The Andean market: an assessment of risks vs opportunities

The TowerXchange Meetup Americas 2016 introduced regional and country-focused panels. In this editorial, TowerXchange reports on key findings from the Andean panel. Joining Eric Crabtree, Chief Investment Officer within the IFC, who moderated the panel were Manuel Aviles, President and Founder of Innovattel; Eric Ensor, COO of Torres Andinas; Fernando García Álvarez, Construction and Network Infrastructure Manager within Entel Peru; Ryan Lepene, Senior Managing Director at private equity firm Peppertree Capital; and Estrella Zaharia, CEO of Andean Tower Partners, the latest addition to Digital Bridge Holdings.

A quick introduction to the participants in this panel. Among its operations, build-to-suit (BTS) firm Innovattel is active in Ecuador and Colombia while Torres Andinas offers BTS services in Colombia and Peru. Entel, the third operator in Peru and second in Chile by market share, currently holds 2,700 sites in Peru since its acquisition of Nextel. Peppertree has extensive investment experience in both the United States and Latin America and lastly Andean Tower Partners has recently launched operations in both Peru and Colombia with a view to expand further in the Andean region.

Crabtree asked the panel to share their views on Colombia, a market that have been targeted by tens of BTS firms over the past couple of years. Innovattel’s Aviles pointed out that while there are plenty of towercos waiting for assignments in the country, operators have put rollouts on hold while waiting for the repeatedly delayed spectrum auction. Eric Ensor agreed and added that Colombia has been hit by a perfect storm combining bad macro-economic conditions, a variety of tough micro-issues such as a sharp decline in lease rates and way too many players chasing too little business; he wouldn’t be surprised if some towercos end up exiting the Colombian market.

One of the risks related to operating in a crowded market unable to offer enough opportunities is that some players might end up making illogical business decisions, such as accepting unreasonable conditions from mobile network operators, just to secure some business. What might seem like a wise short-term move not only disrupts the market but is unlikely to satisfy private equity investors who are usually focused on high returns.

Zaharia added the Colombian regulator - the Comisión de Regulación de Comunicaciones (CRC) - is pushing for small cells and DAS to be deployed in the country and Andean Tower Partners is now looking into this while waiting for the tower market conditions to improve.

And while towercos might struggle to find business opportunities in Colombia, Entel keeps an eye on the country after having expanded to Peru in 2014 with the acquisition of Nextel as explained by García Álvarez.

The other side of the coin is that where there’s abundance of towercos, operators can benefit from a large array of potential partners and can leverage their strong negotiating position. This might be one of the reasons why the Andean region is witnessing a sharp decline in lease rates across the board.

García Álvarez detailed Entel Peru’s journey from October 2014 to date. Entel entered Peru and found itself competing against Claro and Movistar who owned a combined 95% market share.

With the acquisition of Nextel, Entel Peru inherited a portfolio of 800 sites against the 3,000+ portfolios of both Claro and Movistar, which forced the newcomer to find an effective way to deploy sites and be competitive.

By partnering with six different towercos, Entel Peru was able to deploy around 750 sites in 2014 and over 1,000 in 2015 which is an exceptional achievement by any regional standards. While explaining Entel’s success story, García Álvarez stressed that in Peru it’s hard to find towercos able to offer “creative solutions” beyond the traditional 24m or 30m towers. According to him, towercos in Peru don’t engage with small cells or DAS yet, while they also tend to shy away from difficult sites or sites in remote areas while this is specifically what operators need. He then concluded by stressing that smaller towercos seem to be more inclined to create long term partnerships and to assume part of the risks related to a project, such as the worst-case scenario of having to move a tower after having built it.

In Peru there are as many as 60,000 villages with less than 1,000 residents and Entel Peru estimates that it will need approximately 3,000 towers to cover a good portion of them. But in order to assign any business to build to suit firms, Entel is now seeking for partners with a long term vision especially since, according to García Álvarez “Entel is quite fast when it comes to making strategic business decisions and is able to select the right partner quickly, if offered the right conditions.”

Adding pressure on Peruvian operators there is the recently held 700MHz auction which awarded spectrum to Entel, Claro and Movistar. The awarded operators are now required to cover 195 towns with 4G LTE that are either not covered at all or underserved, requiring high investments in a relatively short period of time.

One of the problems that operators face in Peru is the absence of handsets that actually work with the 700MHz band, beside the Samsung S7, and Entel is now working with Huawei on optimising LTE Carrier Aggregation. While Lima will be covered by LTE in the upcoming months, reaching nationwide coverage is a complicated process in light of the high number of small villages and remote areas. Entel is likely to decide in the upcoming weeks whether it will proceed with a fast, 18-month deployment or will take a slower approach and embark into a 36-month project. Towercos operating in Peru will surely gear up to secure a portion of that business!

Absent from the list of operators awarded any spectrum was Vietnamese backed Bitel who, according to the panel, is switching from 3G to 4G (using 900MHz and 1900MHz bands) - and investing US$200mn to do so - but will keep covering mostly rural areas and small cities which represent its core business. Entel noted how Bitel runs a different type of business with a pre-paid model, targeting low ARPU (US$4) customers, using sites that are often unsuitable for swaps among operators. Bitel also owns 20,000km of fibre-optic network.

In response to the operator’s perspective, Aviles highlighted that Innovattel is very flexible and fast when it comes to making business decision too and it is open to building in tough locations and negotiating prices. In Aviles’ words, his company’s attitude implies that “your problem with a municipality is my problem, too.” Zaharia added that Andean Tower Partners (ATP) are now offering small cells and DAS in Colombia.

Peppertree Capital’s Lepene stressed that while investors do focus on returns, much emphasis is on creating productive and long term relationships able to secure continuity, especially during irrational times. And if this sometimes means working on tough, even uneconomic sites in addition to profitable ones, an investor must be open to the idea.

Crabtree noted how lease rates in South East Asia tend to be low compared to international standards in light of the low cost of labour and raw materials. But the same cannot be said about CALA where prices are being driven down to what looks like an unsustainable level. Another panelist added that the U.S. market did deal with some irrational players in the past who created false expectations in terms of their ability to deliver quality sites at low prices, only to then find themselves unable to perform. Cutting corners to accepting bad deals definitely doesn’t help towercos to build difficult sites or become strategic partners to operators in the long term.

The panel then went on to discuss Telefónica’s divestiture of assets, the creation of Telxius and its impact on the telecom tower landscape.

While Innovattel’s Aviles considered Telxius a potential buyer of existing portfolios, Torres Andinas’ Ensor stressed that towercos are specialised companies in their own rights and that the creation of a truly independent tower company isn’t as easy as a transfer of assets. García Álvarez added that Entel doesn’t have any intention to deviate from its core business especially since debt is now more readily accessible.

The creation of a tower company requires a specific vision and strategy and we are now waiting to see what Telxius’ plans are. Plans that should be clearer as the company gets closer to its IPO, which seems to now be on hold due to the impact of Brexit on the international financial market.

Despite a challenging year, the Andean region still presents considerable growth opportunities, especially since 4G penetration is at just 8% in Colombia and 4% in Peru. The panel agreed that mobile data demand will be the main driver of growth throughout the region and that the key challenge is to find ways to achieve higher level of 3G and 4G penetration that make financial sense for both operators and towercos.

The devaluation of most regional currencies, including the Colombian, Chilean and Peruvian pesos, is making in-country financing difficult and as we know, the Andean region isn’t the only area in CALA to deal with forex challenges. And since most regional operators - except Entel - have international roots, they can pick and choose which markets to invest in based on the current levels of devaluation, which is often resulting in the CALA region being last in the queue international investments.

Zaharia commented that while 4G will bring tremendous growth to everyone, data demand will also drive demand for fibre, backhaul, small cells, data centres and cloud technologies to be deployed. And since other companies within the Digital Bridge Holdings offer value-added services to their customers, Andean Tower Partners is now making its first diversified moves in Colombia.

Towercos might be inclined to look at diversification strategies, but investors aren’t always enthusiastic about moving beyond macro towers. On this note, Peppertree’s Lepene commented on the difficulties of making the economics line up when dealing with small cells, fibre and anything beyond towers. The U.S.-based investor added that they remain open to consider opportunities for investments in DAS and small cells but under the right financial conditions.

Since Peruvian towercos don’t seem eager to commit to new technologies just yet, Entel recently deployed its own In-Building Solutions (IBS) to cover main malls. This was one of several pieces of business that Entel wasn’t able to outsource to third parties due to lack of appetite. Torres Andinas’ Ensor responded that for a towerco to move into the network business is quite a leap from “dirt, steel and concrete to a completely different set of skills and know-how” and that “being able to build a system isn’t enough if you aren’t then able to make it work.”

The panel discussed the case of the Lima airport which doesn’t have a DAS system in place yet. In this case, while towercos did look into bidding for its deployment, they didn’t manage to agree on the terms with the airport’s landlord - LAP partners, a partnership between German airport operator Fraport AG Frankfurt Airport Services Worldwide, the IFC and the Fund for Investment in Infrastructure, Public Services and Natural Resources, managed by AC Capitales SAFI S.A.

Looking at some of the limitations that towercos encounter in the region, the panel went on to discuss the complexity of the permitting process. Towercos noted how theirs and the operators’ involvement in the regulatory process is key to ensuring that new legal frameworks are designed to ease network and infrastructure deployment while creating a stable environment for the industry to develop.

There was consensus on the crucial role of towercos in spreading awareness among communities with regards to the nature of the business and positive impact that connectivity can have on rural villages and underserved towns. Many communities located in the most remote areas of the Andean region don’t necessarily grasp the operating principles behind mobile phones and should be educated in order to ensure their buy-in during any greenfield project.

Ecuador and Chile weren’t discussed at length during the Andean panel but Aviles did mention that Ecuador has proven a very positive venture for Innovattel, in spite of the investors’ initial skepticism with regards to committing to a country with such a troubled political situation.

Innovattel built more than 200 sites in Ecuador in less than two years and recently sold 130 sites to SBA Communications but continues to work in the country thanks to its relationship with State-owned Corporación Nacional de Telecomunicaciones (CNT) and Claro.

Briefly commenting on Chile, Torres Andinas’ Ensor noted how the notorious Law 20,599 made it impossible for towercos to be compliant and basically inhibited significant further investment in the country.

Just over a year ago towercos were looking at the Andean region with enthusiasm and expectation, yet we are now facing the first wave of challenges for tower markets like Colombia, Peru and Chile. The tower industry might be heading towards a phase of rationalisation and consolidation in the Andean region but it’s our belief that the outcome could only be positive for long term players truly committed to changing the shape of the local telecom market.

The Andean panel highlighted the tensions between MNOs’ desire to get new sites built at the best possible prices, often in difficult areas, and the towerco business model, which favours building sites in attractive locations where multiple tenants can be attracted. When Entel’s call for towerco business model innovation is juxtaposed with the emerging key theme of the TowerXchange Meetup Americas 2016: that towercos must exercise discipline in contractual terms, building only the right sites at the right prices, you can see a gap in the market emerging for a business model and technical solution that makes economic sense providing service to a village with 1,000 population, unreliable (if any) grid connection, and declining ARPU. A single tenant tower can be a negative asset on the balance sheet, but if MNOs need a certain number of single tenant towers built, but have outsourced their own build capacity, who is left to build the "uneconomic" towers necessary to meet coverage obligations?