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The following segment was excerpted from this fund letter.
Cellnex Hears Shareholder Voices on Capital Allocation
Engaging a company on strategy can sometimes lead to concrete changes. Capital allocation, for example, is a fundamental corporate governance consideration. It is directly relevant to the interests of shareholders, stakeholders and a company’s long-term success. Capital allocation is closely connected to questions of company purpose, strategy, business model, risk appetite and public disclosures – and, ultimately, to a company’s ability to generate sustainable returns. Key capital allocation themes could include the use of debt leverage, the appropriateness of dividend policy and share buybacks, the level of capital spending and executive pay structures — all areas that can involve difficult tradeoffs that balance the interests of shareholders and other company stakeholders, such as employees and customers.
In an October 2022 engagement with Spanish wireless telecom company and ClearBridge portfolio holding Cellnex (OTCPK:CLNXF), we encouraged the company to embrace a fiscally responsible strategy in order to protect the business in a high interest rate environment. In a proactive dialogue with Cellnex management on governance and shareholder feedback, we conveyed our recommendations for a necessary shift in capital allocation and strategic priorities. We insisted that:
- shareholders and bondholders are unwilling to provide capital for large acquisitions, which increase leverage and uncertainty;
- Cellnex should commit to obtain an investment grade credit rating, which will limit cost of capital increases;
- management should focus on refinancing debt maturities immediately to avoid liquidity drying up next year;
- focus on the balance sheet debt leverage should take priority over dividends and share buybacks.
Cellnex’s response during the meeting was thoughtful and receptive. The CFO expressed the company’s fiduciary responsibility to allocate capital only in a way that enhances shareholder value and stressed the importance of growing alongside its telecom customers, building its networks and investing in projects that save customers money and provide good returns for Cellnex at the same time. He provided updates about financial and refinancing risk management, including:
- inflation indexation of lease contracts that accelerates earnings in an inflationary environment;
- $3 billion of available undrawn credit lines that are enough to refinance debt maturities in 2023 and 2024, before free cash flow turns positive from 2025 onward, supporting the refinancing of large maturities in 2026;
- options to sell assets as a measure of last resort.
In a follow-up call in November, Cellnex announced it would make all the strategic changes we asked it to consider. The CFO acknowledged the current environment provides new factors to take into consideration in Cellnex’s decision process, and said the company is listening to the market. He shared Cellnex’s new unconditional commitment to an investment grade rating. This would include a commitment to 2025 financial guidance, a clear capital allocation framework with conservative assumptions, a focus on organic growth with limited capex and high-return projects, limited M&A activity, and a focus on free cash flow, with excess cash deployed in the best interest of maximum long-term shareholder value. The company now expects free cash flow will exceed debt maturities after 2024.
This ESG engagement was a successful example of an impactful dialogue with management, where concrete results were achieved and real shareholder value was created. ClearBridge was just one voice contributing to the realignment of the company’s strategy, but it was encouraging to witness an overhaul of management priorities that fully matched our clearly communicated recommendations.
Cellnex’s ability and willingness to adapt reduced business and financial risk and significantly lowered the likelihood of a large downside to the share price. This brought a significant positive change in our investment thesis, as we were able to incorporate a lower risk outlook for the company and lift our price target. For example, as a result of the changes, Cellnex bond spreads improved by 180 basis points to 280 basis points, while its 10-year bond yield declined from 6.6% to 5.1% within a span of roughly three weeks, lowering Cellnex’s cost of capital.
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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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