O'Brien's cash cow Digicel faces global challenges

Digicel is the dominant player in many markets, which makes it vulnerable to competition and has put it firmly in the sights of regulators

THE SUBSTANTIAL document issued last week for Digicel Group Ltd’s (DGL) $1.5 billion bond offering gives a unique insight into the operation of the company and its amazing growth over the past decade.

It also highlights how the company has become a cash cow for its co-founder and chairman Denis O’Brien.

Digicel has been a staggering success story for O’Brien and his colleagues.

Since its launch in 2001 in Jamaica, Digicel has gone on to establish operations in 30 markets in the Caribbean, central America and the south Pacific, all under the one brand and all by using similar tactics involving aggressive branding and blanket distribution.

It’s worth remembering the significant challenges that mobile giants Vodafone and Telefonica, which owns O2, have encountered in trying to establish global networks.

From a standing start, Digicel has secured 13 million subscribers from an aggregate population of 31.4 million in the areas where it operates.

Just two years ago, the subscriber base was 7.5 million so the company is growing at a rate of knots.

The document states that it is the market leader in 17 of those countries, which means it has a share of 50 per cent or more.

Its share is 75 per cent or more in Jamaica, Haiti and Papua New Guinea, its most lucrative areas of operation.

In poverty-stricken Haiti, the share is a remarkable 83 per cent.

The document highlights its success in certain markets.

Jamaica generated an operating profit of $140 million from revenues of $474 million last year. In Haiti, the operating profit was $86 million off turnover of $439 million.

In Papua New Guinea, the operating profit was $75 million off revenues of $400 million.

Since 2001, Digicel has grown into a business that generated revenues of $2.5 billion in the year to the end of March 2012, and made a net profit of $47.2 million.

While the profit looks small it compares with a loss of $131.7 million in fiscal 2010 and comes after substantial interest costs and network investments have been factored into the equation.

In the three months to the end of June, the first quarter of Digicel’s financial year, its revenues rose by 11 per cent year-on-year to $674 million.

This was due to organic growth in Trinidad Tobago, Papua New Guinea and Haiti, combined with the spin-offs from acquisitions in Haiti and Jamaica and a positive currency movement in Papua New Guinea.

The El Salvador operation, which is slated to be sold in 2013 to Mexican billionaire Carlos Slim, was the laggard.

Revenues there fell by four per cent due to a 12.5 per cent reduction in mobile termination rates implemented in August 2011.

Digicel has become an extraordinary cash cow for O’Brien.

In fiscal 2012, Digicel paid a dividend of $115 million.

According to the bond document, in June of this year it paid a quarterly dividend of $10 million and a “special” dividend of $300 million.

As a 94 per cent shareholder in DGL, O’Brien gets the lion’s share of these payouts.

In addition, other companies controlled by O’Brien are paid substantial sums on an annual basis by Digicel.

As revealed in The Irish Times yesterday, four companies – Island Capital Services Ltd, Communicorp, Ican and AC Executive Aviation Services Ltd – were paid an aggregate $44.4 million over a three-year period to the end of March 2012 for the provision of various services.

In addition, Island Capital stands to earn $7.5 million from the latest bond offering.

This comes via an agreement with DGL that obligates the mobile phone company to pay 0.5 per cent of the aggregate transaction value of any “tender offers, acquisition, sales, mergers, financings, exchange offers, recapitalisation or similar transactions” that its undertakes.

With the bond offering currently in full swing, Digicel declined to comment on any aspects of the information included in the document.

So it was not possible to question why a company owned by O’Brien is able to pull such a substantial fee from this debt-raising exercise.

It’s not all plain sailing for Digicel.

It has gone from being the monopoly buster in most of its various markets to being the established player or incumbent.

This makes it vulnerable to competition from rivals and has put it firmly in the sights of many regulators, who are keen to ensure that it doesn’t use its dominant position to the detriment of consumers.

Regulators in various markets are also beginning to impose lower tariffs on mobile operators.

For example, in the French West Indies, which are covered by EU law, mobile termination rates have been cut by 47 per cent since January 2009.

Substantial rate cuts have also been implemented in Jamaica and El Salvador, while the government in Jamaica has imposed extra taxes to raise revenue for the rollout of broadband to schools and libraries on the island.

In Papua New Guinea, the national authority is planning to regulate prepaid mobile prices, which could force Digicel to reduce its tariff for “off-net traffic”.

“The proposed legislation could take effect as early as September 2012,” the document states.

As the business has matured, its average revenue per user has also come under pressure.

In the three months to the end of June, its Arpu declined by 9.6 per cent to $16.

The global recession has played a role in squeezing this figure.

“In particular, financial centres such as the Cayman Islands, and Turks and Caicos have been negatively impacted by the worldwide economic slowdown,” the document states.

It said that if these conditions continue, this could result in reduced spending by its consumers and reduced roaming revenues as a result of slower tourism in its regions.

“We will seek to offset any decreases in Arpu through the introduction of additional value-added services and through our ongoing cost reduction efforts.”

The document also states that at the end of June, 95 per cent of Digicel’s subscribers are pre-paid.

This can be a double-edged sword. Prepaid customers don’t pose a credit risk to the company and the costs associated with obtaining these customers is usually lower.

However, a prepaid customer base is more prone to switching. In addition, bill-pay subscribers usually generate more revenues for telcos and are more likely to use high-value data services.

Digicel is also facing a number of lawsuits in its various markets.

The Fair Trade Commission in Jamaica has challenged its acquisition of Claro, a rival operator that was owned by Carlos Slim.

The regulator argues that the deal lessens competition on the island.

The Jamaica deal is part of a three-legged transaction that involves Slim acquiring Digicel’s businesses in Honduras and El Salvador.

The Honduras deal has been completed while El Salvador awaits regulatory clearance.

Some of the markets that Digicel operates throw up certain challenges.

Haiti relies heavily on foreign aid, particularly after the earthquake of January 2010 in the capital Port-au-Prince.

Fiji is under military control and Papua New Guinea has been the subject of political instability. Digicel’s document describes the situation as “fluid”.

And O’Brien has leveraged the business significantly in recent years.

Digicel’s total debt stood at at $4.9 billion at the end of March 2012.

When you factor in its cash balances (about $342 million), it has a net debt to Ebitda (earnings before interest, tax, depreciation and amortisation) of about four times.

It’s worth noting that Independent News Media, where O’Brien now exercises significant influence by virtue of his 29.9 per cent shareholding and the recent appointment of his Digicel co-founder Leslie Buckley as its chairman, is working towards reducing its leverage to less than three times.

The $1.5 billion bond offering is just the latest in a long line of financings by the company over the past decade.

It carries an interest rate of 8.25 per cent and will mature in 2020.

It will be used for the most part to repay other loan notes at a more favourable rate of interest.

DGL is a holding company and doesn’t conduct any business operations. It relies on dividends and funds from its various operating subsidiaries to meet its financial obligations.

The document notes that the group’s indebtedness requires it to dedicate a “large portion” of its cash flow to fund debt payments.

It also limits its ability to raise additional debt and places it at a disadvantage to rivals who have no debt.

In many respects, Digicel shares many characteristics with INM under the stewardship of Sir Anthony O’Reilly.

It is operating in a number of disparate regions, enjoys strong market shares and is highly leveraged.

O’Brien’s shadow over Digicel is every bit as large as O’Reilly’s was at INM before the global financial crash in 2008, which exposed the media company’s vulnerability to its huge debts.

To date, O’Brien has kept Digicel on an impressive upward growth trajectory that has it gobbling up customers and market share in almost equal measure.

Capital markets continue to show a healthy appetite for its debt instruments and the ratings agencies remain positive about the company’s ability to meet its obligations.

O’Brien has a lot of credit in the locker from the $2.8 billion sale of Esat Telecom in Ireland to British Telecom in January 2000, just nine years after he had set up the company.

How much longer can Digicel’s growth story continue? Will the bubble burst at some point? These are questions that go unanswered in the bond document.