Valuation drivers in the

telecommunications
industry
About Ernst & Young’s
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Center
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Foreword

The number of mergers and acquisitions (M&A) declined in

recent years due to the economic turmoil and a lack of financing
in the market. However, M&A activity in the telecommunications
industry has now resumed.
The consolidation trend is not about to stop: the markets in the
US and Western Europe are maturing, and have never been
more competitive; revenues from fixed-line services are falling;
technology is driving significant investment programs
(e.g., Fiber); and regulatory pressures are increasing.
It is within this context that operators are pushing to buy or sell
telecommunication assets.
This report, written by Ernst & Young’s telecommunications
valuation professionals, explores a number of sizeable industry
valuation issues that are at the top of the agenda for M&A and
finance departments: key value drivers, valuation multiples, and
different methodologies. It looks at many questions that are
often not explained clearly by the transactions teams and their
advisors, and it is intended to help operators communicate their
strategies more widely, and explain how valuations are derived.
We hope you will find this summary an informative introduction
to some of the approaches that are used, and no doubt this will
raise further questions that my team and I would be delighted to
answer.
Many thanks to all my colleagues who worked on this report.

Nicolas Klapisz
Global Telecommunications
Valuation & Business Modelling Leader

3 Valuation drivers in the telecommunications industry

Key messages
1 M&A activity in the telecommunications sector has
resumed, led by transactions in emerging markets.

2 Valuation multiples are higher for players in high-growth

markets than in mature markets.

3 There is a consensus on the nature and average weight of

the assets recognized and valued as part
of purchase price allocation (PPA).

4 Subscriber relationships are generally the primary

intangible asset in PPA, with a weight of around 33%
of the enterprise value (EV).

5 Goodwill remains significant, with a weight of 60% of the

EV, thus reflecting the growth potential of certain targets,
as well as the importance of synergies expected from any
successful integration.
Contents
Foreword 03
Financial trends in the telecommunications market 06
Valuation drivers in the telecommunications industry 10
Purchase price allocation (PPA) in the telecommunications industry 16
Valuation drivers in the telecommunications industry 6

1.
Financial trends in the
telecommunications
market
 1. Recent M&A activity
Telecoms operators have to grow through acquisition if they are to win the challenge
of acquire or be acquired.
Figures 1 and 2 show the global telecommunications deal volumes and values from
2000 to 20101, with figure 3 detailing the main strategic drivers behind acquisitions
in the sector. In research earlier this year, we surveyed over 50 senior executives in the
telecoms industry about why they were looking to acquire. ‘To enter new geographic
“The bloodbath has started
markets’ came top, followed by ‘to strengthen the core business’.
to happen. There is enough
of it now. Market caps have Figure 1 — Global telecom deal volumes/deal values 2000–2010
halved. Companies are making
500,000 1,600
losses. There will only be a 450,000 1,400
few players: 6, 7 but certainly 400,000
350,000
1,200
Deal value (US$m)

not 12. [Consolidation] is 1,000

Number of deals
300,000
250,000 800
inevitable.” 200,000 600
150,000
400
Bharti Enterprises Chairman, 100,000
50,000 200
Mr. Sunil Bharti Mittal, 0 0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
during the World Economic Forum Deal value Number of deals
27 January 2010
Source: Thomson SDC Platinum

Footprint growth has featured heavily in the last decade, where transaction levels
peaked twice: the first peak was due to the building of scale during the technology
bubble of 1999-2000, which launched the global footprint growth in the mid-2000s.
Regional consolidation phases (e.g., US mobile market and European broadband sector)
led to the second peak of deal activity from 2005 until the slowdown in 2007, predating
the financial crisis.
During this period, large European operators increased their exposure to emerging
markets, with Africa outperforming developing Asia as a target market for footprint
growth.

Figure 2 — Deal values by transaction type 2000–2010

400,000
350,000
Deal value (US$m)

300,000
250,000
200,000
150,000
100,000
50,000
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Local market deals Cross-border deals

Source: EY Survey Why Capital Matters (2000-2009) and Thomson SDC Platinum (2010 data)

1
Source: EY survey Why capital matters — building competitive
advantage in uncertain times — telecommunications survey
snapshot, 4 February 2010.

7 Valuation drivers in the telecommunications industry

 What is your current rationale for considering acquisitions?

Figure 3 — Main strategic reasons for acquisitions — Answer from

telecom operators
Rank Rationale
1 To enter new geographic markets
2 To strengthen the core business
3 To achieve economies of scale
4 To eliminate or reduce competition
5 To acquire new technology
6 To enter new product markets
7 To acquire liquid assets
8 To take advantage of low valuations/distressed assets

Source: EY Survey Why capital matters — Building competitive advantage in uncertain times — Telecommunication
survey snapshot, February 2010

Operators in emerging markets have built regional scale over the past few years, and
contributed to the increasing numbers of deals in those regions, from 16% of the global
deal value in 2007 to 33% in 2009, as seen in figure 4. They now have the technical
and financial capacity to develop and adopt external growth strategies, and therefore
the acquisition of targets in emerging markets is no longer the exclusive domain of
mature operators. For example, Bharti Airtel acquired Zain Africa in March 2010,
for US$10.7 billion.
In 2009, there was a sharp downturn in cross-border deals, whilst activity in any single
country (‘in-market deals’) remained flat. This reflected reduced opportunities in
cross-border footprint growth, whilst in-market deals helped operators reduce costs
and position themselves for convergence.

Figure 4 — Telecommunications deal values by region 2000-2010

500,000
450,000
Deal value (US$m)

400,000
350,000
300,000
250,000
200,000
150,000
100,000 21% 23% 27% 59%
21% 24% 41%
50,000 14% 34% 20% 10%
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Deals in emerging markets All deals (global)
(deals in emerging markets as % of all deals that year)

Source: Thomson SDC Platinum

“I can’t tell you the names of the countries we are

working on. There will be a few more acquisitions
on the African and Middle East footprint in the
next couple of months.”
Gervais Pellissier
France Télécom Chief Financial Officer
Reuters Insider TV, 22 May 2010

Valuation drivers in the telecommunications industry 8

 2. Impact of the recent financial
crisis on telecommunications
operators
The telecommunications industry is usually presented as a fairly stable sector,
focused on the long term. However, the sector did not prove to be particularly
resilient to the recent crisis.

“Uncertainty is one of General economic indices fell on average by 58% between October 2007 (when indices
peaked) and March 2009 (the bottom of the market). Telecommunications sector
the most important indices followed the general economic trend, falling by 49% over the same period.
characteristics of our However, not all operators suffered from the economic crisis in the same way, and many
current environment.” have recovered in line with their local economy. We have found that we can achieve a
more accurate view by analyzing developed and emerging markets separately.
Mr. Jean-Claude Trichet, President
Figure 5 — Emerging telecom industry market capitalizations versus average
of the European Central Bank, emerging economic indices from 01.01.2007
18 November 2009 170

150

130

110

90

70

50
1 Jan 07 1 Jul 07 1 Jan 08 1 Jul 08 1 Jan 09 1 Jul 09 1 Jan 10 1 Jul 10

Emerging operators Emerging economy indices

Source: Bloomberg

As illustrated by figures 5 and 6, operators in developed markets have been slightly

less volatile than global economy indices2. Operators in emerging markets lagged
behind the recovery in the emerging market economies: telecommunications indices
for emerging markets have increased by 31% since March 2009, whilst general
economic indices of emerging markets have risen by 139% over the same period.
Nevertheless, the impact of the economic downturn on the share prices of the
emerging market telcos (-53%) was somewhat consistent with that of their developed
market peers (-47%).
Figure 6 — Developed telecom industry market capitalizations versus average
developed economic indices from 01.01.2007

170

150

130

110

90

70

50
2 1 Jan 07 1 Jul 07 1 Jan 08 1 Jul 08 1 Jan 09 1 Jul 09 1 Jan 10 1 Jul 10
The following general economic indices were included in the
analysis: CAC 40, S&P 500, DAX, FTSE 100, BSE SENSEX 30, Developed operators Developed economy indices
SHANGHAI SE COMPOSITE, BRAZIL BOVESPA, RUSSIAN RTS $,
MEXICO BOLSA, FTSE/JSE AFRICA ALL.
Source: Bloomberg

9 Valuation drivers in the telecommunications industry

Valuation drivers in the telecommunications industry 10

2.
Valuation drivers in the
telecommunications
industry
The purpose of our analysis is to identify the key valuation drivers for telecom
operators, and to consider the impact of their activities (size, exposure to emerging
markets, etc). We have asked the following questions:

• How do investors measure and value growth?

• What are the criteria used by investors in an initial valuation of targets?
• Do these criteria accurately reflect an operator’s unique profile?
We have analysed the financial data of 57 large publicly-listed telecom operators:
25 in emerging markets and 32 in developed markets. We have also divided them
according to their annual revenue (see figure 7).
Our analysis of the financial aggregates, geographical market shares and forecast
stock-based multiples in the telecommunications industry was based on Bloomberg
projected estimates.
In addition, around 70 recent transactions of public and private telecommunications
targets were reviewed and analyzed.

Figure7 — Split of the 57 telecom operators by annual turnover

6 11
> 25 billion US dollars

15–25 billion US dollars

6 10–15 billion US dollars
18
10–5 billion US dollars

< 5 billion US dollars

16

Source: Company financial disclosures, FY09

11 Valuation drivers in the telecommunications industry

The main valuation criteria used by investors in the telecommunications industry in
their initial valuations are shown in the table below.
We have identified the following key differentiators, which affect valuations at this
stage:

• Sales: we have analysed telcos in the ‘larger tier’ (highest sales within our set of
57 operators under analysis) and ‘smaller tier’ (lowest sales within this same set)

• Market type (emerging vs. developed): we have defined ‘emerging operators’ as

telcos with more than 85% of annual revenues from emerging markets

Valuation criteria

Common Telecom-specific Ratios and

valuation criteria Key performance indicators
(KPIs)
EV/Sales ARPU*

EV/EBITDA EV/Number of subscribers

Price Earnings Ratio (P/E) EV/Line installed

Price-to-Book (P/B) SAC*

Beta coefficient (ß) SRC*

*ARPU: Average revenue per user

*SAC: Subscriber acquisition costs
*SRC: Subscriber retention costs

Valuation drivers in the telecommunications industry 12

 Key findings

1. Large telcos that operate in emerging markets

have higher valuation multiples than their peers
in mature markets. Investors place a premium
on growth prospects, so long as they are well
monitored and diversified.

2. Additional risk is reflected by higher betas

(and hence higher costs of capital) for operators
in emerging markets.

The greater the exposure to emerging markets,

the higher the EV/EBITDA multiple, provided
the operator is large enough
Within the large tier, emerging telecommunications operators have higher EV/EBITDA
multiples than their developed market peers.
This trend shows their ability to benefit from market growth rates and better margins,
which are typical of less mature markets.
However, this trend does not apply to the small tier operators, as the markets place a
premium on a diversification of risk, which is supported by the size of the business.

Figure 8 — EV/EBITDA multiples of larger emerging operators by geographical exposure

8.0
7.0
6.0 5.9x
5.5x 5.2x
5.0 4.8x 5.0x
4.4x 4.4x 4.4x
4.0
3.0
2.0
1.0
0.0
2009 2010 2011 2012
Emerging companies Developed companies

Source: Bloomberg

13 Valuation drivers in the telecommunications industry

The smaller the company and the higher its
exposure to emerging markets, the higher the
beta
The beta coefficient (one of the key components of discount rates) contains valuable
information about the company’s risk profile. Typically, the telecommunications
industry is now considered to be slightly less risky than the overall market, with beta
coefficients within the 0.75-1.0 range.
Smaller telecommunications operators usually have a higher beta as their stocks are
more volatile. Their operations are considered to be riskier than a larger comparable
business, and therefore they would normally yield higher returns on investment.
Exposure to emerging or mature markets also influences the operator’s risk.
The market type differentiator provides a measure of this.

Figure 9 — Beta
Beta Weekly 1.5 — Larger vs Smaller Tiers
1.5
1.25
1.0 0.94 0.95 0.97
0.87 0.84
0.81
0.75
0.5
0.25
0.0
1 Jan 08 1 Jan 09 1 Jan 10
Larger tier Smaller tier
Source: Bloomberg

The higher the exposure to emerging markets,

the higher the price-to-book ratio
Price-to-book (P/B) ratios of large telcos operating in emerging markets are higher than
those of their peers in developed markets.

This shows that the market expectations of high growth (i.e., anticipated return on
equity) have been built into their share price, thus boosting their P/B ratios.

Figure 10 — P/B of Larger-tier companies between 2007 and 2010 by region

P/B — Larger Tier
6.9x
5.5
5.0
4.5
4.0
3.5 3.4x 3.3x
3.0 2.9x 3.0x
2.5 2.2x
2.0x 2.0x
2.0
1.5
1.0
0.5
0
1 Jan 08 1 Jan 09 1 Jan 10 30 Sep 10

Emerging companies Developed companies

Source: Bloomberg

Valuation drivers in the telecommunications industry 14

Lower P/B ratios observed for large tier developed and mixed-
market operators might be explained by:

1. Economic factors

Past performance was positive and relatively stable, and is not

expected to grow significantly in the future (past return on
equity is approximately equal to the future return on equity).

2. Accounting factors

Acquisitions reported via PPA led to the recognition of part of

the intangible assets in the acquirer’s consolidated accounts,
increasing the book value of equity.

Thus the book value of these companies better reflects their

market value, leading to lower P/B ratios.

The higher the exposure to

emerging markets, the higher the
implied transaction multiples
The implied multiples of acquired emerging targets were
significantly higher than those of developed market operators.

This is consistent with the conclusions derived from the P/B

analysis: companies with higher P/B were judged by investors as
presenting higher growth potential.

Figure 11 — Recent transaction-based valuation multiples (2008–2009)

18
16 15.6x
14
12.6x
12 11.4x
10
8.2x
8
6
4 3.7x
2 1.2x
0
EV/Sales EV/EBITDA EV/EBIT
Emerging markets Developed markets

Source: Merger Market

15 Valuation drivers in the telecommunications industry

Valuation drivers in the telecommunications industry 16

3.
Purchase price
allocation (PPA) in the
telecommunications
industry
It is vitally important for acquirers to communicate clearly to the market about the
value of assets acquired and liabilities assumed as part of an acquisition.

Therefore, the telecom-specific assets of the target should be identified and valued
using robust valuation techniques and methodologies. Estimated asset values are
reported as part of a PPA analysis, performed in accordance with IFRS requirements.

Furthermore, IFRS 3 (Revised) has introduced new challenges in terms of purchase

accounting. The most critical issues for valuation include:

• Valuation of non-controlling interests

• Option to recognize goodwill on non-controlling interests
• Contingent consideration measured at fair value

1. Benchmarking of PPA in the

telecommunications sector
Ernst & Young’s benchmark analysis of PPA results reported by telcos has shown
that most companies provide detailed qualitative and quantitative information about
intangible assets, their remaining useful lives and the residual goodwill components.

This analysis was based on annual reports of telecommunications companies in

21 countries, disclosing PPA results of 54 telecommunication transactions that
were reported by public companies. The results of this analysis were summarized in
two reports, Global surveys of purchase price allocation practices published by
Ernst & Young in 2008 and 2009.

17 Valuation drivers in the telecommunications industry

According to the last study, published in 2009, recognized intangible assets
represented — on average — circa 30% of the telecommunications industry3 targets’ EV,
while goodwill accounted for about 60% (figure 12).

Figure 12 — Intangible assets recognized in PPA in the telecommunications industry (as % of EV);
source Global surveys of purchase price allocation practices, Ernst & Young 2009, available via
GlobalTelecommunicationsCenter@uk.ey.com

12%

61% 30% 32% 33%

7%
9% 16%

Goodwill Brand/Trademarks Customer Contracts/Relationships

Total Recognized Intangible Assets Technology Non-Compete Agreements

Tangible Assets + Net Working Capital Off Market Contracts/Agreements Other Intangible Assets
(including licenses)

Typical intangible assets in the telecommunications industry

Among the intangible assets recognized in acquisitions, the most significant value was
typically assigned to:

• Customer relationships and contracts

• Licenses for mobile operators or technology-related assets for technology
and equipment companies
• Trade names
Other intangible assets include agreements, such as distribution, supplier or
interconnect arrangements. It should be noted that these results derive from analysis
of operators of different size, markets and technologies. We would recommend that an
in-depth analysis of each target should be carried out before identifying and valuing
intangible assets.

Remaining useful life

Most intangible assets identified in the telecommunications industry would typically
have a definite useful life (including in some cases the trade names or trademarks).
Customer relationships are amortized, on average, over a five- to eight-year useful
life, while the useful life of licenses is often based on their legal term plus foreseeable
extensions in some cases.

3
Telecommunications industry covering all sub-sectors, besides
telephony, internet and mobile operators, including also service,
technology and equipment companies.

Valuation drivers in the telecommunications industry 18

Goodwill components

Our analysis confirmed that telcos disclose information concerning the components
of goodwill in accordance with requirements of IFRS 3/3R and FAS 141/141R. The
existence of goodwill is generally explained by synergies, additional market share and
future services to be offered to the market by the combined business.

Some intangible assets might also be included in the amount recognized as goodwill if
their value is not material (such as distribution networks).

In addition, the following components may also be included in the goodwill calculations:
customer service capabilities, presence in geographic markets or locations (market
power/influence), strength of labor relations, ongoing training or recruiting programs,
outstanding credit ratings, access to capital markets, state of relationships with
governments or regulators. These disclosures are key for investors, and provide
insights about the strategic and financial rationale of the transaction.

2. Asset valuation methodologies

for the telecommunications
industry
All the acquired assets and assumed liabilities should be recorded at fair value, and
their sum compared with the price paid by the acquirer.

According to IFRS 3/3R (Business Combinations) and FAS 141/141R

(Business Combinations), the fair value is defined as “the amount for which an asset
could be exchanged or a liability settled, between knowledgeable, willing parties in an
arm’s length transaction.”

In addition, standards specify that fair value should reflect market expectations
about the probability that the future economic benefits associated with the asset
will flow to the acquirer. Therefore, any analysis should reflect assumptions which
would be common to any market participant if it were to buy or sell each asset on an
individual basis. Thus, the fair value should be determined with reference to market
participants in general, but exclude synergistic values that are unique to a particular
buyer.
The following methodologies are commonly used to value intangible assets:

• Income approach which allows future economic benefits of the asset to be captured
(via the multi-period excess earnings method, relief from royalty method, build-out or
greenfield method)
• Market approach based on comparing the asset with similar assets, and prices paid
for them (comparable transactions method)
• Cost approach relying on the principle that no prudent investor would pay for an
asset more than the cost to recreate it or to reproduce an asset of similar utility
(replacement or reproduction cost method)

More than one approach may need to be considered in order to arrive at a supportable
valuation range. In the following sections, we explain the choice of the preferred
method for each asset valued, and discuss some of the practical challenges.

19 Valuation drivers in the telecommunications industry

Trademarks/Trade names:
One of the most appropriate methodologies for valuing
trademarks is the relief from royalty method, which estimates
the expected royalty savings attributable to the ownership of
the intangible asset. This approach is based on the concept
that if a company owns an asset, it does not have to “rent”
one. The owner is thus “relieved” from paying a royalty, which
represents valuable cost savings. In this context, the theoretical
rent or royalty payment is used as a surrogate for the income
attributable to the trademark.

The key assumptions when valuing a trade name are the revenue
base, the royalty rate and the discount rate.

For telcos, the challenge arises around the remaining useful life
of the acquired trademarks. Specific re-branding and
co-branding relating to the acquisition must not be included.

The intention of the acquirer must not be taken into account,

unless under specific circumstances where it can be proved
that market participants would have acted in the same way,
supported by strict documentation.

Royalty rates for the telecoms industry vary widely, between

0.5% and 4%, depending on the strength of the brand, the
company’s market position (e.g., low cost vs. premium services
or market share), and the operator’s financial performance.

Valuation drivers in the telecommunications industry 20

Subscriber relationships
The multi-period excess earnings method is commonly used to estimate the fair value
of customer-related assets in general, and subscriber relationships in particular.

The key principle of this methodology is that subscriber relationships do not generate
cash flows in a vacuum. Rather, they are supported by several other assets, such as
fixed assets, working capital and intangible assets.

The operating profit generated by customers is attributed to a set of assets. Excess

earnings aims to estimate the value strictly attributable to subscribers over their
remaining useful life (e.g., taking churn rates into account), by subtracting from the
operating profit a contributory asset charge, which represents the theoretical rent that
would have to be paid for the use of these assets were they not owned. The difference
between the operating profit and this charge is called ‘excess earning’ and is fully
attributable to the subscribers. Discounting these excess earnings over the remaining
useful life of the subscribers then leads to an appropriate fair value.

To value subscriber relationships, the acquirer needs a process to remove duplication,

such as multiple SIM customers, non-active cards, and machine-to-machine SIMs.

The application of the multi-period excess earnings method is not easy in the
telecommunications industry:

Firstly, the nature of the subscriber varies (private/corporate, pre-paid/post-paid,

geographic area/country), as each can differ in terms of growth trends, margin levels,
useful lives and churn rates. Consequently, even if the valuation methodology is the
same for each category, there may be a need to split the subscribers into different
categories and value them separately to take these differences into account.
Secondly, the nature of services proposed should also be taken into consideration, to
deal with the specifics of mono-service providers (mobile, fixed, internet and TV) or
those of operators providing bundled offers (triple play, or quadruple play).
Thirdly, the churn rate significantly impacts valuations, with annual attrition rates
varying from 10% to 35%, depending on the subscriber category. In addition, attrition
risks based on the potential transfer of technologies or trade names are to be taken into
account.

Lastly, the useful life is determined in a way that is consistent with the subscribers’ cash
flow patterns. A common rule is to retain a useful life that can capture 90% or 95% of
the total value of subscriber relationships.

21 Valuation drivers in the telecommunications industry

Licenses Main multiples used:
The fair value of licenses may be estimated using a number of different valuation
methodologies. The choice of methodology depends on the availability of information, Price/inhabitant
licenses, and the existence of an active market.
The greenfield approach is specifically used to value telecommunications licenses. This Price/GDP
approach values the license by calculating the value of a hypothetical start-up company
that goes into business with no assets except the asset to be valued (the license). The Price/GDP per inhabitant
value of the asset under consideration can be considered as equal to the value of this
hypothetical start-up company. Price/MHz
The license value can also be derived via the market approach, which estimates the fair
value by referring to purchase prices paid for licenses for similar technologies. Indeed, Price/MHz per inhabitant
the market approach results from the recent sale of similar licences, and how their
valuation metrics relate to the license under consideration.
Finally, the cost approach might be applied by estimating the license value based on
its historical or replacement cost. However, the cost approach results are often limited,
as 2G and 3G licenses become rapidly obsolete in today’s fast-moving regulatory and
technological environments.
The greenfield approach is highly subjective. In Europe, licenses have finite useful lives,
so the value of the start-up company is calculated at the end of the license’s useful life.
This takes into account the fair value of the remaining assets, such as networks and
customers, with a potential discount, and accounting for some continued use. Given
that the assumptions relating to terminal values have a significant impact on the final
valuation, they should be chosen carefully, and well documented.
The market approach is rarely used because of challenges relating to the quality of
the sample, the quality of tender processes, the comparability of the acquired licenses
(technology, territory covered, etc.) and the fee structure for paying for the license
(upfront, annual fees as a percentage of revenues or fixed). However, we believe this
approach should be used more often because it is a useful cross-reference.

Different fee structures exist, which make comparisons very difficult:

1. One-off fees

• Market set: method used by regulators to estimate an upfront fee using market
comparison valuation techniques
• Price floors and minimum bids: method used in auctions where a ‘floor’ price is set to
ensure that the starting point for bids is in line with government expectations

2. Annual or recurring fees

• Revenue-based annual fees set as a percentage of annual gross revenues

• Annual fixed fee or annually-adjusted fee (non-revenue based periodic fee)
• In some countries, additional contributions may include taxes levied by ministries
other than the telecommunications ministry, or may take the form of a small
percentage of gross billed revenues to fund national research programs or to support
a universal service fund

Valuation drivers in the telecommunications industry 22

Contracts
IAS 38 defines contracts as intangible assets that have a fixed or definite term agreed
by both parties. They provide for contractual rights to receive money or contractual
obligations to pay money on fixed or determinable dates. Contracts represent the value
of rights that arise from contractual arrangements.
This methodology is useful for assessing such agreements as MVNO network sharing,
content and applications or roaming agreements.
The main analysis that should be performed concerns the favorable or unfavorable
terms of the contract relative to the market: does this contract provide the operator
with a competitive (dis)advantage?
Other characteristics of the contract to be considered include:
• Renewal clauses
• Historical trends
• Exclusivity or similar characteristics

Contracts that might have a favorable or unfavorable nature include:

• Lease/rental agreements
• Supply contracts
• Distribution agreements
• Indefeasible rights of use (IRU)

Long-term lease/rental agreements signed in the past at market rates (fixed, non-
adjusted rent) might eventually become favorable or unfavorable agreements because
of the cyclical nature of the market. The ‘non-market’ part of rents borne or avoided by
the acquirer due to the existing rental/lease contract should be valued and booked in
the acquirer’s consolidated accounts.
Supply contracts and distribution agreements shall be checked for any off-market terms
and conditions as well as for any exclusivity clauses, as these might give rise to an
intangible asset being identified, recognized and valued.
IRUs enable operators to use the networks of other telecommunications carriers for an
amount that can be compared to a rent. All IRUs are signed for long-term periods and
represent a competitive advantage over other market participants, as capacity is limited
in the market and, once contracted, they are not available to other market participants.
Therefore, these contracts may represent a great deal of value to their owners, and are
often included in the PPA.
Non-compete agreements are contracts between a buyer and a seller of a business,
restricting the seller from competing in the same industry for a specific period of time,
often within a defined geographic area. The principal technique used to value non-
compete agreements is an incremental approach, which values the asset based on the
difference in cash flows between scenarios with or without the non-compete agreement
in place (“with or without approach”). The main limitation of this approach is that it is
highly subjective, and the inputs are discretionary in each case.

23 Valuation drivers in the telecommunications industry

Tangible assets
Tangible assets are generally valued by
applying the cost approach. The principle
behind this approach is that the value of
an asset should not exceed the cost of
obtaining a substitute asset of comparable
features, utility and functionality. In the
context of PPA, the approach is applicable
if the market and income approaches
cannot be applied.
Two methods might be regarded within
the cost approach:
• The reproduction cost method,
which is based on the construction
(or purchase) of an exact replica of the
intangible asset
• The replacement cost method, also
known as the greenfield approach,
which is based on the cost of recreating
the utility of the subject intangible
asset, but in a form or appearance that
may be quite different from an exact
replica of it
To value tangible assets, particular
attention should be paid to the
acquirer’s/market participants’ intentions
(including network downsizing), since
certain adjustments might be needed.
For example, a network that would
be considered “inefficient” by market
participants, because it would require
some redundant antennas to be disposed
of, may justify a discount applied to the
network value. Finally, the economic
useful life of the equipment should be
considered versus its accounting
useful life.
Replacement cost new and reproduction
cost new may follow changes in the
prices of new equipment. Indeed, for
infrastructure assets,replacement/
reproduction cost new may be higher than
historical values, while for technological
equipment assets, replacement costs new
are often lower than historical values.
It should be noted that the target’s
marketplace may also impact the value
estimation using the cost methodologies.
Valuation drivers in the telecommunications industry
Further considerations, such as functional
obsolescence (capacity, rapidity, etc.) and
asset retirement obligations, can also
have a significant impact on values.
Discount rate
When using income as a basis for the
valuation methodology, such as the relief
from royalty method or the multi-period
excess earnings method (MEEM), a
discount rate has to be applied.
The discount rate should be specific to
each asset and reflect its risk profile. It
should also be consistent with the overall
company weighted average cost of capital
(WACC). The weighted average return
on assets (WARA) analysis estimates the
average rate of return of the company’s
economic assets, based on their own
discount rate, and calculates their
respective weight in the total enterprise
value (EV).
Network assets and working capital are
considered to carry relatively little risk
in Telecoms, whereas licenses, customer
bases and trade names demand a
higher rate of return. Goodwill considers
synergies whose realization often proves
difficult and therefore risky.
The WARA analysis aims to check that
the rates used are consistent with the
respective risk profiles of the assets, and
reconcile those with the operator’s WACC.
24
 Goodwill
Goodwill is estimated as the residual between
the value of the business as a whole (the
purchase price) and the sum of fair values
assessed for identifiable tangible and
intangible assets of the business, less the fair
value of liabilities assumed.

Goodwill in the telecommunications industry

often includes the following elements:
Post-acquisition subscriber base development
Any post-acquisition subscriber growth that
cannot be assigned to existing subscribers
might only be captured in goodwill.
Bundled offers (convergence synergy)
The emergence of “quadruple-play” offers
— bundles of fixed telephony, broadband
internet, mobile telephony and TV — are likely
to lead to gains in market share and average
ARPU, and a reduction in churn rates.
Mergers in the telecom sector tend to build
on existing “triple-play” offers. As a result,
goodwill may integrate the future benefits of
bundled services.
Access to powerful distribution networks
Acquiring an operator which owns sales
outlets enables the acquirer to offer its
services to a wider population.
Geographical expansion
Winning new markets for the acquirer will
enlarge its geographical coverage, and
enhance its brand value.
Buy vs. build
Acquiring a profitable business with a large,
established network may lead to future
growth, saving time and money that would
have been required to build a similar network
from scratch.
Defensive strategy
Acquiring a competitor may enable the
acquirer to reduce price wars in certain
geographical areas, or to protect itself
against acquisition by a larger operator.

25 Valuation drivers in the telecommunications industry

Contacts
Global Telecommunications Center
Vincent de La Bachelerie Serge Thiemele
Global Telecommunications Leader Global Telecommunications Center — Johannesburg
vincent.de.la.bachelerie@fr.ey.com serge.thiemele@ci.ey.com

Jonathan Dharmapalan Wasim Khan

Global Deputy Telecommunications Leader Global Telecommunications Center — Riyadh
jonathan.dharmapalan@ey.com wasim.khan@sa.ey.com

Marc Chaya Mike Stoltz

Global Telecommunications Markets Leader Global Telecommunications Center — San Antonio
marc.chaya@fr.ey.com michael.stoltz@ey.com

Nicolas Klapisz
Global Telecommunications
Valuation & Business Modelling Leader
nicolas.klapisz@fr.ey.com

Robin Jowitt
Global Telecommunications Transaction Advisory Leader
rjowitt@uk.ey.com

Serge Pottiez
Global Telecommunications IFRS Advisor
serge.pottiez@fr.ey.com

Steve Lo
Global Telecommunications Center — Beijing
steve.lo@cn.ey.com

Holger Forst
Global Telecommunications Center — Cologne
holger.forst@de.ey.com

Prashant Singhal
Global Telecommunications Center — Delhi
prashant.singhal@in.ey.com
Ernst & Young

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