Inside the data explosion and the consequent hoovering up of capital

This special podcast is brought to you by RMB.

Capital is cowardly, only going where it is welcome and safe. It is also very smart, automatically seeking out the highest returns by flowing to areas of the economy where growth is fastest and most sustainable.

As we become increasingly connected in the Internet age, demand for data is likely to keep growing for many years to come. Keith Webb, an Investment Banker at RMB Infrastructure Finance has had a close look at this explosion in demand – and the sector’s consequent hoovering up of capital.

Most of the data demand is generated by the increased use of mobile phones – Keith shares some background.

Obviously, there’s a reduction in voice traffic as people are moving more towards data as a means of communication. The two macro drivers for the increase in data usage are the increasing number of subscribers that are moving to smart phones (devices which are more capable of uploading and downloading data), and the vast range of data-driven applications that one can download onto these devices. We expect a continued exponential growth in data traffic going forward.

Which serves the industry with quite a challenge as to how to keep up from an infrastructure perspective.

Absolutely. It’s a case of the more cars there are on the highways, the more highways are needed. I guess, that’s where the industry is moving. You’ve got to continually invest in your networks to handle the increased volume of data. That’s going to become a challenge, particularly where consumers are expecting the price of this data not to go up to recover their investment, but to come down to make it cheaper and easier to use.

Keith Webb, RMB

Before we get into how the infrastructure is going to be funded, what does the runway look like, particularly in South Africa and perhaps other parts of Africa on the usage of data?

As I’ve mentioned earlier, I still foresee (and the industry projects) continuous exponential growth in data. Every time you look, there’s another application that’s suddenly useful. All of us are to an extend to blame because these are useful applications. Remember the days when it was difficult to send a 1Mb file via email? Now, one can happily send a 100Mb video link across to your friend.

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YouTube, Facebook and then of course, Google Maps is something that I use all the time (CityMapper). The list goes on and on – our lives are being changed by these very useful inventions.

Absolutely. It’s about volume (large files) and the immediacy of it. When one is for instance using a Google Maps application and you don’t get an immediate response (in other words, you’re not getting data at a higher speed) you will naturally be disappointed. It would then make sense to rather switch that application off. So, I suppose the volume and the speed elements are here to stay.

How is all of this going to be built? How are these fibre networks that clearly, have got to expand to meet this demand, going to be put together?

The drop-down menu of an Android phone, focusing on the mobile data option.

What we’re finding is that the industry is set up with large incumbents – the big, cellular mobile players. Historically, I guess, we’ve all looked to them to increase their investments in the networks which have been driving the industry for the last ten years. What we’re finding now is that increasingly these networks don’t want to or can’t afford to invest in all the required infrastructure.

The industry is separating out into infrastructure specialists/players who will invest in this infrastructure specifically, and then rent it back to the larger players. There are a couple of exciting things that are about to emerge from the separation of the industry along these lines.

We’ve also seen some of those participations by for instance Cell C with its deal with Blue Label and consolidations going through as well. You said there are some exciting stories. What are the ones that have really caught your imagination?

The smaller players obviously need to find other ways to justify their existence and to maintain their margins. We have seen some consolidations in the industry (the Cell C and the Liquid Neotel acquisition). That will continue, but the exciting part for me is separating out the industry where these specialists are investing in the infrastructure side of things. That infrastructure then becomes accessible – not only to the major players, but also to new entrants coming in.

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Across Africa we’ve seen tower players appearing. They will buy the cell phone towers in Nigeria and Zambia etc. and then rent it back to the operators. Those towers do however have more capacity to accommodate additional users. You’ll find new [infrastructure] players open up the industry to new entrants.

As a banker, how do you participate?

Obviously, all of these new players need funding and many of these companies are not starting from zero. They are usually acquiring assets out of the incumbents, so a lot of capital goes towards supporting them, to for instance acquire those towers. We also see quite a lot of this happening in the fibre space. Many players need a lot of capital and funding for that capex to roll out fibre networks. These are not small numbers. They need to grow quite quickly in order to justify their existence.

How would you typically structure a deal of this nature?

Most people understand corporate lending and many large corporates can just borrow on balance sheet –sufficient earnings proven historically, as a fairly-understood industry. The interesting thing about the new businesses is that they don’t necessarily have a proven revenue base and assets upfront. They’re either building those assets or acquiring them. Our view is that the industry has to take a view on future revenues.

Most often, we would look at contracted future revenues such as rental agreements or a lease agreement to get the cash flow to cover our loans as a first step. We’ve done quite a bit of that over the last five years. I think the industry’s pushing even further than that. Not every business can justify a contracted revenue that bankers can take a view on.

Increasingly we’ve been asked to take a view on the growth in the business and monetary draw-downs against the growth in the company. It’s a lot riskier, but we’ll be able to understand these businesses to allow one to actually fund the growth of these businesses.

No doubt, because as you say, it’s a much greater risk. The more flexible you become as a banker, the more you presumably want to be remunerated for that risk. How does that work?

The sweet spot is trying to find the middle ground. If one’s taking pure equity risk – taking a real punt and a guess as to whether the industry’s going to work – you’re going to want that equity return. We’ve got to come up with structures that give us comfort that we will get repaid the asset is in the ground, and we can then bring our funding rates all the way down.

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If you look at the world from an affordable debt point of view, we try and structure away the risks so that we can justify giving good rates to our clients. If these companies’ funding is too expensive then obviously the pricing to the client is going to be too expensive and it’s going to crimp the industry. We are therefore incentive driven and coaxed to find the cheapest form of funding that these guys can leverage.

So it could have a little bit of equity, a bit of long-term debt or a bit of short-term debt – very complex in cases like this, I guess.

Absolutely. What’s quite fun for us is while we might start at the senior debt side, we’ll fill up the capital structure and maximise the senior debt. We might have enough funding to move up into more mezzanine-type spaces which is a bit more flexible. The draw-down and profiles take a bit more risk and is priced up. We prefer, the regulated entity not to take equity positions, but we can certainly support equity partners through what we call ‘back levering’ of their equity positions. There are many ways that banks can facilitate this sort of investment.

How well do entrepreneurs react to this kind of complexity in their financing structures? An entrepreneur just wants to go out there and make a business. Sometimes complexity can be a little bit of a hurdle for them.

Absolutely. It’s a challenge to work with entrepreneurs. They are experts in their fields and that’s why they’re out there building these businesses. We’ve got to develop the financing packages for them and obviously that always has to happen overnight, over weekends. It doesn’t quite work like that, so there’s a lot of education that goes into just explaining how banks mitigate their risks so they can give the entrepreneurs a cheaper source of funding. It’s part of the fun of what we do but – both seeing the businesses grow, but also seeing how people grow in their understanding of how these financing packages work.

From where you’re sitting, is this the most rapidly developing area of the business scene at the moment – the telecoms/media technology sector?

Yes. It is an interesting space. We’ve spoken about the tower side of things, which is largely done across Africa today (except for South Africa). I still see a lot of opportunity for capital to flow into this space – into building up more fibre (both across the continent and South Africa). We are seeing players spending a lot of time and effort on what we call fibre-to-the-home.

While most of your cell phones are tower connected with fibre, customers are now increasingly demanding to be connected at home to download movies on demand. The other thing that interests me (particularly in South Africa) is the LTE space, which is wireless broadband technology.

We are spectrum-constrained in South Africa, and I’m not sure if that’s going to change anytime soon. Spectrum is a scarce commodity and trying to find ways to build the same concept (this infrastructure-sharing in that LTE space), is very much of interest to us. We’ve just funded a player in that space rolling out an open access LTE network. That’s very exciting for us.

Is the company called Rain?

I guess Rain is more the brand of their retail network. Being an open access network, people can rent LTE capacity from them.

It really is an exciting development. This company (Rain) where you’ve got the guy who was instrumental in building Outsurance now moving into the telecoms space. I guess it does show you how attractive the space is right now in South Africa. When you look at it, is it a multi-year growth story?

Absolutely. One doesn’t develop these networks overnight. You roll out the network, but as soon as one rolls out the network, the take-up is quite quick. You almost forget the days when you’d sign on your Google Maps and you could only do that if you were online at home or if you were on an ADSL line. Now you have to drive somewhere and you’re out in the middle of nowhere and you need connectivity. We take it for granted that we now have high-speed wireless connectivity wherever you are.

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And it’s just going to get faster. I suppose that as it gets faster, the demand or expectations of the consumers will grow.

Absolutely. As I was saying earlier, we’re all quite privileged to have access to wireless data at home, without the need to be sitting next to your satellite dish.

How much of an investment are you anticipating we’ll see in this area in the next five to ten years?

How long is a piece of string? It’s all very well throwing a lot of money at the industry to roll out these networks, but I think that the core point is trying to find capital-efficient ways to try to do this. I’d be guessing as to exactly how many Millions/Billions of Rands would go into the industry. What we are finding is that it’s getting more and more efficient – a lot more bang for your buck in terms of capex. Alec, I’d be guessing as to a Billion Rand number but it’s multiple Billions of Rands.

And the reality about all of this is, that as long as the demand is there, people are going to be throwing the supply at them.

Absolutely. Even if the demand isn’t there tomorrow, what we all recognise is that this is building the highways of the future. While you are digging trenches and annoying your neighbours – having their road dug up – you might as well put in sufficient capacity to future-proof this. It’s real and it’s happening –  certainly in the fibre space, and to a greater or lesser extent in the tower space, including the LTE space, to the same extent.

Fascinating insights from Keith Webb, an Investment Banker at RMB. This special podcast was brought to you by RMB.

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