Real Options in Telecom Infrastructure Projects — A Tutorial

Abstract

The rapid technological change and uncertain future evolutions have a large impact on investment projects in the telecommunication sector. When new infrastructure networks are rolled out, the initial assumptions can prove to be untrue in the future, severely impacting the payoff. It is therefore extremely important that projects offer flexibility to allow the management to react to unforeseen changes. Management must, for example, be able to decide to speed up the project, slow it down, or even completely abandon it. However, the standard method used to evaluate investment projects, the Net Present Value analysis, is unable to capture the value of these different flexibility options. The Real Option concept, derived from financial literature, was proposed as a solution and implements this flexibility in the standard calculations. However, the Real Option Theory is only slowly getting accepted within the telecommunication sector. In this paper, we introduce the basics of real options theory and provide a practical methodology to apply real options to realistic telecom business cases. In addition, we will indicate why the characteristics of this sector make it very well suited to apply real options to investment projects. The rollout of fixed next generation access networks offers a broad range of growth options to the operator, e.g. additional network upgrades or the introduction of new services. Using real options allows one to compare the flexibility value of all these options.