Mallinson: Mast portfolio sales in Europe - value growth from co-location or financial engineering?

Keith Mallinson

Europe is awash with transactions financing and transferring ownership of physical network infrastructure including mast portfolios from MNOs to independents specialising in operation of these assets. For example, most recent initiatives include Deutsche Telekom, Telefonica and Bouygues Telecom. But how much value creation will arise from these assets transfers: will lease-up from additional tenants under independent ownership with co-location make assets more valuable or are deals simply to facilitate financial restructuring with balance sheet relief and liberation of capital for the MNOs?

Changing of the guard
According to a recently published a 164-page report about the European tower sector by TowerXchange, "a community of practitioners formed to promote and accelerate infrastructure sharing," 13 per cent of Europe's 600,000 towers sit in the hands of independent "towercos." A further 12 per cent of these are owned by operator-captive towercos and 11 per cent are managed by "JV infracos" -- putting a total of 35 per cent in the hands of infrastructure companies. TowerXchange forecasts that by the end of 2016 this number will increase to 40 per cent with 18 per cent being owned by independent towercos, 11 per cent by operator-led towercos and 11 per cent by JV infracos. It expects 65 per cent of Europe's towers to sit with infracos by 2020. The term "co-location" appears 42 times in the report, mostly in company profiles, but there is little quantification of this or the financial growth that might be achieved with "leasing-up" of these additional tenants. Expected amendments to existing leases, as might be required for capacity increases and installation of new radio equipment, are also a significant determinant of value.

An anonymous commentator on Deutsche Telekom's proposed sale of its German masts notes that "the details of the leasing contracts as well as the assessment of how easily additional users for the masts can be attracted will also be factors in determining a potential valuation of the assets."

Value creation
Deals get done when assets are worth more to the purchaser than the seller. The difference in value, or surplus, as economists call it, ends up being shared on the basis of supply and demand between sellers and buyers with competition among these and their respective negotiating skills. In some cases, the difference can be modest and might only reflect respective costs of capital for buyer and seller. In other cases, such as in the U.S. tower sector in general over the last decade or so, differences have been more fundamental and quite dramatic.

Independent tower companies in the highly-successful U.S. tower sector have been able to co-locate tenants on the same tower to an extent not possible on operator-owned towers. In my work conducting tower portfolio valuations and damages assessments for contract breaches over the last 15 years I have observed that main driver for value growth in the mature U.S. tower market has been co-location on the nation's many tall lattice towers with capacity to "lease up" to three, four or even more MNO tenants in some cases. Towers there have most commonly been valued as a multiple of tower cash flow where the multiple reflects the expected growth in cash flow arising from lease amendments and new tenants. This is because the costs in building and operating a tower site are largely fixed. These are typically covered by the first "anchor tenant." Leasing-up a typical U.S. lattice tower with plenty of "RAD centre" space for co-location can generate large incremental revenue at minimal incremental cost. For example, with the acquisition of Verizon's towers in the U.S., American Tower has the right and a strong financial incentive to lease space on the Verizon towers to additional tenants. The Verizon towers had the lowest initial tenancy of any major tower acquisition at an average of 1.4 tenants per tower. Management's goal is to add an average of one tenant over the next ten years. It is this economic leverage, along with declining interest costs, that has largely fuelled the stellar investment returns achieved in the U.S. tower sector over the last decade.

The potential for lease-up of equivalent assets in Europe seems lower than it was in the golden era for the U.S. tower sector over the last decade. Now residing the UK, I see a very different environment to the U.S. in my European travels with fewer lattice structures, significantly lower average heights and a rather larger proportion of monopoles, which have much less capacity for co-location. This probably explains why the terminology differs with the towers being referred to over there versus masts most commonly referred to over here. By way of example, on a motorway near where I now live in the UK there are five short and separate masts in a row, all right next to each other. There are typically fewer operators per nation in Europe and in many cases these already share infrastructure including much of their radio networks. European tower companies profiled in TowerXchange's report more frequently describe opportunities in dealing with consolidation between merging MNOs than in leasing-up additional tenants. An exception is in France with Free Mobile's need to rapidly expand its new network by co-locating with other MNOs.

Financial liabilities not strategic assets
Mobile operators clearly have significant balance sheet pressures in their highly capital-intensive industry and relish the opportunity to divest high-cost physical assets including towers. They realise that cell sites are not major sources of competitive advantage over other operators and that capital can be better deployed buying spectrum, promoting subscriber adoption reducing debt and expanding radio network coverage and capacity as mast tenants rather than as owners. Whether or not there will be major value creation following ownership transfer remains to be seen. It seems likely that the answer to that question might vary significantly among the many nations of Western and Eastern Europe depending on the number of operators per nation, network sharing arrangements among these as well as the kinds of towers and masts they have already and that they are allowed to construct henceforth. Buyers beware!

Keith Mallinson is a leading industry expert, analyst and consultant. Solving business problems in wireless and mobile communications, he founded consulting firm WiseHarbor in 2007. Find WiseHarbor on Twitter @WiseHarbor.