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The Delta Perspective

August 2010

Tower assets in Africa: Move


now before it’s check-mate
Authors Joao Sousa - Partner
Chris Datta - Principal
Dimitris Lioulias - Manager
Delta Partners Intelligence Unit

Key hIghLIghtS

• Significant value still exists in the tower business in Africa, both in terms of
sharing and selling of towers, especially in markets where new licenses are to
be issued and/or additional network expansions are expected. The likelihood
of increased tenancy ratio, relatively constant rental prices and constraints in
building new towers further enhance the attractiveness of a market.

• Operators must act soon or risk being left out in the cold with assets whose
value is declining and with a higher cost base than competitors.

• However, the tower business game plan is not the same for every player!

• Small players need to either sell now or accelerate efforts towards attracting
tenants on their network.

• Large players need to consolidate the tower space in their markets in order
to secure higher tenancy ratios. Also, they need to close a deal each time
there is a new entrant in the market. Ultimately, once they have good
tenancy ratios and a good idea of their own future network requirements
they should consider selling the towers to capture all relevant capital gain
advantages.

• Tower companies (or private equity funds ready to invest in them) must
have a large portfolio of towers to be successful, i.e. they need to buy big
and be aware of the maximum tenancy ratio they can achieve.

• For a successful foray into the tower space, relevant players have to assess each
market’s tower potential by analysing ‘Addressable Demand’ and ‘Accessible
Supply’.
Tower market in Africa is
heating up

In the Delta Perspective last year (‘Tower sharing


in Africa: Collaborating in Competition’), we stated
our expectation that during this year significant
tower carve out activity would take place. Whilst
no pan-regional deal has yet been closed, there has
been significant deal activity in 2010 across several
markets.

• Millicom Ghana has sold its towers in Ghana to Helios Africa. However, as
part of the deal, Millicom Ghana (operating under the Tigo brand) will retain
minority interest in the entity
• Millicom is expected to formally launch its tower sale process in Tanzania
and DRC
• Cell C, South Africa’s third-largest operator, is close to finalising a tower-
sharing agreement under which it would sell some of its tower facilities and
then lease them back. The operator is reported to be in discussions with
tower companies such as Eaton Telecom.
• Several CDMA players in Nigeria are shopping for their tower assets

Despite the above activity, there has been an absence of a large multi-operator
pan-regional tower carve-out. In our prior predictions, we had expected to see
the emergence of some type of merged InfraCo model in Africa involving some
of the regional heavyweights. However, indications of operational and deal
complexity led some players to be more opportunistic in their approach and act
on a country-by-country basis.

For the moment, the entrance of Bharti Infratel through the acquisition of Zain
Africa, promises to be the most compelling competitive story in the African tower
space. Bharti Infratel is likely to launch tower companies across 8-12 countries
over the course of 2010-2011.

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Meanwhile, MTN Group seems to be the next most advanced operator likely to
carve out its assets. However, they will potentially partner with someone who can
help them operationalise a new towerco entity to capture and maintain control
of their assets. Such carve-outs could likely occur in stages across their country
footprint and could potentially exclude certain countries.

While we have yet to see a ground breaking tower deal, large operators are
beginning to realize that tower sharing is a strategic way to secure value. A
first wave of tower sharing deals has materialised, and more are in the process
of being negotiated. This, in many cases, is a precursor to the carving out of
tower assets, as higher tenancy ratios make them more valuable. The recent
agreement between MTN and Telkom for tower sharing in South Africa
exemplifies this logic.

Aside from the network operators, Helios Africa, American Towers and Eaton
Telecom are the most active parties looking to acquire tower assets. They have
been exploring investments in African markets and tower portfolios, each
wanting to become the leading African tower consolidator over the next two to
three years.

While most telecom groups have subscribed to the concept of tower sharing,
some large groups are still sitting on the sidelines in terms of potential carve-outs
or asset sales. However, once Bharti, Millicom, MTN and possibly Vodacom make
their moves, the remaining pan-African groups will be in a precarious situation as
they would have lost first-mover advantage, and would need to determine their
long-term tower strategy.

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Impact of Bharti, Millicom,
MTN and Vodacom

The tower landscape is set to drastically change. In the short term, Bharti Infratel
is expected to launch tower operations in 4 or 5 countries. Millicom is expected
to carve out towers in 3 countries, MTN is on the verge of implementing its
African tower carve-out strategy in 2 countries and Vodacom/Vodafone is strongly
considering its options in 3 countries. In the next 12 months, the vast majority of
African countries are likely to have experienced some form of a tower deal.

EXHIBIT 1: EXPECTED TOWER LANDSCAPE EVOLUTION ACROSS THE CONTINENT

Source: Delta Partners analysis

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In each of the individual markets where these four operators execute carve-outs,
the remaining mobile operators will need to decide what to do with their tower
portfolios. In most markets, these four operators are either positioned as market
a leader, which means that the remaining operators are unlikely to be tower
consolidators. Therefore smaller operators may need to consider selling their
assets to remain competitive. In such a scenario, time will be of essence as asset
value will decrease depending on how long the small operators take to make a
decision.

Time-to-market in transacting a tower carve-out or asset sale is important for


three reasons:

• Demand for towers from potential consolidators only exists until the big
deals in the market have transacted
• Current tower valuations will factor in demand for space due to data related
network expansion (3G and LTE)
• Potential for new licenses (mobile and fixed wireless) is still a possibility in
many countries and will be factored into tower valuations, especially for the
largest tower portfolios

The message is clear: Operators must execute their


tower strategy soon because the cost of inaction
or delayed implementation is high.

Some regional operators have not placed tower strategy at the top of their
agenda because they feel it is not a critical lever to gain competitive advantage
in a growing market – but they are wrong. Tower sharing is a significant tool to
mitigate margin squeeze as operators address the lower end of the customer
pyramid and potentially the only way to make rural network roll-out profitable
in most African countries. This in effect means that operators do not necessarily
need to sell their towers to capture value. However, once one or more players in a
market move towards tower sharing, the remaining players must get in the game
to remain cost competitive.

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Considerations for operators uncertain of the
tower business potential
Operators, who are uncertain of the value potential represented by tower sharing,
should consider three questions - and their relevant value implications:

• Do I want someone else on my towers?


• Do I manage my towers by myself?
• Do I sell my towers?

As Exhibit 2 suggests, there is value to be extracted in all three options. However,


operators have to try to capture at least two of these three value levers, if they
are to realise a significant part of the value upside.

Despite, the below value drivers and their positive impact on operations, operators
are often concerned about two potential threats:

• Risk of market share loss, if they facilitate the expedited entry of a new
competitor
• Loss of network control and related quality issues

EXHIBIT 2: STRATEGIC QUESTIONS AND VALUE IMPLICATIONS FOR OPERATORS ASSESSING


TOWER BUSINESS POTENTIAL

1
Potential of capital gains upside depends on premium that can be achieved and on cost of capital of potential buyer, i.e. if local funds available, then cost of capital
decreases and valuation increases
Source: Delta Partners analysis

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As previously explained in the first Delta Perspective on Towers (Tower sharing
in the Middle East and Africa: Collaborating in competition), the market share
loss is a very short term consideration, which will in turn be mitigated by the
financial benefits offered by tower sharing. Moreover, the ‘market share loss’
concern can best be compared to the ‘prisoner’s dilemma’ situation, especially
in the case where more than one large network is present in the market. Unless
a solid agreement can be achieved with all existing operators for excluding new
entrants’ access to their networks, then it is highly likely that one of them will
enter into a network sharing or national roaming deal. Those operators who are
slow to react will end up with both loss of market share and loss of an additional
(high margin) revenue stream.

On the other hand, the operational concerns of network quality can be addressed
by selecting experienced third parties as outsourcing partners and agreeing on
comprehensive SLAs.

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Tower deal attractiveness:
Market and players dynamics

Does all of the above then mean that tower deals


are value generating in every situation? Perhaps
not, a worthwhile opportunity for tower carve outs
is not evident in every market and for every player.

Market related dynamics


A market is considered attractive for the tower business when there are
expectations of new licenses to be issued and/or expectations of additional
network expansions. Markets are considered even more attractive when these
conditions are coupled with tenancy ratio increases, relatively constant rental
prices and constraints in building new towers (e.g. Ghana).

However, new licenses do not automatically translate into higher tenancy ratios.
Especially in cases where these licenses refer to 3G and LTE concessions, even
though the number of antennas grows, a large number will be collocated with
operators existing GSM network infrastructure, limiting the potential for a high
tenancy ratio.

Likewise, for capacity expansion, especially in urban settings, the flexibility


to collocate (i.e. the ability for a Towerco to extract additional tenancy ratios
from that player) is very limited due to restrictions imposed by radio planning
requirements.

Lastly, if network expansion is focused towards rural areas, building new towers
could cause a Towerco to struggle as tenancy ratios will be low.

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Player related dynamics
The different players in the tower market should follow a different game plan to
capture the value potential.

For the leading players in a market, owning larger networks is likely to translate
into higher tenancy ratios; especially in the case a new player enters the market.
New entrants will choose to share towers with the market leaders both to
leverage the leaders’ widest network reach and to tap into potential volume
discounts. Moreover, leading operators can enhance their value proposition
towards these new entrants by offering highly attractive national or regional
roaming agreements.

Finally, leading operators should ideally decide to sell their assets when they have
a very good view of what their future network will look like so that they ensure
appropriate contract terms and SLAs are put in place. If for example operators
do not properly assess the requirements imposed on the network by increased
mobile data demand, this could lead to a situation where mass replacement of
microwave transmission with fibre may be needed. The resulting dependency on
the Towerco to perform this replacement in a timely and cost efficient manner
may be more than any operator would be prepared to accept. Such a situation
is exacerbated in the case where there is only one Towerco in the market and is
likely to behave in a monopolistic manner.

For smaller operators, the game plan will include taking advantage of the capacity
constraints of large players, especially in urban areas, and attracting new entrants
to their own towers. However, given the size of the larger players’ networks
and the relative benefits of sharing with only one operator, the demand that
these small players can attract is limited. However, in cases where large operators
have not started renting their towers or carving them out, small operators have a
window of opportunity to attract rental income and also benefit from an attractive
valuation for their tower assets should they decide to sell quickly. Additionally, if
small operators sell to a large Towerco, they can leverage the Towerco’s scale to
enhance their own network performance and reach.

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As for the tower companies, leveraging operational expertise and managerial best
practice will be part of the sales pitch to attract newcomers as tenants. However,
they will have the best chance to achieve an advantageous deal if they have a
first-class portfolio of towers to address the needs of such new entrants. This
is something tower companies can best secure by acquiring the tower portfolio
of a market leader. In addition to this, should the opportunity arise, Towercos
ought to increase their portfolio by buying out small players and by building new
towers.

It is therefore crucial for all players to properly assess the tower business potential
within the context of each individual market. In order to achieve that, it is
important to analyse the following:

• Accessible supply of towers


• Addressable demand for new towers (not the same as demand for new
antennas)

The following section outlines a comprehensive methodology to help players


interested in the tower space to properly assess the size of the opportunity and
develop their strategies on tangible, analytics-based recommendations.

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Assessing market potential
for towers

The driver for value creation in the tower business is


increasing the ‘co-location ratio’. However, the key
problem is determining the market potential so as
to fairly value an operator’s towers.

Delta Partners’ view is that in order to come up with an accurate assessment of


market potential of towers, an analysis must be done that takes into account
both ‘addressable demand’ and ‘accessible supply’. It is these two drivers which
ultimately influence the competitive dynamics and pricing within the tower
industry of a given market.

‘Addressable demand’ is defined as the demand for towers or ‘Points of Service’


(PoS) in the market. The demand is adjusted to take into account that some of
the consolidated PoS demand may never actually hit the market. For example,
operators who have their own carve outs (e.g.: Bharti Infratel) will likely self-fulfil
most of their demand. Only a residual share of their PoS demand would affect the
supply/demand dynamics of the market.

On the supply side, we only take into account ‘Accessible Supply’. Similar
to Addressable Demand, we only include the tower slots which are actually
accessible to the market. To estimate accessible slots, we take the total tower
slots in the market and subtract those which are already used along with those
which are reserved for specific future demand (e.g.: slots reserved for 3G for
existing 2G clients).

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EXHIBIT 3: METHODOLOGY OF DERIVING MARKET POTENTIAL

Source: Delta Partners analysis

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Tower fair share: Key driver
for co-location potential
Once the total tower demand and supply dynamics
are understood and quantified, the next key
question is regarding the co-location potential of
any given tower portfolio.

Delta Partners contends that in the long run, the best way to understand how
much addressable demand a tower player can capture should be based on their
market share or ‘fair share’ of the accessible slots in the market. This is because
tower slots are essentially a commodity where pricing tends to be quite similar
and service levels tend not to vary among competitors. Therefore, all things being
equal, tower slots competing for demand should win on average, a proportion
equivalent to their ‘fair share’.

The main strategic implication of the ‘fair share’ concept is that size is key. Only
the big players will win in the market and therefore consolidation will take place,
leaving the small operators with little choice but to sell their portfolios.

EXHIBIT 4: OUTLOOK FOR TOWERCOS

1
Site sharing index
Source: Delta Partners analysis

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Factors affecting
‘Addressable Demand’ and
‘Accessible Supply’

Overall, Delta Partners expects ‘addressable demand’ for ‘Points of Service’


(PoS) to grow between 6-10% across African markets during the next five years.
However, there are several market forces which could impact both demand and
supply, positively or negatively.

At the same time, the impact of market forces will also be evident on ’accessible
supply’.

EXHIBIT 5: FACTORS AFFECTING DEMAND AND SUPPLY

Source: Delta Partners analysis

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Conclusion
Path forward for mobile operators
For large pan-regional operators who hold leading positions across several
markets, our view is that they should aim at forming a towerco spanning multiple
countries and potentially try and include other operators as well.

This offers the greatest value creation potential while not limiting long term exit
options. However, such a solution requires considerable effort and coordination
and could slow down the process - as it appears to have done so far.

In order to be successful in any market, large operators need to consolidate their


tower space as much as possible in order to increase the ‘fair share’ and secure
attractive co-location ratios. This trend has become apparent in more developed
tower markets such as India, where major consolidation is under way - example
the recent merger of Reliance Infratel and GTL. If the large operators are not yet
ready to sell their towers, they should at least share them.

In our view, smaller telecom groups or those with lower market shares, need to
look to sell their assets now and gain first-mover advantage. We see no clear
benefit in them holding onto their towers in the medium to long term. Smaller
operators can look to merge their towers into another Towerco, retaining an
equity stake if they want to participate in some of the financial upside.

Path forward for equity investors


Given the current selling price of towers in Africa (upwards of US$150,000 per
tower) and expected competition to gain high ‘fair share’, we forecast that it will be
difficult to earn equity returns above 25% in most markets. The opportunity may lie
in marginal markets where political or economic instability presents higher barriers
to entry and lower entry valuations. Beyond the obvious valuation considerations,
equity investors should also consider the need for an established management
with experience and on-the-ground presence to physically run operations.

The key point for equity investors is to become part of a platform which can operate
in difficult African environments and has the track record to win deals. Companies
with experience in Managed Services can be excellent potential partners even if
they have limited previous experience in owning towers. Finally, it is important
to realise that market size alone is not what will drive returns, instead achieving
greater scale (i.e.: high ‘fair share’) is what best guarantees success.

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