1The Rise of the Tower Business

The Rise of the Tower BusinessMore mobile operators are spinning off their tower infrastructures in search of growth, shareholder value, and better margins. Now the questions are: Will the growth continue? Is the value sustainable? Can margins be improved?

2The Rise of the Tower Business

Captive or independent tower companies are emerging like never before as more telecommunications companies sell or spin off their tower holdings. Because towers make up the bulk of their capital investments and, especially in emerging markets, most of their operating costs, mobile operators are opting to share towers—renting them from other telcos or tower companies instead of making ongoing financial investments in infrastructure. In the process, mobile operators are searching to cut costs drastically and maximize profits.

But has it really been a success? Are tower companies creating value for their shareholders and their mobile operator clients? In this paper, we answer these questions and examine what tower companies and mobile operators can do to create a sustainable business and shareholder value.

Spinning Off Towers Is a Hot Topic for TelecomsInspired by the early success of tower companies in India, operators around the world are contemplating selling or spinning off their towers (see sidebar: Tower Sharing in India). The most recent examples include American Tower Corporation’s purchase of Cell C’s towers in South Africa and Blackstone’s unsuccessful attempt to buy Reliance Infratel’s towers in India (see figure 1 on page 3). Private equity investors, excited about opportunities to increase growth and cash flow, have initiated tower spinoffs by leveraging debt. As a result, mobile operators have realized significant value from tower asset deals.

Tower Sharing in India

The Indian telecom sector saw a dramatic growth phase from the late 1990s to 2010. Because operators were focused on acquiring customers and expanding services in the midst of hyper-competitive pricing pressures, they started outsourcing network management, information technology, call centers, and then tower infrastructure— all previously seen as core strategic activities.

In 2008, Quippo, an independent company with a small portfolio of towers shared by operators, acquired 1,000 sites from Spice Telecom, which later became Idea Cellular. In the same year, Bharti Airtel, Vodafone, and Idea created the world’s largest tower company, Indus Towers, through

a joint venture. In 2009, Quippo merged with Tata Teleservices’ tower assets, creating Viom, India’s largest independent tower player. The next year saw a spate of inorganic activity, with American Towers acquiring two smaller tower companies and GTL Infrastructure acquiring 17,500 towers from Aircel in an all-cash deal.

Between 2007 and 2010, the number of towers rose from about 100,000 to 310,000, fueling an increase in tenancy ratios to 1.6 per tower. From 2010 to 2012, there was aggressive growth of new operators, allowing private players such as Viom to boost their tenancy ratio to 2.4.

Tower sharing created a strong incentive in the Indian telecom

market: It allowed operators to reduce costs considerably and focus on core marketing activities while enabling new operators to rollout networks in record times. For example, Tata DoCoMo rolled out 16,000 sites within a year with Viom.

However, hyper-competition in the mobile industry and the ongoing fallout from competitive and regulatory challenges over the past 12 months have put cost pressures on Indian tower companies. With around 365,000 towers, there is now an over-supply, and growth has tapered off. As a result, Indian tower companies have begun to look for new growth avenues and focus more on operational improvements.

3The Rise of the Tower Business

As early movers, Indian tower companies have become global industry leaders with Indus, Reliance Infratel, and Viom managing 110,000, 50,000, and 41,000 towers each, respectively, ahead of industry pioneers American Tower and Crown Castle with 49,000 and 22,000 towers each (see figure 2). However, recent industry developments and regulations in India have raised questions about the sustainability of independent tower businesses. In particular, the exit of some of the newer operators, which were the primary engines of India’s tower growth, is affecting cash flow and debt repayments and could even push some tower companies to the brink of bankruptcy.

Source: A.T. Kearney analysis

Figure 1 Recent tower deals

Deals Country Year Deal size Numberof towers

Enterprise valueper tower

Crown Castle buys Vodafone Towers Australia 2008 $39 million 140 $278,571

Protelindo acquires Hutchison’s towers Indonesia 2009 $503 million 3,630 $138,606

American Tower Corporationacquires XCEL Telecom

India 2009 $170 million 1,730 $98,266

GTL acquires Aircel India 2010 $1.8 billion 17,500 $102,857

Macquarie SBI obtains11 percent stake in Viom

India 2010 $304 million 37,500 $73,697

American Tower Corporation andTowerCo Ghana buy MTN Towers

Ghana 2010 $428 million 1,876 $228,305

American Tower Corporationbuys Cell C’s towers

SouthAfrica

2010 $430 million 3,200 $134,375

Blackstone and Carlyle reported valuation of Reliance Infratel (did not go through)

India 2012 $3-$4 billion 50,000 $60,000 to $80,000

Number of towers, 2011(thousands)

Sources: Company websites, media publications

Figure 2India tower companies are among the global industry leaders

110

Indus Towersin India

50

Reliance Infratelin India

49

American Towerin North America

41

Viom Networksin India

22

Crown Castlein the United States

7

Protelindoin Indonesia

4The Rise of the Tower Business

While some of these developments are specific to India’s market and regulatory situation, we believe it also heralds the changing nature of tower businesses around the world.

From Growth to Operational Excellence Independent tower companies are on the rise, bolstered by two aspects of this emerging industry: a strong focus on operational excellence and a fervent exploration of new business models. Although voice growth is slowing in many markets, data traffic is exploding and driving growth in additional 3G and 4G tenancies and is leading to more in-building solutions and smaller cell sites. As such, it is unlikely we will see the end of the tower growth story anytime soon.

Nevertheless, tower businesses are undergoing a fundamental transformation. For years, one dimension—tenancy ratio—has generally governed tower businesses. But as mobile markets mature, the number of operators a tower company has is no longer a measure of success and may even be risky. Slowing subscriber growth, technology-integrating equipment, operator consolidation, and active network sharing are making it more difficult to add revenue-bearing tenancies and are forcing companies to take another look at the conventional tower business model.

Recent industry developments and regulations in India have raised questions about the sustainability of independent tower businesses.The new measure of success is site-level profitability. This means that operational excellence, somewhat overlooked in the past, is now an essential skill. As with managed services, the value of outsourcing is not just in sharing costs but in a specialist provider’s ability to manage costs and quality.

Several other factors are also fueling the need for operational excellence:

Preference for fixed costs. Increasingly, operators are pushing for fixed power and fuel cost arrangements, rather than the traditional pass-through, to preempt pilferage and disputes. This also works in favor of the tower company because it benefits directly from operational improvements.

Demand for customized sites. One-size-fits-all designs are not working because customers are increasingly demanding more specific solutions, be it for in-building or for rural areas.

Overlap in tower locations. In many markets, tower portfolios are heavily overlapping in urban areas. Rationalization will be important to improve cost structures.

Green telecom requirements. There is more public and regulatory pressure to reduce telecom towers’ energy consumption and pollution, especially from diesel generators. Alternative solutions are being explored, including solar, biomass, and fuel cells, but their economic viability is still not where it should be.

5The Rise of the Tower Business

Developing New Business ModelsTower companies are also exploring new opportunities and business models, with active network sharing and managed capacity becoming topics of interest. Although enticing in concept, it is not yet clear how these can be viable in the long term if provided by a third party or how the financial risks can be shared equitably among all participants.

Another hot topic is energy-management companies that take over power and fuel supply at a predictable cost per kilowatt hour (kWh). Although they offer clear advantages for mobile operators and tower companies to avoid capital expenditures (capex), they are not always beneficial for maintaining or improving earnings margins.1

Considering Different Market ContextsNaturally, market context is important when evaluating tower companies’ business potential, the nature of growth, and operational improvement opportunities. We believe the focus should be on improving operations and site profitability and not just increasing tenancy rates. Our reasons are illustrated by three examples out of South and Southeast Asia:

India. With high mobile penetration—80 to 85 percent of the population—and operators’ restricted financial capabilities, the growth phase for new towers is slowing down. In fact, many regions have an oversupply of towers, and most tower companies already have a high share of single tenancy sites. At the same time, power and fuel costs account for 30 to 40 percent of operator network costs, with rampant power leaks and diesel pilferages. Overall, actual power and fuel costs could be 20 to 25 percent higher than “should-cost.” Focus on operational excellence is the order of the day.

Data traffic is exploding, leading to more in-building solutions and smaller cell sites. As such, it is unlikely we will see the end of the tower growth story anytime soon. Indonesia. Population coverage outside of the island of Java is limited, and only the leading operator, Telkomsel, has a strong footprint in these areas. Recent regulations have made tower sharing mandatory, and we anticipate an increase in tenancies outside Java. Data traffic is expected to grow by 50 percent per year for the next five years, fostering nationwide 3G deployment. This will drive an increase in tenancy ratios and new infill requirements in Java, and in some new sites outside of Java, provided they can be economically deployed to justify this expansion.

1 Earnings in this paper refers to earnings before interest, taxes, depreciation, and amortization (EBITDA).

6The Rise of the Tower Business

Malaysia. Population coverage has reached 95 percent, and operators have shared towers for some time now, both formally and informally. As site acquisition in major cities becomes more difficult, the focus is turning to mobile broadband and the required optimization of in-building coverage and small cell networks. Infrastructure sharing, consolidation, and optimization are the way leading operators are most likely to go.

Tower Operations Have Room to Create Significant ValueTower companies now have significant opportunities to improve their operations along several dimensions. The starting point is the typical profit and loss structure (see figure 3). The key is making existing sites profitable with concerted efforts to improve both the top and bottom lines.

Beyond the profit and loss structure, there are several other ways to improve performance:

Drive comprehensive operational improvements

Power and fuel. Energy costs are often treated as a pass-through to operators, leading to limited incentives for tower companies to contain costs. Inefficiencies are typically found in areas such as monitoring electricity and fuel consumption, equipment upkeep, and equipment configuration, including overly powerful diesel generators. In areas with limited grid power, these inefficiencies are compounded and lead to high pilferage and leaks. We often see too much emphasis on technology solutions, such as using advanced batteries for longer backup or installing cooling solutions to substitute for air conditioners, and not enough focus on

($ million) Illustrative

Notes: Others includes penalties, under-recovery in power and fuel costs, and provisions. O&M is operations and maintenance. HR is human resources. G&A is general and administrative. EBITDA is earnings before interest, tax, depreciation, and amortization.

Source: A.T. Kearney analysis

Figure 3 The starting point for improving operations is the typical profit and loss structure

Grossrevenue

146

Powerand fuel

pass-through

46

Netrevenue

100

Rent

18-20

O&Mand security

12-15

HR andG&A

7-10

Others

8-10

EBITDA

45-55

Depreci-ation

20-25

Interest

20-25

Profitafter tax

5-8

7The Rise of the Tower Business

execution. However, significant savings can be realized through better execution by ensuring correct temperature settings, properly maintaining equipment, and controlling vendor costs. For example, some tower companies in India use prepaid petrol cards to control the diesel filled by vendors and set limits based on each site’s should-be consumption.

Operations and maintenance. Taking care of site infrastructure is crucial for controlling fuel costs and avoiding unscheduled downtime. Thorough equipment checks and adherence to preventive maintenance schedules are vital aspects of sound infrastructure performance. Leading tower companies focus on improving their ability to track site-level performance and profitability. Concepts such as tower operating centers (TOC) are rightly gaining ground in the industry.

Estate management and security. Landlords that pilfer power or fuel can be a big source of problems. Some even resist control with unscheduled outages that result in penalties from operators. Leading tower companies understand the need for good rapport with landlords but are also prepared to use security or police to control abuse when necessary. Security costs can be optimized by adopting a patrolling model instead of a stationed-at-site model. Naturally, these options vary by location and environmental conditions.

Reduce cost structure of sites

New site designs. Innovative sites focus on reducing the total cost of ownership for tower companies and operators. This requires not only building structurally lower-cost sites, but also integrating active equipment components that reduce energy consumption. India, with its frugal engineering capabilities (jugaad), is poised to drive such breakthrough designs; we are already seeing some companies pushing in this direction. Similarly, capex can be significantly reduced by tailoring site specifications to tenancy profiles. For example, a single tenant site in an area with decent grid power can get the job done with just a monopole for an outdoor base transceiver station (BTS) that has an advanced valve-regulated lead acid (VRLA) battery. No diesel generator or shelter is necessary.

Existing sites. Sites are often designed for three to four tenants while the actual number of tenants turns out to be just one or two. This results in over-configurations, such as a 30-kilovolt-amp (kVA) diesel generator for a single-tenant site. At the same time, tower companies have under-configured sites, allowing for swapping of generators and batteries.

Identify incremental site, tenancy, and pricing opportunities

Bottom-up site opportunity analysis. Radio network planning capabilities are essential for maximizing tenancies. Tower companies can map their tower portfolios to operator blind spots and then approach operators to discuss sharing.

New technologies. When outlining service agreements with telecom operators, tower companies often fail to charge adequately for new technologies such as 3G or 4G, which means they do not share in the incremental revenues generated. This can be a significant missed opportunity when operators deploy universal site cabinets for 2G, 3G, and 4G.

Asset utilization. Tower assets can be used for other tenancies that do not require much space, such as Internet service providers (ISPs). Although revenues are generally lower than for a typical operator tenant, the margins can be attractive. Also, the real estate at tower sites can be used for new business opportunities, such as ATMs or Internet kiosks. The availability of power, air conditioning, and security can be an appealing proposition for other service providers.

8The Rise of the Tower Business

Capture other operational improvement opportunities

Vendor management. Many routine tasks such as diesel filling, maintenance, and security are outsourced. As such, vendor management is a core competence for avoiding vendors dictating terms or passing on their inefficiencies. Watertight contracts and stringent enforcement are crucial to deriving value from of an outsourcing model.

Contract management. To deal effectively with both customers and vendors, contracts need to be comprehensive and forward-thinking. Tower companies should not lose out on new technology deployments, wholesale or active sharing arrangements, or when changing to fixed-cost models. Renegotiations are challenging, so these issues require attention when contracts are framed.

Collections. Working capital management can be another improvement area—for example, reducing outstanding days for payment, automating billing to reduce errors, following up on pending receivables, and enforcing contract terms.

Growth: No End in Sight Tomorrow’s tower company will be more than a cost-sharing proposition; it will be a specialist provider of telecom network services with operational skills in energy management, operations, customized site planning, and low-cost design. These companies will offer operators a clear and sustainable value proposition—especially attractive to companies with site rentals, power, and fuel that can account for 70 to 80 percent of network costs.

The economic reasons for mobile operators to spin off their tower operations will be difficult to ignore, with operational improvements dictating partner choices and construct, whether captive spinoff, management contract, or sale to a tower specialist or financial investors.

As the nature of the tower business shifts from growth to operational excellence, the opportunities to improve shareholder value will flourish. And with data traffic accelerating, the tower growth story is certainly not over.

Authors

Nikolai Dobberstein, partner, Mumbai nikolai.dobberstein@atkearney.com

Sridhar Narasimhan, principal, Singapore sridhar.narasimhan@atkearney.com

Ajay Gupta, principal, Mumbai ajay.gupta@atkearney.com

Saurabh Singh, consultant, New Delhi saurabh.singh@atkearney.com

The authors wish to thank their colleague Rajaganesh Sethupathi for his valuable contributions to this report.

A.T. Kearney is a global team of forward-thinking, collaborative partners that delivers immediate, meaningful results and long-term transformative advantage to clients. Since 1926, we have been trusted advisors on CEO-agenda issues to the world’s leading organizations across all major industries and sectors. A.T. Kearney’s offices are located in major business centers in 39 countries.

Americas

Europe

Asia Pacific

Middle East and Africa

AtlantaCalgary ChicagoDallas

DetroitHoustonMexico CityNew York

San FranciscoSão PauloTorontoWashington, D.C.

BangkokBeijingHong KongJakartaKuala Lumpur

MelbourneMumbaiNew DelhiSeoulShanghai

SingaporeSydneyTokyo

AmsterdamBerlinBrusselsBucharestBudapestCopenhagenDüsseldorfFrankfurtHelsinki

IstanbulKievLisbonLjubljanaLondonMadridMilanMoscowMunich

OsloParisPragueRomeStockholmStuttgartViennaWarsawZurich

Abu DhabiDubai

JohannesburgManama

Riyadh

A.T. Kearney Korea LLC is a separate and independent legal entity operating under the A.T. Kearney name in Korea.

© 2012, A.T. Kearney, Inc. All rights reserved.

The signature of our namesake and founder, Andrew Thomas Kearney, on the cover of this document represents our pledge to live the values he instilled in our firm and uphold his commitment to ensuring “essential rightness” in all that we do.

For more information, permission to reprint or translate this work, and all other correspondence, please email: insight@atkearney.com.