Tower deals THINKING TELECOMS SERIES

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1 THINKING TELECOMS SERIES Sydney Auckland Singapore London March 2014 Tower deals Towercos have emerged as key participants in the telecoms value chain in recent years, providing financial and operational benefits for mobile operators through the outsourcing of towers. At the same time, with stable, long-term cash flows, they have proven to be attractive investment vehicles, with listed towercos in the United States currently trading at many multiples higher than fully integrated telcos. In this note, we concentrate on tower deals between mobile operators (MNOs) and independent tower operators (towercos). Other variations on the theme are for MNOs to establish their own towerco, potentially with private equity investment and higher debt levels in the vehicle, and offer tenancies to other market participants. This provides potential for substantial upside for the MNO as the towerco develops its business and tenancy ratios and efficiencies increase. Alternatively, several MNOs could pool their tower assets and lease back to themselves, which then starts to look like a network sharing deal. In another note in this series, we go into more detail on the dynamics of network sharing between operators. Sale and leasebacks At a time when the need for cash to invest in new network infrastructure is growing, the prospect of monetising tower assets through sale and leaseback transactions with towercos is becoming increasingly appealing, in both developed and emerging markets. The purchase price for the tower assets will largely depend on the lease revenue that may be gained from the selling MNO as well as the potential for revenue from additional tenants. To this extent, the interrelationship between the purchase price for the tower assets and the lease revenue to be paid by the selling MNO is critical. It is often the sale price of the tower assets that grabs the headlines, but it is impossible to analyse one part of this transaction without considering the other. Of course, MNOs could potentially realise some of the benefits captured by towercos through leasing out space on their own towers, however this tends not to happen in the absence of a regulatory requirement. An independent towerco is highly motivated to develop and market its tower portfolio and its neutrality assists in attracting other tenants who may not wish to rent off competitor MNOs. In assessing the value of the tower assets, towercos will need to consider the overall state of the telecoms market. This will involve analysis of whether there is the potential for new MNO entry, the prospects for network expansion by MNOs (e.g., brought about by increasing 3G investment in emerging markets and 4G investment elsewhere), technology developments (e.g., smaller antenna or single RAN antenna), replacement of microwave transmission by fibre, prospects for new MNO business models (e.g., RAN sharing), regulatory rollout requirements, any tightening of environmental or planning laws, the potential for the towerco to expand the range of services offered (e.g., providing active equipment or power to users nearby) etc. The potential for additional tenants depends on the structural integrity of the towers and the available space on the towers.

2 Roof top towers can have limited collocation options as compared to ground based towers, however roof top towers are in high demand for collocation as they are typically located in dense urban areas where there is the greatest data usage. Roadway towers are also generally in high demand for collocation, as are towers in difficult geographic or conflict ridden areas in emerging markets due to limited ability and appetite of most towercos to build in these locations. To the extent that extensive refurbishment or strengthening of towers is necessary to achieve greater collocation revenues, then this will also be factored into the sale price. The sale transaction may include sites that will no longer be required on a going forward basis, e.g., because the towerco has another site in close proximity or the MNO no longer has a need for a site in that location. The towercos will then decommission the site and may be able to reuse tower assets in other locations. These rationalisation costs will factor in to the overall value of the transaction from the towerco s perspective. The transfer of operational staff will often be an aspect of the sale and purchase agreement. The MNO may require assurances from the towerco that a proportion of the operational staff will continue to be involved in providing the tower services to the MNO, particularly where the towerco is a new entity backed by a financial investor without the necessary experienced resource in the country. There can be difficult and intractable issues around land ownership and use in many emerging markets. For example, there may be an inadequate land registration system (difficult to identify the owner of the land), rights to use may not be properly documented or even legal, construction permits may not have been properly obtained, uncertain environmental and health and safety requirements the list goes on. Further, MNOs may not maintain accurate records of their tower portfolio GIS location of the sites, what is on them, what are the rental terms, access to electricity, construction permits, tower manufacturer s warranties etc. From the selling MNO s point of view, a well researched and prepared vendor due diligence report dealing with these issues will positively impact on the value of the portfolio. This will usually be time consuming and often costly to prepare and needs to be factored in to the whole process. Given the sheer scale of the assets to be transferred, completion can be a drawn out affair and may take place in phases. To address title uncertainty, there can be a need for a mechanism of control over the site concerned by towerco to enable them to provide tower services to the MNO, with a reversal procedure if title cannot be transferred within a certain period post-completion. The interrelationship with the leaseback arrangements will be important here, so the phasing and potential reversal process will need to be addressed in the associated master lease agreement. Other factors to bear in mind include local laws which may require local ownership of entities that construct, own or operate towers (e.g. Indonesia) and licensing requirements for towercos in some markets (e.g. Myanmar). Build to suit agreements Build to suit agreements are commonly associated with a sale and leaseback of tower assets, as the initial sale will give a towerco an immediate scale that will deliver efficiencies in the construction and operational phases. Under a build to suit agreement, the towerco agrees to develop and build a certain number of sites required by the MNO, who will then be an anchor tenant on those sites. These arrangements can be necessary in emerging markets, where rollout is still to be completed, or in developed markets where greater cell site density is driving the need for new sites. Build to suit moves the execution risk onto the towerco and removes the future capex and opex associated with building and operating the towers from the MNO. The towerco invests its own capital into infrastructure that the MNO needs, it provides roll-out commitments, procures construction materials (which may need to be imported) and provides expert resource to obtain land use consents and approvals that are required for the build. Towercos present other benefits as well, through specialised tower management expertise. They are often superior to MNOs at obtaining the relevant building permits, materials and contractors more cost effectively (due at least in part to the fact that MNOs are deemed to have deeper pockets) and towercos can be quicker than MNOs at acquiring and building sites. This can provide additional speed to market and efficiency gains for MNOs.

3 As an anchor tenant on the new site, the MNO benefits in two ways. The MNO has the right to claim its preferred position on the site, as well as dictating the requirements for the design of the site and tower infrastructure. For some MNOs, depending on the technology that they use, it may be necessary to have the highest position on the tower, so there is a premium for them in this priority right. This also means that larger and higher towers can be necessary for these operators. Towercos have differing pricing schemes. Many use a standard rate that all MNOs will pay, regardless of whether they are the anchor MNO. However, there is often a collocation discount for the anchor MNO, which may be a percentage of the second tenant s rental or a fixed amount to be deducted from the anchor MNO s lease rate. Similar, but smaller discounts (normally fixed amounts) may be available for subsequent tenants. However, second or subsequent tenants do not usually receive a collocation discount, so anchor tenants benefit from additional tenants and can therefore have a long term lower cost than other operators that use the sites. Towercos may try and exclude minor tower users, such as WiMax operators, in determining whether a collocation discount is payable. Volume discount arrangements are also a feature of the market. To provide scale economies for the towerco, it will usually be necessary to have a minimum order of build to suit sites, potentially down to regional level so the towerco can localise their construction and field work forces. From the MNO s point of view, they will be concerned to ensure the rollout timetable aligns with the schedule for active equipment rollout on their network. There is a fairly common build to suit procedure that involves site identification and acceptance, construction and approval and site readiness. These provisions in the build to suit agreement are normally detailed and are designed to standardise a process that will be repeated many times. The land issues mentioned above come strongly into play with build to suit agreements. It can be difficult to establish who the owner of the land is and who is entitled to grant the ground lease. Or an immature consenting system can give rise to considerable uncertainties. If the towerco encounters problems in obtaining good title and relevant consents and approvals, the master lease agreement may allow the MNO to nonetheless require the towerco to proceed with developing and building the site. The consequences of proceeding on this basis can be that any tower build may subsequently be injuncted or at worst a tower and all other equipment will need to be removed from the site until the problem is rectified. How the parties allocate the risks of these consequences can be nuanced. Issues of title and consents are best managed by the towerco, but once identified and disclosed to the MNO, it may be argued that the risk shifts to the MNO. In practice, a risk sharing approach is often adopted in these cases. Critical sites, such as hub sites, are often left out of build to suit deals, due to the size and loading requirements of these larger and stronger towers. This means that a self build by an MNO can be more economic than leasing from a towerco. Leases generally Master lease agreements (MLAs) are long and detailed agreements as a rule. They are long term and need to deal with changes brought about by the dynamic nature of the mobile sector, but also to ensure that a towerco can effectively and efficiently exploit collocation opportunities. In this final section of the note, we outline some of the key provisions that are included in MLAs. Leased space Towers can be ground based or rooftop, and may include monopoles or guyed-mast towers or other structures that are designed to support communications equipment. In most cases, tower space is defined as a band around the circumference of a tower, with a certain height and with the centreline of the band being a number of vertical meters off the ground or from the top of the tower. The bands will usually be different for sectoral antennas as compared to microwave antenna. The MNOs entitlement is normally limited to antenna with a windload equivalent to a certain surface area (sqm), as windload drives the overall structural integrity of the tower. The cables, cable trays and other mounting equipment are usually taken into account in this calculation. The entitlement may also be limited in number and size of antennas (e.g., 3 sectoral antennas and 2 microwave antennas) and number and size of cables. The microwave antenna will be above the sectoral antenna on the tower, often towards the top. The tenant will have rights to use a certain area of usable ground space on the site (sqm) for installation of its equipment, which may be described in terms of the configuration of the area. The lease (legally, a licence to occupy in most countries) comprises the tower, the land and all easements and other access rights to the land, shelters and power and cooling facilities. The tenant will also have the right to place antenna feeder cables on the tower, bring any utility and transmission lines to the site and often to install additional equipment such as remote radio units and tower-top BTS.

4 Ground leases The terms of the ground lease will normally prevail over the MLA terms applicable to the site and the MNO will be required to comply with the operational obligations in the ground lease relevant to them as a tenant on the tower. In cases where the towerco agrees a shorter term with the landlord, the towerco will normally be required to use reasonable endeavours to agree an extension or renewal of the ground lease, so that its term does not expire before the site lease. The MLA will provide for the potential that the extension or renewal requires a rental increase under the ground lease and often this rental increase will be shared between the tenant (and other tenants) and the towerco in some agreed proportion. If the ground lease expires before the site lease term, then the MNO will normally have a range of rights available to it. For example, the MNO may be able to relocate to an equivalent towerco site, or towerco may be required to procure an equivalent site from a third party or build a new site. In these cases, then rental should be approximately the same as the rental for the original site and the transfer costs are typically borne by the towerco. Site lease term As a general rule, towercos can only finance equity and debt on the anchor tenant (and any other committed tenants). Towerco debt financing arrangements may be for five to eight year tenors in the current market, depending on the size and maturity of the tower portfolio and whether the debt structure has recourse provisions. This drives the need for longer term MLAs, with ten year contracts being typical, but can go out to 15 years, often with an automatic right of renewal unless the MNO notifies the towerco otherwise (with the renewal rental agreed at the time of the MLA). Because MNOs are faced with high switching costs at the end of lease terms, high renewal rates are commonplace. Relocation rights MNOs may have rights, in certain cases (e.g., where the MNO is entitled to terminate), to require the towerco to provide an alternative site with similar characteristics (height, area, site topography, customer demographics etc) to the original site. Or, alternatively, if the MNO does not require relocation in these circumstances, and would rather simply terminate, the towerco may seek the right to require the MNO s relocation to such an alternative site. Where relocation is to occur, the towerco may be required to provide a temporary mobile tower (e.g., a non-penetrating temporary tower) to ensure interruption of services is minimised. It should be borne in mind that it is expensive to deinstall and then reinstall equipment and sometimes different (lighter) equipment is required for temporary sites. There are different approaches to MNOs having a discretionary right to relocate to an alternative site. If discretionary relocation is allowed, these rights are normally limited to a set number of towers in a given period. Typically, if there is a right, the MNO will bear the relocation costs. MNOs value this right, as network planning may not be totally accurate and the site may be in the wrong location, or there may be a major change in the population covered by the site for various reasons. The MNO effectively pays for this right, however, through a higher lease charge, as the towerco needs to provide for the risk of a stranded asset. Alternatively, any site lease cancellations are payable at the present value of the remaining site lease term. Network sharing MLA s need to address circumstances where an MNO wishes to engage in network sharing with other operators. Active network sharing among operators, where multiple operators share the same sectoral or microwave antenna, deprives the towerco of an actual or potential revenue stream. Terms are normally included in MLAs to deal with this type of network sharing. These arrangements may be banned outright with respect to the sites, or allowed, but with a rental uplift that is somewhere between the rental for one and for two tenants. The MLA may also contemplate site sharing, so that the MNO can require that its sharing partner can lease site space (if available) on the same terms, but normally this right does not expand the load that may be placed on the tower. The MLA should also address sub-contracting of transmission to a third party, which would effectively require a sub-lease to that third party, or a swap out, for the purposes of providing those transmission services.

5 Exit rights Exit at the end of a site lease can be a very difficult issue at the best of times. Tightening restrictions in granting building permits can create effective local monopolies for towercos. This puts the MNO in an unenviable position at the end of the site lease term. These risks can be mitigated through an open and competitive towerco market, which the MNO can stimulate itself through entering into MLAs with multiple towercos, ideally with each towerco having operations in the same regions to allow for diversity. Alternatively, or as well, it may be appropriate to include a buy-back right for tower sites at the end of the site lease term. This will normally be heavily resisted by towercos, but the right may depend on the reason for the expiry of the site lease (e.g., termination as a result of breach by the towerco, as compared to normal expiry of the lease term). Otherwise, it will be necessary to have a well managed exit plan that provides for vacation of the sites when alternative sites are available to the MNO (which may require building its own site). Webb Henderson is an international law firm, with a specialist focus in the telecommunications sector. We have nine partners and 25 other legal staff in our offices in Sydney, Auckland, Singapore and London. Our telecommunications work spans complex corporate, commercial and regulatory matters for operators, investors, governments and regulators around the world. Over the last year, we have operated in over 25 countries throughout the Asia Pacific, Middle East, Africa, Europe and Latin America. Our partners are among the most respected practitioners in the field internationally. Webb Henderson has extensive experience in advising operators and towercos on tower deals in a number of jurisdictions in the Asia Pacific and Middle East. Contacts Malcolm Webb Angus Henderson Ara Margossian Anisha Travis Direct: Mobile: [email protected] Direct: Mobile: [email protected] Direct: Mobile: [email protected] Direct: [email protected] Level 18, 420 George Street, Sydney NSW 2000, Australia Level 3, 110 Customs Street West, Auckland 1010, New Zealand 8 Eu Tong Sen Street, #23-85 The Central, Singapore , Singapore Parchment House, 13 Northburgh Street, London EC1V 0JP, United Kingdom