If you drew a parallel between the evolution of Russia’s mobile phone industry and humanity, then it is about to go from the “hunter-gatherer” phase of the last two decades to the beginnings of urbanised society.
For much of the last 20 years, running a mobile phone company has been a competition to grab as many customers as possible. The easiest way of doing so was to cover more territory than anyone else, and that meant building transmission towers. However, SIM card penetration in industrialised countries reached 100% some years ago and it then became a battle of providing better and faster services, so a new race began with the advent of 4G, or LTE, technology, which requires a much denser network of base stations. But the leading companies are starting to ask themselves whether it is worth all the cost and effort of building yet another massive network of towers.
The problem is at some point it doesn't make sense to keep building new towers that simply replicate those that your competitors are building to cover the same patch of territory. It is cheaper – as much as two-thirds cheaper – to share towers with competitors and concentrate on improving customer service and offering new services.
That is where Russia is today and sharing towers has become easier following the appearance of about a dozen independent companies which own and operate their own network of towers.
Russian Towers is the biggest of these new players, accounting for about half the independent towers in Russia. Still, that is only 3% of the total 60,000 towers in the country, but Russian Towers president Alexander Chub believes the ‘Big Three’ Russian mobile operators – MTS, MegaFon and VimpelCom – are on the point of offloading their tower networks as part of cost-cutting exercises. “If a large transaction happens, it will change the market and the others will be forced to follow. It could happen soon,” Chub tells bne IntelliNews in an exclusive interview, his first ever with the Western press.
Russian Towers was set up in 2009 and includes the likes of the European Bank for Reconstruction and Development (EBRD), International Financial Corporation (IFC), Macquarie, UFG Asset Management, ADM Capital and Sumitomo amongst its shareholders. It has grown fast and after a long period of steady growth, the business is accelerating. “Things have changed in the last year; we have seen the number of towers we control double. The market has not reached critical mass yet, but we are now entering the fast growth ‘hockey stick’ part of the curve,” Chub says.
In 2014 the company had 950 towers, which nearly doubled in 2015 to 1,700 towers, and it will add another 1,000 in 2016. “That's a 90% growth rate year on year,” says Chub. Revenues in 2015 were twice what they were a year earlier and Chub says they plan to double them again this year. Ebitda tripled over the same period and the company hopes it will triple again this year.
The acceleration has been in part catalysed by Russia’s economic woes. Last year was the first when mobile phone operators started seriously considering selling their towers. The slowdown and difficulty with borrowing money has refocused Russian businesses on cutting costs and improving efficiency. Independent tower operators are in the perfect position, because they can offer the mobile phone operators both. A game-changing deal is close, says Chub, but not all players are quite ready to jump. “Now the opinion of the operators is dramatically changing and focusing on quality of service, getting costs down and leaving themselves free to focus on their services like data, customer service and frequency control. But some of them are still taking an old-fashioned approach,” says Chub.
Market leader MTS is the most conservative of the ‘Big Three’ and still sees owning its own towers as a core part of its business. VimpelCom is at the most advanced stage and has already started to offload some of its towers to independent companies. The second large player in the sector MegaFon is somewhere in between. “MegaFon is considering selling about 10,000 of its telecom towers to a third party and renting them back,” Konstantin Chernyshev, an analyst with Gazprombank, says. “By doing so, the operator plans to cut its capex and maintenance costs and increase [free cash flow] available for dividends and debt repayments. Should MegaFon decided to sell a 50% stake in its tower company, this could raise $250mn-400mn (RUB17bn -RUB27bn), which would also support dividend payments in 2016.”
The total number of LTE base stations in Russia more than doubled in 2015 to 72,200 with MTS owning the most, 27,400, up from 14,300 at the start of the year. MegaFon lost its leading position and came in second with 26,000 base stations (up from 16,400). VimpelCom and T2 RTK Holding (operating under the Tele2 brand) had 11,000 and 3,800 LTE base stations respectively at the end of 2015.
Tele2’s entire strategy is based on using the ready-made independent networks. While the number of base stations it owns outright is small, if the contracts for use of independent towers are included, then it is already on a par with VimpelCom in terms of the size of its tower network. Tele2’s network grew by 41% last year compared with VimpelCom’s 19% growth if tower use contracts are included. “MTS has the strongest operating position on the market, while VimpelCom is the most vulnerable to the increasing competition driven by the expansion of Tele2. Going forward, network expansion will be more selective, in our view, given the economic backdrop, although ruble volatility is adding upside risks to capex spending,” Chernyshev says.
And the 2G and 3G networks continue to expand in the more remote parts of the country with the total number of 3G base stations increasing by 30% y/y in 2015 to 163,600 and GSM base stations increasing by 9% to 223,700.
None of the ‘Bit Three’ will be able to ignore the issue of towers, as the new kid on the block Tele2 is rapidly building up an exclusively 4G service in Moscow almost entirely based on independent tower operators like Russian Towers. Late into the game, Tele2 is already the fastest growing mobile phone operator and hopes to displace Rostelecom as Russia’s fourth largest.
A big deal
In developed countries, independent tower companies are the norm and own most of the telecom infrastructure. The switch comes once the independents reach a critical mass of coverage and Russia is close to that point now, argues Chub. Currently, the split between operator-owned towers and the independents is about 95/5 says Chub. But if there is one large transaction where one of the main operators sells off a significant number of towers, that could kick off a major divestment spree. Towers lose their value quickly after the first deal due to the large coverage overlaps, so the first mover would get the most money for their network with rapidly diminishing returns for the next in line.
And Russian Towers is ready to do the deal. Most of its investments are made out of retained earnings, leaving a large part of their investors' $160mn of paid-in capital in an M&A war chest. Furthermore, thanks to the quality of its investors, the company is confident it can raise more money if it needs to. It has already secured a RUB4bn credit line last year on good terms from the Eurasian Development Bank, a joint venture between Russia, Kazakhstan and Belarus to invest into infrastructure. “If a serious market consolidation starts, I don't think it will be hard to find funding – there are already foreign and domestic investors interested in us,” says Chub. “If we need it, then we should be able to raise more investment.”
The consolidation could start amongst the independents first: Russian Towers has a long-term strategic view of the sector, but some of its competitors were set up as a shorter-term bet on accumulating towers in order to then sell them off to the bigger players. Chub estimates there are about a dozen tower companies in the game in Russia. “Most of them are already for sale and the rest will be soon. A consolidation has started that will leave a handful of large players in the towers business,” says Chub.
The advent of 4G has also been a boon, as not only do all the base stations need to be upgraded to the new technology, but the need for denser networks is boosting demand for new towers. With the switch from voice to data as the main revenue generator, the fastest growing source of income for phone companies has made developing better networks a primary concern. “Customers in cities want seamless connections to data. And content has been growing like crazy. The throughput and speed of distribution is becoming ever more important to the operators and this can’t be served on their existing 2G and 3G networks,” says Chub.
Coverage in all the big Russian cities in the European part of Russia is already at 100%, but as one travels through the rural areas the coverage remains “poor”, says Chub. “That means there is still a lot more to do in terms of putting up towers along railway lines and highways in the interior.”