Deal Mechanic: Network grail

In February, Dutch cable operator Ziggo sold a 21.7 percent stake on the NYSE Euronext Amsterdam stock exchange, initially raising €804 million and valuing the business at €3.7 billion. That made it the biggest IPO in Europe since July 2011.

What’s notable about Ziggo is that it’s a business that only came into being five years ago: it was the result of a consolidation process led by private equity firms Warburg Pincus and Cinven, who combined three regional players into a single market leader.

For a consortium to bring together three separate businesses – all with their own management teams, sales forces, specialisms, head offices and so on – and take the new company public within five years was no mean feat. And while this deal was interesting from a financing perspective (it was done during the boom era at a debt multiple of almost 7x EBITDA, since reduced to less than 4x via three refinancings), there was also some genuine heavy lifting on the operational side.

THE BACK STORY

Chronologically, the process began back in 2004. Warburg Pincus had identified cable as a promising sector, given its growth prospects and consolidation possibilities, and had picked out the Netherlands as one of the most attractive markets. During the summer of that year, the firm first met with the management of Multikabel: the fourth largest player in a national industry dominated by three much bigger rivals, it was being put up for sale by its owner Primacom as a part of a restructuring process. During the time this took to play out (nearly 18 months, all told) Warburg Pincus was able to position itself as the preferred buyer for management, the seller and even the labour unions. The deal was eventually finalised in December 2005.

With an enterprise value of €530 million, Warburg Pincus had envisaged Multikabel as a relatively small growth capital style investment, at least in the short term. But its original investment thesis was rapidly overtaken by events: the following year, the second and third largest players, Kabelcom and Casema, both came up for sale at more or less the same time (Warburg Pincus says it was expecting a consolidation period to happen – just not quite so soon). At this point, the game changed: now the big carrot was the prospect of combining these businesses to create a market leader.

However, this deal was too expensive for Warburg Pincus – or indeed any large buyout firm – to do alone (requiring as it did a seven figure equity cheque).

Enter Cinven. Although both firms cheerfully admit that they prefer not to work with a partner, in this case they didn’t have much choice: they needed each other’s cash. What’s more, both sides brought something extra to the table: Warburg Pincus obviously owned Multikabel, which increased the scope of the consolidation opportunity, while Cinven had lots of experience of integrating cable assets (primarily in France under the Numericable brand), not to mention a pre-existing relationship with Essent, the owner of Kabelcom. It was this combination of resources, relationships and know-how that helped them, in late 2006, to win Casema for €2.1 billion, and then subsequently Kabelcom for €2.6 billion.

The three businesses were combined to create Ziggo – and judging by its subsequent IPO success, this integration went pretty well. Here are five key reasons why it worked.

1. CREATING AN ENTIRELY NEW COMPANY

“The most important thing was the approach we adopted to the post-merger integration,” says Joe Schull, the partner who led the deal for Warburg Pincus. “It was about bringing together three companies into one that would incorporate the best of all three, [but] ultimately build a better company. [So] unlike most mergers, there were no winners and losers.”

“We started off with three head offices dotted around the country; now the vast majority are based in Utrecht – and it’s mostly new people. So we’ve effectively built a new company,” says Caspar Berendsen, Cinven’s partner on the deal.
The value-creating aspect of this was that combining the three companies allowed the new owners to cut plenty of costs – they managed to strip out ‘synergies’ of €120 million a year, equivalent to about 20 percent of the cost base. Assuming a valuation multiple at exit of about 8.5x EBITDA (as per Cinven’s investment thesis) putting €120 million back onto the bottom line creates over €1 billion of value.

This did, of course, mean job losses: Ziggo lost about 10-15 percent of its headcount in the short term (although it’s now about 25 percent up on where it was). There was also a degree of hardware sharing. But that wasn’t necessarily the most important aspect: creating a national player reduced the charges payable to the central network operator, because they could cut out the middleman. “The big cost is not really the cables in the ground; it’s the central network costs,” Berendsen explains.

2. BUILDING A NEW SENIOR MANAGEMENT TEAM

Once they’d taken control of the three businesses, the new owners set about testing the top 20 managers across the three firms. They brought in an external consultant to do this, largely so the process would look more objective from the inside. But the result was a fortuitous one: it was able to fill the top three roles with one person from each company. Kabelcom CEO Bernard Dijkhuizen became Ziggo CEO, while Multikabel’s CEO became the chief commercial officer, and the Casema CFO took the CFO job.

This was remarkably convenient: by having a representative from all three firms at the top table, the new owners could ensure a degree of continuity, and avoid the impression that the merger favoured one of the constituent businesses over the other two. The two buyout firms insist that if the outcome had been that all three jobs had gone to (say) Kabelcom people, they would have gone with that – though we imagine that would have been easier said than done in practice.

This screening process also helped Warburg Pincus and Cinven identify skill gaps. “If there was an internal candidate whom we could promote to a role, we absolutely chose that option – but the most important criterion had to be the requirements of the role,” says Schull. “So if we didn’t have suitable internal candidates – and in several cases we did not – we always went outside the company.” A ‘Young Turks’ programme was also established, to try and fast-track up-and-coming managerial talent.

3. FINDING THE RIGHT CHAIRMAN

The private equity owners are not there to manage the company directly, of course. But it is their job to challenge the management team, set stretching targets, and make sure they get hit. In this, perhaps their most important appointment was that of Andy Sukawaty, chairman and CEO of cable company Inmarsat, as Ziggo’s non-executive chairman. Since he was already used to working with private equity owners at Inmarsat, Sukawaty was well placed to mediate.

“He understands the objectives and speaks the language of both management and shareholders, so he’s a great bridge between the two,” says Schull. “We generally have had a very good rapport with the management team. But there are always occasions when the wheels grind a bit – so having someone who can speak authoritatively in the language of each side is always helpful.”

4. BOOSTING CAPEX

In total, Ziggo has invested over €1 billion in capital expenditure during Cinven and Warburg Pincus’s ownership. This included rolling out a software-based technology called DOCSIS 3.0 across the network, which can increase broadband speeds without the need for new cabling.

“Fundamentally its network is one of Ziggo’s principal sources of competitive advantage; and maintaining the resilience of that competitive advantage takes investment,” says Schull. “Some shareholders with a shorter term time horizon might have sought to extract savings on capex to achieve a short term financial result. But we took the view that we’d invested in a network-based business, so we were going to make the investments required.”

5. GETTING THE PRODUCT MIX RIGHT

One of the most important growth areas for Ziggo was squeezing more cash out of its existing users – and a key element of this was increasing the sale of all-in-one ‘bundles’, which include voice, data and TV. This has become Ziggo’s main sales focus. “We strongly encouraged management to make bundles the main service offering, and Ziggo is now by far largest bundle provider in the market,” says Schull. By the end of 2011 – a year that saw bundle subscribers climb 17 percent – its market share was up to around 43 percent.

Digital TV has also been a big growth area. As with most developed countries, Holland had already started making the transition from analogue to digital – but in many cases, the demand was not there because customers didn’t know what they were missing. So Ziggo chose to try and get out ahead of the market by educating its subscribers about the benefits. This included TV advertising – which as Berendsen points out, was another benefit of the company’s increased scale. Nearly 75 percent of Ziggo’s customers now subscribe to digital TV, up from less than 15 percent in 2007.

The company also put much more effort into selling to businesses, particularly SMEs. This was a relatively easy win, since many of these firms were already subscribers – but this leg of the business is now growing much faster than the B2C side.

That’s not to say the owners got everything right, of course. Perhaps the most high-profile snafu came when they tried to migrate the three companies’ IT systems onto a single, separate platform. As often happens with these big IT integration projects, it went badly wrong. “The issue with the database was that rather than trying to merge two of the systems into the third, we tried to merge all three into a fourth – over the course of a single weekend,” says Berendsen.

But although the episode resulted in some bad PR – management had to spend the next few weeks publicly apologising – the actual impact on revenue was negligible. “It wasn’t pleasant, but we didn’t get much additional churn as we reacted quickly to the problems,” says Berendsen. “We’d learned from our previous cable investments that customers were very sticky, even during periods of operational upheaval.”

And there was at least one upside, according to Schull. “It was a very good trial by fire for a management team that had had a lot of success up to that point; it made them very mindful of the need to pace and sequence complex internal changes.” So it stood them in good stead for the rest of the integration process.

Either way, the numbers certainly suggest a company that’s now going in the right direction. Ziggo’s full year results for 2011 showed a 7 percent jump in revenues year-on-year to €1.48 billion, while EBITDA jumped 6.5 percent to €834.6 million. It was a similarly positive picture when Ziggo reported its Q1 2012 results recently (the company did end up in the red, but that was largely due to one-off IPO costs).

So it’s hard to argue with Schull’s assessment: “Ziggo should stand as one of the singular successes of European M&A… a business that went through a massive programme of change and came out as a better and stronger company.”