn guidance in 2025 and £2bn in 2026. Free Cash flow after interest will be broadly flat before rising to around £350m in 2026.
- We do not expect Capex to fall significantly over time. We have heard the story too often from these companies, there is always a new technology that needs to be deployed.
- OFCOM's agreement to the Vodafone/Three merger will help keep margin-damaging competition in check.
- Leverage will be at the higher end of guidance but we have been here before and Liberty/Telefonica will make the necessary reductions in distributions to ensure the debt stack remains financeable as it falls due.
I look forward to discussing this with you all.
Regards,
Aengus
T: +44 203 744 7055