At the crossroads

Amidst unpredictable oil prices, burgeoning debt and growing unemployment, Saudi Arabia is making some difficult decisions about the way it runs its economy. The decision to de-monopolise STC may be the barometer for the Kingdom’s entire future economic strategy, and set an example for the rest of the Gulf region to follow

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By  Massoud Derhally Published  September 1, 2002

|~||~||~|After a quarter century in the global limelight, change is the new watchword for Saudi Arabia. The Saudi private sector is moving to the fore of economic development and diversification efforts, as the government curtails its own spending. With the continued weakness in world oil prices demonstrating Saudi Arabia’s vulnerability to over-dependence on oil, efforts to diversify the economy’s production base are being stepped up, and new doors are being opened to foreign investors.

The Saudi government has indicated that it wants to retire a portion of its US $170 billion debt by giving local lenders a share in unspecified companies. Among the companies exemplifying the potential for non-oil economic development is the Saudi Telecom Company (STC).
After mandating Gulf International Bank (GIB) in June 2002 to arrange the initial public offering (IPO) of STC before year-end, the Saudi government approved on July 27, 2002 regulations for the privatisation of its telecommunications sector, marking the demise of STC’s monopoly.

Times are changing in the Kingdom. Announcing the end of the monopoly at a press conference [July 28, 2002], the acting minister of posts, telegraphs and telephones, Khaled bin Mohammed Al Qusaibi said: “The executive bylaws allow new operators in the telecom sector. STC will be treated like other operators when the market is opened up for competition.” According to Qusaibi, the Saudi Communications Commission will be in charge of organising the sector, which is one of 19 areas that are off limits to foreign investors, but more on that later.

The move to approve telecom privatisation regulations comes ahead of the expected year-end initial public offering (IPO), of 30% of the government’s stake in STC, or 72 million shares worth an estimated 3.6 billion riyals (US $960 million).

The flotation of STC, which was established in 1998, would be one of the biggest in the kingdom, and is likened by some to selling the crown jewels. Brad Bourland, chief economist at Saudi American Bank (SAMBA), says: “STC achieved US $1 billion in profits last year, and given that the company has a P/E of 10, I estimate it could raise US $ 3 billion in terms of market capitalisation.”

But Johnny Abedrabbo, senior economist at Saudi Arabia’s largest bank, National Commercial Bank, believes STC could be worth a lot more. “Based on STC’s latest net profit of SR 3,953 million and assuming a price earning multiple (PE) of 10, the company would have a market capitalisation of around SR 40 billion,” says Abedrabbo. “The stock market capitalisation represents nearly 47% of nominal GDP, while the introduction of STC would lift this ratio to 53.5%.”
According to analysts and economists, privatisation will help alleviate economic burdens on the Kingdom, which is suffering from anaemic growth, a staggering US $170 billion in debt — equivalent to nearly 100% of gross domestic product (GDP) — and unemployment of an estimated 20%. A growing population and therefore consumer demand, liberalisation of the telecom sector, privatisation of Saudi Telecom and private sector participation are sure to change the playing field in the Kingdom. “I believe it [STC’s IPO] fits very well with the government’s policy of privatisation and should be a successful offering, as there is tremendous appetite in the market,” says Gaby Abdelnour, JP Morgan’s managing director for the Middle East and North Africa.

Saudi Arabia had a leading fixed lines development program in the mid 1980s, and is back to being the fastest growing telecom market in the region. The telecommunications sector in Saudi Arabia has been growing by around 30% annually in the past few years, and the kingdom was estimated to have 3.3 million fixed lines and 3 million GSM mobile lines at the end of 2001, according to the International Telecommunications Union.

The potential for further growth, particularly in the GSM segment, is phenomenal, according to Arab Advisors Group (AAG), an IT and telecomms analyst. The company noted in a March 4 research note that 2001’s GSM penetration rate of 13% was lower than that in less affluent countries like Morocco, Jordan, Egypt and Lebanon. All have had prepaid service and some level of competition for at least two years.

“The Saudi GSM market is in definite need for some competition,” says AAG president, Jawad Abbassi. “With prepay and competition, the Arab Advisors Group believes that Saudi Arabia’s market can easily sustain a GSM penetration rate of more than 50% within 3-4 years of introducing prepay and effective competition.”

According to Qusaibi, two sectors will be open for investment under the liberalisation plan, the landline and mobile telephone sectors. AAG predicts a second GSM operator by 2003 and fixed line competition in 2006.

It’s whether or not foreigners can have a part of this that is the big question. “I still believe that the Saudi market will continue to be closed [to] foreign investors due to the current regulations that don’t allow foreign investment in most of the sectors,” says Wael Ziada, an analyst at Egyptian investment bank EFG-Hermes. “I see this move as a traditional debt to equity swap done within the borders of the country.”
However, the so-called exclusion list is known to be under review and there are other ways for foreigners to invest in the Kingdom. Given Saudi legislation, they may well end up partnering with a local player, very similar to how foreign banks have teamed up with local banks.

“It’s unusual for a country the size of Saudi Arabia to be without competition in the telecom sector. With time it is more likely to see foreign players coming into the market,” says a senior banker in Riyadh.

Some international operators already have a foot in the Kingdom. Ericsson and Nokia, for example, have been working in the Saudi market for some time, and could be serious contenders for a possible joint venture operation in the kingdom.

Ericsson, according to a Jeddah-based industry insider, has been actively supporting STC’s infrastructure and operation, while Nokia, which is new to the market, is presently managing a new GSM network expansion project in the region. There are other providers to be considered, like Lucent, Siemens, Sprint, MCI, British Telecom and Vodafone.

Abdelnour of JP Morgan believes the interest in the Saudi market is certainly there. However, he also believes that there are other variables to be considered. “The concern today is that telecom companies are so loaded with debt that they do not have the flexibility they used to have in the past and the appetite to go abroad has diminished. So many of these operators have scaled back their ambitions and interest in many countries just to focus on their own internal market and their own internal problems,” explains Abdelnour.

Industry analysts also believe that interest in the Saudi telecom market will not only come from international operators but also regional players. The opening up of the Saudi telecom sector could encourage cross border consolidation and regional investment, even more so in the possible absence of international participation.
According to Mohsen Maleki, a senior telecom analyst at IDC, Egyptian operator Orascom is a likely contender for investment in KSA, as is Etisalat in the UAE, and Batelco in Bahrain, which has already branched out in several markets as an internet service provider (ISP) and thus has regional experience.

While the timing for liberalisation will have to be partly a function of market conditions in the telecom market globally, it will also depend on the progress made putting in place a strong regulatory framework within the Kingdom to provide comfort and the necessary guidelines needed by foreign operators. AAG expects the Saudi Communications Commission, to be, “strongly affected by the prevailing government positions and the makeup of the council of Ministers.” However, the analyst is reasonably impressed with the Saudi telecommunications law, which states that, “The policy of the state is to have a proper climate for fair competition across all segments of the telecom market.”

Another benefit of competition, or more accurately, the prospect of competition, is that STC is already taking steps to give customers better value and service. “As a matter of fact, it has been very much noticeable that STC is doing its extreme best to improve its quality of service,” says a Jeddah industry insider.

Saudi Arabia is certainly at the crossroads and while it is hard to prophesise what the future holds for its telecom sector, what can be said with conviction is that this promises to be a very interesting time for the Saudi consumer. Massoud A. Derhally

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