NTL must work to please ITV investors

Laden with debt, NTL is going to have to strain every sinew to make a takeover offer for ITV that is tempting even to the long-suffering shareholders of the broadcaster.

At first glance, a combination of the struggling cable and terrestrial broadcasters looks like a candidate for an all-share deal, since their market capitalisations are not too far apart. The snag is that ITV shareholders could be reluctant to accept NTL’s US-listed, dollar-denominated shares as payment.

This may even apply to ITV investors that already hold NTL stock, since the two shares are typically owned by discrete regional funds. “We would have the same issues with taking US paper as any other ITV investor,” says one shareholder in both companies who asked not to be named.

NTL could conceivably structure a deal to retain a London listing for the merged group. This would allow it to provide a mix-and-match option, where ITV shareholders elected to take cash or shares depending on each other’s preferences.

But given NTL has only just paid its first cash dividend in its troubled 13-year history, ITV shareholders are likely to prefer a cash exit to shares in the merged group.

If an offer is made at a slight premium to ITV’s last closing price of 111p – say, 120p a share – this would mean NTL having to find almost £4.7bn of cash.

It would be a struggle to raise this in debt. Bond covenants restrict NTL’s gross debt to a multiple of 5.5 times earnings before interest, tax, depreciation and amortisation (ebitda).

For the combined group, ebitda is forecast at £1.7bn in 2007, according to a Merrill Lynch research note, implying debt capacity of £9.5bn.

Merrill forecasts that ITV’s and NTL’s combined gross debt will be £7.3bn at the end of this year.

On this basis, NTL could raise an additional £2.2bn of debt through combining with ITV that could then be paid to ITV shareholders.

Adjusting for year-end cash balances – estimated at £387m – this leaves a shortfall of £2.1bn on the hypothetical £4.7bn offer price.

To close the gap, one option would be for NTL to renegotiate the gross debt to ebitda covenant. Bond investors say this could prove tricky.

“It is very unusual to ask existing bondholders to renegotiate a covenant as fundamental as gross leverage,” says Martin Hornbuckle, partner at Picus Capital a London-based credit fund. “Bondholders would expect to be repaid.”

NTL’s second option would be a full-blown refinancing, buying out debtholders while issuing new bonds and obtaining fresh bank borrowings.

Fitch, the rating agency, has indicated that a merged NTL-ITV might help the company’s credit rating. However, redeeming existing debt early would incur penalties. For example, Picus estimates that NTL would have to pay a 14 per cent premium to buy out its £375m of 10-year bonds issued in 2004.

”Assuming that a combined NTL-ITV is a better credit than a standalone NTL, the new debt may be sufficiently cheaper to make this worth doing,” says Mr Hornbuckle. “This deal is financeable in the debt markets. The high-yield bond and leverage loan markets are extremely strong.”

Neatly, NTL would not have to buy out ITV’s low-cost investment grade debt were the transaction structured as a takeover of NTL by ITV.

NTL could always raise cash through a share issue. And under the terms of its bonds, this would have the additional benefit of reducing the premium NTL would have to pay to buy out some of its bonds.

Possibly in combination, these measures might enable NTL to offer ITV shareholders a clean cash exit.