MEA giants well-placed to capitalise on downturn

With value and confidence around the world going into what appears to be chronic decline at the moment, it is hard to see where board room optimism might exist in any business. However, whilst there is no doubt that the regional telecom sector has, and is being impacted to some degree, it is perhaps not all bad news; and the next 12-18 months promises some interesting prospects.

Abdullah Mutawi is partner and head of telecom at Trowers & Hamlins, Bahrain

It is of course true that some of the big regional operators have recently announced substantial drops in their 2008 fourth quarter net profits including STC (62 per cent), Wataniya (33 per cent), and Etisalat (20 per cent). In other quarters, M&A deals have visibly failed to come to market or to close including the privatisations of Batelco, Algerie Telecom and the sale of a strategic minority stake in Omantel. Orascom recently announced a share buy-back plan that has helped to shore up its flagging market value. In other cases, licences have recently been acquired at bargain prices with mobile licences in Bahrain and Iran for example being won for a fraction of the types of valuations that were common in recent years.

Nevertheless, the fundamentals of the telecom business model remain essentially strong. Global consumer trends over the past decade or so indicate that the mobile phone is now regarded as a necessity across the demographic spectrum and, increasingly, universal access to the Web is regarded as a pre-requisite for economic and social development as well. Accordingly, it is highly unlikely that people will place less importance on being able to talk, SMS and access the Internet and it is almost certain they will continue to pay cash on a regular basis to do so. Whilst the sector is by no means immune to the economic crisis, it is worth bearing in mind that the effects of deregulation, liberalisation and further competition may be partly responsible for falling operator profits.

Obviously, regional M&A is already seeing a significant decline – according to MEED, the value of Middle East M&A in 2008 (across all sectors) sank to US$29.6 billion from US$66.8 billion the year before (a 55 per cent drop).

Despite the gloom, there is of course the phenomenon of the solid regional giants, some of whom enjoy strong cash positions and manageable debt ratios. Whilst operating profits may be falling in some cases, this is unlikely to dampen their capacity for doing deals although it is likely that we will see some impact on the aggressiveness of buy-side valuations.

Opinion is divided on whether we are about to see a wave of consolidation amongst the regional giants, but clearly there are going to be some interesting times ahead. Undoubtedly these operators are in a good position to capitalise on the downturn.

Zain Group, in the wake of its incredible acquisitions right across the Middle East and Africa, has recently raised nearly US$4.5 billion in equity from its shareholders with the specific aim of continuing an aggressive and sustained acquisition streak with the unabated ambition to be a ‘top 10 global operator by 2011’. Its highly integrated and strategic approach to building its network and customer base has started to pay dividends for Zain – not just in sheer scale and profitability, but also in terms of its in-house talent pool and an enviable brand that will continue to grow.

STC has also announced a war chest of US$10.7 billion for acquisitions in the coming four years, which is allocated on a part-cash and part-debt basis. STC’s strong cash position and its relatively modest debt position puts it in a good position to capitalise on the opportunities presented by falling values. Whilst STC has had a relatively conservative approach to acquisitions thus far, its strategic and keenly-valued acquisitions of substantial minority stakes (Oger Telecom at US$2.65 billion for 35 per cent, Viva in Kuwait at US$900 million for 26 per cent and Maxis at US$3 billion for 25 per cent) have given it access to numerous valuable markets with considerable growth potential. As the company surely builds its capacity of in-house talent, it will undoubtedly seek out control and consolidation opportunities that eventually will place it in a very strong position relative to its regional rivals.

Having spent US$11 billion in assembling its substantial 17 country network, Etisalat announced a US$3 billion war chest in November 2008 to fund further acquisitions and has subsequently announced US$1 billion investments in each of Iran and Iraq. These are dream markets with superior scale and growth potential in petro-dollar economies.

Qtel too has enjoyed a rapid and substantial expansion acquiring strategic minority stakes in Asia, investing heavily in Indonesia, Iraq and Oman and in a pan-Asian WiMAX business and of course making its US$3.7 billion acquisition of Wataniya which propelled it into the big league of regional operating groups. Qtel will almost certainly seek to expand its portfolio again and will undoubtedly be able to raise the finance to do so for the right opportunities.

Aside from the raft of new licences slated for 2009, there also remain highly attractive brownfield targets in the region with very respectable cash/debt positions. Undoubtedly, depressed values will see shareholders reluctant to sell in the down cycle, but there will be stiff competition to acquire such assets as and
when they become available.

Infrastructure sharing is also a phenomenon that will perhaps acquire a renewed cachè in the down cycle with operators recognising the long term benefits of unlocking value through innovations that they have not perhaps embraced as wholeheartedly thus far.

What will be truly interesting over the next 12-18 months is to see whether the evaluation of deals by the regional giants will lead them to pursue regional consolidation moves on the one hand, or perhaps a focus on opportunities further afield. Most interestingly, Eurozone assets have plunged in value in parallel with a weakening of the euro against the dollar and this presents opportunities in the more developed market, which may have once looked less attractive because of their position in the liberalisation cycle and the highly penetrated and competitive nature of those markets.

The capital markets and the availability of any reasonably priced debt in the region are very shaky, and combined with a rock-bottom oil price that is unlikely to recover in the immediate term, this will have some negative impact on M&A. Nevertheless, if a short to medium term recalibration of IRR expectations takes place in board rooms and new ways of unlocking value are found, it should be expected that the giants will continue their acquisitive projects and that the regional telecom sector will continue to grow over the next few years as it has done so spectacularly over the last few.