Competition within the telecommunications industry is fueling mergers and acquisitions, albeit at a slower pace than in years past. There were 269 telecom mergers in 2015, down 11.5 percent from the 304 mergers that took place in 2014 and off 20 percent from the 339 in 2013. Since the start of 2010, the industry has seen more than 2,400 M&A transactions. The number of telecom players is dwindling, but industry consolidation is still robust between mobile and fixed line/cable operators, resulting in bigger players occupying more dominant positions.
The U.S. and European markets have become almost completely saturated with smart phones, reaching close to 80% penetration. Companies can no longer rely primarily on new customers to drive growth. At the same time, consumers are increasingly expecting data and services to be delivered on-demand to all of their devices seamlessly, and the industry is seeing a shift away from long-term contracts. Companies are changing gears to focus on mitigating churn and expanding service offerings. Despite high valuations and rocky public equity markets, low debt costs and significant cash reserves are ensuring that acquisitions remain a key lever to pursue growth. We expect industry consolidation to continue over the next five years.
Reduced Redundancies, New Businesses
Fueling acquisition activity among telecom firms is a desire to reduce or avoid redundancies. Oftentimes two competing providers within a regional area may both build proprietary infrastructure — cell towers, for instance — or pay separate leases for existing infrastructure. Mergers can eliminate these redundant costs and consolidate the customer base of two otherwise competing companies.
Firms may also choose to acquire to add untapped competencies and non-core businesses that they haven’t previously participated in. They see the vast opportunities of building scale in order to secure a superior return on investment.
Many are seeking to offer customers a one-stop-shop – a quad-play service – that can take advantage of the bundling of a landline phone, broadband, TV and mobile services. Quad-play can help streamline and improve the overall customer experience, while reducing customer churn and thereby reducing new customer acquisition costs. That’s very important given the now-saturated mobile phone market. The AT&T acquisition of DirecTV exemplifies this type of merger.
The quad-play isn’t just limited to the U.S. More consolidation is expected across Europe, as large firms look to expand into international markets in search of new customers. European telecom providers, such as Iliad and Telefonica, have secured millions of quad-play bundled subscribers within the past two years.
Similar trends are playing out in the fiber optic space. Fiber optic providers are realizing significant year-over-year gains, as consumer demand for high-speed connectivity continues to rise in tandem with the increased use of smartphone and wireless mobile devices. Customers are increasingly clamoring for high definition videos, video streaming, 4G and next generation 5G capabilities, and faster, premium speeds. As a result, fiber optic providers have made for attractive acquisition targets. Deals that allow providers to enhance their infrastructure by tapping fiber optics experts are becoming quite common.
Examples of such deals include Level 3’s purchase of tw telecom, which brought the firm additional metro fiber-based on-net buildings and instantly expanded its building footprint to nearly 21,000 buildings. Similarly, Allo Communications’ pure fiber optic service will increase Nelnet’s ability to meet customer connectivity demands. Nelnet acquired Allo this past November.
Challenged by high customer churn rates and rising organic customer acquisition costs, operators are also utilizing acquisitions to enter new customer markets. They seek to provide broader service packages that will increase customer satisfaction and keep existing customers from fleeing to competitors.
Strategic acquisitions also allow operators to tap into new markets in which they have little or no operating experience. Purchasing competitors that are well established in a particular geography gives the acquirer immediate access to that area. Prime targets typically feature premium customer satisfaction rates, which translates to less after-transaction churn. If customers are happy with their current services and price level, they are less likely to jump ship after the merger.
T-Mobile is a good example of a company that has adjusted its business to accommodate the demands of modern consumers. The third largest wireless network in the U.S. has seen significant growth through its unconventional elimination of annual service contracts, and by allowing customers to upgrade their smart phone devices more often than competitors and at lower cost.
Looking further into 2016, the telecom industry will continue to be propelled by major technological trends, including mobile broadband, M2M, cloud computing, OTT services and big data management. With interest rates remaining low and banks willing to underwrite large debt offerings structured for acquisitions, market conditions are favorable for M&A activity.
But tensions do exist. High valuation multiples are driving up the costs of acquisitions. Moreover, regulators are trying to encourage a competitive marketplace while providers are seeking to grow even bigger through acquisitions. Some big deals have been thwarted as a result. The United States Department of Justice and the Federal Communications Commission have vocally opposed mergers involving national carriers, such as the proposed 2011 merger between AT&T and T-Mobile, due to anti-trust concerns.
The industry and regulators are hoping to strike the right balance between ensuring market competitiveness and fostering an environment that allows for the significant investment in infrastructure that strong economies need. Growing consumer demand and ever-evolving technologies should continue to provide plenty of opportunities for telecom companies to navigate.
These trends reverberate in the middle market. Larger operators are trying to remain competitive by seeking smaller, often niche, companies with proprietary services or technologies, high customer penetration in specific geographies or infrastructure layouts that are easily rolled-up. With the current market conditions and increasing competition in the industry, we expect this trend will continue throughout 2016.
Jodi Burrows is a Vice President at SDR Ventures, a Denver-based investment banking firm specializing in mergers and acquisitions. She is responsible for transaction and strategy consulting, and equity and debt financing.