Telecoms Economics

In market economy theory, price is a reflection of supply and demand. Whenever there is excess demand, prices go up, and supply should then increase in order to bring the price close to its equilibrium. If we apply the supply and demand theory to the regional telecoms industry, the disequilibrium is staggering, with strong demand from mobile and integrated operators willing to expand outside their home markets on the one hand, and scarcity of supply with only few greenfield licenses and privatisation transactions to come on the other hand.

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By  Tawanda Chihota Published  December 6, 2006

|~|Marc-Hammoud---SHUAA-CAPITA.jpg|~|Marc Hammoud, assistant vice president of research at Shuaa Capital believes further consolidation in the Middle East telecoms sector is inevitable.|~|Liberalisation of regional telecoms market is well on track. Following the accession of many Arab countries to the World Trade Organisation, a wave of liberalisation has hit the regional telecoms sector during the past two years, leading to more competition and impressive growth in the number of mobile subscribers. In the UAE, a presidential decree cancelled Etisalat's monopoly in April 2004, and a second unified licence was awarded to du in February 2006 with mobile operations expected to be launched early 2007. In Oman, a second mobile licence was awarded in June 2004 to Nawras (55% owned by Qtel of Qatar), breaking Omantel's monopoly in the mobile segment. In Saudi Arabia, a second mobile licence was awarded to Etihad Etisalat (35% owned by Etisalat of UAE) - better known as Mobily - in August 2004, breaking STC's monopoly in the mobile segment as well. In Qatar, the Supreme Council of Information and Communications Technology (ictQatar) ended Qtel's monopoly (the last monopoly in the Arab world) in November 2006, with several licences across all business segments (fixed, mobile, and internet) set to be awarded in the coming few months. The same liberalisation process took place in Bahrain and Jordan, albeit at a faster pace, putting these two countries ahead of others with a fully liberalised telecoms sector and strong competition across all business segments. In Egypt, Algeria, Morocco and Tunisia competition has been restricted to the mobile segment, but has recently been extended to the fixed line and internet segments. Saudi Arabia is set to further liberalise its telecoms market with the award of a third mobile and a second fixed line licence in early 2007. In Iraq, four GSM licences should be granted in 2007 to replace the existing three interim licences held by MTC, Orascom Telecom and Wataniya. In Lebanon, two GSM licences should be awarded sometime during the first half of 2007 - part of the government's privatisation plan in the telecoms sector. It is worth mentioning that MTC and Alfa are now operating the two existing networks under a management contract signed with the Lebanese government in June 2004. Competition for acquisition deals is increasing. While Orascom Telecom, MTC, Etisalat, Wataniya and MTN were the first to initiate acquisition-based growth strategies, Qtel, Batelco, Jordan Telecom and Oman Mobile have recently been trying to emulate these frontrunners. In line with its strategy to accelerate its non-organic growth, Qtel announced at end of October that it is finalising three telecoms acquisitions. It is worth mentioning that Qtel (part of a consortium) already secured the second mobile licence in Oman in June 2004, and was the second runner-up for the third mobile licence in Egypt, which was won by Etisalat with a US$2.9 billion bid. Also in October, Jordan Telecom Group made public its plans to spend US$300 million to buy stakes in Middle East-based telecoms operators in a bid to diversify away from a highly competitive home market. After buying 96% of Umniah of Jordan in June 2006, Batelco stated at the end of September that it plans to make a second international acquisition in the near future, and may buy up to two companies during the next 18 months. Early November, it was Oman Mobile's turn to reveal plans to buy stakes in state-run operators in the region. Finally, South African mobile phone group Vodacom announced in mid-November that it is looking at acquiring a pan-African mobile phone operator as well as at opportunities in Ghana and Nigeria, suggesting that it could target companies such as Celtel International, the 85% owned subsidiary of Kuwait's MTC. However, it is unlikely, in my opinion, that MTC will sell Celtel, as Africa, with an average mobile penetration rate of around 15%, boasts some of the world's last untapped mobile phone markets. Thus, too many operators chasing too few assets should keep acquisition prices relatively high. Another factor that should support prices is the investment strategy adopted by a number of operators. Cash rich and unleveraged operators are willing to look at lower returns and longer time scales. These rather different assumptions about investment have pushed cash-flushed investors to take up positions in strategic markets at relatively high prices. With only a few other new licences to be awarded and privatisation deals to take place in the short term, further consolidation in the telecoms sector is inevitable. Only four to five players should remain in the telecoms business in the medium term. The question is 'who'? In my opinion, operators that first initiated an expansion strategy have an edge compared to those that joined the 'process of revenues diversification' at a later stage. I believe that Orascom Telecom, MTC, MTN, and Etisalat are in a good position to lead in the medium term. Today, competition is stronger and prices have reached stratospheric levels, making it much harder for smaller operators to narrow the gap with first movers. Orascom Telecom, MTC, MTN, and Etisalat have reached critical size on both an operational level (number of subscribers and number of operations) as well as a financial level (market capitalisation), setting high barriers for other operators to buy them. The more geographically spread an operator is, the more difficult it is to integrate it and to create synergies with a complementary footprint. When I see MTN's shares rallying amid speculation that the company could become a potential takeover target for a Middle Eastern operator, I say it would require a buyer with really deep pockets. In addition to a market value of R134.7 billion (US$18.8 billion), MTN operates mobile networks in as many as 21 countries, which would imply that whoever buys it would most likely have to sell part of its assets to only keep operations that fit well with the existing foothold. I think that there are multi-market mobile services providers that are much cheaper than MTN (in absolute terms), and that operate in fast-growing and interesting markets as well. The only alternative I see for operators with relatively shallow pockets and are already finding prices too high would be to buy existing failing operators or start-up telecoms companies at relatively cheap prices, and then turn around their operations by introducing an entirely new brand. In addition to the acquisition of new licences, takeovers bids, and mergers; telecoms operators have begun building Next Generation Networks (NGN) to provide customers with voice, data and entertainment through a single source. Massive amounts are spent in the name of what has become the industry's new mantra: convergence. In September, Vodafone UK unveiled plans to offer fixed-line broadband services to customers as part of its asset-light approach to roll out broadband and fixed-line services in its key markets. Vodafone has already launched such services in Italy, Germany, and the UK. The operator signed a deal with BT to offer broadband services nationwide via the BT-owned national network, but unlike other mobile players entering the market, it has not announced free broadband services. Mobile phone retailer Carphone Warehouse moved into the market with a free broadband service for customers signing up to its fixed line phone service earlier this year. Orange followed and is offering free broadband connectivity to customers signing up to its mobile packages. Satellite television company Sky is also offering free broadband to customers new to its subscription services. Vodafone said its partnership with BT would enable it to offer bundled packages of mobile and broadband services nationwide. Vodafone's asset-light approach differs from that of Carphone Warehouse and Sky, which argue that they can make more profits by investing in their own infrastructure through local loop unbundling. Back in the Middle East, at the end of October Etisalat announced that its migration to NGN had commenced, with 10% of the network set to be NGN-ready by the end of 2006. The Abu-Dhabi based operator plans to migrate 50% of its network by the end of 2007, and 90% by end 2009. Orascom Telecom also outlined plans to give a boost to its internet and broadband services in its three major markets: Pakistan, Algeria, and Egypt. Mobily, the second mobile operator in Saudi Arabia, made public its intention to bid for the second fixed line licence that should be awarded early 2007. Given the competitive atmosphere in the telecoms sector, operators need to provide value-added services to customers. Convergence of telecoms services should allow operators to offer triple and quadruple play. If an integrated operator rolls out an IP-enabled network (extendable to mobile telephony) it would be able to offer bundled services and serve as a one-stop shop for customers. Although the industry likes to depict convergence as bringing benefits to customers, fully IP-based operations should primarily benefit network operators by reducing costs and thus improving efficiency. With the convergence of telecoms services, I would not be surprised to see other regional and global mobile operators diversifying across business segments (fixed line and internet) in an attempt to hook up customers by offering bundled services. Expansion strategies and convergence of services require cash. Many operators in the region built a massive war chest for acquisitions on the back of a strong growth in the number of mobile subscribers and highly profitable operations. However, over the course of two years, most telecoms companies saw their cash melt as asset prices surged, and instead had to raise debt in order to keep pace with the consolidation and the technological shift going on in the sector. Hence, one should keep a close eye on interest bearing debts sitting on telecoms companies' balance sheets, as these could weigh down on net earnings growth going forward. To cite only one example, Orascom's net interest expense jumped from US$98.6 million in 3Q05 to US$252.8 million in 3Q06. This article has been contributed by Marc Hammoud, assistant vice president of research at Shuaa Capital in Dubai. ||**||

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