The Rise of the Tower Business
More 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? 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 drastically cut costs 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 Telecoms
Inspired 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). 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.
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, 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.
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.
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.
Developing New Business Models
Tower 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 Contexts
Naturally, 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 a 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.
Indonesia. Population coverage outside 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, as well as in some new sites outside of Java, provided they can be economically deployed to justify this expansion.
Malaysia. Population coverage has reached 95 percent, and operators have shared towers for some time now, both formally and informally. As site acquisition in key 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 Value
Tower 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 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 amps (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 adequately charge 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.
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.
The authors wish to thank their colleague Rajaganesh Sethupathi for his valuable contributions to this report.
1Earnings in this paper refers to earnings before interest, taxes, depreciation, and amortization (EBITDA).