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Mast companies under pressure as rapidly rising interest rates drive up cost of capital

The founder and chief executive of the largest mobile tower company in Europe resigned on Wednesday after the three-year dealmaking spree that transformed it into one of the biggest players in the sector came to an end.

Tobias Martínez, who has been at the helm of Cellnex for eight years in which time it also became Spain’s largest telecoms group, will step down on June 1, the company said.

“It is a very thoughtful decision, in which various factors — professional and personal — come together,” Martínez told the Financial Times.

Martínez’s departure comes at a time of retrenchment for tower groups around the world. When debt was cheap, masts — the metal structures on which radio antennas sit — were some of the most valuable assets in telecoms, trading at high multiples and offering private investors attractive returns.

But for several months rapidly rising interest rates have driven up the cost of capital for these heavily indebted businesses, causing their share prices to tumble. Cellnex’s share price has fallen about a quarter over the past year.

Cellnex announced in November its ambition to gain an investment grade rating, which would mean reducing its leverage from eight times earnings before interest, tax, depreciation and amortisation to below seven times.

At the time, Martínez told the FT that mergers and acquisitions in the European market — that allowed Cellnex to amass 130,000 towers across a dozen European countries and grow its market capitalisation to €23bn — was “over”.

Cellnex will focus its attention on reducing debt and limiting capital expenditure over the next two years, he said.

Cellnex was not involved in either of the two largest transactions in European towers, when two of the biggest operators — Deutsche Telekom and Vodafone — sold stakes in their masts businesses to private equity groups that were able to offer attractive valuations.

Deutsche Telekom agreed in July to sell a majority stake in its towers business to Brookfield Asset Management and private equity group DigitalBridge, valuing the business at €17.5bn, or 27 times ebitda.

And in November, Vodafone agreed to sell up to 50 per cent of its masts business to KKR and Global Infrastructure Partners, bankrolled by Saudi Arabia’s Public Investment Fund, which valued the company at €16.2bn, or 26 times ebitda.

Even if credit became cheaper again, there are few attractive assets left to acquire.

Martínez, whose current contract would have ended in December 2024, said on Wednesday: “The current economic and financial context demands that we open a new chapter in Cellnex’s story . . . based on maximising organic growth, consolidating the industrial project in the countries where we operate today and focusing on balance sheet management.”

Chair Bertrand Kan said: “During his time at the helm of Cellnex, Tobias has shown vision, energy and expertise in leading Cellnex’s transition from a national operator, focused on the Spanish market, to a European company with a presence in 12 countries.”

Prices have fallen more than 15 per cent since summer with further drop expected

Commercial property deals have collapsed to their lowest level in more than a decade as investors reckon with higher interest rates, the prospect of a lengthy recession and the fallout from the Liz Truss “mini” Budget.

The £7bn of deals transacted in the final three months of last year was the lowest quarterly total since at least 2010, according to real estate analytics company CoStar, which started collecting data that year.

Investors spent £21bn on UK commercial property in the first three months of 2022, £17bn in the second quarter and £11bn in the third. 

Commercial property landlords have suffered as interest rates have risen: investors now have to bear far higher borrowing costs and are unwilling to pay 2021 prices.

UK commercial real estate prices have fallen more than 15 per cent since June 2022, according to an index compiled by property agency CBRE, and most analysts expect them to keep falling in the near term.

Meanwhile, many investors have pulled back entirely while the market adjusts to higher rates, and the data from CoStar suggest that the desire to transact has gradually ebbed away over the course of the past 12 months. 

The lowly investment figures for the fourth quarter stand in stark contrast to early 2022, when commercial property estate agents were toasting the best start to a year since 2015 and looking forward to a period when overseas investors — particularly those from Asia — could once again travel freely. 

But hopes that post-Covid spending would be unleashed on the UK have been dashed since Russia’s invasion of Ukraine in February last year. 

The war accelerated inflation around the world and encouraged central banks including the Bank of England to raise interest rates far faster than expected, as well as increasing the prospect of a lengthy recession in the UK. 

Of the £56bn invested into UK commercial property through the year, around a third was spent on offices, with Asian investors particularly active according to CoStar.

But roughly 80 per cent of the £18bn in office investment came in the first six months of the year, with a handful of major deals for trophy assets struck in the first few weeks of 2022. 

There was also £13bn spent on warehouses, as investors bet that structural trends including the growth in ecommerce and a greater emphasis on stockpiling from companies caught short by the pandemic would inflate values.

That market has been hit hard by rising rates and signs that the runaway growth of the biggest ecommerce operators, such as Amazon, is going into reverse.

Across the board, dealmaking was already slowing when Liz Truss and Kwasi Kwarteng, the former prime minister and chancellor, unveiled their “mini” Budget in September last year. 

But their tax-cutting intervention sowed more uncertainty and was widely cited by investors as another reason to retreat.

Grant Lonsdale, director of market analytics at CoStar, said that dealmaking was likely to remain slow in the next few months. But, he added, “stabilising prices together with more clarity over interest rates and the economic outlook should stimulate activity in the second half of 2023.”

Hail Mary passes coming

Last year may have been an annus horribilis for the IPO market, but it was an annus calamitosas for special purpose acquisition companies, or Spacs.

Spacs are blank-cheque vehicles designed as a backdoor way for a private company to list on the stock exchange without going through the expense and uncertainty of an initial public offering. But things have gone pear-shaped.

For one thing, investors have suffered bone-crushing losses, as companies merging with Spacs (inelegantly known as a “de-Spac transaction”) have vastly underperformed the stock market. The AXS De-Spac ETF fell almost 75 per cent in 2022. Several companies have missed their forecasts, restated their financials and even gone bankrupt. SPACs have in some cases incubated a unicorn-to-penny stock lifecycle — with companies having to launch reverse splits to avoid delisting.

Meanwhile, some Spac sponsors — who typically contribute 3-7 per cent of the listing proceeds upfront to cover underwriting and operating costs — have lost their entire investment because they haven’t been able to conclude a deal. Spacs typically have to be liquidated if they can’t complete a merger within 18-24 months, and when presented with a business combination, most Spac shareholders are now redeeming their shares to get their money back with interest. The average loss for Spac founders from liquidation has been around $9mn.

To make matters worse, sponsors incurred $750mn in losses last month alone, as they rushed to wind up Spacs before year-end, believing that a new 1 per cent federal excise tax on stock buybacks would apply to liquidations of US-domiciled Spacs starting in 2023. A whopping 85 Spacs were liquidated in December, only for the Department of Treasury to say at the very end of the month that the levy wouldn’t apply to liquidations after all. These sponsors acted in (understandable) haste and will now repent at leisure.

And finally, as often happens when people lose a lot of money, lawsuits and investigations are in the offing. Aggrieved investors claim that Spac founders had a conflict of interest in pushing through a merger, and as a result skimped on due diligence, inflated forecasts and failed to disclose important business risks. Naturally, the SEC is revving its enforcement engines.

The cycle of loss, regret and recrimination arises in part due to the same factors that have buffeted financial markets more generally, such as central bank tightening, higher inflation and economic slowdowns. Companies that de-Spac’d are often in high-growth segments, and these have suffered disproportionately in the market downdraft.

However, many of the problems also stem from the way in which the Spac structure embeds a potential misalignment of interests between Spac sponsors and their shareholders. This in turn created a vulnerability that the gloomy market environment is mercilessly exposing.

Sponsors make their money from what is called the “promote” in the form of shares and warrants usually representing 20 per cent of the Spac. But they receive that promote only if they lock down a merger. Otherwise, after (typically) 24 months the Spac is liquidated, investor money is returned with interest, and the sponsors are out of pocket. The sponsors face the choice: either push through a merger (even a suboptimal one) or lose millions of dollars of paid-in capital.

This merge-or-lose dilemma creates a significant potential conflict of interest, even if the shareholder right to redeem is an important protection. Some sponsors care about their reputation and prefer to swallow the loss over pushing a bad deal, but for others there is arguably an incentive to rush due diligence, underplay the risks, and overpay. Around 300 Spacs with $700bn in trust have deadlines to invest in the first half of 2023, and the temptation is to throw a “Hail Mary” pass and hope to score a deal in time.

And the issue goes beyond just the potential conflict. As a 2022 paper in the Yale Journal on Regulation explains, the promote, the underwriting expenses (normally 2 per cent upfront and 3.5 per cent post-merger), and the dilution from warrants and redemptions all combine to create a sizeable gap between the market cap of the Spac at $10 per share and its intrinsic cash value. Just last week the Delaware Chancery Court upheld the legal sufficiency of a complaint alleging that the Spac in question had less than $6 per share in cash to contribute to a merger.

The question, then, is: how can the merger of an operating company and a cash shell create enough additional value to bridge this gap?

One way is for Spac sponsors to deliver some kind of synergy. In some cases sponsors may claim, Liam Neeson-style, to have a “particular set of skills, skills [they] have acquired over a very long career,” and so their ongoing involvement might generate enough value to compensate for the dilution cost embedded in the Spac. But the rapid collapse in de-Spac share prices suggests that such value-adding is more often an article of faith than empirical reality.

Another way to make the numbers work is to talk up the target and its prospects and find new buyers, thereby lifting the share price. Spacs have had a key legal advantage over an IPO to facilitate the marketing: because the deal involves a merger, the company could publish forecasts under the SEC safe-harbour rules. In effect, the more lenient Spac rules gave aggressive sponsors a licence to hype.

With the economics so dependent on promotion, the Spac structure created fertile ground for embellishment and puffery, which has in turn built a growing pipeline of lawsuits. Last spring, the SEC proposed new rules to remove these legal differences between a Spac and an IPO, and the rules are expected to be adopted.

But the litigation horse bolted long before this stable door will have been shut. Last year saw a sizeable increase in the number of lawsuits filed over de-Spac transactions, and 2023 promises a busy litigation calendar. In the meantime, courts are not giving Spac founders the benefit of the doubt, ruling that if the conflicts were significant enough, they would judge deals by their “entire fairness”, instead of deferring to the “business judgment” of the sponsors.

And the likely tsunami of SEC enforcement action has only just begun to build. Already, several cases have been filed alleging due diligence failures by Spac management, and many more are under investigation. Last September the SEC charged a major bioscience hedge fund with advising its clients to invest in Spacs in which its principals had a financial interest.

Spacs had developed as a way for smaller companies to go public when the IPO market was otherwise unavailable or difficult to access. But as they exploded in popularity, Spacs evolved from a useful niche product to a widely-used but problematic pathway for taking a company public.

Investors and sponsors have been caught in the blast radius of the Spac explosion, and courts and regulators will be overseeing the clean-up.

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