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2019 South Africa M&A in the ICT Sector

Summary

2019 SA ICT Mergers and Acquisitions (M&A) deal flow was defined by the acquisition of Vumatel at an estimated R8 billion. The top three deals by deal value were about the sale of telecoms and data centre infrastructure. Six of the eight infrastructure deals involved fibre network operators being acquired.

2019 saw the end of the strong and aggressive M&A strategy used by Blue Label Telecoms, EOH and HeroTel. In 2019, Blue Label Telecoms and EOH sold assets to raise capital to offset long term debt, whereas HeroTel simply ran out of attractive assets to buy.

In 2020, the M&A deals will be defined by companies seeking to add strategic assets to their existing portfolio. Potential deal flow includes the sale of Cell C, the likely sale of the tower portfolios of either MTN or Vodacom or both, and the ongoing select acquisition of fibre network operators and retail service providers by their larger competitors.

2019 M&A Deal Count

Over the past three years, the number of reported ICT M&A deals has dropped from 41 (2017) to 35 (2019). Deal classification system:

  • Networks & Infrastructure category covers deals that involve the acquisition of companies who own network and/or infrastructure (e.g., data centres, fibre networks).
  • Customers & Channels category covers the acquisition of companies that have large customer bases or channels and distribution assets.
  • Capabilities & Skills category covers deals that typically involve IT Services.

This decline has resulted from the slowdown by companies which previously drove M&A activity.

  • From 2016 to 2018, HeroTel was a major driver of M&A through its aggressive acquisition of regional wireless internet service providers (WISPs). In 2019, HeroTel only concluded one transaction. The large decline in network deals resulted from HeroTel’s winding down of its acquisition spree.
  • After many years of driving M&A, EOH in 2018 began the process of selling subsidiaries and equity it held in companies. The selloff gained momentum in 2019.

Interestingly, six of the eight network infrastructure deals involved fibre network operators. There is no single large investor or network operator who has been buying up fibre network assets. Instead, the market has seen selective buying of fibre network assets.

The higher volume, but generally lower priced deals, involving the buying of IT companies, continued in 2019. The number of reported deals has risen from 18 in 2017 to 22 in 2019. It is rare to see IT deals that surpass R1 billion in deal value. Thus, the R1 billion price tag paid by Vodacom Group for its 51% equity in IoT.NXT stands out. It is difficult to unpack this deal’s valuation drivers but it does seem that Vodacom Group may have paid a premium for the equity. There is still some hype around IoT which may have influenced the price tag.

In terms of media deals, the purchase of media assets by Lebashe Investment Group from Tiso Blackstar Group for R800 million is another standout deal. There are very few media deals undertaken in South Africa. This is a reflection of the local media market concentration.

2019 Deals not Concluded

There were two deals that were not concluded: the sale of WebAfrica (an ISP) and Vox (a fibre network operator and a service provider).

The asking price for WebAfrica was not met and thus the sale was aborted. The reported asking price was R300 million while bidders submitted bids in the R170 to R220 million range.

A similar situation arose with Vox where it was reported that an equity sale was imminent, but no deal was concluded. Subsequently, a Vox shareholder, Investec, sold its shareholding to the existing shareholders and a new management shareholding scheme was put in place.

Towards the end of 2019, Telkom Group offered to buy Cell C, but the shareholders of Cell C rejected the Telkom approach. Had a deal been concluded, then this deal would have been the largest deal reported for the year.

2019 Top Three Deals

The top ten deals accounted for an estimated M&A transaction value of R18 billion, while the top three deals accounted for R16.6 billion. The top three deals in 2019 are:

  1. The largest deal is estimated to have been the CIVH acquisition of Vumatel at an estimated value of R8 billion . We included both the first and second transactions in this estimate.
  2. This was followed by Berkshire Partners estimated R5.6 billion purchase of 51% equity in Terraco from Permira. The estimated deal value is broadly based on limited information published about the deal.
  3. The most surprising valuation is the R1.028 billion paid by Vodacom Group for 51% equity in a young four-year old IoT solutions company IoT.NXT. The surprise element is based on the fact that the value of projects undertaken by IoT.NXT to date does not support this valuation. The purchase price must have been based to a degree on anticipated future revenue flow, given IoT market expectations.

The unconfirmed sale of the Standard Bank data centre to Liquid Telecoms is a significant deal. However, there is no published information that indicates that this deal has been concluded.

2020 M&A Outlook

We expect to see the following deal flow in 2020:

  • TowerCo deal with MTN/Vodacom towers: Both operator groups have disposed of tower portfolios in some of their other country markets of operations. SA remains a significant market where both operators own their towers. Over the years there have been rumours about the sale of the respective tower portfolios. We expect that an international towerco with a strong local BEE partner will likely acquire the tower portfolio of either MTN or Vodacom or both in SA.
  • Fibre network operator M&A: There will be continued M&A activity with the smaller fibre network operators being purchased by the larger network operators. A likely M&A target remains Octotel, given its strong position in the Western Cape.
  • IT Service Providers M&A: This will continue through 2020. The focus will see innovative and strong market position players being targeted in a M&A drive.
  • CIVH acquisitions: CIVH has indicated interest in expanding their infrastructure business. This may lead to CIVH buying into a data centre business and/or into a wireless network operator.
  • Blue Label Telecoms and EOH: Both companies will likely continue to seek to sell assets as they strive to raise capital to improve their balance sheet.

We will not see single companies drive aggressive M&A strategies. Rather the M&A deals will be defined by companies seeking to added strategic assets or skills to their existing portfolio.

Contact Andre Wills (andre@africaanalysis.co.za) for further information on this topic.

Vumatel/Fibrehoods deal underlines the FTTH Economics of Scale Factor

Summary

Economics of scale is a critical success factor for open access fibre networks. Achieving scale gives open access network providers a strong competitive advantage. Mergers and acquisitions (M&A) is a critical tool used by fibre network operators in achieving scale. The Vumatel acquisition of Fibrehoods represents the latest M&A deal in the open access fibre market. This deal continues the fibre M&A trend seen in 2016.

Vumatel buys Fibrehoods

In 2014, Vumatel entered the Fibre To The Home (FTTH) market. While there were existing fibre network operators, the entry of Vumatel kick started the entry of many new operators to the market. This in turn triggered a rapid fibre land grab. By March 2016, we estimate there were 196 thousand houses passed. Note this number excludes VDSL subscribers, as in some markets VDSL, who use FTTC, are included in the reported FTTH numbers. The figure below shows the rapid growth in FTTH houses passed over the last two years.

FFTH Market Oct 2016

Scale is critical for an open access fibre network operator

Fibre network scale is a critical success factor for an open access network provider, with scale being measured by the size of its FTTH network. The network operator’s expanding network footprint drives sales momentum among retail service providers using its network. In effect, the open access network operator offers more opportunities for the retail service providers to sell retail services.
The key benefit is that FTTH scale also translates into economic scale in that the operators balance sheet grows stronger. Economic scale means that the operator can access cheaper capital with better terms than smaller operators. This is a strategic competitive advantage as building out FTTH networks is a capital-intensive business.

Open access operators can gain scale through a combination of a build and/or buy strategy:

  • Build strategy: In terms of building out FTTH networks, we foresee a total of R12 billion being invested in open access FTTH networks over the next three to four years. This estimate is based on market announcements and our assessment of capital required to deploy the announced fibre networks. This strategy works well when an operator deploys fibre in areas where there is no existing fibre network to compete against.
  • Buy strategy: We have seen the buy strategy exercised over the past two years, with a significant ramp-up in 2016 MA activity.

M&A is part of the fibre network strategy

“M&A is a key tool used by fibre network operators to expand their networks”

Fibre network operators typically start out as niche operators, who focus on a specific high-income geographical residential area. As the operator gains market traction, it seeks new areas to deploy fibre thus driving the scale of its business.
In doing so, it faces two challenges: (1) funding the network expansion, and/or (2) deploying fibre in an area where there is an existing competing network.

  • Funding: Network operators either sell equity or take on long term debt to fund network expansion. We have seen both options exercised in South Africa. For example, Investec acquired an equity stake in Vumatel and Rainbow Capital acquired an equity stake in Metrofibre Networx.
  • Competitive: The operator can choose to (1) buy the existing network operator, (2) reach a network sharing agreement, or (3) decide to not enter that geographical market. Typically, we see options (1) and (3) being taken. Network sharing and co-build strategies are seen on long-haul fibre routes.

In SA, we have yet to see a new FTTH entrant build FTTH infrastructure in areas where another new entrant has already built out their FTTH network. We have seen new entrants build-out in competition to Telkom’s DSL network. Part of the reason is that there are enough attractive geographic areas for new entrants to choose from. This has led to an explosion in new FTTH players over the last two years that in turn has resulted in a fibre land grab.

There are a limited number of early win attractive areas wherein to deploy fibre. To gain scale and to enter these attractive markets means that the SA fibre operators must move into the M&A phase, and the market has done just that.

The following table (as at 25 Oct 2016) lists the M&A activity in the FTTH market. As can be seen, we have moved aggressively into an M&A phase. Note that the table excludes the establishment of fibre network operators and only focuses on M&A.

FTTH M&A Deals

Source: Company press releases 2015 to 2016, the Date column represents the year in which the deal was completed. It is not the deal announcement date. The Not Complete comment implies that the deal is still awaiting final regulatory/competition approval.

Here are noteworthy fibre deals that were terminated:

  • Vodacom offered to buy Neotel, the deal was terminated in Q1 2016 given the regulatory hurdles that the deal encountered.

The table shows that the year 2016 will be remembered as the year that FTTH M&A commenced.

The FTTH M&A activity seen in SA is reflective of global trends. Global market observations show that consolidation is a natural part of the FTTH market. Examples of such country markets are the UK and USA.

Fibre Network M&A Outlook

Long term sustainability in the open access FTTH network market is defined by one key word “scale”. Scale is generated through network expansion. Operators drive scale through a combination of a build/buy strategy. To date, we see little evidence of operators building competitive fibre networks in the same geographical area.

Furthermore, the South African National Integrated ICT Policy White paper (Oct 2016) promotes open access networks with the objective of limiting duplicate infrastructure build. We therefore expect that M&A will continue to be an important tool to grow network scale. In addition, we expect that more private capital will be attracted to the fibre market.

In 2017 and 2018, we expect further consolidation in the FTTH market. Small open access network operators, who cannot generate enough scale, will ultimately close or be acquired.

The M&A fibre market theme for network operators will be: buy or be bought.