It is easy to assume the telecoms market is booming. Everyone is on video calls for family and work, phoning more often, messaging more often, playing and working remotely. Even granny knows what Zoom is today - But is this reality?
We’ve invited Steve Andrews, Chair of wireless broadband provider Luminet, to give us his view of the winners and losers in both the residential consumer and business sectors, alongside Adam Zoldan of Knight Corporate Finance (a boutique advisor for the technology and telecoms sector) who has added his thoughts on the likely impact of the pandemic on deal activity and multiples across the industry.
What trends are we seeing on the consumer/residential side of the telco industry?
Steve Andrews: Consumer communications services can be simply broken into 2 main categories, both for fixed line and mobile. First, voice calls - Generally calls for both fixed and mobile are declining as messaging and social media communications have grown. However, during the pandemic a significant reversal occurred as people in lockdown typically want to speak to each other. According to the NY Times, Verizon in the US recently reported an average of 800 million wireless calls a day (double the previous highest day) and many telcos have had to react quickly to cater for the surge. For the telco this is not all good news as many customers have unlimited call plans and this growth will not come with a significant increase in revenue. This has been exacerbated by a big reduction in profitable global roaming fees.
Second, broadband lines and usage – Whilst the installation of general consumer lines has been more challenging due to the prioritisation of key workers, COVID rules and staffing implications, installations have continued. There has been a significant increase in data usage, particularly at home, from home working and a huge growth in online entertainment to cope with the “lockdown blues”. Ofcom, the UK regulator, reported a shift from under 3 hours per day average online time for an adult, to over 4 hours during lockdown. Many telcos are reporting a 25-35% increase in home data usage and more than 7 in 10 UK adults are reported as making at least one video call per week. The desire for better broadband will drive upgrades of plans to higher speeds and unlimited data. The public demand for investment in more fibre will increase significantly and telco collaboration tools will increasingly address consumers, not just business.
Adam Zoldan: The telecommunications sector is clearly differentiated for residential and business, and whilst both have to deal with price deflation, they have handled it in different ways. The residential sector is dominated by a few large-scale players including BT, Virgin, Sky TalkTalk and Vodafone. Revenue for calls has been in serial decline but this has been partly driven by charging for call bundles and price increases for monthly subscriptions. There has also been a focus on increasing the number of services sold referred to as the “quad play” fixed-line, broadband, TV and mobile. Notably the main players are publicly quoted companies and their historic performance has not been particularly racy.
For these reasons, in terms of M&A activity the consumer sector is much less interesting than the business sector, with perhaps the exception of the infrastructure investment into the fibre market. A substantial amount of the UK telco infrastructure is old, particularly the “last mile” which comprises copper wires into premises. This is mainly owned by Openreach, BT’s network division. To improve this part of the infrastructure, we are seeing considerable investment into fibre from existing incumbents and start-ups who are raising significant funds from infrastructure investors – examples include Cityfibre, Hyperoptic and G-Network as well as Foresight’s own recent investment into Lightning Fibre in East Sussex. These providers offer massively enhanced bandwidth, at highly competitive rates.
Steve Andrews: I agree that the public demand for investment in more fibre will increase significantly as data usage trends established during the pandemic will continue, in particular the use of video-based applications. Whilst the pandemic has created more growth in home wifi than mobile data, the use of media and video applications e.g. Tik -Tok, Whatsapp and Instagram across all ages, is set to increase overall fixed and mobile data consumption over the long term. Overall, I would say that the data consumption boom has been good for the telco industry.
What are the trends we’re seeing on the business side of the telco industry?
Adam Zoldan: Generally, the business sector is far more competitive than the consumer sector, with the larger players competing with thousands of resellers - known as “the channel” - all of which have a particular niche, whether its geographic, vertical, or product based. Business has a far more complex service requirement with multiple users and locations and a requirement to be always on. The channel has proven remarkably adept at understanding and tailoring services to business requirements and broadening their product scope to include cloud services and IT support. There has been a high level of private equity investment in the sector with funds flowing freely resulting in a substantial M&A volume. This has seen relatively small owner-managed businesses transform into significant competitors for the incumbents with examples including Daisy, Southern Comms, Wavenet, Arrow, GCI, XLN, Sabio to name a few. At Knight we are seeing this trend continuing.
Steve Andrews: The economic impact from the pandemic-driven downturn in retail, hospitality and travel businesses has been offset to some degree by increased demand from professional and services businesses, as they have been forced to invest in remote working technology, cloud, security and network management.
The first priority for many telcos has been to prioritise health services and key workers and this has impacted their response times. As we see the conversion from operating from business premises to work-from-home, cloud services have come to the fore, with online IT/security being adapted to work well remotely. Telcos have seen an increase in business calls during the pandemic although calls from offices have inevitably been replaced by more lines and calls diverted to home or calls on the business mobile from home. However, although business mobiles have been used a lot at home, the unlimited plans and use of home wifi has driven very little incremental income. Office internet networks have generally been under utilised in the pandemic, as most consumption has been over home networks. But, depending on the business network configuration, remote workers often will remotely access office IT systems as well as those in the cloud, so most corporate networks have remained active and necessary even if much of the traffic is over the domestic connection.
For the telco, business customer inertia due to the pandemic is challenging, alongside the likely individual business failures that create increased churn. Deserted offices and closure of businesses is of course a key concern. The big question of how many workers will return to office-based working presents a challenge for telcos that install and service installations. Accessing premises to install circuits or upgrade equipment is more difficult and the general inertia of decision making, as businesses wrestle with the unknown, is consequentially impacting order pipelines.
Apart from the unfortunate businesses that have had to close, there is an expectation that offices will re-open whether in part or fully occupied. In either scenario communications will remain crucial and telcos should expect to maintain their presence, albeit with adjustments to the configurations for more remote access and capacities. There is also increased interest from the property market to improve their technology capabilities to differentiate in a challenging market, with communications being key.
Adam Zoldan: In terms of the COVID-19 impact, not many sectors have performed as well as the telecommunications industry. The sector has proven to be highly resilient and has played a critical part of the UK and world economy. Even with the economic uncertainty from COVID-19, and potentially difficult Brexit-related challenges ahead, there has been no reduction in deal activity with trade buyers and institutional investors seeking well managed, profitable ICT resellers. At Knight Corporate Finance, we are seeing this continued level of activity first-hand having completed eleven transactions since the end of March.
With the exception of the first few weeks of pandemic, buyers, investors and funders have remained as hungry as ever for deals across the channel. The robust nature of the ICT sector, generating high levels of recurring revenue, has resulted in strong competition and maintained valuations. Where there have been some short term one-off COVID-19 related spikes, the crisis has also fast forwarded digital transformation strategies where more robust, sustainable and agile solutions are being sought. When the dust settles, there will be more focus than ever before on businesses having the right infrastructure and solutions in place to allow full flexibility for employees to work from home. That presents a massive opportunity for the telco industry and wider ICT sector as a whole.
The resilience and confidence in the channel have meant valuations are holding up well, driven by private equity interest and the confidence in the sector from banks has resulted in significant increase in funding options for business.
Where are telco sector valuations?
Adam Zoldan: There are many factors that will affect the valuation, primarily size and growth. Typically, for a reseller generating up to £1 million EBITDA, we are seeing a multiple of circa six times “maintainable” EBITDA. For larger targets the multiples increase driven by competition amongst acquirers and investors. There is much competition among PE investors for companies of a reasonable size and beyond EBITDA of £5m we are seeing double digit multiple valuations.
Multiples are too often the talk of the town; as advisors we reinterpret EBITDA and look at revenue, non-recurring and extraordinary costs. We look at run-rate, how the performance is today versus how it was over the last year, we consider work in progress, what is coming down the pipe and how that will add to a business. Multiples are important metrics, but in terms of a comparable valuation you shouldn’t always believe what you read!
We are seeing continued investment in the telco sector and no let-up in the volume of transactions as the market consolidates and grows to encompass an ever-increasing product proposition. Everyone will have witnessed the incredible impact of Zoom and Teams over last year and whilst this poses a threat to a certain extent, the dynamic nature of the sector means some companies will also be viewing this as a significant opportunity to enhance the value of their proposition.
Steve Andrew, Chair of Foresight Portfolio Company Luminet
Adam Zoldan, Director at Knight Corporate Finance