TELCO CARVE OUTS - THE ROAD TO SUCCESS
Telco Carve-outs, or in the Telco world mentioned as Separations, are being executed more and more often. The strategic drivers can be different ones, I will mention two different separation cases, which I have recently led.
- First, a national government / telecoms authority can have a strategy to accelerate the digitization of the country by means of setting up a National Broadband network. In this case, the incumbent telco provider needs to hand-over its network assets (typically fiber), which are being placed into a new, separated entity, which should become the countries’ “National Broadband Network” or NetCo.
- A second case can be where the (new-) owners of the Telco have a strategy which focusses more on the infrastructure of the incumbent, typically leading to the carve-out of the network assets and all the functions that are needed to support it. This way, post separation, both entities (Netco and ServCo) can focus on where they are best in.
Next to that, new revenue streams can be created by opening up the network for new entrants (virtual operators or service providers), who would not be able to invest themselves in their own network. This can also prevent the need to overbuild networks by competitors. Lastly, an important driver is the fact that a vertically integrated Telco with high capital expenditure is paying a relatively high price for financing its investments, due to a WACC which is influenced heavily by the more uncertain retail part of the business. Netco is bearing most of the overall investments (network investments are typically 80-90% of a Telco’s total capex) and can finance these investments at much lower rates, which gives a huge benefit directly starting after functional- & legal separation having been established.
THE SEPARATION METHODOLOGY
This methodology has been translated in the following 8 steps:
- Steerco. The owners to install a Separation Steerco which leads/ guides the separation. It is essential to start the process by an agreed set of Guiding Principles, to prevent lengthy debates between Netco and Servco representatives about their scope and the directions to be taken.
- Carve-out expertise. Appoint an experienced Carve-out specialist / Separation Manager, who, assisted by a PMO office, creates and manages the overall Carve-out plan, reporting to the Steerco.
- Work streams. Create cross-functional work streams jointly led by the functional leads of both NetCo and ServCo, who work together with the Separation Manager and its PMO.
- Introduce the concept of Perimeters as the basis for defining/agreeing the demarcation lines between NetCo and ServCo.
- The work streams to define its perimeters (“demarcation lines”) between NetCo and ServCo, leading to one of the following outcomes (to be approved by Steerco):
- a. Split or move of the function (partly or entirely). After the Steerco decision, HR can lead the implementation, incorporating all the required legal steps.
b. Create a (commercial-) product that ServCo will buy from NetCo or vice versa. This typically leads to a contract to be agreed between the NetCo wholesale team and ServCo. Given the high level of regulation the Telecoms market, this can be a heavy process.
c. Long Term Service Agreement: define and agree on a service, which will be purchased on a long-term basis (typically services which are not strategic and where duplication would be inefficient).
d. Transitional Service Agreement: define and agree on a service, which will be purchased temporarily (typically 1-2 years), till a permanent solution is implemented, which in many cases needs some sort of an IT project to deliver. Service descriptions, i.e., proper specifications of the nature of the services) are essential, and also the definition of a proper and measurable cost basis. Lastly, an exit strategy needs to be defined for the TSAs, in other words: an agreed roadmap of initiatives which are needed to get rid of the TSAs.
- Asset Transfer Agreement. This perimeter-driven approach can be presented as follows: For the transfer of the Assets, an Asset Transfer Agreement will be required. Especially, the complexity of transferring Network & IT assets can never be underestimated. Typically, with incumbents, the fixed asset register might not be fit for purpose and the asset valuation will need advice from specialized consultants, especially when regulated products are in scope. Depending on the specific situation, the approval of the regulator may be needed for this agreement to become effective.
- The Long Term- & Transitional Service Agreements (LTA’s and TSA’s), constructed in line with “arms’ length” principles, are vital input for an Intercompany Billing (ICB) process, which needs to be set up within the Finance function as a new, structural activity. Both finance leads (NetCo and ServCo) already have been involved (as work stream members) in the setup of the LTA’s/ TSA’s and the next step is that dry-runs will be performed for the Intercompany Billing. These dry runs are needed to 1) test if the process of gathering the required data, 2) executing it in the ICB tool works and 3) test if the outcome in terms of financial impact for both NetCo and ServCo are according to expectations. The final, tested versions of the set of LTA’s/TSA’s and its Intercompany billing results clearly require Steerco approval and as it needs to be incorporated in next years’ budgets, alignment with the company’s budget cycle is essential.
- Once the separated budgets have been approved, the incentive plans for the staff can be separately defined for NetCo and ServCo and executed by HR.
The result after a separation program as described above is typically a situation where both entities are:
- Legally separated. A new legal entity has been set up, which is most often NetCo, as the new entity.
- Functionally separated. Both entities have their own functions, albeit that there may still be many dependencies with functions in the other entity, which are covered through LTA’s and/ or TSA’s. If a full function was transferred, the other entity may still be recruiting new staff, in order to get rid of the TSA.
- Financially separated. Both entities have their budgets and all intercompany charges and charging principles have been agreed.
A separation program as described above can be executed in about 12 months’ time, if all 8 steps are taken seriously.
Full Ownership Separation.
If the strategy aims at selling one of the entities, full ownership separation is normally preferred. To achieve that situation, all TSAs should have been exited, i.e. the IT roadmap should have been implemented in full. This may take another 2-3 years after Legal-, Functional, & Financial Separation have been achieved.
- Strategy. The strategy behind the separation should be translated in very clear, unambiguous Guiding Principles. Already before the actual separation starts, there should ideally be a clear view on the (high level-) future target business architecture of the to be- separated entity. Every fixed Telco has a layered infrastructure, consisting of passive and active layers. It helps enormously if the Separation strategy is clear enough to define the demarcations between NetCo and ServCo layers. Unfortunately, this is not always the case, and it can lead to decisions that have to be reversed at a late stage in the process with all the delays as a result.
- Governance. Having a strong governance in place, with an empowered Steerco, a Separation Manager & PMO and well-staffed x-functional work streams is key to the success of any Separation. The Steerco should have the right executive representatives from both entities, but the chairperson should be mandated by the owner; able to take decisions if no consensus has been achieved between the entities.
- People. Any separation impacts the professional life of many of the staff and there will be a lot of uncertainty on where / in which entity the individual will end up and if there is a (hidden) efficiency target, leading to the reduction of the total workforce. Early identification of the key people, needed during the whole process of separation, is key. Short- and mid-term retention bonuses with KPIs that support the Separation should be considered.
- Assets. As already mentioned, the complexity of transferring network & IT assets can never be underestimated and as a result, may need the support from specialized consultants, especially when regulated products are in scope.
- Regulations. Depending on the specific situation, the involvement of the regulator may be needed throughout the entire separation process.
- IT. It can take another 2-3 years (or more) before both entities are fully independent of each other. This is normally driven by the high level of IT impact any separation at a Telco has. Depending on how the perimeter splits have been decided, one of the entities may need to implement its own new E-commerce system, Ordering, Billing & CRM system (BSS), Operational Support system (OSS) and/or ERP system (for its supporting Finance-, HR- & Procurement processes). It will be clear, that this IT roadmap and its required Capex and Opex, needs to be approved from both sides, to prevent that TSAs are needed forever.
This blog is written by Nico Eskes, one of our Associates.