Asia-Pacific telcos are converging on an idea: sell their towers. The disposals can add breathing room to balance sheets squeezed by years of heavy capital expenditure (capex). S&P Global Ratings believes the transactions make business sense for telcos selling towers, as well as tower specialists to which the assets are sold.

Dedicated operators can use towers more efficiently. Parties can extract greater value from the asset, and are willing to buy them at EBITDA multiples up to 30x, according to public disclosures.

The disposals allow telcos to cut leverage. They can also put the cash proceeds to more productive use.

As entities spend more to upgrade to advanced networks, earnings have not risen in tandem. The average adjusted debt of our rated Asia-Pacific telcos has risen by about one-third over the past decade. In contrast, average adjusted EBITDA has increased just 3%.

A recent spate of tower sales in the region by a number of operators isn't coincidental. They are coming when telcos face steep 5G and fiber capex needs, while struggling to achieve earnings growth to create that funding capacity. Entities are raising investments in areas adjacent to the traditional connectivity business, such as in information and communications technology (ICT) services and data centers. Tower sales provide much needed capital for these investments.

We don't think the sale of towers materially harm the competitive advantage of telcos. Transactions have typically been structured so that telcos are able to strongly influence operations and maintain network quality through service level agreements. More importantly, the assets are passive and are not key to network advantage. With tower infrastructure being relatively mature and accessible on a third-party basis, active radio equipment and spectrum holdings as the main differentiating factors between mobile networks. That said, if, and when, telcos take a step further to monetize other more systemically complex and important infrastructure assets, this view could differ.

Investors ask how these tower sales affect the telcos' credit profiles. They also want to understand what is behind the high multiples achieved on these disposals. We address their most common queries here.

Frequently Asked Questions

Why are Asia-Pacific telcos selling their tower assets?

Asia-Pacific telcos have turned to asset recycling to manage heavy investment requirements. The balance sheets of Asia-Pacific telcos have seen better times. Debt has crept up with each iteration of capex that accompanies a new generation of mobile network, while the resultant earnings benefits have fallen short.

Table 1

Chart 1

Upfront investments in 5G networks and spectrum will further test the telcos' leverage. Telcos will need five to 10 years to generate significant returns on their 5G outlays. That's because the most meaningful monetization opportunities lie with 5G industrial use cases, which are still in development. These range from self-driving vehicles to smart factories. For now, 5G is used mainly to offer faster mobile and fixed-wireless access.

Indeed, the move toward a shared tower infrastructure model makes economic sense for telcos in the 5G era. Once sold by telcos, often to infrastructure funds, the towers become part of an ecosystem of shared infrastructure assets. As connectivity demand grows, a denser tower network is needed to support growing data traffic as well as to compensate for the weaker penetrative ability of high-band 5G signals. A shared infrastructure model will benefit telcos. They save time and cost by renting existing towers, rather than undertaking costly builds.

The balance sheets of telcos also need to diversify away from traditional connectivity operations, where earnings are soft, particularly in mature markets. For example, Thailand's Advanced Info Service Public Co. Ltd. and Korea's SK Telecom Co. Ltd. and KT Corp. are investing in data centers. Others such as China Telecom Corp. Ltd. and Singapore Telecommunications Ltd. (Singtel), are putting money into cloud services and information and communications technology.

How do we view such tower sales?

The tower sales are essentially a financing arrangement. The telcos sell the towers and then lease them back. This creates a permanent financial obligation, akin to a sale-and-lease-back transaction.

That said, we recognize the business logic of a tower sale. It provides liquidity to the telco to fund other investments. Letting tower specialists manage the tower business allows the telco to focus on its core business, while enabling entities to realize the full potential of the assets, which can be leased to many telcos. This will improve the tower assets' profitability and has supported valuation multiples significantly above that of integrated telcos.

We treat the incremental lease liabilities as debt-like and add them to our calculations of the telcos' adjusted debt, and corresponding financial ratios. Typically in this region, telcos sell a majority stake in the tower assets and keep a minority stake. The telcos will then recognize an incremental lease liability on their balance sheet from the tower leases.

Our analysis considers the terms of the lease transactions and we may adjust reported numbers to reflect our interpretation of these terms. For example, we consider if the leases have artificially short terms. Tower leases that are less than 10 years as unusually short, in our view. In such cases, we may add a larger-than-reported lease liability to adjusted debt.

Our approach deviates from the telcos' accounting treatment only in a minority of cases. We do so when the accounting treatment does not fully capture the transaction's underlying economics, in our view.

For example, we added incremental lease liabilities to the adjusted debt of Telstra Corp. Ltd. following the sale of a stake in its tower company (towerco), even though Telstra doesn't recognize any such liabilities from the transaction; it consolidates the tower company in its reporting by virtue of its remaining 51% stake. Lease arrangements between the two parties therefore remain eliminated upon consolidation.

We proportionately capitalize the associated lease obligations in our debt adjustments, recognizing the cash outflow to the 49% minority interest. A very different accounting picture would arise if Telstra had instead sold 51% and deconsolidated towerco. Our pro-rata approach then bridges the accounting difference between consolidated and non-consolidated treatments, noting this can change with just a small difference in shareholding. Our present value calculation of the lease liabilities is broadly aligned with international financial reporting standards' lease accounting methodology.

What has been the effect on telcos' leverage?

Tower sales have resulted in more financial flexibility for telcos.

Incremental lease liabilities tend to be lower than the cash proceeds from the sale. That's because lease liabilities capture the existing lease contracts of typically 10-15 years in duration (and, in some cases, potential renewals).

By contrast, the cash proceeds represent the present value of the tower assets' future earnings. These earnings go beyond the length and scope of existing lease contracts. This is reflected in the high transaction multiples on these deals, which capture investors' expectations of earnings for the full life of the asset.

Tower sales by our rated Asia-Pacific telcos over the past two years have cut the ratio of debt to EBITDA by 0.1x-0.5x. This assumes sales proceeds are put toward debt repayment. The eventual extent of deleveraging depends on the degree of cash leakages from returns to shareholders, such as the special dividends paid by Telstra, PLDT Inc. and Spark New Zealand Ltd. We also look at the quantum and timing of any cash dividends that are returned to the telco through their residual shareholding in the towercos, which we will add to the telcos' adjusted EBITDA.

Table 2

Telcos' divestment of tower assets also smooths their cash flow stream. The sale effectively transfers the upfront capex of tower building from the telcos to the towercos.

Why are buyers keen on tower assets?

The highly resilient cash flows and long-term incremental growth potential of the tower assets are key to their attractiveness, in our view. Asia-Pacific tower sale transactions have, accordingly, achieved EBITDA multiples of over 30x.

Tower income is also highly predictable and steady. The timing of the sales has reinforced this. Towercos have emerged from the pandemic relatively unscathed. Telco services are a necessity; the pandemic has reinforced a shift toward hybrid work arrangements and online collaboration. These factors, coupled with the long-dated leases telcos have with towercos, have underscored the stability of towercos' cash flows, even amid black swan events.

Once the towers are sold to third parties, towercos have a high capacity to boost their tenancy ratios (the average number of tenants on a tower). They can do so by hosting telcos other than their former parents as tenants, with some towers having capacity for up to six tenants. Onboarding such colocation tenants bring in incremental earnings to the towercos on much lower capex than, say, building a new site.

When housed within a telco, tower assets tend to have lower tenancy ratios than they would when with a dedicated towerco. We believe telcos may be less adept at renting out space on their towers because tower leasing is not the telcos' core focus; they also don't tend to lease towers to competitors. This limits the returns of that asset.

Table 3

Build commitments that come with tenancy agreements from some selling telcos heightens the visibility of earnings growth potential. For example, underlying Spark's tower transaction was a commitment to build 670 sites over the next 10 years.

Rising data demand and the advent of 5G, as explained earlier, drive tower demand. This bolsters the towers' earnings outlook, and thus multiples.

What's the impact of such sales on the telcos' business risk?

No tower sale in Asia-Pacific has materially hurt telcos in terms of their business risk, in our view.

Towers, being passive infrastructure assets, are not key to the telcos' competitive advantage. As tower networks become denser in tandem with rising connectivity demand, they have become increasingly less of a differentiating factor to a telcos' network quality. Some telcos, such as Singtel Optus Pty Ltd. and PLDT, have sold only towers that they consider nonstrategic. Generally this means towers in areas where there are other towers owned by other operators.

The key consideration for telcos is their ability to maintain service quality. We expect that in majority-stake sales, the service level agreements that telcos entered with experienced tower buyers ensures service quality stays constant. Importantly, the telcos retain ownership of active infrastructure equipment, the mobile core network, and spectrum, which we view as key to a telco's competitive advantage.

Indeed, the sale of the tower assets can allow telcos to improve and expand network coverage more quickly and cheaply. It also lets the telcos focus on things that truly drive their competitiveness.

If telcos sell other infrastructure assets, how will this affect their credit profiles?

We believe towers are just the first of infrastructure assets telcos are monetizing. Singtel and Telstra, for example, have talked about other divestments.

We will apply the same overarching analytical approach toward such transactions as with tower sales, to determine any implications for telcos' credit profiles. Among other factors, we will consider the extent to which the assets drive the telcos' competitive advantage, the level of control entities retain in assets, and the change to leverage. In the case of fixed networks, we have explored these considerations in detail (see "Telecom Fiber Sales: Limited Financial Benefits And Big Credit Questions," published Nov. 30, 2020, on RatingsDirect).

The financial accounts of telcos will likely diverge further from telcos' economic realities as more of these transactions unfold. Accounting often does not fully capture the obligations and cash flow leakages arising from minority-stake sales, as seen in Telstra. The scope of consolidation may become increasingly blurred, especially in cases where the stakes sold and retained by a telco are similar.

Editor: Jasper Moiseiwitsch

Related Research

• Telecom Fiber Sales: Limited Financial Benefits And Big Credit Questions, Nov. 30, 2020