Bharti-Zain deal: Will it benefit Sunil Mittal?
Rijo Jacob Abraham
Sunil Mittal can now have plenty of meat to eat as the Kuwait-based Zain Telecom gave its nod to the transaction with Bharti. The Bharti group chairman, who is in the “due diligence” process for acquiring the African assets of Kuwait’s Zain telecom, avoids meat whenever his group closes in to making business deals. He had done the same twice last year when Bharti was in acquisition talks with South Africa’s MTN. But his spare diet didn’t bear fruit after the MTN deal fell through.
The $24 billion deal was an ambitious one, no doubt. It would have surpassed Tata acquisition of Corus by almost double. The problem, Bharti said in a press release, was regulatory approvals from the South African side.
The talks went on smoothly from May 2008, when they hit on a roadblock in August -- dual listing the company in stock exchanges of two countries. The actual problem was politics, what some columnist call “economic nationalism.” The South African government did not want their flagship corporate firm to lose it national identity.
Mittal’s months of penance failed. But he should persist. Market data shows why he is not giving up, and why he should not. Airtel’s profit margins have fallen lowest in three years in the quarter ended December 2009. ARPU or Average Revenue Per User has fallen drastically to around Rs 24, thanks to the increased mobile subscription rates.
India has the world’s largest growing mobile markets -- the number of cell phone connections stood at 525 million in December 2009. India has around 13 cell phone operators now, with the latest entrants being Telenor and Sestemia (which operates as MTS).
Stiff competition has swamped the call charges in the country. Further, to boost the rural penetration of cell phones, the government had lowered the mobile termination charge (MTC) -- the charge one mobile operator pays to another for each call made to it. Bharti stands to lose the greatest from this move.
With Indian markets showing early signs of saturation, Bharti has few options but to look overseas. According to market analysts, the Indian telecom giant’s operations in Sychelles, Jersey and Guernsey (Channel Island), Sri Lanka and the recent acquisition of Warid Telecom in Bangladesh are just not good enough to increase profits. It needs bigger geographies, like that of he MTN or the Zain with growth potential.
The Zain deal
With the global economy emerging from recession, valuations of troubled assets have increased and loss-making companies like Zain Africa BV (Zain’s Africa operations) are willing to sell them. Merger and acquisition opportunities have widened compared to the past one-and-a-half years.
On February 15, Bharti Airtel announced the USD 10.7-billion deal for acquiring Zain’s 15 operations in Africa.
The deal, Bharti Airtel clarified, includes a $1.7 billion debt assumption, which will be figured into the enterprise value. In this all-cash acquisition, $700 million will be paid a year after the deal is inked. Further the deal carries a penalty of $150 million for the parties if either fails to complete the deal.
Mittal’s ‘Minute’s factory’
Africa is too good an opportunity for Mittal. With a population of a billion spread out in 56 countries, Africa’s cell phone penetration is comparable to that of India 10 years back. Mittal’s “minute’s factory”, what he refers to as low-cost, high volume model, which made him market leader with should work in Africa as well. The demand for mobile services is growing at a rate of 25 percent across these countries.
Despite Mittal’s optimism, its 8.2 million shares changed hands since the deal was announced and its value fell to 16-month low of Rs 272.45. Why? Just market vagaries?
No. Investors knew that the deal will be largely debt-funded. Though Mittal is a man, who keeps his debts low( it is just 0.4 times the 2010 EBITDA), the deal could stretch its balance sheet a tad too much. The upcoming 3G auction adds to the worry. Investors consider Bharti present valuation of $2 billion debt ridden company at eight times its EBITA is not worthwhile. A deal at two times the EBITA, they consider, would have been good enough.
Credit rating agencies Crisil and S&P have placed Bharti’s long-term banking facilities and debt programmes on “rating watch with negative implications.” The macroeconomic set-up of the continent is also not suitable. Also, investors are wary as to how Bharti will fare in African market, with 15 different regulatory bodies. According to Forbes, investors know that it easier for Sania Mirza to win the Wimbledon than for Bharti to make money in Africa.”
Organisationally Zain, with 46 percent of its shares with the Kharafi Group, is a Middle East phenomenon. Its under-investment in the area and weak execution of projects had weakened its prospects. Its top-to-bottom management approach has made it unviable in the African domestic market.
It is precisely here where Bharti aims to capitalise.
Economies of scale and scope
On March1, Sanjay Kapoor was elevated chief executive for India and South Asia. And Mittal’s trusted lieutenant, Manoj Kholi, is to head its international operations. The entire management structure is being revamped. According to reports, Inder Walia, the group’s HR head, has begun gathering top-notch professionals to help the company take root in an alien environment.
Once this, “economy of scale”--liberalising the management and adapting to local culture -- has been set, it would move on to implement the “economy of scope” by manipulating the demand side. This is where Mittal’s “minute factory” or price war will come into play.
This is yet another daunting challenge. Of the African countries, Zain has significant presence only in five, Nigeria leading the lot. This doesn’t mean that Nigerian business is profitable. It means it has 25 percent market share. Bharti’s hope partly lies here too. According to analyst, it is not ARPUs that correlate to profitability. It is the market share. Tower costs in Africa are four times that of India. Bharti can bring down costs considerably.
The debt funded deal will cost Bharti $500 million per year in interest. This means the EBITDA has to be improved by 40 percent to fund just for the deal.
But, Sunil Mittal has not diversified his company much. He is concentrating on what he does best – delivering cheaper rates and higher volume. His mantra is simple – make cell phones the cheapest means for people to stay in touch with each other. Innovation, growth and profits will follow. Hopefully, this mantra will work in the markets of Africa as well.