Telecom infrastructure like towers, fibre networks and data centres are becoming an increasingly attractive addition to private equity portfolios. According to Preqin, telecoms infrastructure investment accounted for 35% of private equity deal value in the United States last year, up a staggering 15% from 2019.
This is due to a combination of factors, some of which are symptomatic of the pandemic, others due to the more predictable condition of exponential digitization. Countless new applications, many of which deploy Internet of Things (IoT) and edge technologies will be added to and running on mobile networks and their infrastructural backbones. Both B2C and B2B market segments are set to fuel further steep increase in wireless data consumption, channelled via the networks’ underlying fibre optic cables and data centres.
This exploding demand for data, in combination with historically low-interest rates, is transforming private equity strategy – and telecom infrastructure investment beckons. However, a constantly evolving market requires a constantly evolving game plan. Now, private equity trends are shifting from pure infrastructure investment to more business service-related engagements.
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Unprecedented times, unique opportunities
Right now, we find ourselves at the confluence of highly unusual events and policy shifts. In a bid to control inflation in the wake of the pandemic, central banks are maintaining historically low-interest rates. In some instances, they’re in negative terrain; this gives private equity a unique opportunity to take advantage of extremely low borrowing costs. Any investment expert worth their metal agrees these funds should be directed towards productivity-enhancing projects in preparation for the intense competition that will define the post-pandemic economy (read: connectivity).
This is because whereas other industries suffered, the pandemic super-charged digital. McKinsey&Co estimate that the pandemic accelerated digital transformation by up to seven years. Private equity should respond; in this economy, many are seeking to pull forward investments in comms and tech that would have occurred over the decade to the next 12 to 24 months.
In light of the negative interest rates, the climate demands that firms act boldly and decisively. Alongside government-backed infrastructure investment, these moves make far more long-term sense than they did before. In the past, the notion of borrowing to make money was heresy, but in this unique context, it could be the route to substantial returns. But why telecom infrastructure investment specifically? Moreover, why get involved in its operation as well?
Why telecom infrastructure investment in particular?
Demand for mobile connectivity has been growing sharply and continuously since the introduction of 2G. With the 3G standard, data growth has created far more bandwidth demand than was ever anticipated at the time. It is expected to further skyrocket with 5G rollout. While it was consumer-driven in the beginning, industry studies forecast billions of new IoT devices will be connected to wireless networks over the coming decade, adding to further data and bandwidth demand.
This increasing cellular internet penetration and exponential growth in data volumes are expected to accelerate the adoption of 5G networks. The nature of 5G – high peak data rates, extremely low latencies, and robust connection density – creates exciting new possibilities in connectivity. This has driven telecom providers to invest in new network technologies to meet the demand for high-speed Internet. 5G could signal the dawn of next-generation IoT capabilities, including smart cities, factories, airports and hospitals, to mention but a few generalised examples.
However, this isn’t to say the consumer segment is in any way lagging. The telecom industry is expected to experience profound disruption in the coming years as digital content consumption and streaming continue to drive the demand for better and more resilient telecom infrastructure. Another contributing factor is the exponential rise in smartphone ownership, driven largely by developing economies. According to a 2019 report published by the GSM Association, over 700 million new cellular subscribers are expected to sign up over the next five years.
Current forecasts from Gartner suggest that the global revenue of 5G infrastructure is expected to grow 39% to a total of $19.1 billion this year, up from $13.7 billion in 2020. Undoubtedly, it’s fertile ground, but it’s not the only driver. There has also been significant growth created by data-driven applications in solely fixed-fixed line connections. Consumer media and gaming as well as B2B cloud-centric products and services are powered by simultaneous fixed and mobile connections. Certainly, mobile gets the lion’s share, but it’s not a stand-alone opportunity.
The bottom line is, this background and outlook are the ideal foundation for capital investments into the sector. As of February this year Preqin data showed that KKR & Co. Inc.’s North America-focused arm is the largest private equity fund in the market with telecoms, media and technology interests, with a fundraising target of $15 billion. The second largest is KKR Asian Fund IV SCSp, which is targeting $12.5 billion. As of the same date, a total of 528 funds with exposure to these sectors aim to raise combined targeted capital of $155.1 billion, with plenty of opportunities across geographies.
The diversification into business and operations
However, the market is gaining complexity. Private equity trends are transitioning from solely asset acquisition as ambitions for return become even greater. This is because the average PE return on investment expectation requires a significantly higher yield compared to sole infrastructure funds. These funds were generally fuelled by pension funds and insurance investors over the last decade, as part of a quest for alternatives to the flattening yields on traditional investment instruments, like bonds and treasury notes.
However, in turn, these infrastructure funds have pushed up the price point of pure asset play acquisitions – too high to allow for PEs to achieve their more ambitious yield targets. While private equity yield expectations are typically beyond 20%, infrastructure funds usually only require a low double-digit yield.
Hence, private equity has started moving into the operations/business services area, around infrastructures like macro and micro sites, fibre networks and data centres. These assets are becoming particularly lucrative as the market grows. For instance, data centre management is becoming a profitable business in its own right.
Whereas historically these assets were owned and operated directly by telecoms companies, various high-value mergers and acquisitions have raised the profile of this segment as a solid investment unto itself. Just look at the recent acquisition of various assets in North America by Equinix; their deal with Verizon was worth $3.6 billion.
Meanwhile, the adaptation of networks to the edge is driving the growth of micro-data centres dotted around cities and towns. This is leading to a cosying up of telecoms and public cloud services, as telecoms provide the expertise about distributed coverage that cloud services crave in our 5G moment. This has already led to some extremely lucrative deals, including collaborations between Google Cloud and AT&T in North America and Telefonica in Spain.
In this context, private equity is significantly increasing its engagement in both greenfield and brownfield telecom infrastructure operations and business services. However, this includes not only an asset investment but also participating in operations, whether it’s investing in a new tower, data centre, or acquiring an existing player in that field. Buy-and-build strategies are emerging as a particularly interesting strategy in what’s currently a highly fragmented market of sometimes hundreds of small businesses within a region.
The investment rationale behind the shift
So what’s the rationale behind this infrastructure-meets-operations strategy, beyond the squeeze from infrastructure funds? Essentially, it’s because private equity has identified hidden optimization potential in four key areas: purchasing power, telecom operations processes, capacity utilisation and the extension of the value chain. We’ll take a closer look at these points below.
- Purchasing power
Private equity has identified that with increasing demand, the price per unit of site equipment like hardware, software and energy supply, usually decreases. This principle also applies for tower procurement items – which are mainly hardware or software – for the passive infrastructure management, construction and maintenance services from third party suppliers and so forth. These reduced prices make the investment in the actual running of the site far more reliable.
- Telecom operations processes and systems
Private equity can bring a range of expertise to the running of these services and their associated assets. Plus, these efficiency gains make them solid investments. For example, greater efficiency can be achieved via harmonized management processes and modernized platforms and systems (OSS and BSS). In turn, robust KPI implementation will encourage efficient use of funds and resources.
This includes written policies and procedures, budgetary controls, supervisory review and monitoring, auditing, and a roll-up process for internal certifications for accuracy and completeness. In summary, an aligned, structured and continuously updated process and procedure framework based on lessons learned from internal and external benchmarking exercises allow for increasing quality of service.
Big data analytics-driven maintenance – for instance, on-site sensors that deliver real-time status on several mission-critical parameters – is another key contributor to a more targeted operational approach. With this preemptive maintenance, and hence, higher efficiency compared to old-school fix maintenance cycles, PE can be confident their infrastructure investment experiences less downtime.
- Better capacity utilization with increased scale of operations
Naturally, better and more balanced utilization of infrastructure capacity can be achieved with broader market reach. This directly allows for better investment cases and return ratio than in smaller, fractionated provider environments. The assumption that asset and workforce utilization will be more stable with business growth is also indirectly supported by the higher EBITDA multiples that investors will be willing to pay with relatively larger business size.
- Extension of the value chain
Events like the 5G rollout have a knock on effect throughout the value chain. The need for additional towers begets the demand for fibre optic connectivity, while the exponential growth in data demands more data centres. As already mentioned, the dawn of computing at the edge necessitates mini data centres, which often marry well with existing distributed telecoms infrastructure.
Opportunities in telecoms are expanding, and with a strong presence in a particular part of the value chain it is easier to reach out to nearby areas. Potential extensions along the value chain could include:
- Data centers, including colocation services
- Structured cabling
- Distributed antenna systems (DAS)
- Electrical, aerial and underground fibre deployment
- Civil construction
- Small cell/micro cell installations
- Indoor DAS (IDAS)/ outdoor DAS (ODAS) integration
With the market growing at such a pace, claiming an early stake in any of these assets and the associated telecom operations seems like a shrewd move at this stage.
Riding the connectivity wave post-pandemic
As the proverb goes, fortune favours the bold. We find ourselves in a unique set of circumstances where private equity can borrow money at lower rates than ever before. This creates the possibility to make money from borrowing, a previously unprecedented condition. This, naturally, is making for a lively investment market in the wake of the pandemic.
Bolstered by the accelerated demand for connectivity, telecoms infrastructure investment is one of the most lucrative opportunities. Demand for data has exploded and the pandemic only added more fuel to the fire. This makes every part of the telecoms infrastructure value chain an interesting investment proposition, especially as 5G spurs growth.
However, to reach across this extensive value chain, the shrewdest private equity firms are looking beyond the bricks and mortar (or cables, towers, what you will). Operations are presenting themselves as increasingly solid investments that create opportunities to further penetrate the value chain.
Ultra-fast connectivity is fast becoming the economy’s growth engine. It will be those that facilitate this machine that come out on top. For private equity, the time is now – and the ways to enter the market are diversifying. It will certainly be interesting to see how the playing field evolves in the coming months as we emerge from the pandemic.