Zegona Communications : 2023 Annual Report

Zegona Communications plc

Annual Report

For the Year Ended 31 December 2023

ZEGONA COMMUNICATIONS PLC

CONTENTS

STRATEGIC REPORT |	Page
Chairman's Statement	1
Strategy and Business Model	3
Business and Financial Review	5
Risks	6
Viability Statement	8
DIRECTORS' REPORT |
Corporate Responsibility	9
Other Matters	12
Directors' Responsibility Statements	15
GOVERNANCE |
Profiles of the Directors	17
Corporate Governance Statement	19
Audit and Risk Committee Report	23
Nomination and Remuneration Committee Report	27
Directors' Remuneration Report	30
Independent Auditor's Report to the members of Zegona Communications plc	37
FINANCIAL STATEMENTS |
Consolidated Statement of Comprehensive Income	44
Consolidated Statement of Financial Position	45
Company Statement of Financial Position	46
Consolidated Statement of Changes in Equity	47
Company Statement of Changes in Equity	49
Consolidated Statement of Cash Flows	51
Company Statement of Cash Flows	52
Notes to the Financial Statements	53

ZEGONA COMMUNICATIONS PLC

STRATEGIC REPORT | CHAIRMAN'S STATEMENT

I am pleased to present Zegona's annual report for 2023.

Agreement to purchase Vodafone Spain

In the past year we continued to focus on finding the right opportunity within the European telecommunications market where we can again successfully apply our proven strategy and capabilities to generate attractive returns for our shareholders. On 31 October 2023 we announced the proposed acquisition of Vodafone Spain from Vodafone Europe B.V. ("Vodafone Europe"). The acquisition is due to complete in the first half of 2024.

The headline purchase price payable by the Company is €5 billion which is subject to certain adjustments as set out in the acquisition agreement. The purchase price is based on an enterprise value of €5 billion which represents a multiple of 3.9x FY23 Business EBITDAaL1 of approximately €1.3 billion. This valuation benchmarks attractively to precedent European telecommunications transaction multiples such as the sale of Euskaltel to MásMóvil Ibercom, S.A.U. in 2021, which valued Euskaltel at a multiple of 10.1x 2020 EBITDA, and the Orange/MásMóvil merger announced on 23 July 2022. That announcement disclosed a valuation for Orange of 7.2x Orange's 2022E EBITDAaL and a valuation for MásMóvil of 8.7x MásMóvil's 2022E EBITDAaL.

We are financing the acquisition of Vodafone Spain through a mixture of equity and debt. We have issued shares and entered into an underwritten financing package, as follows:

• €300 million (£262 million) in gross proceeds through the Placing of 174,413,535 shares at a price per share of 150 pence;
• €900 million (£785 million) in gross proceeds through the conditional subscription for 523,240,603 shares at 150 pence per share by EJLSHM Funding Limited;
• committed debt financing of €3,900 million which consists of a term loan of €500 million and a corporate bridge facility of €3,400 million;
• €0.5 million (£0.5 million) through a separate offering of shares at 150 pence per share; and
• €500 million Revolving Credit Facility entered into on 31 October 2023 which is not expected to be drawn upon at the closing of the proposed acquisition.

The Directors believe the financing package provides Zegona with an attractive cost of capital, in line with the approach taken to Zegona's prior investments in Telecable and Euskaltel. Zegona intend to refinance the corporate bridge facility in the debt capital markets.

Macroeconomic / market update

The past year has been marked by continuing geo-political and macro-economic developments that have impacted European economies. In particular, the ongoing war in Ukraine and events in the Middle East have created uncertainty and have led to increased commodity prices, inflation and interest rates. More recently, there are positive macroeconomic indications, with inflation rates starting to fall and bond interest rates reducing on the market expectation of governments/the European Bank cutting interest rates during 2024. These developments have created a more positive environment for raising finance and are expected to lead to lower finance costs going forwards.

1 "Business EBITDAaL" is defined as Vodafone Group Spain segment's reported Adjusted EBITDAaL adjusted in line with Zegona's accounting policy relating to subscriber acquisition costs. "Adjusted EBITDA" is defined as operating profit excluding net interest, depreciation, amortisation (including amortisation of customer-related intangible assets), and gains/losses on disposal of owned and leased assets, impairment losses, restructuring costs arising from discrete restructuring plans, other income and expense and significant items that are not considered by Vodafone Spain's Management to be reflective of the underlying performance of Vodafone Spain.

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ZEGONA COMMUNICATIONS PLC

STRATEGIC REPORT | CHAIRMAN'S STATEMENT

The telecommunications sector has continued to face challenges during 2023 as it has not been immune to the broader economic and political trends. In particular, the market for mergers and acquisitions in European TMT assets has continued to be affected. Overall, the level of European TMT mergers and acquisitions in 2023 has remained below the historic average, with a tendency for the major international players to focus on their core operations and more difficult financing conditions impacting the ability of financial investors to acquire assets. There have also been a number of in-market consolidations as operators have sought synergies and increased scale, such as the announced $19 billion merger of Vodafone's and Hutchison's UK businesses and the €18.6 billion MásMovíl and Orange Spain combination.

We believe Zegona's proposed acquisition of Vodafone Spain is well positioned to benefit from these developments. We are seeing improved financial market conditions leading to the potential to finance the business at lower cost. Vodafone Spain has market-leading infrastructure with a high quality national mobile network and gigabit capable fixed network. These assets create strong foundations for the business and its future development. Vodafone Spain has already entered into value-creating relationships of this kind, in particular with its joint roll-out with Orange of mobile coverage into less urban areas.

Eamonn O'Hare

Chairman and Chief Executive Officer

29 April 2024

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ZEGONA COMMUNICATIONS PLC

STRATEGIC REPORT | STRATEGY AND BUSINESS MODEL

Vision

• Execute our strategy in the European TMT sector

• Focus on businesses that require active change and fundamental improvement to realise their full value

• Target significant long-term growth in shareholder value

Opportunity

Changing market dynamics in the TMT industry create multiple investment opportunities:

• Demand for data and speed: Data consumption is growing strongly with customers willing to pay for speed and reliability. Gigabit broadband is now a customer requirement in many markets but network rollouts and upgrades need to be efficient.
• Digital convergence: The fixed/mobile divide is increasingly disappearing for users, meaning significant growth in more valuable triple and quad play2 customers who are combining mobile and fixed services. This has driven improvements in economics for converged players since mobile data delivery is heavily dependent on high-capacity fixed networks and customers taking multiple products tend to be more loyal.
• Industry consolidation: The sector has seen M&A activity focussed on improving fundamental economics through bringing businesses together and to realise the delivery of next generation networks. Industry players are increasingly focusing on their core regions, delivering cost reductions and price repair to rebuild margins. Consolidation has also created opportunity as businesses are spun out by the major industry players to meet regulatory requirements and strategic objectives, creating opportunity for Zegona.
• Broad range of attractive assets: Our flexibility in terms of size, geography and category opens a broad universe of attractive target assets across the TMT market. We have identified many businesses of an appropriate scale, including operators which are active in one or more of the mobile, mid-sized cable, fixed fibre network, B2B3, and network infrastructure sectors. The proposed acquisition of Vodafone Spain reflects this openness to identifying opportunities, with a detailed plan already in place to substantially improve the operations, customer service and financial returns from the business.

Advantage

A number of factors make Zegona well positioned to access attractive deals and deliver value:

• Strong, aligned management team: Our management team has a proven track record of delivering strong business performance and investor returns. During 2017, it successfully sold Telecable and was then instrumental in returning Euskaltel to growth. This enabled us to initiate consolidation discussions with MásMovíl that lead to it acquiring Euskaltel in July 2021. In 2023 we were able to gain the trust and support necessary from Vodafone and the financial markets to negotiate and arrange funding for the acquisition of Vodafone Spain. The team has extensive real-world experience in senior operational roles in large public telecommunications companies and its interests are also strongly aligned with shareholders through a long-term incentive scheme that links remuneration directly to growth in shareholder value.
• Entrepreneurial focus: We have considerable freedom in the projects we pursue and the ways we create value. Zegona has a long-term perspective and as a public company, its shareholders can readily realise value at any stage through the improvement and transformation journey of the businesses we own. This makes Zegona fundamentally different from private equity businesses, most of whom work within a short to medium term timeframe. This also permits a focus on fundamental business improvements that are value accretive rather than relying on high leverage and valuation multiple expansion. We are also able to act quickly on acquisition opportunities while maintaining financial discipline. This is especially attractive to potential sellers and a key differentiator.

1. Quad play: customers with four services (pay TV, fixed voice, broadband and mobile).
2. Business to Business.

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ZEGONA COMMUNICATIONS PLC

STRATEGIC REPORT | STRATEGY AND BUSINESS MODEL

• Major global investors: Zegona benefits from having a number of global public equity asset managers with a long-term outlook as shareholders. The strong support which we have from such shareholders was illustrated by our successful placement of over €1.2 billion in 2023. We have an effective investor relations programme which maintains regular contact with our major current and potential shareholders.

Strategy

We seek to provide shareholders with an attractive total return, primarily through appreciation in the value of Zegona's assets. Our strategy focuses on making investments in strategically sound businesses within the European TMT sector that require active change to realise their full value, thereby creating significant long-term returns through fundamental business improvements. The main elements of Zegona's strategy, for the proposed acquisition of Vodafone Spain, are set out below.

Zegona has significant relevant experience in the Spanish telecommunications market. When Zegona entered the Spanish telecommunications market through its purchase of Telecable in August 2015, it identified an opportunity for substantial value creation under new ownership. Zegona took this further through the sale of Telecable to Euskaltel and the delivery of Zegona's transformation programme at Euskaltel to create shareholder value.

Vodafone Spain is one of the leading telecoms networks in Spain with a high quality mobile network and a gigabit capable fixed network covering over 10 million households. The business also has access to the majority of the remaining homes in Spain through partnerships and wholesale arrangements. However, business performance has been disappointing in a changing market and the business now requires change. Zegona believes the future of the business lies in right-sizing its cost base, operating the assets more efficiently and driving value for money service propositions. At the same time, the business needs to focus its investments on next generation technologies that customers will value and be willing to pay for. This is a strategy which the Directors believe Zegona is well placed to execute, having made similar changes at Euskaltel resulting in an 87% return on Zegona's Net Invested Capital.

Zegona has identified key areas where specific cost saving actions can be taken to bring Vodafone Spain's cost base and Business Cash Flow Margin more in line with relevant peers. These actions include targeted cost reductions in areas such as subscriber acquisition costs (driving distribution towards more efficient digital channels), bad debt levels, TV content costs, IT capital expenditure, fixed wholesale access costs and other operational expenditures. Zegona's investment plan for Vodafone Spain rests on five key pillars which the Directors believe will enable the business to continue to compete effectively, deliver its strategic objectives and drive shareholder value:

1. An increasingly attractive, highly developed Spanish telecommunications market, underpinned by strong fundamentals and supported by convergence and consolidation tailwinds;
2. Leading integrated operator with strong market positions in consumer and B2B markets, a diversified product offering and highly converged customer base across the value spectrum;
3. High quality next generation mobile and fixed-line networks supported by strong spectrum positioning, attractive active network sharing arrangements to drive efficiency and extensive nationwide reach through wholesale agreements;
4. Resilient cash flow, with significant upside driven by underlying market growth and bottom-up revenue, cost and capex optimisation opportunities driving strong margin expansion; and
5. Potential for Vodafone Spain to benefit from Zegona's extensive experience driving growth and cost optimisation in the Spanish market.

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ZEGONA COMMUNICATIONS PLC

STRATEGIC REPORT | BUSINESS AND FINANCIAL REVIEW

Review of Zegona's continuing corporate and other activities

Loss for the period from continuing operations

Zegona's corporate and other activities resulted in a net loss for the period of €15.6 million (2022: €3.3 million net loss) which principally comprised:

Operating loss

Operating loss totalled €13.4 million (2022: €3.3 million) and included:

• €8.5 million (2022: €26 thousand) for significant project costs, principally professional fees paid in relation to the proposed acquisition of Vodafone Spain;
• €4.7 million (2022: €3.3 million) for Zegona's ongoing corporate operations. These costs included strengthening the team in order to pursue the acquisition of Vodafone Spain.

Net finance income

Net finance income totalled €5.7 million (2022: €21 thousand of costs) and comprises interest earned on cash deposits recognised within Finance Income net of bank charges, overdraft interest recognised within Finance Costs, and imputed interest income on the €900 million promissory note from EJLSHM Funding Limited which will be satisfied upon the completion of the proposed acquisition of Vodafone Spain.

Exchange differences

Exchange differences totalled a loss of €7.8 million (2022: loss of €3 thousand) reflecting translation of euro- based transactions during the year into the functional currency of Sterling.

Other Comprehensive Income

Exchange differences on translation resulted in a gain of €8.1 million (2022: loss of €0.6 million). The variance

year on year arises as a result of movements in the closing €:£ exchange rates as the functional currency of Sterling ("£") is translated into the presentational currency of euro ("€").

Financial Position

Zegona's Net Assets as at 31 December 2023 were €1,181.7 million (2022: €10.5 million) which substantially comprised the Other Receivables of €1,187.4 million and Income Tax Receivable of €5.1 million. The increase in the period is due to receipt of funds and the receivable recognised from the issue of shares to fund the proposed acquisition of Vodafone Spain.

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ZEGONA COMMUNICATIONS PLC

STRATEGIC REPORT | RISKS

Principal and emerging risks

We have carried out robust assessments of the principal and emerging risks facing Zegona including those that would threaten our business model, future performance, solvency or liquidity. Detailed consideration is given to all of these risk factors by the Audit and Risk Committee and the board of Directors (the "Board").

Principal and emerging risks
		Change in risk assessment
Risk title	Risk rating	since the last Annual Report
Ability to create value in acquired businesses	Moderate	↔ No change
Loss of key management	Low	↔ No change
Foreign exchange	Moderate	↔ No change

The description, impact and mitigation of these risks are set out below:

Ability to create value in acquired businesses

Zegona's proposed acquisition of Vodafone Spain is based on a detailed assessment of the Vodafone Spain's business and where Zegona can create considerable value through its proven long term improvement strategy.

We have a disciplined approach to valuation and, ultimately, we are only prepared to make investments at the right price and after undertaking a thorough due diligence process. When evaluating potential investments, we focus on targets that have strong fundamentals, high-quality customer offerings and strong market positions but which are underperforming their potential and have scope to generate long term sustainable performance and cash flow improvements.

In addition, the success of Zegona's acquisitions depends on our ability to implement the necessary strategic, operational and financial change programmes in order to refocus the acquired business and improve its performance. Implementing these change programmes may require modifications, including changes to business assets, operating and financial processes, business systems, management techniques and personnel, including senior management. There is a risk that we will not be able successfully to implement such change programmes within a reasonable timescale and cost.

We have operated in the Spanish telecommunications market since 2015 and have a good understanding of the market and its key drivers. We are familiar with all the main operators, including Vodafone Spain, and have analysed their market positions, strategies and operational performance over an extended time period. We have been evaluating Vodafone Spain and its operations since 2022, identifying opportunities to improve the business performance. We have developed a detailed improvement plan for the business which sets out specific actions to be taken within each business area and the expected improvements to be delivered from each. We have also evaluated the restructuring investment that is expected to be required and these costs are included in all our financial projections for the business. As a result, we are confident we can materially improve the performance and financial returns from the business over the business plan period.

Loss of key management

Zegona's operations are currently managed by the Chief Executive Officer, supported by the Chief Operating Officer, the Investment Director and the Chief Financial Officer. The absence or loss of key management could significantly impede our financial plans.

We aim to retain our key staff by offering remuneration packages at market rates, as well as long term incentives through the issue of Management Shares and other management incentive plans. In line with the pending completion of the Acquisition, Zegona will strengthen its team through the selective hiring of a small number of highly qualified personnel to support Zegona in implementing its plans for Vodafone Spain.

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ZEGONA COMMUNICATIONS PLC

STRATEGIC REPORT | RISKS

Foreign exchange

Foreign currency translation risk exists due to the Company operating, and having equity denominated in a different functional currency (GBP) to that of many of its likely acquisition targets. The Company raised equity in GBP which was converted into Euros to manage the exposure to currency risk arising in relation to the proposed use of these funds as part settlement of the proposed acquisition price. This means there is currently minimal risk to Zegona's results of operations, however fluctuations in the exchange rate between Sterling and other European currencies could cause potential future acquisitions to become more expensive in Sterling, and therefore potentially less desirable.

The Board and the Chief Financial Officer control and monitor financial risk management, including foreign currency risk, in accordance with the internal policy and the strategic plan defined by the Board.

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ZEGONA COMMUNICATIONS PLC

STRATEGIC REPORT | VIABILITY STATEMENT

Longer term viability statement

In accordance with provision 31 of the 2018 UK Corporate Governance Code, we have assessed Zegona's prospects over a longer period than the twelve months required by the "going concern" provision. This assessment has taken into account Zegona's current position, its strategy, the risk appetite of the Board and the principal risks and uncertainties which are described in detail in this Strategic Report.

The assessment period

We continue to believe that three years - in this case the three years to December 2026 - is the appropriate period as it is the period focused on by the Board during its strategic planning process including an assessment of its principal risks.

The assessment process and key assumptions

In making this assessment the Board undertook a comprehensive and robust analysis of the key risks to Zegona including those resulting from the proposed acquisition of Vodafone Spain including those considered to threaten its business model, performance, solvency and liquidity.

Zegona's position changed fundamentally on 31 October 2023 with the proposed acquisition of Vodafone Spain. The proposed acquisition will be part funded by an underwritten financing package of €3.9 billion, which comprises a term loan facility of €0.5 billion (Term Loan A) and a corporate bridge facility of €3.4 billion (see note 15). The bridge loan is for a term of 12 months, with two 6-month extension options being available at the discretion of the Zegona Directors (Zegona intends to refinance the corporate bridge facility in the debt capital markets). The equity funding and debt financing has been considered for the purposes of this viability assessment. The Directors also considered covenants that upon the completion of the proposed Acquisition, will be attached to the underwritten financing package and will be first measured in March 2025.

In assessing whether the viability assumptions are appropriate, the Zegona Board considered both Zegona's and the combined Zegona and Vodafone Spain Group's (assuming completion of the acquisition) operations, strategy, customer numbers and revenues, direct costs, acquisition and retention costs per customer and customer churn rates together with operating and capital expenditure and Business EBITDaaL4 measures and net debt assumptions.

This assessment also included detailed considerations of current and proposed strategic and business plans, working capital requirements, operating and capital investment plans, debt and funding, available headroom and covenant reporting.

This assessment was conducted considering both a base case and a 'stressed' reasonable worse case scenario, identifying risks and mitigating factors and ensuring both Zegona and the Combined Group has sufficient funding to meet its current, planned and contracted commitments as and when they fall due during the viability assessment period.

Results of the going concern assessment

The assessment showed that, Zegona would have sufficient cash to continue in operation for at least 12 months from the date of issuance of this report throughout the assessment period without taking any mitigating actions available to it.

Statement of viability

Taking into account Zegona's current position and its principal and emerging risks and uncertainties, the Directors confirm that we expect Zegona will be able to continue in operation and meet its liabilities as they fall due over the three years to 31 December 2026.

The Strategic Report was approved by the Board on 29 April 2024 and is signed on its behalf by:

Eamonn O'Hare

Chairman and Chief Executive Officer

4 As defined on page 1.

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