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Dot com diet keeps telecoms in good shape

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But are telecoms deals past it as debt levels mature Telecoms M&A market has recalled the lows of the early noughties with deals values falling 95 per cent over the last two years, a PricewaterhouseCoopers report has revealed.

Fuelled by the O2 deal, transaction values soared in 2006 to nearly 40bn while volumes rose above the 100 mark, and even without this deal the spike resembled that of 2001 - the height of the dot com bubble.

However, after the highs of 2006, the following year saw an 85% decrease in volumes while the average deal in 2008 mirrored that of 2002 with 51m and 47 respectively.

Gary Taylor, director, PricewaterhouseCoopers commented: "Although in terms of deal activity the industry is seeing a return to the recent dark days, on the whole telecoms should stand up against the crippling headwind of the recession. The dot com crash put the industry through its paces and as a result we should see far less distressed debt and insolvencies than other sectors such as banking or retail."

Telecoms companies have emerged from the dot com tougher, thanks to tighter balance sheets," added Gary.

Deals door slams shut

Telecoms' reputation as a defensive sector was reaffirmed through most of 2008 as share prices and transactions volumes held up well. However, the year-on-year picture masks the impact of the sharp decline in conditions after September 2008, when transaction volumes plummeted, and the market for large telecom transactions effectively closed.

Gary added: "Even as late as the third quarter of 2008, transaction values were still at 2003/04 levels, but as recession resistant as telecoms may be, the market was unable to absorb the shocks of late 2008 and fourth quarter volumes were already at record lows."

An identical trend can be seen on a global level. Three mega deals took place in 2006, causing a significant peak in deal activity for that year. The deals in question were AT&T/Bell south (58bn), the 25bn de-merger of Viacom and Telefonica/O2 (25bn). Even 2007 included the 23bn acquisition of America Telecom by America Movil.

By contrast 2008 was characterised by the absence of such a global mega deals; just one was over 10bn (the acquisition of Intelsat by Serafina Holding), and the top five combined barely exceeded the America Telecom deal of 2007.

Debt weight around the neck of the industry

The lack of liquidity (particularly debt) will be a barrier to M&A activity across all sectors in 2009, but these cyclical issues are accentuated by some telecoms-specific issues.

Telecoms, as a large capex intensive industry, will always require a significant amount of debt. The industry has been fortunate in 2008 in that the total amount of debt falling due was less than in previous years. However the longer term trend will reassert itself as 47bn falls due in 2009 - an overall market debt of 180bn owed by 2012.

Gary said: "The farmed resilience of the sector to fend off consumer downturns will doubtless stand it in good stead, but the magnitude of the problem will define the structure of M&A opportunities in 2009 and beyond."

He continued, the cost of debt has risen even for the largest cash rich companies, and as a consequence the industry will need to be particularly clear about its ability to service the debt. This communication may give rise to the possibility of negotiating new structures and transactions. Telecoms businesses may be forced to clarify their thinking around divesting loss-making operations or provide a partition of higher quality assets (such as its local loop of towers) to investors."

"The resilient nature of the telecoms industry offers hope, but the capacity of the banks to renew and extend debt is not at all clear, and few can expect debt to be renewed at the same margin. Telecoms as a rule will get through the overhang of refinancing however tough, protracted conversations will define 2009 as banks become far more wary for renewals. This maybe really convoluted for big loan syndicates with a dozen or more banks and PE involved," he added.

Consumers crack the whip

Consumer and investor confidence in telecoms is propping up the industry as mobile users refuse to reduce their phone bills. In a recent PricewaterhouseCoopers survey, those polled, claimed that cutting back on mobile phone bills was not a priority. In fact less than 20% believe mobile phone bills will be the second item on the chopping list, way behind eating out and clothes purchases.

Gary explained: "Consumers seem to differentiate between usage (i.e. calls, text and browsing) and the device itself, is more sensitive to macro conditions. The continuation of this trend could have important implications for telecoms companies and investors, as consumers defer mobile handset upgrades or switch to pre-pay/SIM-only offers."

"Consumers are no longer effectively paying back the initial subsidy of a handset. That together with the on-going reduction in mobile termination, rates set by the National Regulatory Authorities, looks set to place sustained pressure on reported mobile average revenue per user even before the impact of any changes in customer usage patterns," he added.

Although the large operators will experience a muted impact from a minor shift in consumer behaviour, in turn they will dramatically cost reduce and those smaller players, late entrants and peripheral companies reliant on these monster organisations will be impacted.

"As the consumer cracks the bullwhip those companies at the end of the telecoms supply chain will feel the force of the recession," Gary concluded.

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