One of the most interesting things I’ve witnessed in the industry over my career is how the valuation for telecom companies have increased and decreased over time. Telecom companies are generally valued and sold based on a multiple of earnings. Companies with a higher margin per customer are worth more than companies with lower margins. This method of valuation applies to telephone companies, cable companies, and fiber overbuilders.
For more than a decade, the valuation of small telephone companies has hovered around a base valuation of five times EBITDA (earnings before interest, taxes, depreciation, and amortization). While the price somebody is willing to pay for a company is more complex than that simple math, this basic metric has provided a good way to guess the relative value of a telco by starting with that math.
A given company might sell something other than this average valuation. For example, there might be a motivated buyer willing to pay more, such as a neighboring company that understands the boost to combined margins through economy of scale. Properties sometimes sell for less than the expected valuation if the owners have decided it’s time to exit the business and don’t want to wait for a higher offer.
If you look back twenty years, valuations for telcos and small cable companies sold for ten to twelve times EBITDA. Twenty years ago was the beginning of the transition of small telcos and cable companies into becoming ISPs. Buyers recognized that broadband sales would increase over time and recognized this potential in setting a valuation for these companies. Buyers were willing to pay more to gain the upside from future broadband sales.
After the peak valuations of twenty years ago, valuations dropped over time. Rural telephone companies started to lose the historic subsidies that had bolstered earnings. Small cable companies started to see a serious erosion of cable TV margins as the price of programming skyrocketed. Buyers were less willing to buy into a company with lowered future expectations, and values dropped accordingly. I recall talking to telcos that got offers to sell at multiples of only three or four times earnings.
Over the last few years, valuations have climbed again – at least for some companies. Telcos that invested in fiber and cable companies that upgraded to gigabit capabilities have become worth more to buyers. Companies that didn’t make these upgrades are worth a lot less.
One of the interesting changes in the industry is that external venture capital has become interested in buying telecom properties. When the industry valuations hit the lowest point, most sales of telecom companies were made to other telecom companies. It seems like external interest in the industry has ratcheted up valuations. I always have to wonder if outsiders understand the industry well enough to be willing to pay more for businesses than folks who have been in the industry forever.
There were a few factors that led to increased valuations in recent years. One is historically low interest rates that made it easier and more affordable for buyers to finance the purchase of companies. I also think valuations went up as some ISPs demonstrated the ability to gain near-monopolies in markets. I guess this emboldens buyers that they can duplicate this with a company they purchase.
I’m suddenly talking to companies that are being offered multiples of as much as ten times earnings. That puts these companies back to the heady valuations of 2000. It’s going to be interesting to see how many small telcos and cable companies sell when valuations are high – it has to be tempting.
I’m frankly perplexed by valuation in the ten times range. If a buyer pays ten times earnings and doesn’t improve the business, it will take ten years just to get back the investment – without considering the cost of the debt used to finance the purchase. A buyer has to make huge improvements to an acquisition to get the investment back in a reasonable time. The upside can come from increased revenues, reduced expenses, or a combination of the two. It’s not easy to squeeze that much improvement out of a telecom business without alienating customers.