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Operators considering entering emerging markets can gain a strategic advantage by conducting thorough due diligence.

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By  Roger Field Published  March 9, 2009

Operators considering entering emerging markets can gain a strategic advantage by conducting thorough due diligence.

When Orascom Telecom and Telecom Egypt won a licence to provide fixed-line services in Algeria back in 2005, the two operators were bullish about the potential of their new business venture.

By combining their fixed-line expertise from their home markets, the companies intended to compete with Algeria's incumbent operator, Telecom Algerie, in a market of some 33 million people with a fixed line penetration of 10%.

Africa is probably home to the most frivolous taxation litigation of all the continents. People buy assets which are subject to litigation. - Matthew Glynn.

But just three years later, after making significant investments in the country, Orascom Telecom and Telecom Egypt agreed to liquidate their assets in Algeria, citing "competitive difficulties" as the main reason for abandoning operations in the country in 2008.

While there are many examples of telecom operators losing money on foreign investments, Orascom and Telecom Egypt's Algerian venture served as a particularly costly, and sobering, reminder of the many challenges faced by operators entering more difficult emerging markets.

But despite such high profile investments going awry, many operators still fail to carry out comprehensive due diligence early enough before buying green field licences and assets in foreign markets.

It is a situation that Matt Glynn, head of technology, media and communications at DLA Piper, is familiar with. "The reality is that many companies, especially in this part of the world, do fail to conduct thorough due diligence," says Glynn, who has worked for numerous telecom companies entering foreign markets.

The main reason for inadequate due diligence on the part of some operators is largely market driven, although there are also some regional reasons, including huge pressure on operators to close deals extraordinarily quickly and a "land grab" mentality about opportunities in the region, according to Glynn.

"The pressure to move quickly and try to avoid a spike in prices through competitive forces means people can overlook due diligence," he says.

Furthermore, with the exception of some of the larger operators including Etisalat, Zain and Qtel, which have become adept at asset and licence acquisitions, other companies lack experience of closing deals, leading Glynn to observe that "acquisitions have not been the forte of operators in this part of the world."

The situation is exacerbated by a higher tolerance to risk among many operators in the region compared with their Western counterparts, which may be driven partly by more lenient regulation in  some countries in the Middle East and Africa.

But Glynn also points to the status of some regional operators, many of which are part or wholly owned by governments and royal patrons, as a possible reason for them paying less attention to due diligence.

"Some of these big companies are government owned, which means they are in the hands of royal families and the cross ownership issues that exist weave a pretty tight fabric so some of the operators are of the view that they don't necessarily need it in writing," he says.

"It's often a basis for not pursuing as rigorous due diligence as one might expect from a Western investor."

Finance watch

In terms of the issues that companies need to look at, Glynn points to three main categories, comprising financial, technical, and legal due diligence. In terms of financial due diligence, there are numerous issues to consider.

"If you were looking at the financial and tax issues you will look closely at capital expenditure, capitalisation and tax, and drill right down to the processes that make the company run."

Tax is a particularly important issue that operators must understand, according to Glynn.

"How will it affect the top and bottom line?" Glynn asks. "It is amazing how people have missed this when they have been in this compulsive race to build scale across Africa. All too often we see people failing to understand the tax regime."

Operators need to look out for various types of tax such as duty on handsets, airtime tax and taxes on telecoms equipment being brought into the country.

"Fortunately we are seeing at a macro level a reduction in these taxes, but they are still high. We know Africa is notorious for its taxes and the arbitrary nature they can be introduced," Glynn adds.

Closely related to tax, residual litigation is also a potentially big problem. "Africa is probably home to the most frivolous taxation litigation of all the continents," he says. "People buy assets which are subject to litigation. There might also be regulatory irregularities in terms of how the licence might be granted."

Glynn adds that an operator looking at a foreign licence should also check that the government or regulator in the new market will not deem the company to be a dominant party, or a party that has to make "a massive donation to the USO (universal service obligation) pot."

"USO is a big risk. Many African nations have USO as a feature of their regulatory landscape but rarely is it clearly articulated as to when and how it kicks in," Glynn says.

"That could be a major drain on your revenues. These are the kind of clauses you would want to put in there. It is beyond a gift despite our desire for it. It is beyond the reach of most operators to go out and write their own licences."

 Joao Sousa, a partner at Delta Partners, a management advisory and investment company, agrees that many operators fail to conduct solid due diligence in various areas, particularly with respect to the financial worth of the telecom market they are looking to enter.

"The ultimate objective is to develop a valuation of the licence," he says. "The research and due diligence should focus on operational, financial and license specific issues."

Sousa points to operational variables including penetration levels, informal economies, population distribution, and poverty levels including demographics and illiteracy as important factors to assess.

"Operators need to understand the real penetration versus stated penetration, understanding the effect of ‘dormant' Sims and double Sims to determine the potential penetration," Sousa says.

"Companies usually don't estimate correctly the dormant Sims, double penetration and addressable market taking into account the informal economy. The reason for this is that they do their estimations based on generic data provided by research companies which does not take into account the previous factors," he says.

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