Broadband M&A Set to Grow with a Stronger Market and “Killer Bundle”

Jeff Johnston

November 22, 2024

Though valuations for privately owned broadband providers have remained relatively flat over the last 12 to18 months and below levels two or three years ago, overall investor and strategic buyer interest in the private broadband market remains strong. One reason is a shift in strategic buyers – they are no longer limited to cable companies, traditional telecom or pure-play fiber operators. The national wireless operators, specifically T-Mobile, have been actively buying fiber companies for growth and to complement their smartphone service with the new “killer bundle” – a smartphone plan bundled with home internet. These new merger and acquisition dynamics could help kickstart deal activity.

Here's a look at the factors that have led to lower valuations, reasons why public valuations trade lower than private valuations, and where the market is heading over the next two years.

A look back

Five years ago, broadband valuations looked higher than they do today. Valuation multiples based on Earnings Before Interest Taxes and Depreciation (EBITDA) were trending up as infrastructure funds and private equity sponsors were on a shopping spree. Back then the market was less certain, interest rates were at zero and new fiber builds were growing in underserved areas. Also, access to good quality labor wasn’t much of a problem and costs had yet to feel the effects of the pandemic. These market conditions led to bidding wars for broadband operators looking to cash out at very attractive multiples.

Then COVID-19 hit, and the bets made by infrastructure funds looking to diversify from their traditional investments (roads, bridges, airports, etc.) and into digital infrastructure looked brilliant. During the pandemic, the digitization trend that started years earlier went parabolic thanks to Zoom calls and the surge in streaming video and online shopping. This increased valuation multiples for broadband companies even higher given the uncertainty about future airline travel and the work-from-home trend. In a matter of weeks, a reliable broadband connection went from nice to have to an absolute necessity for many Americans. 

Uncertainty creeps in

Just as COVID-19 showed the importance of having a reliable broadband connection, the inflation it caused negatively impacted broadband valuations. Labor costs shot up 20% –40% over a several year period, supply chain bottlenecks wreaked havoc on operators’ ability to execute their build plan, and the spike in interest rates made financing deals more expensive. These factors were the primary drivers behind the decrease in the number of M&A deals and the lower prices investors and strategic buyers were willing to pay.

With some investor-owned operators missing their build plans and key financial milestones, investors’ timelines for selling them off were pushed out, which has also contributed to the slowdown in deal activity. Also, with the rise in interest rates, future cash flows are worth less in today’s dollars which reduces how much investors are willing to pay to acquire an operator’s business. This has helped lead to a staring contest between some buyers and sellers who struggle to agree on price. Sellers contend that access to broadband is gaining in importance, especially considering the hype around generative AI.  And many believe that since they have upgraded their network with more fiber and demonstrated an ability to reduce leverage and increase cash flows, they should receive a higher multiple than what is being offered by the investor community. Buyers on the other hand point to the increase in labor costs and reduced availability, supply chain delays, rising equipment costs, permitting delays and increased competition as reasons why they are not willing to pay 2022 multiples.

This staring contest between buyers and sellers has reduced deal activity and resulted in a build versus buy/sell. Sellers are walking away and reinvesting in their business, and institutional investors are building out network footprints within their existing portfolio of companies.

The other factor at play is start-up operators who now realize that the broadband business is harder than it looks. This cohort is not hitting plan as it relates to for passings, revenue, customer additions, etc. and their investors have tightened the purse strings. Some of these struggling operators will likely end up being sold at attractive valuations, which is causing some investors to slow down their M&A plans as they anticipate better opportunities are on the horizon.

Valuation gap

The valuation gap between private and public operators continues, with the former enjoying much higher multiples. A comparison of recent private transactions to public multiples reveals a stunning gap of greater than two times.

Why is there a gap?

• Growth in rural markets is better than urban markets. A number of competitive fiber operators will deploy fiber to the home only in HFC and DSL markets. The selective nature of how they enter markets and the weak competition they face enables them to grow revenues quickly.

• Fixed wireless competition from T-Mobile and Verizon has been impacting tier one and two markets and is less of an issue in rural and other smaller markets. Verizon and T-Mobile have been growing their fixed wireless access (FWA) business, and these gains are coming at the expense of the publicly traded ISPs. These competitive headwinds have become a significant concern for public broadband investors.

• Public market investors tend to be myopic and are more sensitive to macroeconomic and capital market conditions. While markets are at or near all-time highs, public investors’ sensitivity to conditions explains part of the valuation gap in the past. Also note that institutional investors have a longer time horizon versus public equity investors, and as such company performance does not influence their valuations on a quarter-by-quarter basis.

• Many private broadband operators are not saddled with cable video assets and large amounts of leverage compared to their publicly traded counterparts. Cable video assets are a drag on overall margins as consumers cut the cord in favor of streaming video. And cable is no longer a strategic part of the product bundle offer. For example, Comcast disclosed that it is exploring the sale of its cable business as the company looks to focus on content, and its wireless and internet businesses.

Smaller/rural broadband operators also enjoy high levels of brand equity, which is not lost on investors and strategic buyers. According to the American Customer Satisfaction Index, ISPs rank near the bottom of all industries because the poor scores of larger publicly traded ISPs drag down overall industry ratings.  Therefore, to own an ISP that consistently delivers high Net Promoter Score (NPS) – as many rural operators do – is rare and coveted.  

Looking ahead

M&A activity should begin to pick up thanks to the combination of lower interest rates, national wireless operators’ interest in owning fiber assets, moderating labor and equipment costs, and expectations for improved business plan execution. Now that interest rates have peaked and price tags for recent deals for fiber rich operators topped about 20x EBITDA, it is reasonable to assume that valuations have bottomed for the near-term. We see M&A interest from the wireless operators, such as T-Mobile and Verizon, as the main catalyst that will fuel deal activity over the next couple years.

T-Mobile and Verizon’s recent FWA success has shown the broadband industry that the new “killer bundle” is a smartphone plan combined with home internet service. Customers want this bundle – and when they subscribe to it, their churn skews lower than those on a standalone service.

T-Mobile and Verizon know their current FWA strategy is not a sustainable one. Wireless networks have less operating leverage compared to fiber networks, so increasing their fiber exposure makes good business sense. And beyond the subscriber bundle benefits, fiber is a good business to be in and has much better margins than the capital-intensive wireless industry. Having to spend  around $10 billion in wireless capex each year just to maintain or slightly grow your customer base is a tough spot to be in. Considering that postpaid subscriber growth is mainly coming from prepaid to postpaid migration and switchers, it’s no wonder the wireless operators are hunting for growth. And it’s not just domestic wireless operators who are shopping U.S. broadband companies. Canada’s BCE just announced a deal to acquire Everett, Washington-based Ziply Fiber for $3.5 billion.

It will be interesting to see if acquisitions made by the wireless operators kickstart a broader M&A trend. We think that is likely, given the ongoing interest in the industry from major institutional investors and private equity sponsors. We could also see a scenario where the Metronets and Lumos of the world become “mini aggregators.” With smaller budgets today, it might make sense for them to acquire smaller operators (ones that would be too small for T-Mobile or Verizon to acquire) to help fill in/broaden their fiber footprint. This would expand the market for the killer bundle, which is a major strategic driver for T-Mobile and Verizon.

So what’s the impact on rural consumers?

The national wireless operators’ move into rural markets would benefit consumers for a couple reasons. First, as illustrated above, the national wireless operators’ bundle of smartphone service with home internet almost always includes a discount. Second, due to a lack of funding to support the Secure Communications Network Act, rural wireless coverage is shrinking in many parts of the country. The national wireless operators’ expanded rural presence could help fix this.

Recall that communications companies that have non-complaint infrastructure equipment in their networks are required to rip it out and replace it with compliant equipment. Many rural wireless operators are in this situation, and the original $1.9 billion authorized to cover the costs of the new equipment is not enough. This has left many rural wireless operators in an untenable situation as manufacturer support/replacement equipment for their legacy 3G networks is gone (non-complaint manufacturers left the U.S. market after the act was implemented). As a result, some parts of rural networks are shutting down. And planning for upgrades to 4G and 5G is littered with uncertainty and risk because of the funding shortfall.

As the national wireless operators increase their rural presence via M&A, it is entirely possible that they can offer the poplar smartphone/internet bundle in markets where rural wireless operators were forced to shut down service.

Sources used

Paul, Trey. “New J.D. Power Survey on Internet Providers Reveals Some Clear Winners (and a Few Also-Rans),” Oct. 10, 2024, CNET.