M&A activity, a fast and furious 2010?
As capital markets start to recover, and some investors look to realise a return, the coming 12 months look likely to be a busy time for mergers and acquisitions. But who will be the big M&A players in telecoms, and which sectors are they likely to target?
When two global carriers both start welcoming a new openness in the capital markets, you can guess that maybe 2010 will be one of those years in the carrier sector where the furniture gets rearranged. When the strong have access to debt and the weak are on the verge of Chapter 11, mergers and acquisitions are never far away.
In their third-quarter earnings calls both Global Crossing and Level 3 welcomed the easing in the financial markets. Global Crossing CEO John Legere welcomed a refinancing of $750 million in debt. “We’re in a different environment,” he told reporters.
At Level 3 Communications, CEO James Crowe went further: “When the economy collapsed, anyone’s ability to price risk and cash flow became difficult. There were big battles about multiples and what assets were worth… You get those things in place – the right mindset of principles in the industry and common views of value – and the necessary predicates of consolidation are going to increasingly be there.”
Already we are beginning to see major operators consolidating. Vodafone and Hutchison announced mergers in Australia, and T-Mobile and Orange followed suit in the UK. Yet as Crowe points out, the global recession has made it tough to value businesses effectively, and so cash-strapped acquirers are loathe to pay over-the-odds, while shareholders in the target company resist what they see as a too-low offer price. This is hardly new territory – recent spats such as the one between the boards of Ibasis and KPN show that even when the market is good, it can be tough to agree on a fair price.
There are several reasons why M&A activity might be fast and furious in the telecoms sector in 2010. The first is that consolidation in the carrier and operator businesses is business as usual, and board directors will often have been through many mergers and acquisitions before. There is plenty of first-hand knowledge that can be applied, but doesn’t make the process any easier to complete. Despite the relative sophistication of telecoms M&A there is, as Kevin Beard – head of media, telecoms and technology at PIPC – points out, a long track record of mergers destroying value because of the way that telecoms mergers need to be structured. “History shows that M&A transactions often destroy rather than grow shareholder value,” he says. “Getting the strategy and integration plan aligned is critical. The key in cross-border acquisitions is deciding early what the target operating model should look like, run the newly acquired company as a separate going concern or integrate it into the acquirer’s existing operation.” He points out that while the latter option is more complicated, it delivers a quicker return – but for international companies often founders on the problems of “culture, language, local market behaviours and regulation”, as well as the more common management failures, such as underestimating how complex integration will be.
The second driver will be the relative strength of the weak and the strong: as the strong get stronger, they will be able to use their power to extract deals on much better terms than they would have contemplated two years ago. It might mean that carriers who lack a large chunk of business will attempt a deal to pull ahead of the pack – “BT needs a mobile business so badly it has to do something,” as one rival CEO points out.
The strong, or at least the large, will attract more investment as their debt is more secure, which can only encourage mergers with altnets and emerging-market operators whose creditworthiness does not encourage investors.
Learning from the past
“If lessons are to be learned from the previous recessions then we should expect to see the larger telecoms operators move further ahead of their smaller competitors. As the recession eases, and as money returns to the markets, we should expect to see these bigger operators take the opportunity to acquire the struggling smaller companies, particularly in developing markets,” Beard says. “With the lowest number of connections against population size, Africa and the Middle East offer significant growth potential so expect there to be an increase in acquisition and consolidation in this market.” On the other hand, regulatory pressures and the problems of government ownership in regulated markets may encourage network sharing which – though still a difficult proposition – may be the quickest way for developing market operators at least to achieve the scale and investment benefits of M&A without the regulatory and integration pain. Or, at least, less of it.
Third, as mid-noughties investments mature, some markets simply have too many companies in them, and hard-headed investors will be looking at the earliest possible time to make a respectable return on their investment.
CDNs – a hyped investment
Note this will not mean a profit for some of them: an example is the CDN market, one of the most hyped investment opportunities of the previous five years. Dan Rayburn, a Frost & Sullivan principal analyst who runs the blog businessofvideo.com and runs the CDN summit, points out that to generate a $100 million business, the average CDN would have to invest $300 million. With a market that he sizes as $400 million in total in 2009, that is beyond the dreams of investors, who may want to cut their losses.
“In the past two years, we’ve seen the number of CDNs coming to the market jump from about a dozen to more than 50 at its peak and combined, they have raised almost half a billion dollars. While all of this growth is great for vendors, content owners, and the industry as a whole, the reality is that the number of CDNs in the market is going to decrease a lot,” he says. “Many people are predicting consolidation in the market. It will happen, but not in a positive way for most of the CDNs and the investors who pumped a lot of money into these companies. Most CDNs don’t have enough revenue, customers, patents, applications, or intellectual property to make them worth more money than they spent to launch in the market.”
Plug some gaps
There are also opportunities for carriers to fill holes in their portfolios: if VC funds have been holding off their investment in European and north American companies to see how they lasted out the recession, those funds need to be invested. “It has been a quiet period over the last two years,” says Gareth Williams, CEO at Interoute, “The belief in the industry is that there is a lot of money with venture capital funds and existing players that will be used for M&A in 2010. From our perspective M&A is a useful tool to accelerate penetration into new territories, add new products to the portfolio or to supplement existing business in a larger market. It can circumvent slow organic growth.” Interoute has been investigating targets, but Williams expresses surprise that there were “no real bargains”. For other carriers, where the need to plug a hole is more urgent, more businesses might seem like a bargain. Williams points out that Interoute has found Amazon, for example, competing with carriers for enterprise business in some territories. As carriers re-evaluate where they see their growth coming from, Williams predicts that many carriers may divest parts of their network – and that companies with large data capacity and a lot of recently-completed call centres might find themselves quietly acquiring another piece of the jigsaw that would strengthen their ability to provide both network and cloud computing resources.
M&A will not just occur between carriers or operators. With PE houses looking to invest, and perhaps being quicker off the mark in consolidating privately-held companies – many of the emerging markets’ equipment and services providers may be looking to do deals in 2010. Also, small-cap companies with comparable size may find a merger preferable to being snapped up by an industry giant. Already in China software and systems integration services Asia Info Holdings and Linkage Technologies International Holdings have announced they are combining to form AsiaInfo-Linkage. Though the name doesn’t trip off the tongue, by the time the merger completes in March 2010 they will have created an OSS powerhouse that can expand into the rest of the world, employing 8,000 staff and with revenues of $400 million.
In India, a Venture Intelligence survey of 50 PE and VC firms, investors predicted that the expansion of services into rural areas would promote growth, investment – and consolidation. While developed markets are unattractive to private investment, India has had a relatively strong 2009, with PE investments in telecoms of $300 million in 11 deals – though this is way down on an average of $1 billion a year for the last five years. Nevertheless, in developing markets there are deals within the reach of PE investment with strong growth potential.
While outside investments in emerging markets are risky (and often hard to complete), operators who are relatively debt-free – often from developing markets themselves – are already looking at investments. In October 2009, BSNL and MTNL announced they were setting up a fund with Delhi-based Vavasi Group, created to invest in Russian and European telecoms operators. They have also bid for Kuwaiti-based Zain Telecom, and BSNL and MTNL are also bidding to acquire Zambian telco Zamtel.
Finally, we move into a decade where shared services are no longer a luxury, and where integration of back-office platforms will be outsourced, shared, or at least built around common standards. “Thanks to quad play, operators are now attempting to deliver a unified service, but this requires them to have a unified architecture behind the delivery of these services,” says Tony Kalcina, chief product officer at Clarity. “With operators offering more services and M&As becoming more common, it is not ideal for individual services to be managed and maintained by their own isolated island of OSS or BSS.”
While shared services alone will not create mergers, when acquirers evaluate targets they will be looking at back-office systems which will take weeks to integrate rather than months. They will see a set of applications and common technologies which can provide common service platforms almost immediately. The result: a dramatic lowering of the cost of integration and an increase in speed. It’s a process that the IT industry’s most dedicated acquirers, such as Cisco and Oracle, found worked for them 10 years ago. At that stage the telecoms business was not ready to follow suit. Now it is.
Top 10 telecoms M&A deals of 2009
10. Hutchison 3G Australia to Vodafone Australia value: $3,112m 9. Vodacom Group (35%) to existing shareholders value: $3,564m
8. Macquarie Communications Infrastructure Group
(81.67%) to Canada Pension Plan Investment Board (CPPIB) value: $4,982m
7. China Unicom (CDMA business) to China Telecommunications
6. Sprint Nextel Corp (Wimax Business Joint Venture) to Comcast,
Trilogy Equity Partners, Bright House Networks, Time Warner
Cable, Google and Intel Capital, and Clearwire to Sprint Nextel
(2.5GHz spectrum and Wimax related assets)
combined value: $7,412m
5. Telecommunications Company of Iran (TCI) (50.0001%)
to Etemad Mobin Development Company value: $7,909m
4. Embarq and Centurytel value: $11,878m
3. China Netcom Group to China Unicom value: $22,766m
2. Alltel Corporation to Verizon
Communications value: $28,100m
1. Time Warner Cable (85.25%) to existing shareholders
While mergers will give some mobile operators, especially in fast-growing markets, the economies of scale that they need to compete, there are many reasons not to merge. Regulatory conditions might prohibit foreign ownership or trigger monopoly concerns. Delays in integration may distract employees at exactly the time they should be building the business. And there are other opportunities to achieve the economies without a merger: not least the chance to share the cost of network infrastructure with your competitor.
There are two flavours to network sharing: it is either active (all components, including transceivers and switches), or passive (towers, pylons, premises). Here’s the first roadblock: active sharing is so close to being the same operation that radio access network (RAN) sharing, for example, is banned in some markets, as it may reduce competition.
Passive network sharing, however, has become massively popular, both as a way to reduce capex while rolling out new technology as well as opex in mature markets. But could network sharing be the way for operators to expand in developing markets, where mergers have been hard to achieve?
Simon Kong, business development director for the Asia-Pacific region at Omnix Software, which provides infrastructure management for operators including Vodafone, Telefonica, Vodacom, Orange and Mobilkom, points out that this will not be easy to achieve in most developing markets, because of some important investors. “Europe and the US have seen a rapid growth in network sharing agreements, while in Asia the uptake of network sharing has been held back,” he says. “Western operators would welcome network sharing agreements [but] government linked operators in Asia want to have full control of their network infrastructure.”
Kong points out that 3G has perhaps accelerated network sharing in these markets. When China needed to upgrade its networks, it turned to western infrastructure providers to do the job using their existing expertise. Now, as the industry deregulates, operators who have relationships with the network providers would like to share the networks if they cannot buy the operator outright.
Domestic network sharing will be held back by the large amount of public ownership in developing markets. “For example, in Malaysia the drive towards network sharing will need to come from the top, since it involves many agencies or ministries and touches on issues like land ownership, telecommunications and housing,” Kong says, “Merging networks is made more complex because operators will want to decommission a roughly even number of towers, so that one of them does not risk severely compromising their network capacity.”
With LTE on the way, countries that are still building an infrastructure will face pressure to consolidate, either at an operator level, or by sharing the build of their networks. The business environment, the struggle for market share and the wish to differentiate not on customer service but on signal quality make the process harder in growth markets, but the fear of missing out entirely is concentrating the minds of many operators.
According to Kong, with about 60% of the cost of doing business in towers and backhaul, there will be more operators forced into network sharing. “With passive infrastructure sharing, we expect operators to save close to 30% on capex and opex,” he says, “operators will increasingly be able to focus more on branding and customer service to differentiate from the competition.”
2010: Making up for lost time
Wherever operators and carriers look in their businesses, they see the market forces that will propel mergers and sharing agreements.
Mobile operators are the most obviously affected. Having waited many years for data services that will drive up the use of their networks, they see them beginning to arrive. Market researcher iSuppli suggests that global shipments of smartphones will rise to 450 million a year in 2013 – in 2009 they were 200 million. Yet when the operators first envisaged supporting millions of data-hungry mobile users, data was assumed to be a metered commodity. Thanks to the iPhone, all-you-can-eat tariffs are now standard. On one hand, that means more users encouraged to use more applications, on the other, it means that the billions invested to roll out LTE and HSPA can only be recouped through subscriptions – and that the strong will get stronger unless the weak combine to share the costs of development.
Detecon Consulting, meanwhile, has been analysing the effect of the crisis on African and European operators. In Europe, Detecon found that the financial crisis was reducing opex and capex for more than half of operators – but also more than 50% had to put M&A activity on hold in 2009 as access to capital dried up.
Africa, like other developing markets, is still a long way from saturation it concludes, but with most infrastructure projects bought and paid in dollars the constriction on funding puts pressure on them to grow. “Compared to their European counterparts more African executives contemplate the current crisis as an opportunity to grow by M&A,” the report concludes.
The re-emergence of dealmaking in developing markets is also prompted by the reduced expected returns in the US and western Europe. At the end of 2009 Finance Asia’s annual M&A survey found that 83% of Asian M&A experts expected M&A investment to flow to Asia, China especially, as potential returns are higher. M&A might be harder to achieve and riskier in emerging markets, but the need to deliver growth after a year of stagnation will be attractive for equity investors and large carriers and operators alike.