The beginning of a new phase

Booz&Co’s Ghassan Hasbani reviews the repercussions of the global economic crisis on telecoms operators in the Middle East.

The recent global markets crisis inevitably is set to impact the telecommunications sector in the region in one way or another. The extent of this impact is not likely to be drastic but nevertheless, it is worth trying to rationalise the situation rather than speculate.

Following several years of high premiums and leveraged acquisitions, we may see the next phase of telecoms M&A unfold within the next few months. This phase is likely to be characterised by mergers, more realistic premiums and clear success of certain operators that have and continue to make the right moves.

We have not seen the end of acquisitions in the region. Activity is intensifying in the short term, led by cash-rich companies from the region and potentially mergers of equals that have complementary assets. Undoubtedly, we are likely to see several acquisitions take place in the next few months with traits similar to those we have seen in the past three years.

Given the current economic conditions, it is less likely for European operators to make significant moves within the region in the short term. Although there has been a growing appetite for re-entry into the Middle East by European players, the relatively low level of synergies that can be achieved by small acquisitions, makes operators in the region better positioned than European operators to pay the premiums on the few remaining opportunities. In addition, the current financing capabilities will make it difficult for European operators to leverage debt, leaving the space open for financially strong regional operators to set the rules of engagement.

Who will be the winners?

In the past six months (ending October 15, 2008), the market capitalisation of the 14 largest telecoms operators in the region has been negatively impacted by the financial markets. On average, the total telecoms market lost around 30 per cent of its stock value. STC remained solid with market capitalisation staying relatively stable with a growth of around 2 per cent. Other regional operators have lost significant market value ranging between 14 per cent and 55 per cent, with Orascom Telecom being the most impacted.

This has drawn a new picture for the telecoms landscape in the market. As of October 15, STC led the market as a clear number one in terms of market capitalisation at US$34 billion, followed by Etisalat at US$24 billion and Zain Group at US$22 billion.

The position of STC was supported by the fact that it had the highest liquidity and profitability ratios among the top operators in the region, despite having invested heavily in the past year.

Deals that may not have been possible in the past may now be more likely to happen, given the sharp drop in market value of certain operators and the increasing demand for cash to finance operations.

Operators with liquidity problems will be impacted most due to difficulties in raising capital moving forward. Debt is likely to become more costly, if available, and floating more shares in the market would further exacerbate the situation in terms of share price, due to the signal effect. This could result in further consolidation in the market. Market players that have invested in, and require significant capital expenditure in the early years of their operation, might face cash problems making them potential targets for acquisition by the larger players. This remains contingent upon the players’ willingness to invest in riskier targets than their current business.

As a result, cash acquisitions may slow down significantly in the medium term. Simply, there will be little credit that will be available for risky operations at attractive conditions, and operators that have cash, may become more prudent in spending it. Potentially stock swaps could become more common, given the low market valuation of certain companies.

Ultimately, the winners are likely to be those that can successfully leverage their strong cash position to execute investments in order to grow in scale in addition to those who will focus on extracting value from synergies and innovate on service and pricing.

Securing future growth

Hasbani is partner with the Global communications and technology practice at Booz&Co

Regional players are at various stages of their development and will continue to find ways to grow either through subscriber revenue growth or through acquisitions.

It is important to remember that growth does not only come from international acquisitions of other operators or licences. While acquisitions cater for scale growth, innovation and convergence of industries caters for scope growth. This may be the perfect opportunity for telecoms operators that can no longer pursue large acquisitions, to look into alternatives that would allow them to grow the scope of the business beyond the traditional telecommunications services like voice and data connectivity.

Growth in scope may come by offering consumers converged services. Convergence with media would allow telecoms operators to offer richer and more tailored content. Electronic, particularly mobile commerce is an emerging area of convergence between the banking sector and telecommunications that would facilitate cheaper and easier small transactions and transfers. There are many other innovative services and applications that would generate traffic, usage and potential advertising value for telecoms operators. Such services can only be successful if operators enter into partnership agreements with key players in the respective industries. Such relationships can be strengthened further if operators acquired or built joint ventures with such entities. Historically, operators did not see much value in doing so and such investments did not receive the right management attention in comparison to large scale mainstream acquisitions. With the financial crisis, operators are likely to pay more attention to such investments, particularly as they require a fraction of the financing needed for major acquisitions. Having the potential to generate new business and provide a competitive edge in customer acquisition and retention is very important at this stage, particularly at times where operators are seeking to grow their revenues through more consumer spending on telecoms services.

Consumer spending on telecoms is unlikely to deviate from the expected general trend under the impact of a possible economic recession. Historically, consumer price indices have increased with inflation as spending decreased in days of recession. Telecoms services have been following a steady general downward trend, with the exception of certain countries where hyper inflation is present. The downward trend has been attributed predominantly to increased competition and the opening of markets. As consumer goods prices are expected to drop in the near future, telecoms prices in the region will likely continue to dropping as was previously expected with no significant impact from recession. The impact of market opening on telecoms prices exceeds that of a recession.

However, some operators may face difficulties in sustaining a long term price war, especially as it impacts their ability to invest further in network expansions at times where attractive financing may not be available. The combination of stable usage of services and a stabilisation of price drops will allow operators to sustain organic revenue growth during the credit crisis:

“Cash is king,” so use it: in a situation where attractive financing is not readily available, maintaining the ability to spend on network expansion and growth is very important. Aggressive price wars would act against this principle.

Eat or be eaten: acquiring a smaller player or merging with equals and consolidating maybe the best move to avoid facing future competition from consolidated regional giants or being acquired by one of them.

Innovate: it is time to take industry convergence seriously and start innovating beyond basic voice and SMS price reduction. Consumers in the region expect better quality and creative services rather than simple low prices for low income communities

Extract value: focus on extracting value from acquired or built assets through leveraging scale and integration at a global level, reducing capital and operating expenditures in the process.

This article was authorized by Ghassan Hasbani