Equity investors will continue to circle the b2b telecoms market this year, searching for further investment opportunities in a consolidating market, according to a report by IS Research.
However, as equity investors continue to drive prices up in the sector, their investments may yield poor returns unless they have the right ‘buy and build’ strategy, the report warns.
Speaking to Mobile, IS Research analyst Philip Carse, the author of the report, said factors driving consolidation in the market remain strong and will continue to attract private equity investors. These factors include economies of scale, distressed sales due to the economic downturn and the move towards unified comms and managed services. In the report, entitled ‘Consolidation: Where’s the return for investors?’,
it states: ‘Consolidation has been a key feature of the sector, with 24 deals costing £744m tracked over the last year, at an average valuation of 5.6x historic EBITDA.’
It adds: ‘Private equity has been behind two-thirds of the deals by number but 94% by value.’
However, the report warns that if private equity investors don’t get their buy and build strategy right they face the prospect of making a poor return on their investments.
‘The answer has to lie in successfully executing a buy and build strategy to create a business with significant exposure to the more attractive parts of the markets such as data hosting and managed services, as well as securing the significant economies of scale that are clearly available.’
The report warns: ‘This is easier said that done; whilst buy and builds such as Daisy (see box), SpiriTel and XLN have demonstrated the significant cost synergies available, poorly executed buy and builds such as Redstone, AT Communications and Azzurri serve as a warning. The real winners will be those companies that can also secure revenue synergies, from, for example, cross-selling, on top of cost synergies.’
Next year could see some investors selling to other contenders. The report says: ‘The larger telcos such as BT and CWW and the mobile network operators are potential buyers, though other b2b providers and other private equity investors will probably be the main exit route.’
Carse told Mobile: ‘Private equity investors are interested in the business telecoms space because it has lots of potentially profitable and cash generative companies.
In addition, there is a lot of opportunity in the market to drive profit by making acquisitions.’
Carse said the investment houses are not looking for one-off investments. Their strategy is to go out and buy a number of companies to get economies of scale.
He added: ‘The sector is also attractive in that it offers other growth opportunities to private equity investors, such as cloud computing, which is driving investment in data centres and network services.’
Carse said private investor interest in the telecoms sector in the past 12 months has been significant.
He said: ‘This is partly driven by strategic interest and partly driven by private equity investors having a lot of money to invest that they raised before the financial crisis. In addition, the financial crisis has led them to turn their attentions to new markets.’
Carse said equity investors active in the telecoms sector include Oakley Capital, which is the driving force behind Daisy and Penta, which backed SpiriTel, Bridgepoint, which invested in Lumison, and Gresham, which invested in Spice Telecom.
Telecoms equipment sellers could miss out on acquisition boom
Telecoms companies focused on selling equipment or professional services are in danger of missing out on the continuing boom in telecoms mergers and acquisitions in 2011, according to M&A specialist Knight Corporate Finance.
Director Adam Zoldan said valuations in the sector are on the rise, driven by trade buyers and the private equity sector.
However, Zoldan warned that businesses generating profit from equipment sales and professional services, such as billing, could miss out on the valuation boom.
He said: ‘It’s all about customer ownership, recurring revenue and a fundamental shift towards managed services. The perceived quality of earnings derived from a customer that pays on a monthly or quarterly basis will deliver the highest valuations. Managed hosting, connectivity, and hosted applications are all high on buyers agendas as we move into the cloud.’
Zoldan said telecom resellers are already recognising the need to move into this space as voice revenues decline.
’They already have the billing systems and back-office infrastructure in place and adding an additional service to the customers’ solution is a relatively simple affair, especially with the high level of support they can receive from suppliers.’
Fellow director Paul Billingham said companies reliant on equipment sales and billing should follow suit.
He said: ‘There are a range of opportunities to increase value as contracted managed services gain widespread acceptance, and we expect to see significant consolidation as larger providers look to gain scale or compliment organic growth. Organic growth is now more difficult and more expensive to achieve, and the desire to add scale, alongside the necessity to develop new expertise, is the driving force behind most acquisitions.’