Lebara at risk of busting year-end leverage and liquidity covenants as earnings slump

24 November 2017

European pre-paid telco Lebara’s bond is getting off to a rocky start. The group issued a EUR 350m senior secured 2022 FRN paying a chunky Euribor+ 675bps at the end of August. But an earnings slide in its first quarterly results since it came to market suggests the group could breach both its net leverage and its minimum liquidity test by year-end, according to two buysiders.

 

The group generated EUR 13.6m EBITDA in 3Q17, which was down from EUR 14.5m for the same quarter last year. Year-to-date earnings reached EUR 35.3m, well below the EUR 41.2m for the same period last year.

 

Revenues declined to EUR 126.1m from EUR 135.9m, while YTD revenues declined to EUR 377.3m from EUR 397.1m.

 

That leaves Lebara around 5.7x net levered based on an LTM EBITDA of just EUR 58.3m and EUR 333.2m net debt, and on course to bust its year-end 5.5x net leverage test.

 

“This is a disaster – if they are not busting covenants today, then they are on track to do so by year-end,” one buysider cautioned.

 

Despite the third-quarter earnings miss, management reiterated its full-year guidance of EUR 62m EBITDA. If it achieves the forecast, Lebara would end up around 5.3x net levered assuming a constant cash balance, which would enable it to scrape past the year-end test.

 

Hitting guidance looks a tall order given that the group would need to generate around EUR 27m in the last quarter. Lebara only generated EUR 23m in 4Q16 and the problems that derailed its third-quarter results will likely spill over into the last quarter.

 

Covenant pressure mitigants

 

“They could avert it (the breach) because their reported EBITDA will be higher than their cash EBITDA since they write up their full-year earnings as a result of a lot of SIMS being dormant,” a second buysider noted.

 

The fourth quarter is seasonally the largest for the group as many vouchers (bought during the peak summer travel period) expire, enabling the company to make adjustments to earnings. Lebara is able to track how much credit has been spent from prepaid SIM cards and treats unspent credit as deferred revenue. It typically assumes that any credit dormant for more than three months will not be used, enabling it to then recognise the unused cash as revenue. Since the group has already incurred all the costs upfront, these revenues are effectively at 100% margins and flow through to EBITDA in full, providing a material boost to fourth-quarter earnings.

 

That suggests the group will likely be able to avert a breach of the 2017 net leverage test. The covenant steps down to 5x end of 2018, 4.25x end of 2019 and at 3.5x thereafter.

 

The group also faces a minimum EUR 15m liquidity (free and available cash) covenant. With just EUR 16.8m of cash on balance sheet at the end of 3Q17 – down from EUR 26.2m this time last year – it also has little headroom under this test.

 

Given its bullish 4Q17 guidance is for adjusted rather than cash EBITDA, the company is unlikely to generate much cash to shore up its balance sheet before year-end. Lebara makes quarterly coupon payments on its EUR 26m annual interest bill and spends around EUR 10m-EUR 15m on capex. It has a sizeable amount of both receivables and payables but expects its working capital flows to remain neutral. That suggests it faces around EUR 5.9m of interest and capex EUR 3m-EUR 4m in 4Q17 ahead of cash taxes, which would imply very little in the way of cash generation assuming cash EBITDA in 4Q17 comes in at similar levels to 3Q17.

 

However, the group can easily avert a breach of this test too. It has additional cash sitting at the issuer level at its digital business, which creates user content, in subscriber accounts. While this cash is restricted and as such excluded from the group's reported cash balance, it could loan it to the operating company. The group is also in the process of obtaining an up to EUR 15m RCF from banks, which it could then draw if needed to bolster cash, a third source familiar with the situation noted.

 

Operational pressure headwinds

 

Lebara expects to conclude negotiations with MNOs (mobile network operators) to reduce carrier costs during the last quarter. Since end-user prices for voice calls and data are continuously falling, the group typically renegotiates lower rates at the end of every year.

 

However, as a result of the technology Lebara uses, it is unable to switch MNO suppliers, limiting its negotiating position, the first buysider noted. And any potential relief will likely also prove short-lived since the group is facing fierce competition, especially from peer Lyca Mobile in its core UK market, which is pressuring its margins, the first buysider noted.

 

“They claim that the networks from which they lease capacity (like Vodafone) need them to reach an audience that they can’t reach otherwise and will agree to price cuts as a result,” the second buysider said. “That I buy to some degree, but their point that data will offset falling call revenues I don’t buy. You can see they are under pressure.”

 

That is a concern since Lebara projected falling prepay revenues in its bond presentation, which it expects to offset through growing bundles (ie voice and data) sales and by moving into the post-paid market.

 

Lebara primarily sells pre-paid cards for cheap international phone calls almost entirely to immigrants, mainly from the Indian and African diasporas, and recently arrived young Eastern European immigrants, such as seasonal workers. That has been a huge growth business for the last few years but is now increasingly at risk of being displaced by evolving technology, such as Whatsapp and other internet-enabled free calls.

 

“They have massive churn rates running at 15%/month, so annualised its enormous. Their turnaround plan rests on selling more bundles for calls and data but that is hard to believe,” the first buysider agreed. “They have also decided to move into post-paid and expect second-generation immigrants to convert, but they won’t be able to compete given they buy capacity. They launched this in Netherlands the week of the bond but have had no success so far.”

 

It is also facing regulatory headwinds in Germany, which introduced legal requirements for Lebara to request ID from all customers, which could lead to material reductions in gross additions. The buysiders noted.

 

“The big concern is that in Germany their customers now need an ID,” the second buysider commented. “Also the EU now has new rules on roaming across Europe, so that people no longer need to change SIMS when moving across Europe.”

 

Despite the headwinds, the company is considering acquisitions, such as rival MVNOs (mobile virtual network operators)  or suppliers, and would look to tap the bond to fund any bolt-ons, management told investors.

 

Lebara’s bonds traded down to around 95/96.5 in the wake of the earnings.

 

The company declined to comment.

 

by Robert Schach