Telecom Investment Banking: Overview and Sector BreakdownPublished:
Telecom deals are rarely those that aspiring summer analysts and associates are dreaming of getting exposure to after securing their offers. This is largely a reflection of the fact that the telecom industry is made up of relatively few players, has relatively few deals per year (they tend to come in fits and spurts), and is a bit more under-the-radar than tech or media.
But the telecom space isn’t an area that should be overlooked and if you land in a TMT group you shouldn’t shy away from working on telecom deals if the opportunity arises. Because the reality is that nearly every sub-sector of telecom is at the forefront of technology. In fact, what telecom companies do largely enables the broader tech and media sectors to exist as they currently do (the rollout of 5G, for example, is enabling the rise of IoT tech companies to truly gain traction after years of marginal progress).
The telecom sector encompasses a wide variety of companies; from those that provide consumer-facing services – like wireless – to those that provide the infrastructure that enables technological communication of any kind to occur.
Some mistakenly believe that the skillset you develop when working on telecom deals will be completely specialized (almost like if you’re in FIG). However, the modeling done for the vast majority of telecom companies is entirely traditional. There are a few telecom-specific multiples you need to focus more on, and valuing telecom infrastructure (like towers) will be closer to valuing a REIT than Facebook. But if you’re worried you won’t be getting solid modeling reps if you’re placed on a few telecom deals then rest assured that you will.
Further, one of the hottest areas through the pandemic – increasingly focused on by sponsors – is telecom infrastructure, which you’ll likely get some exposure to if you’re in a TMT group for a few years. And, while no one knows what the future holds, many are betting that telecom infrastructure (from towers to data centers) is going to see outsized growth over the next decade or two, so it’s a great area to learn a bit more about and provides a nice contrast with just working on tech deals.
Note: Just to illustrate how comparatively small the telecom sector is from a deal flow perspective, here's a little overview of activity right now relative to other sectors. You'll notice that deal volume is down quite sharply but this is mostly a reflection of no large deals getting done recently. The concentrated nature of the sector means that there's always relatively limited activity and that overall deal volume is heavily contingent on what large deals get done in a given year (so the deal activity data isn't quite as smooth as in tech where you not only have much more deal flow, but a greater diversity in deal sizes).
With all that said, let’s go through some interview-style questions that’ll provide a simple introduction to the telecom sector…
Telecom Investment Banking
Instead of going on a long monologue here, below are some questions and answers to try to make this a bit more of an enjoyable read. If you want a little insight into some recent trends in the telecom space, then the S&P 2023 Telecom Trends report is always a good read to get a sense for where the industry stands.
There are some sectors – like natural resources – that have clear sub-sectors that most companies more or less naturally fall into. But when it comes to the telecom sector things get quite a bit fuzzier. This is largely due to how the sector has evolved over the past decade with many companies trying to expand their revenue through diversifying their business lines and, by extension, hopefully insulating themselves from technological disruption.
I think the best way to think about the telecom sector – from an interview perspective – is by just slightly augmenting the traditional classification structure in light of the practical realities of what companies fall under telecom coverage.
Given this, here are the four sub-sectors worth highlighting: wireless telecom providers, convergent (integrated) telecom providers, alternative carriers, and data center and infrastructure providers.
- Wireless Telecom Providers exclusively provide cellular or wireless communication services.
- Convergent Telecom Providers operate fixed-line telecom networks for both wireless and fixed-line communications along with providing internet access.
- Alternative Carriers focus primarily on operating fiberoptic and/or high bandwidth cable for data transmission.
- Data Center and Infrastructure Providers focus on providing services and infrastructure to enterprise clients (i.e., data centers, cloud networking, storage infrastructure, web hosting, etc.). This sub-sector also includes tower operators.
Note: It’s worth mentioning that some would say that cable operators should be classified within telecom, and some would say they should be within media.
Note: If you want to keep everything simple, you can just say in an interview that there are two broad types of companies in the telecom space. First, those providing wireless or fixed-line services to consumers and/or commercial (enterprise) clients. Second, those who provide the infrastructure that is used by those service providers (those who own and operate towers and those who own and operate physical cable or fiber assets). This is a more simplistic breakdown, but it broadly encapsulates the telecom space is a more intuitive way.
In an interview it’ll never be expected that you know exactly where multiples are across sub-sectors. However, you should be able to give a directional answer as to what kinds of telecom companies are likely to have higher multiples based on your intuition.
When taking a stab at answering this, just think about two things: future cash flow certainty and growth prospects. Because you know that a high-flying tech company, where lots of growth is assumed to be occurring in the future, will have a relatively high multiple. Likewise, you know that a solid consumer goods company – churning out incrementally increasing revenue – that is relatively well insulted from economic headwinds will have a (moderately) high multiple due to the relative certainty of future cash flows (even though growth isn’t high).
For wireless telecom service providers and convergent telecom service providers we’ve hit more or less the saturation point (meaning: the amount of new sign-ups will be roughly in line with population growth) and we’re in a competitive, regulated market in need of lots of investment (i.e., for 5G infrastructure). As a result, over the last four years what we see is more or less flat and low multiples here (wireless being slightly lower than convergent and with both being a bit below 10x on average).
For these kinds of companies, we get good subscription-style revenue and there is a high “switching cost” for consumers, but there’s no getting around that some lines of business are in decline (in particular for fixed-line parts of the business of convergent telecoms) and growth prospects are diminished from where they were a decade ago.
Alternative carriers, on the other hand, revolve around newer technologies and haven’t hit the saturation point quite yet (although they aren’t growing nearly as quickly as infrastructure companies are). As a result, the multiples tend to be in-between the older, traditional mobile / convergent services companies and the high-flying infrastructure companies. While there’s substantial diversity among alternative carriers, you can expect EBITDA multiples to be a bit higher than the two aforementioned sub-sectors (ballpark around 10-15x).
Data centers and infrastructure providers have been by far the hottest area of the telecom sector. Companies in this sub-sector have shown strong growth, get stable recurring revenue, have relatively low maintenance costs (but high start-up costs), and have been rewarded by incredibly high multiples.
Today some well managed data center and infrastructure providers have multiples in the 20x or even 30x range due to the rapid growth and stability they’ve shown through the pandemic. Tower operators specifically have also benefited immensely from the rise of 5G and the necessary increase in the number of towers to facilitate a robust 5G network (both in the U.S. and around the world).
Let’s take a step back for a minute and think about what beta really means. In the end, beta is just a measure of a given stock’s volatility relative to some index (most often the S&P 500). So, for example, if a stock has a beta of 1.75 then that means the stock is expected to move, on average, 1.75x that of the index the stock is being compared to.
Therefore, stocks with a beta above one are going to be those that show outsized volatility relative to the overall market (for example, think of the high-flying tech stocks that have whipsawed wildly over the past year on any news coming out of the Fed regarding future rate increases).
Conversely you can think about stocks with a beta of less than one as being a bit more unresponsive to whatever happens to be moving the market on a given day (for example, companies in the utilities sector aren’t going to move as wildly based on Fed speak given that they are unlikely to show gigantic growth during the good times or deep deterioration during the bad times).
Needless to say, there’s significant divergence between the betas of various telecom companies depending on what sub-sector they’re in. However, the betas of most telecom companies are solidly below one and mostly clumped in the 0.5-0.9 range. This shouldn’t be too surprising since most telecom companies (like those in utilities) are characterized by having stable cash flows and not being overly influenced by where we are in the economic cycle (leading, of course, to lower overall volatility in their equity prices relative to the overall market).
Why do many consider tower operators to have a stronger underlying business than companies in other telecom sub-sectors?
In many ways the advantages that tower operators enjoy aren’t fundamentally different than those enjoyed by companies in other telecom sub-sectors. However, they do tend to be greater.
For example, most companies in the telecom space will have relatively durable demand profiles (i.e., if you have a cell phone, you probably aren’t getting rid of it during an economic downturn!). This is why telecom companies, regardless of sub-sector, tend to have betas below one as they’re relatively less sensitive to changes in overall economic activity than companies in other sectors.
However, if there’s a recession and you’re a wireless provider you will probably notice a small dip in subscribers or at least the average revenue per subscriber. It won’t be a large dip since you’re providing something deemed essential to most but there may be a small one (i.e., people downgrading their plans, getting rid of a phone for a child, etc.).
But if you’re a tower operator then you have an even more durable demand profile than those who are paying you. Because, regardless of if the subscriber base of your customer falls, they still need to deploy their equipment on your towers – and switching to another tower comes along with a high cost and the potential to temporarily cause disruption to network functionality.
So even if the mobile network operator (MNO) sees a slight dip in their demand during a recessionary period, that won’t be passed through to the tower operator. Therefore, tower operators have really durable demand.
Other things that people love about towers are their predictable revenue, barriers to entry, limited maintenance capex, high operating leverage, and low operational risk. Let’s think about each of these in turn.
- Predictable Revenue. Generally speaking, contracts for the use of towers are in the ten-year range. Further, many contracts have automatic escalators to account for increased energy costs. The structure of these contracts provide revenue certainty to the tower operator, but also benefit the MNO as well since they lock in a cost-basis and ensure they can provide consumers with the kind of long-term coverage they expect.
- Barriers to Entry. Despite how good the tower business looks on paper, the reason why there hasn’t been an oversaturation (although some could argue it’s coming) is that once a tower has been built in a certain location, it often doesn’t make sense for a competitor to come in nearby. This can be for a number of reasons including lack of available land that’s appropriately zoned, regulations that set limits on electromagnetic frequencies (EMF) in an area, or the fact that in order to fill a new tower it likely requires enticing those already locked onto an existing tower to switch over (something that may be contractually impossible or come at a prohibitive cost).
- Limited Maintenance Capex. As discussed in the Telecom Guide, where we get into the economics of towers a bit more, towers are expensive to build but require limited maintenance capex thereafter. Plus, the maintenance capex is relatively predictable.
- High Operating Leverage. Again, this is something we get into quite a bit in the Telecom Guide when discussing the actual economics of towers. But, in general, a tower can have a number of tenants on it and adding new tenants comes along with very few additional costs but significant new revenue. Generally, with one tenant on a tower it’ll be around break-even or provide a very modest return, with two tenants it’ll provide a 9-13% return, and with three tenants it’ll provide a 18-22% return.
- Low Operational Risk. Finally, one benefit that towers have that isn’t shared with companies in most other telecom sub-sectors is that they aren’t overly complicated to actually operate (in this way, they’re similar to many types of infrastructure assets).
In an interview the expectations are very low for how much a candidate will really know about the telecom space – this is doubly so if you’re interviewing for a TMT group where most candidates will be laser-focused on just talking about tech.
However, it’s always impressive when a candidate brings up an interest in the telecom space and can speak a bit about it, and hopefully this post has helped to shed a little light on it. If you’re curious, we put together an entire Telecom Guide that dives a bit deeper via 52 interview-style questions and answers (covering some basics around sector-specific ratios, etc.).
As you likely already know, telecom banking is usually lumped together with either tech and media or sometimes just with media. In a separate post we discussed media investment banking at length, and we also put together a little primer on TMT investment banking and discussed some TMT investment banking interview questions.
Regardless of the exact structure of the group you’re hoping to join, keep in mind that while your interviewer will be impressed by you having some practical sector knowledge, your interview will still primarily be made up of classic accounting and valuations technicals. And these classic technicals will usually be a bit tougher than you’re used to seeing, so definitely take as much time as you can to prepare for them.