Why I bought a small initial holding in Zegona Communications

Zegona Communications (AIM listing, ZEG.L, Market capitalisation £47m but after deal about £290m, 165p and 1.0% of JIC Portfolio): Whilst sifting through the holdings in Neil Woodford’s Equity Income Portfolio last week, there was one holding which particularly caught my attention. Zegona Communications came to market in March through the placing of 25m shares at 120p raising £30m. It is a new company which was established to acquire and operate businesses in the European Telecommunications, Media and Technology sector, focusing on network-based communications and entertainment opportunities. Its targets for investment are “strategically sound businesses that require active change to realise full value, creating significant long-term returns through fundamental business improvements”.

Topically, given Tuesday’s announcement from Melrose Industries, Zegona’s “Buy, fix and sell” strategy is similar to the “buy, improve and sell” strategy of Melrose which has created so much shareholder value over the years. Ultimately, the success of this type of strategy is all down to management; do they buy well, can they achieve the operational and financial improvements and do they sell well? Melrose’s management have proved themselves; it’s up to Zegona’s to prove themselves in the telecom, media and technology space. Zegona’s management, particularly the CEO, Eamonn O’Hare, has a good track record; prior to setting up Zegona he was CFO of Virginmedia from 2009-2013 where he oversaw a substantial improvement in its financial results before its eventual sale to Liberty Global for $24bn enterprise value.

On Monday, Zegona announced its first deal. It is buying TELECABLE DE ASTURIAS S.A. for €640m from Carlyle Group and Liberbank. It says “Telecable is the leading cable operator in Asturias and has installed over 2,400 kilometres of fibre optic cable and 2,600 kilometres of coaxial cable, with more than 450,000 homes passed in 44 municipalities in Asturias. Telecable complements its own network with a network provided by the Principado de Asturias that enables it to offer fibre optic services to approximately 43,000 homes in rural areas of Asturias. As of 31 December 2014, Telecable was the Asturias region’s leading ”quad-play” residential telecommunications operator, being the largest provider of pay television and broadband services and the second and fourth largest fixed-line and mobile telecommunications provider respectively”.

Zegona has spotted an opportunity to improve the results and grow value at Telecable with the following strategy:

– strengthen the product offering, particularly within television and mobile, providing a foundation for up-selling and greater bundling of services to customers;
– grow revenues in the enterprise division (B2B) by serving larger corporations (in addition to Telecable’s existing customer base) and through delivering more advanced data-orientated products; and
– realise productivity gains by optimising Telecable’s mobile access agreement, enhancing procurement and investment focus.

It is paying through a mixture of debt and equity; the equity element is being financed through the placing of £250m worth of new shares at 150p, which has already been agreed with intuitional investors, as well as some of the proceeds from its initial equity placing in March. A further €270m has been raised through a new term loan arranged by Goldman Sachs. It is acquiring Telecable on a cash free/debt free basis.

Commenting on the acquisition, Zegona Chief Executive Eamonn O’Hare said: “There is a significant opportunity to continue the impressive development of the Telecable business. By combining the local knowledge of the team in Spain with the international experience and track record of Zegona, we have the right leadership to drive Telecable forward and deliver its full potential.”

It plans, although does not guarantee, to pay a 4.5p dividend for the financial year 2016 with the first dividend being an interim payment for the 6 months ending 30^th June 2016. At the 150p placing price this equates to a dividend yield of 3.0%.

In the business presentation on its website it states that it aims to buy assets with an enterprise value of between £1bn and £3bn. Today’s purchase, enterprise value of £467m gives them plenty of scope for further acquisitions along the way.

As well as Woodford, it has a fine shareholder list, including Marwyn Value Investors, Hargreave Hale, Fidelity, Standard Life and Smith & Williamson. Eamonn O’Hare held 6.1% of the equity before this deal.

Conclusion: This acquisition looks like a good start for the management team but is likely to be followed by others given that it has a target of achieving a business with an enterprise value of between £1bn and £3bn. To buy this stock one is taking it on trust that management will be able improve the returns of the business, but given their expertise and previous record in the industry I am prepared to do that, but only with a 1% holding to start with. If/when management prove that the business model is working and that it is receiving further backing from financial markets, I will be happy to add to the position. The equity returns over the next three to five years could be very attractive if they get it right. Unfortunately there is a wide bid/offer spread in the shares, which will hopefully narrow after the placing and acquisition completes in mid-August; liquidity should improve. I approached this carefully, being mindful of paying too much and bought my 1% holding at 155p per share and would be wary of chasing, as I am sure once the deal completes some stock will leak out onto the market.