Alternative telecoms carriers constitute a crowded market in Europe but they have finally started consolidating. In the past few months, a handful of mid-sized operators have been taken out. What hope does this offer to the UK’s beleaguered operators such as Cable & Wireless, Energis and Colt?
TDC, a Danish mobile group, recently acquired Song Networks, a pan-Nordic alternative carrier. BT, the British incumbent, bought the shares it did not already own in Albacom, the second-largest operator in the Italian business telecoms market.
BT also spent significant sums buying a business that manages telecoms networks. So too did Kingston Communications, a UK alternative carrier.
Most of these deals are similar in one respect. A big ex-monopoly operator bought an foreign alternative carrier. Why is this?
The answer is that the deals were not driven by the usual merger maths of cost crunching. Rather, tax savings were the main motive behind them, although traffic economies have played a part.
At first glance, it might seem odd that companies are making acquisitions for tax reasons. But on closer inspection it isn’t that irrational. Many alternative carriers lost pots of money in the past and can offset these losses against future profits for tax purposes. This means they won’t have to pay taxes for years when they are profitable. The potential tax savings can be discounted to their net present value and thought of as an asset.
These assets can be valuable to acquirers. TDC reckoned Song’s tax losses had a net present value of almost e800 million. And BT said Albacom had several hundred million euros of tax losses, which it could start utilizing only after it had bought out the minorities.
But buying tax losses comes with a catch. They have value only if the combined company can generate sufficient profits to use them. The profits, moreover, must be generated in the country where the tax losses were accumulated.
This might explain why big ex-monopoly telecoms groups are buying foreign alternative carriers. For anti-competitive reasons they probably wouldn’t be allowed to buy domestic ones. But many of them do have profitable operations abroad. And that might make acquisitions attractive from a tax standpoint.
Another reason is that they don’t have much competition. Few alternative carriers generate profits and many are still loss-making. This means that, even if they merged with each other, they might not generate enough profits to make much use of tax losses.
Value of alternative carriers subjective
Of course, it would be madness for one company to acquire another for its tax losses, only for the acquired company to keep losing money. However, ex-monopolists might be able to make their acquisitions more profitable by pushing more traffic through underutilized networks. This is possible if the buyer already has operations, such as a mobile unit, in the country where it is buying an alternative carrier.
That said, investors should beware bidding up alternative carriers in the hope of a deal. When TDC bought Song, it paid the value of the tax asset and no more. Likewise, when BT bought out the Albacom minority, the price paid broadly reflected the tax benefits of the deal. The £500 million ($938 million) of tax losses belonging to the UK alternative carrier Colt are equivalent to less than two-thirds of its £780 million market capitalization.
Ex-monopolists, it seems, put little or no value on the underlying alternative carrier business. And that’s not terribly surprising. The industry remains fragmented. That’s especially so in the UK, where more than a dozen players are operating. It all adds up to terrible pricing pressure, as weaker players price contracts uneconomically in a bid to stay afloat.
True, Britain’s Energis, which has already been taken over by its banks, could be a bid candidate. It is thought to have substantial tax assets, and they are concentrated in one country. The problem with Colt, in the eyes of a potential acquirer, is that its tax assets are spread over several countries. Only £33 million of them relate to the UK, for instance. As for C&W, its UK business has hardly any tax assets.
Clearly, it is good news for alternative carriers that consolidation has begun. However, the ranks still need to be thinned massively before the survivors will regain any pricing power. Moreover, if the bespoke transactions that have happened so far are any guide, the deals will take time to put together – and won’t offer much of a premium to the companies selling out.
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