Maxcom, Source Capital, November 2011

7/31/2019 Maxcom, Source Capital, November 2011

1/24

MaxcomTelecomunicaciones,S.A.B.deC.V. November22,2011

$200million11%SeniorNotesdueDecember2014(MAXTEL1112/14)

BUY

Analyst:

StephenBalinskas

[email protected]

Tel:2033413500

Extension237

OurfundamentalopinionisunchangedsinceourMarchreport:We

thinkthat

the

company

has

aliquidity

problem,

not

asolvency

problem,

andtheriskisthusoneofrefinancingthebonds.Thisrefinancingisstill

threefullyearsaway.

Negativefundamentalsattenuating,positivefundamentalspersisting.

MaxcomhashadaneventfulFY11todate,butmostoftheeventshave

beenpositive.Inparticular,thecompanyscoststructurehas

significantlyimproved.Negativefundamentalsdecliningcustomers,

revenuesandcashflowhavestabilizedoratleastattenuated.

Compellingupside.Wevereweightedthescenarioanalysispositedin

ourearlierreport.Wenowsuspectthatcreditors,shouldthe

refinancingthree

years

hence

fail,

might

be

in

astronger

position

than

wethoughtpreviously.Weproposethattherecouldbeways,for

enterprisingandcollaborativecreditors,totakeleadingpositionsinthe

bondsandstillcomplywithforeignownershiplimitationsonMexican

terrestrialtelecommunicationscompanies.WevalueMaxcombondsat

approximately88(previously89).Thisisa6to18monthpricetarget.

Limiteddownside.Inadditiontostrongunderlyingassetvalue,the

breakevenpriceonthenotesinayearis51(thecurrentpriceof62less

the11%coupon).Thebreakevenpriceintwoyearsis40.

Attractiverelative

value.

Maxcoms

bonds

trade

24,000

and

21,000

bps

widerthanissuesofcomparableratingsorcreditsupport.Wefindthe

spreadhighlyexcessive.

Atcurrentindicativepricesinthe60sandyieldsupwardsof30%,we

findthatthebondshavecompellingupsideandlimiteddownside.

Forresearchdisclosures,pleaseseepage24ofthisreport.

MAXTEL 11% due 12/2014 62 33.3 2.1 199.5 Caa1/CCC+

Prices strictly indicative.


2/24

Page2/24

CompanyDescription

MaxcomTelecomunicaciones,S.A.B.deC.V.(Maxcom)isalandlinetelephony,internetandTV

serviceproviderinMexico.Thecompanyprimarilytargetslowerandmiddleincomeresidential

customers,butalsohasasignificantcommercial/SMEcustomerbase.Thecompanyhasmorethan

8,600kmsoffiberandlastmilenetworkinfrastructure,inandaroundtheCentralMexicancitiesof

MxicoDF,Quertaro,PeublaandSanLuisPotos.Maxcomisamongthesmallesttelephonyproviders

inahighlycompetitivemarket.

Background

WeinitiatedonMaxcominMarchofthisyearwhenthebondswereinthemid70s,withthe

recommendationthatinvestorsbuythebonds,withapricetargetofthehigh80s.

1Q11resultsrevealedmarginaldeclinesinthecustomerbaseand7%YoYdeclineinrevenue.Theyalso

revealedareductioninthecompanyscoststructurethat,weestimate,improvedEBITDAmarginby

about700bps,likelyadding~MXN180mtothisyearsEBITDA,constitutingYoYgrowthofabout20%.

Thereafter,thebondsstrengthenedapproximatelytenpoints,tothelowtomid80s.2Qand3Q11

resultsrevealedastablecustomerbase,levelofrevenueandcoststructure.Insummary,thenegatives

declining

customers,

revenues

and

cash

flow,

have

attenuated,

and

the

positive

an

improved

cost

structure,haveheldfirm.Notwithstanding,thebondshavefallentoapproximately60.Withno

particularnegativechangestothecompanyoritsindustry,wefindthebondsmoreattractivethan

before.

RecentEvents

Reducedfixedtomobileinterconnectioncharges.In1Q11results,Maxcomrevealedthat,beginningon

January1ofthisyear,thecompanybegantoaccrueandpayalowerrateforcallsoriginatedonits

(primarilyfixedline)networkandterminatedonmobilenetworks.Thisratewassubsequentlyapproved

bytheMexicantelecommunicationsregulator,ComisinFederaldeTelecomunicaciones(COFETEL).The

newratewasMXN0.3912,down61%fromtheformerrateofMXN1.0.Whileweshouldspeakonlyfor

ourselves,

we

venture

that

this

reduction

was

not

widely

anticipated

by

the

market.

MostMexicansareconsumersofmobile,asopposedtofixedline,telephony.Forthesakeof

perspective,Telcel,thedominant(>70%marketshare)mobiletelephonyprovider,counted64million

subscribersinMexicoatFYE10,whileTelmex,thedominantfixedlineoperator,countedlessthan16

millionlinesinservice.Theupshotis,mostcallsonMaxcomsnetworkareterminatedonmobile

networks.ThereducedinterconnectiontariffssignificantlyreducedMaxcomscoststructure,likely

improving,perourestimates,thecompanysoverallFY11EBITDAandEBITDAmarginbyabout

MXN180mand~700bps,respectively.

Creditratingdowngrade.Aswewarnedinourlastreport,downgraderiskwasafactor.Thisriskwas

realizedwhenS&PdowngradedthecompanysbondstoCCC+(negativeoutlook)fromB.Thisfollows

Moodysdowngrade

to

Caa1

at

the

end

of

2010.

Still,

the

notes

were

split

rated

for

several

months.

"ThedowngradereflectsMaxcom'slowerrevenuegeneration,continuednegativefreeoperatingcash

flow,andacashpositionthatrestrictsthecompany'sfinancialflexibility"saidthepressrelease.Wetake

issuewiththenegativeoperatingcashflow;thecompanyisFCFpositive2011todateandweexpectit

toremainso.Still,thedowngradewaswelltelegraphedandnotbasedonanynewinformation,inour

opinion


3/24

Page3/24

Competitiveenvironmentunchanged.Maxcomstelephonycustomerbasereflectsthesametrend

observedgloballyamigrationfromfixedlinetomobile.Thedeteriorationofitsfixedlinetelephony

customerbaseexceedsthatofpeers,butnotbymuch;fixedlinepeersTelmexandAxtelareallslowly

losingtelephonycustomers,ormoreprecisely:revenuegeneratingunits(RGUs),intheparlanceofthe

industry.MaxcomisaddingTVandinternetcustomersanddoingsoatarateinlinewiththatofpeers.

Relatedly,stillnoTelmexinTV.TelfonosdeMxico,(Telmex)isMexicoslegacyandstilldominantfixedlinetelecommunicationsserviceprovider.AmricaMvil,formersubsidiaryofTelmex,announced

thatitwouldcompletelysubsumeitsformerparent.AmricaMvilsMexicanwirelessoperation,Telcel,

isnotonlyMexicosdominantwirelesstelephonyprovider,butitslargesttelephonyconcernoverall.

Telmexhassince2006beenpetitioningtheconcernedregulatoryagenciesforpermissiontomarketTV

services.Atissueareantitrustconcerns.Telmex/AmricaMvilunderstandthebusiness.Thelatteris

alreadytheleadingTVproviderinLatinAmerica,withlargeTVoperationsinBrazil.Telmex/Amrica

Mvilarelarge,capitalrichcompanieswithconsiderableinfluence.

Ifanything,however,recentregulatoryrulingshavegonenotfortheincumbent,butagainstit.TheCOFETEL

approved

the

aforementioned

61%

in

interconnection

charge

(though

the

loss

to

Amrica

MvilismitigatedbythemoneysavedbyTelmex,itssoontobewhollyownedsubsidiary).The

COFETELisalsoproposinglowertariffsforothertelephonyservicessuchasruralandlocal

interconnection.

WhileawaitingregulatorypermissiontoofferTVservices,Telmexhasprovedanimpatientapplicant.

Earlierthisyear,Telmexbeganstreamingshows,news,sports,andculturalprogrammingforfreeonthe

Web.TVAzteca,Mexicossecondlargestcontentprovider,subsequentlysuedAmricaMviland

Telmex.StreamingontheInternetisntTV,saidaTelmexspokesman.Wedoubtsuchactionsare

endearingtoregulators.Ultimately,webelievethatTelmex/AmricaMvilwillultimatelyobtain

permissiontomarketTVservices,butcannotsaywhenorunderwhatterms.

Inanycase,however,MaxcomalreadycompeteswithTelmex.ItsprovencompetitivewithTelmexin

residentialtelecommunicationsinitsareasofservice.Thecompanyhasnotbeencompetitivewith

Telmex(orothertelecommunicationspeers)intheareaofbusinessservices,butthatsnotgoingtoget

worsewithTelmexacquiringaTVlicense.

Insummary,thearrivalofTelmexintheTVsegmentwillservetoincreasecompetitivepressures,but

theywontservetoweakenrecentfavorabledevelopments,inouropinion.

Companycontinuestodoitselfnofavorsindisclosureandcorporatecommunications.Wefind

Maxcomsomewhatmaddeninginsomeaspectsofitsdisclosure(thoughitdoesntdoanyworsethan

somepeersinthisregard).Thecompanydoesnotdecomposeminutesofuse(MOUs)orrevenuesand

marginsper

service

segment

(i.e.

telephony,

data,

TV),

presumably

for

competitive

reasons.

But

they

coulddobetter.

Inaddition,manyinvestorsmaybeconfusedbytheircashflowdisclosure.ThisisnotsomuchMaxcoms

faultasthatofinvestors.Still,Maxcomcouldhelp.


4/24

Page4/24

ThecompanydisclosesquarterlycashflowasrequiredbyMexicanFinancialReportingStandards,or

MFRS.Foranhistoricalperspective,Mexicancompanieswereformerlyrequiredtodiscloseaquarterly

StatementofChangesinFinancialPosition.Thedisclosureresembledacashflowstatementinsome

respects,butitsprimaryfunctionwastoaccountfortheimpactofinflationandexchangeratevolatility

oncompaniesstates.In2007,Mexicodidawaywithinflationaccounting,whichallowedforother

changestodisclosure.ThenewCashFlowStatementresemblesboththeoldStatementofChangesin

FinancialPositionandatypicalUSGAAPpreparedstatement,butisyetneither.Itsimpossibletocompletelyreconciletheformertothelatter,butyoucancomeclose.Ourapproximatereconciliationis

inthebackofthisreport.

Per3Q11reporting,MaxcomsMFRScashflowstatementsuggestedtotheuninitiatedanalysta

sourceofMXN317m(aboutUSD22m)relatedtothenotes.TheoutstandingamountoftheUSD199.5m

ofnoteswas,ofcourse,fixed.Thecompanydidnotandcouldnothaveissuedmorenotes.Thechange

isuniquelyrelatedtothe16%depreciationoftheMXNagainsttheUSDduringtheperiod.Thechange

wasavaluationone,notoneofcashflow.Wedpreferthatthecompanyprovidesomesortof

unaudited,proformaUSGAAPishaddenduminitsquarterlyreporting;thereareprecedentsforit.

Inaddition,

the

company

assured

listeners

during

the

recent

3Q11

earnings

call

that

it

was

fighting

a

recentsanctionbythetelecommunicationsregulator.Itisnotcleartousquitewhatthesanctionis

about.Norwasitapparentlycleartootherlistenerseitherbecausetherewereatleasttwoquestions

aboutit.Ineffect,managementsresponsewaswerefightingitbuteitherwouldnotorcouldnot

(andfranklywerepartialtothelatter)explainwhatthesanctionwasabout.Managementcould

communicatesuchissuesbetter,inouropinion.Basedonourlimitedknowledgeofthesanction,wedo

notthinkthatitwillhaveasignificantimpact.

Recentinsidersale.OnOctober19,2011,MaxcomexecutiveJacquesGilksbergfiledtosellstockworth

USD76,058.Indicatedinthefieldinthedisclosurerelatedtotheexpectedtimingofthesalewas

ASAP.WenotethiswasBEFOREthereleaseof3Q11resultsonOctober26.However,3Q11results

were

not

particularly

surprising

or

disappointing.

The

sale

nonetheless

is

noteworthy

to

creditors.


5/24

Page5/24

RecentFinancialResults

MaxcomSummaryFinancialStatistics

Source:CompanydisclosureandSourceCapitalGroupestimates Revenuesstable.ForthethirdfiscalquarterendedSeptember30,Maxcomsrevenueswereflat

sequentiallyand

down

8%

YoY.

Virtually

all

of

the

YoY

decline

can

be

attributed

to

the

sequential

declineobservedinthefirstquarterofthisyear.Inotherwords,revenueshavebeenstableoverthe

lasttwoquarters.

GrossProfitincreases.Grossmarginimprovedsequentiallyby153bps,primarilyasaresultofthecompanysaccruinglowerinterconnectionratesforcertainoperations(localtolocal,localtolong

distance,andnetworktonetwork).ThecompanyispetitioningtheCOFETELfortheseratestobe

approved.Confirmationisnotcertainandwedonotbelievethecompanyissettingasideareserve

intheeventapprovalisnotgranted.However,peerAlestrahasbeengrantedpermissiontousethe

samereducedrates.Moreover,thesamedynamictookplaceforthesubstantialreductioninfixed

towirelessinterconnectiontariffsearlierintheyear;Maxcomandotherfixedlinepeersbegan

usingtherevised,lowerratespriortotheofficialapproval.WeexpectMaxcomsuseofthesenew

ratesto

be

approved

as

well.

The

YOY

improvement

was

due

to

the

aforementioned

fixed

to

wirelessratereduction.

HigherSG&Aappropriateandwelcome.SG&Asequentiallyincreasedinabsolutetermsandasapercentageofsalesby7%and212bps,respectively.Theincreasemorethanoffsetthedeclinein

NetworkOperatingServicesexpense.Wearenotsureofthenatureorsubstanceoftheincrease,

butwethinkitappropriateandpositive.FromFY09toFY10,Maxcomcut27%ofitsemployeesto

improveitscoststructure.Morenotably,itsnumberofsalesrepresentativeswasalmosthalved.At

aminimum,thereductioninthesalesforcecouldnothavehelpedcustomeracquisitionand

revenues.

PrimarilyduetothehigherSG&A,EBITDAmarginsequentiallydeclinedby60bps.InUSDterms,EBITDAdeclinedsequentiallyprimarilyduetothe10%depreciationofthepesoagainstthedollar.

Net Revenues (MXNk) 646,980 592,421 594,302 0% -8%

Gross Profit 375,564 392,865 403,184 3% 7%

EBITDA 169,524 201,058 198,159 -1% 17%

% sales 26.2% 33.9% 33.3% (60) bps 714 bps

EBITDA/Int Exp 2.2 2.8 2.4 -15% 8%

Net Debt/EBITDA 2.9 2.7 2.9 6% -1%

US GAAP FCF (approx) (119,986) 67,005 (34,297)

in USDk, for reference:

Net Revenues (USDk) 51,593 50,772 42,859 -16% -17%

EBITDA 13,519 17,231 14,290 -17% 6%


6/24

Page6/24

Debtstable.Netleverage(netdebt/EBITDA)increasedto2.9xfrom2.7xlastquarter.TheincreasewasduetoaweakerMexicanPeso(MXN).InUSDterms,netdebtdeclined.Aswepointedoutin

ourlastreport,Maxcominvestorsareexposedtoexchangeraterisk.MaxcomservicesitsUSD

denominateddebtwithrevenuesdenominatedalmostentirelyinMXN.TheMexicanPeso(MXN)

weakenedtoMXN13.87/USD,down10%sequentially16%YoY.Thedeclinewasinlinewiththose

ofmanyemergingeconomiesassovereignconcernsdominatedglobalcapitalflows.Whilethe

impactonthecompanysdebtservicecapacityismateriallynegative,thedeclinewasentirelyinthe

rangeofnormalvolatilityandismanageablebythecompany,inouropinion.Werecalltoreaders

thatthecompanyhedgesthemajorityofcouponpayments.

GuidanceonTrack.Mostly.

Source:CompanydisclosureandSourceCapitalGroupestimatesThecompanyisontracktomeetorexceedtheguidanceitprovidedearlierthisyear,withthe

exceptionRGUgrowth.Thiswilllikelycomeinflatorintheverylowsingledigitpercentagepoints.

RGUperCustomerSegment

TotalcustomersandRGUsflat.Maxcomstotalnumberofcustomershasbarelymovedinayear,up

only1%YoY.ItsnumberofRGUsisdownabout1%.Stabilitycanbenice,butMaxcomscapital

structurewasconceivedwithgrowthinmind.MaxcomsoverallRGUgrowthalsocomparespoorlyto

Mexicantelecommunicationsatlarge:

ChangeinTotalRGUBaseSince3Q10

Source:CompanydisclosureandSourceCapitalGroupestimates

EOY Cash Bal MXN 340-350m

Rev growth flat

EBITDA growth 2-3%

RGU growth 10%

Capex USD 25m (~MXN 300m)

Cash flow breakeven

-Develop relationships with other companies to reach more customers

5%

0%

5%

10%

15%

20%

3Q10 4Q10 1Q11 2Q11 3Q11

Maxcom Telmex Axtel Megacable Tvisa


7/24

Page7/24

Perourlastreport,recallthatpeersconsistofthefollowing:

Telmexisthedominantterrestrialtelecommunicationsprovider.ItprovidesvoiceanddataservicesthroughoutMexico.ItispetitioningforalicensetoprovideTVservices,

butdoesnotprovideanysuchservicesyet.

Axtel,likeMaxcom,isacompetitivelocalexchangeprovider(CLEC)and,wefind,Maxcomsbestcomp.UnlikeMaxcom,itdoesnotprovideTVservices,thoughit

recentlyannounceditwasstudyingtheprospect.

MegacableisMexicoslargestindependentcableTVprovider.LikecablecompaniesintheUS,ittooofferstripleplayTV,telephonyanddataservices.

TelevisaisasprawlingMexicanmediaconglomerate.ItisthelargestmediacontentproducerintheLatinworld.ItfurtherhasalargecableTVassetbase,andisalso

increasingitssalesoftelephonyanddataservices.

ThereasonsforthefailureofconsolidatedRGUstogroware:

Mobilecustomerbasecontinuestodecline.MaxcomoffersmobiletelephonyviaalicensingagreementwiththelocalMexicanaffiliateofSpainsTelefnica.Mobiletelephonyhasalwaysbeen

anancillary

service

that

Maxcom

offered

to

its

fixed

line,

and

primarily

residential,

customers.

Its

beenuncompetitive.Presumably,customersprefertosubscribedirectlytoTelcelorotherwireless

carriers.

...asdocommercialclients.Aswementionedinourlastreport,MaxcomhasbeenunabletocompetewithotherTelmexandotherCLECsinattractingandretainingcommercialclients,andin

particular,largescalecommercialclients.ThecommercialRGUbaseshrank15%inFY10.Duringthe

1Q11conferencecall,managementmentionedthatitwasrollingoutnewserviceofferingsinefforts

toappealtosmallandmediumsizebusinesses.Weobservenoapparentfruityet.Thenumberof

commercialcustomershascontinuedtodecline,andin3Q11,wasdown10%yeartodate.Still,

GiventhedeclineinFY10,itsnotablethatthenumberofcommercialRGUsandrevenuesseemto

haveatleaststabilizedFY11todate,meaningthenumberofcustomersisdiminishingbutthisis

morethan

offset

by

higher

sales

to

the

customers

they

have.

Voiceinseculardecline.Finally,voiceRGUsareinslowbutsteadydecline.CommercialvoiceRGUsweredown8%YoYandresidentialRGUsdown3%YoY.Together,theycomprisethelargestpart

54% ofthetotalRGUbase,soifthisservicesegmentdoesntincrease,itsdifficulttogenerate

overallgrowthwhenothersegmentsarewaxing(TVandinternet)orwaning(commercialservices).


8/24

Page8/24

Maxcomfurtherappearstobelosingvoicecustomersatafasterratethantherestofthemarket:

ChangeinVoiceRGUBaseSince3Q10

Source:CompanydisclosureandSourceCapitalGroupestimatesHowever,thisrateisnotegregiouslygreaterthanTelmexandAxtel,itsfixedlinepeers,inouropinion.

TheyrealllosingcustomersduetothesameseculartrendobservedhereintheUS:continued

defectionsfromfixedlinetelephonytomobile:

InternetandTVclientbaseisgrowing,andataratethatcomparesfavorablytotherestofthe

market.Wecontend,however,thatthedeclinesincommercialandmobileRGUs,anddisappointing

growthinresidentialfixedlineRGUs,aremitigatedbygrowthofdataandTVcustomers.Growthinthis

partof

the

customer

base

furthermore

compares

favorably

to

that

of

competitors:

ChangeininternetRGUBaseSince3Q10 ChangeinTVRGUBaseSince3Q10

Source:CompanydisclosureandSourceCapitalGroupestimatesTodate,growthindataandTVcustomershasnotoffsetthelossofvoicecustomers,becausethevoice

customerscontinuetoconstitutethelargestpartofthecustomerbase.IfTVanddatacustomergrowth

persists,theirgrowthcouldoutpacethelossofcommercialcustomers.

10%

5%

0%

5%

10%

15%

20%

25%

30%35%

3Q10 4Q10 1Q11 2Q11 3Q11


0%

10%

20%

30%

40%

50%

60%

3Q10 4Q10 1Q11 2Q11 3Q11


2%

0%

2%

4%

6%

8%

10%

12%

3Q10 4Q10 1Q11 2Q11 3Q11

Maxcom Megacable Tvisa


9/24

Page9/24

RevenuesandARPUbyCustomerSegment

Residentialrevenuesdeteriorateslightly,wholesalerevenuesup,andothercustomersegmentsstable

overtheyeartodate.WefindMaxcomsomewhatmaddeninginsomeaspectsofitsdisclosure(though

itdoesntdoanyworsethansomepeersinthisregard).Thecompanydoesnotdecomposerevenuesor

marginsperservicesegment(i.e.telephony,data,TV),onlybycustomersegment(residential,

commercial,etc.).Thelatterisfarlessrevealing.Still,basedonthislimiteddisclosure,revenuesfrom

mosttypesofcustomershavebeenflatorindeclineoverthecourseoftheyear:

RevenuesandAverageRevenueperRGU

Source:CompanydisclosureandSourceCapitalGroupestimatesAnotableexceptioniswholesalerevenues,whichhaveincreasedsignificantly.ARPUinthiscaseisof

limitedvalue,however.Thebusinessoperatesaccordingtotrafficandminutesofuse(MOUs),which

thecompanydoesnotdisclose.Still,wecaninferthatwholesaletraffichasincreasedsignificantly.

(100)

100

300

500

700

900

1,100

1,300

1,500

1,700

50

100

150

200

250

300

1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11e

Residential Commercial PublicTel

Wholesale ResidentialARPU(right) CommercialARPU(right)

PublicTelARPU(right) WholesaleARPU(right)


10/24

Page10/24

EstimatingRevenuesandARPUbyServiceSegment

Asmentionedabove,Maxcomdoesnotdiscloserevenuesandmarginsaccordingtotelephony,TV,

internet,etc.Evenifthecompanydid,itmaynotbeveryinterestingbecausemuchoftherevenueis

somewhatfungible.Servicesaretypicallybundled,likeintripleplaypackages.Still,wesuspectthat,

inferringfrompeerdisclosure,Maxcomgenerates,asaveryroughapproximation,thefollowingEBITDA

contributionperbusinesssegment:

Source:Companydisclosure,peerdisclosure,andSourceCapitalGroupestimatesIf

the

foregoing

is

roughly

accurate,

voice

would

seem

avery

profitable,

if

declining,

business.

We

would

furtherconcludethatTVissignificantlylessprofitablethanotherservices,butisusefulasameansof

retaining/acquiringvoiceclientsviapackedservices.

Evolutionofbusinessmodelnotclear.TorepeatourselvesfromourMarchreport,itsnotcleartous

howtodefinethecompany.Typically,cableprovidershavebranchedintoofferingdata/voiceservicesin

additiontotheircoreTVservices.IsMaxcomaCLECthatiseffectingthissametransitioninreverse,

becomingacableserviceproviderasanyother?Inallcandor,wecanttell.

Voice 130 58%

Data 157 24%

Mobile 84 4%

TV 59 5%

Wholesale and Other NA 8%


11/24

Page11/24

Industry

SelectIndustryPeers

CustomerandRGUdata3Q11orlatestavail;financialdataFY11eSource:CompanydisclosureandSourceCapitalGroupestimatesComparedtopeers,Maxcomremainsonthebasisofitscustomerbaseandrevenues.Intermsof

marginsand

profitability

per

customer

(EBITDA

per

RGU),

it

compares

favorably.

Its

furthermore

easily

thelowestvalued.

Competitorsacquisitiveandevolving.TheMexicantelecommunications/mediaspaceisasdynamicas

itsbeeninyears.Sinceourlastreport,inadditiontothesurprisingaforementionedreductioninfixed

tomobileinterconnectioncharges,thefollowingeventshavetakenplace:

TelevisaannouncedandexecutedtheacquisitionoftheremainingequityofCablemas,previouslya53%ownedcablesubsidiary.ThetransactionvaluedthecompanyatapproximatelyMXN11.2b,or

aboutUSD600persubscriber,accordingtoourestimates.

AmricaMvil,formersubsidiaryofTelmex,announcedthatitwouldcompletelysubsumeitsformerparent.ItsMexicanwirelessoperation,Telcel,isnowMexicosdominanttelephonyconcern.

Telmex,aspreviouslydescribed,continuestopetitiontheconcernedregulatoryauthoritiesforlicensestodistributeTV. MegacablealsoacquiredsomecablepropertiesinCentralMexico,adding44thousandvideo

subscribers,10thousandinternetsubscribersand2thousandfixedlinesubscribers.Megacablealso

addednearly700kmofcabledistributionnetwork,passing112,000homeswithanestimated

populationofover400thousand.ManagementdisclosedthatthevaluewasUSD700750per

subscriber.

Market Cap m USD 72 USD 13,641 USD 456 USD 1,668 USD 1,438 Televisa Sub Totl Tvisa Alfa Sub

Debt Rating Caa1/CCC+ A3/A- B3/B+ Ba3 Cbl Subs B1/B+Fiber Kms 6,426 112,570 11,000 39,687

Custs 247,669 757,000 1,912,940

Voice RGUs 296,505 15,127,000 1,040,000 474,000 231,700 248,713 609,832

Data/Internet RGUs 102,414 7,892,000 822,000 647,000 367,520 425,389 975,084

TV RGUs 54,452 - - 1,864,368 704,580 1,050,415 2,122,159 -

Total RGUs 552,781 23,019,000 1,862,000 2,985,368 1,303,800 1,724,517 3,707,075 887,000

Rev/RGU, monthly 358 395 486 228 444 224 305 440

EBITDA/RGU, monthly 119 159 164 96 156 86 108

Revs, (MXNm) 2,361 109,671 4,661 8,517 6,915 NA 13,129 4,686

EBITDA 793 44,139 1,492 3,644 2,146 NA 4,464 1,587

EBITDA margin 33.6% 40.2% 32.0% 42.8% 31.0% NA 34.0% 33.9%

EBITDA/Int Exp 2.5x 15.0x 3.7x 44.7x 7.1x NA NA 4.7x

Net Debt/EBITDA 2.9x 1.6x 2.3x -0.3x 0.3x NA NA 1.4x

FCF 33 15,266 208 1,634 93 NA NA

EV/Rev 1.0 2.3 1.3 2.7 2.9 NA NAEV/EBITDA 3.1 5.7 4.1 6.3 9.5 NA NA

EV/Gross PP&E 0.3 0.6 0.4 1.7 1.4 NA NA

EV/Net PP&E 0.6 2.6 1.0 2.8 2.3 NA NA

EV/NW 0.9 5.0 2.0 1.7 3.2 NA NA

PE (2.4) 12.3 (16.6) 12.0 62.5 NA NA

PB 0.4 3.8 0.9 1.8 3.1 NA NA

FCF Yield 3.4% 7.4% 3.3% 6.8% 0.6% NA NA

EV/RGU 4,363 10,868 7,550 7,448 15,164 6,327 NA

EV/Cust 9,600 19,129 11,737


12/24

Page12/24

NobodyneedsMaxcom,butwethinkthatanumberofserviceproviderswouldliketohaveit.Webase

partofourvaluationofMaxcomonitsattractivenessasanacquisitioncandidate.Ourthesishere

remainsthesame.Fromacompetitiveorconsolidationstandpoint,Maxcomisattractiveandcheap.We

notethatTelevisaalonehas,throughthefirstninemonthsofthisyear,putcapexofMXN3.1bintoits

cableoperations.Thisamountis30%greaterthanMaxcomsentireenterprisevalueatNovember18.

Suchconsolidationisofcourseimpossibletotime.WenotethatperMegacablesmanagementduring

their3Qearningscall:

Wellthereisnotverymuchmarketsizeorsmaller,orlargeorsmalloperatorstobeacquired

anymore.[Wevebeen]thinkingforthepasttwoyearsthatconsolidationshouldbefasterand

we[]stillexpectthat.

Capitalization

Source:CompanydisclosureandSourceCapitalGroupestimatesMaxcommust,inouropinion,continuetolivebyitscashbalance.Maxcommaynotpresentlyincur

additionaldebtthatisseniororparipassutothenotes,subjecttoaleverageratiointhebond

indenture.OurreadingoftheindenturesuggeststousthatMaxcomcouldobtainsubordinated

debtHowever,thecurrentmarketpriceofitsseniordebtrendersthisunlikely,inouropinion.Recallthat

anyequityparticipationassociatedwithmezzaninedebtwouldbecomplicatedbythatpeskyrule

wherebynonMexicanshareholdersarelimitedto49%votinginterestinterrestrial

telecommunicationsnetworks.Inshort,liquiditywillremaintightatleastuntilthecurrentnotescanbe

refinancedor

exchanged.

Book % Debt/ Mkt Mkt

value Total EBITDA Price Value

Cash 444,112 16% 444,112Investments 92,633 3% 92,633

Other Debt (assumed senior) 98,790 4% 0.1x 100% 98,790

11% Notes due 12/2014 2,684,340 96% 3.5x 60% 1,610,604

Total Debt 2,783,130 100% 3.6x 61% 1,709,394

Net Debt 2,246,385 81% 2.9x 52% 1,172,649

Equity 2,667,333 49% MXN 3.65 1,014,160

Total Capzn 5,450,463 100%


13/24

Page13/24

UpdatedFinancialProjectionsandValuation

Ouropinionisunchanged:WethinkMaxcomwillsurvive.Wethinkthatthecompanyhasaliquidity

problem,notasolvencyproblem,andtheriskisthusoneofrefinancing.Wehave,however,

reconsideredtheweightingofourdecisiontreeanalysis.Thisisnotbasedonanychangeinthe

performanceofthecompanyorthemarketpricesforassets.Infact,webaseourchangeonour

suspicionthatcreditorsmightbeinastrongerpositionthanwethoughtpreviously.

ScenarioAnalysis

Wethinkitmostefficienttovaluethebondsonadecisiontreemanner,perthefollowingscenariosand

whatwebelievetobetheirrespectiveprobabilities:

1. Muddlethrough:bondstradeupandarerefinanced:probability25%(previously29%)2. Acquisition:20%(20%)3. Defaultandrestructuring:25%(20%)4. Consensualrestructuring,e.g.anexchangeoffer:30%(31%)

Andyes,

we

are

recommending

bonds

that

have

anet

likelihood

of

being

restructured.

Muddlethrough:probability25%

Wethinkourbasecaseaconservativeone.Wevetweakedittoaccountforthelastthreequartersof

performance,buttheconclusionremainsthesame.WeassumethatTVandinternetRGUscontinueto

increase,whilemobileandcommercialRGUsdecline,resultinginoverallflatRGUlevels.Revenuesand

EBITDAdecline13%and26%,respectively.Webasethelatteronslightmargincompressionpresuming

recentinterconnectionratereductionsarepassedontothecustomer.Ourcapexspendingestimate

remainsUSD28mvs.guidanceofUSD25m.

Projectionsundemandingandsuggestissueisoneofliquidity,notsolvency.Ourprojectionssuggest

that

the

company

would

achieve

FCF

neutral

and

that

the

company

has

liquidity

issue,

and

not

a

solvencyissue.Thecatalysttoadeclineinyieldssuchthatthebondcouldberefinancedisthe30%yield

currentlyonoffer.Wenotethatonarelativevaluebasis,Maxcomsnotesyieldmorethan15,000

20,000basispointsmorethanbondshavingwhatwedeemtobeonlyslightlystrongercreditmetrics.

Pleaseseetherelativevaluesectionlaterinthisreport.

Bondrepurchaseanoptionandpotentialcatalyst.Itwassuggestedduringthe3Q11conferencecallthe

companyconsiderrepurchasingsomeofitsdebt;thatatyieldsof30%,itsunlikelythecompanywould

findauseforthecashthatwouldbemoreprofitableonanIRRbasis.Weagreewiththatassessment

entirely.Butdisagreethatitshouldbedoneinthenearterm.ThebondsmatureinDecember,2014,or

threefullyearsfromnow.Refinancingdoesntbecomeapressingissuefortwoyears.Untilthen,the

companyshould,inouropinion,useitscashbalanceforrunningthebusinessandmaintainingamargin

offinancial

safety.


14/24

Page14/24

Comecrunchtime,abondrepurchaseshouldbefeasible.Weestimatethatthecompanycouldbuilda

cashbalanceofaboutMXN500m,orUSD38m(atMXN13.5/USD)byFYE13.Ifatthattimebondprices

remainstubbornlylow,sayinthe80s,implyingayieldof~40%,thenthecompanycoulduseaportionof

thatcashbalancetorepurchasebonds.UsingUSD20mofitscashbalancecouldreduceoutstanding

debtbyUSD25m.Theactioncouldnotonlycatalyzebondyieldstodecline,butalso,duetothereduced

debtoutstanding,makingrefinancingmoreappealingtobanks.

Finally,thereismoneyoutthere.OnNovember17,2011,competitorAxtel(B3/B+)obtaineda

USD100msyndicatedcreditfacilty.

WefeelthatifMaxcomdemonstratesthatitisexecutingonitsbusinessplanandthevalueelsewherein

themarket,thebondscouldtradetopar.WethinkthatthemostMaxcomwould(orcould)everpayon

newbondsis12.5%.Thiswouldimplyapriceof95.5ontheexistingnotes.

Acquisition:20%

Maxcomwantstobeacquired.Weretemptedtoqualifythatasouropinion,butwethinkthatsthe

objectivetakeawayfromthepubliccommentsofmanagement.

Asbefore,weruleoutforeignbuyers(suchasSpainsTelefnica,withwhomithasanagreementto

providemobileservices)asthiswouldalmostcertainlyrequireliftingtherulelimitingnonMexican

shareholdersto49%votinginterestinterrestrialtelecommunicationsnetworks.Changingthelawhas

beendebatedformanyyears.Butanychangewouldnotbeintheinterestofinfluential,entrenched

incumbents,inouropinion.Ataminimum,wedontseethelawchangingbeforeMaxcomsbonds

mature.Still,wesuspectthatMaxcomsassetsaredesirableenoughtobeanattractiveacquisition

andsmallenoughtobeafeasibleacquisition.RecallfromourpeeranalysisthatMaxcomisthelowest

valuedtelephonyproviderofanysize.Thebondshaveachangeofcontrolputat101,whichisour

targetpriceinanacquisitionscenario.

Default

and

restructuring:

25%

Weveincreasedtolikelihoodofthisscenarioto25%from20%notbecauseofanychangestoour

perceptionofthecompanysperformance.Instead,wethinkthatinvestorsmaybestronger,andthus

theprospectofanadversarialrestructuringmoreappealing,thanwepreviouslythought.

Wereuncertainhowtheownershiplimitationwouldbeenforced.Firstly,werenotsurehowthe

ownershiplimitationmaybeenforcedintheeventofdefaultandaccelerationofpayments.Would

creditorscumequityholdersbecompletelyunabletoasserttheirclaims?Mighttheyhavesixor18

monthstocomplywiththelimitation(i.e.divesttheirequityholdings)?Toourknowledge,therulehas

notbeentested.

Theremaybecreativewaystocomplywiththelimitation.Secondly,wethinkthatforenterprisingand

collaborativecreditors,

there

may

be

away

to

take

aleading

role

of

the

bankruptcy

process.

There

is

precedenceforUSinvestorstohavealeadingeconomicinterest,thoughnotamajorityvotinginterest,

inaMexicanterrestrialtelecommunicationsconcern:Alestra.


15/24

Page15/24

Inthe1990s,Alestrawasconceivedbyitsshareholdersas,amongotherthings,anAT&TofMexico,

fromwhichtheUSparentwouldbenefituponliberalizationoftheMexicantelecommunicationssector.

Thatliberalizationtooklongerthanexpected.Theoriginalshareholderstructurewasasfollows:

Source:CompanydisclosureandSourceCapitalGroupestimatesAT&Tcontributed49%oftheoriginalcapital.Twolocalpartnerscontributedthebalanceofequityviaan

intermediaryholdingcompany.Alfa,aconglomeratewithinterestsin,amongotherthings,foodand

autoscontributedtheslightmajorityofequitytotheholding,withtheMexicanbankBancomer

contributingthebalance.AT&Tcouldthusclaimthelargesteconomicinterestofthethreepartners.

Fortherecord,thecompanylaterdefaultedonthetwobondissuesaggregatingUSD570m.Ina

restructuring,theshareholderskickedinadditionalequityandnewdebtwasissued.

Inthecontextofanaccelerationofpayments,nonMexicanbondholdersmightbeabletoobtaina

controllingportionofthedebtviaasimilararrangement,andstillcomplywiththelimitation.The

arrangement,ofcourse,wouldtakecreativityandcollaborationamongcreditors.Still,wethink

interestedandcapablepartiescouldbefound.


16/24

Page16/24

Ifoperatingperformancedeterioratesmoremarkedlythanwecurrentlyexpect,thereissubstantial

assetvalueinthecompanyevenintheeventofinsolvency.

MarketMultiples

Intheforegoingweusethelowestofpeermultiples(whichareinmostcasesthoseofAxtel).The

resultingvalues

suggest

that

there

is

plenty

of

value

to

cover

the

notes.

SustainableDebt:

Source:CompanydisclosureandSourceCapitalGroupestimatesInourlastanalysis,weestimatedthatMaxcomcouldproduceaboutMXN200minunleveredfreecash

flowperyearbasedonthenearlyMXN120minunleveredfreecashflowitgeneratedinFY10andits

plantocutcapexbyhalf.Suchestimatessuggestedapriceof64onthenotes.

WenowhavetoaccountforthecompanysimprovingEBITDAmarginby700bpstonearly34%onthe

backoflowerinterconnectioncosts.WeestimatethatevenifEBITDAmargindeclinesto28%,the

companyshouldstillbeabletogenerateMXN300mperyear.Weestimatethatthisamountofcash

flowcould,atcurrentinterestrates(i.e.11%),support98%ofthecurrentlyoutstandingfacevalueof

thenotes.

Sayaswell,however,thatonceacompanyhasmorecash,itfindsawaytospendit.Itmightbetempted

toincreasecapexmarginally,especiallygiventhecompetitivenatureofthemarket.Assuch,we

contendthatlongtermunleveredFCFgenerationofMXN250misfeasible,suggestingapriceof81.

Mult Implied EV Sen Claims Avail for Notes Implied Price

1 EV/Rev 1.3 3,131,542 (530,958) 2,600,584 932 EV/EBITDA 4.1 3,213,634 (530,958) 2,682,676 96

3 EV/Gross PP&E 0.4 3,905,764 (530,958) 3,374,806 121

4 EV/Net PP&E 1.0 3,990,526 (530,958) 3,459,568 124

5 EV/NW 1.7 4,511,474 (530,958) 3,980,515 142

6 EV/RGU 6,327 3,528,661 (530,958) 2,997,703 107

7 EV/Cust 11,737 2,975,594 (530,958) 2,444,636 87

All values per Source Capital Group FY11 estimates, unless otherwise indicated

1, 2, 3, 4, 5 per Axtel; 6: per Cablemas; 7 per recent Megacable acquisition value.

Sen Claims includes pensions, taxes, vendor financing and AP, though some is likely parri passu

Unlevered FCF

150,000 175,000 200,000 225,000 250,000 275,000 300,000 325,000

8% 66 78 89 101 113 124 136 148

9% 58 69 79 89 100 110 120 131

Cost 10% 52 62 71 80 89 99 108 117

of 11% 47 56 64 73 81 89 98 106

Funds 12% 43 51 58 66 74 82 89 97

13% 39 46 54 61 68 75 82 89

14% 36 43 50 56 63 69 76 83


17/24

Page17/24

LiquidationAnalysis:

Anynotionofliquidationisalongwayoff.Besides,wethinkthecompanywillcontinuetoserviceits

debtthroughmaturity.Refinancingistheissue.Still,wedontthinkthatconstructingaFY12ebalance

sheetisastretchgivenwhatweconsidertobethefixednatureofthecompanysbalancesheet:

Source:CompanydisclosureandSourceCapitalGroupestimatesIfthecompanyrestructures,itllbetheFY14orevenFY15balancesheetwellbeconcernedabout.

Notwithstanding,theexercisedemonstratesthatthereisplentyofassetvalueinthenotes.

Assets

Cash 470,661 0% - (assume exhausted)

AR 750,488 70% 525,342

Inventories 18,390 50% 9,195

Prepaid 26,829 20% 5,366

VAT AR 182,440 80% 145,952

Other CA 45,655 0% -

Total CA 1,494,463 685,854

- -

Investments 92,633 0% -

Deferred Tax Asset - -

- - -

Gross PP&E 9,709,207 -

Accum Dep (5,909,416) -

Net PP&E 3,799,791 50% 1,899,895

Intangibles 164,803 0% -

Frequency Rights 42,420 0% -

Other 2 9,771 0% -

Total LTA 4,109,418 1,899,895

Less Liabilities:

Claims Senior to Notes (assumes pensions, taxes, vendor financing and AP are treated preferentially)

STD (& Accrued FY11e Coupons) 18,861 100% 18,861

AP 321,673 100% 321,673

Accrued 108,387 100% 108,387

Other CL 1,910 100% 1,910

Other Debt 5,656 100% 5,656

LT AP 41,831 100% 41,831

Def'd tax liabs - 100% -

Pensions 35,076 100% 35,076

Notes 2,743,125 100% 2,743,125 98% 2,014,390 73

Other LTL 51,699 100% 51,699 2% 37,965 73

100% 2,052,355 73


18/24

Page18/24

Consensualrestructuring,e.g.anexchangeoffer:30%

Maxcomhasdoneitbefore.InOctober,2001,MaxcomhiredCreditSuissetorestructureitsUSD250m

ofdebtthatwas,atthetime,tradingatabout20.PleaseseeourMarchreportforadditional

information.

Estimatingthepriceatwhichanexchangecouldgetdoneismoreartthanscience.Itwouldbeaprice

belowthemaximumyieldatwhichthebondscouldberefinanced,andyetabovewhatbondholderscouldobtainbyotherwisefightingfortheassets.Wevealreadypositedthattheformerpriceas95.5

andthelatterasanywherefrom73towelloverpar.Weposit85,representingayieldof16.5%,asthe

priceintheeventofabondexchange.

Conclusion

Weightingourscenariosandpricesasdescribed,thebondswouldbeunderpriced:

Source:CompanydisclosureandSourceCapitalGroupestimatesLimiteddownside.Thebreakevenpriceonthenotesinayearis51(thecurrentpriceof62lessthe11%

coupon).The

breakeven

price

in

two

years

is

40.

Atcurrentindicativepricesinthe60s,atyieldsofupwardsof30%,wefindthatthebondshave

compellingupsideandlimiteddownside.

Muddle through: 25% 96 24

Acquisition 20% 101 20

Default and Restructuring:

Market multiples 96

Sustainable debt 81

Liquidation 73

MINIMUM 25% 73 18

Consensual restructuring 30% 85 26


19/24

Page19/24

RelativeValue

Spreadtocomparablebondissuesoverdone.MaxcomsbondsarecomparativelyratedtoDigicel,and

theircreditsupportisnotsignificantlyweakerthanAxtels.However,theytrade24,000and21,000

widerthaneach,respectively.Wefindthisoverdone.

Source:CompanydisclosureandSourceCapitalGroupestimates

Source:CompanydisclosureandSourceCapitalGroupestimatesOnarelativevaluebasis,Maxcomsbondsarewellwideofwhatwedeemtobesimilarissues,thus

offeringcompellingvalueatcurrentprices.

YTM

Modified Duration

Maxtel112014

Axtel7.6252017 Axtel92019

Tza7.52018Nihd8.8752019Nihd102016

Alestr11.752014Dlltd122014

Dlltd8.8752015

5.0

10.0

15.0

20.0

25.0

30.0

35.0

1.0 2.0 3.0 4.0 5.0 6.0

Maxtel 11 2014 62.2 2.1 33.3 199.5 Caa1 / CCC+ 2.5x 2.9x 33

Axtel 7.625 2017 84.5 4.0 11.7 275.0 B3 / B+ 3.7x 2.3x 208

Axtel 9 2019 86.0 5.2 11.8 490.0 B3 / B+ 3.7x 2.3x 208

Tza 7.5 2018 100.6 4.3 7.4 300.0 WR / NR 5.3x 0.5x 1,060

Nihd 8.875 2019 106.6 4.5 7.8 500.0 B2 / 5.8x 0.7x (1,761)

Nihd 10 2016 113.0 1.6 6.7 800.0 B2 / 5.8x 0.7x (1,761)

Alestr 11.75 2014 111.3 2.3 7.1 194.4 B1 / B+ 4.7x 1.4x NA

Dlltd 12 2014 111.1 2.0 6.8 585.0 B1 / NA NA NA

Dlltd 8.875 2015 99.5 2.6 9.0 1,000.0 Caa1 / NA NA NA

Dlltd 9.125 2015 101.5 1.0 8.6 415.1 Caa1 / NA NA NA

Dlltd 8.25 2017 101.5 3.1 7.9 800.0 B1 / NA NA NA


20/24

Source: ompanydisclos reandSourceC pitalGroupesti ates


21/24



22/24



23/24



24/24

ResearchDisclosure

Theanalysttheauthorofthisreportdidnotreceivecompensationfromthecompaniesmentioned

hereinforhisorherwork.

Theopinionsandrecommendationsexpressedwithinthisreportarethoseoftheanalyst.

Theanalystdoesnothaveapositioninthesecurityonwhichthisreportprovidesarecommendation.

SourceCapitalGrouphasnotperformedpaidinvestmentbankingservicesforthesecuritysissuer.

Informationinthispublicationhasbeenobtainedfromsourcesbelievedtobeaccurateandreliable;

however,wedonotguaranteetheaccuracy,adequacyorcompletenessofanyinformationandarenot

responsibleforanyerrorsoromissionsorfortheresultsobtainedfromtheuseofsuchinformation.

Redistributionorreproductionofthisreportisprohibitedwithoutwrittenpermission.

Documents

Maxcom, Source Capital, November 2011