Bank Street attended Capacity Media’s 13th annual Metro Connect USA conference in Miami, FL where its co-founder and senior managing director James Henry participated in a panel entitled Consolidation and M&A: Executive Evaluation. The following were among the key topics discussed and important findings that the firm took away from the panel:
- M&A Slowdown in 2013 vs. 2012? In 2013, M&A slowed both in terms of dollar volume and number of transactions amidst a bandwidth infrastructure market environment that can be likened to Lightower and Zayo taking time to digest the large meals they ate in 2012 while the Cable MSOs were just starting on their appetizers. Despite the slowdown, more than 20 deals valued in excess of $1.3 billion closed in North America in 2013, which is an impressive number for the sector looking back over time. Of note, there remain more than 100 independent companies in the North American bandwidth infrastructure sector and new players are periodically entering the sector to take advantage of the attractive market opportunity and improved competitive umbrella that exists thanks to the rampant consolidation that has played out over the past five years.
- Cable MSOs as Consolidators in Fiber? Cable is expected to play a more meaningful role in fiber M&A going forward. Cable MSOs have been extremely active in sale processes in the past year, closing acquisitions of DukeNet, EasyTel, SpectrumNet and U.S. MetroTel, while also looking at many other assets during the course of the year. It is clear that fiber networks are core assets to the Cable MSOs, which can be leveraged across both their consumer businesses and their commercial service businesses. Commercial services – SMB, Enterprise and Carrier – represents a $100 billion market in North America, easily the most significant new opportunity that Cable has ever attacked, and it is driving remarkable growth for these new entrants. As the Cable MSOs move up-market, they will likely need to acquire both assets and talent in order to address the needs of a customer segment that is fundamentally different than their legacy base, in terms of both size and service requirements.
- Cable Geographic Focus? The geographic focus of Cable MSOs has remained inside their franchise footprints thus far, although it seems inevitable that they will ultimately venture outside of their territories as they move up-market to serve larger enterprise customers with multiple locations. The question will be whether or not they do so with owned infrastructure in direct competition with their fellow Cable MSOs, or on an asset-light basis with managed network operators such as GTT or Masergy. Exponential growth in demand for bandwidth, combined with greater consolidation in the industry to form larger, national Cable MSOs like Comcast-Time Warner Cable, has the potential to create a greater need for inter-city fiber among these companies, potentially positioning Cogent or Level 3 as attractive targets at some point in time.
- Comcast-Time Warner Deal Implications? A combined Comcast-Time Warner would have a national footprint with nearly 84 million homes passed, coverage of 43 of the top 50 metro markets in the U.S. and $6 billion in annual commercial services revenue growing at 23%. Accordingly, the combined company has the potential be much more potent in the pursuit of the enterprise and carrier segments. Comcast and Time Warner Cable have had different philosophies with regard to strategies like selling dark fiber and wholesale products that enable their fixed-line competitors, so it will be interesting to see how the new company approaches the market. Cable companies are extremely competitive by their nature and should not be underestimated as competitive forces in the industry going forward, but they should also be buyers of complementary assets as they seek to fortify their position in this relatively new market.
- Fiber M&A Screening Criteria? Geographic coverage remains a key driver with regional companies seeking to extend their footprints into contiguous markets in order to expand their addressable market opportunity and deliver better coverage for customers. Product expansion, time-to-market and “build vs. buy” economics have also been critical decision points for companies with specific network deployment plans or customer contract opportunities that they need to address. In these cases, buying an established player or even just dark fiber can be a compelling alternative. Of note, tactical moves with companies buying in-region competitors in order to consolidate market share and eliminate competition has become increasingly common.
- Valuation Drivers? EBITDA multiples in M&A transactions over the past year have remained steady in the high single-digit to low double-digit range with a number of positive outliers in transactions where asset value or tactical factors led a buyer to stretch on valuation. The key drivers of multiples in M&A transactions continue to be the actual rate of revenue and EBITDA growth a company is generating, the capacity for future growth as measured by the depth of network inventory and directly addressable market opportunity, and the perceived ability to sustain that growth based on the uniqueness of the assets or defensibility of a company’s competitive position. Synergies – both cost savings and the ability to leverage assets to drive accelerated growth – are also critical factors in the eyes of strategic buyers.
- Does Dark Fiber get a premium? The question was discussed as to whether EBITDA derived from dark fiber revenue deserves a premium over EBITDA derived from lit services and whether public market investors would value a business like Zayo at a premium. Predictability and stability of cash flow is a key ingredient to valuation, so long-duration dark fiber contracts that represent core infrastructure to underlying customers and are not exposed to downward pricing pressures to the same extent as lit services should intuitively be viewed very positively by investors and consolidators alike. However, public market investors as a whole are really not that well educated in the bandwidth infrastructure business, primarily because of the relatively limited number of public companies. There will likely be a learning curve during a Zayo IPO roadshow.
- What’s Up with Net Neutrality? There were mixed views on the implications of recent developments on the topic of Net Neutrality such as the D.C. Circuit Court of Appeals overturning the FCC’s Net Neutrality rules and Netflix’s paid peering agreement with Comcast. The consensus was that the huge growth in online video and other hosted applications, which prompted the whole Net Neutrality debate, is indisputably positive for operators of fiber networks and data centers because the huge volume growth should continue to drive more metro PoPs for application and media hosting companies that want to get closer to their end customers for reduced cost and lower latency. While streaming services like Netflix and YouTube account for more than 50% of downstream internet traffic during peak hours, users of those services still represent a fraction of TV viewership, so outsized growth should continue apace.
- Contiguous Lines of Business? While it’s clear that focus on the core bandwidth infrastructure business is job number one for all companies in the sector, contiguous business lines such as data center colocation are nonetheless appealing. Zayo has seen success with its zColo division and finds many customers who want bandwidth and colocation from a single provider. As a bandwidth provider, it can be hard to pursue a truly carrier-neutral model, but there is a subset of the market that doesn’t require an Equinix or Telx type product with dozens of competitive networks in each facility. Small Cells and DAS were also discussed as a potential expansion opportunity for fiber companies, but with less apparent interest. Bandwidth companies are likely better positioned to provide connectivity or infrastructure than to compete head-to-head with the DAS and tower specialists.
- International Opportunities? There has been some degree of international focus by North American bandwidth infrastructure providers, but only by multi-national players that are well positioned to serve customers in multiple geographies or by those pursuing an asset light network strategy. Given the importance of network density, pervasive coverage and overall scale in order to serve bandwidth customers in any market, it is difficult for metro fiber companies to plant flags in the top metro markets around the globe the way data center operators like Equinix have done in foreign markets. There are currently a number of metro fiber companies undertaking sale processes in Western Europe, but those assets seem likely to be more appealing to existing global or European strategic players already established in those markets than they are to North American companies looking for new territories.
The Metro Connect panel took place on Thursday, February 27th and was moderated by Colby Synesael of Cowen & Co. with participation of panelists James Henry of Bank Street, Gillis Cashman of M/C Partners, Chad Crank of Stephens & Co., Tim Horan of Oppenheimer & Co., and Bjarni Thorvardarson of Hibernia Networks.
This article was authored by James Henry, Senior Managing Director of Bank Street Group.
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