In this article, Marija Zrno Prošić and Tamara Jelić-Kazić from CMS Croatia look at how telco companies are transforming themselves into IT and cloud-based service companies to keep up with technological developments and customer demands.
Telecommunication companies have undergone seismic changes since the early 2000s. The traditional markets of fixed lines, radio and television have gradually been replaced by the vast potential of online services. In the last two decades, conventional telecoms have swayed away from heavy infrastructure such as transmitters, data centres, towers, cables, and replaced them with cloud solutions.
This drive towards new cloud horizons was so strong that a completely new market has emerged: a market of pure, cloud telco companies. The services offered by these new businesses with cloud-native infrastructure have started affecting and shaping our lives on many levels. This strategic change has also led to new types of transactions, in particular the carve-out of telco infrastructure assets such as towers and cables, which in turn have become interesting assets for investors in their own right. Although not yet as frequent as in western Europe, in the last two years we have seen the investments into the tower infrastructure of Polkomtel and Play in Poland, the sale of a 30% stake in CETIN (holding tower and cable networks in the Bulgaria, Czech Republic, Hungary and Serbia) to GIC, and there are strong indications that other players in the CEE region will follow suit. The M&A activity in the IT sector has been making the headlines as well, especially the R&D driven investments, with big-ticket players like Porsche expanding their global innovation networks to this region.
However, investor interest is not only in the multi-billion telco infra deals, but goes much wider. From 279 transactions in 2018, the annual dealflow in the sector has gradually increased to 450 in 2021. It has also become the sector with the highest cumulative deal value, reaching EUR 23.4bn in 2021. Interestingly, while traditional telco transactions were collectively good for 86% of the deal value in 2018, now they make up just [28%] of the total with the rest of the money being splashed on IT acquisitions.
Transforming conventional telco companies
“If conventional telco companies want to successfully avoid eroding their position on the market, and tackle the current uncertainties coming from high customer expectations and assertive new competitors, they will have to develop robust, future-facing tools for the transformation of their business,” says Marija Zrno Prošić. “We see that internal corporate restructuring is a useful tool to address efficiency issues. Telco operators used to be focused on the infrastructure-side of business, but once sufficient infrastructure coverage was achieved, it became evident that new growth generators were needed.”
The carve out of the infrastructure business, which was discussed in detail in last year’s Emerging Europe M&A Report, enables them to achieve business efficiencies and focus on new products and digital services. The rapid rise in digital services has also led to the increasing importance of data centres. To achieve optimum business results, companies are restructuring their businesses by choosing new locations for their data centres and reallocating their business operations within the group (for our article on data centres in emerging Europe see here).
Moving to cloud-based telco businesses
“Conventional telcos doing business in a conventional manner seem to be losing customers to emerging cloud service providers,” says Tamara Jelić-Kazić. “These new platforms support the new ways of living, including 5G mobile networks, autonomous cars, the IoT, lightweight authentication protocols, the storage of immense amounts of data, and remote accessibility.”
Cloud-services companies often have an agile team structure and can quickly transform their business and production processes. They tend to be successful in cross-selling and upselling their services, and growing new revenue streams. As cloud demand continues to grow, many telco companies have been focused on inorganic growth to increase market share, translating to significant M&A activity focused on complimentary businesses. Tamara Jelić-Kazić adds: “However, this explosive growth renders cloud telcos vulnerable to many integrating challenges, including company culture, compliance and tax exposures.”
The global expansion of cloud telco companies potentially triggers tax obligations in (offshore) jurisdictions where the business has not been formally established but there is certain connection to the particular jurisdiction, such as the employment of local personnel. Tamara Jelić-Kazić says: “The issue has come to the fore particularly during the pandemic, as a result of which home-office has become recognised as ordinary way of performing work. Suddenly, local workers employed by a foreign cloud telco company have become a permanent establishment topic and a tax issue.” The nature and scope of their workers’ activity are scrutinised by authorities to exclude or confirm whether such engagement triggers tax obligations on cloud telcos in the home country of their distant workers. Even the service agreements concluded by cloud telcos may come under permanent establishment-related scrutiny by local tax administrations.
Other common issues faced by these companies include tax and VAT issues related to server permanent establishments for VAT purposes. “Compliance with administratively burdensome local VAT rules has not made cloud business easy tax-wise,” says Tamara Jelić-Kazić.
Challenges ahead
Both conventional and cloud telco companies have their fair share of challenges ahead. While conventional businesses need to focus on their transformation and define what is core to their business and what is not, cloud companies need to match their rapid growth with strong internal processes and compliance.
At the same time, companies across the Telecoms & IT sector need to pay close attention to growing ESG requirements, such as meeting demand for data and connectivity without adding to greenhouse gas emissions, keeping up with increased exposure to security and reputational risks, and tackling governance exposures like jurisdictional uncertainties or known restrictions on the use of voice over internet protocol (VoIP).One thing is certain: the future of telecoms and IT is certainly intriguing.
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