Plotting a slightly different course
We re-added Vocus Communications (ASX:VOC) to the portfolio around six weeks ago, taking the view that the an inflection point had been reached in the stock, with a senior management refresh underway, and a number of restructuring initiatives on the horizon. One of our beliefs was that the company would also be able to strengthen its balance sheet with the divestment of the company’s business in New Zealand. As it has transpired the company has shelved the sale process with none of the bids quite measuring up.
While this has not quite played out as we expected, we are satisfied with management’s justification, and the new strategy that has now been laid out, with the business retained. With the shares ticking up just a couple of cents since our initial buy we are comfortable continuing to back the turnaround story.
We maintain Vocus as a high risk buy for Members without exposure.
New Zealand Divestment
Last week Vocus (ASX:VOC) announced that it has ended discussions with interested parties for the sale of its New Zealand business. Management said that there were “multiple” offers but none measured up sufficiently.
Chairman Bob Mansfield stated that “Vocus NZ is an excellent business with strong leadership, an attractive growth profile, a clear competitive position and a track record of delivering solid returns on capital. The Board intends to continue to invest in and grow Vocus NZ to enable that business to realise its strategic potential for shareholders”.
As part of our investment case we had been looking for a sale to go through so debt could be paid down, and also pave the way for dividends to restart earlier. It would also enable the company to navigate an impending breach of debt covenants.
Vocus (ASX:VOC) has though said that an agreement has been reached with lenders on debt covenants which will ease some nerves, and refinancing plans are being progressed. A lending syndicate has consented to amending its net leverage ratio cap to 3.5 times until 31 December 2018, with a ratio of 3 times to be applied at 30 June 2019.
A full facility refinance with several banks is expected to be in place by the end of the current financial year. The company also has “no current intention to pursue an equity offering.” Management expects the net leverage ratio to peak in H1 FY19 and ‘organically reduce over subsequent periods’.
Vocus (ASX:VOC) at least therefore it seems has some breathing space in terms of debt, although we have to consider our position given that the balance sheet will not receive the boost we were expecting.
The company clearly has not been able to get a price to quite ‘fit’ with its expectations. Management had been, we believe, to be looking for around NZ$500 million, and we can only surmise that there was an expectations gap too big to bridge or negotiate. There was clearly some bidding interest, but perhaps at the NZ$300 million mark if not lower.
Vocus’ price expectations were based on their view of the quality of the NZ business, and some credence can be given for not engaging in a ‘fire sale’. The unit delivered NZ$342 million revenue last year and N$60.9 million in underlying earnings. The business also operates in a telco market which is arguably less competitive than Australia’s. The onus will though now be to ensure the business reaches its full potential and that debt is paid down organically, with a divestment lump sum not forthcoming.
We had seen a sale as being a potential re-rating catalyst, but there certainly remain others.
New management remains a potential value driver, and ironically given the decision, Vocus NZ’s boss, Mark Callander has been held out as a contender to take over as group CEO (from Michael Simmons who is currently the acting CEO). The company will now need to reduce debt ‘organically’ although a capital raise under a new CEO must be a possibility. A key point also remains that Vocus has the support of Janchor Partners, which has 18% of the register, and backed the turnaround plan and rights issue at Bellamys.
Recap
A recap for Members who have not seen our initial coverage, we previously had exposure to Vocus Group not once, but twice as the company swallowed up both Amcom Telecommunications, and M2 Group. We originally entered both on ‘value’ grounds, and latterly became concerned that Vocus was becoming too big for its boots, with a premium multiple to match. With integration risks abounding, and the technical picture also showing signs of topping out, we finally exited the shares around $7.75 in March 2016.
As it turned out our fears proved well founded, with the integration of the various acquired businesses not going smoothly at all, with synergies over-estimated and financial estimates some way off the mark. This culminated in a series of profit warnings, and ultimately the recent departure of the company’s CEO, and Chairman.
We have confidence in the new management team that has been appointed. Taking over as Chairman is Bob Mansfield, who previously chaired Telstra, and was the founding CEO of Optus. So he certainly has the capacity to make some tough decisions in our view.
We also stand by our view that Vocus (ASX:VOC) is very much a textbook example of why acquisition for acquisition’s sake is not a sure-fire recipe for success. In the past three years, the company has completed $5 billion in mergers with Amcom and M2, while also acquiring Nextgen for $807 million. The key as always is in the detail, and the realistic synergies and earnings drivers that will be gained as a result, and with due regard for the risks. This was sadly lacking in our view with respect to Vocus, and shareholders suffered the consequences.
Financial underperformance was clear to see in the half year results. Interim net profit fell 21% to $37.3 million. Management chose not to declare an interim dividend due to ‘competing demands and opportunities for capital investment’ and as a ‘more nimble’ approach to payouts is being sought. Understandably the market did not take this well.
Source: Vocus (ASX:VOC) Investor presentation
The board also chose to reduce full year EBITDA guidance to a range of $365 – $380 million (from $370 – $390 million). Full-year underlying profit was revised to between $125 million and $135 million, or about 10% below earlier forecasts. This also came on top of a 20% earnings downgrade in May last year.
As noted above, the company’s balance sheet has also been an issue, with net debt ballooning to $1.05 billion following the spate of acquisitions. The company’s net leverage ratio is around 2.9 times, which hasn’t left much headroom below threshold covenants of 3 times. This though has been renegotiated which has provided some breathing space.
Turning to the charts, and on the daily, the bearish moving average crossover present since late-February is suggestive of momentum to favour the downside. This occurs when the 50-day moving average (red line) crosses below the 200-day moving average (green line). At present, a zone of support is located between $2.23 and $2.26. This is made up of the March intra-month low (horizontal solid-blue line) and the September 2017 low (horizontal thin-blue line) respectively. A sustained break above the 50-day moving average (red line) of $2.80 is ideally required. If this was to occur, then this would shift momentum back in favour of the bull-camp.
With reference to the monthly chart, prices are in flirtation-mode with support sighted at the 78.6% Fibonacci retracement of $2.27. It is important that the bulls defend this level, otherwise, the risk of a deeper decline down to the December 2011 low of $1.29 could very well be on the cards. In order for a definitive bullish rotation to evolve, a sustained break above overhead resistance evident at the January high of $3.33 (as marked by the horizontal red line) is required.
From a technical perspective further consolidation is possible near-term, but on balance we are comfortable pre-empting the break-out that looks to be in the offing. There is some risk to this strategy, with the NZ divestment not now happening, and a new permanent CEO not having been appointed to the company yet.
Summary
We re-added Vocus Communications (ASX:VOC) to the portfolio around six weeks ago, taking the view that an inflection point had been reached in the stock, with a senior management refresh underway, and a number of restructuring initiatives on the horizon. One of our beliefs was that the company would also be able to strengthen its balance sheet with the divestment of the company’s business in New Zealand. As it has transpired the company has shelved the sale process with none of the bids quite measuring up.
While this has not quite played out as we expected, we are satisfied with management’s justification, and the new strategy that has now been laid out, with the business retained.
With the shares ticking up just a couple of cents since our initial buy we are comfortable continuing to back the turnaround story.
The business being retained across the Tasman is high quality, and operates in a less competitive market than Australia. Back on this side of the ditch Vocus is one of only four major telecommunications carriers and certainly has an opportunity to benefit.
New management will not be biased by the mistakes of the past which is a good thing in our view. The presence of activist shareholders such as Hong Kong-based investment group Janchor Partners will also ensure that new management are kept on their toes.
While the divestment across the Tasman is not happening, the company has been given some breathing space in terms of covenants and as it seeks to pay down debt organically longer term.
Vocus (ASX:VOC) trades on around 11 times FY19 earnings. This is similar to the multiple on which the shares were trading when we first entered the stock, and some way from the 25 times at which we exited.
Accordingly, we are recommending Vocus (ASX:VOC) as a high risk buy to Members. Please note that this recommendation should be viewed as high risk.
