Brazil: there is light at the end of the tunnel

The Brazilian panel held at the third annual TowerXchange Meetup Americas was moderated by Jonathan Dann, MD at RBC Capital Markets who run a thought-provoking session thanks to the contributions of Peter Bendall, SVP at Macquarie Group; Jim Eisenstein, Chairman and CEO of Grupo TorreSur; Mauricio Giusti, CEO of Phoenix Tower do Brasil; Andre T. Laloni, Managing Director, Head of Brazil and Southern Cone within UBS; David Porte, VP International at SBA Communications; Douglas Silva, Head of Operations Brazil at American Tower; Tom Staz, Managing Partner within Brazil Tower Company; and Aniko Szigetvari, Global Head of the TMT Group at IFC. Here is a summary of key findings from the 90-minute panel on Brazil, its current turmoils and future opportunities.

The current state of the Brazilian economy has had an inevitable effect on demand for new sites and co-locations. Panellists agreed that these tough economic conditions are posing serious challenges to carriers who are forced to reduce their capex, considerably shrinking the volume of business for towercos.

On one hand, the devaluation of the Brazilian Reais has impacted towercos expatriating funds out of the country, whereas on the other hand, towercos seeking to reinvest Reais in Brazil are struggling to do so in light of the reduced spending of carriers over the past twelve months, and the growing gap between buyer and seller valuations of independent developer portfolios.

Phoenix’s Giusti stressed that while Brazil is a large country with a considerable gap in terms of existing versus required infrastructure, 2016 is unlikely to be a positive year for the telecom industry as a whole. In fact, as a result of the macro-economic challenges, carriers are being more disciplined about their investments and exploring new forms of site deployment, which is resulting in a slowdown in network growth.

One way to protect towercos is to have strong underlying MLAs that guarantee continuity to the business. Although this aspect is once again being challenged by Oi who filed for a record US$20bn bankruptcy protection on June 20, days after the end of the Meetup. The impact of Oi’s bankruptcy - the largest in the history of Brazil - on the towerco ecosystem and on the overall telecom landscape is yet to be clear since the company has sixty days from the filing to present a reorganisation plan for the approval of its creditor, thus a rescue plan may yet emerge.

But even before Oi’s potential collapse, panellists agreed that 2016 wasn’t going to be a strong year for build-to-suit (BTS) activities and that 2015 ended up on a positive note only thanks to projects lagged from the previous year. On a positive note though, panellists stressed that this crises is to be treated as a temporary adjustment, and the industry needs to be patient since there are still tremendous growth opportunities in the Brazilian wireless market.

Drawing a parallel with the United States, panellists recalled that when the carriers landscape changed and the number of U.S. operators shrunk to four, the tower industry initially expected this to have a negative impact on the business but then found itself doing business with bigger and stronger players.

So while Brazil now faces the consequences of Oi’s bankruptcy, it’s important to remember that the number of carriers in a given market is less crucial than the creditworthiness of long term contracts with those carriers.

SBA’s Porte added that towercos with a long term view can only see Brazil as a very good market. In fact, while the short-term might remain “lumpy”, the future will present plenty of opportunities for the tower industry. Present times definitely pose challenges especially since most of TIM’s BTS activity is being developed by American Tower and Telefónica is focused on hoarding capital to its HQs back in Spain in order to pay dividends, hence is not deploying much network capex for the time being. But this will change since carriers will eventually go back to deploying more heavily, and they will need as much help from third parties as possible when the market normalises.

And while towercos wait for the market to get back to normal, the key factor that will determine their long term success is their discipline and adherence to the key principles and value of the tower business: working with quality in mind, ensuring paperwork is complete and correct, and negotiating strong contracts is what will make the industry succeed in Brazil and globally.

The panel went on to discuss the growth opportunities especially for private equity-backed firms that are now approaching their five-seven year anniversary (which often coincides with their exit). And while everyone agreed that consolidation among towercos is very likely, it seems clear that until the market conditions stabilise, many deals will remain on hold.

Times of forex volatility usually put a stop to transactions and this might require PE-backed companies to extend their horizons beyond the usual timeframe of their lifecycle. This may be unavoidable since it could be very tough in today’s economy to achieve the multiples upon exit which many set out to achieve.

Even if right now the whole telecom sector is being affected by macro as well as industry-related challenges, the panel that how data demand is still at its infancy, with 4G penetration around 10% and a long way to reach its full potential. According to the IFC, future investments to build the infrastructure needed in the near term could amount to US$3-7bn, meaning that in spite of the current outlook, it’s only a matter of time before market conditions improve and delayed projects are resumed.

In spite of its troubles, towercos stressed the positives of Brazil; its potential for future growth and high returns in comparison with regional standards. And this is particularly true for the likes of Grupo TorreSur and Brazil Tower Company that have looked beyond the country, but haven’t found good drivers to expand elsewhere.

One of the challenges related to the slowdown is that Brazil is now host to a wide array of build to suit (BTS) focused firms, with some of them too small to leverage any scale and struggling to get any business. So the temptation to drive prices down and beat the competition on the few projects being assigned in the country might be high. While driving BTS prices - as well as lease rates - down might offer some short term benefits, it will be value destructive in the long run especially for those towercos looking for a relatively quick exit at high multiples.

On the same note though, the panel noted that one of the positive outcomes of the current state of the market in Brazil is that there aren’t as many new towercos entering the country as we’ve witnessed in the past couple of years. So our hope is that those now active in Brazil realise the importance of remaining disciplined to ensure the industry gets out of this hiatus unscathed.

Right now, carriers might be more inclined to commit to BTS rather than co-locations especially since BTS might offer more favourable conditions for the anchor tenant.

According to some panellists, CTOs within Brazilian carriers are extremely business savvy and have tried to engineer the tower industry in their favour for some time now. So to give an example, a towerco might receive a request to build a new site next to an existing one that already holds two tenants. The rationale behind the request might actually be pricing since the BTS project could be more convenient to the carrier than a negotiation to co-locate on the existing site. Discounted rates for anchor tenants are the norm in many countries but if and when a towerco is focused on quality and long term business, it never makes sense to build adjacent to an existing site with capacity.

Building towers with little or zero prospect of a second tenant seldom makes business sense to towercos and their investors, especially since the high multiples this industry enjoys are based on the growth potential of each individual site.

The risks of devaluing the industry is particularly crucial for PE-backed towercos looking for good exits. In fact, if it’s true that most towercos aim at being acquired by one of the larger entities active in Brazil, deviating from proven best practices can only undermine the likelihood of a deal with any of them.

An additional aspect that needs to be taken into consideration, especially when looking at BTS projects, is the site acquisition and permitting phase which is extremely complex in Brazil (as it is elsewhere in CALA). Certain countries are taking this matter to the extreme and literally tearing down towers built without permits. And even if Brazil doesn’t reach this point, it does present a complicated framework that requires expertise and know-how to be dealt with. So once more, working with strong partners can ensure better results and, most importantly, all the required paperwork!

While the tower industry would very much welcome a move towards simplification in the permitting process, the situation isn’t likely to change especially due to sometimes conflicting dynamics between governments and municipalities; there’s a general lack of cooperation between them. Issues related to permitting are a serious brake to deployments but also to investments since those interested in fast turnarounds need to face the reality of dealing with the local bureaucracy.

Imagining the state of the market in 2020, panellists forecasted the number of subscribers in Brazil to have reached 300 million (60 million more than today!) by then, which is approximately where the United States is today. But the gap with the U.S. standards is still huge in terms of subscribers per tower (4,500 vs 1,000), average tenancy ratio (1.2/1.3x vs 2.5x) and number of sites (55,000 vs 140,000).

So if growth predictions are accurate, Brazil might need close to 100,000 new towers by 2020… And towercos to do the job!

While today’s Brazilian tower market might move slower than hoped, these predictions remind us why towercos aren’t engaging with additional services such as FTTT, backhaul and even energy. The path ahead for towercos is still focused on macro-sites, especially in Brazil, and this is particularly true since the multiples of the tower business are much higher than those of most additional services.

Similarly, the time isn’t quite right yet for alternative types of infrastructure such as small cells and DAS and in spite of much talking, the industry is still very much focused on adding towers to coverage-hungry Brazil.

Upon wrapping up, the panel commented on the possible entrance of Telesites in Brazil and the recent launch of Telxius. Panellists shared the hope that these organisations can contribute to the professionalisation of the tower industry and even become potential buyers. But while their acquisitive appetite remains uncertain, one thing is clear… Telesites and Telxius should operate and act like real towercos in order to add value to the industry.

In this business, just like in any other sector, there are guiding principles with regards to creating and preserving value. And now more than ever, the Brazilian - and CALA - telecom tower industry needs strong towercos able to sail through these challenging times and be part of the next wave of growth!

Brazil needs anything between 80,000 and 100,000 towers to become a world-class telecom market and to achieve even a fraction of these staggering numbers, it needs strong and capable towercos ready to do the job at the right price and conditions.