Why MCG's Share Price Has Fallen - Four key reasons
Before examining the options available to MCG we thought it would be worthwhile examining
why we think the share price has come under so much pressure.
We believe there are four key reasons behind the deterioration in its share price - some of
which are indirectly linked, creating somewhat of a vicious cycle:
1. Concerns over paying up for acquisitions
We believe that MCG spooked the market last year by undertaking 3 acquisitions within a
short space of time. Furthermore, the perception within certain sections of the market was
that the multiples paid by MCG were fairly full, whilst the use of the exchangeable bonds as a
funding source actually capped MCG's share price upside (which is ironic with hindsight).
Our analysis at the time suggested that the acquisitions would add long term value to the
portfolio (albeit in some cases FCF dilutive in the short term), and the earnings performance
from the assets since acquisition has not altered our moderately positive view.
However, clearly the subsequent unfavourable regulatory ruling on the NGW acquisition has
eroded some of the value created by that acquisition.
2. Market gearing ratio
MCG's high market gearing ratio also appears to have captured the interest of hedge funds
wishing to short the stock on the back of the credit crunch. Unfortunately, the more the
share price falls, the worse the gearing slowly becomes and hence this tends to feed on itself.
However given the debt is largely held at the asset level, and the banks lend on the basis of
the assets' ability to service debt, the market gearing ratio of MCG is actually of little
relevance to financiers.
Interestingly, before MCG's share price dropped to such a point that the exchangeable bonds
shifted from being classified as equity to debt (requiring refinancing in 2010 and 2011), MCG
had no significant refinancing due until 2014.
Furthermore, the interest rate exposure on its existing debt was (and still is) effectively
hedged to ~95% for almost the next decade.
However the market seemed more focused on blunt measures such as its market gearing
ratio, which has been supported by correlation analysis we have undertaken in the past (see
Daily Cable article on the Infrastructure Sector published on 18 April 2008).
3. Exchangeable bond
As MCG's share price continued to fall on credit market concerns, the option value of the
exchangeable bonds have eroded to a point where it now seems highly probable that they
will be 'put' at the earliest point of redemption, being May 2010 (A$725m) and July 2011
(US$200m) respectively.
The market's concern over how this issue will be resolved has driven MCG's share price even
lower given:
1. current availability and pricing of debt;
2. MCG's increasing cost of equity (via its declining share price); and
3. declines in global asset prices (although this is debatable within infrastructure), which
could be an issue for MCG if it becomes a forced seller.
4. Longer term refinancing risk
Given the issues BBP has had with its $3.1bn refinancing (albeit that it appears the vast
majority of the refinancing has now been completed), the market has also shifted its
attention to longer term refinancings within other highly geared Funds.
5 June 2008
Macquarie Communications Infrastructure Group
Goldman Sachs JBWere Investment Research All figures in A$ unless otherwise advised
4
Given MCG needs to refinance ~$9.5bn of debt in 2014 (on a 100% consolidated basis, its
actual proportionate share is ~50%), it appears that the market is extrapolating current
conditions out to that point and speculating on how this might impact its ability to refinance
this debt.
However this ignores that the debt is split across two high quality assets (Arqiva and
Airwave) which will have DSCRs of ~1.9x in 2014 (based on our forecasts). This is a
comfortable level for assets of this nature and hence should attract potential financiers.
Exchangeable Bonds - Refinancing options
As detailed below, last year MCG has issued two separate exchangeable bonds which were
used to help fund the acquisitions of NGW, Airwave and GTP.
A$725m face value
− 2.5% coupon; 6.25% yield to maturity
− Convertible into equity at fixed exchange price of ~A$7.89
− Maturity in May 2012
− Early put option in May 2010
US$200m face value
− 2.5% coupon; 6.0% yield to maturity
− Convertible into equity at fixed exchange price of A$8.13 (based on USD conversion at
the time of issue)
− Maturity in July 2013
− Early put option in July 2011
Assuming these bonds are 'put' early, the refinancing options available to MCG include:
Issue Equity
• Very dilutive at these prices
• Highly unlikely given MCG has stated in the past that it does not wish to raise equity
below ~$6.
Hybrid Debt
• Arguably just delays the problem (assuming it's another convertible) unless MCG expects
its share price to materially rerate in the future.
• Unless debt markets materially improve, the pricing of the hybrid would likely be
prohibitive based on the where the exchangeable bonds are currently trading.
Senior Debt
• Simplest solution, but could be costly.
• There is a query over whether it will be available up to the amount required to fully fund
the bonds. However recent examples (eg BBI) suggest that at least a substantial amount
will be available to them.
• Key issue is that eventually the debt is likely to be replaced with equity (at least in the
market's view), so the stock is likely to trade cum equity raising.
Asset Sales
• Based on our analysis, this is the best option available (perhaps combined with a debt
raising) unless equity and credit markets materially improve between now and 2010.
5 June 2008
Macquarie Communications Infrastructure Group
Goldman Sachs JBWere Investment Research All figures in A$ unless otherwise advised
5
• Clearly this is predicated on MCG realising a fair price for these assets. However given
several of its co-investors in GTP and Arqiva comprise unlisted Funds managed by MQG,
these would appear to be the logical purchasers given their understanding of the assets.
• Whilst the FCF yield is least likely to be diluted under this scenario, it should also push
MCG's DSCR to more palatable levels ie ~1.9x.
Sensitivity Analysis - Raising debt vs selling assets
We have set out in a table below various scenarios under which MCG sells assets or raises
debt. Clearly a combination of both is possible, if not probable.
Under the three scenarios where we have MCG selling assets we assume that all of GTP is
sold at our valuation as well as a sufficient stake in Arqiva (with implied Arqiva FY09
EV/EBITDA multiple in brackets) to fund the exchangeable bond liability. Clearly a range of
asset sale options will be available to MCG, these are just examples.
We are comfortable assuming our valuation of GTP is realised under all scenarios based on
the current pricing of the listed US tower companies, which continue to trade on EV/EBITDA
multiples of >20x and have outperformed the broader US market in the past 6 months.
We set out the valuation impact, whilst also showing how MCG's FCF/share, FCF yield and
DSCR will look in FY12. We provide the FCF yield instead of the DPS yield, as this removes
the issue of determining distribution coverage and hence the quality of the distribution yield.
Furthermore, in our cash flow forecasts we assume the assets are sold as and when the
exchangeable bonds are 'put' to MCG, however we use our valuation in today's dollars to
determine the valuation impact.
• Scenario 1 is selling both assets at our valuation;
• Scenario 2 is selling GTP at our valuation and Arqiva at the valuation implied by the
recent sale of CIF's 6.5% stake; and
• Scenario 3 is selling GTP at our valuation and Arqvia at a valuation sufficiently low
enough to achieve the current share price (which we believe is entirely unrealistic).
Under the next three scenarios we assume MCG replaces the exchangeable bonds with
corporate debt, albeit at different rates.
• Scenario 4 is now our base case for MCG, which assumes corporate debt is raised at
7.5%;
• Scenario 5 is debt priced at 8.5%; and
• Scenario 6 is debt priced at 9.5%.
Just on our base case assumption of 7.5%, we believe this is sufficiently conservative given
the GSJBW Economics Team expects interest rates to decline in Australia to 6.5% by
December 2009. Furthermore, as noted earlier in the article, we actually believe the debt is
likely to be sourced in the UK, where rates are currently substantially lower than in Australia.
FY12 Valuation
FCF/Share
(¢)
FCF Yield
(%)
DSCR
(x)
Share price $3.50
Sell Assets
Scenario 1 (15.2x) $6.51 46.5 13.3% 1.9
Scenario 2 (14.5x) $6.25 44.9 12.8% 1.9
Scenario 3 (10.9x) $3.50 27.7 7.9% 1.8
Replace with Debt
Scenario 4 (7.5%) $6.50 42.3 12.1% 1.5
Scenario 5 (8.5%) $6.50 39.8 11.4% 1.5
Scenario 6 (9.5%) $6.50 37.4 10.7% 1.4
Source: GSJBW Research estimates
5 June 2008
Macquarie Communications Infrastructure Group
Goldman Sachs JBWere Investment Research All figures in A$ unless otherwise advised
6
Key Conclusions - MCG has time on its side and options available
Raising corporate debt is our base case
Our analysis suggests that whilst there is some risk that global economic conditions
deteriorate to such a point that in 2010 MCG faces a significant hurdle in refinancing its
exchangeable bonds, MCG should be able to work through these issues given it has time on
its side and various options available to it.
Whilst for the purposes of simplicity our base case assumes that the exchangeable bonds are
entirely replaced with corporate debt sourced in Australia, this is predicated on MCG being
able to gear itself to this level.
Preferred option likely to be a combination of debt and asset sales
However we suspect that the more likely and preferred option may be to combine raising
corporate debt and selling assets. However for now we believe that this introduces too many
variables to be modelled as our base case.
Furthermore, it seems likely that given ~70-80% of MCG's proportional earnings will be
sourced from the UK by FY10, MCG will decide to raise this debt in the UK. It not only
provides them with a more natural currency hedge, but is also likely to take advantage of
lower interest rates (assuming rates remain fairly stable between now and FY10).
Unlisted MQG Funds appear to be likely purchasers
Regarding potential asset sales, it is worth highlighting that MCG is actually in a fairly unique
position given that the co-investors within its offshore assets (Arqiva, Airwave and GTP) are
largely comprised of other MQG managed funds, albeit unlisted.
This provides MCG with a potential opportunity to raise capital through reasonably priced
asset sales to co-investors who understand the assets, whilst still ensuring that MQG keeps
the assets under its management.
We believe this is a key reason why investors can be confident that MCG will not be left
without sufficient options to fund redemption of the exchangeable bonds should listed equity
and debt markets not materially improve before 2010.
Asset sales may also help to prove up the portfolio's value
The only shortcoming from selling part or all of an asset will be the market's reaction to MCG
choosing to dispose of recently purchased investments in order to avoid a dilutive equity or
debt raising that has effectively been forced upon them much earlier than anticipated.
Whilst the market's rating of the Fund may suffer, it is hard to imagine how sentiment
towards the stock could be materially worse than what currently exists. If anything, it would
probably only be existing holders who believe in the long term value of these assets that may
feel temporarily aggrieved.
We would actually expect the broader market to react positively to an asset sale, particularly
given it not only helps to fund redemption of the exchangeable bonds and improve its capital
structure, but it also proves up the value of its remaining portfolio, albeit potentially via a
transaction with a related MQG entity. However given all of the assets could arguably be
disposed of in this manner, we doubt the market will care to make this distinction.
MCG
macquarie communications infrastructure group
