Africa loses its appeal

The review of Zain Group’s African portfolio has taken place for the better part of this year, though still no definitive agreement has been reached. In much the same way that discussions between MTN Group and Bharti Airtel on a merger have yet to be ratified, do these movements in the African telecoms sector signal a cooling of investor sentiment towards African telecom stocks?

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At the end of March 2005, Zain Group (then MTC Group) announced triumphantly that it had entered a binding agreement to purchase Celtel International’s 13 African operations for US$3.4 billion in cash. It was a deal that was meant to herald the ascent of the African telecoms sector as investors looked to participate in the emerging market buzz surrounding the ICT sector on the continent. Less than five years on and Zain is looking to jettison its African footprint at the same time that the continent’s pre-eminent mobile operator, MTN Group, is looking to dilute its own African beachhead through a tie up with India’s Bharti Airtel.

The justification for many a merger is the synergies that are expected to be driven by combining independent entities into a single one. It was one of the key elements in Zain’s reasoning when it acquired Celtel, and is also a factor of consideration in MTN’s dealings with Bharti, so the reasoning in heading in the other direction and sell off assets is a less straight forward one to articulate. Unless, of course, the offer for the assets is appealing enough.

Zain spent US$3.4 billion to enter Africa, and is estimated to have spent another US$6 billion acquiring additional assets such as Zain Nigeria, and in developing new and legacy infrastructure in the markets it offers service. Thus all told, Zain has invested in the region of US$8.5 – 9 billion in Africa over the past four-and-a-half years, and with an asking price estimated at US$10-11 billion for the operator’s footprint, excluding Morocco and Sudan, Zain would look to make up to 30 per cent on its investment.

Add to this upside potential the gains Zain would be able to achieve through paying down its debt, and it becomes clearer how selling its African operations could be a development widely supported by Zain shareholders. However, the timing of such a move during a period of global economic uncertainty and tightened credit markets is questionable, and while Zain claims to be in discussions with at least three parties, whether any one of them actually gets to the point of tabling an offer is still to be seen.

It is clear looking at the financials that while Africa continues to offer massive potential with respect to the number of subscribers that can be added to networks, the value of each incremental user is questionable. Nigeria, for example, is Zain Group’s largest single operation by subscriber numbers, with 17.197 million users at the end of 2008. It also contributed the most revenue of any single operation in 2008, amounting to US$1.64 billion, though it ranked 13th out of Zain Group’s 22 operational entities at the end of 2008 in terms of net income for the year.

Kuwait, which counted one tenth the number of subscribers at the end of 2008 than Nigeria’s base produced 31 times the net income Zain Nigeria achieved, highlighting clearly where the financial clout of Zain operations lie.

Incorporating the net losses racked up by Zain’s operations in Kenya, Ghana, Uganda, Madagascar and Sierra Leone in 2008, Zain Africa operations (excluding Sudan) contributed US$122.2 million to Zain Group’s overall net income of US$1.196 billion in 2008, representing a mere 10 per cent. The net losses totalling US$194 million were incurred by operations in Kenya (US$89.3 million loss), Ghana (US$61.3 million loss), Uganda (US$22.4 million loss), Madagascar (US$19.4 million loss) and Sierra Leone (US$1.6 million loss), are definitely an area of concern particularly in markets in which Zain has had a longer history such as in Kenya and Uganda.

Zain’s African assets that did make money in 2008 produced a combined net income of US$316.2 million, averaging US$31.6 million for each of the 10 operations, which prima facie is a fair return for a going telecoms concern in Africa. It has been proposed that rather than selling the entire footprint Zain only look to exit the non-profit making ones, though the easy rebuttal to that potential avenue is that the valuation of the 14-market block, which has an overall positive net income is much higher than an attempt to sell off underperforming, loss-making units individually.

Should an acquirer come forward for Zain’s African assets, the direction that will embarked by the company that remains after the sell-off is up to speculation. Zain without Africa would occupy a similar space to the one inhabited by Investcom prior to its acquisition by MTN in 2006. Investcom’s speciality had been the Middle East though it had also developed a presence in Africa through opportunistic investments. However, that model of Middle East operator has now been overtaken, principally led by Zain’s own efforts to expand geographically, which has been replicated by the likes of Etisalat, STC, Qtel and even Batelco.

“Everything we have done has been in the best interests of our shareholders,” said a Zain insider who requested not to be identified. “If selling Africa at the right price is the thing to do in order to maximise shareholder value, then it is something we’ll look seriously at doing, and what comes after that would be guided by the same principles,” he added.

Maximising shareholder value is the universal aim of corporate management, but in the case of MTN and Bharti, shareholders and analysts alike have begun to question whether a tie-up would really be in the best interests of investors.

Earlier in August the two companies announced they were extending their exclusive merger talks for the second time, until the end of September, suggesting they still would like to consummate a deal, but have more points that require thrashing out.

Having failed to come to any agreement last year MTN and Bharti resumed merger talks in May and for the last four months have been locked in negotiations that have many people asking whether the structure of the deal is just too complicated to be concluded.

MTN and Bharti have agreed that post-merger Bharti would be charged with exploring any further investment opportunities in Asia while MTN would take responsibility for pursuing deals in the MEA

As per the latest deal on the table, Bharti could acquire 49 per cent of MTN while the South African firm and its shareholders would pick up a combined 36 per cent stake in the Indian counterpart. The deal involves both paper and cash, and under the proposed arrangement, which is valued at around US$23 billion, MTN would pay US$2.9 billion and shares equivalent to 25 per cent of its share capital to Bharti in return for a 36 per cent stake in the Indian firm.

Bharti in turn would acquire a 36 per cent stake in MTN, controlled by the Mikati family and a trust representing senior management and employees. The Mikati family gained a 10 per cent stake in MTN through the acquisition of their telecom company Investcom by MTN for US$5.5 billion in 2006. Bharti’s offer to the Mikati family and MTN trust represents R86 (US$10.44) and 0.5 Bharti share for each MTN share acquired through a global depository receipt (GDR) listing on the Johannesburg Stock Exchange. Together with the earlier 25 per cent crossholding in MTN, Bharti Airtel would end up owning 49 per cent of MTN’s enlarged capital.

The two companies have also agreed that while MTN would be the primary vehicle for both Bharti and MTN to pursue further expansion across Africa and the Middle East, Bharti would be the primary vehicle for both companies to pursue further expansion in India and Asia.

The Mikati family, Bharti’s promoter Mittal family, as well as the senior MTN management led by CEO Phuthuma Nhleko, have fully supported the merger and said they would not buy or sell shares in the deal. The wider investor community, it appears, does not seem to be as enthusiastic about the deal.

Fund managers in both South Africa and India have questioned the length of time it has taken to reach an accord. Analysts have also questioned what synergies are likely to be driven by the two companies coming together given that MTN would be free to examine opportunities in Asia without the tie-up with Bharti.