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About Ernst & Young’s
Global Telecommunications
Center
Telecommunications operators are facing
the challenges of growth, convergence,
business transformation, technological
change and regulatory pressures in
increasingly difficult economic conditions.
Operators choose Ernst & Young because
they value our industry-based approach
to addressing their assurance, tax,
transaction and advisory needs. They
know that they have much to gain from our
clear understanding of the opportunities,
complexities and commercial realities of the
telecommunications industry — wherever in
the world they’re operating.
Nicolas Klapisz
Global Telecommunications
Valuation & Business Modelling Leader
1.
Financial trends in the
telecommunications
market
1. Recent M&A activity
Telecoms operators have to grow through acquisition if they are to win the challenge
of acquire or be acquired.
Figures 1 and 2 show the global telecommunications deal volumes and values from
2000 to 20101, with figure 3 detailing the main strategic drivers behind acquisitions
in the sector. In research earlier this year, we surveyed over 50 senior executives in the
telecoms industry about why they were looking to acquire. ‘To enter new geographic
“The bloodbath has started
markets’ came top, followed by ‘to strengthen the core business’.
to happen. There is enough
of it now. Market caps have Figure 1 — Global telecom deal volumes/deal values 2000–2010
halved. Companies are making
500,000 1,600
losses. There will only be a 450,000 1,400
few players: 6, 7 but certainly 400,000
350,000
1,200
Deal value (US$m)
Number of deals
300,000
250,000 800
inevitable.” 200,000 600
150,000
400
Bharti Enterprises Chairman, 100,000
50,000 200
Mr. Sunil Bharti Mittal, 0 0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
during the World Economic Forum Deal value Number of deals
27 January 2010
Source: Thomson SDC Platinum
Footprint growth has featured heavily in the last decade, where transaction levels
peaked twice: the first peak was due to the building of scale during the technology
bubble of 1999-2000, which launched the global footprint growth in the mid-2000s.
Regional consolidation phases (e.g., US mobile market and European broadband sector)
led to the second peak of deal activity from 2005 until the slowdown in 2007, predating
the financial crisis.
During this period, large European operators increased their exposure to emerging
markets, with Africa outperforming developing Asia as a target market for footprint
growth.
300,000
250,000
200,000
150,000
100,000
50,000
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Local market deals Cross-border deals
Source: EY Survey Why Capital Matters (2000-2009) and Thomson SDC Platinum (2010 data)
1
Source: EY survey Why capital matters — building competitive
advantage in uncertain times — telecommunications survey
snapshot, 4 February 2010.
Source: EY Survey Why capital matters — Building competitive advantage in uncertain times — Telecommunication
survey snapshot, February 2010
Operators in emerging markets have built regional scale over the past few years, and
contributed to the increasing numbers of deals in those regions, from 16% of the global
deal value in 2007 to 33% in 2009, as seen in figure 4. They now have the technical
and financial capacity to develop and adopt external growth strategies, and therefore
the acquisition of targets in emerging markets is no longer the exclusive domain of
mature operators. For example, Bharti Airtel acquired Zain Africa in March 2010,
for US$10.7 billion.
In 2009, there was a sharp downturn in cross-border deals, whilst activity in any single
country (‘in-market deals’) remained flat. This reflected reduced opportunities in
cross-border footprint growth, whilst in-market deals helped operators reduce costs
and position themselves for convergence.
400,000
350,000
300,000
250,000
200,000
150,000
100,000 21% 23% 27% 59%
21% 24% 41%
50,000 14% 34% 20% 10%
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Deals in emerging markets All deals (global)
(deals in emerging markets as % of all deals that year)
“Uncertainty is one of General economic indices fell on average by 58% between October 2007 (when indices
peaked) and March 2009 (the bottom of the market). Telecommunications sector
the most important indices followed the general economic trend, falling by 49% over the same period.
characteristics of our However, not all operators suffered from the economic crisis in the same way, and many
current environment.” have recovered in line with their local economy. We have found that we can achieve a
more accurate view by analyzing developed and emerging markets separately.
Mr. Jean-Claude Trichet, President
Figure 5 — Emerging telecom industry market capitalizations versus average
of the European Central Bank, emerging economic indices from 01.01.2007
18 November 2009 170
150
130
110
90
70
50
1 Jan 07 1 Jul 07 1 Jan 08 1 Jul 08 1 Jan 09 1 Jul 09 1 Jan 10 1 Jul 10
Source: Bloomberg
170
150
130
110
90
70
50
2 1 Jan 07 1 Jul 07 1 Jan 08 1 Jul 08 1 Jan 09 1 Jul 09 1 Jan 10 1 Jul 10
The following general economic indices were included in the
analysis: CAC 40, S&P 500, DAX, FTSE 100, BSE SENSEX 30, Developed operators Developed economy indices
SHANGHAI SE COMPOSITE, BRAZIL BOVESPA, RUSSIAN RTS $,
MEXICO BOLSA, FTSE/JSE AFRICA ALL.
Source: Bloomberg
2.
Valuation drivers in the
telecommunications
industry
The purpose of our analysis is to identify the key valuation drivers for telecom
operators, and to consider the impact of their activities (size, exposure to emerging
markets, etc). We have asked the following questions:
6 11
> 25 billion US dollars
• Sales: we have analysed telcos in the ‘larger tier’ (highest sales within our set of
57 operators under analysis) and ‘smaller tier’ (lowest sales within this same set)
Valuation criteria
8.0
7.0
6.0 5.9x
5.5x 5.2x
5.0 4.8x 5.0x
4.4x 4.4x 4.4x
4.0
3.0
2.0
1.0
0.0
2009 2010 2011 2012
Emerging companies Developed companies
Source: Bloomberg
Figure 9 — Beta
Beta Weekly 1.5 — Larger vs Smaller Tiers
1.5
1.25
1.0 0.94 0.95 0.97
0.87 0.84
0.81
0.75
0.5
0.25
0.0
1 Jan 08 1 Jan 09 1 Jan 10
Larger tier Smaller tier
Source: Bloomberg
This shows that the market expectations of high growth (i.e., anticipated return on
equity) have been built into their share price, thus boosting their P/B ratios.
Source: Bloomberg
1. Economic factors
2. Accounting factors
18
16 15.6x
14
12.6x
12 11.4x
10
8.2x
8
6
4 3.7x
2 1.2x
0
EV/Sales EV/EBITDA EV/EBIT
Emerging markets Developed markets
3.
Purchase price
allocation (PPA) in the
telecommunications
industry
It is vitally important for acquirers to communicate clearly to the market about the
value of assets acquired and liabilities assumed as part of an acquisition.
Therefore, the telecom-specific assets of the target should be identified and valued
using robust valuation techniques and methodologies. Estimated asset values are
reported as part of a PPA analysis, performed in accordance with IFRS requirements.
Figure 12 — Intangible assets recognized in PPA in the telecommunications industry (as % of EV);
source Global surveys of purchase price allocation practices, Ernst & Young 2009, available via
GlobalTelecommunicationsCenter@uk.ey.com
12%
7%
9% 16%
Tangible Assets + Net Working Capital Off Market Contracts/Agreements Other Intangible Assets
(including licenses)
3
Telecommunications industry covering all sub-sectors, besides
telephony, internet and mobile operators, including also service,
technology and equipment companies.
Our analysis confirmed that telcos disclose information concerning the components
of goodwill in accordance with requirements of IFRS 3/3R and FAS 141/141R. The
existence of goodwill is generally explained by synergies, additional market share and
future services to be offered to the market by the combined business.
Some intangible assets might also be included in the amount recognized as goodwill if
their value is not material (such as distribution networks).
In addition, the following components may also be included in the goodwill calculations:
customer service capabilities, presence in geographic markets or locations (market
power/influence), strength of labor relations, ongoing training or recruiting programs,
outstanding credit ratings, access to capital markets, state of relationships with
governments or regulators. These disclosures are key for investors, and provide
insights about the strategic and financial rationale of the transaction.
In addition, standards specify that fair value should reflect market expectations
about the probability that the future economic benefits associated with the asset
will flow to the acquirer. Therefore, any analysis should reflect assumptions which
would be common to any market participant if it were to buy or sell each asset on an
individual basis. Thus, the fair value should be determined with reference to market
participants in general, but exclude synergistic values that are unique to a particular
buyer.
The following methodologies are commonly used to value intangible assets:
• Income approach which allows future economic benefits of the asset to be captured
(via the multi-period excess earnings method, relief from royalty method, build-out or
greenfield method)
• Market approach based on comparing the asset with similar assets, and prices paid
for them (comparable transactions method)
• Cost approach relying on the principle that no prudent investor would pay for an
asset more than the cost to recreate it or to reproduce an asset of similar utility
(replacement or reproduction cost method)
More than one approach may need to be considered in order to arrive at a supportable
valuation range. In the following sections, we explain the choice of the preferred
method for each asset valued, and discuss some of the practical challenges.
The key assumptions when valuing a trade name are the revenue
base, the royalty rate and the discount rate.
For telcos, the challenge arises around the remaining useful life
of the acquired trademarks. Specific re-branding and
co-branding relating to the acquisition must not be included.
The key principle of this methodology is that subscriber relationships do not generate
cash flows in a vacuum. Rather, they are supported by several other assets, such as
fixed assets, working capital and intangible assets.
The application of the multi-period excess earnings method is not easy in the
telecommunications industry:
Lastly, the useful life is determined in a way that is consistent with the subscribers’ cash
flow patterns. A common rule is to retain a useful life that can capture 90% or 95% of
the total value of subscriber relationships.
1. One-off fees
• Market set: method used by regulators to estimate an upfront fee using market
comparison valuation techniques
• Price floors and minimum bids: method used in auctions where a ‘floor’ price is set to
ensure that the starting point for bids is in line with government expectations
Long-term lease/rental agreements signed in the past at market rates (fixed, non-
adjusted rent) might eventually become favorable or unfavorable agreements because
of the cyclical nature of the market. The ‘non-market’ part of rents borne or avoided by
the acquirer due to the existing rental/lease contract should be valued and booked in
the acquirer’s consolidated accounts.
Supply contracts and distribution agreements shall be checked for any off-market terms
and conditions as well as for any exclusivity clauses, as these might give rise to an
intangible asset being identified, recognized and valued.
IRUs enable operators to use the networks of other telecommunications carriers for an
amount that can be compared to a rent. All IRUs are signed for long-term periods and
represent a competitive advantage over other market participants, as capacity is limited
in the market and, once contracted, they are not available to other market participants.
Therefore, these contracts may represent a great deal of value to their owners, and are
often included in the PPA.
Non-compete agreements are contracts between a buyer and a seller of a business,
restricting the seller from competing in the same industry for a specific period of time,
often within a defined geographic area. The principal technique used to value non-
compete agreements is an incremental approach, which values the asset based on the
difference in cash flows between scenarios with or without the non-compete agreement
in place (“with or without approach”). The main limitation of this approach is that it is
highly subjective, and the inputs are discretionary in each case.
Nicolas Klapisz
Global Telecommunications
Valuation & Business Modelling Leader
nicolas.klapisz@fr.ey.com
Robin Jowitt
Global Telecommunications Transaction Advisory Leader
rjowitt@uk.ey.com
Serge Pottiez
Global Telecommunications IFRS Advisor
serge.pottiez@fr.ey.com
Steve Lo
Global Telecommunications Center — Beijing
steve.lo@cn.ey.com
Holger Forst
Global Telecommunications Center — Cologne
holger.forst@de.ey.com
Prashant Singhal
Global Telecommunications Center — Delhi
prashant.singhal@in.ey.com
Ernst & Young