It’s been only three weeks since Israeli communications company Bezeq raised 900 million shekels ($250 million) from institutional investors. The fact that the Israel Securities Authority didn’t permit the company to publish a prospectus for a bond sale led the company’s executives to conclude that it would need to raise money through a private debt sale. And this is what it did, raising the money by selling two bond series only to institutional investors, via a platform for institutional trading.
The ISA halted the prospectus in order to address the questions it raised. It declined to comment.
Now, only 19 days after that July 10 sale, Bezeq said it may need to write down a massive 800 million to 1.1 billion shekels ($228.8 million to $314.6 million) due to the loss in value of subsidiary Pelephone. Bezeq claims it learned of the potential Pelephone write-down only after the mobile carrier’s board meeting prior to the release of second-quarter financial reports.
Yet the announcement’s timing raises serious questions about Bezeq’s management.
1. Why did Bezeq expose the possible write-down only after the bond sale?
It’s not clear why Bezeq waited 19 days to announce the write-down, an announcement requiring only the push of a button. If something significant happened to Pelephone’s valuation in the first quarter, why wasn’t it mentioned in the company’s first-quarter reports. Sources close to the company claim that Bezeq didn’t know about it beforehand, and that when the first indications of the write-down appeared, Bezeq didn’t know what the actual amount would be.
Institutional investors also expressed shock over the announcement’s timing. “It was appropriate that Bezeq announce the expected write-down before raising money,” said an executive at an institutional investor. Other institutional sources concurred, adding, “especially because there wasn’t any drama over the past few months” and “this is a very aggressive, surprising write-down.”
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Ilanit Sherf, the head of research at Israel’s Psagot Investment House, noted that companies occasionally publish new information, but that in this case Pelephone is being valued at one-third of its valuation as of 2018.
“At that time, Pelephone was estimated to be worth 2.9 billion shekels. How is it that nothing changed in the market, and yet Bezeq is suddenly valuing Pelephone at 65% less – some 1.1 billion shekels?” she said.
Sherf said she had spoken with company executives, who explained the valuation was based on forecast revenue per customer. Yet this, too, cannot explain the write-down, she said, given that the conditions in the market as a whole have not changed?
A senior market player called the affair “a scandal,” saying: Bezeq’s entire accounting is a balloon; The only question is when it will deflate and who will be hurt.”
Others were more forgiving. “None of the investors thought Pelephone was worth 2.9 billion shekels, not even 2.1 billion. The institutionals took Pelephone’s cash flow and estimated the company to be worth about 1 billion shekels, maybe even less.” Pelephone’s mobile operations had 195 million shekels in cash flow from operating activities and 63 million in free cash flow.
The U.S. private investment firm Searchlight Capital Partners, which is in the process of buying Bezeq via a controlling stake in its parent company B Communications, stated that the write-down won’t change its plans, indicating that there were prior indications of Pelephone’s value, even before the announcement.
2. What’s the actual write-down amount?
Tel Aviv consulting firm Prometheus Financial Advisory estimated Pelephone was worth 2.9 billion shekels, according to the company’s 2018 financial reports. In Bezeq’s books, Pelephone is worth only 2.149 billion. This caused some confusion among analysts trying to understand the write-down announcement.
“I don’t understand which valuation the billion-shekel write-down is based on. If [it’s Bezeq’s valuation,] the write-down is only about 300 million from the books. If not, then it’s a full billion shekels. If the latter, it means Bezeq’s share capital is worth zero, and may even be negative,” said a senior executive at an institutional investor.
This raises the question as to whether institutionals that participated in the recent bond sale will argue that the announcement constitutes a “significant worsening” of the company’s situation. If so, the bonds contain a clause enabling the investors to demand immediate repayment.
Sources close to Bezeq claim the matter is insignificant. “The write-down is only a matter of accounting, and it doesn’t affect Bezeq’s ability to pay back its debt. There’s a difference between a real loss and a paper loss.”
Bezeq has a massive debt load of 7.97 billion shekels. Sources close to the company argue that the Pelephone write-down even improves the bondholders’ wellbeing, as it keeps Bezeq from paying dividends over the short term, and noted that this is the fifth write-down for Pelephone in two years.
An institutional investor noted, “You need to focus on central matters at Bezeq. For instance, what will happen to the debt following the write-down? What will happen to the company’s valuation?” Bezeq is currently trading at a market cap of 6.6 billion shekels. Currently, most investors don’t think the write-down will significantly affect Bezeq’s cash flow, said the investor, who noted that Pelephone is a marginal part of Bezeq; cable telephony is much more important to the company’s operations.
Not all investors were so sanguine; the company’s share dropped 2.4% Tuesday and regained 1.2% Wednesday, indicating that at least some investors were worried by the news.
3. What should the regulator conclude?
Some market players believe the write-down announcement is actually related to issues between Bezeq and Israeli regulators. Bezeq is seeking permission to dissolve structural divisions between it and its subsidiaries – Bezeq’s landline operations, Yes and Pelephone – that would enable the parent company to take advantage of 1.2 billion shekels in losses previously reported by Yes.
The announcement may be a way for Bezeq to say: Throw us a bone, our mobile operations are much worse off than we thought.
4. What about competitors’ valuations?
If a company like Pelephone is telling investors it’s worth 1.1 billion to 1.2 billion shekels, this also reflects on its competitors in the cellphone industry. Partner lost 4.4% in trade Tuesday and regained 1.2% Wednesday, while Cellcom lost 3.6% Tuesday and 0.1% Wednesday. Pelephone has no debt. Cellcom is valued at 1.17 billion shekels, and has debt of 3.4 billion shekels. Partner is valued at 2.33 billion shekels and has debt of 1.51 billion shekels. But Partner and Cellcom have operations beyond mobile communications, including multichannel television and fiber optic cables.
A senior executive at a institutional investor noted, “This means Partner and Cellcom aren’t worth their current market price, and they may get caught up in debt arrangements the market hasn’t expected.”
Sherf concurred. “Presuming the valuations of Cellcom and Partner are based 50% on their mobile operations (a percentage that keeps shrinking), the reduction in Pelephone’s value indicates their mobile operations are also worth less.”