Cable Cowboy Has Upper Hand in $6.4 billion Poker Game

(Bloomberg Opinion) -- John Malone faces opposition in his latest deal to cut his European exposure. A dominant shareholder in Sunrise Communications Group AG is furious about the terms of its all-cash 6.3 billion Swiss francs ($6.4 billion) bid for the cable tycoon’s Swiss business, UPC Switzerland LLC. Malone should think hard before giving ground.

This is a way bigger deal for Sunrise than for Malone. Sunrise has a market value of just 3.5 billion francs so it’s asking shareholders for some 4.1 billion francs of equity to fund the purchase. Lead investor Freenet AG, the German mobile group with a 25% holding, faces a request for 1 billion francs of that. That’s patently unrealistic. Freenet is already stretched, with 2.2 billion euros ($2.4 billion) of net debt and high leverage.

In a normal rights offer, shareholders like Freenet who can’t or won’t buy the new stock sell their “rights” to participate. That provides compensation for the dilution they suffer.

But things might not be so straightforward when an offer is this big. Supply could vastly exceed demand for Freenet’s rights, driving down their price and, in turn, the value of its compensation. Freenet’s only hope is that there’s a queue of new investors itching to invest in Sunrise because the telecoms operator is undergoing a transformation. Still, there’d need to a lot of them.

Small wonder that Freenet called on Friday for the deal to be revised. Its demands include cutting the price, paying Malone in shares as well as cash, or using more debt and less equity – all ways of reducing the size of the rights offer. Freenet has withheld support for the fundraising. This must be passed by a majority of votes cast at a shareholder meeting. Assume a two-thirds turnout and Freenet would need only to be joined by holders of about another 9% of the stock to kill the entire deal.

While Freenet’s hand is strong, Malone’s is too. In reality, a price cut looks hard to justify. The acquisition doesn’t look expensive for Sunrise, with returns in the high-single digits including synergies, exceeding UPC’s cost of capital within three years. Malone would be a fool to swallow worse terms. That would tarnish his reputation for not budging in M&A. 

Asking Malone to take some of the payment in Sunrise shares looks risky. Minority shareholders would then get wedged between Malone and Freenet, two holders with strategic stakes. 

But Freenet is right that the size of the equity fundraising is probably bigger than necessary. Sunrise says combined net debt after the deal would be about 3 times trailing Ebitda. That’s higher than Sunrise’s multiple right now but on the low side for a telecoms group with lots of cable assets. Sunrise could probably fund this deal with more debt and less equity.

The Swiss company can try getting Malone to blink. It might be easier to find a solution in the debt markets.

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

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