A quick note on the LILAK Rights Issue

I must confess to being initially baffled by the Liberty Latin America Subscription Rights Issue, announced on August 5, as a means of financing their acquisition of Telefonica’s Costa Rican wireless operations. Why announce a $100m share buyback in March, only to issue $350m in equity later the same year?

The company’s valuation sits firmly at prices where buybacks make sense and issuing stock, less so. I don’t think I was the only one confused by the course of announcements, but I believe the two can be explained.

The company recognised and still recognises itself as cheap. Therefore, a buyback made sense given the unexpected price discount due to Covid-19. This was supported by CEO (Balan Nair) buying stock in March and May.

However, on top of making LILAK cheap, Covid-19 has served up a number of potential acquisition targets at potentially even cheaper prices. Management is acting opportunistically and, while some of the Telefonica assets will be debt funded, do not want to lever up the balance sheet exclusively in doing the deal.

Nair is acting like a man intent on creating shareholder value in spades and has been busy since being tapped by Malone from his former position as Chief Technology Officer at Liberty Global. These assets were for sale now and had to be bought or missed in real time.

The textbook argument against issuing cheap equity to fund acquisitions doesn’t apply here. The Costa Rican mobile assets will be strongly cash flow positive from day one.

So often an excuse to pay too much, these synergies are actually very real. LILAK already owns fixed-line provider Cabletica in Costa Rica and the fit of adding mobile to the offering is obvious.

The price is also compelling, coming in at 6x OIBIDA (Operating Income Before Interest, Depreciation and Amortisation- the company’s preferred measure). This is the same multiple LILAK recently paid for AT&T’s Puerto Rican and Virgin Island assets, negotiating a price of $1.95b, after AT&T initially wanted $3b. I am confident the company is being highly disciplined in it’s M&A strategy.

As to the Rights Issue itself, given LILAK’s current Market Cap of $1.8b and EV of $9.6b, we can expect the post issue business to boast numbers of $2.15b and $10.1b respectively.

The prices mentioned have been vague, but the issue has the stated goal of raising $350m and will offer the shares to existing holders at a 25% discount to the weighted average market value over a given time to be announced.

Given the 25% discount, the dilution will have the same effect as having raised $467m which will be 26% increase in the share count. Another way to look at this is that each LILAK share currently held will entitle the owner to buy 26% of a share at 6.5% discount to the determined weighted average. I am making these calculations assuming that the rights will be fully subscribed (at least through others taking up waived rights) and the $350m divided pro-rata across the register.

The combined entity will have Operating Cash Flow of approximately $1.924b (LILAK 2019- $1.541b, AT&T Puerto Rico- $300m, Telefonica Costa Rica- $80m) and I judge will be very capable of achieving $320m of 2021 Free Cash Flow ($275 from LILAK/AT&T +$45m from Telefonica) giving a multiple of 6.7x 2021 normalised FCF, with significant growth potential going forward.

In addition, the post issuance LILAK will be safer, with lower leverage and be able to offer more complete packages to its customers in Puerto Rico, the Virgin Islands and Costa Rica.

So in my summary, the rights offering discount is not deep enough to especially encourage me to dive in and add before the record date of September 8. But I will participate in the raising in full and look to add further shares on weakness as I believe the combined entity will be more stable, is successfully building scale in growth markets and very cheap in relation to its cash flow generation potential.

Liberty LILAK is a 3% portfolio position, initiated in late 2018 at $19/share.

Guy

Always do your own research and seek financial advice where appropriate. This isn’t a recommendation to buy LILAK shares, just my opinions and reasoning for my own decisions.