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Tower power

Telecom operators are hiving off their infrastructure into separate companies, which are commanding heady valuations. Why are they worth so much?

By Anand Adhikari        Print Edition: Sept 9, 2007

The wireless industry doesn’t stand still for very long,” began James Taiclet, CEO of 12-yearold American Tower Corporation. Taiclet has just set in motion a conference call with a dozen analysts from his 11th floor office on 116 Huntington Avenue, Boston. The occasion: A discussion on the company’s second quarter loss on account of a bankrupt subsidiary. But analysts were keener to learn more about the company’s tower business across the globe and the guidance for 2007 from the US’s biggest tower company.

American Tower owns some 22,000 towers, which are primarily used to transmit mobile phone signals. But these towers are beginning to find other uses, too. “The much-awaited Apple iPhone was launched. We believe that this product may be the inflection point of a very important systemic change in the wireless industry,” announced Taiclet. Yet another piece of good news for the tower industry, according to Taiclet, is the rollout of 4G WiMAX (which has a greater coverage than Wi-Fi and can also offer bandwidth at half the cost) by Sprint Inc.

If American Tower has been able to achieve break-even—unlike the two other big boys in the industry, Crown Castle and SBA Communications—there’s good reason for that. For one it has been able to maximise the sharing of its towers, even as it finds new uses for its towers, other than voice traffic. For instance, TV and radio broadcasters, and even the traffic department— which has set up traffic cameras atop these towers—have begun using these telecom towers.

Back home, Indian telecom players have huge plans for growth in the tower business. Already Bharti has 45,000 towers, which makes it two times the size of American Tower. But size alone doesn’t matter. More important is how many operators are sharing these towers. Currently sharing is at a minimum level (operators peg it at under 25 per cent as against 90 per cent in the West) and some operators don’t even share towers at all.

“It’s early days yet for tower sharing, but it would gather significant momentum in the near future,” believes Ramesh Venkat, Group President (Finance) at Anil Ambani’s ADAG Enterprises, which plans to have 50,000-60,000 towers in the next two years. Akhil Gupta, Joint Managing Director & CFO, Bharti Airtel, doesn’t want to hazard a guess about the number of towers Bharti will have in the near future. “There is a huge growth opportunity. We are creating infrastructure for the industry,” says Gupta.

The genesis of the tower business in India is slightly different from that in the West. Most of the towers in the country have been built by the operators themselves, like Reliance and Bharti, for their own use. It’s only now that these companies have wisened up to the possibility of finding other operators as tenants on their towers. As Reliance ADAG’s Venkat says: “Most of our towers will be capable of handling four tenants by March 2008. We can also easily upgrade from four to seven tenants at a fairly low cost.”

Reliance ADAG — which provides mobile services via Reliance Communications — isn’t the only group with such plans. Today, virtually every operator has drawn up a massive expansion plan to spread its tower network. “Tower sharing will bring more efficiency in the industry. It’s a win-win situation for both the operator and the tower provider,” says Gupta of Bharti.

The tower companies say there is going to be a huge demand given the growth in subscriber numbers and also the pan-India ambitions of many operators. Yet, the question persists: If all players are expanding their tower base, why would they need to share towers at all? Prabhat Awasthi, Head (Equities) at BRIC Securities, reckons there will be a case of oversupply in the short run. But he’s convinced that the massive growth in the wireless subscriber base justifies the current expansion spree.

“New operators have ambitions to grow pan-India,” says Venkat, hinting at the ambitions of players like Tata Tele, Idea Cellular, and Spice Telecom. In anticipation of this demand, large players like Bharti and Reliance Communications are creating a ready infrastructure. By 2010, both are expected to control close to 60 per cent of the tower infrastructure in India. Experts say that only once the growth in towers starts tapering off in the next two years, will the sharing percentage rise.

In fact, the single-biggest driver for sharing for Indian mobile service providers will be to continue enjoying the status of lowest tariff rates in the world. Going forward, the pressure on revenues and margins of new operators will only increase as they move away from the saturated metros up-country to probably lower revenue-generating customers. One way to stay competitive will be to keep costs of capital expenditure and operations at low levels during geographical expansions. That’s when sharing will make economic sense. Yet, there’s another reason for operators to focus on the infrastructure end of their business.

And that’s the crazy valuations that these towers are fetching. Reliance Communications was the first company to indulge in a price discovery process when it made a private placement of 5 per cent equity to private equity players. This valued Ambani’s tower business at a mind-boggling Rs 27,000 crore ($6.75 billion). Bharti, which has just decided to transfer its tower to a separate subsidiary, may follow suit. But Gupta insists he isn’t being guided by valuations.

And the operators aren’t the only players in the fray. A number of third-party operators like GTL, Quipo and Xcel Telecom (See Going Solo) have also emerged. But the operator-promoter companies clearly have a head start over their third-party competitors, who have to start operations from scratch. But that’s not dampening their growth expectations. “Our plan is to grow to 20,000 sites in the next three years,” says Ajay Madan, CEO, Essar Telecom Infrastructure Company, which has set aside Rs 1,200 crore for tower expansions. For their part, the new players would appear better positioned to evolve a more integrated business model that can accommodate new wireless technologies.

“We are talking to a few internet and broadband players who want to share our towers for deploying WiMAX services,” reveals Madan. But the operators, too, are in the same game. Gupta of Bharti says: “A tower is just a physical infrastructure where you can increase the capacity anytime to accommodate newer technologies.” Venkat of Reliance is betting on the faster roll-out of WiMAX and broadband services, which in turn will provide him with new revenue streams. “If there are two occupants, the business breaks-even, but if there are more than two, the profit starts flowing in,” says a chief executive of a tower company, on the condition of anonymity.

It’s the hope of such profits that’s responsible for the heady valuations the tower companies are commanding (See No Pie in the Sky). Tower companies are valued at a multiple of earnings before interest, depreciation, taxes & amortisation (EBITDA). Companies operating in mature markets such as American Towers are valued at 16-17 times the EBITDA. “There is a case in India of taking a much higher multiple because the market in India is growing much faster than that in the US,” says Venkat. Adds Shubham Majumder, telecom analyst at Macquarie Research, who has also penned a report on the tower business: “We expect Indian tower companies to trade at a much higher multiple (as compared to global peers) in view of strong growth in the subscriber numbers.”

Despite new revenue streams like WiMAX and wireless broadband emerging, the tower industry will have to rely on voice traffic as its bread and butter for the next 3-5 years. And it’s this dependence on a single revenue stream that will lead to a shakeout—just as in the US, where a dozen players got reduced to three giants, with the smaller firms going bust in the late ’90s because of underpricing in anticipation of big volumes. “They (tower owners) just cannot price arbitrarily or abnormally. Any new operator will outsource a tower only if it makes business sense for him,” warns Awasthi.

The high capex in towers is yet another scary part of the business. A few US companies have a debt-equity ratio as high as 8:1. Typically, a ground-based tower costs Rs 25-30 lakh. A roof-based tower can be built for Rs 13-14 lakh. If you look at the additional 1,10,000 towers that are expected to come up by March 2008—at a conservative cost of Rs 15 lakh per tower—some Rs 16,500 crore would have been sunk into them as capex. Industry insiders say a debt-equity ratio of 1.5-2 would be comfortable, and is not impossible.

Clearly, the tower business is not a easy business, soaring valuations notwithstanding. Promoters would do well to keep an eye on the industry in the US—where the #2 and #3 players are still not profitable.

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