Mega-buyout in UK mobile risks skinny returns

February 19, 2013

By Quentin Webb

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

A 10-billion-pound leveraged buyout of Britain’s biggest mobile operator would be dazzling in its sheer ambition. But the payback would be more in short-term glory than long-term financial returns.

Two teams – KKR and Apax, and rivals CVC and Blackstone – are dusting off old deal dossiers. It’s easy to see why these and other buyout shops may be circling. Debt is cheap and plentiful. Big M&A is stirring. And EE’s parents, France Telecom and Deutsche Telekom, have put the parent of Orange and T-Mobile UK in play by talking about a potential float.

A deal would be a milestone: not just another huge British takeover soon after Virgin Media, but also Europe’s biggest LBO since Lehman Brothers collapsed. The snag is that it’s hard to see how it could deliver the 20 percent-plus returns that buyout investors expect.

The widely cited 10-billion-pound ($15.5 billion) price tag looks like a non-starter. That would entail a monstrous 2.3 billion pounds in equity and bid costs – assuming the sellers helpfully kept 20 percent of the shares for themselves. Even if debt worth 5.5 times EBITDA was available at an all-in cost of 6.5 percent, the annual return, for a 2018 sale at the same exit multiple, would hit only 15.3 percent. Moreover, this calculation requires the dark arts of private equity to reduce EE’s tax bill to almost zero, allowing all of EE’s prodigious cashflow to pay down debt after meeting investment and interest needs.

A more conservative assumption might be an 8-billion-pound takeout funded 30 percent with equity, and debt of 4.1 times EBITDA. That would imply a price of 5.8 times forward EBITDA. A sale at 10 billion pounds – producing a similar exit multiple – would return an annualised 17.6 percent over five years. The equity required would still be hefty.

Scraping under the usual return hurdle might be acceptable for a banner deal in a low-yield environment. But the current owners may balk at selling EE at a sub-20 percent premium to rival Vodafone’s lowly market multiple.

So an EE LBO seems to work only with a bargain purchase price and masses of cheap leverage. A float is still the more likely call.

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