freenet AG reconfirms its decision to vote against the proposed capital increase of Sunrise in relation to its envisaged acquisition of UPC Switzerland
 

Büdelsdorf, 30 September 2019 - freenet AG ("freenet") [ISIN DE000A0Z2ZZ5] reconfirms its decision to vote against the proposed capital increase of Sunrise Communications Group AG ("Sunrise") in relation to its envisaged acquisition of UPC Switzerland (the "Transaction").
 

The adjustment to the target capital structure scratches only at the surface of the package of highly unfavourable deal terms and the fundamental strategic challenges of the transaction - in its entirety still leading to value destruction for all existing Sunrise shareholders. freenet regards the strategic rationale of the Transaction as fundamentally flawed.
 

freenet is highly convinced that Sunrise is excellently positioned on a standalone basis, with massive share price upside on the back of its impeccable strategic positioning in one of the most attractive telecom markets - with all of these upsides being achievable without the discount of meaningful integration risks attached to the Transaction.
 

The change in the target capital structure is only a scratch on the surface of the package of highly unfavourable transaction terms, such as the inflated acquisition price for an inferior technology and the inadequate risk and value distribution between Sunrise, Liberty Global and UPC bondholders:

freenet welcomes that Sunrise reviewed the target capital structure and considers a higher leverage. Sunrise management, despite their initial resistance, have recognised that our concerns around the initial target capital structure were justified and in the best interest of all Sunrise shareholders. However, the increase in leverage doesn't go far enough to address the overall package of highly unfavourable deal terms, nor does it improve the strategic rationale of the transaction - it only reduces dilution.

In particular, freenet reiterates its deep concern that the terms of the Transaction are highly unbalanced and unfavourable for all existing Sunrise shareholders, not taking into account the operating and economic reality of UPC Switzerland and Cable in general (for more details see additional information as set out in Annex 1):

- Strategic rationale: The strategic rationale of the Transaction is fundamentally flawed, given the inferiority of Cable vis-à-vis 5G and fibre becoming even more visible based on accelerated technological progress, and as evidenced in many other telecom markets already.
 

- Purchase price: The purchase price and implied valuation for UPC Switzerland is too high.
 

- Synergy allocation: A significant portion of the potential hypothetical synergies are being paid away to Liberty Global in advance and shall be funded by existing Sunrise shareholders only. freenet acknowledges the announcement of higher expected synergies but remains highly sceptical as dissynergies are being expected.
 

- Transaction structure: Structuring the acquisition as an all-cash Transaction leaves still all execution risks with existing Sunrise shareholders.
 

- Debt structure: The takeover of the UPC bonds may lead to significant risks to the detriment of Sunrise and its shareholders. There is a significant value transfer from Sunrise shareholders to UPC bondholders in excess of EUR300mn as a result of the latter's free upgrade to an investment grade structure.

 

freenet's representatives remain disappointed to be excluded from ongoing discussions on the Transaction on the Sunrise Board of Directors, as this is not an adequate way to handle constructive shareholders with an opposing opinion. This practice has taken away the opportunity to jointly evaluate a solution in the best interest of Sunrise as well as for all of its stakeholders.

freenet management has consistently communicated its concerns around the Transaction and its terms. The sudden change of the suggested transaction financing after denial of this possibility for seven months raises the question whether Sunrise management is still convinced about the Transaction and its parameters overall.

Taking the above concerns on transaction terms and strategic rationale into consideration, it is in the best interest of Sunrise and all of its shareholders to oppose the deal, as the strategic logic and transaction terms are not acceptable and value destructive - especially as freenet believes in the strong prospects and value creation potential of Sunrise standalone.

Sunrise has a bright future standalone with massive value upside - especially if not deploying its capital and management attention to an overpaid asset with an inferior technology.

Consequently, freenet reconfirms to vote against the rights issue at the Extraordinary General Meeting.

Annex 1 - additional information

The strategic rationale of the Transaction is fundamentally flawed in light of fast technological progress, leaving Cable behind as inferior technological solution:

Besides Sunrise's excellent positioning standalone, there is limited strategic rationale for Sunrise to acquire a Cable asset given the increasing advancements of Fibre and 5G technologies.

5G is the new normal, and Sunrise's 5G strategy is in full motion: 5G will redefine the relative positioning of fixed vs mobile, with 5G becoming a competitive alternative to fixed infrastructure. Sunrise already provides >150 cities and villages with 5G, and promotes 5G as fibre substitute since 2019. Further, even the Swiss Competition Commission (WEKO) has built its decision to approve the Transaction without remedies on the argument that mobile technologies can increasingly be used as a cost-effective replacement for fixed line broadband internet. The massive investment into UPC Switzerland and related capex will lead to unfavourable internal asset allocation between cable and 5G at Sunrise, and will hinder Sunrise's ability to further pursue its own 5G strategy at appropriate pace in the future in order to fully participate in the upside inherent in this technology - eventually creating significant dissynergies.

The Next Generation fixed network infrastructure is Fibre (FTTH), not Cable: Leading industry experts support freenet's view that Cable is inferior to Fibre, being already considered a technology of the past for many markets and operators given its inherent speed and capacity constraints, as well as future substantial capex requirements. These drawbacks don't only significantly shorten the lifetime of UPC's cable network, but also reduce the payback time to create value for all Sunrise shareholders. A Cable strategy can work temporarily in markets with low fibre penetration such as Germany, but is challenged in markets like Switzerland with significant existing fibre deployment. The competitive pressure from FTTH is further enhanced by Swisscom and Salt who push for the superior Fibre technology.

Evidence of Cable already being a technology of the past in many markets globally: The above challenges of Cable have been prominently observed in various markets already. There is significant evidence that Cable has materially underperformed and is falling behind as a result of 5G and Fibre competition - with material downside after reaching a tipping point off its peak. Meaningful examples include the following countries, where Cable has significantly deteriorated after passing its peak (% implying decline vs L5Y Peak Cable Subs): Sweden (5%), South Korea (20%), Spain (25%), and Singapore (67%). For that reason, peers have consistently chosen Fibre over Cable, such as Liberty Global and Sky co-investing in UK Fibre, or Salt partnering with Swiss Fibre Net (SFN).

UPC Switzerland already showing clear signs of Cable challenges: Recent negative operational developments at UPC Switzerland confirm freenet's concerns that the company is already in full swing on the downward spiral of Cable. UPC Switzerland is struggling, and has not managed to develop a convincing turnaround strategy. The company's growth has been underwhelming for some time, and a more drastic revenue backdrop as well as faster customer decline could only be avoided by meaningful price discounts (see Chart) - underlining the limited sustainability of the current business model. UPC Switzerland has lost c. 10% of its EBITDA in the year prior to the transaction - the worst performance of the seven targets in transactions referred to in Sunrise's deal announcement presentation. These issues have been even more pronounced on Cash Flow level, and will be further aggravated by drivers around future capex requirements, competitive pressure from FTTH, content price inflation and a hyper-competitive fixed market.

Sunrise already convergent today: On the back of excellent access to convergence via long-term fibre contracts with Swisscom as well as alternative Fibre providers, Sunrise is already excellently positioned for convergent offerings standalone, realizing a converged customer base of 12% already today. Future FMC growth will be enabled by significant investment from alternative Fibre providers.

Sunrise has a bright future standalone with massive value upside - especially if not deploying its capital and management attention to an overpaid asset with an inferior technology:

Sunrise has historically proven its superior momentum standalone, evidenced by gaining c. 6% mobile revenue market share and more than 2% fixed subscriber share since its IPO. Furthermore, Sunrise has recently highlighted its robust economic profile by its strong momentum in service revenue (+3.0% YoY in 1H19) and EBITDA growth (+4.2% YoY in 1H19).

Sunrise is excellently positioned to benefit from the challenges Cable faces down the road. As a recent example, the majority of TV subscribers lost by UPC Switzerland have been won by Sunrise. Aiming the management's focus at a standalone case will foster growth momentum and enhance competitiveness in all business segments. Further, Sunrise can build its future on the fundament of outstanding network quality, offering a global top 3 network (connect.de testing), leadership in Swiss client satisfaction, and an attractive convergent offering based on excellent access to fibre already today. Future FMC growth will be enabled by significant investment from alternative Fibre providers (Swiss Fibre Net expected to reach over 40% HH penetration by 2020).

Lastly, there is no threat from a competing Salt/UPC transaction, with Salt clearly communicating plans for a standalone future, and no financial means for a cash acquisition.

Consequently, freenet is convinced that Sunrise can realize significant growth projections within the next years, growing at a faster pace and more sustainable than a business combination with UPC would offer.

In summary, Sunrise has an excellent positioning and outstanding prospects as a standalone entity and could over proportionally benefit from the downturn in the Cable technology, expecting a re-rating of the Sunrise share price significantly above pre-Transaction levels on a standalone basis.

All of these upsides can be achieved without any integration risks, while any synergies from a combination require significant discount for uncertainty around execution.

The change in the target capital structure is only a scratch on the surface of the package of highly unfavourable transaction terms, such as the inflated acquisition price for an inferior technology and the inadequate risk and value distribution between Sunrise, Liberty Global and UPC bondholders:

freenet reiterates its deep concern that the terms of the Transaction are highly unbalanced and unfavourable for all existing Sunrise shareholders, not taking into account the operating and economic reality of UPC Switzerland and Cable in general:

- Strategic rationale: The strategic rationale of the Transaction is fundamentally flawed, given the inferiority of Cable vis-à-vis 5G and fibre becoming even more visible based on accelerated technological progress, and as evidenced in many other telecom markets already.
 

- Purchase price: The purchase price and implied valuation for UPC Switzerland is too high, in particular in light of the cable industry being under severe pressure and UPC Switzerland's underwhelming operational performance giving testimony that the company is already in full swing on the downward spiral of Cable. freenet provides more considerations on the challenged strategic rationale of the Transaction in light of accelerated technological progress in 5G (which WEKO also quotes as key reason for the Transaction approval without remedies) in this release.
 

- Synergy allocation: The purchase price implies that potential synergies amounting to CHF 1.3bn are being paid away to Liberty Global in advance. Sunrise shareholders are required to underwrite a UPC Switzerland turnaround and related integration risks, while paying away much of the upside. freenet acknowledges the announcement of higher expected synergies, but remains highly sceptical on their achievability overall: besides generally high integration risks, the assumptions are aggressive in light of latest operational and financial developments (such as meaningful price discounts to stop further bleeding of UPC Switzerland's customer base (see Chart)). Further, negative effects resulting from the transaction in UPC Switzerland need to be taken into account, such as future unfavourable internal asset allocation between cable and 5G at Sunrise going forward, ultimately hindering Sunrise's ability to further pursue its own 5G strategy at appropriate pace in the future.
 

- Transaction structure: Structuring the acquisition as an all-cash Transaction leaves all execution risks with Sunrise shareholders. For a fair transaction for all Sunrise shareholders, Liberty Global should have received a stake in the combined entity, creating a more adequate risk and upside sharing set-up.
 

- Debt structure: The takeover of the UPC bonds may lead to significant risks to the detriment of Sunrise and its shareholders. There is a significant value transfer from Sunrise shareholders to UPC bondholders in excess of EUR300mn as a result of the latter's free upgrade to an investment grade structure. For a fair transaction for all Sunrise shareholders, Liberty Global should have retained the UPC bonds after the Transaction.

Chart:
Concerning customer trends despite aggressive promotions and permanent price cuts question the sustainability of the current business model

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Source: Company disclosure and website. (1) 12 months for against increase of monthly fee to CHF99,-. (2) Including installation fee.

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