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Valuation drivers in the telecommunications industry - Tangible assets - EY - Global

Valuation drivers in the telecommunications industry

Tangible assets

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Tangible assets are generally valued by applying the cost approach. The principle behind this approach is that the value of an asset should not exceed the cost of obtaining a substitute asset of comparable features, utility and functionality. In the context of PPA, the approach is applicable if the market and income approaches cannot be applied.

Two methods might be regarded within the cost approach:

  • The reproduction cost method. This is based on the construction (or purchase) of an exact replica of the intangible asset.
  • The replacement cost method. Also known as the greenfield approach, this method is based on the cost of recreating the utility of the subject intangible asset, but in a form or appearance that may be quite different from an exact replica of it.

To value tangible assets, particular attention should be paid to the acquirer's/market participants' intentions (including network downsizing), since certain adjustments might be needed.

For example, a network that would be considered "inefficient" by market participants, because it would require some redundant antennas to be disposed of, may justify a discount applied to the network value. Finally, the economic useful life of the equipment should be considered versus its accounting useful life.

Replacement cost new and reproduction cost new may follow changes in the prices of new equipment.

For infrastructure assets, replacement/reproduction cost new may be higher than historical values. For technological equipment assets, replacement costs are often lower than historical values. It should be noted that the target's marketplace may also impact the value estimation using the cost methodologies.

Further considerations, such as functional obsolescence (capacity, rapidity, etc.) and asset retirement obligations, can also have a significant impact on values.

Discount rate

When using income as a basis for the valuation methodology, such as the relief from royalty method or the multi-period excess earnings method (MEEM), a discount rate has to be applied.

The discount rate should be specific to each asset and reflect its risk profile. It should also be consistent with the overall company weighted average cost of capital (WACC). The weighted average return on assets (WARA) analysis estimates the average rate of return of the company's economic assets, based on their own discount rate, and calculates their respective weight in the total enterprise value (EV).

Network assets and working capital are considered to carry relatively little risk in telecoms. Licenses, customer bases and trade names demand a higher rate of return. Goodwill considers synergies whose realization often proves difficult and therefore risky.

The WARA analysis aims to check that the rates used are consistent with the respective risk profiles of the assets, and reconcile those with the operator's WACC.

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