Jeff Johnston: Hi there, and welcome to the All Day Digital Podcast. I am your host, Jeff Johnston. For today’s episode, we are going to do things a little bit differently than we have done in the past. Normally, of course, I have a guest on the podcast, and we have a back and forth conversation about a particular topic.
For today’s episode, you are just going to hear from me. At CoBank, we often get questions from customers or banking partners around our thoughts and our perspectives as it relates to M&A and valuations in the private broadband market.
You see, it’s difficult to get insight into the private market because unlike the public market, where you can just go to cnbc.com and type in a stock ticker and pull up a valuation of a particular company, you can’t do that in the private market. That data isn’t readily available.
At CoBank, we sit in a unique position in that we are involved in a lot of discussions and transactions in the private market. It gives us pretty good visibility into what’s going on in the market. That’s what I wanted to spend some time with you here today.
Now, of course, we can’t share any particular names, or any specifics on any particular deal. But we can certainly provide direction and perspective on what we’re seeing.
If we take a look back, call it five, six years ago, and compare it to where we are today, things looked a heck of a lot different six years ago in the broadband market. Actually, for a number of reasons. One is interest rates were at zero. The growth in the private broadband market or the rural market was very attractive.
There were a lot of unserved and underserved markets. To be fair, there still are a lot, but there was a lot more attractive markets to go into back then. We didn’t have concerns around inflation, and the labor market looked really good. An so this ideal market situation attracted a lot of institutional money into the market.
We saw a lot of institutional investors, specifically infrastructure funds, come into the market from Europe. We saw a number of private equity sponsors enter this market. Now, for the infrastructure funds, they’ve historically invested in roads, and bridges, and airports, and things like that.
They still do, but back in ‘18, ‘19, they started to slightly pivot their strategy to get more exposure to the digital economy. Of course, this was all pre-COVID. They saw that as a long-term secular growth play that they wanted to get some exposure to.
Again, we started to see this pretty significant amount of money enter the market. Anytime a new operator was up for sale, we saw a lot of bidding activity between these professional investors. That drove up valuations pretty high.
Then, of course, COVID hit. Then for those who thought the digital infrastructure or the digital economy was a good investment pre-COVID, they look like absolute geniuses post-COVID. As we can all remember all too well, how we were streaming video at home like we’d never done before, we’re on Zoom calls like we’d never done before, we were doing online shopping, et cetera.
The value of these broadband companies and these networks went up overnight given this rapid digitization trend that COVID brought in. That drove valuations even higher. It brought in even more money into the market, because at the time, people--if you remember back during COVID, it was really unclear how much we were going to fly or how much driving we were going to do, or is anybody ever going to go back into the office. There was a lot of that uncertainty around, are we going to go back to how we used to be?
What was not uncertain, at least at the time, was that the value of digital networks or of broadband networks was most likely only going to go up over time given what we saw during COVID.
Again, there is this surge of capital coming into the market, which drove valuations, in some cases, well north of 25 times EBITDA for a fiber-rich broadband operator with a lot of growth opportunity.
We fast forward to more recently, call it the last 12 to 18 months, and the market looks a lot different than it did back in ‘18 and ‘19, right? There’s more uncertainty in the market right now. There’s not as much growth as there used to be.
Again, I think there’s still a decent amount of growth, but there was not as much growth. Of course, interest rates are a heck of a lot higher than they were back then. The labor market is much tighter than it was back in ‘18 and ‘19. Labor has gotten a lot more expensive. We’ve got issues related to permitting and just overall labor availability.
Of course, inflation impact on equipment has caused all sorts of problems for a number of companies out there. From a valuation perspective, we’ve seen companies and investors pull back a little bit, and they’ve pulled back for a few reasons.
One is the struggle that some operators have had in terms of executing on their build plan because of labor, because of permitting, because of inflation has changed the business case for investors and it’s impacted their ability to be able to turn over or sell these companies that they’ve acquired.
For example, if you’re a private equity sponsor, maybe your time horizon is five years. You buy a company, you invest in that company, and then you turn around and sell it in five years, assuming the company can hit all of their objectives.
When those dates start to slip and companies don’t start hitting their plan, it pushes out the timeframe for when you’re going to turn that portfolio over. That’s one factor. Of course, with costs having gone up as much as they’ve had for labor and equipment, it’s changed the business case a little bit as well for investors. That’s a concern.
Certainly we’ve had recessionary-related concerns. Not so much today, but 12 to 18 months ago, it seemed like every economist out there was predicting doom and gloom for the economy, which hasn’t happened.
Nonetheless, that was a cloud, an overhang in the market that probably caused some investors and strategic buyers to be a little bit more conservative with their balance sheet. Then you’ve also got a staring contest going on between sellers and buyers.
What’s happening is, because interest rates have gone up so much and a number of these other factors, you’ve got buyers looking at some of these companies and saying, “well, because interest rates are a lot higher than they were in 2019, the impact that that has is it reduces the present value of future cash flows.” As a result, it reduces the value of the company in today’s dollars or reduces the amount that they’re willing to pay for that company in today’s dollars.
Whereas the sellers are looking at it and saying, “Hold on a second. Wait a minute. You’re telling me that digital networks or broadband networks are more valuable today to society than they were back in ‘18 or ‘19, because we’re all just doing so much more. Then, of course, we’ve got this thing called generative AI that’s also going to put a lot of demand on fiber networks. You’re telling me that these networks have more utility and more value than they did five or six years ago. I get that.”
Then secondly, I, Mr. Operator, I’ve actually built out my fiber network into new markets. I’m generating more cash flow than I was five years ago. I’ve paid down debt. I’ve really got my company in a really good position. But considering all of that, you’re not willing to pay a multiple of whatever it was five years ago. You’re looking at a multiple that’s much smaller than that.
The sellers are like, “That doesn’t make any sense to me. I’m not going to sell.” The sellers are like, “You know what? I’m just going to go back and continue building out my network, looking for opportunities to grow the business. I’ll come back to the market down the road when I think time is right for me to sell.”
Then the buyers are like, “You know what? We’re not going to pay what you’re asking. We’re going to do the same thing. We’re going to go back to our own company, our portfolio of companies, and we’re going to continue to invest in building out those networks. When we can agree on a price, then maybe we’ll try and get a deal done.”
That’s been putting downward pressure on just overall deal activity. Then the other thing I would point out, too, is, over the last several years, there’s been a number of startup fiber operators that were able to get access to some institutional money to build brand new networks.
These are brand new businesses. They’ve gotten into this after a few years and realized that, “This broadband business is a lot harder than we had thought going in.” They’re not hitting plan. They’re overrun on their costs. Their investors are really tightening the purse strings and saying, “We’re not going to give you any more money until you right the ship,” so to speak.
There’s some investors and strategic buyers who are sitting on the sidelines saying, “We’re just going to let this play out. We’re going to wait and see how this plays out. Our bet is that these new greenfield startup operators are eventually going to be sold.” The hope, of course, is that they get sold at values lower than where they are today and somebody can scoop them up for a good deal. That’s also impacting just the overall deal activity as well.
When we look at some of the numbers, TMT Finance does a real good job tracking overall deal value. When we compare telecom deal value from 2023 to 2021, we saw a pretty significant decline in just overall deal value.
Overall deal value in 2023 was down by 78% over where it was in 2021, and it was down by 48% over where it was in 2022. It looks like 2024, we’ll be tracking something similar to what we saw in ‘23 in terms of overall deal value.
Now, the one exception to that, of course, is the data center market where we’re seeing a tremendous amount of capital being put to work in this market, as everyone’s running out trying to build data centers for generative AI and build out the necessary energy infrastructure to support this truly explosive growth in data center demand because of generative AI. That’s an exception to the overall telecom deal space.
When we look at fiber operators, and transport companies, and cable operators, and legacy LECs and so forth, the numbers are down quite a bit. The other thing that we’re seeing is the market is not really giving companies the benefit of the doubt in terms of valuation.
When we look at Cable One, for example, in 2020, they were trading at about 22 times EBITDA. That was their multiple. At that time, their EBITDA was growing, but it started to stall a little bit in 2022 and then started this decline a little bit in 2023 and more in ‘24. Not that much, but just a little bit.
The market got a little whiff of that and it just punished them from a valuation perspective. Their valuation went from, again, call it 22 times EBITDA in 2020 to seven or eight times EBITDA in 2024. Again, that’s just because of a peak and then a small decline in EBITDA generation. Their multiple just got punished as a result of that.
Again, the market’s not really being patient or giving companies the benefit of the doubt right now either, which is putting, again, downward pressure on multiples.
Now, if we look through our binoculars or look into our crystal ball and try and put some thought around where we see the market going, I think we need to pay close attention to what’s happening with the national wireless operators, specifically here more recently, T-Mobile and Verizon.
T-Mobile has been on a bit of a shopping spree this year, and they’re doing it through these joint venture agreements with institutional investors. This is off-balance-sheet-type acquisitions.
In April of this year, T-Mobile and EQT announced that they were acquiring Lumos. Then in July of this year, T-Mobile along with KKR, announced that they were acquiring Metro. Again, these are JV acquisitions.
Then, of course, here more recently, we saw Verizon announce its plans to acquire Frontier. My sense to what’s happening here, it’s a couple of things. First of all, growth in the wireless industry is slowed significantly.
Most of us have a smartphone and postpaid subscriber growth right now is largely a function of switchers and people upgrading from prepaid to postpaid. These national wireless operators are looking for growth opportunities.
I think what they’ve realized through their fixed wireless smartphone bundled offering that they’ve had out there for a number of years is that, this new bundle is really the new killer bundle. This is what people want, right?
If you can get somebody on a smartphone plan coupled with a broadband plan, you probably have a customer for life. Churn is incredibly low and it’s a very attractive bundle.
Now, the reality for T-Mobile and Verizon is that their fixed wireless strategy has, that network doesn’t have as much operating leverage as say a fiber network, so they recognize that. I think what they’re trying to do is piece together as big of a fiber-to-the-home footprint that they can, that they can bundle their smartphone offering with. A, it’s what people want and, B, at the right price and the right economics, this fiber-to-the-home business is a really good business to be in with incredibly high margins, much higher than they’re used to in their wireless business.
I think that’s something we need to pay attention to. I think what we might also begin to see are these JV acquisitions. Lumos and Metronet, for example, these companies could become mini aggregators. I wouldn’t be surprised if they start going after much smaller operators to fill in that fiber footprint.
T-Mobile is not going to go out and buy a small rural operator, but Lumos or Metronet, as a part of this JV, might. That’s something to watch out for. I guess the question I have and the way to think about this is, what does this wireless foray into the broadband market mean for M&A and valuations overall?
Will this start to unlock some deals that have been frozen? Or will this bring those who’ve been sitting on the sidelines back into the market now that we’re starting to see some pretty big players out there with very deep pockets go shopping?
I think the answer to that is probably yes. I’ll tell you that there are a number of institutional investors out there who are invested in the broadband market. They’re saying, “Look, we’ve seen this movie before. We’ve seen consolidation happen in the wireless industry. We’ve seen consolidation happen in the cable industry. It’s just a matter of time until we see a similar consolidation trend play out in the broadband industry.”
There is a school of thought out there by a number of investors that believe this is how the market’s going to go.
I think the bigger players could start to unlock some deal activity. Then, look, with interest rates going down and most likely going to continue to go down in 2025, that might make it a little bit easier for buyers and sellers to agree on a price. It might reduce the risk profile for companies to get back into the M&A market. I think that that’s probably something to watch out for.
As I mentioned earlier, recessionary concerns have abated quite a bit. I think that for those that were worried about those concerns and therefore being more cautious or conservative with their balance sheet and how much debt they wanted to take on, the lack of recessionary concerns might bring some of those folks off the sidelines as well.
From a valuation perspective, I think it’s fair to assume that there’s probably bias to the upside, especially if we do get more bidding activity, more M&A activity in the market. If you look at what T-Mobile and Verizon are paying for their recent acquisitions, they’re 15 to 20 times, which is pretty good.
I think there’s probably limited downside risk to valuations. I say that for a couple of reasons. One, of course, just looking at the recent transactions that we’ve seen would suggest that that might be the case.
Truth be told, there haven’t been a lot of transactions either. It has been hard to get a real true mark-to-market view of where valuations truly stand right now. What we’ve done is we’ve looked at some of these recent asset-backed lending structures where companies put a major city that’s got fiber to the home, that’s an established market generating cash flows with a stable business operating environment.
They’re using that effectively as collateral to borrow money against it to invest in their network. We’re trying to use the valuations of those deals as a proxy for where the market’s at.
It feels like those are coming in in the low double digits of EBITDA, which I think bodes well for overall multiples from an M&A perspective going forward. Again, we do think things are going to start to pick up for a number of factors.
Again, I would definitely want to be paying attention to interest rates clearly, but then also, any additional movement or M&A out of the big national wireless operators, again, could bring a number of folks off the sidelines into the market as well.
That brings me to the end of what I wanted to cover with all of you today. Thank you for listening. Hopefully that helps you think a little bit about 2025 from an M&A perspective. I wanted to give a special shout-out to my fellow CoBank associates, Christina Pope and Tyler Herron, who make this podcast a reality.
