Friday, October 21, 2011

Kingdom Holding and Batelco Scrapped Their Joint Bid for Zain Saudi Arabia's 25 Percent Stake

October 21, 2011

At the end of last September, Kingdom Holding and Bahrain Telecommunications (Batelco) decided to scrap their non-binding joint bid to purchase a 25 percent stake of Zain Saudi Arabia. The deal was valued $950 million (although for some analysts the value was at least a third more, i.e., $1.2 billion). Officially, the two companies stated that it had not been possible to finalize the deal. A joint statement said that "the Kingdom Batelco consortium announced today that it will not proceed with making a binding offer". At the same time, on Thursday, September 29, 2011, Zain Group released an emailed statement where it said that "acting in the best interest of its shareholders it will assist Zain Saudi Arabia in developing its telecoms business in Saudi Arabia".


Batelco is the principal telecommunications company in Bahrain. It's listed on the Bahrain Stock Exchange and has operations through ownership, subsidiaries and joint ventures with telecom companies in several regions: Middle East, Africa and South Asia. Batelco serves both the consumer and corporate markets in Bahrain while it offers fixed and wireless telecom services in Kuwait, Saudi Arabia, Jordan, Yemen, Egypt and India.

Kingdom Holding is the investment vehicle of Prince Alwaleed bin Talal, a Saudi billionaire. The holding invests in very different business sectors, is headquartered in Saudi Arabia (in Riyadh) and its 6 percent is publicly listed on the Saudi Stock Exchange while the remaining 94 percent is owned by Prince Alwaleed.

In September 2010, U.A.E.'s telecom operator Etisalat bid for the takeover of Zain Group’s 46 percent stake valued at around $12 billion (1.7 Kuwaiti dinar the share). This deal was then called off in March 2011, but its main precondition was that the Zain Group had sold its 25 percent stake in its affiliate Zain Saudi Arabia. In fact, Zain Saudi Arabia competes with Mobily (Etisalat) in the Saudi telecoms markets. Saudi Arabia’s I.T.C. regulator, the Communications and Information Technology Commission (C.I.T.C.) would have never accepted to have two out of three mobile licenses controlled by the same operator (Etisalat).

While the Etisalat-Zain deal was sinking, on March 14, 2011, the Zain Group decided to accept a joint offer to sell its 25 percent stake in Zain Saudi Arabia to Batelco and Kingdom Holding for little less than $1 billion. Since its setting up this deal was delayed by a lot of problems, but still on September 26, 2011, Batelco's chief executive, Peter Kaliaropoulos, told Reuters that he forecast due diligence to be completed by the end of September.

Instead, the deal was not finalized. The problems that derailed it may be divided into four categories:

         Management fees structure

         Debt guarantee currently provided by the Zain Group

         Shareholders subordinated loans to Zain Saudi Arabia

         Zain Saudi Arabia contingent liabilities.


The most problematic of these categories is with no doubt the huge accumulated debt. According to Q1 2011 results, Zain Saudi Arabia's debt was more than $5.5 billion. Within this amount it was included a $2.6 billion Islamic credit that could be extended until August 2012 and that was partially guaranteed by the Zain Group, and $651 million owned by the Zain Group. At the same time, Zain Saudi Arabia had to complete a capital restructuring in order to face $2.5 billion of accumulated losses. "Zain injected further capital into its Saudi affiliate worth about $365 million" reported Marc Hammoud, Deutsche Bank telecom analyst in Dubai. The problem is that these injected resources were not part of the proposed capital restructuring of Zain Saudi Arabia.

The basic idea of this capital restructuring was to convert loans into equity. In the end, with their purchasing offer, Kingdom Holding and Batelco did not want to be charged with the additional shareholder loans provided by the Zain Group. This debt burden was since the beginning a relevant hurdle in order to reach an agreement. In the end, Batelco and Kingdom Holding's bid failed because the two companies were not able to convince the banks, which previously had lent funds to Zain Saudi Arabia, of the benefit of their eventual acquisition. These banks, among them BNP Paribas, Credit Agricole, Citigroup and Saudi's Al Rajhi Bank, refused to transfer debts guarantees to the two purchasers because they considered insufficient a $950 million offer for Zain Saudi Arabia's 25 percent ownership. For these banks, there should have been at least an offer as high as $1.5 billion. All this said, it's now quite probable that a $22 million termination fee will be erased. The reason is that the deal was not concluded. The following events were not controllable either by the purchasers or by the Zain Group. At this moment, the possible future developments for Zain Saudi Arabia will be a capital restructuring, probably by end year. In fact, having cumulated about $2.5 billion of losses, Zain Saudi Arabia will be obliged to cut its capital in order to abide by Saudi Arabia's bourse rules. Accumulated losses reached 9.2 billion Saudi riyals ($2.5 billion) equal to 66 percent of its paid-up capital. The rules of the Saudi stock exchange require a listed firm to reduce its capital if losses are higher than 75 percent of the paid-up capital.

"The timing (of the purchase) was just wrong. ... Zain could extract more value if it restructures its affiliate first and then waits another 12 to 18 months to show better operational and financial performance" still reported Mark Hammoud. Similarly, according to Prince Hussam bin Saud, chairman of the Board of Directors of Zain Saudi Arabia, the failure of the deal with the Kingdom Holding/Batelco consortium will not be an additional problem in order to implement the scheduled growth plans that should be able to move Zain Saudi Arabia to net profit in 2012, following a positive restructuring. In other words, the Zain Group is not thinking of selling anymore its 25 percent stake, but it is fully committed to developing Zain Saudi Arabia.

Capital restructuring should permit Zain Saudi Arabia to refinance the $2.6 billion murabaha credit. Then, the company could try to improve its profitability. At the same time, it's also true that it is not clear who would assume shareholder loan of the Zain Group. Earlier this year Zain Saudi Arabia signed a 2.25 billion Saudi riyals refinancing facility with a group of lenders with the aim of getting funds for its network expansion and future growth. Rumors said that the Zain Group was intentioned to invest $700 million to restructure Zain Saudi Arabia.

It should point out that already in August 2010 and in February 2011 Zain Saudi Arabia had announced the intention of delivering capital reorganization. In specific, in February 2011, it was ventilated the idea of asking shareholders to reduce capital by 55 percent to 6.3 billion Saudi riyals ($1.68 billion) from a value of 14 billion Saudi riyals. After this initial step, the company would have issued new shares for a value of 4.4 billion Saudi riyals. This quite structured plan was never implemented because, first, the  Zain Group and then Zain Saudi Arabia were object of takeover offers. A rights issue is interesting, but it's very difficult to understand how the market would respond now. Being the third operator is not an easy task in Saudi Arabia where telecom competition is very tough.

Zain Saudi Arabia started its operations in Saudi Arabia in March 2008. Up to now the company has never generated any profits. For some analysts, part of Zain Saudi Arabia's difficulties derive from the expensive $6.1 billion license fee paid in order to operate as third operator in the Kingdom of Saudi Arabia. In practice, the company has been a cash-lacking entity since the beginning of its activity. In addition to this, competing in a country where mobile penetration in 2010 reached 188 percent  (third highest position on a global scale) is very complex. In Q1 2011, Zain Saudi Arabia had 15.8 percent share of the Saudi mobile market (a year earlier it had the 18 percent), but both Saudi Telecom Company (S.T.C.) and Etisalat — the other mobile competitors — have respectively 46.4 percent and 37.4 percent of the market.

The latest available financial data related to Q3 2011 (but, Q3 2011 statement of operations is not yet available. The table below shows Q1 and Q2 2011 interim statements of operations) demonstrate some improvements at reducing losses, but still the results are short of analysts' forecasts. With no doubt — given the current situation — at the beginning of October 2011,  Prince Hussam bin Saud's declarations about the future performances of Zain Saudi Arabia resounded very optimistic.

In Q3 2011, the telecom operator reported a net loss of 484 million Saudi riyals, while the previous year the loss had been 544 million Saudi riyals. Analysts instead forecast a 346 million Saudi riyals loss for the same period. The additional losses are equal to 138 million Saudi riyals or 28.5 percent more than the forecasted value. Gross profit was 870 million Saudi riyals, i.e., 158 million Saudi riyals more than the previous year. According to a statement released by Zain Saudi Arabia, the reduction in net losses was related to the expansion of the customer base and to the increased demand of broadband services. 


But apart financial issues, on the management side two recent events have continued to show how the Zain Group — and consequently Zain Saudi Arabia — is experiencing divisions among its shareholders. These disagreements do not permit the company to have a clear management pathway.

The first event has been a Kuwaiti court's recent decision, which has declared invalid the Zain Group's April 2011 shareholder meeting. When a former board member, Sheikh Khalifa Ali Al-Sabah filed a lawsuit for irregularities based on a report by the Ministry of Commerce, the court stated that the telecom operator was guilty of at least two relevant violations: failing to record shareholder's objections to the Zain Saudi Arabia deal and preventing some shareholders from entering the meeting, looking the doors. The direct consequences of this decision — although the decision is not final — are that the normal general assembly was not able to elect the Zain Group board and that the resolutions taken by the irregularly elected board were invalid. The for-the-moment-irregular board was elected on April 14, 2011. Sheikh Khalifa Ali Al-Sabah through his Al-Fawares Holding Co. owns 4.5 percent of the Zain Group and was not trying to get an appointment to new board. Instead, he was part of the previous board and during that mandate he had strongly opposed the Zain Group's 46 percent sale to Etisalat.

The second event has been the resignation of Zain Saudi Arabia's chief executive, Saad al-Barrak. He stepped down two weeks immediately after the stop to the sale of Zain Saudi Arabia's 25 percent stake. Khalid Al-Omar, who was the C.E.O. of the Zain Group operations in Kuwait has been appointed as chief executive and managing director of Zain Saudi Arabia. Moreover, Badr al-Kharafi, who is a member of the Kharafi family, has now entered the board of directors of Zain Saudi Arabia. The Kharafi family is one of the major shareholders in the parent company. And it was a consortium led by the Al-Kharafi Group which wanted to sell the Zain Group 46 percent stake to Etisalat. During the last years, Saad al-Barrak has never been able to work cooperatively with the Kharafi family.

The reason is quite simple. They had diverging ideas about the telecom business for the Zain Group. In fact, when Mr. al-Barrak was previously C.E.O. of the Zain Group, he was the mastermind behind the Zain Group's acquisition spree which the Kharafi family is now trying to reverse by selling separately the assets and then by cashing in their value. Twice the Kharafi family tried to sell controlling stakes in the Zain Group. The first time, to an Indian-led consortium, which included the Indian telecom operator, Bharat Sanchar Nigam Ltd (B.S.N.L.), in the fall 2009. And then, the second time, to U.A.E.'s Etisalat in 2010-11. In the last months, the same Mr. al-Barrak has wanted to buy out Zain Group's 25 percent in Zain Saudi Arabia. "I see a repeat of what happened when Barrak resigned as Zain Group C.E.O. — Zain went through a period of lack of focus and unclear strategy for more than one year" added Nadine Ghobrial, E.F.G.-Hermes telecoms analyst. Again history repeats itself.


As already pointed out in BACCI, A., What Future for Zain? A Rosy One (Part I)  Is the Etisalat-Zain Deal Definitively Over?, May 2011, the Zain Group had — and has still today, although operating in only seven countries — interesting assets. Instead, what is really missing in the company is a clear management leadership. Inside the Zain Group there are currently power games between two different management mindsets. Both mindsets recognize that the Zain Group is an important telecom operator in the MENA region with relevant assets. The problem is that one side, linked to the Kharafi family, wants to cash in resources by selling different assets and/or controlling stakes, while the other side, linked to other major shareholders, do not want to disinvest, but quite the opposite it would like to continue expanding the company.

In absolute terms, none of these two positions is right or wrong. They have different targets and point toward diverging directions. The side linked to the Kharafi family is probably focused on the short term and it understands its investment in the Zain Group as a pure financial investment. The other side is ost likely focused on the long term and it considers its investment not only as purely financial but also as operational. All this said, the simple result of this division is damaging the business of the Zain Group.

Up to the beginning of 2010, the process of consolidation of the telecom sector in the MENA region had underlined the presence of three big players: Saudi Arabia's S.T.C., U.A.E.'s Etisalat and Kuwait's Zain. Since then, Zain has been losing strength and has been retrenching from the positions it had before. Part of this comes down from the mounting debt and losses, but part comes down from the power games inside the company.

Putting aside the failed attempt at selling a controlling stake to an Indian-led consortium at the end of 2009, in June 2010 the company sold Zain Africa B.V. (through which it operated in 15 African countries) to India's Bharti Airtel for $10.7 billion. With this move, the company reduced its operations to seven countries from the previously 22. Immediately after, in fall 2010, it started the negotiation to sell Zain Group's 46 percent to Etisalat and then in March 2011 there was the offer to sell Zain Saudi Arabia's 25 percent stake to Kingdom Holding and Batelco. Both the last two negotiations failed.

With no doubt the sea change in the strategy of the company derived from the pressure of the indebted Kharafi family, who was also probably behind Zain Group's decision to pay 1.59 billion Kuwaiti dinars ($5.78 billion) in dividends in the last year and a half — diverting economic resources from productive investments.   

The graph below shows how 2011 events vehemently had impacted Zain Saudi Arabia's share value. The wide value fall of the company shares between February 15, 2011 (8.1 Saudi riyals) and March 3, 2011 (5.5 Saudi riyals) was due to the rejections of all the offers to purchase the 25 percent stake belonging to the Zain Group. Similarly, the great value increase of the company share between March 3 (5.5 Saudi riyals) and March 14 (7.6 Saudi riyals) was linked to the negotiation with the Kingdom Holding-Batelco consortium.

On October 19, 2011, the share was valued 5.75 Saudi riyals, while on September 28, 2011, the day before the announcement of the retirement of the Kingdom Holding-Batelco consortium the value was 6.25 Saudi riyals.