Leila Abboud is a Bloomberg Gadfly columnist covering technology. She previously worked for Reuters and the Wall Street Journal.

(Corrected )

Telefonica has spurned an opportunity to create the leading mobile towers company in Europe.

The Spanish telecoms giant has handicapped its plan to sell shares in a new infrastructure company with poor choices on what assets to include and how to value them. That will leave the new company, Telxius, roughly the same size as its two listed European peers, Cellnex and Telecom Italia’s Inwit, when it could have been larger and more liquid.

Telefonica set an indicative price range of 12-15 euros per share for the sale of up to 40 percent of Telxius, implying a market value of 3-3.75 billion euros ($3.4-$4.2 billion) . That's lower than Telefonica hoped. It needs the sale to cut debt and avert a credit rating downgrade. Telxius will own about 16,000 towers in Spain, Germany and Latin America, as well as undersea cables connecting Europe and North America to Latin America.

Investors like mobile towers companies for their generous dividends and predictable cash flows. The model was created in the U.S. by leaders American Tower and Crown Castle more than a decade ago, when operators like Verizon and AT&T decided they didn’t need to own the masts in their networks. So they spun out the business and signed long-term contracts to lease back capacity.

Towering Above
Inwit and Cellnex both listed in mid-2015, and have since outperformed a basket of European companies
Source Bloomberg

It’s a nice bit of financial engineering since the operator gets the proceeds to invest or pay off debt, while investors can back a reliable infrastructure company with attractive yields.

Unfortunately, Telefonica has departed from the tried and tested model by lumping in its undersea cable business, which contributes about 60 percent of Telxius revenue and Ebitda. Investors are certain to ascribe less value to that unit because of its lower profitability and higher capex. The cable business is not simple to value since there's no listed peer, although broadband infrastructure providers Cogent Communications and Zayo provide some comparison. Zayo's enterprise value is about 10.3 times expected Ebitda, according to Bloomberg data, while Cogent's is 12.4 times. Some analysts reckon that the cable portion of Telxius should be valued around 7 times forward Ebitda, so there is likely to be much debate over this issue among investors. 

So, the cable bit's worth less than the 14 to 15 times EV to Ebitda multiples of Telxius' listed towers-only peers, thereby dragging down the overall value of the new company.

Cable Weight
Telefonica has put its undersea cable business, which commands lower multiples into, Telxius along with mobile towers. That has proven a drag on valuation.
Source: Telxius IPO prospectus
Telefonica refers to OIBDA rather than Ebitda in its company filings

Telefonica could have blunted the pain of this by putting more towers in the spin-off. In Spain, it's only including about half of them. What's more, the operator seems to be paying Telxius a less favorable rate to lease each tower than Inwit and Cellnex do. Telxius's 2016 Ebitda in Spain is expected to be about 85 million euros from 10,700 towers, whereas Cellnex should earn about 62 million euros from 5,800 towers there. Inwit's on track for about 157 million euros from about 11,000 towers.

Had Telefonica added more towers and offered better lease-back terms, it could conceivably have doubled the spin-off's trailing earnings to about 600 million euros. That would have commanded a higher value and been more liquid, setting Telxius apart from Inwit and Cellnex.

As it stands, it'll just be one of the pack.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

(Corrects enterprise value to Ebitda ratios for Zayo and Cogent Communications in sixth paragraph. Chart called Cable Weight updated to reflect pro forma figures.)

  1. Telefonica uses the term "Operating Income Before Depreciation and Amortization," or OIBDA.

To contact the author of this story:
Leila Abboud in Paris at labboud@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net