TOWER ASSETS IN AFRICA: MOVE NOW BEFORE IT'S CHECK-MATE

 

August 2010

 

Authors		Joao Sousa - Partner
		Chris Datta - Principal
		Dimitris Lioulias - Manager
		Delta Partners Intelligence Unit

 

 

 

 

 

 

 

KEY HIGHLIGHTS

 

 

 

TOWER MARKET IN AFRICA IS HEATING UP

 

 

Millicom Ghana has sold its towers in Ghana to Helios Africa. However, as part of the deal, Millicom Ghana (operating under the Tigo brand) will retain minority interest in the entity.

 

Millicom is expected to formally launch its tower sale process in Tanzania and DRC.

 

Cell C, South Africa's third-largest operator, is close to finalising a tower-sharing agreement under which it would sell some of its tower facilities and then lease them back. The operator is reported to be in discussions with tower companies such as Eaton Telecom.

 

Several CDMA players in Nigeria are shopping for their tower assets.

 

Despite the above activity, there has been an absence of a large multi-operator pan-regional tower carve-out.  In our prior predictions, we had expected to see the emergence of some type of merged InfraCo model in Africa involving some of the regional heavyweights. However, indications of operational and deal complexity led some players to be more opportunistic in their approach and act on a country-by-country basis.

 

For the moment, the entrance of Bharti Infratel through the acquisition of Zain Africa, promises to be the most compelling competitive story in the African tower space. Bharti Infratel is likely to launch tower companies across 8-12 countries over the course of 2010-2011.

 

Meanwhile, MTN Group seems to be the next most advanced operator likely to carve out its assets. However, they will potentially partner with someone who can help them operationalize a new towerco entity to capture and maintain control of their assets. Such carve-outs could likely occur in stages across their country footprint and could potentially exclude certain countries.

 

While we have yet to see a groundbreaking tower deal, large operators are beginning to realize that tower sharing is a strategic way to secure value.  A first wave of tower sharing deals has materialised, and more are in the process of being negotiated. This, in many cases, is a precursor to the carving out of tower assets, as higher tenancy ratios make them more valuable. The recent agreement between MTN and Telkom for tower sharing in South Africa exemplifies this logic.

 

Aside from the network operators, Helios Africa, American Towers and Eaton Telecom are the most active parties looking to acquire tower assets. They have been exploring investments in African markets and tower portfolios, each wanting to become the leading African tower consolidator over the next two to three years.

 

While most telecom groups have subscribed to the concept of tower sharing, some large groups are still sitting on the sidelines in terms of potential carve-outs or asset sales.  However, once Bharti, Millicom, MTN and possibly Vodacom make their moves, the remaining pan-African groups will be in a precarious situation as they would have lost first-mover advantage, and would need to determine their long-term tower strategy.

 

 

Impact of Bharti, Millicom, MTN and Vodacom

The tower landscape is set to drastically change. In the short term, Bharti Infratel is expected to launch tower operations in 4 or 5 countries. Millicom is expected to carve out towers in 3 countries, MTN is on the verge of implementing its African tower carve-out strategy in 2 countries and Vodacom/Vodafone is strongly considering its options in 3 countries. In the next 12 months, the vast majority of African countries are likely to have experienced some form of a tower deal.

 

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In each of the individual markets where these four operators execute carve-outs, the remaining mobile operators will need to decide what to do with their tower portfolios. In most markets, these four operators are either positioned as market a leader, which means that the remaining operators are unlikely to be tower consolidators. Therefore smaller operators may need to consider selling their assets to remain competitive. In such a scenario, time will be of essence as asset value will decrease depending on how long the small operators take to make a decision.

 

Time-to-market in transacting a tower carve-out or asset sale is important for three reasons:

 

Demand for towers from potential consolidators only exists until the big deals in the market have transacted.

 

Current tower valuations will factor in demand for space due to data related network expansion (3G and LTE).

 

Potential for new licenses (mobile and fixed wireless) is still a possibility in many countries and will be factored into tower valuations, especially for the largest tower portfolios.

 

 

The message is clear: operators must execute their tower strategy soon because the cost of inaction or delayed implementation is high.

 

Some regional operators have not placed tower strategy at the top of their agenda because they feel it is not a critical lever to gain competitive advantage in a growing market – but they are wrong. Tower sharing is a significant tool to mitigate margin squeeze as operators address the lower end of the customer pyramid and potentially the only way to make rural network roll-out profitable in most African countries. This in effect means that operators do not necessarily need to sell their towers to capture value. However, once one or more players in a market move towards tower sharing, the remaining players must get in the game to remain cost competitive.

 

 

Considerations for Operators Uncertain Of the Tower Business Potential

 

Operators, who are uncertain of the value potential represented by tower sharing, should consider three questions - and their relevant value implications:

 

Do I want someone else on my towers?

 

Do I manage my towers by myself?

 

Do I sell my towers?

 

As Exhibit 2 suggests, there is value to be extracted in all three options. However, operators have to try to capture at least two of these three value levers, if they are to realise a significant part of the value upside.

 

Despite, the above value levers and their positive impact on operations, operators are often concerned about two potential threats:

 

Risk of market share loss, if they facilitate the expedited entry of a new competitor

 

Loss of network control and related quality issues

 

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As previously explained in the first Delta Perspective on Towers (Tower sharing in the Middle East and Africa: Collaborating in competition), the market share loss is a very short term consideration, which will in turn be mitigated by the financial benefits offered by tower sharing. Moreover, the ‘market share loss’ concern can best be compared to the ‘prisoner’s dilemma’ situation, especially in the case where more than one large network is present in the market. Unless a solid agreement can be achieved with all existing operators for excluding new entrants’ access to their networks, then it is highly likely that one of them will enter into a network sharing or national roaming deal. Those operators who are slow to react will end up with both loss of market share and loss of an additional (high margin) revenue stream.

 

On the other hand, the operational concerns of network quality can be addressed by selecting experienced third parties as outsourcing partners and agreeing on comprehensive SLAs.

 

 

Tower deal attractiveness: Market and players dynamics

 

 

 

Market related dynamics

 

A market is considered attractive for the tower business when there are expectations of new licenses to be issued and/or expectations of additional network expansions. Markets are considered even more attractive when these conditions are coupled with tenancy ratio increases, relatively constant rental prices and constraints in building new towers (e.g. Ghana).

 

However, new licenses do not automatically translate into higher tenancy ratios. Especially in caseswhere these licenses refer to 3G and LTE concessions, even though the number of antennas grows, a large number will be collocated with operators existing GSM network infrastructure, limiting the potential for a high tenancy ratio.

 

Likewise, for capacity expansion, especially in urban settings, the flexibility to collocate (i.e. the ability for a Towerco to extract additional tenancy ratios from that player) is very limited due to restrictions imposed by radio planning requirements.

 

Lastly, if network expansion is focused towards rural areas, building new towers could cause a Towerco to struggle as tenancy ratios will be low.

 

 

Player related dynamics

 

The different players in the tower market should follow a different game plan to capture the value potential.

 

For the leading players in a market, owning larger networks is likely to translate into higher tenancy ratios; especially in the case a new player enters the market. New entrants will choose to share towers with the market leaders both to leverage the leaders’ widest network reach and to tap into potential volume discounts. Moreover, leading operators can enhance their value proposition towards these new entrants by offering highly attractive national or regional roaming agreements.

 

Finally, leading operators should ideally decide to sell their assets when they have a very good view of what their future network will look like so that they ensure appropriate contract terms and SLAs are put in place. If for example operators do not properly assess the requirements imposed on the network by increased mobile data demand, this could lead to a situation where mass replacement of microwave transmission with fibre may be needed. The resulting dependency on the Towerco to perform this replacement in a timely and cost efficient manner may be more than any operator would be prepared to accept. Such a situation is exacerbated in the case where there is only one Towerco in the market and is likely to behave in a monopolistic manner.

 

For smaller operators, the game plan will include taking advantage of the capacity constraints of large players, especially in urban areas, and attracting new entrants to their own towers. However, given the size of the larger players’ networks and the relative benefits of sharing with only one operator, the demand that these small players can attract is limited. However, in cases where large operators have not started renting their towers or carving them out, small operators have a window of opportunity to attract rental income and also benefit from an attractive valuation for their tower assets should they decide to sell quickly. Additionally, if small operators sell to a large Towerco, they can leverage the Towerco’s scale to enhance their own network performance and reach.

 

As for the tower companies, leveraging operational expertise and managerial best practice will be part of the sales pitch to attract newcomers as tenants. However, they will have the best chance to achieve an advantageous deal if they have a first-class portfolio of towers to address the needs of such new entrants. This is something tower companies can best secure by acquiring the tower portfolio of a market leader. In addition to this, should the opportunity arise, Towercos ought to increase their portfolio by buying out small players and by building new towers.

 

It is therefore crucial for all players to properly assess the tower business potential within the context of each individual market. In order to achieve that, it is important to analyse the following:

 

Accessible supply of towers

 

Addressable demand for new towers (not the same as demand for new antennas)

 

The following section outlines a comprehensive methodology to help players interested in the tower space to properly assess the size of the opportunity and develop their strategies on tangible, analytics-based recommendations.

 

 

Assessing market potential for towers

 

 

Delta Partners' view is that in order to come up with an accurate assessment of market potential of towers, an analysis must be done that takes into account both ‘addressable demand’ and 'accessible supply'. It is these two drivers which ultimately influence the competitive dynamics and pricing within the tower industry of a given market.

 

'Addressable demand' is defined as the demand for towers or 'Points of Service' (PoS) in the market. The demand is adjusted to take into account that some of the consolidated PoS demand may never actually hit the market. For example, operators who have their own carve outs (e.g.: Bharti Infratel) will likely self-fulfil most of their demand. Only a residual share of their PoS demand would affect the supply/demand dynamics of the market.

 

On the supply side, we only take into account 'Accessible Supply'. Similar to Addressable Demand, we only include the tower slots which are actually accessible to the market. To estimate accessible slots, we take the total tower slots in the market and subtract those which are already used along with those which are reserved for specific future demand (e.g.: slots reserved for 3G for existing 2G clients).

 

	Exhibit 3
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Tower fair share: Key driver for co-location potential

 

 

Delta Partners contends that in the long run, the best way to understand how much addressable demand a tower player can capture should be based on their market share or 'fair share' of the accessible slots in the market. This is because tower slots are essentially a commodity where pricing tends to be quite similar and service levels tend not to vary among competitors. Therefore, all things being equal, tower slots competing for demand should win on average, a proportion equivalent to their 'fair share'.

 

The main strategic implication of the 'fair share' concept is that size is key. Only the big players will win in the market and therefore consolidation will take place, leaving the small operators with little choice but to sell their portfolios.

 

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Factors affecting 'Addressable Demand' and 'Accessible Supply'

 

Overall, Delta Partners expects 'addressable demand' for 'Points of Service' (PoS) to grow between 6-10% across African markets during the next five years. However, there are several market forces which could impact both demand and supply, positively or negatively.

 

At the same time, the impact of market forces will also be evident on 'accessible supply'.

 

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Conclusion

 

Plan forward for mobile operators

 

For large pan-regional operators who hold leading positions across several markets, our view is that they should aim at forming a towerco spanning multiple countries and potentially try and include other operators as well.

 

This offers the greatest value creation potential while not limiting long term exit options. However, such a solution requires considerable effort and coordination and could slow down the process - as it appears to have done so far.

 

In order to be successful in any market, large operators need to consolidate their tower space as much as possible in order to increase the ‘fair share’ and secure attractive co-location ratios. This trend has become apparent in more developed tower markets such as India, where major consolidation is under way - example the recent merger of Reliance Infratel and GTL. If the large operators are not yet ready to sell their towers, they should at least share them.

 

In our view, smaller telecom groups or those with lower market shares, need to look to sell their assets now and gain first-mover advantage. We see no clear benefit in them holding onto their towers in the medium to long term. Smaller operators can look to merge their towers into another Towerco, retaining an equity stake if they want to participate in some of the financial upside.

 

 

Path forward for equity investors

 

Given the current selling price of towers in Africa (upwards of US$150,000 per tower) and expected competition to gain high ‘fair share’, we forecast that it will be difficult to earn equity returns above 25% in most markets. The opportunity may lie in marginal markets where political or economic instability presents higher barriers to entry and lower entry valuations. Beyond the obvious valuation considerations, equity investors should also consider the need for an established management with experience and on-the-ground presence to physically run operations.

 

The key point for equity investors is to become part of a platform which can operate in difficult African environments and has the track record to win deals. Companies with experience in Managed Services can be excellent potential partners even if they have limited previous experience in owning towers. Finally, it is important to realise that market size alone is not what will drive returns, instead achieving greater scale (i.e.: high ‘fair share’) is what best guarantees success.