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. 

 

 

 

 

Batelco and Viva Received Notices by Bahrain’s T.R.A.

 

September 16, 2011

On Monday, September 5, 2011 the Telecom Regulatory Authority of the Kingdom of Bahrain (T.R.A.) said that it had issued notice to the Bahrain Telecommunication Company (Batelco) and the Saudi Telecom Company of Bahrain (Viva). This notice followed the implementation by the two companies of anticompetitive prices for international calls. For the T.R.A., these prices harmed consumers' interest. The third Bahraini mobile operator, Zain Bahrain did not receive any notice. Batelco and Viva compete in the market for international calls with Zain Bahrain and more than a dozen of other companies selling prepaid cards.

The T.R.A. said that it had concluded investigations about some complaints received from a group of licensed operators. The complaints affirmed that Batelco and Viva had launched anticompetitive pricing for mobile-originated calls towards Bahrain’s Zone 2 of the international calls market. Of the four international calls regions, Zone 2 is by far the most lucrative because it comprises Bangladesh, Sri Lanka, the Philippines, Pakistan and India. The reason is quite simple: According to Bahrain Census in 2010 the population accounted for 1.234 million of which 54 percent (666,172) was made up of non-nationals coming mainly from South Asia (in 2008 there were 290,000 Indian nationals, the largest expatriate group in the country).

The table above and the picture below give a very clear idea of the different relevance of the four international calls zones for Bahrain’s telecom operators.

The latest available data from the T.R.A. cover the period from 2005 to 2009, but given the nationalities of non-nationals in Bahrain, it’s quite probable that the trend has been the same also for the following years. And, as a matter of fact, during the considered timeframe, Zone 2 had experienced an 86 percent C.A.G.R., that was by far more than the double of the second best minute-consuming zone, which is Zone 4.

According to T.R.A.’s estimates in 2009 the overall value of telecommunications revenues was 338 billion Bahraini dinars ($896.7 million at the September 2009’s exchange rate) — of which more than one quarter was linked to international calls (26.1 percent) — for an approximate value of 88.218 million Bahraini dinars ($260.24 million). Within the international calls markets, the lion’s share of the consumed minutes comes from Zone 2.

On August 23, 2011, under the Bahrain’s Telecommunications Law, the T.R.A. issued notices to Batelco and Viva. For the T.R.A., the two operators’ conduct engendered an abuse of dominance in the international mobile telecoms market not guaranteeing a competitive level playing field as it’s instead requested by the Bahrain’s Telecommunications Law.

The T.R.A. is scared that this pricing policy could really wipe out a free and fair telecom market and it opposes any reduction of the competition level in the telecommunications market.  Following the Telecommunications Law, when the T.R.A. detects anticompetitive practices it has to step in to protect consumers’ interest with the preservation of a fair and competitive market. Now, before issuing its final decision, the T.R.A. is waiting for Batelco's and Viva’s replies to the notices. Abdulelah Abdulla, the T.R.A. spokesman, said that the two companies had until October 13 to respond to the T.R.A. notice. If the complaint is upheld the two telecom operators will probable face some fines.

Immediately, on September 6, the two companies released a communiqué commenting the notice. “We look forward to the opportunity to outline our case to the T.R.A. and we are confident we will receive a fair hearing” affirmed Rashid Abdulla, Batelco’s C.E.O. in an emailed statement. Viva’s declaration acknowledged that "Viva Bahrain is collaborating with Bahrain’s T.R.A. on its investigation regarding alleged anti-competitive conduct and will provide its position to the T.R.A. in due course. Viva Bahrain believes that it acted within the limits of the telecommunication law and in the best interest of the Bahraini consumer."

In this regard it’s necessary to remember that as soon as last year, in February 2010, the T.R.A. introduced a new competition-based framework for the regulation of retail tariff. This framework paved the way for the deregulation of Batelco’s mobile tariffs and calls to certain international destination. On that occasion, Dr. Mohamed Al Amer, T.R.A.’s chairman and acting general director expressly said that “As competition develops, there is a point at which aggressive competitive behavior may damage the normal operation of market forces and may be detrimental to consumers. The competition guidelines launched recently are an essential instrument that offers guidance on where and how T.R.A. may draw the line between anticompetitive and pro-competitive behaviors and how we will deal with anti-competitive complaints.”

On July 29, 2010, the T.R.A. released the Order no. 3 of 2010 (Batelco’s Retail Tariffs of International Calls to India and Bangladesh) aimed at Batelco’s anticompetitive behavior in the international calls market towards India and Bangladesh. The telecom authority had received complaints from other licensed operators (O.L.O.s), which alleged that their revenues and traffic minute volumes for calls to India and Bangladesh had declined dramatically since April 2010. The added cause for this decline was, according to the concerned O.L.O.s, that Batelco’s retail tariffs were below cost. For the O.L.O.s, these tariffs created a margin squeeze and/or a predatory pricing. After some investigations, the T.R.A., in order to prevent the likelihood of irreversible and irreparable harm to competition in the telecommunications market, ordered "Batelco to immediately  increase its Effective Retail Tariffs to the Relevant Routes to be less than the Retail Price floor for the Relevant Routes until such time as the Authority notifies Batelco".

This time, it’s possible to assume that probably the regulator’s decision won’t be severe. But it’s likely to think of having both Batelco and Viva obliged to increase their prices. This will have an impact on their market share, but in the end a price increase could help them to boost margins.        



 

International Code +211, Zain Sudan Is Already There!

July 21, 2011

Welcome to the Republic of South Sudan! Following January 2011 referendum in which 98.83 percent of the population of the previously Southern Sudan Autonomous Region voted for independence, on July 9, 2011 the Republic of South Sudan became an independent state from Sudan. And then, five days later the new country was admitted to the United Nations (U.N.). South Sudan seceded from Sudan after decades of civil war (First Sudanese Civil War 1955-72 and Second Sudanese Civil War 1983-2005). South Sudan’s population is estimated at eight million people while the country gets almost all its revenues from oil.

A few days after the independence, the new country received by the Geneva-based International Telecommunications Union (I.T.U.) a new international country calling code, which is +211 (before it used Sudan’s international code +249).

The telecommunications era started in Sudan before the end of the nineteenth century. Since then the telecommunications sector had been divided until twenty years ago between several government-owned small entities with scarce operational and financial autonomy. Notwithstanding a myriad of development efforts until the beginning of the 1990s, the telecoms sector remained very poor.

Only with the Government’s Three-Year Economic Salvation Program (1990-93) the role of telecoms sector was incentivized. At that time, telecommunications were recognized as a primary tool for the socio-economic development of Sudan. The program required the abolition of the monopolistic structure of Sudan’s telecoms sector and it called for admitting local and foreign private sector investments. Summing up, important investments were required in order to build the lacking infrastructure. 

The system is now based on three different subjects: the Ministry of Information & Communications, the National Telecommunication Corporation (N.T.C.), which is the regulator, and the licensed operators. In relations to mobile telecommunications the licensed operators are three: Zain Sudan (57 percent of market share in Q1 2011, license released in August 1996), Sudan’s Sudani (24 percent, license since February 2006) and South Africa’s M.T.N. (19 percent, license since October  2003). Sheer numbers explain that the most important player in the Sudanese theater is with no doubt Zain Sudan.

Zain Group is currently operating in seven countries of which six are located in the Middle East (Bahrain, Iraq, Jordan, Kuwait, Lebanon and Saudi Arabia) and one in Africa (Sudan). Before selling Zain Africa B.V. (which was present in 15 African countries) to Bharti Airtel in June 2010 for $10.7 billion, Zain was operating in 22 countries. Now Zain in Africa has operations only in Sudan, which is indeed a very relevant market with an interesting potential yet to be developed.

In February 2006, Zain purchased the remaining 61 percent stake of Mobitel, which was Sudan’s first mobile operator. This deal was valued $ 1.332 billion and thanks to this operation Zain obtained 100 percent ownership. Later, in September 2007, the company was rebranded to Zain Sudan and subsequently it renewed its license for a period of 20 years. Zain’s operations started in April 2008.

Q1-2011 data — the latest published — confirm potential of the Sudanese market. The company was able to increase by over 20 percent its customer base from Q1-2010 and to remain consistently the market leader with a market share of 57 percent. Notwithstanding the fact that Q1-2011 was one of the more problematic period of Sudan’s history  because of the political instability (January 2011 referendum decided for the independence of South Sudan), Zain Sudan reported in local currency (Sudanese pound) a 13 percent increase in revenues and an 11 percent increase in Ebitda in comparison to Q1-2011. In U.S. dollars the results are not as positive as with the local currency because of a more-than-13-percent devaluation of the Sudanese pound versus the U.S. dollar between the beginning of January 2011 and the end of March 2011. The graph below by ExchangeRate.com shows this trend.

In specific, on January 3, 2011, 2.5 Sudanese pounds were required for $1 while on March 29, 2011, (around the end of Q1-2011) 2.87 Sudanese pounds were required for $1. This translates into an almost 13 percent devaluation in just three months. As a matter of fact, Zain Sudan’s net profit was impacted by currency variance. Zain Sudan’s operation reported in Q1-2011 a foreign exchange loss (F.X. loss) of $52 million while in Q1-2010 there had been an F.X. gain of $32 million. Another factor impacting its operations was a 12 percent tax increase on the operations as of February 2011. This tax in 2011 reached 15 percent  while in 2010 it was just 3 percent. All this said, Zain Sudan aims at increasing its market share through an acquisition and retention strategy.  

Zain Sudan is currently in negotiations with the new country to pay a fee aimed at extending its Sudan license and being entitled to operate in South Sudan. Elfatih Erwa,  Zain Sudan’s managing director (previously a Sudanese state minister and Sudan’s permanent representative to the U.N.) pointed out that Zain Sudan would continue operating in South Sudan as it had done during the last three years (Zain started its operation in Sudan in April 2008) when this territory was not yet an independent country. Things may change once a new specific license is agreed upon.

It’s interesting to underline that although the fee to be paid to South Sudan, Zain Sudan excluded the possibility of demanding a reimbursement to Khartoum’s government in order to compensate the new costs required for operating in South Sudan The reason is that Zain Sudan’s plan is to split the companies into two entities: one operating in North Sudan and one operating in South Sudan.   

        

While in the last three years, the company has invested $1.2 billion in the whole Sudan, in the last five years it has invested around $300 million for what is now South Sudan. But, according to Elfatih Erwa, Zain is devoted to expanding its 3G services in South Sudan and the company is investing in 2011 around $110 million in fiber and its core network. In fact, the company is ready to roll out a fiber network to the Red Sea. Being a landlocked country, this fiber network will incur high costs because it necessarily has to be rolled out through North Sudan or Kenya for access to undersea cables. In South Sudan 3G services are already offered, but internet access is via satellite and for this reason the capacity is quite limited. A fiber network could really be a sea change.

In dealing with the poor South Sudan the real challenge for Zain Group will be to balance the possibility of an untapped, although poor, market with the high costs required for providing telecom services. What is positive now is that with a stabilized political environment companies deciding to do investments in South Sudan may base their strategic plans on a sounder basis.



 

What Future for Zain? A Rosy One (Part II) — The Reason: Balance Sheets Are Good

June 17, 2011

In Part I — Is the Etisalat-Zain Deal Definitively Over? it was explained that the failed Etisalat-Zain deal made sense for the Emirati company. The aim of Part II — The Reason: Balance Sheets Are Good is to provide a clear picture of Zain's markets and to analyze the company's full-year 2010 and Q1 2011 financial results. The latter, which are the latest available data, were released by the company in May.

Zain is currently operating in seven countries, of which six are located in the Middle East (Bahrain, Iraq, Jordan, Kuwait, Lebanon and Saudi Arabia) and one in Africa (Sudan). Before selling Zain Africa B.V., which operated in 15 African countries, to Bharti Airtel in June 2010 for $10.7 billion, Zain had operations in 22 countries. In five countries out of seven, the Zain Group has an ownership stake bigger than 51 percent (Kuwait, Sudan, Jordan, Iraq and Bahrain). In other words, it has management control. In Zain Saudi Arabia, the Zain Group owns a 25 percent stake while the remaining 75 percent is split between a Saudi Consortium (25 percent), the Public Pension Authority (5 percent) and free float (45 percent). Through its 25 percent, the Zain Group has the company’s management control, but Zain Saudi Arabia pays 4 percent of its annual revenue to the Zain Group for management duties. Moreover, the Zain Group nominates and appoints four members of the nine-member board of directors. In Lebanon, the Zain Group operates through the subsidiary M.T.C. Touch (no ownership), which since June 2004 has been developing one of the two G.S.M. networks thanks to management contracts renovated every time they have expired (the current contract will expire on February 1, 2012).

In five (including Lebanon) out of seven markets Zain is ranked first operator. In Saudi Arabia, it’s the third operator with a 16 percent market share, while in Bahrain it’s ranked second, but there, the three licensed operators have all similar market shares (Bahrain’s Batelco 37 percent, Kuwait’s Zain 32 percent and Saudi Arabia’s S.T.C. 31 percent). 

Kuwait, Iraq, Sudan and Jordan are the key markets for the Zain Group. Together they account for around 92 percent of the 2010 revenues. At the same time, these are the markets with the largest populations, and all with the exception of Jordan (already a mature market) have a relevant potential growth in the short to medium term.

Source: Zain’s Earning Release (2010)

Source: Zain’s Earning Release (2010)

Before analyzing the financial data it’s necessary to provide some preliminary considerations.

• Given the Zain Group’s ownership limited to only 25 percent, Zain Saudi Arabia is considered an associate company (the Zain Group has non-controlling interests) to the Zain Group, and its revenues are not added up directly to the consolidated statement of income.
• In the Zain Group’s statement of income 2010, Zain Saudi Arabia appeared only in two items: share of loss of associates (45,018,000 Kuwaiti dinars) and when differentiating net profits attributable to shareholders of the parent company (1,062,805,000 Kuwaiti dinars) from net profits attributable to non-controlling interests (25,013,000 Kuwaiti dinars).
• Although Zain Saudi Arabia reported for year 2010 a $628 million net loss, part of the overall net profit of the entire Zain Group has to be passed to the 25 percent stake in Zain Saudi Arabia — a percentage stake that is a non-controlling interest (associate company). And the Zain Group’s 2010 consolidated statement of income perfectly confirms this net income differentiation.

The below table shows Zain Group’s key performance indicators (K.P.I.s) for 2010.

In a nutshell, 2010 financial results show a strong increase in relations to many K.P.I.s:

• Consolidated net profit of $3.675 billion (1.063 billion Kuwaiti dinars, 445 percent increase), which is the highest ever in the Zain Group’s history. Net profit result is impressive, but it has to be underlined that $2.653 billion (770.3 million Kuwaiti dinars) is the capital gain linked to the sale of the African assets.
• Net profit from continuing operations amounts to $1.022 billion (293 million Kuwaiti dinars) with a 50 percent increase over 2009 net profit being $675.1 million (195 million Kuwaiti dinars).  
• Consolidated revenue reached $4.74 billion (1.35 billion Kuwaiti dinars) with a 7 percent year-on-year increase.
• The board of directors decided to release a $0.72 (200 Kuwaiti fils) cash dividend.
• Customer base increased 23 percent reaching 37.24 million in the seven markets considered.

It’s really important to understand that in 2010 the Zain Group was able to increase by around a 50 percent its net profit. Having had $675.1 million of net profit in 2009 and just after 12 months almost duplicating its net profit ($1,022 million) is quite an impressive result accomplished thanks to two primary factors: operating in very valuable countries and having developed a more efficient operational model. 

In specific, between 2009 and 2010 continuing operations increased overall their revenues by 7.02 percent (by 15 percent in Sudan, by 12 percent in Iraq and by 7 percent in Jordan. Saudi Arabia’s revenue — although not added directly to statement of income — increased by 98 percent). In addition to this, the Zain Group strongly reduced its finance cost and its share of loss of associates (Zain Saudi Arabia). Moreover, the Zain Group in 2010 experienced some gain from currency revaluation.  

The consolidated statement of income, partially reported below, well explains why — also not considering capital gain — net profit increased by 50 percent in just one year.  

The divestiture of African operations (cashing in $10.7 billion through the sale to Bharti Airtel) was aimed at focusing the Zain Group’s operations on fewer but highly cash-generative markets. In this way, cost synergies could be implemented as the Zain Group’s C.E.O., Nabeel Bin Salamah, pointed out in his C.E.O. statement included in the Zain Group's 2010 Annual Report. The Zain Group entered the African markets in May 2005 when it purchased Celtel International, which operated at that time in 13 countries and served around 5.2 million customers (data relative to beginning 2005). Later, Zain acquired one license in Ghana and one in Nigeria, while it improved the networks in all the served countries. The Zain Group’s 2009 Annual Report showed that at the end of 2009 the Zain Group had — only in Africa and excluding Sudan — 42.1 million customers of which 14,777,000 in Nigeria and 1,283,000 in Ghana. All this means that if Celtel had around 5.2 million customers in 13 countries at the beginning of 2005, only five years later Zain Africa B.V. had in the same markets 26 million customers, i.e., it had obtained a 500 percent increase in the customer base without counting Nigeria or Ghana, both of which were not part of the Celtel deal.

 

Moreover, comparing the K.P.I.s between Zain, Etisalat and S.T.C., which are the three most relevant Middle Eastern telecom operators, shows very impressive results on the part of Zain. In general, the Kuwaiti firm with just one quarter of the customers served by Etisalat and S.T.C. has been able to obtain around 50 percent of Etisalat’s profits and 40 percent of S.T.C.’s. It’s with no doubt a very good result. Understanding the reasons behind this achievement would require additional research, but it’s possible to assume that one ingredient of the rationale — apart from the profitability of the markets where the company operates — is entwined with Zain’s operational efficiency, which is the cornerstone of Zain’s new way of doing business. And Chairman of the Board of Directors, Asaad Al Banwan explicitly affirmed in his Chairman’s Message included in the Zain Group's 2010 Annual Report that the Zain Group had launched comprehensive restructuring initiatives with deep changes at the level of all of its various executive departments and sectors. The aim was to align its operations with the new strategic directions (See the Zain Group's 2010 Annual Report p. 5).

At the beginning of May 2011 Zain posted very positive Q1 2011 (Q1 ended on March 31, 2011) financial results showing vigorous growth with reference to several K.P.I.s. The results underlined a year-on-year 40 percent net income increase to $251.1 million (revenues $1.163 billion) and a 20 percent increase of the served customers (in total they were 37.6 million). The above table specifies the results for Q1, 2011.

In addition to increased net income and served customers, Zain improved by 1 percent in comparison to Q1 2010 its consolidated revenues reaching $1.163. Ebitda at $529.7 million was up 10 percent than in Q1 2010 with a 46 percent margin (4 percent higher than the previous year). EBIT also increased by 10 percent reaching $379.9 million. Earnings per share were $0.06 (for Q1 2011 U.A.E.’s Etisalat paid the same amount while Saudi Arabia’s S.T.C. paid $0.13).

From sketching some conclusions at the end of this research, it emerges that the numbers expressed by financial data confirm a positive trend for the Kuwaiti company. At least three of the markets where it operates have a huge potential still to be fully developed.  Some analysts affirm that although the numbers look fine, Zain is an expensive stock. They are cautious because they think that Zain’s shares are trading at too high a multiple compared to the rest of the sector.

The latest data — as shown by the above table — portray a partially different picture with Zain’s P/E and P/BV in line with the values of Etisalat and S.T.C. This readjustment followed the price reduction of Zain’s share that had been a constant trend since the last two weeks of December 2010 (on December 19, 2010, the Etisalat-Zain deal was canceled for the second time) until the end of May 2011. The chart below fully shows the movement of Zain’s share price in the last year.

Zain’s Share Price in the Last Year

Summing up, the Kuwaiti company has very positive balance sheets reflecting operations and assets in very profitable markets, top-notch operational model, and relevant cash resources to be invested in future acquisitions. All these elements contribute to depicting a rosy future for the Zain Group. “Zain’s numbers don’t show management has been distracted by the takeover talk — its core operations have been performing okay” said Nomura’s telecom analyst, Martin Mabbut,. In other words, the only change to be done now pertains to the shareholders’ side. In fact, after the failure of the Etisalat-Zain deal, it’s still not clear whether the consortium led by the Al-Kharafi Group, which wanted to sell a 46 percent stake in Zain, still wants to (and is able to) carry on with that project. If the answer is negative some other alternatives will have to be developed.