Value Call

Etisalat surprised many onlookers by bidding US$2.9 billion for the privilege of becoming Egypt's third mobile operator. Analysts continue to question the business case given the massive upfront cost of the investment, though senior Etisalat management insist a prudent investment strategy is their mantra, and that the UAE operator was in fact willing to bid even higher for the Egyptian concession.

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By  Tawanda Chihota Published  August 7, 2006

|~|Al-Qamzi2001.jpg|~|Etisalat's CEO Mohammed Al Qamzi is confident of the operator's capacity to continue growing, both from a financial resource point of view, as well as with respect to skills. |~|“Our limit was higher than the amount we paid [for the GSM licence in Egypt],” asserts Etisalat chairman Mohammed Omran, defiant to the end regarding Etisalat's record US$2.9 billion bid at the beginning of July, for the third GSM licence in Egypt. On the face of it, market commentators and analysts tend to agree that Etisalat overpaid for its position in Egypt, and no party could be more pleased with the outcome of the award process than the Egyptian government, which had set a reserve price of US$434 million on the licence. Thus the price Etisalat pledged represents a premium of 568% on the reserve price, and was a clear 20% higher than the US$2.46 billion bid tabled by fellow pan-regional investor MTC, which offered the second highest bid. Analysts point to the relatively low and falling revenues per subscriber found in the Egyptian market, the limited addressable market, the strength of the incumbent operators — Mobinil and Vodafone Egypt — and the large amount of capital investment required; as major factors that make the opportunity less valuable than the amount paid by the UAE incumbent. For its part, Etisalat is convinced of its ability to build its investment in Egypt into a viable business in a few short years. “Well you look at Egypt and the price of the licence is very high. Earlier on we acquired a licence in Saudi Arabia for AED12.5 billion (US$3.4 billion), which was seen as very expensive. Today we are breaking even. So we do have a strategy about how we run the business (in Egypt), and how to segment the market,” says Mohammed Al Qamzi, CEO of Etisalat. “Our position in Egypt today is that we believe only the top-end of the consumer market has been targeted. The other segments have not really been developed as markets. There is a big portion of the Egyptian population that has not really been covered for consumers, only a certain level who can afford such prices,” Al Qamzi states, suggesting that part of Etisalat's market entry strategy will be aggressive pricing, which will potentially undercut offers currently available from the incumbents. The issue with pursuing an aggressive pricing strategy is that while a large number of subscribers may be attracted early on, the actual value of such subscribers is questionable, thereby leading to the payback period on the initial investment being extended. Etisalat chairman Omran estimates that ARPU in Egypt currently stands at around US$12 or US$13 per month, though with the growth of the overall subscriber base, this is likely to fall to levels of around US$8 per month in the next few years. Such revenue erosion is a real concern for analysts, and Shuaa Capital's Marc Hammoud estimates that given various bullish and less bullish scenarios, the payback period for Etisalat's upfront investment in the Egyptian market is somewhere in the region of 10 to 13 years. Given that the licence has a lifespan of just 15 years, this does not leave very much time to make significant money off of the investment. ||**|||~|Foto-Kristoff-Puelinckx200.jpg|~|Delta Partner's Puelinckx believes that the scarcity premium for greenfield opportunities in the region is what is driving the high valuation for investments. |~|A look at the market capitalisation of the incumbent mobile operators Mobinil and Vodafone, which had installed bases of 6.965 million and 6.6 million subscribers respectively at the end of 1Q06, throws up an interesting perspective in terms of the value of the amount splashed out by Etisalat. At the time of Etisalat's US$2.9 billion offer at the beginning of July, Mobinil's market capitalisation stood at about US$2.7 billion and Vodafone Egypt's stood at US$3.8 billion, implying what the UAE operator paid for just the licence, it arguably could have acquired Mobinil for. “I think if you start to add things up by drawing up a traditional discounted cash flow based business case, the valuation (of the Egyptian licence) looks high,” comments Kristoff Puelinckx, managing partner of Delta Partners, a Dubai-based advisory and telecoms investment company. “I mean what Etisalat paid seems very high especially if you look at the market cap of some of the existing players in the market. If you compare it to the current valuation for both players of Mobinil and Vodafone, which are around US$2.78 billion and US$3.8 billion. Theoretically speaking they could have bought Mobinil, acquiring not only a licence, but an existing infrastructure and customer base, giving them an immediate position in the market. ” Puelinckx estimates that if one were to take a relatively conservative approach, the fair valuation of the licence would be about US$1.5 billion. “Now for certain of the groups that could apply synergies (from international roaming, group procurement etc), and for whom it has certain strategic importance in terms of footprints, in terms of having an extended footprint in Africa, and direct access to the Middle East as well, I think you can reasonably push it up to potentially US$2 billion. Yet that to me is stretching it, especially if you expect reasonable returns from your investments in line with industry returns. I think beyond that other reasons come into play,” he says. Omran remains unfazed by doubts from the market. “Telecoms investment is a long-term commitment. Whether it is a three- or four-year return on investment period, it takes time. Look at what analyst reports said with regards to payback and the break even period at the time we bid and won the licence in Saudi Arabia,” Omran says. Etisalat did bid a colossal amount of money for the greenfield licence in Saudi Arabia in 2004, but in the year since it launched in May 2005, has been able to grow the business into a profitable operation on a month-on-month basis, counting more than 3.5 million subscribers. Analysts, however, explain that market conditions in Saudi last year are very different to the Egyptian situation, and that Etisalat would be wise to recognise this point early on in terms of building expectations for its entry into the North African market. “I think what is clear is that when they (Etisalat) went into Saudi they bid very high. Now what happened is that they actually had a good deal. Why? Basically two effects. On the one hand the actual cash they put in was limited because they had local partners, and secondly because there was a float of part of the shares,” explains Puelinckx. “Secondly beyond the direct investment and the cash, the overall contribution to the Group’s market capitalisation has been much more than the actual investment that they have made there, justifying the investment from a pure shareholder value creation perspective in terms of stock appreciation, at least in the relatively short term. Egypt seems different though, as financial analysts have not necessarily received the deal positively.” Shuaa Capital's Hammoud is adamant about the distinct investment cases at the time Etisalat won the licence in Saudi as compared to the win in Egypt. He points out that for one, Etisalat entered the market as the second operator in Saudi, poised to take on a government-backed incumbent. In Egypt, Etisalat will be faced with two commercially oriented, experienced players, making the competitive landscape much harsher in Egypt than it was in Saudi. ||**|||~|Omran2001.jpg|~|Etisalat chairman Mohammed Omran is confident Etisalat can gain a market share of around 25% with 3-5 years of operating in the Egyptian market.|~|Also, ARPU levels at the time Etisalat acquired its licence in Saudi in August 2004 ran to around US$55 per month, while average ARPU in Egypt currently stands at around US$13. In terms of penetration, Etisalat does benefit from a lower mobile penetration rate in Egypt than there was in Saudi when it was awarded the licence, standing at 20% and 40% respectively. Egypt's significant population, estimated at around 75 million, also offers a large base of potential users to aim for, though demographics and the economic profile of the country limits the total size of the addressable market. As is the case with most greenfield operators, Etisalat intends to utilise its lack of legacy infrastructure and access to 3G spectrum to actively differentiate itself from the two other providers right from the very beginning. “We possess a 15-year licence, the other two licences have seven years left to run and they will need to pay a sum to renew them,” Omran says. “We have 3G technology, while the others will have to pay for it, and I believe generally there is still significant growth in the market,” he adds. Given Etisalat's own references to its market entry strategy in Saudi, it was conceivable that the operator would move to liquidate a portion of the stakeholding in the winning consortium in Egypt to help pay some of the start-up funding. Thus it came as no surprise that towards the end of July reports surfaced that Etisalat was looking to sell-down its 66% stake in the winning consortium by 15%, and had been receiving offers for the stake from international bidders. The operator promptly issued a statement rebuking suggestions that it planned to sell off the stake, following quotes in regional newspapers attributed to Etisalat spokesperson Jaber Al Janahi saying that the operator would retain a controlling stake, but was in talks with several bidders for a 15% equity position. “We see it as an opportunity. We are in talks with several bidders but have not yet chalked out the details of the sale,” he was quoted as saying. The responding statement declared that while Etisalat is still receiving offers from companies interested in purchasing part of its share in the consortium, it was not looking to sell any share at this point. “Etisalat does not intend to sell at this point,” the statement claimed. Early in August, therefore, the winning consortium is set to officially sign the licence, and after six months the expectation is that the company will start commercial operations. Etisalat expects initial CAPEX on the network to run to approximately US$1 billion, and that the vendor selection process is well under way, having commenced prior to it having been declared the winner of the licence. Etisalat has not yet made any announcement regarding the branding set for the new operation. Given Etisalat's recent and rapid expansion into a number of large markets including Pakistan and Saudi Arabia, a concern may exist that the operator could find itself spread too thinly both in terms of financial resources as well as human capital. Al Qamzi, however, remains quietly confident of the operator's capacity to continue pushing ahead further into new markets. “We do have a lot of resources in terms of our know-how in the telecoms area, in manpower and everything,” Al Qamzi asserts. “We have a lot of this. We also have the financial resources. In Saudi Arabia, for example, we sent 550 staff members who did the work and came back and now only 50 or so are left. We like to develop local skill, so in Egypt, we will send our people, they will do the job and they will train the Egyptian people and they will come back. And that is how we do it all the time, in terms of deployment,” he adds. Omran forecasts that within three years, mobile penetration in Egypt will rise beyond 50%, representing around 40 million mobile subscribers. Etisalat is aiming to command a market share of around 25% after three to five years of operation, suggesting a subscriber base of upwards of 10 million users by 2010. “If you don't make dust, you'll eat dust,” quips Omran with respect to the rapid pace of development at Etisalat. “This was the right decision taken at the right time and it will continue to spark the uplifting of economic growth in Egypt.” Entry into the market will be the true test of Etisalat’s self-confidence. ||**||

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