PhilMarshall-113NEW ANALYSIS: The telecom tower industry is seeing tremendous growth as investors seek opportunities to capitalise on the burgeoning mobile industry and service providers raise capital for network expansions. Every month deals are being struck in virtually every region across the globe.

We believe that this will continue for the foreseeable future and within the next five years the lion’s share of telecom towers will be owned and operated by independent tower companies. Several notable deals this year include:

• In June America Movil CEO Daniel Hajj indicated it had plans to divest its 28,000 towers in Mexico. While this divestiture supports regulatory demands for America Movil to reduce its market dominance in Mexico, Hajj also indicated that it was considering tower divestures in other regions as well.
• In July Tower Besama announced plans to acquire XL Axiata’s tower assets in Indonesia, and in Africa Airtel sold 3,100 of its 15,000 towers to Helios. Also in July China Mobile, Telecom and Unicom announced a joint venture with $1.8 billion in funding that will aggregate the 600,000 tower sites of the three companies for network sharing purposes.
• In August Etisalat Nigeria announced the sale of over 2,000 towers to IHS holdings, BSNL struck a leasing deal with Reliance Jio for 4,000 towers in India, and Viom announced potential IPO plans.
• In September IHS agreed to acquire 9,000 of MTN’s towers in Africa and Verizon Wireless indicated that it is planning to sell the remainder of its towers.
• This month Tower Besama announced plans to invest in Telkom Indonesia’s tower subsidiary, and Oi announced plans to divest 3,000 towers in Portugal.

While the fundamental value proposition for tower outsourcing is relatively straight-forward, the structure and viability of individual transactions require close scrutiny. The value proposition for service providers is to strategically reallocate capital and operational resources tied up in physical infrastructure. Tower companies are compelled to invest in mobile tower sites, since they have relatively predictable cash-flows that benefit from the expanding mobile industry.

Balancing act
As service providers evaluate tower transactions, they must balance the benefits of reallocating capital and operational resources relative to the associated costs. These costs include:

• Financial costs, which are essentially the increased operational costs associated with a transaction relative to the purchase price of the towers. These operational costs can be estimated by the monthly rent for tower space, less the operational costs passed from the service provider to the tower company. In the absence of other considerations, service providers should compare the financial cost of proposed tower transactions relative to that associated with other sources of capital. In cases where financial costs are excessive, service providers might opt to divest their tower assets into subsidiary organisations. Commonly these subsidiaries benefit from improved operational performance, decreased tax liabilities and increased tower valuations in cases where tower space is leased to other service providers.
• Organisational costs. Tower outsourcing invariably impacts network operations. This impact is particularly acute when new technologies like LTE and VoLTE introduce operational instability and require extensive network modifications. Tolaga learned from interviews with network operations executives at several tier-1 service providers, which are engaging in the optimisation of their LTE networks for VoLTE, that tower outsourcing can hinder optimisation efforts because of inadequate governance regimes and unfavourable pricing models. These difficulties must be anticipated when outsourcing deals are negotiated.
• Market costs. Tower outsourcing has traditionally been derided for reducing the competitive advantage of dominant service providers or those that have the largest network footprint. This has become less of a concern in recent years with network maturation and zoning rules that favour tower infrastructure sharing. Furthermore, infrastructure sharing is becoming necessary as data services challenge the economics of the mobile industry. We believe that it is these market conditions that are currently fuelling accelerated tower outsourcing activity.
As independent tower companies seek reliable free cash-flows from their investments, they are confronted with a variety of technical, market and regulatory challenges that impact risk adjusted return requirements. In some cases, these returns can be generalised to particular regions. For example, American Tower typically seeks between 10 and 15 per cent internal rates of return (IRR) in Latin America and between 15 and 20 per cent in Africa. However, individual transactions also require careful scrutiny, particularly in cases when tower companies are investing in new markets. Companies should consider six factors.
• Zoning regulations increase the intrinsic value of incumbent towers in areas where the towers cannot be easily substituted. However, these rules may constrain a tower company’s ability to modify towers to meet future market demands. Furthermore, countries like Chile have recently introduced new and stricter zoning regulations that are being applied retroactivity to existing towers.
• Mobile service provider consolidation is inevitable in markets that have more than four dominant service providers, such as India. When consolidation occurs, the number of candidate customers for each tower decreases, but the industry as a whole normally benefits from healthier conditions. Since consolidation results in modest cell site rationalisation, the viability of each tower in an investment portfolio must be assessed in the context of market consolidation scenarios.
• Foreign ownership rules and tax obligations are subject to change, particularly in markets where the tower industry is growing fast and is of political significance. Some markets like Indonesia, restrict foreign investments, while others like India have moved to embrace it. However, Vodafone-Hutchinson’s nearly five-year tax dispute with the Indian government is an illustration of the potential challenges facing multinationals as they broaden their investment tentacles.
• Radio spectrum licensing creates demand for overlaid network equipment that results in tower lease amendments, but reduces network densification demand. The inter-play between network densification and overlays can have a tremendous impact on tower demand. For example, tower companies in the US are seeing an average increase of $600 to $700 per lease amendment for LTE, approximately half of the value of each tower collocation associated with network expansions.
• Land ownership. Normally towers have ground leases for the sites where they are constructed. In some cases, tower companies are vulnerable to poor land ownership laws and the potential for ground lease investors to manipulate rental fees and lease terms. Since ground leases can be as much as 40 to 50 per cent of the tower rental per broadband equivalent customer, the leases can have a tremendous impact on the profitability of tower portfolio investments.
• Advanced radio technologies such as multiband antennas and high performance power amplifiers enable service providers to consolidate radio equipment and reduce tower rental obligations. Typically these technology advancements impact network overlays and are of limited consequence to incumbent systems. However, in cases where service providers opt for “rip and replace” upgrades, the impact of advanced radio technologies can be more problematic for tower companies.

Market dynamics and risk factors have a tremendous impact on the valuation of tower portfolios. The chart below demonstrates that for a tower portfolio in Latin America an average tower transaction price of between $160,000 and $180,000 is needed for the service provider to achieve a 6 to 8 per cent effective cost of capital (financial cost). Within this price range, the tower company would achieve an internal rate of return (IRR) between 12 and 15 per cent, and 15 and 19 per cent with an average of 2 and 2.5 collocations per tower, respectively.

Chart 1 (click to enlarge): Sensitivity analysis of proposed tower deal in Latin America
tolagaTelecomTowers0814fig1
Source: Tolaga Research, Telecom Tower Transaction Analysis, 2014

The tower industry will continue to be vibrant for the foreseeable future as service providers, tower companies and their investors jockey for favourable positioning in the mobile industry. Given the dynamics of the mobile industry, tower investments are prone to volatility and will require careful due diligence on the part of investors. This is not only the case for emerging markets, but also mature markets where valuations are particularly sensitive to mobile market growth expectations.

By Phil Marshall, chief research officer at Tolaga Research

The editorial views expressed in this article are solely those of the author and will not necessarily reflect the views of the GSMA, its Members or Associate Members.