The phoenix effect

At the end of March, Scott Gegenheimer completed his first full quarter as Zain Group CEO. Expectations for him to turn the Middle East player around are high, and the service provider’s operational results for the first three months of the year clearly identify the areas that require Gegenheimer’s attention. The question being whether current and future market conditions will permit him to raise Zain up to its former glory

Gegenheimer’s first full quarter as Zain CEO has seen him shift the company’s focus to several key areas, including customer experience, operational excellence and synergies, human resources, and new business areas

Zain Group reported a 27 per cent decline in its first-quarter net profit to end-March, blaming steep devaluation in the Sudanese pound and loss-making unit Zain Saudi Arabia as the main contributing factors for the fall.

The operator recorded net profit of KWD52 million (US$182.6 million) in the three months to March 31, down from KWD70.9 million a year ago.

Sudan accounted for nearly a third of Zain’s customer base and a fifth of group revenue in 2012, but the country has been mired in economic turmoil following South Sudan’s succession in 2011.

Zain stated the devaluation of the Sudanese pound against the dollar, by 53 per cent in the 12 months to end-March, was a significant contributing factor in reducing group revenue by US$179 million, EBITDA by US$76 million, and net profit by US$44 million.

Group revenue was down eight per cent year-on-year to KWD299 million, while the operator added 1.386 million subscribers in Q113, up from just 37,000 in Q112. Zain reported 44.1 million active subscribers as of end-March.

Amongst the most concerning areas of Zain Group’s Q113 operating results was the fall in revenue and net profit despite the strong recapture of lost subscribers in comparison to the same period in 2012, compounded by the 16 per cent year-on-year decline in EBITDA, pointing to margins being squeezed and the cost of doing business rising. Indeed Zain reported that its EBITDA margin in the first quarter had fallen to 42.4 per cent, down from 46.3 per cent a year earlier.

Severe competition in Zain’s historical cash cow market of Kuwait continues to also impact the group’s results as does its unpredictable operations in Saudi Arabia, Sudan and South Sudan.

Despite these key performance indicators showing signs of being under pressure, it is clear that Scott Gegenheimer’s arrival at Zain Group last December has brought with it an acknowledgement that work needs to be done, and more importantly, a resolve on the part of the company’s executive management to work at turning things around in an active and determined fashion.

One example of Gegenheimer’s impact on the operator’s outlook is that for the first time in numerous quarters, the Zain Group’s management opened itself up to scrutiny from the analyst community by hosting a conference call and offering more details and insight into the company’s strategic direction. This included referencing a number of problem areas and discussing what plans are afoot to resolve them.

“I’m genuinely enthusiastic to be at the helm of such a great company,” Gegenheimer said before identifying what he believes to be some of Zain Group’s strategic assets including its regional footprint; its market leading positions in six out of the eight markets in which it operates; and the company’s willingness to use technology as a tool to work more efficiently and to deliver cutting-edge products and services to end-users.

However, Zain’s operational results do point to a number of problem areas, which Gegenheimer will be under pressure to resolve. At a group level, the company has suffered from a type of corporate inertia since Etisalat Group’s pursuit of the company ended officially in March 2011. Since that time, the Kuwait-headquartered operator has found it challenging to re-establish a corporate identity of its own, with a vision of where it currently stands and where it intends to go.

Gegenheimer says Zain is now executing strategies that will address the challenges that it faces. “Having had an opportunity to assess the businesses, I have reshaped the strategy of the group to focus on several key areas, including customer experience, operational excellence and synergies, human resources, and new business areas,” Gegenheimer said.

The main aim of Gegenheimer’s strategy is to stem the company’s decline in revenue and profitability, and like operators the world over, look to new services and delivery mechanisms to drive incremental income. Interestingly for a business in which size and scale is an important success factor, Gegenheimer has chosen not to focus on subscriber acquisition and subscriber growth as one of the company’s driving priorities.

“From a group perspective, we have not really focused specifically on the growth of the customer base as we want to be careful about flooding the market with SIM cards and multiple SIM cards,” Gegenheimer said. “…We don’t particularly want to give a forecast for that [customer growth] because it is not one of the KPIs that we want to drive the market with,” he added.

Mobile broadband is a definite area of interest to Gegenheimer and Zain, and with commercial LTE deployments in Saudi Arabia, Kuwait, and Bahrain the company is staking its claim to being one of the leading regional innovators. Zain Group’s data revenues increased 14 per cent year-on-year during the first quarter with data now accounting for 12 per cent of overall service revenue, without the inclusion of value added services and SMS revenues included. With these other non-voice services included, data would account for 21 per cent of Zain’s overall service revenue as at the end of March.

On a country-level, there is work to be done across much of Zain Group’s footprint. In its home market of Kuwait, competition is squeezing the operator’s margins significantly, and generating incremental revenues from the subscriber base is proving challenging.

Revenues in Kuwait were down five per cent year-on-year in Q113 to US$287 million, while EBITDA was down eight per cent to US$136 million, and net income dropped 13 per cent to US$90.4 million. The operator attributed the decline in EBITDA and net income mainly to the cannibalisation of voice revenues due to the increased use of VoIP and over-the-top solutions, as well as the heightened level of competition in the market. However, Zain Kuwait continues to generate a healthy ARPU of US$39.

Gegenheimer’s experience extends to a decade working in various management positions within Ooredoo-controlled Wataniya Telecom in the Middle East and North Africa

“Clearly it’s [Kuwait] a very competitive and tough market for us. We have been undertaking a number of measures to improve results there,” Gegenheimer said. These measures include locking customers into long-term contracts in preparation for the introduction of mobile number portability later this year.

Saudi Arabia continues to be a loss making entity, though losses are narrowing year-on-year. What investors will be most pleased to learn about with respect to Zain Group’s exposure to Zain Saudi Arabia, is that the group does not expect to inject any more cash into the operator beyond what it had already committed to in last year’s capital restructuring arrangement. Zain Group management is also confident a settlement is imminent between Zain Saudi Arabia and creditor banks over a Murabaha loan that is set to be restructured.

There is limited proactive action that Zain can take with respect to the macro-economic and political issues adversely affecting its operations in Sudan. The significant depreciation of the Sudanese pound against the dollar has adversely affected the country operations as well as denting the group’s metrics, and Gegenheimer is hopeful that a measure of stability will return to the region soon, allowing for more predictable performances from both Sudan and South Sudan.

The shortage of foreign currency in Sudan has resulted in unpredictable remittances of cash from the local operations, another area of concern that is beyond the group’s immediate influence.

Initial public offerings are also on the horizon for Zain’s operating companies in Iraq and Bahrain. The requirement to list in Iraq, and in the process comply with its licence conditions, has loomed since the latter part of 2011, and finally seems to have kicked into high gear. The goal is to float 25 per cent of Zain Iraq before year-end, which in turn is expected to generate in excess of US$1 billion. Local competitor Asiacell listed on the Baghdad Stock Exchange at the start of this year, raising in excess of US$1 billion, while the country’s third mobile operator, Korek Telecom, is yet to list.

In preparation for its own listing, Zain Iraq is in the process of forming the requisite joint stock company, with the company initially in possession of the operating licence having been an offshore entity, which is in the process of being brought onshore.

With respect to Bahrain, the regulatory requirement is for Zain to float 15 per cent of the issued share capital prior to listing or 13.04 per cent post-offering, and the operator expects to accomplish this before the end of the year. Zain Group also awaits the licensing of 3G spectrum in Iraq and given the emphasis the company places on driving new revenue streams through digital services, is keen to have the network operational as soon as possible.

“I am confident that in the years ahead the group will continue to deliver exceptional value for our shareholders,” Gegenheimer predicted, perhaps referencing the multi-billion dollar windfall received by shareholders through the sale of Zain Group’s assets in Africa to Bharti Airtel in 2010. However, with the company’s share price under pressure, down around 10 per cent since the start of the year, Gegenheimer will need to work hard on developing organic revenue streams rather than relying on inorganic windfalls in order to drive shareholder value.

In Kuwait for example, Zain intends to push actively into the small and medium size business sector, believing this to be a prime area for growth. The expectation is that other segments and niches across its areas of operation shall continue to be tapped and developed, with Zain expected to articulate a group-wide corporate strategy in the coming months.