The differing opinions of private infrastructure investors compared to the stock market are particularly visible when it comes to the masts on which mobile telephone operators hang their antennas. Deutsche Telekom AG’s strategic review of its $20 billion tower business has attracted significant private interest.
These assets are attractive in a stagflationary world, according to analysts at Citigroup Inc. Mobile operators sign long-term contracts, usually agreeing to some indexation to consumer price inflation (although often subject to a cap). The rollout of 5G mobile networks also offers growth potential and the ability to add more customers per mast as telecom owners stop monopolizing real estate. Consequently, the towers command valuations far above those of their current or former telecommunications parent companies.
And yet, for all their appeal in the current economic environment, listed European tower companies have lost their luster. Sector bond yields have climbed not only in sympathy with rising government rates, but also because investors view them as riskier credits.
In turn, higher bond yields have driven down valuations of listed stocks since they reduce the theoretical value of future cash flows in today’s money. This is a particular problem for growth stocks, and the sky-high earnings multiples that telecom towers are trading on have started to fall. This year, telecom companies themselves have performed better as investors have targeted value stocks.
The situation highlights the problem with classified infrastructure. As analysts at Barclays Plc warned in November, the inflation-driven escalation in earnings may not fully offset the drag from higher funding costs on stock market valuations. Indeed, long-term inflation expectations have not risen as much as bond yields, and the decline in higher financial costs on the stocks of publicly traded tower companies may not be over, warns NewStreet Research.
All of this plays into the trading hand of private infrastructure funds looking to buy assets. Not only are public company references cheaper, but listed acquirers like Cellnex Telecom SA (also part-owned by the Benettons) are falling behind. The plummeting valuation of the shares of the Spanish mast operator deprived it of useful currency to finance its own operations.
There is still enough competition among private equity buyers to keep prices high in the M&A market. The auctions will be won by funds willing to accept the lowest returns as they inject ever larger wads of equity into deals. While a conventional buyout would aim for a 20% return, the infrastructure fund can settle for less than half.
Accepting low returns leaves no room for error. Yet infrastructure is not a one-sided bet. In towers, for example, the risk is that satellites or alternative terrestrial networks become a serious competitive threat. Consolidation among mobile operators could limit the universe of customers. And telcos that have transitioned from mast owner to mast renter have a reason to minimize rental costs that didn’t exist before.
Of course, private equity and infrastructure funds are drawn to situations where equity investors worry and potentially miss the long-term upside. Macquarie’s tilt on gas goes badly with the energy transition until you consider the possibility of adapting the grid to hydrogen. And it’s not like private equity doesn’t have a painful barrier: A £15 billion ($18 billion) deal for UK Power Networks recently fell through because supplier CK Infrastructure Holdings Ltd. wanted a higher price, prompting buyers KKR and Macquarie to pull out, according to the Financial Times. reported.
But without shareholders asking them to immediately justify every move, infrastructure fund pricing discipline will have to come from within.
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Chris Hughes is a Bloomberg Opinion columnist covering the deals. Previously, he worked for Reuters Breakingviews, the Financial Times and the Independent newspaper.
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