Wholesale world 2012: Telecoms mergers and acquisitions
16 January 2012 | Richard Irving
Despite mounting economic gloom, the telecoms sector is set for another flurry of M&A. Richard Irving separates the hunters from the hunted.
Which company is persistently the subject of more takeover speculation than any other on Wall Street? Step forward Akamai, the Cambridge, Massachusetts-based content delivery specialist powering Apple’s iCloud initiative and the US’s most rumoured bid target. According to Bloomberg, the financial information provider, Akamai has been the subject of no fewer than 21 separate bid rumours in the financial press over the last five years, stoked by suggestions that anyone from AT&T to Verizon – and just about every carrier, IT specialist or media giant in between – wants the company’s cloudbased technology.
It is perhaps no surprise that a telecoms business should top Bloomberg’s inauspicious league table – the sector is on the cusp of an unprecedented boom in mergers and acquisitions (M&A). Indeed such is the speculative storm swirling around the market, that it is not entirely clear – with the notable exception of Akamai – who will emerge as bidders and who will be their prey. Many are cited as both – often, in the same breath.
Some industry observers believe that cable operators will spark a bidding war among telcos, citing mounting evidence that a gentleman’s agreement precluding them from competing with one another on their respective home turfs is on the brink of collapse. Such a move would undoubtedly clear the way for them to attack the high-end enterprise market via deals with metro providers or competitive local exchange carriers (CLECs). Others see an urgent need for CLECs themselves to hit the acquisition trail to build scale and better focus their own attack on the business market. And many more are convinced that opportunities in the cloud could help cash-rich telcos – and indeed some computing companies – find much needed revenue growth.
Uniting them all, however, is an unshakeable conviction that the wholesale telecoms market is ripe for consolidation. Booz & Co sees a convincing parallel with the pharmaceuticals sector. According to the management consultant, more than 1,300 drug companies have fallen to bidders in the last 20 years as part of a process that has seen a top tier of 30 multinational players whittled down to just five. Karim Sabbagh, a senior partner in the firm’s Dubai office has identified three major phases of consolidation in the drugs industry, arguing that wholesale telecoms operators will follow suit: the first centred on the push for market share; the second focussed on deals that brought synergy savings through scale; and the third highlighted mergers that brought unique intellectual property rights and cutting edge innovation to the table.
But while consolidation in the drugs industry was relatively slow, the process will be compressed into perhaps just five years in telecoms – partly because telcos face competition from deep-pocketed rivals such as Apple, Google and IBM, and partly because the pace of innovation means that product cycles play out in months rather than years.
Nowhere is this “Big Pharma”-style consolidation more urgently needed than among America’s long haul network providers, where no fewer than eight major players continue to operate at unsustainably low margins. Tim Horan, an analyst at Oppenheimer, the US investment bank, highlights four potential bidders (AT&T, Verizon, CenturyLink and Level 3) and four targets (Sprint’s wireline business, XO Holdings, Cogent Communications and AboveNet).
In the short term at least, the dynamics in this particular market segment are likely to focus on Sprint, the third largest US carrier. The company is in the early stages of building a new LTE network which aims to cover more than 250 million people by the end of 2013 and could well look to finance the initiative through the sale of its wireline business. The unit, which has suffered in recent times from a lack of investment could fetch anything from $5 billion to $7.5 billion and could prove attractive to either CenturyLink or Level 3.
CenturyLink, fresh from its $22.4 billion acquisition of Qwest and still in the throes of bedding down the $2.5 billion purchase of Savvis, would find Sprint’s big enterprise customer base particularly attractive. However, the more heavily indebted Level 3, which itself is preoccupied with integrating the $3 billion purchase of Global Crossing, has previous form, having tried to stitch together a deal with Sprint in 2009. Those discussions came to nothing, primarily amid concerns at the mountain of debt sitting on Level 3’s balance sheet.
Level 3 has since laid those fears to rest – through acquisition. The purchase of Global Crossing, which regulators finally signed off last autumn, not only gives Level 3 a deep footprint in the long haul, metro and data centre markets across three continents, but also puts the company in a prime position to go after yet more targets. Explains Horan: “Consolidation begets consolidation – Level 3’s leverage will almost halve over the next two years as it puts Global Crossing’s revenues to work. Its net debt will fall by more than $1 billion and the cost of financing that will fall from around 10.9% to 8.6%. That should prompt a rerating of both the company’s paper and its shares, making both a more attractive currency against which to finance future acquisitions.”
Analysts speculate that the company probably cast an eye over both AboveNet and Sidera, the metro fibre providers that were put up for sale last year, but those negotiations came to nought and both auctions were pulled from the market. With the Global Crossing deal now bedding down nicely, the time might be right to start casting around for another deal.
Ironically – and in a sign of just how complex the interacting layers of M&A in the telecoms arena can be – the most attractive target is widely thought to be Level 3 itself. As Oppenheimer’s Horan explains, CenturyLink could strip almost $700 million in cost savings out of a merger with Level 3, creating a $55 billion behemoth with annual revenues of more than $25 billion. “The financial rationale would be very compelling”, Horan notes, adding that the savings would be at least $200 million more than anything that could be achieved by any other combination of top long-haul network operators. “A combined CenturyLink/Level 3 would also benefit from substantially lower borrowing costs given CenturyLink’s higher credit rating”, he adds.
In an uncertain world, further consolidation among competitive carriers is a given. Here the mantra is to build scale, extend geographical footprint, and most importantly, attack the enterprise market.
As Colby Synesael, an analyst with the New York investment banking boutique Cowen & Co explains: “If you had to sum up the driver fuelling M&A in the coming months in a single word, it would be infrastructure.” The assumption that metro assets are good because they essentially serve the enterprise market, and long haul assets are bad because they are commoditised is outdated, he says. “Valuations are getting far more sophisticated – it’s all about the uniqueness of the route, what you put at both ends and the overall solution that you then offer your business customer – that’s how your assets are getting valued now. If you look at the deals that Windstream, EarthLink and CenturyLink have closed, it’s all about the infrastructure component because ultimately, that’s how you attract enterprise customers.”
Aaron Blazar, vice president of Boston-based Atlantic-ACM, agrees: “More often than not, the big carriers find themselves competing not just against one another, but against systems integrators like IBM, HP and Accenture. These guys are layering some very clever end-to-end solutions throughout their product offering – from the network through to data storage and on to enterprise applications. I think you would have to assume players such as AT&T, CenturyLink, Verizon and Windstream have more deals up their sleeves, but really, when you start talking about who’s looking to buy assets in the enterprise market, you have to start broadening your horizons to almost any large carrier and you have to cast the net as wide as Europe and Asia for attractive targets.”
Certainly, grave economic uncertainties and the slow motion unravelling of the European Union will undoubtedly proffer some attractive assets, although European M&A is unlikely to be for the faint hearted. As Hunter Newby, chief executive of Allied Fiber explains. “There doesn’t seem to be much conformity in how to value sovereign debt in the Eurozone at the moment, so I am not entirely sure how you might go about valuing, say, a Spanish metro.”
That said, given the enterprise focus that many European competitive providers can bring to the table, a cross border deal must surely be only a matter of time. Analysts see a raft of potential targets in Europe, including Colt, Jazztel and Tiscali. Colt in particular looks attractive and analysts have mooted a tie-up with either Level 3, Windstream or EarthLink.
Another CLEC that often gets bandied around investment bankers is TW Telecom. So far, the company has set itself apart from the current flurry of deal making, preferring instead to return cash to shareholders through a $300 million share buyback programme. However, like Level 3, the company is understood to have cast an eye over AboveNet last spring and the carrier retains a $500 million war chest that could certainly set the metro market alight.
But TW Telecom is itself in the cross-hairs, as Cowen & Co’s Synesael explains: “The carrier has a great footprint – it’s in 75 markets – and has a full suite of products and a large sales force, both direct and indirect. It pretty much ticks all the boxes for any CLEC but also for a cable operator looking for a very clean entry into the enterprise arena”.
The emphasis on infrastructure also manifests itself in the way carriers are looking at cloud-based IT solutions. The only way large telcos can ever hope to compete with – and pare back the dominance of – Amazon and Microsoft is to target M&A in such a way as to leverage off their own very high quality networks and the strong customer relationships they already have with the enterprise sector. Last year, CenturyLink, Verizon and Time Warner Cable alone spent a total of more than $4 billion on cloud companies and that, analysts believe, is just the tip of the iceberg.
“We are on the verge of the enterprise market embracing cloud services root-and-branch. If telcos really do want to dominate this market, then we will see a lot more acquisitions in the coming months”, says Oppenheimer’s Horan.
Top of everyone’s target list is Rackspace, the data centre and web hosting provider which recently joined forces with Equinix to develop an open source cloud computing platform. Shares in the company, which currently boasts a market capitalisation of around $5 billion have almost doubled in the past year amid persistent speculation that a telco might be circling.
And step forward, again, Akamai, the content delivery provider which specialises in speeding up data traffic. Although the company took a knock last year when Netflix moved some of its video traffic to Level 3 and Limelight, there continues to be enough speculation swirling around the company to keep it at the top of the rumour mill for some time.
FCC ruling could pave way for cable bidding bonanza
In June 2012, the US telecoms landscape could change beyond all recognition when Washington-based policymakers decide whether to overturn a cornerstone of regulation dating back 15 years.
In a move that could stoke the fires of an already heated mergers and acquisitions (M&A) market, the National Telecommunications & Cable Association (NTCA) is asking regulators to ease rules which effectively bar cable companies from snapping up competitive carriers.
Under the current framework, enshrined in the Telecoms Act of 1996, cable operators may not seek to merge with competitive local exchange carriers (CLECs) in their own franchise areas.
Now, the NTCA, the mouthpiece of the $250 billion US cable industry, wants the Federal Communications Commission (FCC) to lift the ban, arguing that CLECs weren’t even around when the provision was set and that huge advances in technology make it anachronistic and anti-competitive.
A final decision is unlikely to come out of the agency until the June deadline and insiders say that it is impossible to second guess which way the commission might go. Tellingly, however, the move is supported by individual CLECs as well as the US Telecoms Association. Moreover, when Comcast, the largest US cable operator, bought Cimco Communications, a privately held metro provider based in Chicago in March 2010, the FCC waived the requirement, effectively setting a precedent that it could now find hard to overturn.
Behind the NTCA’s political rhetoric lies a simple but crucial goal: to establish a new platform from which the cable industry might launch an attack on the all important enterprise market. Cable operators have been quietly easing their way into the business market since the credit crunch and by 2014 the industry is expected to earn more than $17 billion from commercial services revenues – including voice, data and video.
But as Colby Synesael, an analyst at Cowen & Co, the New York-based investment banking boutique explains, the real prize lurks higher up the spectrum: “The small and medium-sized business sector is not the end game for cable operators but rather a launch pad to target rapid expansion into the high-end enterprise sector.” To go after the really large business customer, he adds, operators need a national network, a full product suite and a dedicated sales force capable of taking that portfolio of services out into the market. “It would be just too timely and too costly to do that organically, so it follows that many of the fibre network providers that remain independent today are probable targets.”
And if the prospect of an acquisition bonanza isn’t enough to spark interest in the telco sector, a far bigger boost might come from the dawning realisation that cable operators are looking to change their game plan for good.
Synesael explains: “Historically, cable companies do not compete with one another in their home territories and that has to some extent precluded M&A activity. But if cable operators start amassing telco assets across the US, then they will necessarily become far more aggressive in each other’s traditional franchises and the consequences of that will indeed be very significant – not least, in the form of considerably greater competition.”
And that, surmises Synesael, will further fuel the M&A boom. “I truly believe we could be seeing the dawn of a whole new period in the telco sector.”
Europe in the spotlightWould-be buyers are keeping a watchful eye on the worsening economic outlook in the Eurozone amid indications that a sudden lurch into a new credit crunch could shake free some potentially lucrative fibre assets. Here are some of the runners and riders...
Based in the UK but listed on the Spanish stock market, Jazztel operates fibre networks in more than 10 Spanish metro markets as well as a host of services including intelligent networks and internet, voice, data and mobile services. The company is expected to grow earnings before interest, tax, depreciation and amortisation by 40% this year as it continues to win share from Spain’s incumbent, Telefonica. But with a market cap of just under €1 billion, it still offers value as a metro play.
Based in Luxembourg but listed in London, Colt operates metros in 38 European cities with direct fibre connections to 17,000 buildings and 19 data centres. Annual revenues are expected to remain flat this year at around £1.5 billion but management is investing heavily in its data centre business. Worth around £800 million, the business could prove a useful in-fill to Level 3.
The London-based company, which is majority-owned by the Sandoz family, is one of Europe’s largest fibre network providers linking 90 cities in 20 countries. The company, which has an extensive enterprise footprint, recently entered into a major strategic partnership with Telefonica under which it will make its European network available in exchange for access to Telefonica’s US assets.
TiscaliThe Italian-based broadband provider suffered badly in the credit crunch, forcing it into a fire-sale of its UK business to Talk Talk in 2009 and its subsequent retrenchment to Italy. Since then, however, it has been gradually building a strong enterprise custom
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