Prior to the global economic slowdown in 2008, the telecom industry was in the midst of a wave of mergers and acquisitions as operators pursued inorganic growth.
In the ensuing two years, operators shelved all but a few small transactions, opting to focus on coping with the fallout of the economic turmoil.
However, after a two-year lull, deal activity may be back. There are clear signs that mergers and acquisitions could steadily be picking up in 2011 and 2012, as several operators have announced large transactions as they resume their quest to pursue inorganic growth in the face of saturation and strong competition in their home markets.
The next wave of merger and acquisitions is likely to manifest through consolidation. The telecom industry remains fragmented relative to other industries – the largest operators earn a smaller percentage of total industry revenue than peers in other industries do, suggesting that the sector is primed for further consolidation.
As it enters a new phase of inorganic growth, three types of consolidation activity are likely to reshape the telecom industry. Large, cross-border megadeals are expected to dominate. In-market transactions and consolidation of ownership stakes also will resume, though at a slower pace. The operators that capitalise on this wave of consolidation could emerge as the global winners in the telecom industry.
However, according to Booz & Company, not all operators that pursue consolidation, specifically mega deals, will succeed. Operators that are best positioned to succeed will have both ample financial firepower and strong organisational readiness, encompassing governance, operating structure, processes, and skilled management. Several GCC telecom operators fit the bill and may emerge as global consolidators. GCC operators need to assess their current financial standing and organisational readiness, and then implement the changes that could position them to succeed as the industry’s consolidation resumes.
Before the global economic crisis emerged in late 2008, telecom operators were in the midst of a large scale merger and acquisition wave. Deal activity in the Middle East and North Africa (MENA) had been brisk for years, averaging in excess of $8 billion in annual transaction volume from 2006 through 2008. Operators completed only a handful of small M&A deals in 2009 and 2010 as management yielded to shareholder demands to adopt a prudent and risk-averse approach to weather the storm of the economic downturn.
Karim Sabbagh, senior partner and global head of communication, media and technology practice at Booz & Company says: “So far, 2011 has already indicated a strong M&A revival with several announced transactions pointing to the fact that operators are renewing their focus and willingness to allocate major resources to pursue growth outside of their markets.”
Furthermore, activity in the Middle East reflects a global uptick in M&A. As of the end of April 2011, closed and announced M&A transactions worldwide had already reached $69.8 billion, exceeding the $50.3 billion total for all of 2010.
“Many operators will again spark a new wave of inorganic growth. They will turn to consolidation to achieve their goals, recognising that there will be limited opportunities to enter new markets, with just a handful of potential new licenses available and few viable single-market opportunities,” Sabbagh says. “Accordingly, operators will compete fiercely to pre-empt rivals on attractive deals,” he adds.
“Going forward, all of these factors combined will lead to a more aggressive yet targeted approach to M&A,”
In addition, an analysis of other industries shows that the telecom sector remains relatively fragmented – indicating that it is poised for further consolidation.
For both the healthcare and oil and gas sectors, companies in the top 5% generated 79% of total 2009 industry revenue. By contrast, telecom operators in the top 5% of the industry accounted for 62% of industry revenue. That relatively small concentration of sector revenue among leading competitors suggests that telecom will follow in the footsteps of other major industries and enter a phase of major consolidation.
Accordingly, this M&A activity is expected to manifest through consolidation, which will take one of three forms: cross-border megadeals, in-market transactions, and consolidation of ownership within the same operator. These options are not mutually exclusive and several operators are likely to pursue a combination of some or all of these types of inorganic growth.
• Cross-market consolidation – The pursuit of scale: The first form of consolidation, which likely will dominate the sector for the next several years, pertains to cross-market “mega deals” – transactions in which major telecom operator groups acquire controlling stakes in other groups that have a presence in multiple markets. These transactions are attractive to acquiring operators for a number of reasons. Large transactions let operators complement their footprint in regions where they already have a presence, or augment it by entering promising new markets.
Large multi-market transactions also allow operators to enter into multiple markets with a single stroke, thus eliminating the complexity, cost, and time lag entailed in identifying and completing multiple transactions. Finally, large transactions offer a competitive advantage, enabling operators to pre-empt their competitors from acquiring increasingly scarce and attractive targets.
• In-market consolidation – gaining competitive advantage: The second form of consolidation will likely take place at the market level and will involve merging operations within the same market. Operators will seek to acquire current competitors and merge competitive organisations. Although this will be less prevalent than cross market consolidation, it can still offer compelling advantages for operators.
In-market consolidation would enable operators to increase their subscriber base and garner higher market share, while eliminating a direct competitor. Such transactions also may provide access to specific, lucrative market segments, such as enterprise or youth subscribers. Moreover, in-market consolidation can help operators gain additional spectrum, expand network coverage, and improve service quality while providing a better cost structure by optimising network and IT infrastructure.
• Consolidation of ownership – gaining control: The third form of consolidation will transpire at the individual operator level. In some cases, shareholders will seek to gain full control over a specific operation in which they have an existing stake, or shareholders might seek to exit their investment. In both cases, ownership consolidation will provide greater control of operations. There are three main reasons for operators to seek to increase control of their businesses.
First, cementing control enables shareholders to make more effective and agile decisions on strategic, financial, and operational issues. Second, increasing control facilitates value and synergy creation across the group, providing a more cohesive approach to group initiatives such as rolling out products and services or implementing technology and procurement cost optimisation programmes. Finally, increased control lets operators consolidate their financials – an important consideration as regulators likely will not allow partial consolidation going forward.
Winners in the next wave
In the near term, telecom operators will likely revive and accelerate their inorganic growth activity through all three types of consolidation – cross market, in-market, and gain of control.
However, cross-market merger and acquisition activity between group operators likely will dominate and reshape the industry. Analysis shows that cross-market consolidation is on the rise, whereas opportunities for in-market consolidation will become increasingly scarce.
“It is absolutely critical for operators to define their strategies and the role that they will play in this consolidation game. Within this context, shareholders and management must achieve strong alignment on strategy and objectives from the onset,” says Chady Smayra, principal at Booz & Company.
Smayra adds that not all operators that plan to participate in the “megadeal” consolidation are capable of success. The operators that are best positioned to capitalise on the next wave of sector consolidation are those with strong financial firepower to participate in transformative deals and robust organisational readiness to absorb and manage the operational complexity necessary to reap the promised gains of the “megadeals”, according to Smayra.
Telecom operators need to assess their financial prowess to determine whether they are capable of executing large transactions and succeeding in the upcoming consolidation wave. This assessment encompasses both an operator’s current capital position as well as its ability to raise funds going forward.
Operators can assess their financial strength based on six parameters:
Revenue provides a strong indication of investment scale capability. Because M&A opportunities are scarce, there is heightened competition for deals and large transactions. Therefore, only the largest telecom operators (measured by revenues) can afford to participate, especially in megadeals.
Recurring cash flow as a percentage of revenue measures cash generated from operations and underscores a company’s ability to generate cash internally to finance a large transaction, as well as its ability to maintain the financial standing to issue debt. Solid free cash flows will improve net debt to EBITDA ratios.
Net debt to EBITDA ratios measures additional debt capacity and provide insight into a company’s ability to issue debt in order to finance future transactions. Net debt to EBITDA is a key metric used by investment and commercial banks to determine additional debt capacity.
Average dividend payout ratio measures liquidity and indicates a company’s ability to raise funds by modifying its dividend policy. Some companies, for example, can reduce dividends to improve cash availability.
Ownership by primary shareholder reveals flexibility for stock transactions, such as paperless deals. Companies in which the primary shareholder controls a large stake, such as 80 percent, easily can issue additional equity or swap shares without losing majority control.
Ability to raise equity is a subjective interpretation of the willingness of shareholders to inject more capital in the business directly and, thus, indicates the company’s ability to raise equity capital to fund M&A activity.
Organisational Readiness to Integrate Large Targets: Parallel to bolstering financial strength, operators need to enhance their level of operational involvement to add value and actively manage new and existing components of their portfolio. They also must realign their organisations to be prepared to absorb large acquisitions or participate in mega-mergers. Organisational readiness will be a key component of success in upcoming sector consolidation – those operators that can successfully transition from a mere collection of independent multimarket companies to a truly integrated one.
Operators can assess their organisational readiness along five key variables:
• Governance model: Adopting a strong governance model should integrate large acquisitions as a key to success.
• Organisational model: To overcome the organisational challenges of large consolidation transactions, many operators will require to restructure to integrate, support, and manage sprawling global operations.
• Management processes: Operators will need to standardise, integrate, and institutionalise strategic management processes to facilitate a seamless flow of information and allow effective decision-making and accountable execution.
• Value and culture: Operators initiating an acquisition, need to operate smoothly across multiple geographies with different socioeconomic, market, and competitive dynamics, as well as, also across traditional and emerging value chains.
• Talent management: As operators expand internationally, they must focus on attracting and retaining capable executives that can manage both globally and locally.
The operators that will succeed from this upcoming wave of consolidation are those that have the financial strength to execute cross-market megadeals. However, having the financial wherewithal to initiate and complete big transactions will not necessarily be enough.
“After two years of caution during the global economic crisis, telecom operators are entering a new wave of consolidation – one that will determine which players will emerge successful,” says Amr Goussous, senior associate at Booz & Co.
“Operators that succeed in developing a global footprint also will need to have the organisational readiness to execute and absorb transactions – and have the necessary buy-in from their shareholders,” he adds.
“Conversely, operators that either lack the financial resources or are behind in their organisational preparedness might find themselves either left behind in the impending wave of consolidation or acquisition targets themselves.”