The telecommunication industry in Latin America continues to see delays in the transition to a 5G network and fiber optic (from copper) compared to other regions such as North America and Europe. In S&P Global Ratings' view, one of the main reasons for the slow pace of the industry's transition is the lack of alignment between telecom carriers and government plans for telecom services.

In addition, most telecom carriers have entered a vicious cycle of competition. To maintain their market share, they have kept limited price increases in recent years, unable to compensate for higher inflation, interest rates, operating costs, and investments. The carriers wind up compensating for the losses by stressing their liquidity positions, delaying capital expenditures (capex), or taking on additional debt. The result is the delays in technology advances and investments in towers and fiber assets.

Investments for technology upgrades have been a major challenge for telecom participants that aren't the leading players in their regions, given their different financial risk and liquidity positions. In Colombia, the financial position of America Movil S.A.B. de C.V. (A-/Stable/--), better known as Claro, is very different than that of Colombia Telecomunicaciones S.A. E.S.P. (Coltel; BB/Negative/--) mainly because Claro is the market leader in fixed line, broadband, and mobile services. In the last 12 months, Claro reported EBITDA margins of about 40%, compared with about 20% for Coltel.

We think companies with the strongest profitability (above 30%) have shown more capability to manage current price dynamics, competition for market share, and license renewals. Therefore, we expect that Claro will be one of the main participants in the upcoming auction for 5G spectrum licenses in Colombia during the rest of 2023. In terms of credit ratings, we believe that Latin American telecom companies that deploy 5G networks the fastest will drive growth and consequently strengthen their credit profiles.

Cash Flows Amid High Competition Aren't Sufficient For Large Infrastructure Investments

Most carriers still want to keep prices competitive to maintain their market share, but these prices aren't necessarily enough to generate the cash flow required for investments in new technology or rising operating costs. For the most part, telecom companies' main commercial strategy is offering bundle packages that include all broadband, fixed line, and TV services, creating a stronger revenue-generating unit (RGU). To date, some market strategies include streaming applications, but we think that although this allows the carriers to somewhat raise prices, it does not substantially strengthen liquidity for investments.

High competition and price disruptions can also come from new entrants

The entrance of Telefonica S.A. (BBB-/Stable/A-3) in Mexico over 20 years ago or Wom S.A. in Colombia in 2021 are some examples of market destabilization. In these cases, consolidated peers chose to aggressively compete with prices, but then returned to normal prices given the weakening of their financial positions.

Shared Investments Could Reduce Cash Flow Pressures For Telecom Carriers

Considering the limited cash flow available for large investments, we think the trend we saw for fiber--related to sharing the fiber optic infrastructure among more than one regional carrier--could also occur for 5G towers, with the differentiator between carriers their quality of service and commercial strategies. This shared infrastructure could reduce the investment exposure for all carriers, since the capital required wouldn't have to be duplicated because the assets can connect more than one carrier. Therefore, we think joint investments could be one of the solutions to reduce cash flow pressures on carriers.

For example, in 2019, the consortium Altan Redes was created, funded by the private sector following the Mexican government's plan to attain higher telecom coverage in the country. The company operates a telecom network that serves populations of less than 1,000 people. America Movil, Telefonica, and AT&T Inc. (BBB/Stable/A-2) all use this network.

In addition, we have also seen that some players don't include in their growth strategies entrance into cities where the presence of other carriers is so high that investments in new infrastructure would potentially not be profitable. In these cases, these companies decide not to invest in new infrastructure and instead lease assets.

Alignment Between Latin American Governments And Telecom Players Could Generate Benefits

Currently, most governments in the region have been focusing on getting coverage to areas that still don't have access to telecom services, as well as completing the transition from copper to fiber. These priorities have delayed 5G spectrum license bids and haven't contributed to the investments needed for 5G infrastructure assets. In our opinion, once both parties' focuses align, the acceleration of new technology will benefit both of them.

For example, Mexico, which is receiving growth opportunities from industries such as automakers and auto suppliers, requires best-in-class technology and telecom services to remain competitive and to continue be an attractive region for foreign investments, especially those from North America. Therefore, we believe the return on capital requirements for faster 5G deployment could strengthen economic growth prospects for Mexico.

Chart 1

Companies That Specialize In Telecom Infrastructure Are Becoming More Relevant As Latin America Transitions To New Technology

Some companies, such as Telefonica and Claro, have divested and spun off telecommunication assets mainly to reduce their capex needs and lower their financial risk, but also to monetize these assets and reduce financial obligations. This also allows the companies to set more competitive prices. Even though the carriers face higher operating costs due to leasing expenses, we think these could be manageable if the companies are able to pass through these costs to final customers.

Telefonica received cash for its infrastructure assets in Colombia, Peru, and Chile. It then used this cash to reduce debt and slightly strengthen its financial position, and also has lower capex needs. However, we haven't seen an improvement in Telefonica's credit quality because aggressive competition, higher operating costs, and license renewal investments continue to hamper the company's metrics. America Movil also unlocked value from its assets by separating its telecom business into two segments: services and infrastructure.

In the last five years, we have seen telecom infrastructure (towers and fiber) companies, such as Operadora de Sites Mexicanos S.A.B. de C.V. (BB+/Stable/--), Sitios Latinoamerica (BB+/Stable/--) and ATP Tower Holdings (BB-/Stable/--), are becoming more relevant in terms of market share due to their participation in infrastructure development. These companies usually have high leverage given their investments and constant growth activities. Because they are growing quickly, they have sought financing to cover their investment needs in Latin America. Despite their pressured financial positions, these companies also usually benefit from stronger business risk profiles due to higher margins and predictable revenues and EBITDA.

Some of the largest companies on this side of the industry globally are the top players from the U.S., such as American Tower Corp. (BBB-/Stable/--) and SBA Communications Corp. (BB+/Stable/--). Considering this, we think that Latin America will follow in the footsteps of North America, with industry growth driven by highly leveraged independent operators, which generate value from their investments by incorporating more than one tenant or carrier into their infrastructure. As a result, we expect the leverage burdens of telecom carriers to slowly transfer to telecom infrastructure companies, improving the carriers' credit profiles.

We note that compared to North America, Latin America has high growth potential for infrastructure companies because most regions have fewer telecom assets (such as towers and fiber) than the industry average.

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We Don't Expect Regulatory Risks For The Industry In The Coming Years

Regulation in the region licenses and authorizes carriers to use and exploit frequency bands of a country's spectrum. In Latin America, we think regulatory risks related to spectrum license cancellations or paused renewals that would impede technology advances in the industry are unlikely. On the contrary--there have been active bids for new 5G spectrum licenses.

Governments continue to be active beneficiaries from the telecom industry because it contributes to large-scale economic growth. During the pandemic, the Caribbean islands, where the main economic activity is tourism, contributed to their economies' recovery by opening voice and broadband lines to foreign carriers to allow free roaming services so that tourism could rebound. In our view, governments no longer consider telecom services as a luxury, and we do not see operating limitations from governments in the coming years.

Although Latin American governments don't get involved in telecom company operations, there are industry risks related to higher tax rates or licensing prices. There could be cases in which carriers don't renew licenses or delay investments given higher tax burdens. In our view, governments in the region are contributing to the industry's growth by not interfering with new entrants, not restricting spectrum bids, and limiting new taxes on the industry.

Price Dynamics And Ability To Invest In New Technology Will Determine The Path To Improving Credit Profiles For Telecom Companies

Companies that tend to use competitive pricing to maintain market share usually have lower profitability margins and therefore lower cash flow. This has prevented the industry from advancing investments in new technologies, which will attract more foreign investment to Latin America's emerging markets.

Most of the region's governments have launched the necessary auctions for the new network and have granted permits to increase infrastructure coverage. However, the necessary investments represent a major risk to the credit profiles of the main carriers. As a result, companies dedicated specifically to infrastructure investments have become more relevant in the region over the last five years.

We expect to see a closer operating dynamic between service companies and telecom infrastructure companies to accelerate the deployment of new technologies and achieve the expected coverage targets for the next three years. In addition, we expect those regions lagging the furthest behind in technological evolution to continue closing the gap, following other regions' trends in terms of shared investments and infrastructure.