Tower M&As riding on data growth prospects

Telcos need to continuously invest in data networks to improve tenancy for tower firms

There has been a flurry of mergers and acquisitions (M&As) in telecom in the recent past. Vodafone and Idea are in talks to merge while small operators such as Telenor are looking at an exit. Severe pricing pressure brought on by the launch of Reliance Jio’s services is forcing telecom companies to consolidate.

All this will impact the telecom tower business, which has seen its fair share of M&As. While Reliance Infratel sold its tower portfolio to global alternative asset manager Brookfield at an enterprise value of Rs 21,500 crore, American Tower Corporation acquired Viom Networks for about Rs 21,000 crore. The likes of Apax Partners, Blackstone, Brookfield and Carlyle are reported to be in the race to acquire a controlling stake in tower operator Tower Vision. Also in the works are plans of Bharti Airtel to offload a major stake in Bharti Infratel as well as Idea’s plan to sell its tower portfolio.

So what interests these investors to take part in the tower infrastructure space? To analyse the attractiveness of a telecom asset, analysts at Goldman Sachs identified five criteria — ownership, regulations, strategic rationale, size and valuations. Unlike the telecom space, in which regulations have hindered M&As, this is not the case in the telecom tower business, which is less regulated. With telecom players keen to divest stake and valuations at reasonable levels, this is perhaps a good time to lock in a quality asset for the long term. The holding period and strategic rationale of potential acquirers are, however, different.

While Brookfield is a strategic investor with a medium-term holding period, for American Tower Corporation, the world’s largest telecom tower infrastructure company, India would be one of its key long-term bets because it is growing at a faster clip than other countries in its portfolio.

For both, the key rationale is the growth potential. Tanu Sharma, associate director, Large Corporates, India Ratings and Research, says that exponential data growth will be a key driver for tower companies and, given the stiff competition, telecom operators will need to continuously invest in data networks. This, according to her, will help improve tenancies over the medium to long term. Tower companies are expected to be major beneficiaries as telcos intensify their data rollout to counter Reliance Jio.

Macquarie Capital’s Chirag Jain believes that India’s data consumption will grow 12 times by 2020 from the current levels on account of a sharp fall in data tariffs and rise in smartphone penetration. This, according to Macquarie, is leading to higher tenancies for tower companies as operators rapidly roll out 4G services in parallel with their existing 2G set-up and expanding 3G networks.

Despite the potential, industry experts say that investors have not made much money on their investments and some such as New Silk Route have barely broken even (see table). Typically, private equity funds would look at a 30 per cent return on their investment. While the tower business might not have yielded good returns, investors are interested, given the steady cash flows. “Given their annuity-like business model, long-term contracts and a 2.5 per cent annual cost escalation, there is revenue visibility for the tower firms. These seem like infrastructure-type bets with long-term revenue visibility though not oversized returns,” says the head of a consultancy firm. Unlike those in India, the cost of capital for foreign P/E funds is much lower, making investments in tower firms, just as they do in commercial real estate, viable.

Further, tower set-up costs in India are much lower, about a tenth of those in the US and less than half of what they cost in Africa. This leads to higher gross margins. But what spoils the show for Indian tower companies is the high maintenance costs and capex as Indian companies are responsible for battery backup, DG sets and cooling systems. Globally, telecom operators are responsible for arranging and maintaining power. Thus, what appears as a key advantage is diluted at the pre-tax level. Despite this, returns on invested capital for players such as Bharti Infratel at 17 per cent are higher than tower company returns in most countries. A reason why tower companies in India appeal to investors is attractive valuations. Bharti Infratel, for example, trades at 10.5 times its FY18 estimated enterprise value (market capitalisation+debt-cash) to operating profit which is at a 40 per cent discount to global peers American Tower Corporation and Crown Castle International. The reason for the valuation discount, according to Sunil Tirumalai and Viral Shah of Credit Suisse, is the perceived ‘lack of independence’. About 78 per cent of all towers are owned and controlled by telecom operators, which are thus users as well as owners. This makes tower contracts here favourable to operators as against those in other countries. Operators thus enjoy low loading fee (fee charged for placing equipment on a tower), higher discounts on incremental tenancies and land rent pass through, among others.

This could change as telecom companies are shedding tower assets as they consider them non-core and it should lead to specialist and independent tower companies. Consolidation, thus, is likely to gather pace both in the telecom and telecom tower sectors. Fewer telecom service providers due to consolidation means that tower firms such as Bharti Infratel will have fewer clients to service and thus falling tenancy ratios. Emkay Global’s Naval Seth believes that the Vodafone Idea merger could impact 13-19 per cent of Bharti Infratel’s existing tenancies and 14 per cent of incremental tenancies. The only consolation is the exit penalty clause which will compensate Bharti Infratel for revenues foregone. Most experts believe that uncertainty could impact valuations of these tower firms going ahead.