Financing 3G start-ups
Following the auction of Universal Mobile Telecommunications
Systems (?UMTS? or ?3G?) licenses in the UK in April/May 2000,
telecom operators, vendors and financiers worldwide are now focused
on licenses due to be awarded across Europe, US and Australia over
the next 12 months. The cost of each licence is expected to be s8
billion or more in countries such as Germany and extremely high in
most other countries as well. While GSM infrastructure across the
mobile telecom industry was implemented over a period of
approximately 10 years, existing and new operators will require the
implementation of UMTS networks over a much shorter time frame (2-3
years). Thus, significant financing challenges present themselves
particularly for new market entrants UMTS operators may be split
into two broad categories from the perspective of
credit-worthiness:
i) those that have an existing mobile 2G license in the relevant country; and
ii) the new 3G operators which do not own a 2G license in the relevant country and will be starting up a new service from scratch.
This article focuses on the latter: i.e. new 3G operators such as Hutchison/ TIW in the UK.
The Challenge
A new operator generally enters a market as either the 4th or 5th entrant behind some very well established incumbents. Depending on the country, the new 3G operator is likely to pay s8 billion or more for a license, and, in many cases, will be required to pay a substantial portion up-front. Additionally, it will pay another s5 to 10 billion on capital expenditure, subscriber acquisition and other operating costs associated with the build-out of this type of network and business on a national basis.
In return for this expenditure and risk, the new 3G operator will get access to spectrum and will be afforded the opportunity to generate a return on its investment, given that there exists sufficient market demand on the one hand and on the other the technology required to provide profitable services.
Assuming that both the technology and the market demand do materialize, 3G and their advisors will have to think very carefully in order to structure viable financing solutions. Since it is unlikely the operator go cashflow positive and start to repay debts for at least 5 to 6 years from the date of award of license.
Key Credit Risks
In analysing the risks associated with a new 3G operator, one approach is take the simple GSM operator model for which market and technology risks are well understood by the financial markets and then to introduce new market and technology risks. The nature of these risks is discussed as follows:
Market Demand Risk
Market analysts forecast global wireless data subscribers of 730 million by 2010, up from 15 million in 1998. They predict revenues from these subscribers related to wireless data in 2010 will total some $123 billion with West Europe accounting for nearly 44% of that amount, whit the US and Asia/Pacific accounting for 25% and 22% respectively.
Such mobile wireless data revenues are expected by operators to be derived from a variety of services including banking services, music, video, games/gambling, email and news services. Recent experience in Japan suggests that the optimism in the sector is not necessarily irrational with NTT DoCoMo announcing in May 2000 that it already has 7 million subscribers for its internet capable ?i-mode? mobile phones with 20,000 subscribers signing up each day. DoCoMo forecasts 20 million by the end of next year.
Despite the crude nature of current methods of accessing the internet via mobile handsets, mobile phones have become the most popular way of accessing the internet in Japan. Initial results suggest that the demand exists but whether and how much subscribers will pay for it is likely to remain a question for a little longer at least.
Much of the equity analysis of wireless data revenues to date has been ?top-down? derived from the percentage of GDP that is likely to be attributed to mobile. Increasingly, debt providers taking a more bottom-up approach will demand analysis based upon average revenue per user (?ARPU?), one of the major building blocks for those analysing cellular operators. Lenders will wish to see that projected ARPUs are reasonable although it is now accepted that, thanks to 3G, there are many more ways to make money out of each subscriber. For each subscriber there is an amount that the subscriber will pay and an amount that businesses will pay for having access to that subscriber.
An estimation of voice versus data revenues for a new 3G operator might appear as follows:
There are currently no clear answers on what the precise make-up of 3G revenues will be. However, the fact that all of the world's leading mobile operators are taking such an aggressive approach to this new sector means that the financial markets have to take 3G extremely seriously and suggests that the financial markets will soon develop a good understanding the inherent market risks.
Technology Risk
Technology risk may be divided into risks associated with infrastructure and those associated with handsets. While the infrastructure such as base stations and networks for UMTS is understood to be at an advanced stage of development, the development of handsets is further behind. Lucent predict that commercial 3G handsets will not be available until late in 2001 and suggest that commercial launch will only be possible in 2002 and thereafter.
In the interim there are other technologies that will be used to migrate subscribers from voice only to substantially data-based usage of their mobile handsets. This process has commenced with the introduction of Wireless Application Protocol (?WAP?) in Europe and the more advanced General Packet Radio Switching (?GPRS?) ? one of the so-called ?2.5G? technologies in Japan as referred to above.
Globally in 2010, market analysts predict that of the expected 730 million wireless data users, 36% will access 2.5G networks, 33% will access 2G networks and 30% will access 3G networks. Of the expected worldwide wireless data revenue of $123 billion in 2010, 3GB predict that 3G systems will generate 51%, 2.5G networks bringing in 36% and 2G networks accounting for 13%. While there might be a premium paid for high-bandwidth, 3G does not become the dominant revenue technology until 2008.
Such predictions are based in part upon the need for existing operators to leverage off their existing assets which 2.5G do but 3G does not. Hence a large part of the game-plan for the new 3G operator will be to implement 3G before it is economically sensible for its competitors to do so and by doing this to steal as many as possible of the existing incumbents' higher value subscribers.
The bottom line is that technology risk can not currently be mitigated by the demonstration of a fully functioning commercial 3G handset. However, the fact that all of the world's leading vendors are locked in a race to be the first to achieve this will give the financial markets great confidence that the technology will be available in the near future.
Variations on the Structure of the 3G Borrower
In our attempts to develop financing solutions for 3G borrowers, Bank of America has developed several financial and corporate structures to enhance the financeability of the 3G Borrower. One such structure involves the establishment of a Network Special Purpose Vehicle (?Network SPV?).
The Network SPV would own and develop the network and contract with the new 3G operator to provide it with 3G capacity. The Network SPV's revenues would be further enhanced by the sale of capacity to other Virtual Mobile Network Operators (?VMOs?). The selected equipment vendors might take some level of ownership in the network SPV and would thereby assume a level of risk and responsibility associated with development and operation of the network. The capital needed to be raised by the new 3G operator would be reduced and part of the risk would be passed on to the equipment vendor.
This structure may be further enhanced by combining two different licensees and achieving economies of scale by convincing them to share one network. Whether it would be possible to get two 3G operators to cooperate in this way in practice is an open question.
From a financier's perspective, considering any of these options will involve a focus on which entity owns the license and the assets, which entity is taking the market risk, which entity is taking technology risks and to what extent there is recourse to the vendor or the operator's shareholders.
Sources of Finance
A typical financing profile for a start-up telecom operator may be seen as follows:
Equity
Following the UK 3G auctions, operators bidding for the ?new? 3G licenses around Europe are realising that there are benefits (at the very least from a cost sharing point of view) to teaming up to bid on a joint basis. Sonera and Telefonica are known to be in discussions in relation to auctions in Germany. This would be a strong partnership both with good financial strength, the strong industry capability as demonstrated by Sonera's leading edge activity in mobile wireless and Telefonica's ability to implement ventures successfully overseas.
Operators will undoubtedly seek to recoup value from their 3G activities through the public equity markets either on a country by country basis or, as some operators have suggested on a pan-European basis. In the case of 3G, it is likely that the public markets will be approached only once initial needs have been met in the debt financial markets.
Vendor Finance
Operators seeking bids from equipment vendors will be heavily focused upon the following selection criteria:
? Availability of handsets;
? Availability of infrastructure;
? Price; and
? Financing.
While the first two are of extreme importance to a new 3G operator trying to establish itself in the shortest possible time as a credible competitor in the 3G market, financing is likely to be next most important, even before price. This is reflected in recent vendor bid processes in the UK where financing has already made the difference between success and failure for vendors.
The principal vendors looking to win mandates for 3G are Nokia, Nortel, Siemens, Motorola, Ericsson and Lucent. For those companies having less success in 2G, the introduction of 3G represents an opportunity to take the lead in market share in the future. If it takes aggressive financing terms to achieve this then it is likely that this will be offered.
So far in the UK, Vodafone have announced that they have awarded a 3G supply contract to Ericsson while BT Cellnet is understood to have chosen Nortel. The question for the remaining vendors is ... can they afford not to win a contract with one of the three remaining 3G licensees in the UK?
Traditionally, financing has been provided by vendors on a straight-forward bridge basis for the value of their contract amount less any amounts attributable to sub-contractors. In the case of 3G we expect to see many of the vendors considering larger underwriting amounts and longer tenors. It is also likely that certain operators will seek to transfer equity risk on to vendors by requesting pay-as-you-grow solutions linking repayment of vendor debt to the meeting of certain revenue or business milestones by the new 3G operator.
Vendor finance will undoubtedly be the primary source of debt underpinning the initial build-out of 3G networks across Europe. Given that vendors are not in the business of providing debt financing, this is not a prospect that they relish...although the associated 3G sales contracts will certainly ease the pain!
High Yield
The high yield market likes precedents. So ... who were the last borrowers in the mobile telecoms sector that required billions of dollars of financing before they had generated any revenues (let alone net cashflows) with uncertain market demand and where there was a high degree of technology risk? Yes, that's right! Iridium and ICO, both of which subsequently went into administration under Chapter 11.
While the stakes in 3G are already many times higher than those in mobile satellite services, the fundamental differences in the case of 3G are:
? 3G is not aiming to satisfy a niche market; it is aiming at the whole market place with a view to ultimately replacing 2G;
? 3G is actively supported by all the major mobile operators world-wide, rather than by a selection of satellite operators and equipment manufacturers; and
? 3G technology is being actively developed by all the major equipment manufacturers world-wide.
Nonetheless, the high yield markets are expected to be cautious at first. It is currently anticipated that in the case of the new 3G operator in each country, the high yield market will be looking for some comfort from both the market risk and the technology risk perspective. Assuming handsets are ready within 18 months and it takes another six months to conduct initial market testing, initial pessimistic views are that it may take as long as two years before the high yield markets open for new 3G operators.
Further good news in the sector and good sponsorship will no doubt accelerate this timetable. The amount of funding required and the immediacy of timing suggests that the high yield markets must at some stage become an essential form of funding for 3G.
Term Senior Bank Financing
As the graph above indicates, term senior bank financing is not usually available to start-up operators until well after all other forms of financing have been tapped. Where senior debt financing is raised at an earlier stage in the development of a start-up telecoms operator, this is usually on a guaranteed basis with the guarantee falling away as certain milestones are met. This is the case even where there is limited technology risk.
Currently, there is no consensus view amongst senior banks except to the extent that all such financing to date in the UK has been done on a guaranteed basis. Some banks have suggested that financing 3G at this stage is effectively the same as financing a vision, something banks in the cashflow or even asset based lending business are not especially comfortable with. However, in the same way as there is pressure on operators to pay high license fees and upon vendors to provide aggressive financing terms, so banks will be forced to scratch their heads and think about how they can push the envelope and provide debt financing for 3G.
Much of the comfort for senior bank lenders will be derived from soft support from sponsors, from structural mitigation through the value of the license as a form of security, from shorter tenors and through incentives to refinance. Banks will seek comfort from initial voice based revenues to be derived by the new 3G operator as it builds out its business and they will focus on the ability of the new 3G operator to survive competition from the incumbent licensees.
Conclusion
There is no doubt that both operators and vendors are making a statement that they believe that 3G will be even more important in the future than 2G is today. The financial markets are now being forced to think hard about how they view the future of telecommunications globally and what the position of 3G will be within that future.
i) those that have an existing mobile 2G license in the relevant country; and
ii) the new 3G operators which do not own a 2G license in the relevant country and will be starting up a new service from scratch.
This article focuses on the latter: i.e. new 3G operators such as Hutchison/ TIW in the UK.
The Challenge
A new operator generally enters a market as either the 4th or 5th entrant behind some very well established incumbents. Depending on the country, the new 3G operator is likely to pay s8 billion or more for a license, and, in many cases, will be required to pay a substantial portion up-front. Additionally, it will pay another s5 to 10 billion on capital expenditure, subscriber acquisition and other operating costs associated with the build-out of this type of network and business on a national basis.
In return for this expenditure and risk, the new 3G operator will get access to spectrum and will be afforded the opportunity to generate a return on its investment, given that there exists sufficient market demand on the one hand and on the other the technology required to provide profitable services.
Assuming that both the technology and the market demand do materialize, 3G and their advisors will have to think very carefully in order to structure viable financing solutions. Since it is unlikely the operator go cashflow positive and start to repay debts for at least 5 to 6 years from the date of award of license.
Key Credit Risks
In analysing the risks associated with a new 3G operator, one approach is take the simple GSM operator model for which market and technology risks are well understood by the financial markets and then to introduce new market and technology risks. The nature of these risks is discussed as follows:
Market Demand Risk
Market analysts forecast global wireless data subscribers of 730 million by 2010, up from 15 million in 1998. They predict revenues from these subscribers related to wireless data in 2010 will total some $123 billion with West Europe accounting for nearly 44% of that amount, whit the US and Asia/Pacific accounting for 25% and 22% respectively.
Such mobile wireless data revenues are expected by operators to be derived from a variety of services including banking services, music, video, games/gambling, email and news services. Recent experience in Japan suggests that the optimism in the sector is not necessarily irrational with NTT DoCoMo announcing in May 2000 that it already has 7 million subscribers for its internet capable ?i-mode? mobile phones with 20,000 subscribers signing up each day. DoCoMo forecasts 20 million by the end of next year.
Despite the crude nature of current methods of accessing the internet via mobile handsets, mobile phones have become the most popular way of accessing the internet in Japan. Initial results suggest that the demand exists but whether and how much subscribers will pay for it is likely to remain a question for a little longer at least.
Much of the equity analysis of wireless data revenues to date has been ?top-down? derived from the percentage of GDP that is likely to be attributed to mobile. Increasingly, debt providers taking a more bottom-up approach will demand analysis based upon average revenue per user (?ARPU?), one of the major building blocks for those analysing cellular operators. Lenders will wish to see that projected ARPUs are reasonable although it is now accepted that, thanks to 3G, there are many more ways to make money out of each subscriber. For each subscriber there is an amount that the subscriber will pay and an amount that businesses will pay for having access to that subscriber.
An estimation of voice versus data revenues for a new 3G operator might appear as follows:
There are currently no clear answers on what the precise make-up of 3G revenues will be. However, the fact that all of the world's leading mobile operators are taking such an aggressive approach to this new sector means that the financial markets have to take 3G extremely seriously and suggests that the financial markets will soon develop a good understanding the inherent market risks.
Technology Risk
Technology risk may be divided into risks associated with infrastructure and those associated with handsets. While the infrastructure such as base stations and networks for UMTS is understood to be at an advanced stage of development, the development of handsets is further behind. Lucent predict that commercial 3G handsets will not be available until late in 2001 and suggest that commercial launch will only be possible in 2002 and thereafter.
In the interim there are other technologies that will be used to migrate subscribers from voice only to substantially data-based usage of their mobile handsets. This process has commenced with the introduction of Wireless Application Protocol (?WAP?) in Europe and the more advanced General Packet Radio Switching (?GPRS?) ? one of the so-called ?2.5G? technologies in Japan as referred to above.
Globally in 2010, market analysts predict that of the expected 730 million wireless data users, 36% will access 2.5G networks, 33% will access 2G networks and 30% will access 3G networks. Of the expected worldwide wireless data revenue of $123 billion in 2010, 3GB predict that 3G systems will generate 51%, 2.5G networks bringing in 36% and 2G networks accounting for 13%. While there might be a premium paid for high-bandwidth, 3G does not become the dominant revenue technology until 2008.
Such predictions are based in part upon the need for existing operators to leverage off their existing assets which 2.5G do but 3G does not. Hence a large part of the game-plan for the new 3G operator will be to implement 3G before it is economically sensible for its competitors to do so and by doing this to steal as many as possible of the existing incumbents' higher value subscribers.
The bottom line is that technology risk can not currently be mitigated by the demonstration of a fully functioning commercial 3G handset. However, the fact that all of the world's leading vendors are locked in a race to be the first to achieve this will give the financial markets great confidence that the technology will be available in the near future.
Variations on the Structure of the 3G Borrower
In our attempts to develop financing solutions for 3G borrowers, Bank of America has developed several financial and corporate structures to enhance the financeability of the 3G Borrower. One such structure involves the establishment of a Network Special Purpose Vehicle (?Network SPV?).
The Network SPV would own and develop the network and contract with the new 3G operator to provide it with 3G capacity. The Network SPV's revenues would be further enhanced by the sale of capacity to other Virtual Mobile Network Operators (?VMOs?). The selected equipment vendors might take some level of ownership in the network SPV and would thereby assume a level of risk and responsibility associated with development and operation of the network. The capital needed to be raised by the new 3G operator would be reduced and part of the risk would be passed on to the equipment vendor.
This structure may be further enhanced by combining two different licensees and achieving economies of scale by convincing them to share one network. Whether it would be possible to get two 3G operators to cooperate in this way in practice is an open question.
From a financier's perspective, considering any of these options will involve a focus on which entity owns the license and the assets, which entity is taking the market risk, which entity is taking technology risks and to what extent there is recourse to the vendor or the operator's shareholders.
Sources of Finance
A typical financing profile for a start-up telecom operator may be seen as follows:
Equity
Following the UK 3G auctions, operators bidding for the ?new? 3G licenses around Europe are realising that there are benefits (at the very least from a cost sharing point of view) to teaming up to bid on a joint basis. Sonera and Telefonica are known to be in discussions in relation to auctions in Germany. This would be a strong partnership both with good financial strength, the strong industry capability as demonstrated by Sonera's leading edge activity in mobile wireless and Telefonica's ability to implement ventures successfully overseas.
Operators will undoubtedly seek to recoup value from their 3G activities through the public equity markets either on a country by country basis or, as some operators have suggested on a pan-European basis. In the case of 3G, it is likely that the public markets will be approached only once initial needs have been met in the debt financial markets.
Vendor Finance
Operators seeking bids from equipment vendors will be heavily focused upon the following selection criteria:
? Availability of handsets;
? Availability of infrastructure;
? Price; and
? Financing.
While the first two are of extreme importance to a new 3G operator trying to establish itself in the shortest possible time as a credible competitor in the 3G market, financing is likely to be next most important, even before price. This is reflected in recent vendor bid processes in the UK where financing has already made the difference between success and failure for vendors.
The principal vendors looking to win mandates for 3G are Nokia, Nortel, Siemens, Motorola, Ericsson and Lucent. For those companies having less success in 2G, the introduction of 3G represents an opportunity to take the lead in market share in the future. If it takes aggressive financing terms to achieve this then it is likely that this will be offered.
So far in the UK, Vodafone have announced that they have awarded a 3G supply contract to Ericsson while BT Cellnet is understood to have chosen Nortel. The question for the remaining vendors is ... can they afford not to win a contract with one of the three remaining 3G licensees in the UK?
Traditionally, financing has been provided by vendors on a straight-forward bridge basis for the value of their contract amount less any amounts attributable to sub-contractors. In the case of 3G we expect to see many of the vendors considering larger underwriting amounts and longer tenors. It is also likely that certain operators will seek to transfer equity risk on to vendors by requesting pay-as-you-grow solutions linking repayment of vendor debt to the meeting of certain revenue or business milestones by the new 3G operator.
Vendor finance will undoubtedly be the primary source of debt underpinning the initial build-out of 3G networks across Europe. Given that vendors are not in the business of providing debt financing, this is not a prospect that they relish...although the associated 3G sales contracts will certainly ease the pain!
High Yield
The high yield market likes precedents. So ... who were the last borrowers in the mobile telecoms sector that required billions of dollars of financing before they had generated any revenues (let alone net cashflows) with uncertain market demand and where there was a high degree of technology risk? Yes, that's right! Iridium and ICO, both of which subsequently went into administration under Chapter 11.
While the stakes in 3G are already many times higher than those in mobile satellite services, the fundamental differences in the case of 3G are:
? 3G is not aiming to satisfy a niche market; it is aiming at the whole market place with a view to ultimately replacing 2G;
? 3G is actively supported by all the major mobile operators world-wide, rather than by a selection of satellite operators and equipment manufacturers; and
? 3G technology is being actively developed by all the major equipment manufacturers world-wide.
Nonetheless, the high yield markets are expected to be cautious at first. It is currently anticipated that in the case of the new 3G operator in each country, the high yield market will be looking for some comfort from both the market risk and the technology risk perspective. Assuming handsets are ready within 18 months and it takes another six months to conduct initial market testing, initial pessimistic views are that it may take as long as two years before the high yield markets open for new 3G operators.
Further good news in the sector and good sponsorship will no doubt accelerate this timetable. The amount of funding required and the immediacy of timing suggests that the high yield markets must at some stage become an essential form of funding for 3G.
Term Senior Bank Financing
As the graph above indicates, term senior bank financing is not usually available to start-up operators until well after all other forms of financing have been tapped. Where senior debt financing is raised at an earlier stage in the development of a start-up telecoms operator, this is usually on a guaranteed basis with the guarantee falling away as certain milestones are met. This is the case even where there is limited technology risk.
Currently, there is no consensus view amongst senior banks except to the extent that all such financing to date in the UK has been done on a guaranteed basis. Some banks have suggested that financing 3G at this stage is effectively the same as financing a vision, something banks in the cashflow or even asset based lending business are not especially comfortable with. However, in the same way as there is pressure on operators to pay high license fees and upon vendors to provide aggressive financing terms, so banks will be forced to scratch their heads and think about how they can push the envelope and provide debt financing for 3G.
Much of the comfort for senior bank lenders will be derived from soft support from sponsors, from structural mitigation through the value of the license as a form of security, from shorter tenors and through incentives to refinance. Banks will seek comfort from initial voice based revenues to be derived by the new 3G operator as it builds out its business and they will focus on the ability of the new 3G operator to survive competition from the incumbent licensees.
Conclusion
There is no doubt that both operators and vendors are making a statement that they believe that 3G will be even more important in the future than 2G is today. The financial markets are now being forced to think hard about how they view the future of telecommunications globally and what the position of 3G will be within that future.
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