The global pandemic has accelerated demand for connectivity, yet European telecom equities have registered material underperformance in recent years.¹ We believe this reflects equity investors’ unwillingness to own businesses that require large network investments with extended investment horizons that are potentiality dilutive to returns on capital. Over the last 12 – 18 months, we have seen an increasing number of telecom operators in Europe being taken private, with the most recent examples being Xavier Niel’s take-private of Iliad in 2021 and two major incumbents, Telecom Italia and BT, seeing private equity-related bid speculation. According to S&P Global Intelligence, worldwide telecom transactions accounted for 35% of total private equity deal value in 2020, up from 15% a year earlier as COVID-19 accelerated growth in aggregate value.²
The European telecom sector is mature yet fragmented, with three to four players per country driving competition. Organic revenue growth is limited, absolute debt is high and cash generation is currently being pressured by heavy infrastructure investment (fiber and 5G) and spectrum payments. In order to remain competitive, operators have been investing heavily in new technologies, upgrading networks to offer higher quality and greater reliability. In turn, capex requirements are elevated and are expected to remain high over the near term. This has driven operators to increasingly utilize asset monetization to support capex requirements and strengthen balance sheets—selling majority or minority stakes in their tower, fiber and/or data center assets at high valuations. Asset sale multiples have ranged from 8.0x to as much as 25.0x (EV/EBITDA), providing PE owners who are typically more willing to bring changes to the status quo the potential to increase returns.
Positive underlying trends such as the demand for connectivity and the digitalization of services should drive long-term growth. In addition, it would seem that PE sponsors are willing to look further out: Once fiber and 5G investment are complete, the businesses should generate stronger cash flows and command higher enterprise value multiples assuming well-invested network infrastructure.
We expect the current gap between private and public valuations to persist, and while it does, that elevated LBO-related deal flow continues in 2022. One consequence may be increasing “LBO risk” for bondholders, where bonds reprice to reflect the possibility of the higher debt loads typical of PE-owned names. However, we see opportunities here to invest in higher-coupon debt instruments in companies with asset coverage (high-quality networks) that may improve over time as the need for high performance connectivity continues to grow.