The ‘quacking ducks’ Denis O’Brien stuffed with Digicel debt wait in the reeds

Nicole Laframboise, an International Monetary Fund (IMF) economist, didn't mince her words on Monday when she wrapped up the fund's latest review of the state of Haiti, the poorest country in the Americas.

“The political, economic and social crisis confronting Haiti is without precedent,” said Laframboise, head of the IMF mission to a nation that has been hit by violent protests in the past year against its president, Jovenel Moise, amid anger over fuel and food shortages and allegations of economic mismanagement and general political corruption.

The unrest, forcing schools, public offices and businesses to close for weeks at a time, has pushed inflation up towards an annual rate of 20 per cent and is likely to tip Haiti, where more than half of the population live below the poverty line on less than $2.41 a day, into recession this year for the first time since it was struck by a devastating earthquake in 2010.

It's also driven a more than 30 per cent slump in the value of the local currency, the gourde, against the dollar over the past 12 months. That creates an additional headache for Irish businessman Denis O'Brien – whose Digicel phone company is one of Haiti's biggest outside investors – at just about the worst possible time.

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Digicel is currently weighing options on how to deal with $1.3 billion of company debt that falls due in April 2021. The odds are stacked against it, according to Fitch, one of the world’s main credit ratings firms. It warned last week that Digicel’s wider debt structure, with almost $7 billion of borrowings, is “unsustainable”.

Digicel's rapid growth over the past 18 years into a business with 13.3 million customers spanning 32 markets across the Caribbean, Central America and Asia Pacific region has been built on the back of O'Brien flogging a particular type of debt: junk bonds. These are deemed by credit ratings firms to be below what they call investment grade and command high market interest rates, or yields.

Fitch now says the company will "struggle to refinance" the 2021 bond and is likely to seek a debt restructuring arrangement with holders of the notes. This, in turn, could trigger a restructuring of other debt, including $3.8 billion of bonds that would ordinarily be due to mature between 2022 and 2024, Fitch analyst Sul Ahmad told The Irish Times.

Debt market investors, left with a sour taste in their mouths after an aggressive debt restructuring that concluded in January, will be waiting in the long grass.

"Denis's previous love affair with the bond market has soured," said a US-based manager of a fund that holds Digicel bonds, who declined to be identified. "He kicked the can down the road last time round in a way that was not very friendly to bondholders. Next time will be much harder for him."

Disclosed dividends

The junk-rated borrowings have helped the group to invest more than $5 billion developing its networks since O'Brien set it up in Jamaica in 2001 after netting about €200 million from his sale of Esat Telecom to BT Group the previous year. They also allowed O'Brien take at least $1.9 billion of disclosed dividends out of the group between 2007 and 2015.

Luck had long been on his side, like when Digicel sold $1.4 billion of high-cost debt in February 2007, just days before financial markets tumbled. Some $800 million of the amount raised was used to fund dividends – mainly to O’Brien.

The entrepreneur boasted at the time to Forbes that he could have sold the bonds five times over. “Look, when the ducks are hungry, you have got to feed them,” he said. “You feed them with pieces of paper.”

In more recent times, the ducks have felt more like the sitting kind.

Against the backdrop of falling sales and earnings, O’Brien last year went about restructuring $3 billion of Digicel debt that was due to be repaid in 2020 and 2022, to give the group breathing space.

Following months of negotiations, Digicel managed in January to convince owners of most of these bonds to put off getting their money back for a further two years. It involved bondholders swapping the notes for longer-dated paper in a deal that was classified as a “distressed debt exchange” by ratings firms.

O’Brien refused demands during those negotiations from groups of bondholders, represented by US law firms Akin Gump and Milbank, Tweed, Hadley & McCloy, to inject fresh equity into the business, according to sources close to the negotiations. The prospect of a debt-for-equity swap was not on the table at the time, they said.

Discount

The bondholders have paid the price. Most of the new securities handed out in the exchange rank towards the back of the queue in terms of recovery should Digicel run into financial trouble. The $937 million of new 2022 subordinated debt started trading in January at a 50 per cent discount. They are currently changing hands at about 25 cents on the dollar.

The $979 million of new 2024 notes are currently trading at a little over 16 cents on the dollar – reflecting a market perception of the risk of bondholders not recovering in full what they are owed.

“The price of the bonds is telling you, clearly, that the market believes there’s no equity cushion in the business,” said the fund manager.

Digicel's chief executive of less than a year, Belgian telecoms veteran Jean-Yves Charlier, told bondholders on a call on Tuesday that Haiti – one of the group's three top earnings contributors, alongside Jamaica and Papua New Guinea – stands out as the biggest external risk facing the company, according to sources.

This took away from an underlying improvement in the company’s sales and revenues in the three months to the end of September, its second financial quarter.

The previous day, Digicel revealed to creditors that the gourde’s decline lay behind a $26 million currency hit to its results for the quarter. It turned an underlying 4 per cent increase in revenues for the period into a 1 per cent decline, to $554 million, and led to a 1 per cent decrease in earnings before interest, tax, depreciation and amortisation (Ebitda), to $249 million.

Underlying sales were helped by the fact that Digicel, which, like phone companies globally, had been battling with declining mobile voice revenues in recent years, has seen a surge in mobile data sales in the past year as it continues to roll out fourth-generation, or 4G, networks across the Caribbean and Pacific islands.

Data revenues jumped 15 per cent in the second quarter to $233 million, making up more than half of total mobile revenues, which stood at $430 million. Voice revenues continued to decline during the period.

“Ten years ago, Digicel could go into a country, undercut the incumbent, usually a sleepy former state monopoly, and build up a share of the more than 50 per cent share of the mobile market within 18 months or two years,” said the fund manager. “But, over time, its competitors have gotten better and it now has to do a lot more work to make money.”

While revenue from Digicel’s business solutions and home entertainment, covering fibre and broadband, have been growing strongly in recent years, these areas still only make up about a quarter of group sales.

“On the call, management emphasised progress made on underlying revenues in mobile, especially data, business solutions and home and entertainment,” said one source. “While the data figures are encouraging, they are still not enough to fully offset lower voice revenues, adverse [foreign-exchange] impact and high leverage.”

Bondholders took some comfort in the fact that the company – which saw stabilisation in its business in the first quarter after years of decline – has maintained its full-year forecasts for revenue to grow by a “low to mid-single digit” percentage and earnings to expand by a “mid-single digit”.

Still, gross borrowings are set to amount to an unsustainably high seven times Ebitda. Cash burn, too, remains an issue. The group’s cash position fell to $180 million in September from $214 million three months’ earlier, and $279 million in March.

The general view among analysts and investors is that O’Brien has long regretted pulling a planned initial public offering (IPO) of the business four years’ ago. It was a deal that aimed to raise $2 billion, mainly to pay down debt. But the businessman baulked at the 11th hour when it became clear that investors were looking for an equity stake of more than 50 per cent.

“Liquidity remains weak, by the company’s own admission,” said a source on the earnings call, adding that management “vaguely” highlighted the possibility of raising money from asset sales.

Headroom

Fitch highlighted that Digicel International Finance Ltd (DIFL), a company within the group’s corporate web, has some headroom to issue debt secured against its assets. But any significant additional borrowings incurred at DIFL “would strain” overall finances, it said.

Investors on the conference call hoping for some insight on how Digicel plans to handle the 2021 bonds were left disappointed. O’Brien knows that these notes will need to be dealt with in the coming months to avoid a cliff-edge crisis when the debt actually falls due.

Management only offered that they were evaluating financing options and were not complacent about the upcoming debt maturities, two of the sources said.

“The operations are showing indications of improvement but the headwinds continue and the growth may not be enough to stabilise the company’s capital structure,” one of the sources said.

Dropped hints

As the markets eye a round of tougher debt restructuring negotiations within the next six months, O'Brien has dropped hints elsewhere that he may strike a more conciliatory tone this time around than during the last round. When asked at a Deutsche Bank debt conference in Arizona in recent months whether he would be prepared to inject equity into the business, the Malta tax resident said all options were on the table, according to one source who was present.

“I took that as significant. In the restructuring talks last year, he just said no,” the source said.

The US fund manager said O’Brien would need to pump as much as $500 million into Digicel. There is a strong view in the markets that the businessman has access to the funds, even if he is better known in Ireland for the estimated loss of at least €450 million he made on an investment in newspaper group Independent News & Media (INM).

New equity could be used to offer to buy back a chunk of Digicel’s $1.9 billion of those restructured subordinated bonds that are due in 2022 and 2024, which are trading at between 16 and 25 cents on the dollar, according to the fund manager. Buying all that debt back at current market rates would cost less than $400 million.

“It’s difficult to see a favourable outcome [from debt restructuring talks] without an injection of fresh equity,” said an analyst that follows Digicel.

Orange

Meanwhile, Digicel has its eye on €346 million that French telecoms giant Orange has sitting in an escrow account. A Paris court ruled in 2017 that Orange owed Digicel the money after it was found to have abused a dominant position between 2000 and 2005 in the French West Indies. An appeal is due to be heard early next year. It is understood that part of any final award would have to be shared with French phone company Buoygues Telecom, which sold its French West Indies business to Digicel in 2006.

If Digicel secured enough take-up on a buyback offer as well as a favourable ruling from the Paris court, it may clear the way for O’Brien to refinance the $1.3 billion of 2021 notes through a straightforward bond sale, according to analysts.

However, they cautioned, Digicel would also have to show continued underlying improvement in its business.

Haiti, where the company has over 4.5 million customers, stands out as the biggest obvious risk. Aside from the impact of a depreciating gourde on Digicel’s earnings, company executives highlighted on the bondholder call how power outages have hit mobile users’ ability to charge their phones at times.

For the moment, subscribers in Haiti remain loyal, helping to deliver a 11 per cent increase in underlying revenue in the market in the second financial quarter, to $88 million.

But the country remains on a knife-edge, according to the IMF.

“It is important to note that a continuation of the current political crisis would have devastating consequences for the country over the longer term, owing to the likely losses of physical and human capital,” said Laframboise. “We sincerely hope that political stability will return.”

O’Brien and his Digicel creditors do, too.