Will Telecom Italia's Fixed Network be Privatized?

Telecom Italia’s board of directions is said to be meeting Nov. 21, 2021 about a possible fixed network privatization effort by private equity fund KKR, which is already an investor in the Italian phone group's fixed network, Reuters reported. 

At first glance, the proposed deal looks like a standard private equity deal: buy an underperforming asset, make changes and then sell. But the deal might also reflect another private equity focus: buying infrastructure assets to hold longer term, as an alternative asset. 

Telecom Italia, for its part, also fits the scenario: it has high debt and shrinking recurring revenues and profits, arguably impairing its ability to invest in digital infrastructure including fiber to home facilities. 

At the same time, the access network scarcity moat is challenged by the building of a rival Open Fiber wholesale network owned and operated by electrical and gas provider Enel. 

KKR might or might not see value in merging merging TIM's access network merged with that of rival Open Fiber, which would then be able to run as a single national internet and communications access asset supplying retail services to other internet service providers and telcos.

Alternatively, the former Telecom Italia assets might have enough scale to operate independently of Open Fiber. In either case, the value KKR sees is linked to the scarcity value and regulated, stable cash flows the access network would generate.

As the access network is deemed to be a strategic asset by Italy’s government (as is the case in virtually every country), it presumably would benefit from investment to eliminate the digital divide. That changes the business model for FTTH as it introduces subsidies. 

Were the government to sanction a merger of Telecom Italia and Open Fiber assets, to create a single national wholesale provider, KKR’s investment would acquire a business moat. 

Future KKR options would then involve a sale of the assets to a third party or a longer-term holding as an alternative asset. 

Institutional and private equity investor interest in communications infrastructure waxes and wanes. Right now it is waxing, after a precipitous drop in interest in the wake of massive facilities overbuilding around the turn of the century. 

In large part, the interest is driven by returns on other assets, leading investors to desire some exposure to alternative assets, including infrastructure with some market moats, scarcity and dependable demand, plus free cash flow. 

That appetite is matched by connectivity provider capital investment issues, namely low returns on invested capital that have bedeviled connectivity providers in recent years. 

In many cases, service providers have trouble earning back their cost of capital, according to some analysts. 

source: Arthur D. Little

All of that creates a heightened private equity and institutional investor demand for investments in “digital infrastructure” that is similar to demand for the more-traditional interest in real estate and utility investments. 

But the strategies can vary. The easiest and arguably safest choices are core infrastructure operations where most of the return comes in the form of cash dividends. This is most often found in regulated segments of the industry, with low growth but consistent demand. Ownership of electrical utilities provides a good example of this type of asset. 

Most digital infrastructure assets do not offer predictability or moats as high as might be the case for electrical utilities or airports, but arguably is most true for mobile towers. 

In other cases, there are some specific drivers that shift a bit of the story to more growth, if some tweak to the business model is made. That seems to be the case for mass market telecom networks where the upside is the upgrade from copper internet access to fiber to home. 

In other markets, the same thinking underpins buying a regional airport with expectations of creating a higher-value super-regional hub. In the communications assets business, perhaps an example is the “roll up” strategy of amalgamating many diverse and smaller connectivity or data center assets to create scale. 

The point is that a confluence of connectivity provider need and investor want is fueling a resurgence of private equity and institutional investor interest in a growing range of digital infrastructure assets.