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Revival Strategy: Financial solutions for the tower industry

October 31, 2011
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Telecom tower companies, which came into existence in 2008, are yet to break-even. To achieve this, they have shifted their focus from tower rollout to increasing tenancies and managing energy costs. Industry experts share their views on the nature of costs incurred by the tower companies, their revenue trends, the investment requirement going forward and the changes needed in the business model for these entities to become profitable…

Ashish-Basil-Partner-ErnsAbhishek-Chauhan-Frost--SMohammad-Chowdhury-PwC-4forumAnjan-Ghosh-ICRARohan-Lobo-KPMG

What is the nature of costs incurred by tower companies? What percentage of these costs is shared by the operators?

Ashish Basil 

The key costs incurred by a passive infrastructure provider include operation and maintenance (O&M) expenditure, and interest and finance charges. A major part of the operational cost is on account of fuel charges due to constant scarcity of power. An estimated 2 billion litres of diesel is consumed by Indian telecom tower companies annually to ensure uninterrupted power supply for the towers. This translates into a cost of Rs 65 billion. Other expenses include finance and interest charges, which are associated with the huge debts taken by these companies to erect towers. In addition, the states charge different fees for setting up towers and granting clearances.

Abhishek Chauhan

Costs for tower companies can be divided into two components – capex and opex. Passive infrastructure generally accounts for 60 per cent of the capex. The capex is directly proportional to the price of metals like steel and copper, and has reduced over the years due to the availability of new materials, improved tower design, etc. The passive infrastructure capex is about $63,000 for ground-based towers (GBTs) and $32,000 for rooftop towers (RTTs). Active infrastructure capex is about $26,000 for GBTs and $24,000 for RTTs.

The opex for passive telecom infrastructure depends predominantly on the fuel cost. The power availability scenario in India is not encouraging with most parts of the country facing frequent outages. In regions lacking grid connectivity, the telecom infrastructure is operated through diesel generator (DG) sets. Also, fuel theft and site maintenance contracts add to the operational expenses. Operators enter into service level agreements with tower companies as per their requirements. They can either bear a part of the network costs or completely hive off non-core operations to these companies. This will allow operators to focus on their core competencies like customer experience management. On an average, the site rental for a GBT is about $650 and that for an RTT is $450. This is in addition to ground rentals and fuel costs.

Mohammad Chowdhury

The key components of the cost incurred by tower companies include network development and O&M, with power, spare parts and labour being the major expenses.

Anjan Ghosh

The cost structure for a telecom tower company primarily comprises:

•   Operating expenses: Expenses on security, maintenance, etc. are usually borne by the telecom tower companies

•   Space/Ground rental:  Rentals are usually borne by the telecom tower company. Additional costs over a pre-specified level are generally shared with the tenants (telecom operators)

•   Variable costs like fuel and energy charges: These are charged from tenants on the basis of their actual consumption

Telecom operators pay a monthly rental to the tower companies. It includes the infrastructure provisioning fee, capex, maintenance fee and site O&M fee. Energy costs (electricity and fuel charges) are reimbursed by the operator to the tower company based on the proportionate consumption by the former.

Rohan Lobo

Tower companies’ capex includes expenditure on building non-electronic components such as tower foundation; the tower structure; the base transceiver station shelter; mounting points for antennas; air conditioners; and power supply units such as DG, inverters, diesel storage tanks and alternative power source equipment. The capex for GBTs and RTTs is in the Rs 1.5 million-Rs 2.5 million per tower range.

Operating costs are predominantly site lease rentals. Key infrastructure and operational expenses include power and fuel costs, O&M of various equipment, rates and taxes, and security costs. These costs comprise about a third of the total revenues from the site. Tower companies have traditionally charged about half of the diesel and power costs from telecom operators.

How have the tower industry’s revenues grown over the past three years and what is the expected trend over the next two years?

Ashish Basil

The tower industry generated revenues of $3.5 billion in 2009-10. The past two years have seen a slowdown in the telecom industry, which has resulted from the aggressive tariff war. Per second billing plans have pushed call costs to an all-time low. The tower industry, being a derivative of the telecom service sector, has also witnessed a slowdown. The next two years seem to have a bright future for the passive infrastructure industry. The coming years are expected to witness a data explosion, which will offer the opportunity to monetise the outlay on airwaves and the capex.

Abhishek Chauhan

The revenues have been stagnant and are expected to remain flat in the coming years. The National Telecom Policy (NTP) 2011 might allow active infrastructure sharing, which would enable tower companies to increase their tenancies. The NTP 2011 may also allow tower companies to support backhaul operations. Thus, their future is in the hands of the regulatory bodies.

Mohammad Chowdhury

Tower companies’ revenues have grown significantly with the rapid pace of network development. However, in the past one year, as network build-out has slowed down, revenue growth has stagnated. The outlook for revenue growth depends on the prospect of a return to the levels of tower build-outs witnessed during 2008-10. Such build-out rates are unlikely unless the pressure on operating margins for operators eases and until investment in additional rural rollout becomes more attractive.

Anjan Ghosh

As per the Telecom Regulatory Authority of India (TRAI), the average revenues for the telecom tower industry are around Rs 190 billion per year. This revenue has grown over the past few years owing to increased network coverage by the existing operators and with the entry of new players. Moreover, the increasing focus of operators on tower sharing has provided an impetus to the profitability of tower companies.

As per ICRA, the number of telecom towers in the country was around 330,000 as of February 2011, and going forward, this will witness a compound annual growth rate of 17 per cent in the next four-five years. However, for this addition to translate into strong revenue growth, the tower companies need to ensure healthy tenancies, especially in rural areas.

Rohan Lobo

The past three years have seen consolidation of tower companies and a greater focus on developing sites at quality locations in order to increase tenancy. With unprecedented sector growth, the entry of new operators, and the increasing focus on 3G and rural areas, TRAI estimates a required addition of 136,000-220,000 sites to the currently operational 330,000-350,000 by 2014. An increase in tenancy is expected to lead to a compound annual growth rate (CAGR) of 22-25 per cent in revenues and over 30 per cent in earnings before interest tax depreciation and amortisation (EBITDA) over the next two-three years.

When are the tower companies expected to break even?

Ashish Basil

The tower companies need to achieve an average tenancy of over 1.6x to be sustainable in the medium term and of over 2x in order to provide a reasonable return on capital employed.

Abhishek Chauhan

Generally, a tower company is expected to break even when it achieves an average tenancy of 2x for all its towers. In India, most companies have a tenancy below 2x, which impacts their profitability.

Mohammad Chowdhury

Until revenue growth resumes, the sector will depend on efficiencies to increase profitability in the short term. This efficiency augmentation will be driven either by consolidation or by further cost reduction achieved through greater improvement in operation.

Anjan Ghosh

Given the current cost structure, a tower company is likely to achieve break even at an occupancy of 1.6x to 1.8x.

Rohan Lobo

Tower companies break even at a tenancy of 1.5x-1.6x after considering interest, depreciation and taxes. With most towers capable of accommodating four-seven tenants, there is a major opportunity for increasing the tenancy ratio. Large tower operators are already EBITDA positive, while small operators are increasing their focus on enhancing tenancy. With more towers being constructed through internal accruals and an increase in tenancy to approximately 2.2x, the industry is set to break even by the end of next year. Consolidation among independent tower companies is expected to raise the tenancy beyond 2.2x in the next two years, which will drive the profit after tax to a healthy 20 per cent in the next three-five years.

What changes are required in the business model of tower companies for them to become sustainable in the long term? What are your views on the fixed cost model?

Ashish Basil

The business model would witness a shift from the rental plus pass-through structure to a fixed monthly rental package model.

Abhishek Chauhan

The fixed cost model might become the preferred one for most companies to remain sustainable. The real challenge is to control costs and increase revenues. The regulatory bodies need to take initiatives that would help the tower companies to increase tenancies as well as reduce costs. Green telecom initiatives might help in controlling their operational expenses.

Mohammad Chowdhury

Tower companies will have to either pursue cost efficiencies through operational programmes or consolidate to drive greater synergies and find ways to achieve higher occupancies.

Anjan Ghosh

The current business model of tower companies offers a stable cash flow once a reasonable level of occupancy is achieved. This makes it sustainable in the long term.

Rohan Lobo

The business model will achieve sustainability when costs are stabilised. The risk of operator churn or technological obsolescence is very low. Also, revenues are fairly stable and predictable.

The fixed cost model will be a driver for long-term investors interested in enhancing valuations by increasing tenancy. It will also enable consolidation in the industry.

What is the current investment requirement for the telecom infrastructure sector? Going forward, how is this likely to change?

Ashish Basil

Operators would invest about $10 billion in the next three-five years in network rollout for next-generation technologies. In fact, telecom spends are expected to increase at a CAGR of 13.5 per cent from $7.7 billion in 2005 to $95 billion in 2025.

Future investments in infrastructure will be focused on adding 150,000 towers in order to meet the requirements of 2G/3G/broadband wireless access (BWA) services. Also, tower companies will shift their focus from building new assets to enhancing tenancy to an average of 2.0x by 2015. Future growth areas include in-building solutions, which will reduce tower rollouts for network expansion.

Abhishek Chauhan

The investor sentiment has been impacted by the 2G scam. However, this should be a temporary phase considering the fact that the sector is expected to witness a CAGR of 16 per cent in the next five years. In the coming years, investments would be required for network expansion and upgradation as well as for promoting BWA, value-added services and 3G services.

Mohammad Chowdhury

India has around 800 million mobile connections and this means probably only 600 million unique users. Therefore, there is a long way to go in terms of providing mobile connectivity as well as quality networks.  The investment requirement for the next phase of development, which involves increasing access to rural areas and improving network quality in metros and Category A circles, is significant.

Anjan Ghosh

Going forward, telecom operators are expected to expand/roll out networks in semi-urban and rural areas. This would be the primary growth driver for the tower industry and necessitate investments in tower infrastructure development in these areas. In addition, the companies would need to upgrade existing towers for higher occupancy.

Rohan Lobo

In July 2011, India reported about 892 million subscribers and 600 million active visitor location register subscribers. At the current growth rate, the subscriber base would reach 1 billion by 2014.  In order to serve the additional 400 million wireless subscribers and to meet the expected growth of wireless data services, 330,000-350,000 additional sites will be required at current tenancy rates. An increase in tenancy could lead to a reduced requirement of at least 150,000-200,000 towers over the next three to five years. This could entail a capital investment of $7.5 billion-$12 billion over this period.  Consolidation of the industry, increased private equity participation and foreign investments are expected to fund this growth.

 
 
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