CAN TELCOS CREATE MORE VALUE BY BREAKING UP? - JANUARY 2020 - MCKINSEY
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Can telcos create
more value by
breaking up?
January 2020McKinsey & Company
Can telcos create
more value by
breaking up?
Once primarily a regulators’ tool, structural separation
is beginning to attract growing interest from operators
facing financial and market pressures.
Gustav Grundin, Robin Nuttall, Lorraine Salazar, Halldor Sigurdsson, and Nemanja Vucevic
Sometimes, the whole is less than the sum of For management, boards, shareholders, and
its parts. At least that is the belief underpinning regulators pondering the prospect of separation,
structural separation—splitting an integrated the central questions remain: Can breaking up a
telco operator into two freestanding businesses: telco create more value in the long-term? Is doing
one that operates the network (the NetCo) and so worth the risk? And how can telcos minimize
one customer-facing entity (the ServCo). The that risk?
idea is that the resulting units will perform better
by clarifying management focus and improving The Czech case for separation
capital allocation, given the fundamentally
Separation can take different forms, from
different nature of these two businesses. The
accounting separation (the simplest and most
hope, also, is that such a move will create a
basic) to functional separation (where the
market structure that requires less regulatory
wholesale and retail businesses are set up as
intervention.
independent units) to legal separation (where new
The concept of separation in the legal entities are established but overall ownership
telecommunications industry has been around remains the same).
for over two decades, though for most of that
The most sweeping change is a full structural
time, it has been the government’s decision to
separation, which entails creating two distinct
mandate it, not the telco’s choice to pursue it. Yet
legal entities. Historically, most such splits have
integrated incumbents are beginning to embrace or
been the consequence of government action,
at least consider separation voluntarily as a way to
as a way for regulators to address perceived
address deepening financial and market pressures
deep-rooted market inefficiencies resulting from
as required infrastructure funding increases
having one entity, often the former state-run
dramatically in the face of the investment-heavy
monopoly, dominate the telco market. While a
evolution toward 5G and fiber to the home. So
few incumbents have considered breakups on
far, only a few telcos have fully taken the plunge.
a voluntary basis, most have ultimately opted
But with the telecom sector facing headwinds,
against this path given the massive complexities
structural separation is becoming a more frequently
involved.
discussed topic of major industry stakeholders.
Can telcos create more value by breaking up? 1McKinsey & Company
That is starting to change. In 2014, O2 in the from Telefónica Group. The new owner separated
Czech Republic showed that pursuing structural the network from the retail business and took the
separation voluntarily could generate superior infrastructure unit, now named CETIN, private,
stakeholder returns while greatly improving while keeping the retail unit publicly listed under
the infrastructure of the country. Four years the O2 Czech Republic name. It didn’t take long for
later, Denmark’s TDC Group was acquired by the move to pay off for the investors (Exhibit 1).
a Macquarie-led consortium of buyers at a 34
The deal not only benefitted the new owners;
percent premium to the market price with a
the country received a significant infrastructure
structural separation initiative as one of the core
upgrade as well. The creation of a pure network-
pillars of value creation justifying the takeover.1
infrastructure player lowered borrowing costs
Telecom Italia 2 in 2018 started to evaluate the
and improved capital access such that CETIN
possibility of setting up a separate NetCo, and
increased its network capital expenditures by
that same year Telstra 3 came out with plans to
40 percent a year after separation. From there
establish a separate infrastructure business unit.
on, capital expenditures increased by 13 percent
Meanwhile, shareholders or board members of
annually. This led to a jump in fiber coverage and
at least two other carriers, British Telecom4 and
broadband speeds at a level rarely seen in Europe
Telefonica, 5 requested their companies consider
(Exhibit 2).
the same.
A detailed examination of the O2 Czech Republic
case offers a good illustration of the potential
upside of separation. In 2014, PPF Group, a local
private-equity fund, bought O2 Czech Republic
Exhibit 1
Separation in the Czech Republic created tremendous value for shareholders
O2 market capitalization, O2 return on invested capital,
CZK billion %, (including goodwill and intangibles)
Before After separation NetCo* ServCo Before After separation
separation separation
36.9
151.7
145.9 33.6
136.2 82.8 135.7 32.0
77.0
67.3 66.8
99.1 +89%
+97%
30.2
16.9
72.3
68.9 68.9 68.9 68.9 68.9
10.1
Jan Jun Jun Jun Jun Jun 2012 2015 2016 2017 2018
2015 2015 2016 2017 2018 2019
Source: CETIN; investor presentation; Bloomberg; expert interview
*
NetCo privately held after separation, so no market valuation available
1
“Denmark’s TDC to be split into three units—Macquarie-led consortium,” Reuters, February 28, 2018, reuters.com.
2
Agnieszka Flak and Stephen Jewkes, “Italy’s network plan turns up heat on Telecom Italia CEO: sources,” Reuters, November 11, 2018,
reuters.com.
3
Will Irving, “Establishing a standalone infrastructure business unit,” Telstra Exchange, June 30, exchange.telstra.com.au.
4
Christopher Williams, “BT faces fresh calls to spin off Openreach,” Telegraph, February 10, 2018, telegraph.co.uk.
5
“Telefónica considers fixed network sale,” Mobile World Live, July 5, 2018, mobileworldlive.com.
2 Can telcos create more value by breaking up?McKinsey & Company
Exhibit 2
Separation in the Czech Republic has led to a wave of fresh investment in the
NetCo, which has resulted in faster broadband speeds
Cetin capital expenditures, Cetin fixed access network performance by Mbps,
CZK billion % share of subscribers
4.1
10
3.5 3.6 20 >250 Mbps
20
+44% 20 56–100 Mbps
2.5 70
55
50 16–56 Mbps
30
15 10McKinsey & Company
customer satisfaction ratings for CETIN, and a the ServCo and the NetCo.
faster buildout of O2’s O2 TV.
Separation is also costly and time-consuming.
5. Better suited for a 5G world. Although British Telecom estimated that a previous
analysts disagree on the exact numbers and functional separation had cost them more than
magnitude, there is broad consensus that $1 billion, 8 and historic cases indicate that the
5G will drive up the total cost of network process can take anywhere from two to five years,
ownership, given the massively increased consuming significant management attention, and
densification of urban areas and the resulting potentially all but paralyzing leadership. IT systems
heightened requirements on capillarity of fiber separation alone can take as long as 18 months,
deployment. A strong, independent NetCo during which time typical product development
is better positioned to support the industry’s generally grinds to a halt.
need for fiber rollout than an integrated
carrier. As a neutral party, it is also a natural When separation makes sense—or
orchestrator for the increased network sharing doesn’t
that 5G is likely to prompt. A recent McKinsey
Carefully weighing the pros and cons of separation
5G survey found that 93 percent of chief
before making a choice is not simple. Individual
technology officers expect increased network
markets and operators differ greatly with regard
sharing to occur with the onset of 5G.7
to the parameters that determine the potential
upside and downside. Given the irreversible
Why separation can backfire nature of the decision, management, boards and
While separation has the potential to generate investors should carefully evaluate each of the
significant value creation, it is also a high-stakes drivers.9
venture that can destroy value if managed poorly
These determinant factors include the scope of
or pursued under the wrong preconditions. By
the current regulatory environment, which could
giving up their network ownership ServCos could,
be reduced as a result of separation and thereby
for instance, face higher transaction costs in their
unlock value; the amount of growth potential from
day-to-day dealings with the NetCo and lose
increasing investments in infrastructure; and the
several important advantages, such as:
extent to which the NetCo could play an active role
— preferential treatment in fixed deployment in future network-sharing arrangements. They
through price differentiation or operational also include the ability of the ServCo to lock in
integration some post-separation downside protection, such
— ability to apply similar preferential treatment as a limited form of preferential coordination with
in mobile through bundling and cross- the NetCo or a clear commercial opportunity on
subsidization the retail side. Finally, there is the sheer complexity
of the undertaking, the time required to complete
— power to direct NetCo investments into areas it, and the sustained management focus required
that benefit the ServCo, driven by regional (Exhibit 3).
market-share differences
— full control of certain types of product
development that require deep integration
into the network (for example, certain IoT use
cases)
The extent to which the loss of these advantages
will impact the ServCo depends largely on the
regulatory frameworks that will be adopted after
the separation as well as on the details of the
commercial contracts governing relations between
7
Ferry Grijpink, Tobias Härlin, Harrison Lung, and Alexandre Ménard, “Cutting through the 5G hype: Survey shows telcos’ nuanced views,”
February 2019, McKinsey.com.
8
“Strengthening Openreach’s strategic and operational independence,” Ofcom, July 2016, ofcom.org.uk.
9
For a broader overview of separation and spin-offs and key drivers of value creation, see Bill Huyett and Tim Koller, “Finding the courage
to shrink,” August 2011, McKinsey.com.
4 Can telcos create more value by breaking up?McKinsey & Company
Exhibit 3
The desirability of separation depends on a number of variables
Value creation opportunity potential
LOW HIGH
Regulatory environment
● No wholesale regulation on access ● Strict wholesale regulation (breadth of services under regulation,
and price allowed margin over cost)
● No or low level of retail regulation ● High degree of retail regulation (SMP, predatory pricing and,
price caps) hampering performance (eg, regional pricing
variability)
● Potential for regulatory relief following separation (eg, EU
mandate)
Investment level
● High fiber or cable household ● Comparatively low share of fiber penetration (HH Passed)
penetration ● Capital expenditure constraints preventing business case
● Highly competitive environment with positive investments
players not CapEx constrained ● Ongoing land grab with multiple fiber alt-nets
Sharing potential
● High level of site fiberization ● Low degree of site fiberization
● High level of network sharing ● Limited network sharing
● Population dispersed or mostly in low ● High concentration of population indicating high share of small
density housing/SDU cells in 5G deployment
● Few options for small cell real estate
Complexity
● IT systems are not modular and ● Modular IT systems (e.g., front-end clearly separated from
intricately meshed; substantial legacy back-end)
system still in place ● Large portfolio of wholesale products already in place with
● Processes for wholesale products not established processes
clearly established
Downside protection
● High market share for ServeCo ● Low market share for ServeCo
● No to introduce volume or discount ● Regulatory flexibility to introduce volume to discount based
based wholesale pricing wholesale pricing
Source: McKinsey analysis
Getting separation right and how wholesale capacity decisions are made.
There is no doubt that executing structural — Organization and process redesign. The
separation is one of the most complex and arduous breakup will require the NetCo and ServCo
journeys a telco management team can undertake. to create new processes, retrofit other ones,
Yet, done well, it can potentially deliver huge returns. and create efficient information-sharing
Success stories to date provide a clear picture of the mechanisms. These efforts are complicated
trickiest issues to address. These include: by two factors. First, many processes (such
as provisioning) crisscross the incumbent’s
— Asset and activity delineation. Deciding
network and customer-facing organizations.
which assets belong to the ServCo and which
Disentangling them requires a comprehensive
should transfer to the NetCo is not a trivial
process redesign effort. Second, integrated
exercise. When figuring out how to divide assets,
players also depend on many informal and
executives need to consider both synergies
undocumented processes in their day-to-day
and downstream implications. In addition to
work. Failing to manage the process-redesign
apportioning out core network functionalities
effort effectively will almost certainly lead to
and different customer interfaces, they need
disruptions in the network operations.
to address strategic questions such as how
spectrum ownership will be assigned, choices — Commercial contract. Creating a
that impact how the mobile network is designed commercial contract that governs every
Can telcos create more value by breaking up? 5McKinsey & Company
activity and service that the NetCo is currently addressed in parallel, since the resolution of some
providing to the ServCo is a monumental are prerequisites for tackling others. Secondly,
task. From a transparency and governance different tasks require very different talent profiles
standpoint, it is also the most critical way to and capabilities. Some tasks, for instance, require
clarify any advantages the ServCo may forfeit significant expertise and analysis. Others require
after the split. a tolerance for slogging through straightforward
but laborious work for weeks or months on end.
— IT-systems separation. Each telco has a
Still others, like the separation of IT, require both.
unique IT setup, usually a patchwork quilt of
Shaping the right road map and establishing the
operations support systems and business
right project teams will have a significant bearing
support systems, some of them homegrown,
most of them integrated across functions that on the quality of the outcome (Exhibit 4).10
will end up on different sides of the separated
entity. Inevitably, some systems will have to be
duplicated, some retired, and some built anew.
Addressing these changes successfully hinges
on two things—timing and teaming. First,
management needs to pay attention to the
proper sequencing of tasks. Not all issues can be
Exhibit 4
A structured approach is required in defining, negotiating, and documenting
all principles toward structural separation
Phases of separation
TODAY Up to up to FUTURE
8 MONTHS 12 MONTHS
(Organizational (Legal separation, (Legal separation,
separation) with group structure) of entities)
1 2 3
Formalise target Negotiate principal Write out contacts and terms
deal structure agreement of service agreements (TSAs)
Objectives
● Define overarching ● Write out contract principles ● Develop TSAs and contracts
direction and principles of ● Mediate and “judge” ● Mediate and “judge”
separation between NetCo and ServCo between NetCo and ServCo
(core team)
Activities
1 Develop “paramount 1 Define financial split, to act 1 Write up TSAs for each
principles” of separation as baseline for contracting overarching product/service,
2 Define list of requirements terms including:
for legal separation 2 Develop business principles ● Service catalogue
3 Develop list of for each overarching ● Pricing catalogue
products/services required product/service ● Service level agreements
between NetCo and ServCo, 3 Define responsibility matrix ● Transition governance
and prioritize based on of NetCo and ServCo in each 2 For relevant products/
criticality process step of services, write up long-term
4 Define negotiation product/service contracts
governance 4 Define high level business
5 Describe NetCo and ServCo model for each
business model and contract/service
simulate P&L
6 Stress-test business
models
Source: McKinsey analysis
10
Sean O’Connell, Michael Park, and Jannick Thomsen, “Divestitures: How to invest for success,” August 2015, McKinsey.com and Obi
Ezekoye and Jannick Thomsen, “Going, going, gone: A quicker way to divest assets,” August 2018, McKinsey.com.
6 Can telcos create more value by breaking up?Structural separation offers the potential for significant value of the market and regulatory environment, a comprehensive
creation, but the risks and complexity of carving out deeply change-management plan, and an investment case that
interconnected businesses are great as well. While the jury recognizes that separation is a long-term play that requires
is still out on whether it will become a more widely adopted considerable ramp-up time and downside protection for
business model, success depends on a close understanding ServCo businesses.
***
Gustav Grundin is a partner in the Tokyo office,
Robin Nuttall is a partner in the London office,
Lorraine Salazar is an expert in the Singapore
office, Halldor Sigurdsson is a partner in the
Paris office, and Nemanja Vucevic is an associate
partner in the Madrid office.
The authors wish to thank Stephanie Man,
Shannen Poon, Colin Shea and Maarten van der
Velden for their contributions to this article.
Copyright © 2020 McKinsey & Company.
All rights reserved.Can telcos create more value by breaking up? By McKinsey January 2020 Copyright © McKinsey & Company Designed by US Design Center @McKinsey @McKinsey
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