The comms sector’s resilient performance continues unabtated and is an auspicious omen for the channel’s future prospects at a time of extensive industry change, writes Philip Carse, Analyst at Megabuyte.com.
At the risk of sounding like a broken record, the key themes for the UK telecoms sector continue to be – resilient trading, bumper corporate activity and strong FTTP momentum. However, there is a nuance within each: The trading outlook for many companies remains tough given a dearth of projects and broader headwinds such as equipment and skills shortages and energy prices. That said, more than ever M&A is being used by resellers and MSPs to bring in IT skills, and while banks are now prepared to support FTTP rollouts with debt far earlier in the process than hitherto, not all can qualify, with smaller players starting to be acquired by better funded peers.
Resilience but tough trading
A picture of resilient trading through the early stages of the pandemic came both from trading updates from public listed companies such as BT, Vodafone, Virgin Media, Gamma, Redcentric etc, as well as from anecdotal feedback from private company CEOs, reflecting the mission critical, recurring revenue nature of telecoms. We had previously estimated that the major UK network operators suffered only mid-single digit declines in revenues, EBITDA, capex and FCF in calendar 2020, while some companies continued to grow, for example Gamma with 9% organic revenue growth. A more typical impact for B2B telecoms was a double digit revenue decline, but with more limited profit impacts due to cost saving measures.
We are now starting to see private company accounts covering pandemic trading – to December 2020 or March 2021 which confirm these broader trends. For example, Daisy’s EBITDA fell 4.5% to £73.0m (boosted by £5.9m of government support payments) on revenues down 9% (estimated -14% organic) at £417m. Some have suffered more, typically because of sector exposure, for example hospitality focused cloud communications provider Fourteen IP’s EBITDA fell 83% to £0.2m on revenues down 8.9% to £10.1m. However, it still remained profitable. There have therefore been very few bankruptcies among resellers, and those that have experienced problems (eg Origin Broadband, acquired by TalkTalk) were typically challenged even before Covid.
What about now? While there are clear growth hotspots (eg m2m, SD-WAN, Teams voice), many broader based suppliers expect stable revenues or modest growth at best from the Covid floor, with mid-market focused players such as Redcentric highlighting a dearth of large customer projects. This is being compounded by hardware and skills shortage, while higher energy prices are starting to impact profit outlooks. However, most companies are still upbeat on the future.
IT focused M&A
The already strong pace of reseller M&A has picked up in recent weeks, with at least 15 buyers in the last three to four months, several with multiple acquisitions, including Arrow, Babble, Convergence, Chess, Croft, Daisy, Focus, Modern Networks, Onecom, Redcentric, Southern, Telappliant, TelcoSwitch, Wavenet and Windsor. The many and varied strategic rationale include scale, customers, vertical focus, capability and geographic presence, but an increasing number of deals have an IT focus. Recent notable transactions of this nature include Arrow/Circle IT (for Microsoft capabilities), Redcentric/Piksel (for digital transformation and cloud skills), Chess/Armadillo (cybersecurity), while Focus has signalled its intent by appointing a CEO from an IT services company (Barney Taylor from Ensono).
Adding IT to telecoms services is partly market driven given the convergence of IT and telecoms at the technology level, with the WAN and the LAN becoming one and the same and voice becoming just another software application. It also, according to Vodafone estimates, broadly doubles the addressable UK B2B opportunity in terms of market size, but actually more than this in practice given that the UK telecoms market is still dominated by the major network operators whereas the UK IT market is far more fragmented. For telecoms resellers, the move into IT adds a significant growth opportunity, more acquisition opportunities, and also a wider pool of buyers. Telecoms resellers are better placed to make this move using M&A than IT resellers in the opposite direction, given the debt facilities that can be supported by telecoms recurring revenues.
FTTP funding and convergence
The most notable FTTP news recently was CityFibre’s new £1.1bn investment, comprised of £825m equity from two new investors - Mubadala (Abu Dhabi’s sovereign wealth fund) and owner of IKEA (Interogo Holdings) – and £300m in debt. Meanwhile, new FTTP players continue to come out of the woodwork, the most notable recent one being Liverpool-based rural broadband Internet service provider Broadway Partners which secured a £145m investment from Downing LLP.
So what’s changed? One emerging trend is FTTP players tapping bank debt far earlier in the process than hitherto, with for example Zzoomm and Airband both raising £100m debt facilities. This reflects debt providers’ increasing comfort with the FTTP model, supported by valuations (and hence chance of being repaid in a sale situation) being a multiple of invested capital (typically 2-5 times). To put the raises into context, Zzoomm will have secured it with almost certainly fewer than 5k paying customers currently.
Conversely, the continued flow of debt and equity into FTTP/next gen networks isn’t available to all, and we are now starting to see smaller players sell out to larger, better funded peers. Recent examples include Community Fibre/Box, Quickline/Boundless and Voneus/Solway/ResQNet. This is unsurprising given the major challenges in first building next generation networks and then monetising them, and its probably only a matter of time before we start to see consolidation involving some of the larger players with target rollouts above 100k premises. After all, at the latest count there are 50 players with plans to build fibre past 70m+ UK premises (and potentially 7m more from VMO2), versus 32m existing UK premises.