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Those looking for convergence between du (Emirates Integrated Telecommunications Company), MENA’s top telecom YTD at +10.5% through end-May (20.1x 2011e P/E and 7.1x EV/Ebitdba) and Etisalat (-5.1%; 7.8x and 2.9x, respectively), which was recently ranked the GCC’s second most valuable portfolio brand (USD3.622bn) by Brand Finance, a consultancy, may have to hold on. Analysts with Egypt’s CI Capital Research recently noted for instance that risk averse capital and bank deposit flow into the UAE from relatively unstable regional geopolitical backdrops “should in turn boost subscriber growth and limit average revenue per user (ARPU) erosion.” To this end, it wrote, “driven by mobile services, du continued to deliver a positive performance in 1Q11, where earnings more than doubled [y/y].” Moreover both players should benefit via the impending introduction later this year of long-term evolution (LTE, or “4G”) and voice over internet protocol (VoIP) services (i.e. the ability to make phone calls over the internet), as well as mobile number portability (MNP) which mark a paradigm shift within the sector towards liberalized, revenue diversification outside of the traditional fixed-line and mobile voice segments. Etisalat’s agreement with France’s Alcatel-Lucent in mid-February to help develop its LTE network, for instance, which will enable high-speed access to multimedia content such as video conferencing, was predicated on said shift: “Over the last year we’ve witnessed a 200% growth in data roaming traffic. There is an exploding demand for new technologies and large bandwidth to support and enable the surging data traffic,” commented Marwan Zawaydeh, Etisalat’s chief technology and information officer at the time. Yet to date du has been more aggressive in its rollout: this spring it successfully conducted and completed its first LTE pilot, a move which followed the launch of the latest 42Mbps mobile broadband services, currently the fastest in the country, after having recently upgraded its network to next-generation DC-HSPA+ technology.
The strong push is somewhat characteristic, however, and EFG Hermes, an investment bank, wrote in April that unlike its rival, which maintains a presence in multiple frontier markets, du is a pure play on the various Emirates and moreover “has managed to cement its position in the [UAE] market over the past two years, strongly pressuring Etisalat’s operational and financial performance to its own benefit. Operationally [it has] reached a 36% share of the mobile market and a 31% fixed-line market share only four years after its launch.” Plus, room for growth remains ample: UAE population and mobile penetration rates should rise from 4.9m and 245% in 2010, for instance, to 5.6m and 301% respectively in the next five years per analysts, and du’s higher-than-average expected growth (2010-2012 earnings before royalty growth 28.5% versus regional -1.1%) make it best in class, per a spring research note. In fairness, some observers wonder to what extent du’s high multiple is merely a product of artificial subsidy: it paid a 15 percent royalty fee to the government in 2010, while its rival, Etisalat , paid 50 percent of its annual net profit as royalties. Analysts with EFG admit that “there is little clarity on whether the Ministry of Finance will soon inform du of the royalty charge starting in 2011 or not,” and its sensitivity model indicates a fairly dramatic (~25%) increased intrinsic value per share if the royalty is cut even by as little as 10% this year. Etisalat’s shares would theoretically have even more to gain, however, given its hitherto under-performance as well as the thesis that the government is priming it for its own royalty cut in advance of allowing non-local ownership of shares which in and of itself should be a huge liquidity boon for an already attractive country and sector.
Though Etisalat remains in our view the head and shoulders frontier market telecom equity to hold from both a value (2011e EPS of 6.8x is a 30% discount to EEMEA peers at 9.6x/3-year average of 10.4x per Morgan Stanley) and growth standpoint (despite the latest Zain-pullout) given its relatively high EBITDA margin (despite intense pressue from du), wide geographical footprint (though its foothold in Saudi Arabia remains the foundation) and strong net cash position, Egypt’s hitherto distressed domestic sector presents its own opportunities. Ahead of tomorrow’s stock exchange reopening, and while reiterating his long-term confidence in Egypt to Bloomberg yesterday, Templeton Asset Management’s Mark Mobius underscored telecoms in particular as one of his favorite sectors. To that end, both Orascom Telecom (OT) and Telecom Egypt (TE), which trade at a relatively low 7.3 and 8.5x earnings respectively and are down 16.2 and 11.3 percent YTD, look attractive at current levels. In regards to the latter, wholesale services–including bandwidth capacity leasing to ISPs, and national and international interconnection services–continue to be the crucial growth driver as declining retail revenues are likely indicative of an increasingly competitive landscape (though while the firm’s fixed subscriber base declined to 9.3 million, from 9.6 million at the end of 2009, the market share for data subscription now sits at 63% versus 61% at the end of 2009). While overall revenues grew by 4% y/y in 2010 (4x estimates), for instance, full year wholesale revenues for TE grew by 18% YoY to EGP 4.9 billion, representing 48% of total group revenues. Finally, the company’s net cash position is strong, rising to EGP 4.1 billion (from EGP 1.4 billion at the end of FY2009) and leading the Board to recommend a cash dividend of EGP 1.3 per share–equating to a dividend yield of 8% and a payout ratio of 67% (versus 74% in FY2009). Meanwhile, the former continues to be considered a strong value play by many analysts given its leading position in core markets aside from Egypt such as Algeria, Pakistan and Sub-Saharan Africa. That said, J.P. Morgan noted last month the firm’s equity remains “very speculative” given the uncertainty underlying the current row in Algeria.
Sandy Pomeroy, manager of the Neuberger Berman Equity Income Fund was interviewed by Bloomberg this morning and mentioned that one of the fund’s top ten holdings included an intriguing emerging/frontier market firm, Philippine Long Distance Telephone (NYSE: PHI), which is a play not only on foreign telecoms–an industry recently touted by Investor’s Business Daily–but also on an implicitly government guaranteed dividend stream of roughly 7.6%. As IBD notes, both Indonesia and the Philippines have proved prime regions to weather the global recession through the enduring and inelastic demand for wireless and broadband–in the third quarter, Indonesia and the Philippines ranked No. 1 and No. 3, respectively in broadband growth. And while Fitch Ratings offered only a modest outlook on the firm’s medium-term growth prospects earlier this fall–citing the country’s cellular market maturity (73 million subscribers through 2009, up from just 6 million in 2000)–a Frost & Sullivan report from September on the Southeast Asian mobile market concluded that while growth would be “marginal” for saturated markets like Singapore and Malaysia, “growing markets like Cambodia, Vietnam, Indonesia and the Philippines, with low mobile penetration and even lower fixed broadband penetration, are likely to see growth in new subscriber additions.”
Citing Dubai’s deteriorating credit worthiness–government debt is expected to reach some 40% of GDP by year’s end–Fitch placed the UAE’s largest telecoms firm, Etisalat, which is 60.03% owned by the UAE and is the second-largest operator in the MENA region by market capitalization, on watch with a negative outlook. The firm’s AA- credit rating could be downgraded, Fitch warned, if government officials did not further articulate its willingness to cover the company’s debts (some commentators astutely noted that what this is in fact asking is to what extent will Abu Dhabi’s massive oil reserves further insure its arguably profligate sibling). “While the [UAE’s] sovereign credit remains strong, the lack of clarity on the process for non-budgetary financial transfers between the UAE federal government, central bank and individual emirates, is a source of weakness,” the rating agency noted.
The downgrading of Etisalat, however, would be curious, and almost certainly arbitraged away. The company enjoys a share price to operating cash flow ratio of 8, and a beta of .63, meaning it is less volatile than the overall market. Most important to its prospects for sustained profit growth, however, is a growing portfolio of overseas assets. This is especially vital to operations as the UAE’s mobile penetration rate has now exceeded 209%, meaning every single resident of the country currently has two lines to his or her name. While 90% of its revenues are UAE-derived, Etisalat is poised to capture emerging market share: in addition to the seventeen countries it currently operates in, the company acquired an Indian operator earlier this year and has submitted bids in Sri Lanka and Libya.
While assigning a “buy” rating to Egypt’s Orascom Telecom Holding (OTH), MENA investment bank Naeem Holding praised the company’s growth strategy and noted that it has “evolved into a well-balanced group with operations in mature markets providing healthy cash flow, while more exotic markets offer growth.” Its analysts forecasts the firm to generate free cash flow of roughly $1.6 billion in 2009. Through its wholly-owned subsidiary, Telecel Globe, Orascom invests in small and mid-cap mobile operators across Africa and Asia. And back in December, it raised eyebrows by becoming one of the first countries to invest in North Korea when it opened Ora Bank–a joint venture along with the country’s state-owned Foreign Trade Bank–while concurrently launching a high-speed mobile network that is 75% owned by Orascom Telecom and 25% by the state-owned Korea Post and Telecommunications Corporation after receiving a 25- year license and exclusive access to the country. Per Naeem: “Its entry into North Korea faces high execution risk, but strong subscriber growth is not in doubt.”
Yet Orascom’s frontier-dominated strategy–it is well situated in Algeria (”OTA”), Pakistan (”Mobilink”), Egypt (”Mobinil”), Tunisia (”Tunisiana”), Bangladesh (”Banglalink”) and Zimbabwe (”Telecel Zimbabwe”)–has not precluded it from eyeing value elsewhere, even in a relatively developed nation like Canada; the company entered the Canadian market in the fall when it began backing Globalive Communications in an attempt to pierce a Canadian mobile market dominated by three established operators (Rogers Wireless, Telus Mobility and Bell Canada Mobility). Orascom hopes that the country’s low mobile penetration rate of less than two-thirds will allow room for Globalive to grow, and Naeem concurs. “Sharp focus on the nascent pre-paid market will see Canada exceed early expectations,” it predicts.
Per its recently published quarterly results, du, a Dubai-based integrated telecom services provider, reported an increase of 156,000 new subscribers (giving it a total of 2.9 million active mobile customers), in addition to a 12% increase in revenues on the previous quarter and a greater than doubling of profits. With an estimated 30% of the UAE’s mobile market, du is competing chiefly with Etisalat, which presently reports 7.26 million subscribers (though it just disclosed a loss of around 80,000 customers over the past three months). According to its chairman Osman Sultan, du hopes to gain an addition 5% market share over the next year, as well as grow usage of mobile broadband on its network–i.e. the BlackBerry mobile e-mail handset and also the launch of Apple’s iPhone.
Once considered the mere low-cost, low-quality network compared with Etisalat, du’s surging customer base is testament to the brand’s perceived value, as well as its growing competitiveness in a market where the cost of a new mobile line today is a third of what it was a year ago, and mobile data rates and fixed-line internet costs continue to fall as well. However, some analysts wonder whether the company’s edge will disappear once protection originally granted to it (in order to shepherd in competition) from the UAE’s Telecommunications Regulatory Authority (TRA) subsides, and/or a third operator joins the fray? For instance, reports allege that Etisalat has previously complained that it would like to lower some prices, but has not been given regulatory permission.
According to its Assistant Chief Executive for Business Development and Government Relations Barrak al-Subeih, Zain’s possible decision to sell its African operations would be made in order to “look for expansion opportunities in other areas with higher growth rates, such as the Middle East or the Far East.” Hitherto, the Kuwait telecom firm has spent upwards of US$12 billion in Africa since 2005 (when it purchased Celtel International), including roughly $3b in Nigeria alone, the continent’s most populous nation, while continuing to expand and operate in 23 countries across the Middle East and Africa. Per Bloomberg, Zain has around 40.1 million subscribers in Africa, a figure that constitutes nearly 62% of its client base. Additionally, more than half of its $7.4 billion of annual sales in 2008 came from Africa.
The strategy of chasing higher growth rates is not without concern, however. A study published last year by Booz & Company, a global management consultancy, concluded that most markets in the GCC were quickly reaching “saturation levels”. Further growth, it noted, would thus have to adopt strategies that address both the scale and scope of their services. In terms of scope and growing revenues, operators must extend and diversify their business to include offerings that go beyond basic telecom services. “As for extending scale, operators must acquire and/or pursue strategic alliances, either with local or international players, to create a much sought-after critical mass,” remarked Ghassan Hasbani, a Booz VP. And as for scope, he continued, operators must extend and diversify their business to include offerings that go beyond basic telecom services.
Yet as of late, at least, Zain has shown a propensity for both. Two months ago it expanded its scale in West Bank and Gaza (a region with a paltry 35% penetration rate) through a 56% ownership stake in Paltel. And several weeks ago the company announced the implementation of ZAP–a new service allowing customers to make cross-border payments and transfers between Kenya, Tanzania and Uganda with no extra charge.
Reports surfaced this past week that Kuwait’s Mobile Telecommunications Co. (Zain)–the leading African and Middle Eastern mobile operator–is close to rescheduling a $2.5 billion two-year “murabaha” loan agreement on behalf of its subsidiary, Zain Saudi Arabia, that it signed in 2007 in order to finance the development of its infrastructure and the expansion of its subscribers’ base. Commitments will likely come from Saudi Arabia’s Al-Rajhi Bank and Banque Saudi Fransi, as well as France’s Calyon.
Under murabaha, a intermediary financier buys a property or commodity and sells it to the buyer at a higher price (retaining free and clear title/ownership until the loan is paid in full), thus complying with Islam’s ban on interest. The theory under murabaha is that the transaction is not an interest-bearing loan, which is considered “riba” (excess). To prevent riba, the intermediary cannot be compensated above the agreed upon terms of the contract–even through late penalties should one party default. Murabaha is therefore a permitted method form credit extension under Sharia (Islamic religious) law, since the fee earned is not interest per se, but rather a holding-related charge.
Back in May Zain lowered its net profit growth targets for 2009 from 30% to 20% due to the global recession, and also announced that it would seek a credit rating in order to tap longer term debt markets by 2010-end. It also unveiled a plan to slash its expenditure targets by half, and to focus on “synergies among its various units,” per Ibrahim Adel, its Chief Communications Officer.
Egypt’s benchmark CASE 30 stock index, the EGX 30, gained 2.2% yesterday, primarily on the strength of its telecoms and specifically rumors that a row between Mobinil shareholders will soon be resolved. Orascom Telecom (OT) and France Telecom have been engaged in battle over their joint holding in Mobinil–one of three mobile operators in the most populous Arab country–since the two sides went to court in 2007. OT had previously stated that it considers the deal ordered by an international arbitration court in March to sell its 28.75% stake in Mobinil to France Telecom “null and void” after the French company failed to meet a deadline to transfer certain funds in time.
The telecom sector is of particular interest to investors looking to add Egyptian exposure. Egypt’s Minister of Investment declared this week that the sector grew by 14% Y-OY in the third quarter of the current fiscal year, which ended in March. The sector contributed less than 3% to GDP, while the number of internet users increased to 13 million. And last week Telecom Egypt announced a surprise 72% rise in net profit for the first quarter, a better than expected result that shocked traders.
According to Business Monitor International (BMI), Egypt’s mobile subscriber market grew by 9.6% in the third quarter of 2008. Including inactive mobile users, which all three of Egypt’s operators are assumed to have, the total Egyptian mobile customers expanded to 42.275m at the end of September 2008–equivalent penetration rate of just over 53%. Moreover, it envisions a total market of over 59m mobile customers at the end of 2009– equivalent to 74% penetration.
“Prepaid services,” it states, “will continue to drive market growth in the immediate future, and this phenomenon is expected to put downward pressure on operator average-revenue-per-user (ARPU) levels. However, recent developments, including Mobinil’s launch of 3G services in September and Vodafone’s November announcement that it was preparing to launch Apple’s iPhone 3G, should help to boost the market for mobile internet and data services. This in turn will help to stabilise falling ARPU levels.”
Interesting piece on the challenges facing Middle East telecoms in light of a recent study that forecasts average revenue per user (ARPU) in sub-Saharan Africa and South Asia–regions where future market share lies–to drop by half by 2013.
For Middle East mobile telecom firms such as Zain, Qtel, STC and Etisalat, most of their recent growth has come from emerging markets with high population and relatively low rates of penetration, such as sub-Saharan Africa and South Asia. But these operators are now challenged to boost profitability, as average revenue per user (ARPU) levels in such markets have been dramatically decreasing, because of increasing competition, price reductions, and a second wave of customers who are predominantly lower-income.
Much like uber-competition among German banks turned out to be a bad thing, one wonders if consolidation in the Arab telecom market will ultimately not only be inevitable, but also beneficial.
JGW
Frontier Markets 