Tenancy troubles hang over Brookfield’s $3.5 billion Jio tower bet

India’s telecom tower industry is set to get a new top dog. Having already pipped its older rivals—Vodafone Idea Ltd (VIL) and Bharti Airtel—to become the largest Indian telecom operator by number of subscribers, Reliance Jio is set to replicate that feat in towers.

Reliance Jio Infratel—Jio’s tower asset venture—aims to add another 45,000 towers to its 130,000-strong portfolio over the coming year. This would beat the combined might of Bharti Infratel and Indus Towers, which hold around 163,000 towers. The two have been in merger talks since late 2018. Once these plans come to fruition, Jio Infratel’s portfolio will be the second largest in the world, bested only by China Tower, which has a whopping 1.95 million towers in its home country.

Jio Infratel’s surge comes on the back of its new ownership. It was recently acquired by Canadian asset management firm Brookfield Infrastructure and its institutional partners, with a committed investment of over $3.7 billion.

As part of the deal, RIL’s subsidiary Reliance Industrial Investments and Holding Limited (RIIHL) signed a master services agreement with Brookfield for 30 years. For Brookfield, Jio’s long-term tenancy assures it a meaningful, predictable stream of revenue. A single-tenant arrangement—something that Jio Infratel has previously had with Reliance Jio—however, makes Brookfield’s investment something of an oddity.

Conventional wisdom in the telecom industry holds that multi-tenancy, where a single tower hosts the equipment of more than one telco, is the only viable model. Without it, turning a profit is improbable, if not impossible, many in the industry believe.

The current state of the industry makes this clear. Indus Towers is a joint venture between Airtel, VIL, and UK-based Vodafone Group. Indus and Bharti Infratel, which is solely owned by Airtel, have two anchor tenants—Airtel and VIL. Even American Tower Corporation (ATC), the other major tower company in the country, has multiple tenants across 70% of its tower assets, said a senior tower industry executive. He requested anonymity as he is not allowed to comment on specific telcos.

Even as the Jio-Brookfield deal awaits regulatory approval, Brookfield CEO Sam Pollock has already weighed in on the tenancy issue. In a statement, Pollock spoke of “meaningful upside” through multi-tenancy. Bucking Jio’s captive towers arrangement, while appealing in theory, may be difficult to put into practice though. 

Since Jio’s entry into telecom in 2016, the market has seen rapid consolidation. While there were many telcos and few tower providers earlier, something that naturally lent itself to multi-tenancy, that is no longer the case. There are, in essence, three tower operators on the supply side—Indus-Bharti Infratel, ATC, Jio Infratel. On the demand side, there are three telecom operators—Jio, Airtel, and VIL. Acquiring a second tenant, therefore, could be easier said than done.

Even as telecom remains a three player market, none of the tower companies will have two plus tenancies– they will have between 1.6 and 1.8. Only way to make incremental revenue is as data increases operators will have to add data tenancies.

— Former CEO of a leading tower company

Already, the outlook for existing tower operators is grim. Bharti Infratel, for example, has seen its revenue growth more than halve between 2018 and 2019 on the back of falling tenancy. Brookfield must buck this trend.

Tower costs

For Reliance Industries Ltd (RIL), the parent company of Jio, the impetus for the Brookfield deal is simple. Currently saddled with Rs 2,87,000 crore (~$40 billion) of gross debt, about Rs 1,08,000 crore (~$15 billion) of which was transferred to it from Reliance Jio, RIL has been trying to cut debt across businesses. The Jio Infratel acquisition does that.

For Brookfield, though, the upside is less obvious. Because while its big bet on Jio Infratel may say otherwise, India’s tower industry has seen brighter days. 

Towers have two major costs—site rental and power costs. The land or rooftop that houses the tower is usually rented or taken on a long-term lease, while the towers themselves require batteries and diesel generators to function. After factoring in these costs, tower companies add their profit margins on top of this and charge tenants accordingly. 

Although the unit economics may vary from company to company and operator to operator, here is how it broadly works. If an operator fixes a base transceiver station (BTS), it is considered a single tenancy. For every additional BTS the operator adds on the same tower, it pays only around 10-30% of the full tenancy cost.

In the case of multi-tenancy, the overall cost of tenancy isn’t simply split between the two operators. However, it does reduce cost by a few percentage points for each. This ensures that the costs for telcos reduce, while the tower provider earns more overall, even if it charges each tenant less.

According to various industry sources The Ken spoke with, single tenancy is, quite simply, untenable. It is only through multi-tenancy that tower companies start to turn a profit. In fact, as per a 2019 report by financial services firm Motilal Oswal, it takes 5-6 years for a tower to break-even at a tenancy ratio of 1.6. The report assumed a cost of Rs 25 lakh ($35,264) for ground-based towers.

The lack of multi-tenancy was never an issue for Jio because monetisation was an afterthought. The goal was dominance of the Indian telecom sector. “When RIL started building Jio, the towers were meant to be captive. Unlike other tower companies, the towers it built were leaner, thinner and lacked sturdy foundations,” said the senior industry executive quoted earlier in the copy. These towers can’t hold more than two tenants.

For the deal to be viable for Brookfield, it must reverse course and increase the tenancy ratio of Jio Infratel. Multi-tenancy, though, has been in decline. Ironically, due to Reliance Jio.

The death of multi-tenancy

Until three years ago, the tenancy ratio for major tower companies used to be more than 2. There were 10-11 telecom players in every circle, meaning enough demand to go around. That demand, however, shrank considerably once Reliance Jio entered the market.

Reliance Jio’s aggressive entry into the telecom sector—where it offered data at rock-bottom rates, forcing others to as well—ensured various smaller telcos couldn’t compete. They either went out of business or were swallowed up by larger players.

When the dust cleared, only a few were left—Vodafone India, Idea, Airtel and, of course, Jio. Vodafone India and Idea, once mighty telcos in their own right, would merge in 2018 in the hopes of survival.

This rapid and unrelenting consolidation has left tower companies struggling to maintain the tenancy ratios they once took for granted. Bharti Infratel is a good indicator of the effect this has had.

The tower provider has seen its revenue growth slowing year-on-year. While Bharti Infratel recorded revenue of Rs 6,618 crore (~$934 million) in the year ended March 2018, an 8.77% increase over the previous year, it recorded revenue of Rs 6,821 crore (~$962 million) in the year ended March 2019. This amounts to just a 3.06% improvement.

Bharti Infratel’s struggles come on the back of its inability to improve, or even maintain, its ratio of tenants to towers. Credit rating agency CRISIL notes that tenancies for the tower provider decreased from 89,263 in March 2017 to 76,341 in March 2019. Despite having two anchor tenants—Airtel and VIL—its tenancy ratio has dropped from a relatively comfortable 2.28 to a less manageable 1.89 over the same period. 

Sentimental market

Bharti Infratel’s share price has also plummeted due to the aggressive consolidation in the telecom operators market—from Rs 471 ($6.64) in June 2018 to Rs 248.5 ($3.5) on January 14, 2020.

Indus Towers, which has the same two tenants but more towers overall, has a tenancy ratio of 1.95. Analysts estimate that ATC’s tenancy ratio is around 1.3-1.5, while a senior ATC executive claimed this was closer to 1.7.

With VIL currently on life support thanks to mountains of debt and payments due to the government for spectrum fees as well as back taxes, tenancy ratios may only worsen.

If VIL’s situation were to worsen and it were to shut shop, there would be three major tower companies for two private operators and state-owned telco BSNL. In such a situation, while Bharti-Indus and Jio Infratel would remain compelled to stay the course due to their ties with the various telcos, ATC would be left with two choices. It would either have to acquire the Bharti-Indus combine to become the largest telecom tower company. Or, as an analyst says, it may exit the Indian market.

Multi-tenancy is the bedrock of the viability of the tower industry. With that gone, said a Mumbai-based analyst, there is no way the tower companies can make money in the current scenario. “Their bargaining power will be reduced,” the analyst said. 

Brookfield’s big challenge

None of this has deterred Brookfield. It has long-wanted to diversify its portfolio in India and add telecom assets. In 2017, it almost succeeded in buying the tower assets of now-defunct Reliance Communications, but the deal didn’t go through. So when RIL needed cheap capital, it was more than willing to lend a helping hand despite the current struggles of the tower space.

While Brookfield’s Pollock did play up the potential of Jio Infratel embracing multi-tenancy, he has also been careful not to hedge Brookfield’s plans for success to this. “In the Indian market, we’ve actually assumed a relatively modest level of co-location, just given the consolidation that’s gone on. But that could be where we could over-exceed our underwriting and hopefully do a lot better,” he said, during an investor call in 2019.

A source in the know of the agreement struck between Brookfield and RIL also says that the terms of the deal allow for the former to manage a decent return even through single tenancy. According to the source, the price per tower that Brookfield has managed is a clinching factor in this calculation.

Though the equity value of the Jio-Brookfield deal was Rs 25,215 crore (~$3.5 billion), the enterprise value of the same was pegged at Rs 55,400 crore (~$7.8 billion). For 130,000 towers, the acquisition cost per tower comes to around Rs 43 lakh ($60,648) in line with an earlier deal in the space. In 2018, ATC picked up 10,200 of Vodafone India’s standalone towers for Rs 3,800 crore (~$535 million). This works out to roughly Rs 37 lakh ($52,186) per tower. All told, the source quoted above said, Brookfield is hoping for an internal rate of return in the mid-teens, at par with similar private equity bets in infrastructure.

Crucially, Jio Infratel’s towers are also significantly more advanced than those bought by ATC. According to the source mentioned above, around 70% of Jio Infratel’s tower assets have an optical fibre backhaul, as opposed to just 25% of the towers held by other telecom providers. The Tower and Infrastructure Providers Association (TAIPA) estimates that only 31% of telecom towers in India have an optical fibre backhaul.

As India’s telecom operators increasingly gravitate towards 4G and, eventually, 5G, the business case to use Jio Infratel’s towers would be much stronger, said Tilak Raj Dua, director-general of industry body TAIPA.

The source in the know of the Brookfield-RIL deal also argues that the distribution of Jio Infratel’s tower sites played a major factor in piquing Brookfield’s interests. According to the source, the tower operator’s penetration into rural India will become an increasingly valuable asset as telecom operators move beyond urban centres. In such a scenario, Jio Infratel’s towers will become a natural magnet for multi-tenancy.

There will be other streams of revenue—such as adding WiFi equipment to towers or the opportunities that will arise from the government’s smart cities initiatives, for example—that could aid Brookfield’s cause. However, the source close to the RIL-Brookfield deal plays down the importance of these. Earnings from telecom operators, the source insists, will be far and away the biggest source of revenue, and multi-tenancy will be achieved within a year of the deal going through. If it executes on this, Brookfield may just prove its doubters wrong.

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