Telco delayering: where might it take us?

1 November 2024

‘Delayering’ – the separation of telecoms business into their infrastructure and service components – is becoming increasingly popular. Countless mobile operators have carved out their towers, snapped up by the likes of Cellnex and Tawal, whilst Telecom Italia is the latest example of a fixed operator selling its network. With more telcos opting for vertical disintegration, the question arises: where might this lead?

The case for delayering is compelling

Delayering creates much needed financial breathing room for telcos. Calving out fibre, towers and data centres into an InfraCo and selling a stake generates cash, helping to manage rising debt or develop new income streams. The rising cost of capital can also be offset by separating the infrastructure business, which becomes an attractive target for capital seeking lower risk investments.

Delayering can also improve operational efficiency. ServCo and InfraCo often have minimal shared fixed costs, and independent management allows each to pursue growth through more tailored strategies.

The immediate effects are appealing, particularly in a sector struggling for profitability. A leaner business model combined with new resources for innovation can be a welcome development for shareholders.

Define the ‘layers’

There is not just one way to ‘delayer’ a telecoms business. The number of layers and the division of assets across them can vary significantly.

For mobile operators, a common model is to separate the passive infrastructure (towers) into a TowerCo, while the active network remains within the ServCo. Vodafone’s creation of Vantage Towers in Spain and other countries is just one example of this model.

Other models also exist. Danish telecom TDC, for example, split into TDC Net and Nuuday, with TDC Net retaining both passive infrastructure (ducts, fibre, and towers) and active networks (e.g. Radio Access Network).

Both approaches have their merits, and there is even an argument for creating a third “NetCo” layer to house the active network separately from both InfraCo and ServCo. With distinct investment cycles and risk profiles, the passive infrastructure, active network, and retail business each appeal to different types of investors.

Long-term risks

However, delayering introduces long-term challenges as it transforms communications infrastructure into a distinct market. The potential risks are threefold:

• Independent InfraCos could make deals with new entrants, reducing barriers to entry and intensifying competition in an already crowded service market.
• An independent infrastructure market may also lead to commoditisation of coverage amongst ServCos, shifting the focus of competition towards brand and price.
• While delayering deals typically include substantial ‘lock-in’ periods – which dictate long-term pricing between ServCos and InfraCos – these will expire. When that happens, ServCos could find themselves dependent on a concentrated supplier base.

Examining this last point, the telecoms infrastructure market, like most infrastructure sectors, naturally tends toward high concentration. Duplicate networks are economically inefficient and consolidation facilitates the returns expected by infrastructure funds.

InfraCos will argue that consolidation will drive efficiencies, ultimately benefiting customers. Consolidated TowerCos will be able to improve coverage, secure favourable supplier deals, and create a modern, efficient infrastructure.

The crucial role of lock-ins

The ‘lock-in’ is therefore a crucial consideration. ServCos may in theory benefit from the flexibility that a dynamic infrastructure market provides. However, with likely consolidation, locking-in long-term deals may be attractive. However, such lock-ins entrench the duplication of infrastructure between telcos, which may otherwise be eliminated through other mechanisms such as network sharing.

So, as these lock-in agreements approach expiry, what are ServCos to do?

In Spain, Vodafone Zegona’s response has been to renegotiate before their supplier base consolidates. With Vantage considering the sale of its Spanish towers and other TowerCos as potential buyers, Vodafone Zegona has threatened to switch providers unless it secures more favourable rates. Its leverage depends on the feasibility of moving to alternative suppliers’ towers, but clearly, its bargaining position would weaken if Vantage’s towers were acquired by a competitor.

Another option for ServCos is to consolidate with each other. By merging or forming network-sharing agreements (where they retain the active network), ServCos can eliminate duplicate demand for towers. This would allow ServCos to create competition among InfraCos, choosing whose infrastructure to stay with and whose to leave.

A race toward consolidation

This logically leads to a race for consolidation within both the ServCo and InfraCos markets as lock-in periods approach expiry. The relative competitive intensity between these two ‘layers’ will likely shape the balance of negotiating power in the post-lock-in world. Meanwhile, with such strong incentives for consolidation, competition authorities will be watching closely.

Ultimately, delayering offers a route for telecoms to unlock value, but it comes with strategic and competitive trade-offs that will shape the industry for years to come.