**UPDATE** Telefonica has agreed to sell a 40% stake in Telxius to KKR, beating bidders including GIC Private, CVC Capital Partners, and Ardian, who were all believed to be interested in the asset. The deal is valued at €1.3bn and includes a call option for 62mn Telxius shares for €790.5n.
Investors were underwhelmed by the package of infrastructure assets Telefónica brought to market and, despite a downward recalibration of valuation, ultimately rejected the proposition. What specifically did they not like about Telxius, what lessons can be learned, and what next for Telefónica’s towers?
It’s no secret that Telefónica has been increasingly keen to restructure their balance sheet, relieve debts in excess of €50bn, and raise capital for dividends to prop up their valuation. With their effort to raise capital through the proposed sale of O2 in the UK to Hutchison blocked by the European Commission, Telefónica brought forward plans to monetise a 40% stake in infrastructure carve out Telxius, which had been inaugurated in February 2016.
Telefónica bundled 31,000km of subsea cable, plus all 11,000 of their towers in Spain and a selected 2,350 of an estimated 14,318 sites in Germany. The package of European towers was supplemented by 1,655 towers in Brazil, 849 in Peru, and 328 from Chile.
Why did investors balk at Telefónica’s €3-3.75bn valuation of Telxius?
One obvious concern voiced by investors TowerXchange has spoken to was the challenge valuing the subsea cable component of Telxius, from which 60% of the infraco’s revenues were derived. Investors are simply less familiar with subsea cable businesses, and what comps there were suggested a valuation around 7x, less than half the multiple Telefónica hoped their towers were worth.
If Telefónica were to monetise a consolidated subsea and tower business, would the valuation discount necessitated by the cable element bring the tower valuation significantly below the multiple a company like Cellnex might pay for just the towers in a sale and leaseback?
And what value did Telefónica place on retaining control? Evidently a gap emerged between what Telefónica thought the business was worth and the value the capital markets would ascribe it.
Some investors cited a concern as to why Telefónica was retaining some towers yet bundling others into Telxius; were strategic, high value towers being retained on the MNO’s balance sheet? We think not - the 11,968 sites Telefónica retained in Germany were mostly (perhaps entirely) rooftops rather than ground based towers, and rooftops are notoriously difficult to co-locate at good margins in Germany due to landlord demands.
Another concern: why were so few LatAm towers transferred to Telxius? TowerXchange feel there is justification in excluding Argentinian towers from Telxius as the depreciation of the assets, combined with devaluation of the local currency, and an unfavorable tax regime, makes the monetisation of towers difficult in the immediate term; meanwhile the government stake in Telefónica’s operations in Colombia likely precluded the inclusion of those towers.
Ultimately the value of any towerco is a sum of the value of their contracts and, among other concerns, the Telxius MSA required that all contracts be renegotiated if Telefónica’s stake fell below a certain percentage. Even if Telefónica intended to retain a majority stake, valuation benchmarks against other public towercos are less meaningful if there is no prospective future sale to a strategic. And a strategic could not buy Telxius at full value if all the contracts would need renegotiating.
Tower industry insiders were quick to point out that most of Telefónica’s Brazilian towers had been offered to towercos in their sale and leaseback transactions, and only remained on Telefónica’s books as a result of being swapped for better sites. One simple illustration of this: many of Telxius’ Brazilian towers are relatively small and lack the structural capacity to accommodate heavy lease up.
Finally, the Telxius IPO looked hasty. Global comps suggest it takes one to two years for new carve out towercos to tidy up their asset register, identify and upgrade (where necessary) sites where there might be pent up demand, and to prove their ability to lease up sites and sweat the assets. Telxius was simply not given long enough to prove its worth as an independent entity.
Timeline of the creation and cancellation of Telxius
What Telefónica might do next
So what next for Telefónica’s towers?
While it might be tempting to fall back on the security that the IPO was the victim of macro-economics (Brexit and the surprise US election result combined to undermine investor confidence in equities across every sector), TowerXchange don’t think that is the sole explanation. The towerco asset class remains in vogue, and investors would have welcomed a viable multi-country independent towerco platform to compete with Cellnex in consolidating European towers. With a different package of assets, and a revised MSA, Telxius may have found the capital markets more receptive.
Telxius still looks like a good play in the long term; tidy it up and lease up the assets for a year, reengineer the MSA – if investor sentiment towards Argentina continues to improve (particularly if the government responds to pressure to ease certain taxation conditions adversely affecting tower valuations), maybe add the Argentinian towers. If there are other ground based towers in Germany that could be included, they should be included. Consider extracting the submarine cable business but, if it is to remain in the bundle, perhaps focus on investor education to help them get more comfortable with the mash-up.
Telxius could reboot their IPO in 2017-18 and list successfully for a similar valuation which they sought in October 2016. Telefónica has appointed a capable management team at Telxius – I for one am glad we’ll have the opportunity to see how they can add value before the asset is monetised.
In the meantime, if Telefónica needs to raise some cash, there will be no shortage of independent towercos queueing up to cash in their Spanish, German, Peruvian, Chilean or Argentinian towers!
Transferrable lessons learned from the cancelled Telxius IPO
If MNOs want to carve out towers, retain a controlling stake yet utilise the capital markets to release some capital, they should allow at least 18-24 months to establish their modus operandi and to prove the concept. Telxius follows an underwhelming debut of America Movil’s towerco Telesites at the turn of the year, but both ventures might have elicited a more favourable response from the capital markets had management teams been bedded in, with the first wave of improvement capex deployed and the sites proactively marketed for a couple of quarters, enabling would-be investors to quantify pent-up demand for co-location.
Telefónica were not alone in having to cancel the IPO of a carve-out towerco in 2016. Turkcell suffered the same fate. With 20:20 hindsight it can be easy to blame investment bankers for inflated valuations, but the fact remains that an operator-led towerco is a very different investment proposition from a pureplay independent towerco. Cellnex and American Tower are imperfect valuation benchmarks. The valuation of a towerco is a function of the investibility of it’s MSA, and if the MSA grants favourable terms to a controlling-interest retaining parent MNO, such as preferential lease rates, most favoured nation clauses, RANsharing provisions or substantial reserve space, then valuations should rightly be downwardly adjusted.
MNOs often seem to be tempted to bundle a variety of infrastructure assets into these carve outs to maximise scale. If you’re creating, but not monetising, a newco infraco you can put anything you want in the package. But bear in mind that there are hundreds of investors with a taste for towers, who are comfortable valuing passive infrastructure, and who currently value it highly. Why dilute the premium product?
Stop press: Telefónica in discussion to sell minority stake in Telxius to one of several funds - report
On the eve of publishing this Journal, El Economista broke a story that several investment funds were in negotiation to acquire a substantial yet minority stake in Telxius, including usual suspects KKR, Brookfield and Blackstone, as well as Apax and CVC. Telefónica evidently wishes to retain control. A valuation of €1.3bn for 40% equity has been mooted.
