Telecom Industry: M&A Strategy to drive digital business models by EY India

Telecommunications

Capital Confidence Barometer

November 2016 | ey.com/ccb/telecommunications | 15th edition

Telecommunications companies sharpen M&A focus in the drive towards digital business models

Telecommunications highlights Telecom

Global

48% 57% expect to actively pursue acquisitions in the next 12 months

Telecom

Global

71% 52% indicate that acquiring talent is the most important or second most important strategic driver for pursuing an acquisition outside their sector

Telecom

Global

43% 34% say that the impact of digital technology on their business model is the most prominent issue on the boardroom agenda

Telecom

Global

37% 49% have five or more deals in the pipeline

Telecom

Global

49% 46% cite sector convergence and increases in competition from companies in other sectors as the biggest disruptor to their core business

Telecom

Global

67% 71% are shifting skills and talent within the business to gain efficiencies from greater automation

Digital disruption and the talent agenda drive corporate strategy and deal intentions Sector convergence and advances in technology and digitalization are altering the telecommunications landscape.

As companies seek to adapt and excel by reimagining business models and making the most of innovation and automation, talent has become a key priority to drive both the corporate strategy and deal intentions, according to the most recent edition of the Capital Confidence Barometer.

Positioning for convergence is driving a number of highprofile deals, such as AT&T’s announced acquisition of Time Warner, yet smaller deals that can fill gaps in portfolios or provide innovative assets or people are also moving into focus as companies look to overhaul their business models. In this light, a number of carriers are pursuing “bolt-on” acquisitions in areas such as the Internet of Things (IoT) and over-the-top (OTT) video services.

Deal intentions bounce back As deal intentions rebound from six months ago, 48% of telecommunications executives indicate that they are actively pursuing a merger or acquisition in the next 12 months. Deal fundamentals support this surging confidence with executives feeling stable or positive in their confidence about the number of acquisitions and the likelihood of closing. This confidence bears out in the number of deals telecommunications companies have on the go, with 37% indicating that they have five or more deals in the pipeline.

Telecommunications companies look to win the war for talent As telecommunications companies react to the digital disruption that has upended business models across the industry, acquiring talent has become the most significant strategic driver for pursuing acquisitions outside of their own sector.

Talent is also top of mind as a business imperative as companies look to reskill workers and shift skills and talent within the business to gain efficiencies from greater automation. This is particularly important given that a third of telecommunications respondents indicate that the prior investments they’ve made in automation have not proven to have been as successful as they would have liked. As well, in a move that defies popular perception, increasing automation and technological advances have telecommunications companies creating more new jobs rather than reducing headcount.

As telecommunications companies seek to reinvent themselves to compete in a digital world, they are considering deals that not only bring them to the forefront of technology and innovation, but also acquiring the talent they’ll need to get there.

Gaeron McClure Global Telecommunications Leader Transaction Advisory Services

Capital Confidence Barometer |

1

Macroeconomic environment

Telecommunications executives offer a more tempered economic outlook, but market fundamentals remain strong Political stability and currency volatility, largely a result of the UK’s decision to leave the European Union (Brexit) and the US 2016 election cycle, combined with slowdown in global trade flows,

have telecommunications companies feeling less optimistic than six months ago. A feeling of stability remains for the majority of respondents (51%), but a feeling of modest decline is on the rise.

Telecommunications

51+49+M 31+69+M

Global

51%

see the state of the global economy today as stable

31%

believe high volatility in currencies and commodities to be the greatest economic risk to their M&A strategy in the next 12 months

Despite a more tempered economic outlook, economic fundamentals appeared to have rebounded somewhat, with the exception of equity valuations. Telecommunications companies are feeling more positive about corporate earnings and short-term market stability, and about the same concerning equity valuations.

38+62+M 2

|  Capital Confidence Barometer

32%

However, their confidence in credit availability has dipped from six months ago, and lags behind the sentiment of their global counterparts. Credit availability concerns may be influenced by the continuation of quantitative easing, particularly by the European Central Bank, and by the timing and tone of the US elections.

Telecommunications

38%

54+46+M 32+68+M 54%

have a positive level of confidence in credit availability

Global

41+59+M 41%

Corporate strategy

Telecommunication companies are looking at organic and inorganic opportunities to boost growth and earnings Sector convergence and increasing competition from companies in other sectors, combined with advances in technology and digitalization are disrupting business models across the

telecommunications landscape. Industry regulation adds another layer of complexity in a fast-changing, yet already highly regulated environment.

Telecommunications

22+78+M 34+66+M 43+57+M 22%

see sector convergence as the greatest disruptor to their core business

34%

identify advances in technology and digitalization as having the second most meaningful disruptive impact on the core business

43%

say the impact of digital technology on their business model is the top issue on the boardroom agenda

Global

23+77+M 34+66+M 34+66+M 23%

34%

34%

Fifty-nine percent of executives indicate they are seeking organic routes to higher earnings as acquisition opportunities prove more scarce.

Capital Confidence Barometer  |

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Corporate strategy

Telecommunication companies are looking at organic and inorganic opportunities to boost growth and earnings (continued) Fifty-nine percent of executives indicate they are seeking organic routes to higher earnings as acquisition opportunities prove more scarce. Another 41% are turning to a mix of buying and partnering to take advantage of a shifting tide across the industry, although alliances have fallen short of expectations, having not produced the returns companies had anticipated. That said, telecommunications companies know that alliances are key to their success as the IoT, robotics and automation become crucial to delivering growth.

In terms of boardroom priorities, the impact of digital technologies on the business model tops the list for 43% of respondents, with sector convergence and increased competition ranking as the second most important, as new entrants from outside the sector drive the need to find new ways to thrive in a broader, more dynamic, more complex world.

The talent agenda takes center stage Talent has become a key issue as digital disruption takes center stage, with 67% of telecommunications executives indicating that they need to shift skill sets and talent within their business to gain efficiencies from greater automation. Further, contrary to popular

perception, automation and technology appear to be creating more jobs than fewer, with 53% of telecommunications executives saying that they need to hire more talent in the months ahead.

Telecommunications

67+33+M 29+71+M 67%

say they need to shift skills sets and talent within their business to gain efficiencies from greater automation

29%

suggest that they are still duplicating automated and non-automated processes

Global

71+29+M 25+75+M 71%

25%

Contrary to popular perception, automation and technology appear to be creating more jobs than fewer, with 53% of telecommunications executives saying that they need to hire more talent in the months ahead.

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|  Capital Confidence Barometer

M&A outlook

Deal intentions rebound, remaining above historical averages Deal fundamentals support a more positive outlook with executives feeling good about the number of acquisitions and offer stable confidence in the likelihood of closing acquisitions. In terms of the quality of acquisitions available, executives still feel good, but are slightly less optimistic than they were six months ago.

Up five percentage points from six months ago, deal intentions have rebounded somewhat and remain above historical averages as telecommunications executives expect the M&A market to remain stable in the next 12 months.

57%

56%

Expectations to pursue an acquisition

53%

59%

45% 41%

41%

39%

41%

39%

40%

43%

49%

48%

38% 35%

27%

33%

57%

Capital Confidence Barometer average 42%

36% 40%

38%

50%

50%

29%

31%

30%

25% Apr

Oct 2010

Apr

Oct 2011

Apr

Oct 2012

Apr

Oct

Apr

2013 Telecommunications

Oct 2014

Apr

Oct

Apr

2015

Oct 2016

Global

Deal pipelines surge, with a focus on innovative technologies and emerging assets While in-market convergence and consolidation remain key drivers of sector M&A — witness megadeals such as AT&T/Time Warner — many telecommunications companies are turning their attention to smaller deals and more of them to help fill gaps in existing portfolios and acquire emerging assets that boost innovation and competitive advantage. Up from 17% six months ago, 37%

of telecommunications respondents indicate that they have five or more deals in the pipeline, almost half of which are valued at US$250m or less. Executives are also feeling more positive about deal completions with 40% looking to close three or more deals in the next 12 months.

Telecommunications

37+63+M 49+51+M 37%

have five or more deals in the pipeline

49%

are looking at deal sizes of US$250m or less

Global

49+51+M 42+58+M 49%

42%

Capital Confidence Barometer |

5

M&A outlook

Talent tops the list of strategic drivers for acquiring outside the sector As companies look outside their sector to address digital disruption and a rapidly changing industry landscape, they are zeroing in on talent as their number one priority when it comes to dealmaking outside their sector. Twenty-nine percent of telecommunications

executives indicate that acquiring talent is their most and second most strategic driver for pursuing an acquisition. New product or service innovation also tops the list, along with access to differentiated customers, and access to new technologies.

Telecommunications

71+29+M 33+67+M 71%

Global

rank acquiring talent as either the most important or second-most important strategic driver for an acquisition outside their own sector

When it comes to M&A within the sector, growing market share surfaces as the most important factor, suggesting the importance of market dominance within a geography as a means to remain

competitive. Reacting to customer behavior ranks as second most important.

Telecommunications

34%

52+48+M 23+77+M 52%

see growing market share as the primary strategic driver for pursuing acquisitions in their current sector

Global

23%

Twenty-nine per cent of telecommunications executives indicate that acquiring talent is the most important strategic driver for pursuing an acquisition outside their own sector.

6

|  Capital Confidence Barometer

M&A outlook

Start-up opportunities make emerging markets attractive for buyers

While the US and Canada remain top destinations for acquisitions in the coming months, the UK has fallen out of favor as Brexit concerns make investors cautious. In emerging markets, the vibrancy of the start-up market makes China and South Korea attractive options for M&A activity.

Top five investment destinations Global

Telecommunications

1

United States

United States

2

China

China

3

Germany

Canada

4

Canada

South Korea

5

France

Japan

Valuation and regulations have investors and boards scrutinizing deals As the gap between buyers and sellers creeps higher, with 49% of telecommunications executives indicating that they expect the valuation gap to be somewhat higher in the next 12 months, investors and boards are being more cautious in approving potential deals.

In the past 12 months, 95% of telecommunications respondents say that they have canceled or failed to complete a planned acquisition. Thirty percent say that investor or board scrutiny killed the deal; 25% suggest the gap between buyer and seller was too wide. For 31%, economic or political instability was the second most important reason for a deal not going through.

Telecommunications

49+51+M 30+70+M 49%

see the valuation gap between buyers and sellers as somewhat higher (10% to 25%)

30%

cite investor or board scrutiny as the reason they failed to complete an acquisition

Global

56+44+M 19+81+M 56%

19%

Capital Confidence Barometer  |

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M&A outlook

Valuation and regulations have investors and boards scrutinizing deals (continued) As for the reason a deal does not meet expectations, almost half (47%) cited poor identification and quantification of synergies.

The level of preparation and readiness of key functions and stakeholders is key to a successful integration. Executives must be

realistic about potential negative synergies, including customers who may be unable to continue their relationships with the new entity, additional regulatory costs or underfunded pension obligations.

Telecommunications

47+53+M 47%

cite poor identification and quantification of synergies as the reason a deal didn’t meet expectations

Global

39+61+M

About this survey The Global Capital Confidence Barometer gauges corporate confidence in the economic outlook and identifies boardroom trends and practices in the way companies manage their Capital Agendas — EY’s framework for strategically managing capital.

The Barometer is a regular survey of senior executives from large companies around the world, conducted by the Economist Intelligence Unit (EIU). Our panel comprises selected global EY clients and contacts and regular EIU contributors.

• In August and September, we surveyed a panel of more than 1,700 executives in 45 countries. Nearly 50% were CEOs, CFOs and other C-level executives.

• Respondents represented 18 sectors, including financial services, consumer products and retail, technology, life sciences, automotive and transportation, oil and gas, power and utilities, mining and metals, diversified industrial products, and construction and real estate.

• Surveyed companies’ annual global revenues were as follows: less than US$500m (18%); US$500m— US$999.9m (24%); US$1b—US$2.9b (17%); US$3b—US$4.9b (17%); and greater than US$5b (24%).

• Global company ownership was as follows: publicly listed (66%), privately owned (30%), family-owned (2%) and government/state-owned (2%).

8

| Capital Confidence Barometer

39%

Telecommunications contacts For a conversation about your capital strategy, please contact: Prashant Singhal Global Telecommunications Sector Leader Ernst & Young Private Ltd. (EYPL) +91 124 671 4746 prashant.singhal@in.ey.com

Gaeron McClure Global Telecommunications Leader Transaction Advisory Services Ernst & Young LLP gaeron.mcclure@ey.com +1 212 773 9988

Adrian Baschnonga Global Telecommunications Lead Analyst Ernst & Young LLP +44 20 7951 1724 abaschnonga@uk.ey.com

Global contacts For a conversation about your capital strategy, please contact us: Global

Americas

Japan

Steve Krouskos EY Global Vice Chair Transaction Advisory Services steve.krouskos@uk.ey.com +44 20 7980 0346 Follow me on Twitter: @SteveKrouskos

William M. Casey EY Americas Vice Chair Transaction Advisory Services william.casey@ey.com +1 212 773 0058

Vince Smith EY Japan Leader Transaction Advisory Services vince.smith@jp.ey.com +81 3 4582 6523

Julie Hood EY Deputy Global Vice Chair Transaction Advisory Services julie.hood@uk.ey.com +44 20 7980 0327 Follow me on Twitter: @JulieHood

Harsha Basnayake EY Asia-Pacific Leader Transaction Advisory Services harsha.basnayake@sg.ey.com +65 6309 6741

Barry Perkins EY Global Lead Analyst Transaction Advisory Services bperkins@uk.ey.com +44 20 7951 4528

Asia-Pacific

Europe, Middle East, India and Africa (EMEIA) Andrea Guerzoni EY EMEIA Leader Transaction Advisory Services andrea.guerzoni@it.ey.com +39 028 066 3707

Capital Confidence Barometer |

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How EY’s Global Telecommunications Sector can help your business Telecommunications operators are facing a rapidly transforming business model. Competition from technology companies is creating challenges around customer ownership. Service innovation, pricing pressures and network capacity are intensifying scrutiny of the return on investments. In addition, regulatory pressures and shareholder expectations require agility and cost efficiency. If you are facing these challenges, we can provide a sector-based perspective on addressing your assurance, advisory, transaction and tax needs. Our Global Telecommunications Sector is a virtual hub that brings together people, cultures and leading ideas from across the world.

Whatever your need, we can help you improve the performance of your business. Š 2016 EYGM Limited.

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EYG no. 04035-164Gbl ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice.

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