Title: TDCs Uncertain Future Under New Owners
1TDCs Uncertain Future Under New Owners
- Professor William Melody
- CICT Policy Conference
- Implications of Private Equity Ownership of
Information Infrastructure - The Case of TDC
- 13 October 2006
- CICT/COM
- Technical University of Denmark (DTU)
2Private Equity Ownership (PEO)
- Increasing vehicle of investment in several
industries - It began in the US in 1980s in general industry
and in the 1990s has spread to Europe and to
telecom, and infrastructure industry - Private finance firms use a relatively small
amount of their own funds and the assets of the
target company as security for loans to buy the
equity shares of the target company called a
leverage buyout - After the purchase, the debt incurred is an
obligation of the target company, increasing its
debt/equity ratio dramatically
3Why Do They Do It?
- An opportunity to unlock capital not being used
productively in the target company and paying out
that which can be converted to cash in the
short-run - An opportunity to reap substantial short-term
returns by radically increasing debt and
financial risk - PEOs sell off the target companies as soon as
the unlocked capital can be cashed out
generally within 5 years of takeover - PEO is not ownership to invest in the long-term
growth of the company, but rather to disinvest by
removing capital and selling the residual company
4How Do They Do It?
- By dramatically changing the financial structure
of the company increased debt/equity ratio - By examining all assets and activities for
possibilities of freeing up cash for distribution - Withdrawing capital as cash payments for
financial services fees and returns of capital to
new owners - By removing transparency and accountability so
regulators, tax authorities, politicians and the
public are unable to scrutinize the changes
introduced and the amounts of cash removed from
the company
5Divergent Views on PEO Based on Experience
- It increases competition in the financial
management of companies, forces managements to
adopt more efficient financial practices, and
frees up capital to be reinvested elsewhere in
the economy - It makes management more directly accountable to
owners than widespread public stock ownership - Barbarians at the Gates. Vultures that raid
the treasury of good companies, remove capital
needed for investment in long-term growth, and
leave the company laden with excessive debt,
unacceptable financial risk and little ability to
invest for expansion. - It is financial manipulation that bypasses
regulation, avoids taxes and public scrutiny and
needs to be brought in line with other forms of
financial regulation.
6Research on PEO Experience
- Some evidence of companies doing well thereafter
- Some evidence of companies doing poorly
- Almost universal evidence that financial gains in
fees and capital payments have provided
outstanding returns - The transactions costs of making the changes in
financial structure are high. Do these represent
the efficiency of unlocked capital or the
inefficiency of unnecessary costs associated with
the transfer of capital out of companies?
7Characteristics of Good Target Companies?
- Highly inefficient financing structures
- Generate a large and stable cash flow
- Compliant management and board
- Significant monopoly power in their industry
8The Dilemma for Management of Takeover Targets
- Resistance invites PEO criticism and loss of job
if hostile takeover is successful - Co-operation offers rewards far exceeding normal
pay - Perverse incentive is created for management and
its financial advisors to establish an
inefficient financing structure to invite PEO
takeover and greater rewards them
9TDC as a Takeover Target
- Significant monopoly power over telecom and cable
facilities and most services - Controls public resources as highly undervalued
assets rights of way, spectrum, telephone
numbers - Generates exceptionally large, stable cash flow
- Compliant management and board
- Highly inefficient financing structure????
10TDCs Financing Structure
- According to TDC annual reports, its financial
advisors and auditors, it has had an optimal
financing structure - The Annual Report for 2005 describes how TDC uses
the latest techniques and expert advice in
carefully managing all elements of financial risk
and costs
11The Financing Structure Contradiction
- TDCs financial structure before the takeover
(about 1/3 debt), and after the takeover (more
than 3/4 debt) cannot both be optimal - Either the old structure was extremely
inefficient, or the new one imposes unacceptable
risks and constraints on future growth. - How can TDC management and its financial advisors
support both scenarios?
12Evidence on Efficiency of TDC Financing
Structure
- TDCs capital structure is comparable to many
other European incumbent telecom operators - When some European incumbent telcos acquired debt
mountains with their 3G spectrum bids, investment
rates were reduced significantly until they could
reduce interest obligations, improve their
credit ratings and reduce their interest rates - TDCs credit ratings have been down-graded
several times since the takeover. - Evidence suggests that the old capital structure
is closer to an optimal financing structure for
TDC than the new one imposed by the PEO
13Infrastructure Operators as PEO Targets
- Good cash generators from large long-term
investments in network assets - Stable client base and significant monopoly power
- Undervalued public resources
- Lower business risk than general industry
- Conservatively managed
- Subject to special sector regulation and public
policy direction, but not usually on financing
policy - Public responsibilities can be avoided in the
short-run - Negative effects of reduced investment in
infrastructure unlikely to have significant
effect on earnings and cash flow in the short run
14Assessing TDC as Infrastructure Operator under
PEO Management
- The differences between the short-run financial
interest of the PEO (divestment) and the Danish
public interest in continued long-term investment
in an upgraded broadband infrastructure for the
future Danish economy are far greater than for
general industry, and are likely to have far
greater repercussions - One cannot pretend that a major divestment of
capital and adoption of a debt mountain wont
have a negative impact on the both financing
costs and future investment possibilities of TDC
15TDC and Public Interest Regulation
- As TDC and other major infrastructure operators
represent a special class of industry, long ago
called business affected with a public
interest, PEO takeovers should be subject to
public interest monitoring, in the same manner as
key infrastructure operators have been in the
past, and in some countries still are, by
infrastructure regulatory authorities.
16Recommendations for TDC Public Interest
Regulation
- Transparency is essential for businesses affected
with a public interest. The reporting and
accountability requirements of public
infrastructure operators should be imposed.
These derive from the public interest of the
activity, not the ownership structure. - Non-arms length transactions involving
significant amounts should be approved as
reasonable by the appropriate financial or
telecom regulatory authority - ITST (telecom regulator) powers over TDC should
be strengthened to require monitoring and
reporting of infrastructure investment and
services development in the sector, and direct
regulation over prices and quality of services
where TDC has significant market power under the
new European Regulatory Framework.