VodafoneZiggo success depends on realising sales synergies

Thursday 5 January 2017 | 17:10 CET | Background

VodafoneZiggo is the new number two on the Dutch market from the start of this year. Much is still unknown about how the joint venture plans to develop its branding and product offers. We look here at the company's financial situation, which shows a high leverage. The parent companies appear to already be taking cash out of the company, and if this is to continue, VodafoneZiggo will need to work hard to achieve its expected cost and sales synergies. If it doesn't, a sale of the company could be the next step. 


We compare below the reported figures for Vodafone and Zigoo up to Q3 2016, along with the combined group's reported results and those of its main competitor, KPN. All figures are in euros. 

   Ziggo Vodafone   VZ  Vodafone  KPN  KPN
   excl. Ziggo Sport  NL  incl. Vodafone Thuis  Thuis  NL  incl. iBasis
   Q3 2016 Q3 2016  Q3 2016  4 quarters  Q3 2016 Q3 2016
 Revenue  611 mln  459 mln  1,070 mln  53 mln  1,525 mln  1,718 mln
 Revenue growth  -0.3%  -6.1% -2.9%  NA   -1.5%  -2.6%
 EBITDA  337 mln  159 mln  496 mln  -29 mln  661 mln  665 mln
 EBITDA growth -3.6%   -6.5% -4.6%  NA   +9.1%  +10.5%
 EBITDA margin  55.1%  34.8% 46.4%  NM   43.3%  38.7%
 Capex  124 mln  61 mln  185 mln  44 mln  264 mln  265 mln
 Gross debt      10,000 mln      8,040 mln
 Leverage      4.5-5.0x      3.0x

A small detail in the figures: VodafoneZiggo reports Ziggo's 12-months revenue at EUR 2.446 billion, while Ziggo itself reported EUR 2.433 billion. The difference is the channel Ziggo Sport, which thus had revenue of EUR 13 million over the period.

Synergies difficult to realise

At the completion of the joint venture, VodafoneZiggo announced a lower target for cost savings but still has high expectations for sales synergies. These are estimated to be worth at least EUR 1 billion. The question is how the company expects to grow sales this much in a market that is hardly growing and highly competitive. Will it target market share expansion through cross- or upselling or will it try price increases (a strategy already in use)?

The emphasis will most likely be on the former: convincing Vodafone mobile customers to take fixed services from VZ and Ziggo fixed customers to take mobile from the new company. It's a big question whether that's possible in the current market. Vodafone's performance in the mobile market has been weak in recent quarters, and Ziggo has been losing customers since it merged with UPC. 

KPN is unlikely to stand by and watch its customers be taken, and T-Mobile is gearing up to tackle the fixed market after buying Vodafone's business (Vodafone Thuis - now renamed T-Mobile Thuis). As we've said previously, T-Mobile does not appear concerned about sacrificing its margin in order to win market share. Deutsche Telekom seems willing to invest in the Dutch company in order to raise its value ahead of another attempt at selling it. Tele2 meanwhile has written down the value of Dutch activities "as a result of a reassessment of future cash flow generation".

At the same time VodafoneZiggo has started with debt of EUR 10 billion, even more than its bigger rival KPN. A company with this level of leverage usually carries a higher growth and margin profile. VZ though is operating in a difficult market and has set itself a very ambitious task. Its two shareholders must be very confident.

Cash withdrawal

How are Liberty Global and Vodafone taking cash out of VZ?

  • Additional debt was added to the new company's balance sheet. 
  • As Vodafone NL is worth less, it's paying an equalisation fee to Liberty to make it a 50-50 joint venture. This was reduced from EUR 1 billion when the deal was first announced in February to EUR 0.8 billion at the end of 2016 when the deal closed due to the increased debt and likely also a reassessment of the assets, including the growing Vodafone Thuis business. A new loan raised EUR 2.8 billion, so EUR 1.4 billion for each shareholder. Along with the equalisation fee, that means a net EUR 0.6 billion in cash for Vodafone and EUR 2.2 billion for Liberty.
  • Since the JV was first agreed in February, both companies have withheld free cash flow from their subsidiaries: EUR 300 mln at Vodafone and EUR 500 mln at Ziggo. This raises Vodafone's total to EUR 0.9 billion and Liberty Global to EUR 2.7 billion.
  • Leverage at the new company is targeted at 4.5-5.0, which allows for a "predictable dividend". Along with the existing free cash flow, growing EBITDA should allow the company to take on additional external debt ("expected to undertake periodic recapitalisations"), which can then be paid out as dividends to the parent companies.
  • VF is also expected to pay annual fees to its shareholders, in order to "benefit from the full scale and complementary expertise of each partner". This is for services such as using trademarks and internal services, content and infrastructure. In 2017 the fees will total EUR 211 million, of which EUR 97 million to Liberty and EUR 114 million for Vodafone.

The shareholders have chosen to leverage the company similar to Liberty Global's profile, rather than Vodafone's much lower debt ratio of 2.6. Will VZ be able to merge a mobile operator and cable operator and support a cable-like leverage and the associated growth and margins? Given all of the above, this should be considered a challenge. Nevertheless, the company was still able to raise new debt. What's remarkable though is that the proceeds from the debt issue were taken out of the company and given to the parent companies. Cash is already being sucked out of the joint venture, just when one would expect investments in order to realise the sales synergies. VZ appears to be planning to finance this from its own cash flow, supported by lowering its cost level.

The withdrawal of cash from the company could also be seen as a first step towards leaving the Dutch market for the two parent companies. Something similar occurred in the UK, after Deutsche Telekom and Orange started with network sharing, then formed a joint venture, picked a new brand (EE) and then finally sold the company to BT.

Vodafone on top

At Vodafone Group's last quarterly report, the Netherlands was the weakest performing country based on service revenues, despite the strong growth at Vodafone Thuis. Ziggo was also the poor cousin at Liberty Global. If either really wants to stay on the Dutch market in the long term, Vodafone seems to have a somewhat better chance. On the one hand, Ziggo is the bigger party and Liberty was able to impose its high leverage on the new company. On the other hand, Vodafone is providing the CEO for the new company and receives a greater share of the annual shareholder fees.

The partners have agreed that an IPO of the company is possible from 2020 and a sale (to a third party or one of the shareholders) from a year later. This doesn't stop them from selling earlier though, if they reach agreement. The most likely bidder for VZ would be a European multinational, which can generate synergies through procurement and rebranding. That is a limited group, all of whom want to gain scale. Outside the Netherlands, such candidates include Orange, Sky, Hutchison, Telefonica, Iliad, Altice, Telekom Austria, Telia and Telenor. The most obvious would be the French operators Orange, Altice and Iliad.

Both VF's parents will keep their options open. They have already secured a partial return on their Dutch investments with the cash taken from VZ. They also have an asset in their stakes in VZ, the value of which depends heavily on realising the expected synergies. If the Dutch joint venture proves a success, other countries could follow, such as the UK, Germany, Ireland, Hungary, Czech Republic and Romania. If not, VZ could someday become French. 

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