Tag Archives: valuation multiples

Some Musings on Telecom Valuations

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.

Is it Time to Sell?

A lot of ISPs hope to someday cash in on their sweat equity by selling the business. There have been some surprisingly high recent valuations in parts of the industry which raises the question if this is a good time to sell an ISP?

Anybody that has considered selling in the last decade years knows that valuation multiples have been stagnant and somewhat low by historic standards. A lot of properties have changed hands during that time with multiples in the range of 4.5 to 6.5 times EBITDA (earnings before interest, taxes, depreciation, and amortization). Some ISP properties have sold outside of that range based upon the unique factors of a given sale.

In November, Jeff Johnston of CoBank posted a long blog talking about how valuations might be on the rise – particularly for companies with a lot of fiber or with other upsides. He pointed to three transactions that had valuations higher than historic multiples for the sector.

  • Zayo sold their network of 130,000 route miles of fiber transport for a multiple of 11.1 times EBITDA.
  • Bluebird Network in Missouri and nearby states sold a 6.500-mile fiber transport network for a multiple of 10.4 times EBITDA.
  • Fidelity Communications of Missouri sold an ISP with nearly 135,000 customers for a multiple of 11.7 times EBITDA.

Johnston doesn’t say that these high multiples are the new standard for other ISPs. However, he does surmise that the high multiples probably indicate an uptick in valuation for the whole sector. That’s something that’s only proven over time by seeing higher valuations coming from multiple and smaller transactions – but the cited transactions raise the possibility that we’re seeing an increase in valuation for fiber-based businesses.

It’s important to ask why any buyer would pay 10 or 11 times EBITDA. A buyer paying that much will take a decade to recoup their investment if the purchased business continues to perform at historic levels. Nobody would pay that much for a business unless they expect the margins of the acquired business to improve after acquisition – that’s the key to higher valuations. The buyers of these three businesses are likely expecting significant upsides from the purchased properties.

Buyers often see a one-time bump in margin from the increased efficiency of adding an acquisition to their existing business. This is often referred to as an economy of scale improvement – overheads generally become more affordable as a business gets larger. However, buyers rarely will reward a seller for the economy of scale improvements, so this is rarely built into valuation multiples.

A buyer is usually only willing to pay a high multiple if they foresee the possibility of significant growth from the purchased entity. The purchased company needs to be operating in a footprint with upside potential, or else the purchased company needs to demonstrate that they know how to grow. A buyer must believe they can grow the acquired business enough to recoup their purchase price and also make a good return. For a fiber ISP to get a high valuation they have to be able to convince a buyer that the business has huge upside potential. An ISP needs to already be growing and they need to be able to demonstrate that the growth can be ongoing into the future.

One of the more interesting aspects of getting a high valuation multiple is that a buyer might expect the core management team to remain intact after a sale. That often means that part of the compensation from the sale might be incentive-based and paid in the future based upon post-sale performance.

To summarize, an ISP can get a higher valuation if they can convince a buyer that there is future upside to the business. ISPs that don’t have growth potential will not see the higher valuation multiples cited above – although many potential sellers will think these multiples apply to them. The bottom line is that if your ISP is growing and can keep growing, and you can paint that picture to a buyer, your business might be worth more than you expected.