BUSINESS UPDATE


www.comms-dealer.com Private equity pays off


Rates of decline in the UK communications market slowed during 2010, and the M&A sector proved to be especially dynamic with ongoing activity driven by growing interest from private equity, observes Philip Carse, Telecoms Analyst at IS Research.


Philip Carse V


irtually all of the larger players are suffering revenue declines (for example, BT, CWW,


COLT, Kcom), while many smaller companies are only registering growth through acquisition. But despite the revenue challenge, EBITDA profitably is improving for the sector. For the publicly quoted companies, the average 25 per cent (pc) growth in EBITDA helped drive a 29pc one-year share price performance (a 20pc out-performance against the FTSE All Share). Good share price performances over the last year have come from Iomart (+103pc), Maintel (+51pc), Alternative Networks (+46pc) and Telecity (+42pc); whilst under-performers included consolidators past and present - Pinnacle (-6pc), SpiriTel (-5pc), Daisy (-5pc), Adept (+2pc) – as well as COLT (+3pc).


Despite the poor recent share price performance of the B2B consolidators, M&A has clearly been a key feature of the sector, with 24 deals costing £744 million tracked over the last year, at an average valuation of 5.6x historic EBITDA. The M&A drivers are well understood and include economies of scale, distressed sales, changes to Capital Gains Tax and strategic positioning for


unified comms and/or managed services. Private equity has been behind two thirds of the deals by number but 94pc by value, either directly (buying companies such as Host Europe, XLN, Easynet and Spice Telecoms) or through investee companies such as Daisy and SpiriTel (which of course have recently become one).


Many of the private equity buyers are investing in the sector for the first time. For example, ECI, Montague and Bridgepoint, often with a buy and build strategy in mind. Non private equity backed buyers, which include Alternative Networks, Maintel, Chess and GCI, have been in the minority. Given the inherent cash generative nature of the sector, as evidenced by well run companies such as Daisy, Alternative Networks, Unicom and XLN, we expect private equity interest, and M&A generally, to continue.


While the average deal value over the last year is not that different from current public market valuation multiples (6.4x EBITDA), the post acquisition deal multiple for strategic buyers can fall dramatically with synergies. As an example (albeit a relatively extreme one given its distressed nature), Daisy’s 2009 Eurotel deal multiple


fell from 6.75x to 2.3x EBITDA. This is not the case for standalone private equity deals, where indeed the average multiple, at an estimated 6.3x, has been higher than deals involving strategic buyers.


While the private equity standalone deals have been larger (for example, Host Europe, Spice Telecoms, Easynet, XLN), and arguably involving higher quality assets, prices have been pushed up by private equity money looking for investments, and it begs the question as to how private equity buyers will make a return given the lack of organic growth in the sector. The answer has to lie in successfully executing a buy and build strategy to create a business with significant exposure to the more attractive parts of the markets (such as hosting and managed services), as well as securing significant economies of scale. This is easier said that done.


While buy and builds such as Daisy, SpiriTel and XLN have achieved significant cost synergies, poorly executed buy and builds such as Redstone, AT Communications and Azzurri serve as a warning. The real winners will be those companies that can also secure revenue synergies from areas such as cross selling, on top of cost synergies.


The second necessary element to a successful buy and build is the exit. The larger telcos and the mobile network operators are potential buyers, though other B2B providers and other private equity investors will probably be the main exit route. Despite NTT’s recent acquisition of Dimension Data, we would discount overseas strategic buyers. The IPO route may return at some stage, though the fact that Solution1 (MDNX) had to revert to private equity to fund acquisitions in the summer, rather than an IPO, suggests that private equity investors should not rely on this as an exit route.


The exit timing is also crucial. Azzurri’s initial private equity backer, 3i, made a decent return when it sold the business in 2006, but a lack of execution and too high price paid have left the current private equity investor, Silverfleet, many years away from securing a profitable exit.


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IS Research publishes www. megabuyte.com, a company analysis and intelligence service covering over 200 public and private UK technology companies. Megabuyte’s recent annual review of the hosting and fixed line sector is available from the author at philip.carse@is-research.co.uk.


Despite the poor recent share price performance of the B2B consolidators, M&A has clearly been a key feature of the sector


Mark the date for 2011 16 COMMS DEALER JANUARY 2011 Gleneagles Hotel


9th, 10th & 11th November 2011 www.commsvision.com


www.comms-dealer.com


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