Telco M+A in Africa : TDD means TOTAL DUE DILIGENCE !!


Nothing symbolizes the African renaissance better than the mobile phone. It represents technological advancement, deepening connectivity, and economic inclusion. Unfettered by outdated fixed-line infrastructure, Africa is at mobile technology’s bleeding edge — pioneering everything from mobile payments to crowd-sourcing. Unfortunately political upheaval and commodity price volatility have posed a big challenge for investors in Africa . Furthermore Telcos are a capital intensive business so there are special ROI challenges in monetising in hyper competitive low ARPU markets that characterise Africa. In any case most Telcos must slim down their various network, sales and service business models, abandon secondary activities and use M+A or cooperative ventures to penetrate fast-growing markets.

Large telcos that operate in emerging markets have higher valuation multiples than their peers in mature markets. Investors place a premium on growth prospects, so long as they are well monitored and diversified . Equity investors we are looking for a business that generates positive free cash flow from wireless and mobile broadband operations by year 5, and a business valuation based on EBITDA positive operation by year 2 and a 5x EBITDA and 2x revenue multiplier valuation .Acquiring a profitable business with a large, established network may lead to future growth, saving time and money that would have been required to build a similar network from scratch. Acquiring a competitor may enable the acquirer to reduce price wars in certain geographical areas, or to protect itself against acquisition by a larger operator.

Capital markets prefer businesses that have a homogenous operational and capital structure because they are easier to understand and value. This is the reason that conglomerates often trade at a discount to the „sum of the parts‟ and end up being broken up. MNOs essentially have a highly capital intensive infrastructure-based portion of the business (deploying and running the network) and a low capex, innovation-focused services portion. Splitting these two parts could be perceived by investment bankers to be logical as it would enable management to focus, make performance more transparent, and valuation easier.

Cash Returns On Invested Capital (CROIC) is a good measure of company performance because it demonstrates how much cash investors get back on the money they deploy in a business. It removes measures that can be open to interpretation or manipulation such as earnings, depreciation or amortisation. Telcos tend to focus on the existing capital-intensive business (which currently generates CROIC of around 6% for most operators) rather than investing in new business model areas which yield higher returns.

The new business models ( monetising Web 2.0 services) require relatively low levels of incremental capital investment so, although they generate lower EBITDA margins than existing services, they can generate substantial CROIC margins .You want to invest in a Telco with a consistent record of sales growth or a Greenfield that can deliver this in their business plan with a committed management team. Mergers in the telecom sector tend to build on existing “triple-play” offers. The emergence of “quadruple-play” offers — bundles of fixed telephony, broadband internet, mobile telephony and TV — are likely to lead to gains in market share and average ARPU, and a reduction in churn rates. There is a class of intelligent network investments that are relatively straightforward to implement and will yield a bigger bang for the buck :

• More efficient network configuration and provisioning
• Strengthen network security to cope with abuse and fraud
• Improve device management (and cooperation with handset manufacturers and content players) to reduce the impact of smartphone burden on the network
• Traffic shaping and DPI which underpins various smart services opportunities such as differentiated pricing based on QoS and Multicast and CDNs which are proven in the fixed world and likely to be equally beneficial in a video-dominated mobile one.

When evaluating wireless investments , the net profit margin is a critical metric : a fat margin means more money to expand operations, refresh network technologies and marketing and brand building . Invested capital is reduced through the deployment of more efficient technologies and processes that enable effective network capacity to be increased (including better network provisioning, traffic shaping, mobile Wi-Fi offload, femto/pico underlay network, network sharing, Multicast and CDN usage etc.Good acqusition targets are Telcos that can rigorously and swiftly farm out everything apart from their true core business can cut costs by as much as 12%, investment spending by 6% and the workforce by 50%. In return, they become more agile, engender a more entrepreneurial spirit and can realize the value of each part of the company.

Telecom-specific assets should be identified and valued using robust valuation techniques and methodologies. Tangible assets are generally valued by applying the cost approach since no prudent investor would pay for an asset more than the cost to recreate it or to reproduce an asset of similar utility (replacement or reproduction cost method) . Bear in mind that Networks are built and then adapted over many years challenge any operator’s staff to keep accurate records of exactly what has been deployed. Poor record keeping affects the ability to audit physical infrastructure and connection topology, and also its management and maintenance.This is especially true when there are mergers and acquisitions; not only may there be many inconsistencies in each company’s records, but there is also a significant challenge to integration of often disparate management and inventory platforms.

A simple Network assessment and inventory audit ( as part of the DUE DILIGENCE process ) can reveal various technical parameters in broad network domains such as : Infrastructure components and capabilities , infrastructure topology and traffic patterns , infrastructure design, capacity planning, and scalability , Infrastructure policy services , Infrastructure management and OAPM (Operation, Administration, Provisioning and Maintenance) , Business continuity policies and practices. So you pay for what exists in reality not in a cooked up asset register or a pompous mission statement.

According to Accenture to reflect the real value relationship, the bulk of the due diligence effort needs to focus on helping the acquirer understand the target’s future prospects and how those fit with the acquirer’s strategy. This can require a disproportionate emphasis on at least two due diligence work streams: strategic and operational.

Strategic due diligence involves validating the acquisition target’s fit with the acquirer’s strategic rationale for the acquisition, and understanding the target’s market position and outlook to inform the price offered. Operational due diligence involves understanding the operational characteristics of the target (for instance, organization structure, IT systems, and culture) and hence the integration approach and timeline that will be required, as well as validating the target’s operational and capital expenditure outlook to inform the price offered.

In contrast with the financial and legal varieties, high-quality strategic and operational due diligence do not generally require an army of specialist advisors. Rather, the due diligence work streams can be staffed by the acquirer’s own people, selectively augmented with advisors who bring targeted insights, such as independent perspectives on the market outlook or an in-depth assessment of the timeline and cost to get to a common IT platforms.

Acquisitions and partnerships are essential for success in emerging market segments such as mobile advertising and cloud computing. However Telcos need to clearly discriminate between when they should acquire and when they should partner. The ability to sustain partnerships will emerge as a strategic differentiator. Effective management and implementation of M+A and partnerships offers significant operational upside to telecom players.

In the final analysis a careless approach to investment in Africa can be disastrous to the share price is evidenced by the Telkom SA / Multilinks Nigeria debacle. Over time about one billion dollars went down the drain in a classic case of poor INVESTMENT DUE DILIGENCE practices ( or lack thereof ).

Sadiq Malik ( Telco Strategist )


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