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Swiss strife: Sunrise, Freenet and Liberty Global

Swiss telco Sunrise has fallen out spectacularly with its biggest shareholder, Germany’s Freenet, over the planned acquisition of Liberty Global’s Swiss business.

Sunrise this week accused Freenet board representatives of “a conflict of interest” and resolved to exclude them from discussions about the merger. The telco also asserted that Freenet had previously proposed an illegal acquisition by Liberty Global or Sunrise of Freenet shares at the expense of minority investors in exchange for a green light, and had engaged in an “opportunistic and inappropriate”push for Liberty Global to retain debt rather than transfer it to Sunrise as part of the deal, among other things.

Liberty Global’s plan for a smooth sale of its Swiss business has thus hit two possible roadblocks in the shape of the opposition of Freenet and the Swiss regulator’s decision in June to launch an in-depth examination of the deal.

The competition watchdog, COMCO/WEKO, said that its preliminary look at the deal had revealed some indications that the combination could create or reinforce a dominant position in different markets.

The acquisition deal thus stands accused of being both against the interests of investors and, potentially, consumers.

Sunrise and Liberty Global do not seem particularly concerned about the regulatory threat. A Sunrise/UPC Switzerland combination would, in their view, provide effective competition to Swisscom as a converged player and this could only benefit consumers. While European antitrust watchdogs have been cautious about facilitating the reduction of the number of players in markets from four to three, a regulatory block seems, on the face of it, unlikely.

The appeal of the deal to investors is another story, Sunrise’s earlier optimism about securing approval notwithstanding. Freenet contended that Sunrise has outperformed its peers and that the telco’s falling share price showed that the Liberty Global deal is unfavourable to Sunrise shareholders.

According to Freenet, Sunrise agreed to pay too much for UPC Switzerland at a time when the cable business is under pressure. Moreover, it said that Sunrise shareholders are being required to underwrite a UPC Switzerland turnaround and related integration risks, while paying awaypotential synergies of CHF1.3 billion (€1.2 billion) to Liberty Global in advance. It alleged that the all-cash nature of the deal means that Sunrise shareholders rather than Liberty Global is bearing all of the risks and contended that Liberty should take a stake in the combined entity. It argued that Sunrise’s proposed rights issue of above 100% of its market cap to fund the deal is not fair on Sunrise shareholders, and that debt should play a greater role. Finally, it said that the proposed transfer of UPC debt to Sunrise is not fair and that Liberty should retain the UPC debt post-transaction.

Sunrise issued a point-by-point rebuttal of Freenet’s case against. It said that Freenet had acknowledged that a price reduction is difficult to argue for and that the agreed price was supported by an independent assessment. It contended that the multiples involved compare favourably to similar transactions, especially when Switzerland’s relatively low tax and interest rate levels are taken into consideration. It said that Sunrise had increased its expectation about annual synergies and that Sunrise shareholders would retain over 60% of the net present value of these, again comparing favourably to recent deals. It claimed it had been unable to agree a deal with Liberty that involved the latter retaining a stake and that Freenet had been on board for the all-cash transaction that was eventually agreed. It said that it was open to an increase in leverage and a CHF1 billion reduction in the rights issue but that this had been rejected by Sunrise. Finally, it said that the debt burden it was taking over from UPC compared favourably to the alternative or raising new debt, and that market conditions had improved since the deal was announced.

However, Sunrise went further, accusing Freenet’s representatives on its board of being obstructive and the company itself of being “evasive, opportunistic and inconclusive”. It said that Freenet’s aim was to sell its stake in Sunrise to ease its own over-leveraged balance sheet and effectively ‘transfer’ its own indebtedness to the Swiss operator by changing the structure of the deal.

Whatever the truth of those assertions, Sunrise’s deal with Liberty was not without critics, with analyst Steve Malcolm of Redburn Partners telling the Financial Times at the time it was announced that the sale was “a great deal for Liberty shareholders” but a “terrible” one for Sunrise shareholders. Redburn pointed to “fast shrinking” UPC’s underperformance and high debt.

On the other hand, analysts at Jefferies, while noting Freenet’s opposition, said that the agreement made financial and industrial sense. They calculated that it would ultimately deliver double-digit accretion to earnings and free cashflow and argued that the industrial logic of setting Sunrise up to compete with Swisscom in fixed-mobile convergence was unassailable.

From the point of view of Swiss consumers, the benefits are likely to be more mixed. According to Jefferies, the pair are likely to compete on product, branding and network rather than price, as Sunrise will not be in a position to engage in deep discounting to increase market share.

The potential spanner in the work lobbed by Freenet will not be welcomed by Liberty Global, for whom the sale of UPC Switzerland is an important move in its wider European game plan. Together with the now completed sale of German and central European assets to Vodafone, it is one of the company’s two key disposals as it restructures itself into a smaller, leaner entity anchored around its ownership of Virgin Media, and the reduction in debt it represents would free the company up to relever its remaining central European businesses in Poland and Slovakia with a planned additional US$900 million in debt to be raised, according to CFO Charlie Bracken.

Freenet’s hostility also flies in the face of what Liberty has pitched as a remarkable turnaround. In the company’s most recent earnings call, CEO Mike Fries said he “couldn’t be prouder” of the work the Swiss management team under Severina Pascu had done to arrest the company’s decline after the Swiss unit decreased its rate of subscriber losses and added mobile customers.

Much could hang on whether that story convinces Sunrise’s stockholders.