In the past year there have been a number of changes of ownership and take-overs among communication service providers (CSPs) in emerging markets. This is part of the process of the network consolidation taking place across emerging regions as the realities of operating in low ARPU markets, such as increased competition and rising fuel and labour costs, begin to bear down on CSPs.
Inevitably there are winners and losers in terms of market share, and there is clear evidence that investors and shareholders in many emerging markets are getting over their initial exuberance and are now considering the longer term value of their investments. In parallel with this there are a number of strong and successful CSPs with ambitions to grow. Traditionally these have mainly been operators from developed world looking to build global brands and coverage, but the trend is now growing for CSPs from emerging markets to expand and become pan-regional or even global operators.
Access to finance is a key determinant in this process, and it is clear that some of the top buyers in the current M&A action have very good access to outside investment capital or little need to access it at all. This is according to Erik Arveschoug, Managing Director of CEE-MEA and Head of Strategic Advisory with Citi Bank, speaking at the CTO organised ICT Financing for Emerging Markets Summit at the end of last year.
This is much more likely to be the case when the buyer is from an emerging market. A key factor in this is that emerging markets’ governments, and investors who are in many cases very closely aligned with governments, place a much higher value on the strategic interest of developing a powerful global business than their counterpart in developed markets. While this may be motivated to a degree by national pride and prestige, there is also a strong financial foundation to this. In many emerging markets the leading CSP will also be the largest tax payer in the country. Protecting and growing this business is therefore a key objective for many governments, and the preferential provision of capital is a way of achieving this.
Sources of Finance
On the surface at least, there are a large number of sources of funding available. A key source of finance is investor capital, which can come from commercial banks, private equity and the venture capital market. In recent years, the bond market has become an additional major source of funds, as has the global insurance market.
There are some additional funding sources available exclusively to developing markets. Given the recessionary economic conditions now found in developed economies in Western Europe and North America, it is unsurprising that the appetite for risk and the availability of investment capital have both been reduced markedly in the past three years. This is despite investors having an awareness of the better growth opportunities that emerging markets offer.
Emerging markets have traditionally had access to other sources of investment, including direct sovereign wealth funds and state investment agencies, bi-lateral and multilateral aid, and the universal Development Finance Institutions (DFIs) such as the World Bank and the Asian Development Bank (ADB). The problem with all of the above is that the standards of credibility to be achieved by projects and the rates of return demanded can be difficult to achieve, particularly for late market entrants.
For these reasons other funds have increasingly filled the funding gap, most notably local banks based in emerging markets and vendors. Emerging market banks are often willing to use more favourable lending and project evaluation criteria, offer lower rates of interest and also take more account of the national or regional impact projects might have.
Vendor funding is another valuable source of project finance for emerging markets. However, whether most vendors actually want to be in this business or reluctantly accept it as a necessary precondition of making deals is a moot point. Chinese vendors such as Huawei and ZTE are well known for their aggressive funding projects in many emerging markets in the past decade. But Dean Byrne, Head of Customer Financing at Huawei makes the point that the much speculated on ‘wall of Chinese money’ is a myth. He maintains that Huawei have no wish to become banks: ‘there are already enough bankers in the world!’ In his view Huawei see their role principally as a provider of interim or mezzanine finance in order to lend credibility to projects during the critical early period until longer term investors can be found and brought on board.
A factor in being able to gain access to funding which is often overlooked by developers is the scale of projects. Typically funders from developed countries will be looking for large scale projects - generally above US $100 million. Investments at this scale are expected to have the necessary impact on a marketplace to become market leaders in their field and generate significant revenues over the medium to long term, defined as 10 to 15 years.
Large scale projects also have a big appeal for Venture Capital (VC) and Private Equity (PE) investors from developed countries. These typically look for an exit at the 3 to 5 year point. Large scale projects offer them time to add value via their management skills and sell on to subsequent investors with a lower risk appetite, a more ‘hands-off’ style and a longer term investment view.
This, however, leaves a funding gap in the mid-market area, particularly for projects in the US $20 - $50 million sector. These projects suffer because the costs related to doing deals are the same as with larger scale projects but the returns potential is significantly lower.
It is this area where the greatest opportunities lie for local banks and the bond market, according to Thierry Levenq, Head of Telecoms MEA at the Royal Bank of Scotland Global Markets. His view is supported by Roland Janssens, investment advisor to the Emerging Africa Infrastructure Fund (EAIF), who makes the point that many smaller projects struggle to get finance when the period of return is long. Fibre optic cable projects, which typically need 10 – 15 years to make a full return, are a case in point. As a result these types of project tend to find better funding offerings from the DFIs.
Quality wins – but M&A wins big
With such a wide range of funding opportunities available to them it is hard to see why good projects find access to capital a problem. But according to the experts, project quality is the key; the most important factor in obtaining finance is the difficulty of the project, and the bottom line is that the best projects will always find funding on favourable terms.
In the current market there are not only a large number of new projects wanting to get off the ground, but there are also competing demands for finance from the M&A sector as consolidation gathers pace - and there is little doubt amongst the project finance specialists that this is the area that investors find most attractive. The businesses are already established and the growth opportunities are more clearly defined. In this case it is scarcely surprising investors favour opportunities in the M&A sector. The current M&A activity in emerging markets is being driven forward by its ready access capital.