A Guide to Zegona for Spanish Journalists

Amigos de la Prensa

Amigos de la prensa,

Given our ongoing interest in Zegona Communications we have been consuming a lot of Spanish financial press lately. Reporting on the company is frequent—daily, in fact—and given the limited direct communication from Zegona itself, we often end up debating the details of these articles internally. At this point, we’ve stopped referencing newspapers by name and simply refer to the authors like they’re colleagues. “Ramon wrote another one,” Ernest will say, “but Ignacio and Fernando completely disagree.” This is now a perfectly normal sentence in our office. And while the quality and volume of the reporting has been impressive (the Spanish M&A market appears to leak like a sieve), we’ve also come across our fair share of inaccuracies and analytical missteps. We highlight a couple of them (translated) below.

That’s the printed market cap by data providers, but it is completely unrepresentative.

The value of Zegona/Vodafone is not nearly 10 billion. Its currently closer to 6 billion (debt + equity).

The JV is not owned equally by Masorange and Vodafone.

Vodafone isn’t selling a 40% stake, but an 18% stake.

There are plenty more. So, we thought it was perhaps helpful if we would lay out some of the complexities of the Zegona investment case. If you’re a Spanish financial journalist covering this story, this one’s for you. Ramon, Fernando, Ignacio, and all the others—thank you for all your effort and attention. Let us now return the favor and try to offer a bit more clarity on Zegona.

Zegona and the acquisition of Vodafone Spain

First, let us quickly recap what Zegona is: a British listed investment vehicle that buys-fix-sells (Spanish) telecommunication assets. Previously it has been succesfully involved with Telecable and Euskatel.In May 2024, Zegona finalized the acquisition of Vodafone Spain. It paid 5 billion euros for the asset. Zegona financed the deal as follows:

• €300m paid by Zegona

• €900m through vendor financing by the seller Vodafone group in the form of redeemable preference shares. The preference shares in turn hold an entity that holds ~70% of the outstanding shares of Zegona. A very rare financing instrument which is the cause of much confusion (and opportunity).

• €3800m in debt.

So, just 6% of the acquisition price came from Zegona’s own capital. The rest was leverage. A bold move, for sure—but not without precedent in this type of vehicle. A lot has happened since, both operationally and financially, but we won’t expand too much on that here (though we will say: the execution to date has been very impressive). We wrote about the investment case in our december letter.

The heart of the confusion: redeemable preference shares

The most misunderstood piece of the puzzle is the €900 million of redeemable preference shares provided by Vodafone. Vodafone Group helped Zegona finance the acquisition of Vodafone Spain with €900m through a unique financial instrument called redeemable preference shares. This is only the first time we as financial professionals have come across this structure, so it is entirely understandable that many of you are unfamiliar with its mechanism. Its structure is odd and we had to spend quite some time in the prospectus and back-and-forth’s with the involved bankers to make sure we properly understood how this works.

These shares carry no voting rights, accumulate 5% interest per year the first three years, which rises to 10% interest in year four and 12,5% in year five. The most important aspect is that they are redeemable at nominal value, through the payment of 150p dividend. So while they might look and feel like equity (and are even treated as such by Bloomberg), they are not permanent capital. Once redeemed, they vanish.

Because ordinary shareholders must also receive the dividend, Zegona will need to pay around €1.4 billion to trigger the redemption. But there’s a catch: it can’t pay that dividend unless its net debt/EBITDA falls below 2.25x—a covenant set by lenders. Which means that deleveraging (either through EBITDA growth or asset sales) is a prerequisite for unlocking value.

The market cap isn’t the market cap.

The preference shares thus lead to a frequently repeated error. Many headlines have claimed that Zegona is worth €7–8 billion. Or that Telefónica would need to pay €11 billion to acquire the business (equity plus debt). These numbers are wrong.

Financial data providers mistakenly count the redeemable preference shares as if they were regular shares. They’re not. They are designed to be redeemed and cancelled—at a fixed value. Once you adjust for this, Zegona’s true market cap is about €2 billion at a share price of 720p. We estimate net debt stands around €3.3bn. If you include the preference shares as a form of debt (which is probably more accurate), you arrive at a total enterprise value of just under €6 billion.

What do you get for that €6 billion? About €1.2 billion in EBITDA, a run-rate free cash flow of roughly €600 million, and a probable dividend of ~150p within six months. Not bad.

Zegona’s management team is—how shall we put it—highly incentivized to get the share price up. They know full well that redemption of the preference shares is the key to a much higher valuation. To achieve this, Zegona is monetising its fibre infrastructure via two joint ventures—one with Telefónica and one with MasOrange. Roughly speaking we expect the company to raise 2 billion euros by doing so, which should be enough for redemption. It works as follows: the telco’s bring their infrastructure in the JV in exchange for an equity stake. The infrastructure is valued far better than the telco itself. By separating their fibre infrastructure, the companies can unlock and monetize the valuation difference. This is some nice financial engineering.

Fibrecos, its all about the debt

Of the two fibrecos, the most important one because of its much larger size is the one with Masorange, also called Surf. We estimate Masorange owns 72% and Zegona 28%. Both parties plan to sell part of their stake to an external investor, with Zegona selling down to 10% and MasOrange to 50%.

You’ve likely seen the press speculate about the equity valuation of the JV (between €6 and €10 billion). That’s fine, but the debt is where the real action is. Roughly €4.7 billion in leverage is being put on the structure, which is used to buy assets from the parents and pay dividends. Zegona will extract at least €1 billion from Surf just via the debt—before selling a single share.

Hence the equity sale is far less relevant for the partners. The CEO of Masorange, the other partner agrees with us.

Given the debt, the equity portion is “only” worth between €2-4 billion, of which they are selling 40%. The actual money paid by an outside investor is between €800m and €1600m. So for Zegona the difference between a low price and the top price is only €400m. Given it takes at least a billion out of the debt on the fibreco, Zegona roughly extracts 1.8 billion from the fibreco in the best case and at worst €1.4bn. For Masorange this is even more lobsided because they will take at least 3 billion out of the fibreco through the debt.

Similarly the difference between a 20% and 40% sale of stake is also less impactful, given the enormous debt pile on the fibreco. If you take the lowest valuation and only a 20% stake sale, Zegona would still extract 1.1 billion euros from the fibreco at a minimum.

This table demonstrates the range of outcomes for Zegona:

So, for us, the news that the financing was done was big news and for us really de-risked the investment case. You’re not the only one who more or less missed this as an important fact as the Zegona share price didn’t even move on the day this news came out.

The smaller JV, the one with Telefonica, is already running and the proceeds from debt on the structure and the sale of the stake are expected to generate between 300-600m for Zegona.

Its all about redemption, not a Telefonica bid

The core of the investment case is the redemption of the preference shares. As the fibrecos have advanced and made redemption more likely and likely, the share price has increased. An eventual acquisition by Telefonica is a nice extra for Zegona shareholders, but redemption of the preference shares is far more important.

If the fibrecos in any way fail that will create uncertainty with regards to redemption, but Zegona has many other ways to solve this.

Since you have also written quite a lot about the potential acquisition of Vodafone Spain by Telefonica, we’ll also briefly address it here. Acquiring Vodafone Spain from Zegona is a complete no-brainer for Telefonica. It would achieve:

· The acquisition of €5.6 billion worth of tax compensable losses.

· Enormous synergies due to much redundant infrastructure and personnel.

· Taking a competitor out makes Telefonica’s existing business churn less and thus be more profitable.

Since Zegona is a buy-fix-sell vehicle it would be willing to sell. Yes, we also saw the comments from the Vodafone Spain CEO who said he’s not interested in selling. Every football club says its star striker is not for sale... until the right offer comes in.. Price is not the problem here because of the synergies listed above Telefonica should be willing to pay far more than what any Zegona investor could dream of. In-market consolidation multiples and the above benefits would make a price in the GBP15-20 range (which is between ~€6-7bn enterprise value) very reasonable for Telefonica shareholders. The huge obstacles are the regulators, public opinion and politicians. Understandably Telefonica is seeking to address those obstacles first, before making an offer.

Now, our friends, here we end our explanation. We hope this helps clarify the situation for those of you following Zegona closely. As we said, we rely on your reporting as official company disclosures have been sparse. Let’s keep the conversation going.

Gracias y Adios!

disclosure: we hold a position in Zegona Communications.

appendix: - Illustrative example of the current situation versus the situation post EUR2bn of proceeds from fibrecos. where EUR1.4bn is used for the 150p dividend and 0.6bn for delevering. Does not consider organic cash generation and interest payments.