KKR Knows a Good Monopoly Play When It Sees One
(Bloomberg Opinion) -- One easy way to lose money in European telecoms has been to invest in Telecom Italia SpA. That’s an inauspicious backdrop to the deal between U.S. buyout firm KKR & Co. and the owner of Italy’s fixed-line phone network. This time the range of outcomes is wide open.
Italian broadband infrastructure badly lags the rest of Europe. Overstretched legacy monopoly Telecom Italia has struggled to afford the needed investment. It also faces competition from Open Fiber SpA, a broadband partnership between utility Enel SpA and state-backed bank Cassa Depositi e Prestiti SpA.
Finally, Telecom Italia has arrived at a seemingly neat solution to the problem. It’s creating a new company called FiberCop to house its so-called secondary network (the cables that connect households to the cabinet in the street) and its current fiber assets. A KKR infrastructure fund is buying a 38% stake in the venture for 1.8 billion euros ($2.2 billion). This cash will help keep the lid on leverage, freeing up funds for investment.
Telecom Italia would then merge FiberCop with Open Fiber itself to create a regulated national broadband monopoly. Look beyond the cost of laying the fiber, and this asset could eventually generate prodigious and predictable cash flow.
It’s enough for KKR to pay generously to get involved. Factor in assumed debt and its investment values FiberCop at 7.7 billion euros, roughly 9 times the Ebitda profit measure. That’s at the top end of where European telcos trade. It’s a punchy valuation for an asset where capex will wipe out cash flow for the next few years.
Telecom Italia says investment spending will fall sharply by 2025, and eventually to below 10% of sales. If that’s achieved, it would support the price KKR is paying, argues New Street Research. That’s a big if.
What’s more, there are risks around that hoped-for merger with Open Fiber. Before it happens, Telecom Italia will put more assets into FiberCop. The dilution implications of this move for KKR’s stake aren’t clear. And while the Italian government has been pushing for a single network company, the transaction currently rests on a “letter of intents” — that’s not a definitive deal. The plan is for Telecom Italia to own more than half of the tie-up, precisely how much is not yet set.
Failure to agree terms would change the outcome from a regulated monopoly to a continued turf war in the provision of fiber broadband. Even if a deal is struck, and trust-busters approve, the details matter. Telecom Italia and KKR might rue sharing the upside from the merger with Open Fiber if they end up doing all of the heavy lifting, New Street Research points out.
So the potential gains for KKR depend on many variables. The telecoms industry has a history of broken promises on capex reduction. The Italian state’s exposure is a complicating factor, too. Cassa Depositi e Prestiti owns 10% of Telecom Italia and half of Open Fiber. Economically, it gains if the network merger comes at Telecom Italia’s and KKR’s expense.
Yet KKR is willing to write the check anyway. Given the history, it should know what it’s getting into.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.
©2020 Bloomberg L.P.