Whitepaper_Investing in telecoms towers-DR-080216

White Paper

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Investing in telecoms towers

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Authors: Dominique Reverdy, Pierre Blanc and Vladimira Pavcova

March 2015


Table of Contents

Table of Contents.................................................................................................................................................2

EXECUTIVE SUMMARY.......................................................................................................3

THE CASE FOR TOWER SHARING........................................................................................5

Alternative structures...........................................................................................................................................5

Regulated facilities sharing..................................................................................................................................6

Tower swaps........................................................................................................................................................6

Spinoff..................................................................................................................................................................6

Joint Ventures (JV)................................................................................................................................................7

Independent TowerCo..........................................................................................................................................8

Tailored transactions............................................................................................................................................9

THE TOWERCO BUSINESS PLAN........................................................................................11

Key assumptions and drivers..............................................................................................................................11

THE TRANSACTION..........................................................................................................19

Due diligence......................................................................................................................................................19

Pricing parameters.............................................................................................................................................22

Key contract terms.............................................................................................................................................23

Valuation considerations....................................................................................................................................23

CONCLUSION...................................................................................................................24

AUTHORS.........................................................................................................................25

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Executive summary

In the early phases of mobile network development, technology was considered as a key differentiation factor. Emphasis was put on controlling the network infrastructure, and an operator was often valued based on the coverage and the quality of service provided by its network. Infrastructure ownership ensured long term viability to the business.

In recent years, the focus gradually shifted to more service- and customer-centric structures, with certain network elements becoming non-core. As competition was eroding margins, operators also became more cost-efficient and tended to favour leaner structures and outsourcing network maintenance activities.

In a tighter financial environment, the carve-out of such assets could also help de-leveraging operators’ balance sheet and create shareholders’ value.

As operators became more familiar with these processes, different outsourcing alternatives were considered, with varying degrees of success. MTN for instance, over 5 years ago, decided to adopt a strong approach by carving out its International Carrier Services branch, MTNICS, and outsourcing its operations to Belgacom ICS, through a sophisticated M&A transaction in return of a 20% participation in BICS.

With the simultaneous deployment of several layers of mobile technologies (2G, 3G, and now LTE or 4G) over a wide range of spectrum holdings, civil and engineering works have become a burden for the operators. Regulators also started to view favourably a rationalisation of the infrastructure which ensures a better economic sustainability for the industry whilst addressing key environmental concerns. This has led to the conclusion that some level of sharing passive infrastructure is beneficial to the industry.

There are many ways in which an operator can seek to optimise the return on investments made from its tower asset. We propose a distinction between 6 main business models, depending on the operator’s relationship with its partner(s) and the required level of ownership of the assets in fine:

Regulated facilities sharing Tower swaps Spinoffs Joint Ventures (JV) Independent TowerCo Tailored transactions

Independently of the chosen business model, careful thought will have to be applied to the drivers that will make the business case positive, whether inherent to the operation, or coming from synergies between stakeholders.Despite the very different nature of each business model, all of them share the same main driver for success, the so called tenancy ratio. This ratio is defined as the average number of expected tenants per tower. From looking at tower sharing ventures across the world, below 1.5, it is very unlikely that the business case turns positive. In general, potential partners start looking into a tower sharing opportunity when a sustainable tenancy ratio above this threshold can reasonably be expected.

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For this reason, the strategist will mainly concentrate on accurately forecasting this ratio, and developing tactics to improve this along the years. This could range from opening the access of the towers to alternative wireless players, such as WiMax, TV broadcast, etc…, to working alongside operators in order to define in total partnership each tower park expansion, with early acceptable commitment levels from the operators.Then, setting up the appropriate price structure for the rental of tower space will be key to generating sufficient return on investment, as well as insuring enough cash flow for growth.Typical pricing structure will attempt to cover for investment costs, such as infrastructure costs, with a set non-recurring upfront payment, while recurring fees will be adapted to operating costs, such as, typically, power usage. It will therefore be in the interest of the tower operator to reach a lean costing structure where operating costs prove as variable as possible so as to keep control of the generated margins.Recurring fees will generally be given per tower space utilised, and include power and utilities, security, colocation if any, as well as operation and maintenance. However, more customer centric approaches are increasingly created, based not on cost recovery, but on customer benefits. For instance, some players have chosen a pricing approach based on the frequency bandwidth utilised by the tenant, or the coverage reached from the tower. These are still marginal instances, though clearly reflect a higher consideration for a more sophisticated business model.

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The case for tower sharing

Operators are increasingly aware that keeping large assets on their books might not generate sufficiently attractive returns and could be optimised. A carve-out of assets is one of the options to address a number of benefits for the operators:

Early monetisation of non-core assets Reduction in asset management burden Opex and capex savings

The optimal transaction, however, will depend on a number of factors Regulatory factors – limiting or qualifying the transfer of assets Market factors – which are key to assess the potential returns of a shared infrastructure

deployment Operator’s own risk assessment – in particular trading of cost savings and deployment

flexibility and operational quality The operator’s ability to access attractive financing conditions and its imperatives to de-

leverage its balance-sheet or monetise quickly its assets

In practice, the industry has developed several models which are briefly described below.

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Alternative structures

The priorities of the different market players and the market conditions will balance the different options open to the industry. The options are summarised in Figure 1 along two main axes:

The operator’s relationship with its partner: commercial agreements versus cooperation Level of ownership of the assets

Maintain Ownership

Separate Accounts

Transfer Ownership

Regulated Facilities Sharing

Spin Off

Independent TowerCo

Tower Swap

Join Venture

Tailored Transaction

CooperativeCommercial

Figure 1: Asset optimisation alternatives

Regulated facilities sharing

Whereas, historically, operators were reluctant to share core network assets, regulators often opened the way to sharing as a key remedy to dominance. Smaller players, in highly unbalanced markets, find it difficult to replicate the required network investments when market distortions prevent them from competing for a larger portion of the addressable revenue. In such cases, regulators have acted to ensure a more cost-efficient access to existing infrastructure. One such measure is to force dominant operators to open access to their towers, via bilateral commercial agreements.

This was the case when European markets opened to new players for 3G services. The entry of a new player was motivated by the regulator’s desire to increase consumers’ benefits through increased competition. However, the network rollout costs for a greenfield operator were making the financial case difficult, if not unviable. In addition, the awareness of environmental risks increased, often making the search for new sites difficult and costly. By opening existing towers to new entrants, initial set-up costs could be reduced.

This type of asset optimisation is still largely used to regulate fixed telecoms: dominant operators are typically required to open their ducts to alternative players in order to create a fair competition on the fibre access market. In mobile markets, operators were initially reluctant to share assets, at a time when differences in coverage had a material impact on market share due to the strong differences among consumers of the quality of the coverage. As mobile markets have matured, operators have embraced sharing solutions, making the need for regulation less acute.

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Tower swaps

As markets evolve, operators continuously need to optimise their networks, swapping sites for optimised coverage as well as deploying new sites to cover new geographic areas. Different networks would often overlap but, due to the particular trajectory of each operator, they could have different densities of sites in different areas. An alternative experimented by many operators was to introduce bilateral agreements by which the operator shares its infrastructure with other operator(s), not for a defined access fee but against reciprocal access to the other’s facilities based on a fair swapping principle.

The fairness of the swap agreement can take many forms. The most common remains one-to-one site swaps, according to which sites are not differentiated in their quality, which could prove unrealistic. In some cases, operators have chosen to swap sites based on coverage area, but more sophisticated swapping principle are more common, especially making difference between various clutters, as a tower located in a dense urban area cannot be swapped with a rural site. A system of ranking based on points allocated according to a series of predefined criteria, clutter, height, geography, social environment, etc. is now typically used in swap agreements in order to avoid future disagreements.

Spinoff

Swap arrangements miss out the opportunity of efficiency gains by adding new tenants to a site portfolio. To realise this market opportunity, some operators have favoured the set-up of a standalone entity whose core business is the management and the wholesaling of their tower assets.

This requires setting-up a separate entity, with majority ownership and control remaining with the operator, to ensure clear accounting separation. The ownership of the assets is transferred to the spinoff, usually together with part of the operator’s staff. The spinoff then leases back the towers to the original operator as well as to other operators. The spinoff is managed at arms’ length to ensure fair treatment of all clients.

Technically, both swap and asset sharing can be proposed by the spinoff, though in practice, the purpose of the spinoff is the creation of a wholesale business, and it favours sharing-type services.

This approach has been chosen recently by America Móvil, which announced that they would spin-off their 28,000 towers in Mexico, in order to create a new independent business entity, partly to protect against dominance rulings and the risk to see the regulator imposing on them tight network sharing obligations. The operation is claimed to be giving the new TowerCo higher growth potential as it will enable to open the access to America Móvil competitors. According to Chief Executive Officer Daniel Hajj, a spinoff will better reflect the value of the towers, which can be rented to competitors. This represent a significant strategic choice as the sale value assets has been estimated to reach c. USD 8bn (Source – Bloomberg). This was very well perceived by the market, and America Móvil’s shares increased by 2.1% as a result of the announcement.

The Mexican case shows how regulatory pressure to impose infrastructure sharing can incentivise operators to create a new wholesale market. In many other countries, obligations on accounting separation have led to the spinoff of tower assets.

A tower spinoff is also an opportunity to monetise the assets in the medium-term. Once the entity has been set-up and has proved its ability to increase the value of the underlying assets beyond long-term contracts with its anchor tenant, it can be partially or totally sold, either through a private transaction or an IPO.

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The Malaysian operator Axiata may take this route. It announced in October 2014 its plans to spin off up to 19,000 of its towers. Reportedly, the operator is concentrating on cost management in light of strict market conditions, and an infrastructure arm could help it centralize procurement and deliver better economies of scale (Source – telecomasia.net). If concluded as planned, the potential IPO would raise up to USD 500m. However, this remains a medium term potential transaction, and the spinoff is only the first step.

Joint Ventures (JV)

For similar sized operators, a JV delivers substantial capex and opex reductions, whilst they continue competing on services. The operators create a JV where they consolidate their respective tower portfolio. This brings one step further the concept of tower swap: the operators can benefit from each other’s asset on fair and equal terms.

Business Wire announced in June 2014 that the three state-run telecom operators in China had established a JV to share telecom infrastructure and reduce their related capital expenditure. The newly formed company has a registered capital shared 40% by China Mobile, 30% by China Unicom Hong Kong with China Telecom holding the remaining 30%. The scope of the company will be construction, maintenance and operation of telecommunications towers, including base stations control rooms, power supplies, air conditioning and interior distribution system and outsourcing services for base station equipment maintenance.

As in a tower swap deal, the ownership of the JV is calculated based on “quality” criteria, as well as the number of towers put in the deal. Once the JV is put in place, it can either share the asset between the initial owners, or decide to wholesale the access to external players.

The JV also opens up the possibility to monetising the asset in a later stage, either through a sale or an IPO.

Independent TowerCo

A transaction involving an independent third-party TowerCo has been a preferred route for many operators recently. Figure 2 below shows some transactions that were completed in the last 5 years:

TowerCo Operator Year Country HIS MTN 2014 Zambia, Rwanda HIS MTN 2014 Nigeria HIS Etisalat 2014 NigeriaEaton Towers Airtel 2014 Ghana, Niger, Burkina Faso,

Kenya, Uganda, MalawiAmerican Tower NII 2014 MexicoHelios Towers Airtel 2014 AfricaSBA Communications Oi 2014 BrasilHelios Towers Vodacom 2013 TanzaniaCrown Castle AT&T 2013 USASBA Communications Oi 2013 BrazilAmerican Tower Nextel 2013 BrazilAmerican Tower Nextel 2013 MexicoBR Towers Oi 2013 Brazil

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American Tower Axtel 2013 Mexico HIS MTN 2012 Cote d'Ivoire, CameroonAmerican Tower Vivo 2012 BrazilGP Investments Vivo 2012 BrazilProtelindo Hutchinson 2012 IndonesiaTower Bersama Indosat 2012 IndonesiaProtelindo KPN Telecom 2012 IndonesiaTorres Unidas Telefonica 2012 ChileSBA Communications Telefonica 2012 BrazilGrupo TorreSur Oi 2012 BrazilBR Towers Telefonica 2012 BrazilAmerican Tower Telefonica 2012 ChileHelios Towers Millicom 2011 TanzaniaHelios Towers Millicom 2010 GhanaGTL Aircel 2010 IndiaAmerican Tower Cell C 2010 South AfricaAmerican Tower Essar Group 2010 IndiaProtelindo Hutchinson 2009 IndonesiaAmerican Tower Xcel Telecom 2009 IndiaCrown Castle Vodafone 2008 Australia

Figure 2: Recent tower transactions

These transactions are usually referred to as sale-and-lease-back, as they include a sale/buy agreement, supplemented by a medium term lease contract by the operator for the use of the towers. The operator’s objective in this type of transactions combines operational and financial elements. From a pure financial standpoint, the transaction removes the asset from the balance sheet for a significant cash inflow. The cash inflow will generally be used to deleverage the operator, so as to reduce financing costs. The operator might plan alternative investments, either in M&A or in service related growth.

There is an additional benefit to the operator, once the initial cash inflow has been recognised. Through higher tenancy rate, the TowerCo can more effectively divide the high fixed costs over a larger customer base. It can also leverage the larger scale of its portfolio to create substantial efficiency gains. These can be partly passed on to the original owner through a lower operating cost per site. In Africa for instance, six major tower companies operate today, building economies of scale and pooling expertise.

The transaction allows the operator to focus on core services, outsourcing day-to-day engineering issues whilst maintaining operational flexibility and speed of deployment. The benefits of focusing management on core skills are less tangible but have proven to be highly valuable across most industries.

Eaton Towers has recently acquired Airtel’s towers in 6 African countries (Ghana, Niger, Burkina Faso, Kenya, Uganda and Malawi). The transaction included a lease back contract for an initial period of 10 years. According to Manoj Kohli, chairman of Bharti Airtel International, the agreement represents the next phase of Airtel’s growth journey in Africa. We (Bharti Airtel) are the pioneers and strong proponents of telecoms infrastructure sharing, which results in industry-wide cost efficiencies. The agreement with Eaton Towers is an extension of this philosophy and will lead to far superior utilisation of passive infrastructure and help drive the proliferation of affordable mobile services

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across Africa. According to analysts, the agreements will allow Airtel to focus on its core business and customers, enable it to deleverage through debt reduction, and will reduce its on-going capital expenditure on passive infrastructure.

Tailored transactions

The sale-and-lease-back of asset is based on a simple commercial relationship based on an existing tower portfolio. More creative transactions can be required in more complex environments. Often, the TowerCo agrees to expand the portfolio, adding build-to-suit (BTS) sites in line with the operator expansion strategy. For BTS sites, the site acquisition process can be co-organised by both companies so as to improve deployment accuracy and efficiency. The operator keeps the advantage of a shared asset, together with some level of technical competitive edge.

IHS has acquired 1,269 mobile network towers from MTN Rwanda and Zambia for a total of USD 620m. According to HIS statement on the transaction, IHS will acquire and operate the towers and related passive infrastructure and will invest in a build-to-suit programme to support MTN’s future requirements in both countries. MTN Rwanda and MTN Zambia will become the respective anchor tenants on the towers while collocation services will be offered to the other operators in these markets.

In some cases, the operator and the TowerCo enter more complex financial agreements. For instance, they can agree on an IRU type structure: a lump sum is paid up front, at a discounted price, and annual O&M charges are applicable for the duration of the contract. The lower upfront fee is compensated by lower recurring charges. This also decreases the funding requirements for the TowerCo. In a country with high interest rates, this could prove highly valuable for the TowerCo.

It is worth noticing that some collaborative agreements between operators and TowerCo do not involve the change of ownership of the towers – which, in some cases, is prohibited by the law of the operator’s concession. For instance, in 2010 Vodafone Ghana and Eaton towers have agreed on an outsourcing contract, whereby Eaton would manage Vodafone’s towers, and invest directly in new radio sites to increase Vodafone’s coverage and capacity. Deployment plans remain to be agreed between the parties. Eaton was allowed to lease spare capacity on Vodafone’s towers to Vodafone’s competitors.

Figure 3 compares the advantages and disadvantages of the different optimisation solutions

Alternative Pros ConsTower Sharing Generates additional revenues No operational benefit

Tower management can divert attention from core business

Swap Increases significantly the deployment capacity

Fixed costs can be shared

Difficult to ensure one-on-one fairness. Operators must have equivalent tower park to benefit equally

Tower management can divert attention from core business

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Spin off Enables both entities to focus on their core businesses

Give flexibility to the business model

Potentially increases the value of the asset over time

Increases overhead

No operational benefit

No financial benefit without opening access to the infrastructure

JV Enables all entities to focus on their core businesses

Creates operational synergies

Increases significantly the deployment capacity

Fixed costs can be shared

Potentially increases the value of the asset over time

Lengthy negotiations due to the difficulties of agreeing in the compared value of the assets

No consolidated investment benefits

Depending on the shareholding, the operator can lose long term asset on the balance sheet without compensation

Sale and lease back

Generates significant cash inflow at the transaction day

Enables to concentrate on core business

Decreases potential collateral for operator's funding

Only creates operational and financial benefits if the TowerCo already has agreement with competitors

Tailored transactions

Depending on the actual structure of the transaction, the operators can benefit from any of the above pros

Depending on the actual structure of the transaction, the operators can suffer from any of the above cons

Figure 3: Site optimisation alternatives

The TowerCo business plan

A carve-out of tower assets allows an operator to monetise non-core assets through a sale and lease back arrangement. Ultimately, the seller and the buyer need to agree on:

The appropriate trade-off between the upfront payment and the recurring fees as both are linked – the seller needs to ensure that the transaction reflects a lower cost of equity than its own

How the upside (increased tenancy ratios, operational efficiencies) are shared between the parties

This is achieved in establishing a business plan that is agreed between the parties and reflects accurately the total cost of ownership of the assets, i.e. both the recurring operation costs as well as appropriate capital expenditure (capex) levels for maintaining the asset portfolio.

The business plan takes into account local market conditions, commercial opportunities, operational and financing constraints to define a price grid to reach a predetermined return on investment. The price level must be at an affordable level for operators to justify the need of a TowerCo.

The business plan typically follows a three-step approach:

A business as usual (BaU) plan for the existing tower assets under the current tenancy

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A business plan reflecting the network expansion requirements of the operator A business plan reflecting the upsides from additional tenancy and the resulting efficiency

savings

An illustrative example of a TowerCo P&L is described below.

Key assumptions and drivers

The BaU plan reflects the current asset portfolio and its future utilisation. To illustrate this, we consider the following portfolio:

Number of towers # 5,000Tenancy # 5,0302G # 5,0003G # 30Monthly cost per tower USD 1,100Rental USD 450Maintenance USD 350Electricity USD 200Personnel USD 80Insurance USD 10G&A USD 10Cost escalation % 2.0%NBV USDm 250Capex per new tower USDk 120Upgrade cost per new tenant USDk 15Maintenance capex per year USDm 5.0

Figure 4: Tower portfolio [Source: Aetha Consulting]The BaU considers the number of towers that can be carved-out in the asset and lease back transaction. Key parameters in developing the BaU scenario include:

The projections of tenancy – in particular the take-up of new technologies and related equipment per site

The operating cost per tower – in practice, the business plan will distinguish several types of towers (e.g. rural or urban, rooftop, etc.). Some of these costs are variable (e.g. rental) whereas other may be more fixed in nature (e.g. some G&A personnel costs).

The escalation factor for costs – in this example a simple inflation-indexed escalation factor can be used. In practice, different factors may be used for different cost types.

The net book value (NBV) of the assets for sale – the depreciation projections of these assets will depend on the timing of the investments and the age of the towers. This will impact taxable profit and cash flows.

The analysis of historic costs – typically over audited results for the last few years of operations – will also allow identifying key capex components:

The average cost for building a new site – again, this may depend on the site typology used. Capex can be further broken down into: civil works and permits, build out costs (tower, shelters, etc.), energy (generators, batteries, etc.), manpower

The upgrade cost for new tenancy i.e. the incremental costs for additional equipment on the tower. This can cover additional shelter space, incremental energy costs etc.

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The maintenance capex – the total cost of ownership needs to include the required maintenance capex over the long-term.

Figure 5 below shows the evolution of key cash flow parameters over the period:

Revenue increase as 3G tenancy increases before stabilising in the medium-term Improved utilisation of the site is reflected in the EBITDA margin

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Figure 5: BaU [Source: Aetha Consulting]

Under these conditions, and excluding, for the sake of illustration, the additional complexity of equity and debt funding costs, the plan allows defining a base monthly rental per site:

EV USDm 220Sale price USDm 250Premium / (discount) to NBV % -Base monthly rental USDm 1,650Escalation % 2%Incremental tenants as % of base % 30%IRR % 15%WACC % 15%Perpetuity % 2.0%

Figure 6: BaU – key transaction prices [Source: Aetha Consulting]

Assuming a sale of the assets at net book value (i.e. USD 250m in this example), a base rental of USD 1,650 per month generates an IRR of 15%, equal to the WACC. There is a trade-off between the asset sale price and the monthly rental. Operators need to assess the trade-off between higher upfront cash and lower operating costs.

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The BaU represented is useful as a base to understand the operations and profitability of TowerCo. However, key assumptions relate to the upside potential:

Tower portfolio expansion – typically based on the anchor tenants needs for additional coverage and capacity

Increased tenancy ratios with additional operator clients on the towers Efficiency gains realised by TowerCo on its portfolio.

Portfolio expansion – build-to-suit sitesTowerCo will seek to expand the portfolio base to leverage efficiency gains over the period. Typically, both parties agree on a commitment level for site expansion. From an operator’s perspective, this reflects its business expansion plans, which is a combination of:

Geographic coverage expansion Requirements for additional capacity sites – in high traffic areas Network upgrade to new technologies, from 2G to 3G and 4G

Figure 7 presents the assumption for the illustrative case.

In practice, the parties need to agree on the level of commitment by site typology.

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2G 3G

Figure 7: Build-to-suit assumptions [Source: Aetha Consulting]

Tenancy ratiosA key parameter in the business plan is the tenancy ratio, i.e. the potential to increase the number of tenants per site. The market potential may vary from country to country, local market conditions, such as number of mobile players, coverage requirements or new technology deployment and availability of alternative wireless technologies. The TowerCo will quantify tenancy ratio forecast per type of tenant, including:

Other mobile operators, for different technologies (2G, 3G, 4G) Other telecoms players (e.g. WiMAX players) TV players, notably for DTT networks

Figure 8 below presents the improved tenancy ratio based on an increase in 2G and 3G tenants.

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2G 3G Operator per site Tenant per site

Figure 8: Additional tenants and tenancy ratio assumptions [Source: Aetha Consulting]

In most cases, a tenancy ratio higher than 1.5x has proven sufficient to ensure a viable business case with affordable prices to operators.

There is, however, a balancing exercise between anchor vs. new tenant economics:

Mobile operators need to assess the competitive risk of opening towers. This has been historically a major issue although its importance should possibly be down-played today as networks are more mature and efficiency gains play a more important role in operators’ network economics.

TowerCo needs to assess the optimal rental price point for new tenants – which may be defined lower than for the anchor tenants – in order to attract new customers. The anchor tenant, however, may in turn assess the competitive risk differently and resist lower price points.

Efficiency gainsAs the tower and client portfolios increase, TowerCo is able to leverage efficiency gains, notably energy costs. Overall efficiency improvements on opex per site in the range of 8% to 10% are typical. The mobile operator will want to capture in the transaction price a share of these gains.

Cash flow impactThe different models built based on BTS, new tenancy and efficiency gains will result in an improved cash flow profile for the TowerCo.

Figure 9 shows the different revenue scenarios – assuming for illustrative purposes the same price point for all tenants – this, as mentioned above, is a key discussion point between the anchor tenant and TowerCo.

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Figure 9: Revenue scenarios (USDm) [Source: Aetha Consulting]

For TowerCo, additional sites and tenants have a significant impact on investment requirements, as shown in Figure 10 below:

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Figure 10: Capex scenarios (USDm) [Source: Aetha Consulting]

Additional tenants, however, improve the investment case, as shown in Figure 11 below:

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Figure 11: Capex to sales scenarios [Source: Aetha Consulting]

New tenants also improve the EBITDA margin profile of TowerCo as shown in Figure 12 below:

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Figure 12: EBITDA scenarios, before savings (USDm) [Source: Aetha Consulting]

The result is a set of cash flow profiles with different risk profiles associated to them, as shown in Figure 13 below.

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No tenant + BTS+ New tenants + Savings

Figure 13: FCF scenarios (USDm) [Source: Aetha Consulting]

Valuation and price negotiationThe simple case presented above illustrates the key negotiation points for the valuation.

Valuation EV (USDm) IRR (%)No tenant 220 15% + BTS 152 10% + New tenants 245 17% + Savings 269 18%

Figure 14: Valuation scenarios [Source: Aetha Consulting]

Based on the same base monthly rental, the valuation of TowerCo improves significantly with more tenants and adding the expected efficiency gains. The mobile operator will want a share of this upside – it needs to ensure that a portion of the upside and the savings are passed on to improve its own cash-flow projections. This can be achieved through a combination:

A higher upfront payment, i.e. increasing the premium on the NBV of the assets A lower monthly payment.

The mobile operator needs to assess the trade-off between these options. This needs to be considered under different scenarios for other tenants’ prices and its broader competitive impact.

Whereas both parties need to agree on a set of common assumptions to agree on valuation and price, TowerCo will need to develop its own financing plan, including ability to leverage the acquisition and its impact on cash-flows to assess its own IRR and valuation.

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The transaction

Tower transactions create long-term relationships (typically 12 to 15 years) between operators and tower companies (TowerCo) and can be complicated. Careful planning in the process for establishing a TowerCo will ensure a better chance of successful implementation.

An asset carve-out is attractive for mobile operators: it is an opportunity to realise cash, to focus on its core business as well as potentially to reduce overheads. There is, however, a tension between the parties. Operators require flexibility, high levels of service and cost savings whereas tower companies focus on rental yield and drive efficiency savings. Both parties want to protect themselves from surprises.

In particular, the operator will consider its options for:

Rights of first refusal and privileged access for a sub-set of the assets – where access to the tower may reduce a key competitive advantage

The quality of service levels required to the TowerCo to meet its internal objectives (availability, repair time)

Operational flexibility, notably in terms of numbers and timing of towers required in the future

The TowerCo, in turn, will seek certainty for future cash-flows whilst maximising the market opportunity. In particular, it will focus on:

Usage and build-out commitments from the mobile operator to guarantee a minimum level of revenue streams

Pricing flexibility for new tenants Post completion protection against business risks such as risks related to asset ownership

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The valuation, as explained in the previous section, needs to be set on a common understanding of the business opportunity, including potential upside both in terms of revenue and cost savings. This is achieved during the due diligence process ahead of setting key contract terms.

Due diligence

A tower transaction requires a detailed due diligence of the portfolio and the transaction structure.

Tower portfolio due diligenceIn case of a transfer of the operator’s assets to the TowerCo, a complete due diligence of the assets need to be performed to ensure:

The assets are properly documented in the asset register – documentation will include site plans, technical documentation, building permits.

The titles of ownership, lease and lease renewal are documented and valid – establishing legal titles is likely to be more complex and involve a measure of the risks in some countries.

All conditions are met for transferring the assets (e.g. change of ownership close, other commitments). Amendments to existing leases may be required.

The status and cost of maintenance are documented – e.g. existing vendor maintenance contracts which will be transferred to TowerCo.

The objective is to establish a catalogue of towers based on small set of categories which can then be used for pricing purposes. Typically, categories are defined based on criteria that include:

Type of lease: freehold or leasehold – these categories need to be further defined according to aging (expiry date of the contract), renewal terms, key leaseholders etc.

Current tenants: by technology (2G/3G), by capacity (available place for other tenants), by operator (if some towers are already shared with other operators)

Towers included or excluded from the carve-out: some towers may be excluded due to the relationship with the tenant or limitations in the rights-of-use (e.g. the State) or because they are deemed as strategic by the operator

Type of towers: monopoles, towers (of different heights), rooftops etc. Age v life time of the asset Location: e.g. rural, urban, high-dense urban Maintenance contracts, by vendor

Legal/regulatory due diligenceThe transfer of assets to TowerCo will raise a number of legal and regulatory issues that need to be well understood ahead of the transaction. Legal systems vary across countries, but typically issues relate to:

Foreign ownership restrictions. Some jurisdictions have established restrictions on ownership of assets or land. These restrictions are sometimes overcome by incorporating a local subsidiary. Specific rules may apply for telecoms assets and/or may require relevant licences.

Local ownership/partner. Some jurisdictions may limit the percentage of shares held by foreign investors in the TowerCo.

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Investment vehicle. Tax and accounting considerations often drive the acquisition structure. In some jurisdictions, establishing an SPV (special purpose vehicle) can be a lengthy process.

Legal compliance. Each jurisdiction will have a number of legal requirements that will impact TowerCo operations, e.g. anti-corruption rules, environmental legislation, etc. Issues of non-compliance with planning and environmental regulation can be material issues on a portfolio basis.

Telecoms regulation. In recent years, telecoms regulators have tended to favour infrastructure sharing, establishing rules to ensure non-discriminatory pricing, and access to towers for late entrants. These regulations will impact TowerCo. A clear understanding of the Licence or Concession conditions – including coverage obligations, facility-sharing obligations and rights-of-way legislation are all material.

Government and regulatory approvals. The carve-out of assets is likely to require a number of approvals from the government or governmental entities such as the Competition Authority, the Telecoms Regulatory Authority or Civil Aviation Authority. The number of approvals may delay the process.

Third-party consents. Due to the large number of third party consents, the due diligence can be a time-consuming activity. In fact, the transfer of assets will trigger a range of third-party consents, starting from a large number of landlords, but also government (notably if some of the towers are built on government-owned land) and financial institutions who have provided financing to the operator (possibly with a pledge of certain assets). Some transactions may have multiple closings, when the full portfolio could not be carved out at once due to delays in obtaining landlord consent.

Post-completion formalities. The process to ensure how land interests can be protected and registered can be lengthy and time-consuming. Even in countries where land registration exists, there is a risk that the buyer or its lenders may be reluctant to assume. These considerations will need to be incorporated in the final transaction documents.

The legal due diligence highlights key risks of litigation (notably on permits and deeds) and will be the basis to define potential representations and warranties in the final contract.

Market due diligence An understanding of the market dynamics is key to assess the viability of the carve-out and the financial profiles for the TowerCo.

Typically, the due diligence process needs to review:

The current infrastructure in place, in particular the number of towers for the different mobile operators, but possibly also existing broadcasters and other players (WiMAX etc.)

The future of the mobile sector: e.g. potential new entrant, or risk of market consolidation The future of mobile technology: e.g. take-up of 3G, introduction of 4G. As markets become

more mature, the incremental cost of an additional technical layer and/or additional frequencies is becoming a key issue for operators – a more efficient management of multi-frequency, multi-technology networks is becoming a key driver of the consolidation of tower portfolios.

The expected capacity demand from new players, e.g. new WiMAX or WiFi players, future of DTH for broadcasters, demand from public safety networks.

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The objective of the market due diligence is to assess the addressable market for TowerCo. This will be used as a key input to the business plan.

Cost structure due diligenceThe pricing schedule is negotiated between the parties based on a review on current costs, typically based on audited cost information for the previous two to three years.

Cost review includes capex and opex for the existing tower base. Costs are aggregated according to the site typology agreed during the site survey.

Opex categories usually include:

Rental – this can be based on a large number of individual contracts, with different aging profiles, currencies, renewal conditions, pricing schedules and escalation factors

Outsourced maintenance contracts which can vary by supplier, region and pricing terms. Different contracts may also have different warranty schemes affecting the cash flow profiles of the TowerCo

Electricity and air conditioning – electricity prices can be regulated and will depend on the type of equipment and the number of tenants and technologies (an incremental 3G equipment will typically increase the electricity bill by ~30%)

Insurance Employee costs (for in-house maintenance) SG&A (e.g. headquarter costs, IT systems, SG&A personnel)

Opex can be fixed or variable.

Costs that can be capitalised include:

Site analysis and survey Site acquisition Permits and legal due diligence to ensure compliance Site development Site construction Equipment installation

In addition, and based on the tower portfolio, one needs to consider capex upgrades required, as well as longer-term maintenance capex.

In some transactions, the operator has transferred personnel in addition to tangible assets to the new TowerCo.

Tax and accounting legal due diligenceThe operator also needs to consider carefully the accounting impact of the divestiture, notably tax impacts.

Under a TowerCo transaction, the mobile operator sells passive network elements to the tower company. The operator then leases allocated slots from the tower company. The accounting treatment can be either an operating lease, a finance lease, or be accounted for as a service contracts – with different cost recognition and tax implications.

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Pricing parameters

As highlighted in the Business Plan section, agreed pricing terms allow both parties to share the upside of the carve-out.

Key pricing parameters include:

Upfront payment Site rental costs on existing and build-to-suit sites Maintenance costs – these are typically based on current costs plus a margin – e.g. 15% Site costs for future sites – including escalation and price revision points

Due to the long duration of the contract, price revision points need to be defined (every five years, for example) at the start of the contract. The revision points will take into account changes in the market environment, the overall demand, and new technological developments.

Price escalation for site rental can be based on, or linked to, inflation. Parties need to balance the certainty of price escalator factors versus the risk of underlying rental and other cost increases, after taking into account potential cost efficiency savings.

Pricing can vary based on the typology of sites (e.g. urban, rural). Incremental sites on 3G or 4G technology can be priced at a portion of the 2G site (e.g. 30%) based on certain limitations on the maximum additional equipment (e.g. cabinets, microwave, antennae).

The pricing can also be set separately for the anchor tenant and other tenants – with the anchor tenant being guaranteed the lowest price. Typically, for other tenants, some conditions may be altered, e.g. shelter space included or an ‘as-available’ basis rather than being guaranteed.

Key contract terms

Asset transferThe transfer of assets will depend on the selected structure of the transaction (e.g. finance or operating lease, TowerCo or JV, etc.).

Duration and renewalTower transactions are long-term transactions, typically 15 years or more. The transaction term sheet needs to consider renewal conditions – which sometimes can be subject to the operator’s licence renewal.

CommitmentsFinancial visibility is central for the TowerCo to reduce its operating risks. Typically, tower transactions include certain commitments:

Timing and number of sites to be rolled-out in the future (2G/3G/4G) Pricing catalogue

Service Level AgreementsFor operators, the challenges of monitoring network performance and quality increases as their control over the infrastructure decreases. These challenges are controllable through appropriate governance procedures and service level agreements.

The final transaction documents need in particular to cover:

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Share of Responsibility matrix (SoR) : operational, new site rollout, site acquisition, site permits, civil works, equipment

SLA & KPI definitions for site acquisition, operation, inventory management, new site implementation works and services

Penalty structure to be used with the SLA & KPI

Representations and warrantiesBoth parties will require some level of protection against future risks, notably on permits and deeds.

Valuation considerations

A satisfactory closing of the transaction requires both parties to agree on a valuation base case which includes similar cash flows to the standalone situation:

Roll-out of current costs without further efficiency gains Site costs for existing sites Estimated needs for additional sites over the period No new tenancy over the period

For the operator, the IRR of cash flows delivered to the tower company need to be lower than its own cost of capital. The ability for the tower company to access cheaper funding is therefore a key element to improve the equity IRR for the transaction.

The tower company return should be enhanced through incremental cash flows from third parties and potential efficiencies. A good understanding of the market dynamics are central for the TowerCo investors.

For the operator, other considerations often include:

Access to short-term liquidities Tax impact Valuation

Conclusion

For a wireless operator owing a significant tower park, options are many to generate additional profits, and in the revenue dropping age the telecom industry is going through, in particular mobile telephony, these new profits would be welcome by shareholders.

However, many parameters prove to have major impact on the profitability of any tower sharing option. The operator will then have to balance potential new profits with the risk appetite of its shareholders.

But the separation between infrastructure and service industries seems inevitable, and probably still at its early stage. More profound infrastructure separation is increasingly considered, climbing up the network topology, through passive as well as active elements, in the fixed telecommunications, as well as mobile, and as a result, one can expect in the medium term an entire transformation of traditional telecom landscape as we know it.

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Authors

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Dominique Reverdy - Partner, Salience Consulting Dominique is a senior consultant with over 15 year successful delivery in financial, strategic, managerial and technical roles for operators and consultancies. Expertise in finance management, business and financial planning, business strategy and valuation, cost recovery.Dominique worked for MTN in Dubai in the Group Wholesale and Finance division and as Senior Manager for M&A activities at Etisalat. Before that he was Head of Treasury for Watanya Algeria and has also spend number of years as a management consultant advising on economic issues.He is has and Advance Diploma of Management Accounting from CiMA, an MBA in International Business from Instituto de Empressa and a MSc in Communication Systems from university of Wales.

Pierre Blanc - Partner, Aetha Consulting

Pierre is a founding Partner of Aetha Consulting, with more than 17 years’ experience focusing on mobile strategy, business planning & transactions. Pierre directed over 30 due diligence projects, delivering transaction and post transaction support, and worked for operators in Europe, the Middle East, Africa and Latin America. Pierre holds a Master’s degree in physics from ETHZ (Zürich).


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