Should SA telco firms shift into infrastructure?

While Covid-19 provided telecommunications firms (telcos) with an opportunity to strengthen connectivity, as regulators released more spectrum, many of these firms have become de-rated over the past 3 years, with risks like disproportionate regulations, volatile exchange rates, and unforeseen geopolitical issues coming into play.

The de-rating, especially for South African telcos, has come about partly because of a shift in investor sentiment – they’re now not only looking for a dividend yield, but are also concerned about debt and foreign exchange risk and volatility. Ratings are rewarded where debt and foreign exchange concerns are minimal, and a company such as Vodacom, with its strong balance sheet and free cash flow generation, experiences minimal volatility in terms of foreign exchange rates and actually trades at more than double the forward P/E multiples of MTN and Telkom.

It makes sense to create an infraco

What these South African telcos can do to de-risk from a leverage and regulatory standpoint, without actually settling their debt, is carve out their tower infrastructure and other related telco infrastructure into a separate entity – what we call an infraco.

Investors are valuing tower companies much more highly than they are valuing a good-quality telco

This approach to infrastructure within the business would unlock value in different ways. In an analysis of global new-generation or infraco telcos compared to traditional telcos, we found that a new-generation telco trades at a much higher multiple. This can often be a difference of trading at around 16 times forward embedded-value-to-ebitda multiples, compared to a traditional telco, for which the multiple would be around 3.5 to 7. These companies can therefore take on much higher debt levels, around 4.7 times net debt to ebitda, compared to our more traditional African telcos, which see around 1 to 2 times net debt to ebitda.

Generating more revenue

These new-generation telcos have a steady income stream that is linked to inflation for 10-year periods, and the infraco arrangement means that they have an anchor customer, which is the actual telco. For example, a company like MTN Ghana, a very high-quality African telco, has 20% service revenue growth, 35% ebitda growth and 54% margin. If we compare this to an infraco like Helios Towers, MTN Ghana generates 2.5 times more revenue and 2.5 times more ebitda. It grows its ebitda about 2,4 times faster than Helios, yet its market cap is 23% smaller and trades at a 3.3 times smaller embedded-value-to-ebitda multiple.

This indicates that investors are valuing tower companies much more highly than they are valuing a good-quality telco. It therefore makes sense, and unlocks more investor value, to carve out that tower infrastructure and put it into a separate infraco.

Moving into infrastructure in this way, in a fairly benign regulatory environment like we have in South Africa, means that these telcos can take advantage of the temporary release of bandwidth spectrum and will be well positioned to benefit from the permanent allocation of additional spectrum to mobile operators.