The troubled image of the telecoms sector is putting most investors off and the public markets’ treatment of telecoms remains punitive but private equity players are still interested and their money is more in demand than ever. Andy Sukawaty, president and chief operating officer of cable investment company Callahan Associates International, says: “There’s a real shortage of capital, things are very tight in the sector because it’s so out of favour.” Telecoms certainly has its attractions: low prices, good cash flows if you know where to look and the upside of growth potential, all elements that warm the heart of any deal-hungry venture capitalist. “I’m more excited about putting money to work in this sector now than I have been for the past four years,” says John McMonigall, head of Apax Partners’ telecoms team.
Can private equity investors avoid the problems of the last few years or does telecoms deserve its blighted reputation? The sector is suffering from a hangover of the craziness of the bubble years when telecoms were over-hyped and over-priced. James Brocklebank, a principal at Advent International who focuses on telecoms and IT, says past over-investment in the sector has led to loss of appetite on the part of some telecom investors and a dearth of new deals being completed, although deal flow has recently started to accelerate. Former deals, often completed at over ten times today’s values, are causing problems now. According to Robert Conway, head of PricewaterhouseCoopers’ technology, media and telecom team, although the shake down continues apace there are still too many players in some areas of the market. Another problem among service providers is over-capacity. However, the development of the market has been slower than expected with profits remaining elusive in some areas. One depressing example is the non-incumbent penetration of DSL (Digital Subscriber Line that uses ordinary phone lines to carry high-bandwidth information), which is still below 10 per cent.
Conway says to avoid repeating past mistakes private equity firms need to focus on how to get synergies from their investments, he tips roll-ups as one way forward. “They need to be creative, merge things to save costs and get positive cash flows.” One danger that investors must avoid is returning recycled capacity to the market, after buying it for next to nothing, when there is still an over-supply. The failure of telecoms companies to drive the market forward with new service offerings has been noted, McMonigall says: “New products and services must be based on real customer needs not the assumption that if you introduce something there will be an automatic demand for it.” Companies also became victims of their own aggressive forecasts. Now proven, solid performance is crucial. “In the past there was a lot of over-projection, you need forecasts you can absolutely hit and to keep hitting them, ” says Sukawaty. McMonigall also emphasises performance: “Companies need to be profitable in the true sense, not in terms of EBIT, but after tax.” Despite these warnings there are undoubtedly opportunities. “You make money at the bottom of the market, we’re pretty close so now’s the time to invest – but selectively where you can create value,” says Conway. As always, the real challenge for private equity players will be getting exits. With valuations unlikely to rise in less than 12 months it’s going to be at least 2004 or 2005 before IPOs or even trade sales are likely.
The biggest problem for telecoms companies, their debt, has been exacerbated by all of the issues already mentioned. Recently the industry has been beset by a stream of high profile collapses, mainly stemming from what is now recognised as over-borrowing. Even the most prestigious and previously stable names have been forced to implement large divestment programmes to reduce debt incurred partly by bidding for 3G licences. Many past telecoms deals were funded inappropriately with too much debt when realistically they needed more equity. Ultimately they found that as the market failed to fulfil its promise they couldn’t produce the cash flows needed to maintain the debt and bond holders have lost out. There’s been a number of forced refinancings and debt/equity swaps to redress the balance.
Debt multiples on current deals are much lower, in part due to reduced appetite for telecoms loans. Sukawaty says ratios have fallen from six times EBITDA to three or four times. This, together with more realistic performance predictions, will ease the pressure on companies. Banks’ reluctance to lend has meant that in some cases borrowing is now more expensive, although the cost of debt is very much determined on a deal-by-deal basis. Nevertheless, none of the deals private equity houses are looking at now are likely to be highly leveraged.
The telecoms sector is far from homogenous and while the current squeeze is universally painful different areas of the market have different prospects. So where are the opportunities? Market conditions mean virtually all vendors are distressed sellers, reluctant to sell because prices are so low and only putting things on the market because they really have to. Buyers have also been hesitant, anxiously awaiting the very bottom of the market and believing it’s better to do nothing than to do a deal at the wrong time. Conway suggests avoiding infrastructure deals in favour of applications and niche technologies. He says distressed companies are offering good opportunities, with divisions of over geared corporates such as Marconi well suited to buyouts.
Sukawaty is no stranger to the problems faced by Europe’s cable companies. This July German laws, which state that if a company’s market value falls below its debt level it must file for bankruptcy, came into effect and Ish, the North Rhine Westphalia network bought from Deutsche Telekom in 2000 was declared insolvent. Callahan is currently working with Ish’s lenders on a restructuring plan, the details of which are as yet undecided. Sukawaty says the North Rhine Westphalia operating company is still solid and operational, producing positive cash flows of around EURO200 million a year. GIMV, one of the investors in Callahan’s latest deal, Belgian operator Telenet, recently restored its stake to the original investment value, writing-off some EURO86.6 million. However, in August Telenet completed the EURO944 million acquisition of the cable activities of the Mixed Cable Companies in Flanders and secured a EURO1.25 billion loan to be used for refinancing.
“In cable just about everything in Europe is for sale,” says Sukawaty. He says Callahan prefers the northern European model, where cable is seen almost as a utility. Although revenues are quite low penetration tends to be high, producing good cash flows that aren’t vulnerable to competition from satellite. However, cable remains overshadowed by the problems of NTL in the UK and UPC in the Netherlands. He believes the telecoms industry is still a land of giants, making it difficult for private equity firms to compete in monopolised markets like the UK, France and Germany. However, consolidation is opening up opportunities in third, fourth or fifth operators and in Scandinavia, Central and Southern Europe. He also has faith in mobile wireless: “There’s been an over reaction to the level of competition [in mobile wireless], this area remains very strong.”
“The telecoms sector can be split into two halves, service providers and equipment suppliers. Both are hugely leveraged and in deep, deep trouble at the moment, ” says McMonigall. One of Apax’s existing telecoms investments is Damovo, which was formed in 2001 through the GBP312 million buyout of Ericsson Enterprise’s direct sales and service operations for voice, data and mobility products and services. McMonigall says the deal is a good analogy for equipment supply deals, providing Ericsson with much needed cash and solving its channel conflict problem. He says Apax is looking at another equipment supply deal at the moment. “I believe the alternative network supplier model does work, we’re looking at a number of opportunities in a variety of countries,” he adds. Apax already has one such company in its portfolio, Tropolys, a company formed from a group of local carriers in Germany.
Deals: past, present and future
Deutsche Telecom’s remaining cable television assets are currently on the market, with Apax Partners, Permira, CVC Capital Partners, Hicks Muse Tate & Furst and BC Partners all bidding. Liberty Media is also reported to be interested, despite having had a EURO5.5 billion bid rejected by the European Competition authority earlier this year. The deal is expected to close by year-end but reports have speculated that the successful buyer may face problems financing the deal. Banks already uncomfortable with the poor performance of telecoms loans on their books may be put off by the problems of Deutsche Telekom’s former North Rhine Westphalia subsidiary, sold to Callahan Associates. Deutsche Telekom, the largest phone company in Europe, is currently working to reduce its debt from EURO65 billion to EURO50 billion. The company has supposedly received offers in the region of EURO2.5 billion to EURO2.8 billion for the six cable television units, which it values at around EURO3 billion. Apax Partners, BC Partners and Carlyle have all been linked with Eutelsat, the satellite operator controlled by debt-ridden industry giants France Telecom, Deutsche Telekom and BT. The business is attractive because of its predictable cash flows and a private equity buyer may be favoured as a trade sale to satellite operators Intelsat or Panamsat is likely to trigger EU Competition antitrust ruling. French investment company Eurazeo withdrew from bidding earlier this year.
Advent International is one of the groups reported to be bidding for BTC, the Bulgarian State-owned telecoms monopoly. The country’s communications minister has expressed disappointment at the size of the bids, which are topped by Advent International’s offer of EURO200 million for a 65 per cent stake in the company. Earlier this year the Czech government withdrew Cesky Telecom from the market after private equity bidders, Blackstone and CVC Capital Partners, failed to match its price expectations. The deal ultimately went to Deutsche Bank in August after a change of government. Brocklebank says there is now potentially more money available in the private market than in the public market for many telecom companies so the remaining active private equity firms may now be a more realistic source of funds than trade buyers or an IPO. However, this has not necessarily made the private equity firms more aggressive in terms of the prices they are prepared to pay: there’s always likely to be a difference between how vendors value companies and what bidders ultimately fund. Conway says: “Private equity firms are willing to pay fair prices, they’re not uncompetitive.” Other near misses for private equity last year were UK telecoms operator, Energis and BC Partners’ bid for CS Communication & Systemes telecoms division in France.
Deals that did make it in the last 18 months include Damovo, Telenet and Eircom, which went to the Valentia Group, a consortium led by Sir Anthony O’Reilly and including Providence Equity Partners, Soros Private Equity Partners, Goldman Sachs and Eircom’s Employee Share Ownership Trust (ESOT). Irish telecoms company, Eircom, avoided over-gearing in the 3G crush and competition for it was fierce. The dominance of US private equity houses was maintained by Platinum Equity Holdings acquisition of the European operations of Alcatel’s enterprise distribution and services business. The company provided a strategic fit with NextiraOne, a US-based investment in a provider of network services. Earlier this year CDC Ixis Equity Capital, Charterhouse Development Capital and Caisse des Depots bought France Telecom’s transmission tower business, Telediffusion de France.
This year has not been without its casualties. UK cable company EON Communications, renamed Omne Communications, went into administration at the beginning of May. Its investors, TD Capital Communications Partners, Madison Dearborn Partners, Bank of Scotland and TD Securities, committed GBP265 million of debt and equity last year. Likewise, Storm, an optical switched service provider backed by Soros Private Equity and Merrill Lynch Ventures, bowed out of the market after raising $400 million.