Monday, 20 October 2014

Avanti (AVN) ... the debt rises

Monday 20th October 2014

I finally got round to reading Avanti's year end results to 30th June 2014 (released on 15th September 2014). And then I shorted some more stock. 

2014 was a major year for Avanti. Its revenue doubled, the net loss nearly doubled, net debt ballooned to $321.7 million, and backlog went nowhere. 

Around this time last year, I took a look at the composition of its 2013 revenue, attempting to fathom the revenue level that was related to satellite capacity. A year down the line and revenue discovery remains somewhat opaque: 

  • Q4 2014 revenue was reported as $26.5 million, however, the statement warns that revenues in Q1 2015 "... are expected to be around the average of the last year, with new contracts driving into growth in subsequent quarters." Hence, Q1 2015 revenue is expected to be c. $16 million. This would imply a Q3 2014 to Q1 2015 revenue trend of $14 million, £26.5 million, $16 million. This is not altogether reassuring for a company with an interest bearing bond of $508 million and ambitions to raise a further $125 million in debt and $100 million in junior finance (most likely equity).
  • As compared to 2013, I find it even less clear what makes up this year's group revenue.

    Whereas in 2013 the list of other revenue sources included:
    Consulting revenue;
    ESA contract; 
    and kit. 

    This year has seen the following added to the mix:

    Contracting and building several cellular back-haul networks;
    A customer who has initiated an infrastructure project, which is of strategic importance to AVN (this was provided as the main reason for the increased debtors at the year end);
    and revenue where infrastructure has been disrupted by civil unrest.
Sticking with revenue, there should be some concern regarding its future:

  • For the first time that I'm aware, the credit quality of the backlog figure has been raised by the group. Within the "Finance and Operating Review", it is highlighted that:

    "Backlog has a mixture of companies with varying credit qualities."

    The company goes on to highlight that:

    "The average credit quality has improved over the last 18 months." 

    However, the fact that the prior backlog revenue declared for 2014 (as reported 10th July 2013) of £42 million or $69.2 (£42 million at $1.65) failed to fully come through, goes against the grain of the latter statement. I note that there was also the expectation that:

    "... orders under framework contracts (not included in backlog), new contracts and possible renewals (of contracts expiring between 2014 and 2016) [would be expected] to increase these numbers."

    This expectation didn't seem to come through as, overall, revenues fell short of what was in backlog last July. The other alternative is that backlog materially under-delivered. This may explain the disappearance of this KPI?!?
  • In the CFO's review, he notes that $26 million of backlog moved to revenue. However, we know that revenue included the construction of cellular backhaul networks, so the construction of networks must be - or have been - in backlog - how much is it? The key question is how much backlog is pure satellite revenue that is expected to earn adequate margins to service and repay the ballooning debt whilst leaving a return for equity holders?
  • Finally, when discussing Cost of Sales, Avanti reveals that 2014 revenue may have been somewhat bolstered by projects where it has acted as the prime contractor, and so taking 100% of the revenues and then paying out the costs of the secondary contractors. How "incremental" these sub contract costs and associated revenue were, would be interesting to know.
The Gross Loss
One would imagine that a satellite company has a significant fixed cost base. And yet Avanti's "Other cost of sales" line (excluding depreciation) has remained stubbornly high at around 60% for the last several quarters, even as sales have risen sharply. The flat margin may suggest that either a lot of the growth in revenue is not bandwidth related sales, or the bandwidth is earning less/costing more to deliver than expected. I would've though that there should have been a ramp up in margin by now if significant satellite capacity was being sold, and yet this has not been the case.

In the third bullet point of the company's "Financial Highlights", it mentions that it was "EBITDA positive for the full year for the first time." This is somewhat misleading and Paul Walsh, AVN's Chairman, should probably know better than to permit the statement as it was. The positive EBITDA was prior to the "non-cash share based payment charge" and after the addition of $5.3 million of an ex-gratia payment relating to HYLAS 2. Incidentally, in a legal sense "ex-gratia" is a payment made without the payer recognising any liability or legal obligation to the payee. Given that the builder of the HYLAS 2 satellite is the payer, and is also the builder of newly ordered HYLAS 4 satellite, perhaps there is some sort of jiggery pokery going on? Either way, it's not an ongoing profit so the company was not EBITDA positive in a prudent understanding. 

A review of Moody's analysis of the high yield bond shows that, just 12 months prior, Moody's had been expecting sufficient positive EBITDA for FY 2014 to provide an adjusted leverage multiple of 10x EBITDA. As highlighted below, Moody's most recent report after the additional bond suggests that: 

"The change in outlook from positive to stable reflects our expectation that the additional investment to fund HYLAS 4 will weigh on free cash flow, increase debt levels and increase the time frame for deleveraging. Based on the increased amount of debt, we now estimate that Moody's adjusted leverage as at the year end 2014 will be significantly above 10x-our expectation at the closing of the transaction in October 2013."

Source: Moody's Global Credit Research - 23 June 2014

This is a worrying deterioration from forecast positive EBITDA at the time of the issue of the $370 million High Yield bond, to now actual negative EBITDA with $508 million in High Yielding debt. It may prove difficult to raise further capital at a similar rate of interest in the debt markets. Indeed as the chart below highlights, Avanti's existing debt has already begun to price down over recent months, so that it has dropped below par and is now yielding 10.5%.           

Price of Avanti debt
Source: Bloomberg
Yield on Avanti debt - gone above 10%
Source: Bloomberg

Non-controlling interests
We await the full year accounts, but the reported loss attributable to the non-controlling interest suggests that Filiago made another loss despite its significant valuation held on AVN's balance sheet. More on Filiago here. In the light of the group's enormous debt pile, the condition of Filiago is almost irrelevant, barring the fact that it provides a further example of a lack of transparency. 

Balance sheet
The capital structure of the group and its associated cost changed dramatically during 2014. The group made a noble effort to suggest that the change was due to the prior debt being "... overly restrictive in terms of the Group' growth aspirations." The facts look more to suggest that the replacement of the old loan with a new more punitive loan was essential, and quite possibly to stall the event of a default. 

As it is, gross debt has risen a whopping $204 million during 2014, to $517 million. Meanwhile, net debt now stands at $322 million (2013: $254 million) and the group's interest expense has risen to $39 million (2013: $6.5 million). That is some rise to allow for less restrictive terms to meet growth aspirations! 


There were further red flags I could mention, however, there are already enough here to prompt me to increase my short. So I did.

Avanti's share price
Source: Bloomberg
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