Telecom operators have been facing growing competition in recent years, not only from other operators, but increasingly from over-the-top players such as WhatsApp and Facebook Messenger. This has eroded returns from their core products, with messaging increasingly viewed as a zero-cost service by consumers and voice-over-internet protocol solutions starting to lure away some voice traffic. While operators have been beneficiaries ofthe related increase in data traffic, their inability to capture the full margin consumers are paying for these services has resulted in lower overall returns.
Faced with threats of this magnitude in the past, telecom operators have had the tendency to deploy small amounts of cash to understand the change and how it will affect them better. In the current environment, this is taking the form of operators looking to exploit innovation outside their organisations via partnership or investment in third parties,particularly venture firms. Growth in venture capital investment by telecom operators in recent years has been significant, reaching over $1.4bn in 2014 across 240 deals.
These investments, although large in size, will never meaningfully move the needle in an industry valued wellin excess of $1 trillion. The real reason for deploying this capital, therefore, has to be to drive potential synergies or generate intellectual capital that can be fed back to the core business. This allows operators tocreate a competitive edge or, even more importantly, react early to threats that may significantly change their way of doing business for the worse.
Given the importance of the strategic angle of any investment, operators must devote time and effort to finding the right structure and team. We have observed two different methods of investment by telecom operators. The most common avenue has been to establish corporate venturing funds withinthe firm, but external to the regular corporate structure. The second approach taken has been to invest via third-party managed funds or externally managed diversified internet ventures.
Investing through a fund or holding company results in operators being one step removed from investee companies and also sacrifices some discretion over where funds are invested. It should also be clearly recognised that external managers are typically focused on driving financial returns, not strategic benefits to investors.
It is therefore critical that mechanisms exist for operators to capture this strategic value. They should ensure that throughout the investment process there is a complete understanding of the telecoms environment, its challenges and expected evolution, and that these inputs are appropriately factored into decision-making. We have seen a number of different practical approaches to address this.
Most commonly, significant influence by the operator at the fund or holding company level is secured through seats on investment committees or other managerial structures. This link is typically cemented through dedicated operator personnel who are held accountable for the delivery of synergies and regular interactions between investee companies and the operator more generally. Secondments of personnel to both the fund or holding entity and even investee companies are other common ways operators deliver onthe synergies and lessons that were the basis for investing.
The benefit of investing through third-party funds or holding entities is that a number of the challenges of establishing a well-functioning in-house corporate venturing fund are overcome. Aligning with an established investor provides instant credibility when approaching investment targets as well as establishing a network in global innovation centres from day one. Furthermore, for operators facing challenges with excessive bureaucracy or reluctance to accommodate the change in culture and compensation structures that a successful corporate venturing fund requires, it can be seen as a more acceptable and lower-risk innovation strategy.
At Delta Partners, we work with clients who have both in-house corporate venturing funds and third-party investments. It is imperative that, whichever avenue they follow, operators deliver on a few key success factors – a clear focus on why corporate venturing activities are being undertaken, appropriate sponsorship by business leaders so that lessons permeate the organisation, and ensuring investments have relevance to the operator and therefore the ability to drive synergies. With these things in mind, we believe either method of investing can allow operators to attain their goals.
Delta Partners Corporate Finance focuses on assisting clients in the telecoms, media and digital space investing in both emerging and developed markets.