What investors want

Six of the foremost minds in telecom tower investments shared valuable insights at the recent TowerXchange Meetup Americas, and we’re pleased to share some of those insights here. Moderated by experienced tower deal-maker Marco Cordoni, Senior Partner at Analysys Mason, the panel included Mark Johnson, then an MD at The Carlyle Group; Ryan Lepene, MD at Peppertree Capital; Zaid Alsikafi, MD at Madison Dearborn Partners; Eric Crabtree, the IFC’s “tower guy”; and Patrick Tangney, Chairman of Alcazar Capital whose subsidiary ASEAN Towers owns Irrawaddy Green Towers in Myanmar and Golden Towers in Vietnam.

This carefully chosen panel represented a breadth of different tower investment appetites and criteria, reflecting the differing maturity of towerco proposition in which each typically invests.

For an investor in relatively mature, proven platforms like The Carlyle Group, the key was finding great management talent and working backwards from there to evaluate the specific market and opportunity, in search of returns in the low to mid 20’s. Such later stage investors might be able to write cheques of US$250mn – US$1billion, and they tend to be more patient, allowing a deal to take perhaps seven or eight years to reach the targeted multiple, riding the ups and downs of currency fluctuations, before reaching an exit opportunity.

A firm like Madison Dearborn Partners might be interested in opportunities at a slightly earlier stage; in their case smaller towercos in LatAm or Europe that have secured build to suit opportunities and are seeking capital to make early acquisitions.  Such pioneering earlier stage investors typically seek returns in the mid-20’s or higher, and are often more interested in certain countries than others, trying to find a happy medium between avoiding high risk countries prone to currency fluctuations, but at the other end of the scale cautious of markets so attractive that valuations have become frothy.

In contrast, an early stage venture investor like Alcazar Capital might seek a smaller cheque of up to US$50mn from angel and ‘B round’ investing through to more substantial institutional capital, seeking returns significantly beyond the 20s.

Ryan Lepene described Peppertree Capital as “less IRR sensitive, more focused on the cash on cash multiple.” One of the reasons for the attractiveness of this asset class is the proven path to ‘sweating the assets’, adding leaseups and ultimately attracting multiple buyers. So it’s seldom a short term hold: “time horizons are less important than value creation and doubling our investment,” added Lepene.

The IFC plays a slightly different role in the market, combining debt and equity, but with a different level of flexibility to a commercial bank. Readers familiar with investment trends in emerging market towers will recognise that the IFC has a lot of capital at work in this asset class, with US$400mn invested in towers, another US$400mn secured through partners, and access to sovereign wealth funds and Asian banks. The IFC are also able to provide local currency, taking currency risk off table. IFC’s Eric Crabtree expressed a personal preference to participate in growth capital over the venture space, and also called attention to an appetite for pure debt opportunities for larger players needing to mobilise significant capital.

The prevailing view was that, given sufficient patience, emerging market tower investments could yield similar to returns to those delivered by US towercos in the late 1990s.

In terms of returns, for one investor tower deals fall into three buckets; those delivering high teens, those delivering mid twenties and those in the high twenties. Towers are a well-worn model that investors can be comfortable with, and the transparency of the tower business model affords towercos and their investors the opportunity to enter geographies and startup environments which many investors wouldn’t as readily enter.

In terms of the variation of expected returns in different geographies, it becomes a question of how much compensation the investor deserves for engaging with currency, counterparty and political risk. One investor suggested that Africa may be the only continent where carriers have defaulted to towercos. When counterparty risk is compounded by political instability, it ratchets up required returns.

Ultimately, the aforementioned ‘gold standard’ growth in US tenancy ratios and asset values in the late 90s was driven by data growth, and the need for capacity and infill sites. Investors in emerging market towers are buying in to the same effect of evolution taking place in those emerging markets, however long it takes. And there is an ‘escape clause’ offered by the secondary buyouts starting to happen in emerging markets, which also demonstrates the repeatability of the model.

Some of the major investors in this asset class are opening local funds for emerging markets. The Carlyle Group, for example, has a US$1bn Latin American fund, from where they can draw on local knowledge for sourcing opportunities and legal advice. Carlyle have also recently released a fund in sub-Saharan Africa.

How do the risks of backing a larger towerco pursuing substantial sale and leaseback opportunities, which benefit from a degree of co-location from day one, compare to backing a build to suit-centric towerco which doesn’t require transaction funding, but which can be more capitally intensive when operated?

Some investors prefer a mix; a substantial sale and leased back portfolio, which might look more attractive if secured with local funds to avoid currency risk, with a BTS opportunity attached. For others, like Peppertree Capital, “BTS and small acquisitions are our bread and butter – whether we’re building 25 or 50 sites, our objective is to grow with management teams and deploy capital incrementally over time, creating value for a future sale,” said Ryan Lepene.

There are a lot of BTS opportunities in CALA, particularly in Brazil. There is a pool of BTS-centric investors in parallel to a class of BTS-centric towercos. From a certain point of view, they’re playing the same game as the sale and leaseback focused firms, but the growth expectations and timing are different.

Later, larger investors in more mature portfolios are looking for towercos with the potential to drive to scale, and to access a less expensive form of capital. From such companies’ perspective, too much focus on BTS can be dangerous and a hindrance to achieving that scale. If the towerco only does BTS, you have small to medium sized business which might perform from an IRR point of view, but there’s a risk of talented management getting bored and leaving. Sale and leasebacks offer the chance to prove a towerco’s ability to execute at scale, attracting share of mind with carriers, especially the big international carriers who represent the most credit worthy anchor tenants.

Investing in BTS-centric towercos is taking a risk on their ability to pick right sites, their relationships with the carriers, and ability to deliver. Credit risk is also critical to operating successfully in BTS. Working with credit-worthy first or second ranked operators is usually fine, savvy firms will shy away from the regular inbound calls from fourth, fifth or sixth ranked operators seeking BTS partners. Unfortunately, carriers have been known to get in trouble going by going haywire investing in BTS, which contributed to the bankruptcy of one Indian towerco for example. BTS investments need to be structured to make financial sense with a single anchor tenant, or have clear visibility of a second tenant.

Reviewing the history of tower transactions in LatAm, Africa and Asia, one finds huge variations in cost per tower not just because of the leaseback rate and term, but also because of market conditions. So what are the valuation drivers for investors?

People who have tower experience are more apt to do more deals because they think about valuation relative to construction cost and cost per tower, which itself is influenced by capacity, the credit worthiness of the anchor tenant, the leaseback rate, and the desirability of location – it sometimes seems more of an art than a science. And beware missing the potential upside from non-MNO tenants, which can be easy to overlook and represents a hidden source of value.

Of course, the investibility of the towerco business model is very sensitive to tenancy ratios. In the first round of many processes, you often don’t see management’s projections of tenancy ratio, but that’s all the savvy investor wants to know!

So, it seems there is a sanctity to the independent towerco business model and how it has been proven in mature markets. So how much tolerance do investors have to adapting that model for emerging markets – how much risk is too much?

“I’m more nervous of low multiple environments than high,” said one of our investor panelists. “Compensating for weak regulatory environments that might have an inability to defend the zone around tower puts the normal functioning of the business model at risk.”

“There are a variety of exit strategy options, which makes this asset class attractive,” said one of our investors. The most talked about exit options were trade sale, IPO or offload to an infrastructure or sovereign wealth fund once the tower portfolio had matured.

One investor said there was a “higher propensity for strategic exit” in this asset class – the acquisitiveness of the international tower companies offering an obvious exit opportunity, particularly in Latin America where AMT and SBA have both acquired several ‘middle market’ towercos as well as acquiring portfolios from carriers. There isn’t, yet, the same history of towerco consolidation in Africa, while in Asia AMT completed acquisitions in India before the MNO market was restructured, and is rumored to have appetite to bid for Viom Networks.

The option for an industry sale means there’s a viable alternate to an IPO exit for late stage infrastructure investors in emerging market towers – one investor noted that five years after the sale and leaseback deals started in LatAm, the big towercos started consolidating. And TowerXchange expects more towerco consolidation in LatAm before year end 2014.

“AMT and SBA are effectively conditioning public markets to accept that the independent towerco business model works,” added another investor. “I could see a day when a towerco with a diversified interest in multiple emerging market countries could go public because the public markets that see it worked with the three big US towercos.”

“It’s more than just a choice between selling to one of the big three US towercos or an IPO,” added another investor. “There are also infrastructure funds, mega family offices and sovereign wealth funds; there could be a dozen people round the table. If you build a nice business with good cash flow and good growth, you’ll find a good exit.”

“I don’t see AMT and SBA having the bandwidth to roll up all these emerging market towercos,” added a panelist. “But sovereign wealth funds from Gulf and the Far East want to put long term capital into this asset class in significant volume – there will be options.”

Experienced tower owners’ long term a focus on cost reductions can drive as much value as co-location sales. Again, the panel preached the need for patience: “we like to see folks get to a strategic sale or IPO. I’ve stayed for 12 years to get to a good IPO. Investors can take comfort in the transparency of the towerco model – the gains secured by first movers acquiring the best portfolios,” concluded one investor.

While the formation of a major Chinese towerco, China Communications Facilities Corporation was recently announced, with ownership split between China Mobile (40%), China Telecom (30.1%) and China Unicom (29.9%), there remains no obvious opportunity for foreign investors to participate substantially in the entity prior to IPO – “we’ll believe it when we see it” was the prevailing opinion among participants in the last TowerXchange Meetup, albeit that was prior to the announcement. Investors will remain cautious of Chinese towers as long as they feel that the entity is being run solely for the benefit of the operators, rather than as an independent commercial entity.

A contrast was offered to the European tower market, where towercos like TDF have constantly exceeded anticipated topline growth rate expectations. The telecoms landscape in Europe has changed dramatically with both positive and negative implications for the investibility of towercos; there is tremendous demand for capacity and infill, but many operators are under financial pressure due to macro trends such as the elimination of interconnect and roaming fees, regulators encouraging successful new entrants which take value out of incumbents, and the costs of spectrum and rollout for 4G.

While there are more transactions happening in broadcast towers in Europe, mostly involving infrastructure funds, there has been less deal flow in mobile towers, where the notion that these assets remain strategic is limiting MNO’s appetite to bring towers to market. With saturated operator markets and declining margins, growth opportunities may seem limited in Europe compared to the greater potential upside investing in African towers, for example. To make the independent tower business model work in Europe, one may need to decommission a lot of towers to achieve tenancy ratios approaching three, so the business would take on a different shape.