By Marnix Rasterhoff, Research Analyst at King’s Private Equity Club
Telecommunications (Telecoms) companies revolve around the transmission of data across the world (whether it be in the form of words, voice, audio or video), and create value through infrastructural assets such as towers, fibre networks, and data centres. The largest firms in the sector will typically act as internet service providers, telephone operators, and/or cable companies – simply put, they are the reason we have WiFI and are able to call others on a daily basis. The article aims to elucidate the prominent role of private equity in the telecoms sector and its rationale behind widespread investment in such companies in recent years.
Telecoms have become increasingly popular among private equity investors, with this sector accounting for 35% of the total value of PE infrastructure deals in the United States in 2020, marking a 15% increase from a year earlier. Developments in Europe, in particular, have also been widespread, with notable recent acquisitions being Inmarsat Group Holdings (UK), Masmovil (Spain), T-Mobile (the Netherlands); which have all cost more than $5 billion (S&P GMI, 2020). And it does not look like this trend will stop anytime soon, with KKR’s recent interest including the largest telecom companies in respectively Italy and the Netherlands, i.e. Telecom Italia and Royal KPN NV.
The rationale behind Investment:
On the face of it, the Telecom sector has little short-term appeal to investors: not only is there little potential for organic revenue growth due to the maturity of the telecom markets but a significant amount of financial leverage is also necessitated to set up or replace infrastructure. However, while the massive CAPEX requirements and extensive time horizons of Telecoms puts off many equity investors, it creates a profitable opportunity for private equity funds.
Here’s why:
1. Demand for Connectivity and Digitalisation of Services
Since the introduction of the 2G cellular network, the demand for mobile connectivity amongst both consumers and businesses alike has grown steeply and consistently to become the market it is today. In 2019, it was predicted that over 700 million new cellular subscribers were expected to join the market in the next five years.
The COVID-19 pandemic has only further stimulated this demand for connectivity – with estimates by McKinsey&Co predicting that the pandemic has accelerated digital transformation by up to 7 years. Consumers are fuelling significant demand for high-speed internet, having become accustomed to substantial digital content consumption and streaming during the pandemic. In addition, both B2C and B2B market segments have also become reliant on the creation and processing of large volumes of data. It is forecasted that billions of new IoT (internet of things) devices – spanning from smart cars to smart hospitals – will be connected to the wireless network over the next 10 years, which will only further stimulate the demand for data and bandwidth.
And the Big One: 5G rollout will disrupt the sector with exceptionally low latencies, extremely high data rates, and robust connection density. The aforementioned increasing demand for high-speed connectivity, in combination with the exponential rise of data volumes, is expected to accelerate the adoption of 5G networks worldwide. Consumers are after more reliable and fast connectivity for digital content consumption, whereas businesses worldwide will look to use telecom providers to facilitate big data analytics, IoT and machine learning.
As a result, new infrastructures which accommodate 5G and fibre high-speed internet are becoming increasingly lucrative assets. Investing in infrastructure such as towers, fibre networks and data centres at this point in time is a strategic move that will create superior value. ‘First mover’ advantage being that companies that build expensive CAPEX infrastructure first within a specific geographic area will create high barriers to entry for other competitors. This is because they can acquire customers earlier and benefit from a degree of monopoly power; thereby making the business case for a second entrant less attractive.
However, most Telecoms cannot financially afford to set up these new infrastructures and network sites alone, and so this is where private equity funds come in. Though the initial investment for infrastructure is significant, firms that act as a ‘first-mover’ can take advantage of economies of scale with the price per unit of hardware, software, and energy supply decreasing over time. Once the infrastructure has actually been built, variable costs are low and cash flow is high; with passive infrastructure management and maintenance typically being the main cost drivers. Furthermore, it is currently a particularly lucrative time for investment, with the historically low-interest rates in both Europe and the United States facilitating long-term investment at low borrowing costs.
2. Long-term secular growth
Telecom infrastructure deals recede risk in the portfolios of private equity companies due to their long term secular growth, acting as “safe havens” during periods of market volatility. Whether a consumer has lost their job or is facing a difficult financial situation, they’ll (almost) intrinsically need WiFI or the ability to call others; and the same goes for a business. There are also typically only limited alternative infrastructures available, and where they are present, most consumers have historically not been willing to switch telecom providers. The willingness to switch is exceptionally low if a consumer has been with a supplier for a long time.
Therefore, when acquiring a mature telecom company, a captive customer base will be inherited by the PE firm; one which is unlikely to decline in times of economic hardships. As such, PE firms can capitalise upon a unique opportunity: if they can retain their existing customer base and, additionally, use their financial supremacy (i.e. over traditional companies) to attract new B2C or B2B market segments with modernised infrastructures in these times of rapid technological development, they can potentially achieve sustained long-term returns. Stability in the cash flows will be driven by the loyal existing customer base, the high entry barriers for other firms to replicate assets, and – if acting as a ‘first mover’ – the potential monopoly power in the 5G and optic fibre landscape.
3. Improving Efficiency
Moreover, private equity funds are often led by experts in their fields, and as such can bring in a plethora of highly qualified individuals into the firm that will drive cost control, increased efficiency, and execution power. In regards to specifically the Telecom sector, greater efficiency can be achieved by harmonised management processes as well as modernised platforms and systems – OSS & BSS for example. This includes improving the quality of service through written policies and procedures, budgetary controls, auditing, and/or supervisory review; which are driven by both external and internal benchmarking practices. It can also bring in its expertise in big data analytics to introduce a more targeted operational approach.
Conclusion
With historically low-interest rates, a time of rapid technological development (enabling the potential for attracting new consumers), and the prospect of long-term profits, the Telecoms sector provides a unique opportunity for Private Equity funds to diversify risk in their portfolio and capitalise upon the widespread demand for connectivity.
Katz, Raul L. “The Private Equity Phenomenon in Telecoms and Media.” Vol. 1, 25 June 2008, https://www8.gsb.columbia.edu/citi/sites/citi/files/files/Private%20Equity%20Phenomenon.pdf
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