5. CASE STUDY: THE VIRGIN MEDIA ACQUISITION
5.1. ENTERING THE UK MARKET
On February 5, 2013, it was announced that Liberty Global would be taking over UK cable-television and internet provider Virgin Media. The 16 bio USD deal was set up to create a stronger rival to market leader British Sky Broadcasting Group. Mr. Malone’s international cable group eventually bought the company with a mix of cash and stocks, valuing Virgin Media at 47.87 USD per share. This price reflected a premium of 24% to Virgin Media’s closing price the day before the announcement. The transaction made Liberty Global the dominant player in the European television market, covering 47 mio homes and serving 25 mio customers across 14 countries. Upon completion of the acquisition, about 80% of the Liberty Global’s revenue was then coming from five European countries: the UK, Germany, Belgium, Switzerland and the Netherlands.
The main motivations for the deal included Virgin Media’s tax losses and low interest rates, which made it possible for Liberty Global to take on more leverage to finance the deal. Also strategic considerations were taken into account. Virgin Media’s expertise in serving business customers and 180 mio USD worth of annual cost savings after the integration were some of the main factors identified here. A last important factor that Liberty Global considered when taking over the company was timing. Virgin Media was just looking for a new CEO and some analysts believed the UK cable provider was heavily undervalued, especially considering its multibillion-dollar cable infrastructure. This again exhibits the sometimes opportunistic behavior of John Malone, always trying to be responsive to what is going in the market and anticipating future evolutions. Below, we discuss some of the deal’s main motivations more in-depth.
5.2. TAX BENEFITS AND LOW INTEREST RATES
A first important rationale for taking over Virgin Media was the tax benefits related with the takeover. The company had been accumulating losses over the last two decades while making significant investments in its network infrastructure. This is also the case for Liberty Global itself. The last three years, the company reported net losses between 121 and 671 mio USD (see Figure X). When taking into account the company’s future profit potential, this provides the company with significant benefits going forward, reducing (or even eliminating) its tax bill on future profits. Analysts at Espirito Santo bank even foresee that the company will not be paying any taxes for the next 15 years.
A second reason for the acquisition were the low interest rates that Virgin Media was paying on its outstanding debt. For example, the company was only paying an effective interest rate of 2.4% on its senior credit facility and had been going through a financial optimization program in the years preceding the takeover. The fact that interest rates in general were (and still are) at an all-time low, was, as mentioned before, an additional driving factor.
5.3. STRATEGIC CONSIDERATIONS
With over 25 mio customers, Liberty Global’s combination with Virgin media created the largest broadband communications company in the world in terms of number of subscribers. For a long time, Liberty Global had been looking to expand its foothold in Europe. Before acquiring Virgin Media, it also raised its stake in Telenet for example. Indeed, scale is one of the most important profit drivers in the industry and the company was actively looking to obtain these economies of scale in the European cable market. Liberty Global’s CEO, Mike Fries, argued that the UK was Europe’s largest and most dynamic media and communications market. He claimed that the basis for operating synergies was enormous, both in terms of revenue-enhancement as in terms of cost-reduction. First of all, the companies had very complementary portfolios and had the ability to share their know-how in order to come up with new, innovative strategies and groundbreaking technologies. Second, there were ample opportunities for cross-selling. But the main motivation, next to expanding its market base, were cost reductions. A total of 180 mio USD of annual savings, both in terms of operating and capital expenditure are expected once the two companies are integrated.
5.4. DEAL STRUCTURE
The deal valued Virgin Media at 23.3 bio USD, including debt. This represented an EBIT multiple of 19.70x, which was well above the median multiple for transactions in the cable industry, 13.81x. This can partly be explained by Virgin Media’s low EBIT figures compared to industry peers. Due to an extensive amount of investments in the past two decades, the company’s profitability was quite low. However, the company’s prospects, especially in combination with Liberty Global’s operational capabilities were bright. This explains the relative high price the company paid for the acquisition.
As mentioned before, John Malone’s international cable business usually takes on a large amount of leverage to finance its acquisitions. This is also the case for the Virgin Media transaction. When announcing the deal it was said that the 5.9 bio USD cash component of the equity purchase price would be funded with a combination of 3 bio of debt financing and 2.9 bio of internal available liquidity.
One might argue that Liberty Global paid quite a lot for the acquisition, taking into account the relatively slim growth prospects in a mature market as the UK. Are all the tax losses that Virgin Media is carrying forward deductible in the near future? Will it be able to compete with Rupert Murdoch’s British Sky Broadcasting Group? All questions that had to be answered after the acquisition.
5.5. EVENT STUDY
In order to assess the market’s reaction to the transaction, we conducted an event study investigating the cumulative abnormal returns on Liberty Global’s stock and Virgin Media’s stock the days around the announcement of the transaction. We opted to use the market model when estimating the expected returns on the companies’ stocks. In both cases, we used an estimation window of [-250,-51] to determine the coefficients used in this model. These coefficients were then applied to the observed market returns of the S&P Europe 350 to come up with expected returns on Liberty Global/Virgin Media stocks. Comparing these returns with actual returns eventually gave us the abnormal returns around which our analysis evolves. More specifically, we observed the cumulative abnormal returns on both stock in the period [-20,20], our so-called event window.
5.5.1. LIBERTY GLOBAL
Investors in general had some mixed feelings about the transaction. On the one hand, it was a nice step forward for Liberty Global, becoming Europe’s largest cable company. On the other hand, investors did not seem to be convinced about the price paid for Virgin Media. Especially taking into account the limited growth prospects of the UK market, an EV/EBIT multiple of 19.70x seemed a bit over the top. This also becomes clear when analyzing the cumulative abnormal returns on Liberty Global’s stock the days around the announcement (see Figure 7). The days before the announcement, some rumors were spreading that Liberty Global was considering to buy Virgin Media combined with rumors about a share buyback program. At first, investors seemed to like it. The fact that the company would become the most important player on the continent and would get foothold in the biggest European market seemed to excite them and abnormal returns were quite positive.
5.5.2. VIRGIN MEDIA
For Virgin Media, we notice the expected evolution of cumulative abnormal returns as a result of a bid made on the company (see Figure 8). On the day of the announcement, the company’s shares jumped 17.9%. This resulted in cumulative abnormal returns almost up to 20%. The fact that the target’s share price almost immediately evolved towards the bid price shows that investors had great confidence in a positive outcome for the deal.
The question is now whether Liberty Global has done a good deal in acquiring Virgin Media and what the consequences of the deal will be going forward. For sure, integrating the two companies successfully will make up the largest (and hardest) part of the work. The company has already been cutting quite some costs in the past couple of months. For example, last September, 600 jobs were cut in order to eliminate duplicate roles across the company’s business. This is quite representative for what Liberty Global tries to accomplish in every acquisition it makes. The business is made more efficient and a cost-cutting attitude is implemented throughout the whole organization. In that sense, the Virgin Media takeover was a good idea. It was a company that made significant investments in the past and that was now ready to reap the benefits of its past efforts, provided that it could make its processes more efficient. The fact that Liberty Global, backed by John Malone’s extensive experience in the cable industry, now took over the company could prove to be beneficial in the future.
On the other hand, one might question whether the company has made the right choice in fully opting to go for the European cable market. Does the industry have bright prospects going forward? Especially in the saturated European market, the cable industry does not seem to be the most attractive industry around. However, both Liberty Global and Vodafone keep on investing billions of dollars to get a foothold in every possible country in Europe. Eyes are more and more pointing towards Eastern Europe now. We will try to explain Liberty Global’s rationale in moving in these markets more into depth in the next part, when discussing the industry’s prospects and Liberty Global’s future in particular.