Why investment houses are so interested in telecoms

Mike Cansfield, Research Director

On 9 October 2006, activist fund Cevian announced it had bought 72 million shares in TeliaSonera. In July, the Australian-based investment fund Babcock and Brown bought a controlling interest in Irish incumbent Eircom. Last year, Apax Partners led the purchase of TDC in Denmark, and in Spain France Telecom had to beat two rival offers from investment groups for Amena. Why are investment houses so interested in the telecoms sector?

Reasons behind this growing interest

Firstly, there is a view within the financial community that telcos are underperforming in terms of what they give back to their shareholders, and in terms of their share prices. While telcos (particularly incumbents) can generate cash (and so pay short-term dividends), they are finding it much harder to grow revenues as the fixed business declines and as mobile growth becomes increasingly difficult in matured markets - hence low share prices. But there is a belief within the financial community that telcos could do far better, particularly as they are high-tech industries. The opportunity for investment houses is to buy now while share prices are low, get involved in the management of the company, develop the business and then sell in the future when bigger profits drive values higher.

Secondly, if we look at how the telcos are structured, it is not difficult to conclude that the whole is worth less than the sum of its parts. Traditional telcos used to be organised in vertical silos, such as fixed/mobile/ISP, or by product line within these broad headings. We refer to these structures as 'monuments to the past'. While this approach has its advantages - in terms of P&L focus, clear management responsibility, etc - they are largely internal to the company. Externally, they create obstacles to doing business; customers have to talk to each line of business separately, and in general none of the silos are able to talk to each other freely. The opportunity for financial investors is to re-orientate the business to create a greater customer/market focus and in so doing simplify their operation and release value. This is rationalising the distribution side of the business.

The third reason why investment houses are interested relates to consolidation and transformation. So far we have seen consolidation through ownership - Cable & Wireless/Energis in the UK, Neuf Telecom/Cegetel in France and SBC/BellSouth/AT&T in the US are all examples. The first thing Cable & Wireless and Energis agreed to do was to consolidate their business onto one network and so take out a large swathe of costs. But consolidation of this type does not have to take place at an ownership level. There is no reason why telcos cannot consolidate the supply side of their business (including the network) onto a wholesaler or outsourcer. The transformation of the industry through next-generation networks (NGNs), convergence of telecoms and IT, and convergent services enhances this opportunity rather than diminishes it. So opportunities exist in telecoms to rationalise the supply side of the equation too.

But there are also associated risks

Telecoms is a complex high-tech sector that also happens to be undergoing a fundamental transformation. NGNs underpin much of the potential in the sector, but these investments are not risk free. Without a vertically integrated national telco (that is, an incumbent) it is hard to see how this key enabler could be deployed nationally. So whilst the sector is attractive to investment houses, nothing is straightforward.

Mike Cansfield is a research director with over 17 years' experience in the industry, and now also leads Ovum's Telecoms Strategy practice. He is responsible for leading Ovum's research in this area and managing relationships with several key clients.