Initiating with Hold. Silknet’s US$200mn 11% bonds due 2024, the debut issue of the second-largest telco in the country, offers a generous premium that can be explained by a lack of track record in the public debt market, relatively high pro-forma leverage (given the FX mismatch) and its private ownership, with no visibility of the parent holdco’s financial position. However, manageable liquidity due to backloaded debt repayments (with the next significant maturity falling in 2024), an adequately high interest coverage ratio and hedging partially offset the risks. Silknet’s lack of a public track record in the international debt markets is likely to continue to result in a premium over other Georgian issuers. However, when and if investors get comfortable with the corporate disclosure and shareholder distributions, the bonds have potential to outperform the market. We assign a Hold recommendation to the SILNET 24s.
A leading telco in a small market. In 2018, Silknet held second place in terms of subscribers in the mobile, fixed internet, pay TV and fixed voice services in the concentrated and competitive Georgian telecommunications market, according to Georgian National Communications Commission (GNCC). Georgia is a relatively small country, with a population of 3.7mn and total electronic communication sector revenues of US$333mn. The mobile segment is quite mature and competitive, with the number of subscribers and ARPU relatively stable over the past five years. Fixed internet has demonstrated growth, supported by subscriber CAGR of 11% in 2013-18, but promotional pricing exerted pressure on ARPU in 2018. In line with global trends, fixed-to-mobile migration has cut into fixed-line revenue, and pay TV has emerged as a fast-growing segment. In 2018, Silknet’s revenue on a pro-forma basis came to US$157mn, adjusted EBITDA stood at US$74mn (corresponding to an EBITDA margin of 49%) and net leverage was at 2.4x (Table 1).
Leverage increased to 2.4x on acquisition and could grow further on capex. In 2018, Silknet acquired Geocell, the second-largest mobile operator in Georgia, for US$152mn. The transaction was debt-funded by a combination of senior and subordinated loans from banks and the controlling shareholder. According to the bond prospectus, proceeds from the US$200mn issue will be used to refinance the acquisition debt and boost the company’s liquidity position, extending maturities to 2024. We estimate pro-forma debt taking the 2018 financials as a starting point and making adjustments for the full effect of the Geocell acquisition, the newly issued US$200mn bonds, interest on the bonds and a US$20mn revolving credit facility to be raised in connection with the bonds. According to our estimates, Silknet’s interest coverage ratio is 2.7x and net leverage is at 2.4x, well below the 3.5x debt incurrence covenant.
FCF-negative in 2019 if capex remains at 2016-18 levels. Silknet’s capex/revenue ratio was in the range of 28-35% in 2016-18 on the back of high investment in the fibre rollout and the newly acquired mobile business. Other things being equal (GEL exchange rate, revenue and cost trends), we expect the company to be slightly free-cash-flow negative after dividends, assuming Silknet’s capex is at 30-35% of revenue in 2019. Under this scenario, net leverage could increase to 3x. If GEL depreciates more than 5%, we are likely to see higher net leverage.