Cash calls

When the European Commission launched its i2010 Agenda in May 2005, it announced a set of policies intended to promote digital convergence in the communications sector during the next five years. The Commission’s programme will focus on the three ‘Is’: integration of the European Information Space across Europe; investment in faster, more innovative and competitive broadband services; and inclusion of underserved areas and disadvantaged consumers. Independently of these initiatives, developments in the financial markets are resulting in an unprecedented infusion of private equity investment in the European communications sector. This phenomenon raises the question of whether private equity will facilitate and even accelerate integration, consolidation and convergence.

Private equity meets telecoms

European cable television properties were an early attraction for private equity, primarily because of their predictable and presumed increasing cashflows, limited competition and the potential to develop triple play offerings of voice, internet and video programming. Although some of the early, highly leveraged private equity investments in cable (particularly in Germany) had to be written off, European cable transactions have, for the most part, been a success story for private equity investors. As this trend continues, expect private equity to become an even more powerful force for change by creating economies of scope and scale through cross-border consolidation, and by providing the strategic and financial acumen needed to achieve the long-awaited convergence of voice, video and internet.

Policy implications

The increasing influence of private equity investment in the communications sector may also provide the financial and managerial muscle that telecoms companies need to press ahead with the rollout of advanced broadband networks. Rather than undertaking the transformation of European telecoms operators subject to the pressures of short-term performance objectives and continuous disclosure obligations to which publicly traded companies are subject, private equity sponsors have the ability to take these companies private. In such an environment, investors may have greater flexibility to change and empower management and to provide managers with ample incentives to pursue medium and longer-term strategies.

This means that private equity may be able to play a catalytic role in melding together fixed and wireless voice, data and media applications, technologies and back office systems into a truly converged business model, moving beyond the mere service bundles that have been cobbled together thus far. Moreover, private equity investors may be able to exert a profound influence over regional integration if, when they exit, they facilitate the merger of national champions whose governments have previously impeded the creation of major pan-European players with the scale of US behemoths such as Verizon/MCI and SBC/AT&T.

Potential landmines ahead

The quest for convergence will require huge capital outlays for construction projects which are likely have long payback cycles, even if a ‘killer app’ emerges in the near term and helps boost revenues. It remains unclear whether the magnitude of the capital expenditures required will be compatible with the investment periods favoured by private equity investors.

Recent history provides some clear warning signals. Telecoms companies that took on massive debt at the turn of this century in order to finance the construction of long-haul fibre-optic networks paid the price in the ensuing industry collapse. Those that survived have spent the past several years in a painful effort to restructure their businesses and reduce the debt. Ironically, these are the companies that appear to be the most attractive targets for private equity today.

Another caveat is that the European telecoms industry retains a public service mantel, despite the fact that it has largely been privatised. It is viewed as a key economic driver by policymakers and has come under increasing scrutiny as a critical component of member states’ national security infrastructures. Private equity fund managers are therefore well advised to keep an eye on the regulatory ball and be prepared to participate in policy debates at the Commission and with member states as they pursue investments in the sector.

As part of its i2010 Agenda, the Commission is spearheading a comprehensive review of the EU regulatory framework applicable to electronic communications. This will include a review of regulations affecting the deployment of broadband services. At this stage, the Commission seems minded to proceed along a deregulatory glidepath in the hope that reduced regulation of incumbents, cable operators and mobile networks will result in greater infrastructure investment and service innovation.

There is also the ‘inclusion’ plank of the Commission’s i2010 Agenda to be considered, which will entail a review of the scope of the Universal Service Directive and the potential introduction of subsidies for underserved regions and disadvantaged consumers. These policy initiatives could have a major impact on the economics of the business for most players in the sector. Private equity investors that ignore these regulatory and policy changes do so at their peril.

Ann LaFrance is head of European communications law and Mara Babin is London managing partner at Squire Sanders & Dempsey