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THE PRIVATE EQUITY TAKEOVER of TELECOM INFRASTRUCTURE in DENMARK Implications for Network Development and Public Policy

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THE PRIVATE EQUITY TAKEOVER of TELECOM INFRASTRUCTURE in DENMARK Implications for Network Development and Public Policy THE PRIVATE EQUITY TAKEOVER OF TELECOM INFRASTRUCTURE IN DENMARK Implications for Network Development and Public Policy William H. Melody is guest professor at CICT (Center for Information and Communication Technologies) at Technical University of Denmark, visiting professor at London School of Economics, UK, and University of the Witwatersrand, South Africa ABSTRACT The debate over the implications of private equity leveraged Telephone Co. (NTC) in a leveraged buyout. In the largest buyouts revolves primarily around one central issue, the extent takeover in Europe at the time, for DKK 76 billion (about EUR to which private equity ownership promotes efficient long-term 10.3 billion), the purchase of 88.2% of TDC shares was made investment and operational management in the target firms, or with borrowed funds secured by TDC’s assets. The new own- the maximisation of short-term returns to private equity inves- ers are a group of five private equity specialists: Apax Partners; tors to the detriment of the target firm’s long-term development. Blackstone Group; Kohlberg Kravis Roberts; Permira; and Supporters of private equity buyouts claim they introduce a Providence Equity. They did not claim that TDC is an inef- longer term planning horizon for firms with public sharehold- ficient company where significant profit can be made by -fun ers who have demanded that management be preoccupied with damental reforms. In fact, they did not even claim to bring quarterly earnings improvements and short-term movements telecom industry expertise, and were extremely vague, if not of the stock price. Critics claim private equity groups maxim- evasive, about their future plans for TDC. They have stated ise the short-term cash value of the assets for payouts to inves- only that they plan to change the financial structure of the tors and impose unsustainable debt structures that preclude in- company, reduce operating costs where possible, maintain own- vestment in long-term growth opportunities. It would appear ership for about five years and then sell it. They have not re- from the evidence to date that the objective of the leveraged vealed who they think the potential target buyers of the com- buyout of TDC is not to invest in TDC’s growth and devel- pany might be. opment, but rather to withdraw as much cash as possible from TDC through the combination of special dividend payments, TDC owns the vast majority of both the telecom and cable management and financing fees, and finally the sale of a much television facility infrastructures in Denmark. It is the domi- smaller residual company. nant services provider for all major services. It is a major rea- son Denmark ranks as one of the world’s leading countries in KEYWORDS developing the advanced infrastructure and services necessary Private equity ownership, leveraged boyouts, information so- for the next-generation Internet, e-commerce and an informa- ciety infrastructure, telecom operators tion society. A matter of concern is the commitment of the new owners to maintaining Denmark’s leadership position. Are they 1. INTRODUCTION interested in enhancing the build-out of next generation infra- On 1 February 2006, TDC, Denmark’s incumbent telecom structure networks and services as a foundation for a productive operator and by far the largest player in the Danish market, future information economy in Denmark? Will they be imple- was taken over by a private equity group (PEG), the Nordic menting and extending TDC’s vision for becoming a more sig- nb!¡ct 27 nificant player in the European telecom market, which requires well as the public utility infrastructure industries more broad- continuing major investment for benefits to be realised over the ly – airports, transport, gas, electric and water utilities. This pa- long-term? Or are they interested in the short-term goal of cash- per examines the TDC case and its implications for telecom ing out TDC’s assets where possible, tax avoidance, and selling sector and information society development in Denmark. For on the residual operation in a much smaller, debt-ridden, high- reference it reviews the only other European experience with a risk, investment-constrained company incapable of maintain- PEG takeover of an incumbent telecom infrastructure provider, ing a leadership role even within Denmark, let alone Europe? eircom in Ireland. It does not examine the generic issues asso- Private equity takeovers of companies by leveraged buyouts ciated with the implications of PEG investment for the econo- became significant in the US during the 1980s and more re- my generally or the detailed implications for taxation. However, cently have expanded to Europe, including the Nordic region. this case study provides an input to that ongoing examination, They are viewed by some observers as a new competitive mar- and will be especially relevant for infrastructure providers in ket force stimulating greater financial efficiency in the targeted the telecom sector, and for the public utility infrastructure in- firms; and by others as ‘vultures’ simply engaged in asset strip- dustries generally (Hall 2006). A matter of concern is the commitment of the new owners to maintaining Denmark’s leadership position. Are they interested in enhancing the build-out of next generation infrastructure networks and services as a foundation for a productive future information economy in Denmark? ping by legal financial manipulation, and ‘grasshoppers’ mov- 2. PRIVATE EQUITY GROUP (PEG) INVESTMENT ing across companies and countries. The experience to-date PEGs provide an alternative form of investment. They assem- provides both success stories and failures. One must examine ble funds from a small number of investors, each committing a the specific circumstances to determine the likely consequenc- relatively large amount of funds. The investors include wealthy es (Fenn et al. 1997). individuals as well as institutions, such as pension funds. The funds are managed by the PEG specialists. Although PEGs may What makes the TDC case distinct is that this is only the sec- invest some of their own funds, this is not a significant part of ond time a PEG has taken over a national incumbent operator the investment. They make their money principally from man- that provides the vast majority of a country’s telecom facilities agement fees and a share of the returns. The standard fee struc- network, and is subject to sector specific regulation of its mo- ture is 2% of the assets under management and 20% of the re- nopoly power and universal service responsibilities. Thus the turns to investors above a minimum hurdle rate. In leveraged consequences of this takeover for the Danish economy, and the buyouts, such as the case of TDC, these investor funds are used government’s ability to implement its telecom sector and infor- as leverage to borrow much larger amounts for the purpose of mation society policies, are far greater than takeovers of firms buying target companies that will assume the debt after the in general industry where the fate of a single firm will have little purchase. effect on the long-term development of an industry or a coun- try’s economy. PEGs are attracted to firms they regard as inefficient and ripe for profitable reforms. They seek to invest in firms in which The Denmark experience with TDC, in turn, will be instruc- majority or total ownership can provide significantly higher tive for other countries where incumbent telecom operators than normal returns as a result of proactive intervention in firm may be potential targets for PEG takeovers. The financial press management, typically for a short period of time (three to five has noted increasing interest by PEGs in the telecom sector, as years). Value for the new investors is created by major interven- 28 nb!¡ct tion and restructuring activities, and the eventual sale of the The case of TDC is a leveraged buyout with the cooperation firm. Unlike investors on the public stock market who have ac- and continuation of TDC management. This is the type of cess only to public information without being able to direct- PEG investment that has stimulated most of the controversy ly influence the behaviour of the management, private equity over whether it is an innovative and efficient form of financing, managers can obtain valuable company information internally or simply a means to facilitate asset stripping and tax avoid- and direct the strategy and major decisions so as to maximise ance that is a parasitic threat to efficient firms and efficient re- returns for the PEG investors (Melody 2006). source allocation in the economy. Concerns have been raised at two levels. One is investor protection. Many investors in PEG Private equity investments can be classified into a number of leveraged buyouts, including pension funds, are not generally categories: aware of the higher risks they are assuming when investing in • venture capital, start-up businesses and early stage companies; PEGs. A second is the broader effects of growing private equi- • expansion (or growth) capital, for later stage company ty financing upon overall risk and stability in an economy with initiatives; much higher debt and leveraged financing than has existed pre- • management buyouts; and viously (Cook 1998). • management buyins. This paper is primarily addressed to a third concern, the im- Each market segment corresponds to specific company pro- plications of leveraged buyouts of major public utilities that files or situations, uses differing financial structures and is dis- provide the infrastructure for the economy, and have special tinguished by different holding periods for investments and rights and privileges granted by government that are associated performance criteria. Venture capital, start-up businesses, and with public service requirements and public interest obligations. expansion capital investment all provide new investment capi- In these circumstances, leveraged buyouts may significantly af- tal to develop or expand the business in anticipation of good re- fect the economy served by the public utilities, and the effec- turns on these investments from the expansive surge of rapid tiveness of implementation of government social policies.
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