Monday, July 31, 2017

Can Telecom Industry Afford its Coming Consolidation?

While there always are lots of reasons why a particular merger idea does not get traction, one is worrisome for any weaker firm: potential acquirers believe the asset is going to depreciate further.

That, in fact, is one strategy some have floated for “when” to make a bid to acquire Sprint, or any other major set of telecom access assets.

Not now” is the rationale some would put forward, even if a later bid makes sense. Some would argue Sprint has not stabilized its business. Others might argue the asset will be available for less money, later, because they sense Sprint cannot fix its problems.

That is likely to be a growing issue over the next decade as a huge wave of consolidation starts to sweep over the telecom industry. At a high level, here is the problem. It will take huge amounts of capital if 85 percent of today’s telecom assets are acquired over a 10-year period.

One can question whether enough borrowing power exists to get that done, if at the same time capital is plowed into building new 5G networks and, at the same time, tier-one providers make investments in new businesses “up the stack” that are meaningful contributors to present or future revenue streams.

Assume, as a figure of merit, that a telecom company can be purchased for about twice its annual revenue. Assume annual telecom industry capex is about $355 billion, but that these amounts are going to be needed to build the coming 5G networks, as well as maintain existing networks.

Assume annual industry revenues are in the range of $2.4 trillion. Assume 85 percent of total assets are acquired over a decade. That suggests $2 trillion of revenue. At a multiple of “two times revenue,” that implies an investment of about $4 trillion over a decade, to consolidate 85 percent of today’s assets.

Assume global telecom debt stands at a bit less than $1.5 trillion. Assume half of the consolidation is comprised of no-cash mergers of equals. That leaves about $2 trillion of new debt to be funded. In other words, global service provider debt would more than double over a decade.

You can make your own decisions about whether that is possible, much less a workable scenario.

Some of us might argue that new debt load does not account for any investments in new lines of business at the application or platform layers (content, apps, middleware, operating systems).

Assume such investments eventually have to be made at a significant level to have any hope of affecting telecom service provider earnings. Assume that means a level of investment at least as large as the investments in horizontal scale.

That implies an additional debt load of perhaps $2 trillion, for a total new debt load of about $4 trillion.

For an industry that arguably will have issues covering $1.5 trillion in debt, you might wonder whether it is even conceivable that lenders will approve debt levels of as much as $5.5 trillion.

But there is one way to reduce some of the debt burden: a collapse of equity values, which makes the acquired assets much less expensive. That will be the case, earlier, in markets where assets become “distressed” sooner rather than later.

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