Sunrise has become embroiled in a battle with its major shareholder Freenet over the proposed acquisition of UPC Switzerland. Freenet thinks the takeover is too expensive, and the seller, Liberty Global should share in the risk. The company has a point with the former but is on less firm ground with the latter. With a stake of 24.5 percent in Sunrise, Freenet can make it difficult for Sunrise to success in its planned rights offering to finance the deal. Sunrise will need to do its best at a roadshow with investors in the UK and US this month to convince the other shareholders to stay on board.
If the deal does not go ahead, Liberty Global is the big loser. It could be ready to try the deal the other way around, where UPC takes over Sunrise. Freenet would undoubtedly support this, especially at the current agreed valuation.
Sunrise and UPC fated to merge
Sunrise announced the takeover of UPC Switzerland at the end of February. It plans to pay in cash and will take over UPC's debt. Given the size of the deal, a rights issue is needed to cover the financing.
The cards are already dealt in the Swiss market, with three fixed networks and three mobile operators. Sunrise and UPC appear fated to come together, especially given the growing importance of fixed-mobile convergence.
Sunrise is the number two mobile operator in Switzerland, after incumbent Swisscom and ahead of Salt. The company is listed on the stock market and has German challenger Freenet as its biggest shareholder, with a stake of almost 25 percent.
UPC Switzerland is part of Liberty Global, which has been selling off a number of subsidiaries. UPC's network covers around 80 percent of the Swiss population, making it the second-largest fixed operator on the market.
Like in other countries, fixed-mobile convergence is an important factor on the Swiss market. Salt has agreed a partnership with Swiss Fiber Net (SFN, an open fibre network) in order to offer fibre services and recently passed 50,000 customers. Sunrise has chosen for a takeover of cable operator UPC Switzerland. Sunrise already has wholesale agreements with various local fibre operators, including SFN, but access to Swisscom's fibre network remains difficult.
Freenet wants to block takeover
Freenet is not happy with the takeover price and risk and said it plans to vote against the rights issue. Will that be enough to torpedo the share offering? Sunrise suspended the Freenet board representatives from participating in further talks on the acquisition. It also raised its target for the synergies expected from the merger and said it's confident the rights issue will be approved. Liberty Global said it has no interest in re-opening negotiations on the deal. UPC Switzerland's Q2 results showed the negative trend has not ended, but the figures were somewhat better than Sunrise and Liberty Global expected.
High valuation
As usual, the companies gave a valuation of the deal in terms of multiples. These can be based on the past, current or next year's expected EBITDA or cash flow and may or may not include synergies - to the buyer and seller to each choose the most flattering figures. A valuation of any company is a complicated business, and if the results are falling, it gets even more difficult. And this is exactly the problem at UPC Switzerland.
The company's revenues peaked in Q4 2017 and have been falling since, and EBITDA is declining since the end of 2016. UPC has only a small presence on the mobile market as a MVNO, so can not really compete on the FMC market. Sunrise has more of a presence in fixed but is facing competition from new arrivals on the fibre networks, such as Salt. As such, the seller Liberty Global focused on multiples for expected results in 2019, while the buyer Sunrise used multiples based on the results in 2018.
Sunrise is prepared to pay a multiple of 9.9x adjusted EBITDA before synergies, or 8.0x including synergies. The mutliples have since been lowered to reflect the upgraded targets. In comparison, KPN has a current enterprise value of around 7.7x adjusted EBITDA over the past four quarters. This puts the agreed price for UPC Switzerland (fixed-only, declining results) on the high side, especially as KPN's share price also prices in a premium for an expected takeover bid.
Sunrise needs to convince shareholders
Freenet's concerns about the risks of the deal are less convincing. It's unclear why Liberty Global should share in the risk of the merger and realising the projected synergies. Only if the seller were to retain a stake in the merged company (as Tele2 did in the sale of its Dutch operations to T-Mobile) would the risk be shared. This was not an option for Liberty Global.
How the transaction will proceed is uncertain. If Freenet does not participate in the rights issue, Sunrise may not be able to raise enough capital. The latest reports suggest other large shareholders may also have a problem with the deal. If Sunrise abandons the takeover, the company will need to pursue alternative fixed network deals with Swisscom and/or SFN (not to mention the possibilities of 5G). Salt, backed by Xavier Niel (owner of French/Italian operator Iliad), will not be led into an expensive takeover of UPC Switzerland. This leaves Liberty Global as the big loser. It may be forced then to turn the tables and make a bid for Sunrise. In that case, Freenet comes out a winner.
The last scenario seems unlikely. More likely is the other large shareholders will be asked to over-subscribe their share of the rights issue to ensure sufficient capital.
