Talking telecom M&A

Citigroup''s head of Asia Telecommunications group, Greg Mazur talks about the trials and tribulations of telco M&A.

Do you think SingTel is going continue to be active in its buying?

SingTel is starting to play the role of a regional telecoms company. It is pursuing a smart strategy, given the limited size of its domestic market. It is a well-capitalized, skilled company which has a combination of access to capital, human resources, and technical skills to offer other companies in the region. SingTel will increasingly be viewed as a regional telecom company.

What are the synergies in being a regional telecoms company?

Telenor, whom Salomon has advised on investments in Thailand and Malaysia, has experienced mobile professionals who have gained experience from their 14 international investments. They operate somewhat as a swat team of 500 mobile professionals who are able to take the best practices learned from these investments and transplant these to new investments. There are significant strategic benefits in exchanging information regarding branding, network operation, future 3G platforms, etc.

There are also economics of scale in equipment purchasing issues. For example, Telenor has investments in DiGi.com in Malaysia and Total Access Communication in Thailand. Immediately after making these investments, they called the suppliers and said we want you to reduce the equipment cost by 30%. They did. That’s immediate – a 30% drop in capex.

SingTel definitely has a geographical reason for being here in Asia. Its strategy has been to incrementally acquire assets around the region, and at some point in time, when they acquire enough companies, get enough control of these assets, enough influence and synergy, you get an inflection point. The light goes on, and you get a critical mass. This happened for Spain’s Telefonica in Latin America a few years ago. At a point in time, SingTel is going to hit this inflection point.

Where does SingTel have most of its assets? Australia and India?

Yes. In addition to these, the company is in AIS in Thailand and Globe Telecom in the Philippines. They also have invested in New Century Infocom, which is in the process building out a fixed network and is a future challenger to Chunghwa Telecom in Taiwan. If they could get a significant stake in a mobile operator in Taiwan, I think they would do so. Same in Korea – it makes perfect sense for them.

SingTel is clearly one of the key M&A clients in Asia.

In terms of M&A, they are clearly going to keep bankers active for a while. They will probably take a breather however, to digest the recent Optus acquisition in Australia. Telstra is another key player, although they are behind SingTel, in terms of the number of investments they’ve made, and where those investments are in their life cycle. DoCoMo would be another contender for a regional telecom operator.

Do you envisage consolidation among the Indian mobile phone operators?

The current mobile operators are probably too small right now to be able to access the capital markets in the current environment. Even though there are various IPO mandates outstanding, markets are becoming increasingly selective in the types and size of companies they will fund, thus consolidation makes sense.  Current mobile operators do not have a national or near-national footprint.  Its necessary for them to increase in scale and size for a variety of reasons. The most important is access to capital. It is incredibly difficult to try to do an IPO of a mobile company in Asia if you only have 500,000 -700,000 subscribers. However it’s not just IPOs, but other forms of capital as well, whether it be bank debt or public debt. So, my guess is you’re going to see further consolidation.

How many mobile subscribers do you require in order to have access to public markets?

This will vary depending on country and profitability but you are looking at something close to a million subs at a minimum for most markets. However it also depends on what the capex needs will be in the future, and where are you in the life cycle of your operations. Are you cashflow positive? how positive? Because investors, whether they be public equity investors or debt investors, are no longer looking at five year business plans anymore. They are saying what is your two-year business plan, how many subs are you going to have next quarter?, not next year. What is your operating and free cash flow and what is your net income level going to be? Most importantly they want to see whether you are fully funded. The pendulum has swung back to the side of “old-fashioned” profitability and balance sheet analysis and telecom companies are being assessed by investors more like traditional old economy companies.

For telecom companies and their bankers, this can be a rude awakening. We have been on a roadshow recently where we were talking about the operating cash flow, saying it is going to grow by 150% this year and subscriber numbers are going to double. Investors reacted calmly saying this is good, but what’s the net income margin and how much is net income growing by?

So if you are a telecom company and you’re small, you’re not the incumbent, and you’re looking for access to capital, it is extraordinarily difficult in today’s environment.

What this means is all the second/third tier operators in Asia will have to consider consolidation, as it is unlikely they will have access to significant sources of capital in the next 12-18 months.

So what would be your forecast for the total volume of mergers in the next 18 months?

I can’t give you a number, but some of these companies will have no choice but to consider merger activity. They had better bulk up, achieve better economies of scale, and become a financially stronger operator. Only then will they be something that the capital market might look at seriously.

The parties that have cash in India are the Ambani family and Hutchison Whampoa.

Hutch clearly has cash, as do the Ambani’s in India. With regards to the mobile operators, there will be a first mover advantage for the first pair to merge. If BPL merges with Bharti they create a stronger, leading Indian mobile operator. If HutchMax and Bharti merge, then what happens to BPL, etc.? So you’ve got to be first. Investors are not looking to fund the third and fourth players in a respective market anymore. You’ve got to be one, or two in order to get access to capital at present. So taking it back to the Indian context, what can the market fund? Maybe two or three future nationwide or near-nationwide operators.

Does this put Hutch in the driver seat because it has cash, and the others would have to use stock?

Yes. Those who have the cash or access to cash now have a huge competitive advantage. In Korea, Korea Telecom, because of its sheer size has a significant advantage over other fixed/broadband players.  The other Korean players have limited access to funding. So KT is able to push ahead with its broadband rollout and acquisition of subscribers very very quickly. If they were smart, they would move quickly now while the other operators do not have access to funding. There will be broadband consolidation in Korea just like there will be mobile consolidation in India. Without access to capital, Korea Telecom’s competitors cannot fund their growth. In some cases, they are over-leveraged. So no growth also means potential bankruptcy. The bottom line is there are too many players.

A similar situation exists in Malaysia, where there are five mobile operators –  it can’t last.

Do you think BT will have trouble selling its stakes in SmarTone and LG Telecom?

Given that they’re not already sold, it must indicate that it is taking them longer than they anticipated. The whole environment has changed since they made their original investments. Take SmarTone as an example. It has cash on the balance sheet, it is a well-run company, and it is a nice mobile asset. But very few companies want to buy into a market where you have six mobile operators and 3G licensing coming up. In addition, operators will have to make 30% of their 3G network capacity available for anyone who wants to come on and use their network. So there is going to be more, not less competition in Hong Kong. That’s great for consumers, but bad for the company and its shareholders, and creates significant uncertainty for strategic partners coming in to the market.

Let’s talk a little bit on Indonesia. Some people reckon the telecom deal of the year so far was the deal you have done between PT Telkom and PT Indosat.

This may be a biased response given Salomon advised PT Telkom on this deal, but I do feel this deal was a win-win situation. The Indonesia telecom market was complex and the historical government policy that was in place wasn’t driven by commercial logic. That’s why you had these cross shareholdings. The government wanted to make sure that the government or government-controlled companies had a say in everything telecom-related.

This was fine up until a point. It was fine because the IDD business for Indosat was growing and making a lot of money and the fixed-line business of PT Telkom was doing the same. Areas like mobile were just an infant businesses that didn’t matter that much. Then everything changed. Fixed-line, voice-only emerging market telecom operators lost  investors’ interest. Indosat’s revenue base began to deteriorate because IDD rates were falling. Telkom did not have negative growth but it began to grow more slowly.

At the same time the Indonesian mobile market was exploding. It was taking off in a period where there were riots in the streets, a significant economic downturn, a change of government, etc. However people were continuing to spend money on mobile phones. The mobile operators were actually both profitable, and experiencing rapid growth. Telkomsel had a 57% operating cash flow margin. It was the highest in Asia. Its net income was positive. It had zero debt, and was taking on almost 80,000 net subs per month. Satelindo had issues with regards to a complex shareholding structure, and debt covenants, but the business itself was a strong, growth business.

So what do you do? Telkom needed full control of a mobile asset, whereas at the time it had stakes in both Satelindo and in Telkomsel, but had no control in either and from investor’s perspective, it was just receiving financial income. Telkom needed a high growth asset if it was going to change investors’ view on Telkom, and show there was growth. Indeed,  I would argue that the mobile business is the most attractive industry in Indonesia right now.

So, Telkom buys control of the largest mobile operator in Indonesia, and hopes to be re-rated by analysts, more in line with a growth story.

Indosat was in a more precarious situation. Their revenue base was actually deteriorating, because it was pure IDD, and so they too needed a growth asset. So it made sense for them to acquire Satelindo. So what you’re effectively doing is restructuring the entire country’s telecom industry. There was a lot of effort that all sides put into to convincing the government of the right way forward.

It sounds like China. You’re creating two strong, viable players.

It does look somewhat similar. The model was actually very simple. You’ve got two of Indonesia’s largest companies. One of them is facing declining growth, and one of them is a stable utility, generating an annuity type revenue base. We had an opportunity to eliminate all of the complex cross shareholdings and make the telecom market more transparent to investors.  In addition, we were able to take these two companies and radically change their growth profiles. So again, you’re marrying the stability of Telkom revenues with a high growth mobile asset. You’re taking Indosat and radically restructuring the growth of the company.

After all, investors are not buying Indonesia for stability. They’re buying for the future growth potential. And if you’re making a bet on Indonesia, you’re making a relatively high risk bet. You better have the potential upside that matches the risk profile of the country. Following the cross-shareholding elimination, this is now what you have with these two companies.

As Citigroup you have a balance sheet. Does that give you a competitive advantage vis-a-vis pure investment banks?

Absolutely.  Being part of Citigroup is a definite advantage.  We are able to offer companies an extremely broad spectrum of financial services.  However, at times you need to educate the market.  We use our balance sheet carefully and only when a company’s credit profile is strong enough.  After all, lending $100mm to a company is significantly different than simply accepting an advisory mandate.

So you can do the bridge financing if necessary?

Yes, but that is not something most banks are targeting. In this environment – for telecom companies – bridges are all but non-existent. Citigroup will lend based on the stand-alone credit worthiness of the company, but we will not lend solely based on getting an investment banking advisory fee.