NEW YORK-As the Internet accelerates the globalization of telecommunications, mergers and acquisitions among traditional and nontraditional players have eclipsed initial public offerings as the preferred strategy for retaining competitive advantage.
“In the United States, the Internet economy generated $301 billion in 1998 and will generate $350 billion this year,” said Samuel W. Trotter, director of business development for Nortel Networks, Richardson, Texas. “This is putting a lot of pressure on networks to handle convergence.”
As increasing numbers of players enter the telecom market, the technology is undergoing diversification, even as the applications are converging, said Margaret Biner, global practice director of telecommunications consulting for Ronin in Princeton, N.J. This convergence of telecommunications, information, the Internet and software is giving telecom carriers opportunities to offer services on a nonregulated basis.
Opposites attract
“The industry has been moving in opposite directions at the same time. On the one hand, economies of scale and the benefit of a broader line of products as well as an international presence have motivated a multitude of mega-mergers among the large established operators: for example, Vodafone’s acquisition of AirTouch (Communications Inc.) and AT&T (Corp.’s) acquisition of MediaOne and Tele-Communications Inc.,” said Sanjay Jindal, manager of the communications services group of Houlihan Lokey Howard & Zukin, Los Angeles.
“On the other hand, demand for improved services and lower prices has created opportunities for firms to provide niche telecommunications products and services that exploit the many opportunities presented by deregulation and the auction of various frequencies.”
Trotter said telecommunications is undergoing a sea change in which the market share held by traditional network operators is decreasing.
“In the current phase, the carrier owns the value chain and the primary service is voice content and things that look like voice. In the next phase, the concept of content expands and customer ownership fragments because open platforms mean (network) operators cannot control distribution,” he said.
“In the third phase, new types of service providers will appear as access technology disappears and there is full-fledged multimedia content.”
Market deregulation, rapid advances in technology and growing consumer demand for services have spawned legions of new carriers, Internet service providers and equipment vendors.
“Globally, what we now think of as traditional telecommunications-wireline and wireless carriers-will be a $1 trillion industry next year. Underlying this is the addition of 30 million new wireline and 30 million new wireless customers a year,” Biner said.
“Each year for the last five years, 500 new service providers have been created (worldwide), although a lot will go out of business. In the United States, there are about 5,000 Internet service providers today, many of which are being acquired by traditional telecommunications companies. Most forecasters predict this number eventually will drop to about 500.”
Like free radicals in chemical reactions, both new and established companies are searching to supply missing links in their value chains through combinations with compatible counterparts. For larger carriers and equipment providers, acquisition can be a cheaper and faster way than building from scratch in order to keep up with competitive demands, Nortel’s Trotter said.
In the last six years, Cisco Systems has spent about $30 billion acquiring about 30 different companies, and Lucent Technologies Inc. has spent a bit less to buy 15, Biner said.
“Microsoft has started quietly buying switching manufacturers. It spent $130 million in May to buy Sendit, a Swedish mobile telephone and Internet company,” she added.
Investment strategies
Biner also said she expects to see more foreign companies, like Alcatel, Nokia Corp., L.M. Ericsson and Cable & Wireless plc, take minority stakes in American companies.
“European M&A activity in U.S. telecommunications has dramatically increased in the last year. For the most part, buying a minority stake that gets increased over time is really a takeover play. This is taking the place of alliances and joint ventures.”
Biner also said she expects to see more hostile takeovers like those of AT&T acquiring MediaOne.
Last year in telecommunications, M&A activity exceeded IPOs by 20 percent, not only because of blockbuster transactions but also due to accumulation of many small, privately held companies by larger corporations seeking to round out their portfolios, Biner said.
Venture capitalists traditionally have viewed mergers as an exit strategy that is an admission of failure by the small companies in which they had invested. However, these firms and their private equity stakeholders also have experienced the public capital markets as a town without pity toward niche players perceived as “one trick ponies,” Ronin said.
“Interestingly, IPOs generate an average return on investment of 30 to 40 percent, while acquisitions can generate an ROI usually in the range of 50 to 60 percent, especially for one-trickers,” she said.
This positive development has encouraged continued venture-capital investment in new ideas, therefore keeping an important financing pipeline open, Biner said.
Buyout plans
Other segments of telecommunications also are ripe for ongoing consolidation, which is accompanied by the entrance of new players that result from divestitures, spinoffs and employee buyouts of business units. Qualcomm Inc.’s spinoff of Leap Wireless, which seeks to be a wireless competitive local exchange carrier, is one such example.
“There also is a substantial up-tick in activity focused on operational support systems for billing and service provisioning. There are hundreds of players and few are public,” Biner said.
“Cisco, Lucent, IBM (Corp.), Microsoft, ECI Telecom of Israel, Fujitsu (of Japan) and Telstra of Australia are looking at smaller-cap companies focused on OSS, (including) alternative directory assistance and information systems.”
The wireless tower sector is proceeding on a parallel track, said Paul E. Spurgeon, president of Nations Media Partners, a Kansas City, Mo., firm specializing in telecom mergers and acquisitions.
Wireless carriers are divesting themselves of their tower businesses, which they established “by necessity in order to launch services,” he said.
Companies like Crown Castle International Corp. and Pinnacle Towers Inc. have been buying these properties, then leasing space on the sites back to the service providers. These arrangements give new telecom entrants access to existing cell sites while relieving incumbent and new wireless carriers of the need to negotiate with their competitors, he said.
“The tower market has been extremely fragmented. The end goal is to give carriers access through a single master lease to 100 percent of their (respective) markets,” Spurgeon said.
“The concern carriers have is there could be a quasi-monopoly. But there is enough competition … five to seven buyers for the assets becoming available. A single asset could be (something like) 25 towers. At this point, no one company has control.”
Furthermore, there is a continual replenishment of mid-level companies looking to provide regional tower service that, in turn, are buying up smaller tower companies.
“As that happens, new (tower) companies are being formed and getting venture capital funding.”
Among domestic wireless carriers, Spurgeon noted that companies like Alltel Mobile Communications, Little Rock, Ark., and Rural Cellular Corp., Alexandria, Minn., have been active over the past year in acquiring small carriers in rural, duopoly markets.
“In terms of multiples (price/earnings ratios), they have paid substantially higher prices th
an in the last several years,” Spurgeon said.
Within the personal communications services sector, he noted that the merger between Western Wireless Corp. and Omnipoint Corp. “could be the beginning of a trend that has to be in reaction to the national platform that AT&T Wireless and Sprint (PCS) are rolling out.”
Sprint has taken the tack of partnering with local companies “with deep roots in their communities, so it would be really difficult for Sprint to take them over,” Spurgeon said.
AT&T Wireless, by contrast, has formed alliances with start-ups, but whether it ultimately will buy them remains to be seen, he added.
Broadband play
As certain segments of telecommunications undergo consolidation, new kinds of providers are emerging, Jindal of Houlihan Lokey said. Wireless broadband services, which are just beginning to compete with cable TV and digital subscriber line technologies, represent one key sector to watch.
“Broadband local access continues to be the name of the game, with companies as disparate as [America Online] investing in Hughes Communications Direct TV/Direct PC, Paul Allen buying a piece of Allegiance Telecom, a CLEC, and AT&T, Sprint and MCI WorldCom buying wireless cable and cable properties,” he said.
“Wireless broadband as the third medium comes in many different technology flavors and is being aggressively deployed by a number of well-funded players, both in residential and business markets.”
To foster competition and innovation for consumer benefit, telecom regulators have unleashed forces with unanticipated consequences.
“Regulation has been turned upside down because regulators are used to seeing mergers among similar kinds of companies,” Biner said.
“A lot of mergers passed regulatory scrutiny on the promise of bringing new technology to market faster. If they don’t, the regulatory climate that encouraged this will tighten.
“On the other hand, you don’t want to be the country at competitive disadvantage relative to other countries, so it is a delicate balancing act.”
