Jeff Johnston: Hello there, and welcome to the All Day Digital podcast, where we talk to industry executives and thought leaders to get their perspective on a wide range of factors shaping the communications industry. This podcast is brought to you by CoBank's Knowledge Exchange group, and I'm your host, Jeff Johnston. On today's episode, we get to hear from Steve Soraparu, Managing Director at Stifel Financial Corp, to get his thoughts on M&A in the communications market.
As a communications banker, Steve has a bird's-eye view as to what is happening on both the investor side and the operator side. Investor interest in the communications market is red hot, and consolidation has been a major theme over the last few years. The shift to digitize how we work and live is moving at an accelerated pace, and the amount of money that has been raised to fund this industry is unprecedented. It's an exciting time to be an investor or an owner. Without any further ado, pitter-patter, let's hear what Steve has to say. Steve Soraparu, welcome to the podcast.
Steve Soraparu: Great to talk to you today, Jeff. Been looking forward to this.
Jeff: Great. It's certainly a pleasure to have you here today. Let's jump right into it. It seems like every time I read updates on the communications market on a daily basis, I'm hearing about this infrastructure fund coming into the market and buying up a communications company, or this private equity fund buying up a communications company. There seems like there's a lot of interest in the communications market from an investor perspective. What do you think is driving all of this interest?
Steve: Investors are really excited about the tremendous customer demand for high speed connectivity. Really, that's what it comes down to. We all know that demand was rapidly increasing before the pandemic, but the last 18 months have taken it to another level. You might say, well, where is it coming from? It’s things we've been living. The evolution of working from home, remote learning has taken a greater position in our lives.
Then you add that to the things that were taking place already: online gaming, over-the-top video. Then from a business standpoint, just think about all the things that are in the cloud today and all the data transfer and storage needs that exist for individuals and organizations. It's really just driving the need for great connectivity.
Jeff: Yes, that makes sense. I can tell you from personal experience, I cut the cord, so to speak. A few years ago, I finally convinced my wife that that was the right thing to do, and I think it was the right decision. We've got lots of options and a great experience. That certainly goes over the broadband network, this whole over-the-top streaming video.
Steve: Building off of that, we don't have the telecom infrastructure in place to be able to deliver what we need. Hundreds of billions of dollars have been invested in this country for telecom infrastructure, but as a nation, we're far from having what we need to meet the demands. On the fiber side, whether it be last mile, middle mile, or long-haul fiber, it's the data centers, it's wireless infrastructure, whether it be macro towers, or small cells, or those distributed antenna systems that are increasingly being used in dense areas. Those are things that are essential, and we don't have all that we need.
If you think about the demand and you think about the gap that exists, if you're an investor, you're excited about what that equation looks like. Then you say, "Well, what has happened over the last handful of years? How have we done with our investments? How have our peers done with investments?" And they say, "Wow, there is this demand, there is this gap. People that have made investments in telecom infrastructure have done well." It's been a very lucrative time for investors in this space. What we've seen is that those professional investors have made significant returns over that time.
Jeff: Let's talk a little bit more about these professional investors. If I understand it correctly, we've got infrastructure funds, which are large funds. I think a lot of them are coming from Europe and in other places. Then we've got private equity sponsors or PE funds. I'm just curious, if you were to compare and contrast the two, how do you see their strategies differing, if they differ at all?
Steve: To talk about financial sponsors, that's really what we're referring to here as investors. It's different types of institutional investors that put money to work for these sponsors. What they do, they make investments in individual companies. They look to what they call build a platform, which is something that they could invest in. They back a management team with their plan. That plan could say that we're going to build it and have an organic strategy, or could be inorganic, where we buy other businesses and clamp them on to the one that we already have, or it could be a combination of the two.
No matter who the financial sponsor is, and no matter what the business plan looks like, what those firms do is focus on the metrics and on continuous improvement. Meaning that they manage those metrics, and they see how financially and operationally a business does over time and what tweaks they need to make to ensure that it's operating as optimally as possible.
To your question about who these financial sponsors are, financial sponsors have been involved in telecom for decades. If we go back in time, it was largely private equity firms. Those were the ones that were most commonly involved in making investments in the telecom sector. More recently, we've seen infrastructure funds enter. They're both financial sponsors, but they each have different types of investors, they have different types of targeted returns that they try to achieve. That's the biggest difference.
Private equity, for its entirety, has targeted returns, typically, in the 20% to 25% per year range. They're looking for annual returns in the 20s. Infrastructure funds are funds that look for durable businesses that have consistent cash flows, that have significant assets. If you go back in time, infrastructure funds were involved in a lot of the energy infrastructure. They've been involved in transportation. They've been involved in environmental assets, things that are highly durable. Over time, these infrastructure funds who've been around for decades have moved to telecom. They like to call it digital infrastructure.
These infrastructure funds, because of the durable nature of the assets that they're investing in, are willing to take lower returns, lower targeted returns than the private equity firms. For example, most often we see these infrastructure funds targeting 12% to 18% annual returns. Well, 12% to 18% is meaningfully lower than where the private equity firms are looking to get returns.
Jeff: Great to know. I appreciate that. I would think that the current environment, meaning what the pandemic has done to us, also probably plays a role in this from an infrastructure standpoint. You mentioned their traditional investments of roads, and I'm assuming airports and things like that. I think there's a greater degree of uncertainty around those types of investments for these folks because we don't really know what air travel will look like from a business standpoint, and as more people work from home, the idea of investing in toll roads and things like that may be a little bit riskier for them now, whereas this digital investments might become that much more attractive. Is that a fair way to think about it?
Steve: I think you're right in pointing that out. If you go back to these infrastructure funds and the way that they've communicated with their investors, and where they said they were going to spend their time and money in these durable investments, the pandemic showed that they weren't as durable as maybe they thought. Again, this is a point in time. We'll see how things continue to recover. One thing that we saw that was not impacted by what we've just gone through is digital infrastructure.
I think what we are seeing real time is that the allocations to digital infrastructure are growing and growing meaningfully because of what we've just gone through. I think that's terrific for any owner of telecom infrastructure today, whether you're a management team, whether you're a broader group of constituents, because you have now a different party that is highly engaged and wanting to be able to participate in all the opportunities that may be out there.
Jeff: Those are all super encouraging trends for the communications industry and hope that they continue. It's not just institutional investors or infrastructure funds who are buying companies. We also have strategic buyers who are actively involved in the markets. We'd love to get your take on this group and characteristics of these types of buyers.
Steve: Strategics are interested in how a given company would fit into their own company's business plan. It's always been a part of investing and M&A transactions strategics because there's always been a desire to be able to add to what an existing business has. I think the question that shareholders and management teams of strategics ask themselves is what can we do to add to what we have? What can we do to add from a acquisition standpoint, not organically, but inorganically? What we've seen time and time again is strategics going after horizontal expansion.
That could be an acquisition to be able to cover additional geographies that are deemed to be attractive that the company does not serve today. It could be a horizontal expansion into a different vertical, meaning that you may be serving a set of customers, but if you bought this other business, it would take you into another vertical and be able to serve a broader customer base. Or, third, it could be having to do with the services that you offer. That if you bought a business that is doing things similar to you but has a broader service portfolio, by buying that company, you have the ability to very quickly change the span of what you can offer your customer base.
Those are all highly attractive reasons why a existing company would choose to buy another company. Then, aside from that, just fundamentally, acquisitions to add scale. Beyond that, other reasons why they would want to do deals is that you could eliminate any weaknesses that may exist in your own business. You might get some additional horsepower for the management team.
Jeff: That all makes a lot of sense. How much does geography play a role when strategics are looking at acquisitions? I guess what I'm trying to get to is, do these target companies need to be adjacent to existing markets, because, presumably, integration would be a little bit easier, or is that less of a concern and it's more about all the factors you brought up: scale and management horsepower and so on?
Steve: From what we've seen, there is benefit to having concentration of operations. Now, concentration could be defined differently by different people. I think if you go back to the '90s, telecom companies that were looking to grow themselves, I think in the '90s, there was a fair amount of mergers and acquisition activity that spread out across the whole country, where you had entities that felt very comfortable operating in the Midwest, in the Southeast, in the Pacific Northwest. It was a time where that all seemingly made a lot of sense.
You fast forward to the current era, and more often than not, we see a greater geographic concentration. The view is that maybe to be as successful as we want to be and to execute the plan that we think is right, we could accomplish that by being in one region or in a set of geographies that are contiguous.
Jeff: Got you. I want to bring up a fairly recent transaction to get your take on it because I think it was a little bit unique. I don't know if we've seen this before, but perhaps I'm wrong. I'm referring to Atlantic Broadband's acquisition of WOW's Ohio broadband network. I think they paid a little over $1 billion for this transaction. Correct me if I'm wrong, but is this the first time we saw a traditional MSO acquire an overbuilder? If that's the case, is that a trend you think we might see more of down the road?
Steve: Well, I think what we see in the current environment is a view that having last-mile infrastructure, there isn't necessarily only one type or one orientation that will be what the business is today. Meaning that you have different technologies, you have different competitive situations, and for investors or strategics that are making investments in the sector, they are interested in having technology and operations in geographies that make sense to them. It very well cut across different technologies. It would very well cut across different orientations.
That I think is carrying the day, not labels or limitations to what we feel that we should look like. I think that's just the era that we're in. It's really an expression of openness as to where a business could go and openness as to how one serves.
Jeff: Let's jump back to the investor side of things. I think you did a really nice job explaining what strategic buyers are looking for and why they're entering these transactions. Back to the investor lens, if you will, what are some of the things they're looking for? For example, do their target companies need to have a certain leverage ratio? Do they need to have a bunch of fiber to be an attractive candidate? Are there certain competitive dynamics in the industry that an investor is looking for? What are some of those characteristics?
Steve: Well, I think investors are absolutely interested in investing in attractive market opportunities. Places where there's significant demand for a given product or service. The conversation that we had just had about high-speed connectivity, it's a wonderful example. It's something that's very tangible and something that the investors themselves live with every day. We know that there's significant demand. Investors are looking for places where there's a real market opportunity.
If the market opportunity checks out, then they want to look at what the business plan is. What's that business model that's established? What does it say that we're going to do? How much money are we going to spend? What type of penetrations are we going to hit? What type of revenue and EBITDA and income growth are we going to have over time based on the level of investment that we make? Does that all check out? Then you go and you say, well, if the plan makes sense and it's in an attractive market area, then how effective is this management team? How deep are the resources of that entity?
From a labor perspective, investors are highly interested in backing experienced teams that have a history of delivering great results. That goes all the way down through the organization. How well have they executed? How well have they competed against others?
Jeff: Is it fair to say then that most investors, when they acquire a company, their preference is to keep the existing management team in place? Is that typically what you see?
Steve: There has been an evolution of thinking there. If you go back in time, over the last couple of decades, seemingly, investors felt that they had their own plans they'd want to put in place, and they would buy businesses and swap out management teams and use individuals that they felt would fit the plan to be able to optimize the opportunity. Today, we see the opposite occurring. We see the investors looking at businesses, not from the lens of what can we do to change what's taking place, but actually to enable what that company and that management team and what that plan is today.
If you don't have a management team in place that is going to execute that plan, it's actually something that is less attractive for those investors, because it's not as though in the current environment, they have management teams lined up to slot into investments they make. Also, the amount of risk that injects into an investment, switching from one team to another and the inherent pause that you take when you're getting the new team up to speed, it's just something that is out of favor.
Jeff: I guess, too, wouldn't it also be true that in maybe some of the smaller or maybe with some of the smaller rural operators, there's probably a certain amount of equity in the relationship that the management firm has with the community? Is that a fair statement as well?
Steve: We absolutely think that that is the case. In existing business with an existing team, there are numerous local relationships that exists not only with municipal officials, county officials, to the major businesses in the area, to the schools, to anyone who benefits from the service of a telecom provider in a given geography, the telecom provider is very close to those parties.
Jeff: Steve, when we think about all of this in the context of risks, because every time we make investments, we need to think about risks, it's just the reality. What are some of the risks you think investors need to be aware of, and maybe what are some of the risks owner operators need to be aware of as they think through the strategic decisions that they need to make?
Steve: From our standpoint, first is the pace of change that we're seeing. I think that the competitive landscape for providers is rapidly evolving. It's frankly the fastest that has been seen since the late 1990s. What it means is if there's a strategic move that a provider wants to make, they should seriously consider making it and shouldn't wait, because the practical matter is if it looks like a good opportunity to you, a provider, it will look attractive to somebody else. Very well could be something that would be pursued by another party while you're trying to determine if it made sense for you to proceed.
What we like to call this is staking a claim. We believe that we are in an era where it's important to stake a claim on communities, on customers that any provider wants to serve. Whether it's a place that you've been in for 100 years, a place that you've been in for 10 years, or a place that you have never been but have thought about entering into. I would say, secondly, the supply chain is something that's getting a lot of press these days.
Historically for telecom companies, it's rarely been an issue, but there's a double whammy right now that is impacting providers. The first is pandemic driven, and it's impacting a lot of the goods that are out there. That's having to do with the chip shortage, it's having to do with transportation bottlenecks, specifically, a lot of the fiber to the home, brownfield and greenfield builds. The amount of labor resources that historically had been available are not there today.
Jeff: If I was reading between the lines on your stake a claim comment, if I've got that correctly, it sounds to me like M&A activity is pretty competitive. If you see something you like, to your point, others might see it the same way and you should probably be ready for a competitive bidding environment. Am I reading between the lines accurately there?
Steve: Yes, that's right, Jeff. Again, it could be coming from financial sponsors, it could be coming from other strategics. There is a great desire for telecom infrastructure assets and for telecom infrastructure providers, especially ones that are doing well. If there is a desire to get liquidity and to be able to reward your shareholders, there's going to be a wide range of parties that would be interested in being the next owner of a given business. It could very well be across the board from different categories.
Jeff: Great. That makes a lot of sense. That'll bring us to the end of our time with you today, Steve. This was really, really great. I certainly learned a lot and I'm sure anyone who listened to this podcast will also learn a lot. Thank you so much for being with us today.
Steve: Oh, my pleasure. Thanks, Jeff.
Jeff: A special thanks to Steve for taking time out of his busy schedule to share his thoughts and insights with us. There is so much private capital that has been raised, and investors are beating the bushes to put it to work. I think it's important to recognize that the large infrastructure funds are rebalancing their portfolios towards communication-related assets because their traditional investments, think toll roads and airports, have a greater degree of uncertainty. More people are working remotely, which puts less demand on toll roads. Who knows if business travel will ever get back to its pre-pandemic levels.
The other factor that's in play is that the rate at which we are digitizing our lives is accelerating and investors want exposure to that. These infrastructure funds manage billions of dollars. A portfolio rebalancing has the potential to open the proverbial financial flood gates for the communications industry. Hey, thanks for joining us today, and please watch out for our next episode.
