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Valuation drivers in the telecommunications industry - Valuation criteria and findings - EY - Global

Valuation drivers in the telecommunications industry

Valuation criteria and findings

  • Share
Valuation criteria
Common Valuation criteria
EV/Sales
EV/EBITDA
Price Earnings Ratio (P/E)
Price-to-Book (P/B)
Beta coefficient (ß)
Telecom-specific Ratios and Key performance indicators (KPIs)
ARPU*
EV/Number of subscribers
EV/Line installed
SAC*
SRC*
*ARPU: Average revenue per user
*SAC: Subscriber acquisition costs
*SRC: Subscriber retention costs


Large telcos that operate in emerging markets have higher valuation multiples than their peers in mature markets.

Applying the main valuation criteria used by investors in telecommunications, we examine key value drivers, valuation multiples and different methodologies. We learned that for large telcos, higher emerging market exposure resulted in higher valuation multiples. For smaller telcos, higher emerging market exposure equaled higher beta.

Valuation criteria for telecoms

We set out to identify the key valuation drivers to telecom operators, and to consider the impact of their activities (size, exposure to emerging markets, etc.). We asked the following questions:

  • How do investors measure and value growth?
  • What are the criteria used by investors in an initial valuation of targets?
  • Do these criteria accurately reflect an operator's unique profile?

We analyzed the financial data of 57 large publicly-listed telecom operators: 25 in emerging markets and 32 in developed markets. We also divided them according to their annual revenue .

Split of the 57 telecom operators by annual turnover


Source: Company financial disclosures, FY09

Our analysis of the financial aggregates, geographical market shares and forecast stock-based multiples in the telecommunications industry was based on Bloomberg projected estimates.

We also reviewed and analyzed approximately 70 recent transactions of public and private telecommunications targets.

Main valuation criteria used by investors

The main valuation criteria used by investors in the telecommunications industry in their initial valuations include: enterprise value (EV)/sales; EV/EBITDA; price earnings ratio; price-to-book; and beta coefficient.


Valuation criteria

Differentiators affecting valuations

We have identified the following key differentiators, which affect valuations at this stage:

  • Sales. We have analyzed telcos in the "larger tier" (highest sales within our set of 57 operators under analysis) and "smaller tier" (lowest sales within this same set).
  • Market type (emerging vs. developed). We have defined "emerging operators" as telcos with more than 85% of annual revenues from emerging markets.

Key findings

  • Large telcos that operate in emerging markets have higher valuation multiples than their peers in mature markets. Investors place a premium on growth prospects, so long as they are well monitored and diversified.
  • Additional risk is reflected by higher betas (and hence higher costs of capital) for operators in emerging markets.

Higher emerging market exposure, higher valuation multiples for large telcos

Within the large tier, emerging telecommunications operators have higher EV/EBITDA multiples than their developed market peers.

This trend shows their ability to benefit from market growth rates and better margins, which are typical of less mature markets.

However, this trend does not apply to the small tier operators, as the markets place a premium on a diversification of risk, which is supported by the size of the business .

EV/EBITDA multiples of larger emerging operators by geographical exposure


Source: Bloomberg

Higher emerging market exposure, higher beta for small telecoms

The beta coefficient (one of the key components of discount rates) contains valuable information about the company's risk profile. Typically, the telecommunications industry is now considered to be slightly less risky than the overall market, with beta coefficients within the 0.75-1.0 range (see Figure 9).

Smaller telecommunications operators usually have a higher beta as their stocks are more volatile. Their operations are considered to be riskier than a larger comparable business, and therefore they would normally yield higher returns on investment.

Exposure to emerging or mature markets also influences the operator's risk. The market type differentiator provides a measure of this.

Beta Weekly 1.5 — Larger vs Smaller Tiers


Source: Bloomberg

Higher exposure to emerging markets equals higher price-to-book ratio

Price-to-book (P/B) ratios of large telcos operating in emerging markets are higher than those of their peers in developed markets.

This shows that the market expectations of high growth (i.e., anticipated return on equity) have been built into their share price, thus boosting their P/B ratios .

P/B of Larger-tier companies between 2007 and 2010 by region


Source: Bloomberg

Lower price-to-book ratios

Lower P/B ratios observed for large tier developed and mixed-market operators might be explained by:

  • Economic factors. Past performance was positive and relatively stable, and is not expected to grow significantly in the future (past return on equity is approximately equal to the future return on equity).
  • Accounting factors. Acquisitions reported via PPA led to the recognition of part of the intangible assets in the acquirer's consolidated accounts, increasing the book value of equity.

Thus the book value of these companies better reflects their market value, leading to lower P/B ratios.

Higher exposure to emerging markets, higher implied transaction multiples

The implied multiples of acquired emerging targets were significantly higher than those of developed market operators.

This is consistent with the conclusions derived from the P/B analysis: companies with higher P/B were judged by investors as presenting higher growth potential .

Recent transaction-based valuation multiples (2008–2009)


Source: Merger Market



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