Operators are facing an increasingly tough financial situation, as increasing competition and high subscriber churn collide with the need to invest in new infrastructure to support new technologies and greater demand for bandwidth. Put simply, financing telecoms requires new models of operation and innovative approaches to the business.
At a time when operators are under greater pressure than ever to invest in the rapid development of new and increasingly converged services, and to shift business models to address churn in a world rife with subscriber promiscuity, financing — the key to innovation — remains a fraught issue.
Even for relatively stable incumbents, the challenge of cutting costs while addressing technology and service evolution through strategic acquisitions andcollaborative services is a constant influence — some would say constraint — on their ambitions. For the new breed of multimedia service providers, flexibility is hampered by limited financing opportunities which impede growth in a market that is still nervous, despite the gradual improvement of the global economic landscape.
These frustrations are likely to dominate the agenda as top telco executives gather in Dubai for this month’s TMT Finance Middle East North Africa 2014 Conference.
Philip Shepherd, partner and TMT leader Middle East for global professional advisory firm PwC, who will chair the TMT M&A panel, said consolidation is a key factor in the global market as operators seek ways to combat mature markets, high Capex, and declining margins. And this world picture is being replicated at a local and regional level. Shepherd identified Africa in particular as a region of escalating consolidation, with underperforming businesses targeting mergers, and the sale and outsourcing of tower assets preoccupying mobile operators.
“While relatively insulated in their domestic markets, the Middle East operators are facing financial pressure in many of their overseas subsidiaries which could result in mergers, sales and tower asset outsourcing,” he said ahead of the conference. “However, the large operators still seek value through acquisition and new licences in emerging markets in Africa and Asia as well as attractive investments in digital assets to drive data innovation.”
A recent Deloitte report — Restructuring in TMT: Debt and Digital Disruption — confirmed that many of these financing themes continue to exercise operators and service providers throughout Europe. According to the report writers, Deloitte partners Jas Sahota and Andrew Grimstone, the industry faces an imminent wave of debt maturities from next year, which is compelling stakeholders to address capital structures.
“In addition to their debt maturities, TMT businesses will continue to face pressure from increasing competition, market and regulatory developments, technological change and further ‘digital disruption’,” they wrote. “Significant capital investment will be required to address many of these issues, adding further pressure to balance sheets.”
They urged operators to act decisively on several fronts, from developing new revenue streams and building closer relationships across value chains to re-engineering financial and operational performance indicators and welcoming innovative operating models as a means of improving cost efficiency as well as customer experience.
“In many markets, revenues and EBITDA are either flat or declining,” said Stefan Zehle, CEO at telecoms management consulting firm Coleago. “Yet operators have to acquire new spectrum to deploy and roll out LTE. This means free cash flow will decline while the balance sheet expands. Currently, returns are dipping below the cost of capital and this will not be sustainable, particularly if governments continue to set high prices for spectrum.
Operators are trying to take cost and capital out by selling towers or by going down the network sharing route. Network and even spectrum sharing is a hot topic and we have seen a steady rise in enquiries to support operators in setting up networking sharing deals and also in tower due diligence.”
Fede Membrillera, managing partner at Delta Partners, corporate finance, said that for large regional operators in the Middle East, financing as such is not the main issue. Instead, the challenge is really around value creation — managing existing portfolios, improving profitability and returns, and looking for new avenues for growth.
“Variations on financing and pricing differ more on an operator-by-operator basis, rather than country-by-country, and are driven by the local macro situations (political, economic and social) as well as by the availability and appetite of financial institutions on the ground, and other factors such as financial availability and pricing,” he said.
“Also, laws in the country that impact the repatriation of dividends or influence of a holding company into an operating company (where the ownership of the assets sits) would have an impact on covenants and pricing conditions."
In some countries — particularly in Africa — financial availability remains a big concern. According to Wafik Al Shater, group CEO at LAP GreenN, credit is generally available for telcos in Africa — for the right kind of projects such as vendor financing for network expansion or M&A.
“However, debt markets in smaller countries lack the depth required for large-scale financing in local currency,” he said. “That, combined with the fact that a number of banks already have high exposure in the sector, primarily due to the financing of tower companies, results in further reluctance to lend more to the sector. Add limited foreign currency supply in some countries and operators small and large have challenges operating in some of the fastest growing markets.”
LAP GreenN operates in a number of markets throughout sub-Saharan Africa, and Al Shater said credit availability varies per market.
“For example, it is more of a challenge to find financing options in South Sudan, as the country is not only newly established but also just faced a civil war,” he said.
“Recently, we have seen banks becoming more selective on who they lend to. Having the backing of a strong group of shareholders is a key differentiating factor, particularly for smaller operators.”
Cost-cutting is still seen as a key way to improve returns on capital. But at Delta Partners, Fede Membrillera said this is just one measure for delivering efficiencies and improving shareholders’ returns. Investing in growth is also crucial.
“Investment in technology such as 4G and into expanded service offerings might fall under the cost/investment axe,” he said, “although [for the time being] operators do not seem to be hesitant to invest in these prospective high-growth areas when it comes to growth and efficiency measures. For example, MTN is undertaking cost-cutting initiatives while at the same time making investments into high-growth e-commerce ventures.”
Membrillera said sharing infrastructure and utilising more existing assets will need to be factored into mobile operators’ strategies sooner rather than later.
“Optimising expenditure does not necessarily have to have a negative impact on services and the customer,” he said. “Mobile operators should not focus purely on cutting Opex but on enhancing the way they operate at becoming more efficient.
“Capex optimisation is probably the pending subject for them, making sure that there is a direct correlation between where Capex is deployed and a profitable top line. The true challenge for operators is to reduce their invested capital. Once a market becomes mature, investors will look for a return on that capital.”
Al Shater said that customer demand for and expectation of constant connections and data services is keeping up the pressure on operators who would ideally like to cut expenditure.
“To maintain competitiveness, it has become increasingly difficult for telcos to reduce costs,” he said. “Capex, for a typical state telco, tends to average around 10% of annual revenue, and range from 7% to 8%, on low, to 12% to 15% on high, depending on the business cycle, regardless of global locations. If cost cutting does take place, it tends to reflect on network coverage and quality and breadth of service, especially with new technologies entering the market.”
In African markets, according to Al Shater, smaller operators are struggling to secure the proper amount of financing — and this is making them less competitive.
“This could result in more consolidation, which would be a welcome development in highly fragmented African markets, where more than four players exist in some countries,” he explained. “It could bring about a positive change for smaller telcos, allowing them to benefit from their partnership, making the market more competitive and customer driven.”
Al Shater said that it is vital for operators to invest in opportunities that are specific to the region. In Africa, this means value-added data services such as mobile money. But he warned that, without proper financing, operators can quickly fall behind.
Conditions are more flexible in the Middle East, suggested Membrillera. “Technological innovation is at the core of the business, and financing restrictions, at least for leading regional operators, are not substantial enough to hinder technological investments,” he said.
“In particular, there is an increased appetite for operators to acquire assets within the digital space, to complement their presence across the value chain, acquire new capabilities and achieve valuable synergies. Markets seem to be rewarding this strategy — for example, the recent MTN/Rocket alliances in Africa and the Middle East will hopefully accelerate and further develop the nascent e-commerce market in region.”
While consolidation will continue in emerging markets, Membrillera said that, in the Middle East, this trend will apply mainly to smaller players as they look to build the critical mass that will make them attractive targets for larger operators who may want to partner with them further down the line.
“We will more likely see vertical integration as operators continue to acquire complementary assets and capabilities in the booming data market,” he said.
This will almost certainly lead to more network sharing — a trend that Coleago’s Stefan Zehle tagged ‘merger lite’. “It is generally not contentious as there are no competition concerns,” he said. “In contrast, outright mergers often attract competition concerns and might be blocked.”
With analysts predicting continued pressure on operators to innovate and deliver improved return on investment, financing challenges will continue to exert a major strategic influence over the next 18 months.
“Operators are expected to continue financing their operational and expansion needs in the medium term via a combination of internal cash flow generation and external sources,” said Membrillera.
“Capital markets are expected to play and increasingly important role in providing innovative financing solutions given the appetite for high credit quality telco names across the MEA, as demonstrated by recent issuances.
“Also, the disposal of non-core assets — particularly of passive infrastructure — will be another way to free up valuable cash and optimise capital structure.”