Telco M/A Reloaded : the anatomy of a good deal !!!

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Mergers and acquisitions have been a mainstay of the telecom industry for many years. In the past decade, the telecom industry has spent an astounding USD 1.5 trillion + on M&A activities, investments that have transformed the industry landscape into the competitive playing field we see today. McKinsey reckon that over 80 percent of aggregate deal value has focused on core telecom services and spectrum license market segments, with the remainder targeted toward adjacent markets such as infrastructure, connectivity providers, multimedia and financial services.The twin requirements of nonstop technological advances and ever more capital to pay for them produce an inherently dynamic marketplace that will keep the telecoms industry at the forefront of M&A action around the globe.

Wealthy telcos from Middle East and China are on the prowl for well-priced targets both within and outside of their home markets, and in general strategic operators will outbid private equity players for attractive targets. The continued tension between growth in allied fields (for example, telecom operators acquiring cable TV companies or application providers) versus specialisation in one subsector (telecom operators spinning off cell towers) will also serve as kindling for M&A activity throughout the sector.Vodafone agreed to pay 7.7 billion euros for Kabel Deutschland, the country’s largest cable company, because it combines phone, Web and TV services to increase customer loyalty and stabilize prices.

In one of the largest M&A deals this year was Telfonica’s agreed to buy the E-Plus German wireless unit of Royal KPN NV (KPN) in a cash-and-stock deal valuing the unit at 8.1 billion euros ($10.7 billion) to become the country’s biggest mobile-phone operator by customers. The Dutch phone company will get 5 billion euros in cash and a 17.6 percent stake in the combination of E-Plus and Telefonica Deutschland Holding AG (O2D), the Spanish carrier’s German unit, which uses the O2 brand. As the EU commissioner in charge of the digital agenda, pushes reform in favor of a single European telecommunications market, carriers have become more emboldened to pursue deals. They are seeking to share expenses to build so-called fourth-generation networks to cope with rising demand for faster data connections

An analysis of the transactional rationale of the Telefonica deal provides valuable insights into the main elements for considerations of “ best of breed “ Telco M&A deal meaning covering the financial and non financial bases. Ofcourse there is no substitute for old-fashioned focus on the fundamentals of M&A: a clearly articulated and well thought-out strategic rationale for the acquisition becomes the yardstick by which to measure individual decisions that arise during the course of a transaction. Without one, decisions are made that end up being costly and inconsistent with the ultimate strategy chosen – or worse, require divestment of the entire acquisition years later as a ‘bad deal’.

First Telefonica’s desire to create a Digital Telco Titan : become a leading player with a combined customer base of 43m, 42% in postpaid and derive strong scale benefits with combined mobile revenue market share of 32% . O2 and E-Plus’s combined customer base at the end of March would leapfrog Vodafone’s 32.4 million and Deutsche Telekom’s 37 million, according to data compiled by Bloomberg Industries. Germany has become the hottest battleground for telecommunications assets in Europe as demand for video and music delivered wirelessly and over the Internet increases, while voice revenue declines.

Second motivation was value crystallization through significant synergies. Telefonica is targeting NPV of synergies of €5.0–5.5bn, net of integration costs with projected Net savings from year 2 and Annual run-rate synergies of approx. €800 m; 75% of run-rate synergies by year 4. The deal will result in cost savings and revenue “synergies” of around 5 billion euros. Telfonica identified achievable synergies by rationalisation of distribution network ; increased efficiency in customer service costs leveraging best practices and scale ; better channel management and reduced overheads ; focused rollout on one common nationwide LTE network and improved quality from 3G network consolidation ; backbone, backhaul and core network consolidation, with reduced OpEx from network integration (rentals, power, maintenance, transport costs, overheads) ; site consolidation and rationalisation via reduction of around 14,000 sites ; increased efficiency by leveraging scalable transmission agreement with Deutsche Telekom and reduced SG&A expenses by process rationalisation and a focus on become a more lean agile organisation.

Third motivation Telefonica wants a single LTE network to provide what they call the Best Mobile broadband experience. Key factors included giving customers to benefit from the best high speed mobile and fixed experience from a single LTE network and access to future-proof DT NGA network ; Tariff innovation, voice & mobile data bundling ; Strong multi-brand portfolio across segments ; Offering ICT / cloud solutions for business customers ; extensive distribution channel and outstanding customer service ;Leverage convergence through cross-selling / up-selling opportunities as well as profiting from digital innovation and scale from Telefónica’s global capabilities ( data centres , portfolio of OTT services and partnerships ) .

Final motivation was value Creation for Telefónica Deutschland Shareholders . Here they were looking for enhanced financial flexibility (improving leverage) while maintaining an attractive shareholder remuneration ; maintaining conservative pro forma balance sheet with a projected EPS and FCF accretive from first year of full operation. In addition the M&A was all about investing in future growth while reinforcing geographical diversification, increasing exposure to an attractive market with a positive impact on Telefónica’s cash flow generation profile.

Telfonica opted for the “ Financing Without Increasing Leverage “ motto meaning the deal is very positive for Telefonica from a business perspective while it doesn’t affect its debt position. They have a Rights Issue in enlarged Telefónica Deutschland of €3.70bn. Telefónica subscribes prorate to its stake of 76.8%, €2.84bn + €1.30bn to KPN for 7.3% stake in the enlarged Telefónica Deutschland. Required total financing of €4.14bn is structured as 50-65% Hybrid, 100% equity under IFRS/ 50% equity for credit rating agencies and 20-30% Mandatory Convertible. Their objective is weighting around 2x incremental OIBDA, excluding synergies ; with Net debt/ratio preserved in short term for neutral to positive impact but keeping strong liquidity to maintain 24 months maturities for FCF generation till deal completion. Economic KPIs and cash flows must be consistent with real value creation. There is no place for speculation, particularly in these variable markets where sources of capital are skeptical, margins becoming tighter, and the consequences of missing forecasts are more direct.

As the folks at Ey rightly point out that a fanatical focus on due diligence of all aspects of the target’s business and complete regulatory and market landscape is indispensable when there is so much money at stake . There is no substitute for old-fashioned focus on the fundamentals of M/A: a clearly articulated and well thought-out strategic rationale for the acquisition becomes the yardstick by which to measure individual decisions that arise during the course of a transaction. Without one, decisions are made that end up being costly and inconsistent with the ultimate strategy chosen – or worse, require divestment of the entire acquisition years later as a ‘bad deal ‘.

Proactive Telcos clarify their M/A approach, organization and the way they source deals globally, and work closely with investor relations to ensure they have the right story to tell the capital markets—especially if they aggressively pursue new adjacent areas that have different value creation profiles or emerging market economies with majority low ARPU subscribers .

Sadiq Malik ( Telco Strategist )

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3 thoughts on “Telco M/A Reloaded : the anatomy of a good deal !!!

  1. Hey there just wanted to give you a quick heads up.
    The text in your article seem to be running off the screen in Safari.

    I’m not sure if this is a formatting issue or something to do with internet browser compatibility but I
    figured I’d post to let you know. The design and style look great
    though! Hope you get the problem solved soon. Thanks

    1. Maybe a browser issue : i am using wordpress which has standardised formatting : so i dont think i can do anything from myy side : sorry

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