M&A in European communications infrastructure: multiples, opportunities and longevity

At TowerXchange Meetup Europe 2019, we brought together M&A experts Jonathan Dann, MD at Greenhill & Co, Kevin Smithen, MD at Digital Colony and Paolo Crochetti, Head of Institutional Affairs at EI Towers. Although their remit was to discuss M&A in Europe, the panel all felt they needed to address the state of the market and the valuation of European towers to contextualise the conversation, resulting in a wide ranging conversation between highly commercial leaders in the industry. 

Although towers look very similar on a spreadsheet, investors want assets with growing cashflows, and the believability of forecasts can start to be questioned, particularly in some European markets, where there are more neutral host operators than tenants. 

Paolo Crochetti described how they put in place a target to increase their tenancy ratios. Over the last six years they have closed 42 M&A deals with small companies who may have had as few as two or three towers, but some with as many as 20 tenants. They have customers from digital TV, public safety, IoT networks and more. The legacy from the broadcasting sector means they’re accustomed to managing different expectations and different customers. EI Towers went through two phases of acquisitions: one from 2004-2008, then after a break their M&A activity resumed again in 2013 until the present day. During the first round of acquisitions they acquired more single tenant towers but today they’re focussing on mature portfolios and the growth to be had in these towers comes from reducing costs rather than increasing the number of tenants. 

Kevin Smithen from Digital Colony said that value comes down to creating a fast and flexible turnkey approach to provide a variety of solutions. Infrastructure like edge data centres, CRAN, small cells, rooftops or billboards will be increasingly important to provide coverage in a 5G world. In the past, towercos have struggled when they didn’t focus on their customers, with the ‘Big Three’ in the US facing a backlash as we move from 4G to 5G technology – something which Digital Colony has been able to profit from. In Europe there are customers who are not healthy even with 50-60% EBITDA margins and $50 ARPUs, so the approach must be more customer friendly to provide solutions and lower costs. The European market is much less focussed on network quality because it’s seen as a ‘given’ in most market and more on driving returns on capex. 

The panel was sceptical about the potential for growth in the French market, suggesting there may be as few as five years of predictable earnings, despite existing contract lengths. With five towercos in France already, and just four MNOs, plus rumours that Orange may be gearing up to launch their own towerco, the only growth in is build to suit. There’s also a significant risk of consolidation between two French MNOs, taking the number of tenants down from four to just three. The panel said they saw ‘value destruction’ in the French market, and stated that it’s not setting a good precedent for the rest of Europe. Kevin Smithen sees Europe as the most profitable market for towers in the Western world, as there’s plenty of capital, but European markets can only support two or three independent towercos without there being a negative impact on returns. He foresees a lot of M&A taking place over the next decade, with perhaps only three independent towercos in the European market ten years from now. 

Moderator Darragh Stokes argued that, despite the panel’s concerns about sustainability, the level of interest from active investors has never been so high, and there’s never been more exuberance in terms of valuation. Jonathan Dann explained that the valuation of the larger towercos in the market is driven by the expectation of consolidation. Deals between EI and RAIWay, INWIT and Vodafone and acquisitions by Cellnex are driving an investment hypothesis which is raising the interest of public markets at the moment. 

Paolo Crochetti stated that there is a tremendous interest from investors and a lot of money on the table, but the reality is that not all towers are the same, just as not all operators are the same. Industry players are in the industry for the long term, expending effort, investment and time, whereas investors are looking for much quicker returns. 

Kevin Smithen agreed, saying that customers are looking for longer term solutions and won’t see a return for seven to ten years, well beyond the investment horizons of many investors. MNOs want to know they have a trusted counterparty who will be there for the next decade, rather than being there for rollout and then disappearing. He feels investors underestimate how important these relationships are, and how tough this can be in a recession, particularly with too much leverage, counterparty credit and sub-investment grade tenants. He sees the tower business as becoming more operationally intensive, and requiring more and more specialist expertise. 

Paolo Crochetti gave an example of the risk in convergence, saying they’ve just bought a small DAS company. If a company makes €100mn revenue then a €1mn DAS company is not a problem to their business model. But if you assume that in five years 50% of the company’s revenue comes from DAS, the lifecycle of the equipment becomes an issue. A tower’s lifecycle can be as much as 40 years, but the first generation of DAS technology can’t be expected to last more than five years. Investors haven’t understood that the capex cycle for new services is vastly different to that of traditional towers. 

Another challenge raised by Darragh Stokes was that of manpower. He pointed out that a submarine fibre business could consist of a few desk-based employees, whereas DAS and small cells are much more manpower intensive, with a five year refresh cycle. 

Kevin Smithen agreed that it won’t be possible to harvest dividends out of the box, and that the money will have to be reinvested. Investors need a long term perspective and in the case of outdoor small cells they’ll need to be supplemented with fibre and datacentres. The economics of small cells in the US barely work, needing a lot more connections on the fibre point and meaning MNOs alone won’t provide the kind of returns needed and infrastructure owners will need to serve different customer bases. 

Jon Dann said that as you add in complexity moving from pure towers to towers plus fibre, the shape of the business changes. He referenced FTTH start ups, which have grown from 50 to 500 people in 12 months, needing new management who can develop a larger business, rather than needing an entrepreneurial skillset. Towercos will find themselves going from dealing with four MNOs to thousands of enterprise players, a lot of these factors are glossed over in business plans. 

Looking back, Paolo Crochetti remembers that there was no implied 4G valuation in EI’s multiples during the move from 3G to 4G, and he doesn’t feel the shift to 5G is reflected in their multiples today. He anticipates seeing the valuations included if MNOs work out a better way to monetise 5G, and the general feeling from European policy makers is that they’re happy with their success in reducing the cost of mobile connections for consumers, and they aren’t making the connection between lower ARPUs and MNOs’ reluctance to invest in deploying 5G networks. 

Kevin Smithen feels that tower valuations in Europe are very high. There’s a lot of scepticism towards 5G, which will be underwritten through a three, five or seven year investment thesis and certainly not in the short term, which is very different to the US market. He feels that 5G is, however, priced into recent multiples in the fibre space, based on the view that metro fibrecos will own the small cell opportunity – and that this has driven values up considerably.