Ardian on why we are not facing another telecoms bubble

Valuations may be high, but they are supported by real demand and real growth prospects, say Ardian managing directors Michael Obhof and Gonzague Boutry.

This article is sponsored by Ardian

Gonzague Boutry

Where do you expect to find the most interesting investment propositions within the European digital infrastructure space over the next few years?

Gonzague Boutry: We saw record capex in the telecoms sector in 2020, with more than $50 billion expenditure, followed by another record year at $55 billion in 2021. There are two main trends driving that investment: the first is fibre and the second is 5G.

Europe only has 50 percent fibre coverage today and the majority of that 50 percent is in city centres. We strongly believe that there is an opportunity to support rural rollout. Last year for example, we acquired Spanish fibre-to-the-home operator Adamo, which currently covers more than two million homes, and plans to increase that figure to more than three million as it expands its backbone network to more than 11,000km in the coming years.

Meanwhile, 5G deployment is at an even earlier stage, accounting for less than 5 percent of mobile connections. There is therefore a significant need for investment. Eighteen months ago, Ardian took a stake in Italy’s Inwit, the market leader in towers for open fibre. A big part of Inwit’s growth plan is linked to 5G and we believe there will be further opportunities in the months and years ahead.

Michael Obhof

Are the deployment opportunities different in the US?

Michael Obhof: 5G has historically been viewed as a towers play in the US, and valuations in that sector are pretty high. However, we believe there are a number of new and re-emerging trends associated with getting 5G signal to customers which are going to prove very interesting. The first is inbuilding wireless systems as 5G does not propagate through buildings as well as 4G – particularly energy-efficient buildings.

The second is outdoor small cells. That market experienced material growth between 2010 and 2018, but took a backseat when mobile network operators (MNOs) shifted their focus to getting their 5G spectrum up and running.

Those MNOs are now returning to addressing coverage and capacity constraints and so we expect the outdoor small cell market to provide material year-on-year growth.

Finally, MNOs in the US are strongly favouring alternative suppliers and are shying away from the large incumbents. This bodes very well for our mid-market strategy.

Can you talk more about what that strategy entails?

GB: Our strategy is threefold. First, we work with our portfolio companies to help expand their platforms. For example, Inwit is looking to expand outside of Italy. We expect consolidation of the fragmented towers market in Europe to continue over the coming months and years. That will create an opportunity to add value by combining Inwit within a larger platform. Similar trends are true of fibre.

Second, we embrace complexity. For example, last year we signed an agreement for the acquisition of Mila, the largest telecommunications infrastructure service provider in Iceland. Mila owns a network of fixed broadband, mobile access and backhaul covering the entire country. We will work with Mila to focus on accelerating 5G deployment and fibre rollout in rural areas. We will continue to look at similar opportunities.

MO: The third leg of our strategy involves cross-border activity between Europe and the Americas. Ardian is a global firm with offices in 15 countries, but each of those offices is run by a local team with local insight and expertise. And when we first launched an infrastructure office in the US in 2017, the move was primarily driven by appetite from our European strategic relationships to expand into the US; we have also seen significant interest from US businesses looking to Europe.

For example, we made an investment in Unison Site Management – a company that has been buying telecom ground leases for the past 18 years. The business is an industry leader in the US and understands that market inside out, but was interested in expanding into Europe. Ardian’s global-local approach was a big part of why they decided to work with us. Overlaying all of these strategic approaches is our commitment to backing the best businesses with the best management teams.

What are some of the ESG issues associated with investment in digital infrastructure, and how is Ardian addressing those?

MO: Ardian is, of course, a firm with European roots, and European firms tackled the issue of ESG sooner than the majority of American firms. ESG has therefore been a core part of the way we think and operate for quite some time. We were one of the original private equity signatories to the UN Principles for Responsible Investment in 2009 and having ESG in our DNA has served us well as these issues become increasingly important for limited partners.

GB: ESG plays a vital role in every decision we make throughout the portfolio company lifecycle, from the initial decision to invest, through asset management and into exit. For example, one of the things we liked most about Mila was that it is fully powered by renewable energy.

Inwit, meanwhile, already had a stated objective of reaching carbon net zero by 2025 when we invested 18 months ago. Around 70 percent of the company’s energy stems from renewable sources today and that net-zero target has since been brought forward to 2024.

ESG is hugely important in all sectors. But digital infrastructure’s energy consumption means it is vital that it is front and centre of our acquisition and asset management mindset.

How do you expect the digital infrastructure industry to fare going forward, particularly in the context of a potentially challenging and inflationary macroeconomic environment?

GB: Digital infrastructure has proven itself to be not only resilient in a crisis over the past couple of years, but also to have experienced strong upside. There is significant inflation protection built into the asset class, with many contracts inflation linked. At the same time, cash-strapped MNOs need to build this infrastructure. This will create opportunities for firms like Ardian to provide capex and become the digital infrastructure partners that deploy the network, whilst providing the MNOs with best-in-class assets, service agreements and technology.

Having said that, we do need to be careful when thinking about cost inflation; it is something we are monitoring very closely as part of our asset management work.

MO: I agree that the sector will perform well over the next year or two, particularly given our focus on high-quality businesses and management teams, and due to the inflation linkage in contracts in many of the geographies where we operate. Coupled with that, internet and mobile phones are increasingly viewed as essential utilities. They are both things that even in difficult economic times people cannot go without.

MNOs in the Americas, meanwhile, will continue to focus on deploying the 5G that they have spent so much money on. Companies like AT&T and Verizon are in such intense competition with each other that they have to tackle the coverage and capacity constraints; while that doesn’t mean valuations won’t moderate over the next 12 to 18 months, the fundamental demand drivers aren’t going anywhere.

How will you be looking to maximise your portfolio’s chance of success against this more volatile backdrop?

MO: The big risk that we need to manage over the next year or so will be the risk of not achieving our business plan. And that is where Ardian’s industrial approach will come into its own. We have industrial partners across the globe and we take a very hands-on approach to asset management. It isn’t just our deal teams that continue working on investments post-transaction; we have a dedicated asset management team as well.

Unison and its internationalisation plans is a great example. We have weekly conversations with our operating partners in Europe to ensure we are tackling that business plan appropriately and that we are getting the right information, knowledge and expertise into the company. Over the course of the next 12 to 18 months in this more challenging economic environment, it will be imperative to take all steps to ensure that portfolio companies meet their business plan objectives.

What are your thoughts on valuations in the sector? Is there a danger that we could be heading into another telecoms bubble?

MO: We don’t think so. Yes valuations are elevated, but there is real demand behind that trend. Average data consumption in the US has increased by 200 percent over the past five years and telcos such as Verizon and AT&T are spending tens of billions of dollars on their 5G spectrum.

A huge amount of investment is going to be required to get to that signal from a capacity and coverage perspective. We absolutely see healthy growth in sectors such as outdoor small cells and inbuilding wireless. Valuations may be high, but they are supported by real demand and real growth prospects.

GB: Inwit currently has a colocation ratio of 2, compared with 1.88 just a year ago. That is a huge increase in a short period of time and really demonstrates the level of growth that is underpinning this market. Just as Mike describes in the US, we are seeing very strong growth in data consumption in Europe. High valuations are underpinned by real demand and so, no, we don’t believe we are in a bubble.