By Oliver Wolf, Partner, Strategy, TMT, EY. At EY, we continue to be at the forefront of transactions in the tower market. We provide our clients the full range of advisory services to ensure a successful transaction from lead M&A advice to commercial, financial and tax due diligence and tax structuring. EY has advised on tower infrastructure transactions with a total consideration of cUS$6.0bn in the last 24 months, and on 12 of the 15 most significant processes in the African tower sector. We provide unrivaled sector knowledge and know-how combined with local presence.
In our last article we discussed the preparation of data for, and approach to financial diligence. This article will cover the key considerations, role and importance of commercial due diligence for tower transactions.
Similarly to our last article, the towerco business model referred to here is the own and operate model, although the purpose and benefits of commercial diligence are equally applicable to managed services and management and marketing models.
As noted in our previous article, the assets comprising towerco sales offerings are often not material components of MNO businesses, and as a result detailed metrics, including all relevant revenue and cost data, may not be provided by the seller.
In addition, as a result of the non-core nature of tower asset portfolios, MNO sellers may not have fully considered the wide range of scenarios potentially affecting commercial viability of the portfolio on a stand-alone basis. In the section that follows, this article considers a number of these scenarios, and other commercial issues that are of paramount importance in towers transactions.
Forecast tenancy ratios are of fundamental importance given return on investment is largely a factor of ability to generate additional revenue per tower. In order to understand future revenue drivers, sellers and investors need to consider sector technology and consolidation trends, often out to a time horizon of 10 to 15 years from the date of investment
Which commercial considerations are most pertinent to the deal process?
The commercial viability of top line projections is a key consideration for buyers and sellers alike, and the area of focus for commercial due diligence.
Examples of key areas buyers, sellers and providers of finance need to understand include:
Key assumptions underpinning revenue projections, in particular forecast tenancy ratios
MNO industry consolidation
Historically achieved top line growth rates for towercos in the region
Where multiple assets are geographically diverse, TCO segmented by key geographies
Proximity of current and anticipated third party towers
Forecast tenancy ratios are of fundamental importance given return on investment is largely a factor of ability to generate additional revenue per tower. In order to understand future revenue drivers, sellers and investors need to consider sector technology and consolidation trends, often out to a time horizon of 10 to 15 years from the date of investment. A consolidation of MNOs in the target’s region may substantially impact a towerco’s ability to increase co-location, while 3G and 4G rollout plans may have the opposite effect.
Local regulation is also of central importance in assessing the outlook for towercos, in particular in relation to minimum levels of coverage to become licensed; the releasing of spectrum from, for example, television which is then made available to MNOs; and antitrust laws prohibiting consolidation. An intelligent investor must be confident in their understanding of the regulatory landscape and its likely evolution over time.
In the European market, trends towards RAN sharing must be considered with extra care based on recent trends. Since the active infrastructure is retained by MNOs in the majority of towerco deals, RAN sharing may allow the incumbent tenant to effectively share the tower without co-location benefitting towerco revenues. Detailed understanding of the current strategies of senior MNO decision makers is essential in predicting whether RAN sharing is likely to become widespread in a particular region.
In addition, thorough commercial due diligence considers significant supply-side factors potentially impacting the projected profitability of the target post-acquisition, including but not limited to:
Forecast operating margin of the passive infrastructure relative to comparable towercos in the region
Local cost to build relative to value per tower (i.e. opportunity cost and barriers to entry)
Since the attractiveness of tower deals hinges on the ability of towercos to either extract additional revenue (primarily through co-location) and/or reduce tower operating costs below those incurred by MNOs, revenue and cost management is equally important to the commercial viability of the transaction. If the seller appears to operating at a lower than average margin, this may present an opportunity for an experienced towerco management team to increase the rate of return through operational improvements. Where margins are substantially above expectations, investors may question whether the seller has correctly apportioned all costs and revenue streams to the towers for sale.
Competition and barriers to entry are key aspects to consider. A bottom up analysis of costs to build a new tower is typically required; such analysis needs to be overlaid with current and potential leasing rates to assess the potential for new entrants. In addition, market development scenarios need to assess the possibility of other MNOs selling all or part of their tower portfolio.
How does commercial due diligence help?
Commercial due diligence is a powerful tool to robustly evaluate the commercial viability of a towerco investment. In the first instance, we often seek to understand the key assumptions underpinning, and historical precedent for projected returns, and to ensure these are grounded in reliable data. In addition, high quality diligence providers are able to draw on an extensive network of industry experts and key decision makers to establish a market-leading view of the outlook for the region and the target assets in particular.
As noted earlier in this article, the relative lack of materiality of a tower portfolio to an MNO business may result in a lack of quality data for tracking the performance of the target assets historically. Commercial due diligence providers draw on years of experience on comparable deals to evaluate the metrics available, and share unique insights into the industry and competitive landscape with clients to better inform their investment or divestment decision.
When working with buyers, commercial due diligence seeks to address issues including:
What is the future demand for mobile communications, both voice and data?
What are the MNO scenarios (number of players, propensity to share towers, RAN share, sell towers)?
What is the future demand for towers and what are the tower ownership scenarios?
What is the potential tenancy ratio of the target tower(s), and what does this mean for revenue?
Is the proposed leaseback rate sustainable based on the historic performance of the towers, and how resilient is the rate in a range forecast scenarios?
How will regional factors including densification, regulation, MNO consolidation and 3G/4G rollout impact the attractiveness of the investment? Have these been incorporated into the forecast?
What other towercos and MNOs are operating in the region? What will our client’s competitive position be following investment?
How do operating profit / EBITDA forecasts compare to towercos operating in the same or comparable regions? If below, is there scope to bring these in line with best in class margins?
Commercial due diligence can also help optimise the sell side of the transaction by performing:
Robust and credible business forecasting, reducing the need for prospective bidders to allocate time and resources to constructing their own, potentially more cautious model
High quality, granular analysis of historical data to provide clear insights into the past performance of the investment and its key organic growth drivers
Evaluation of the performance of the asset for sale relative to appropriate market indicators such as cost to build over time, tenancy ratios and market leaseback rates in the region
EY’s market leadership in the sector is underpinned by unparalleled levels of access to key MNO decision makers (including Heads of Network), as well as strong relationships with key towerco operators and regulators globally. We are able to leverage a truly global network of professionals, both within and outside the firm, to provide our clients with unique commercial insights to inform their investment and divestment decisions. Our towerco commercial due diligence scope may include:
Evaluation of a range of technological, regulatory and competitive scenarios out to a time horizon of ten to fifteen years from the date of transaction; quantifying the impact of these on present value of the investment
Performing numerous structured interviews with key industry decision makers, including MNO senior management, regulators and industry experts to inform a view on the outlook for market demand
If required, detailed site-by-site analysis (with appropriate radio planning base data) facilitating bottom-up evaluation of the attractiveness of the portfolio of towers for sale
It is also worth noting that many of the towercos that diligence providers serve have wider operations in addition to the core sale and leaseback of towers to the MNO, such as separate M2M operations or other uses of the passive infrastructure. Depending on their contribution to forecast rates of return, it may be necessary for diligence efforts to be split to some extent between the core sale and leaseback business and other sources of profitability. With detailed knowledge and broad experience in the sector, EY is ideally placed to quickly understand and robustly analyse a wide range of business models.
As commercially astute advisors, we are primarily concerned with creating value for our clients. Understanding the importance of robustly challenging investment opportunities to identify red flags warranting bid reduction; but equally in recognising overlooked upside potential to ensure our clients are able to be competitive in the bidding process for an attractive investment. Commercial diligence bolsters the negotiating position and confidence of the parties benefiting from it, often improving their bargaining power. Moreover, commercial diligence reports authorised for release to financing institutions provide credibility to lenders, and help secure competitive finance, improving overall returns on investment.
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