THE EMERGENCE OF GLOBAL INDUSTRY TITAN AND IMPLICATIONS FOR EMERGING MARKET PLAYERS

 

June 2007

 

Authors		Kristoff Puelinckx - Managing Partner
		Juan Jose Rio - Principal

 

 

 

 

 

 

 

Similar to the evolution in the financial services industry in the last decades, if not centuries, the still very young telecom industry is moving away from a local service provider model that addresses local needs with local offerings

 

The trend is increasingly towards a truly global model with global players serving global needs, complemented with regional players, dominating specific regions, especially in less developed markets. From an end customer perspective, telecommunications, especially mobile, is already very much a global industry or service. Most national subscribers can travel around the world and connect to local networks wherever they go through international roaming agreements established across most operators around the globe. The industry though has not followed this globalization trend yet, with the largest players operating in a maximum of 20 to 30 countries around the world. Generally further consolidation is expected. Question is more on the pace rather than the reason.

 

Key drivers today include:

 

 

Deals in recent years pointed more towards efficiency gains, as well as regional footprint development and seamless cross border service provisioning. The latest trends seem to move some of the industry leaders more and more towards looking for the next growth driver, rather than just continuing to drive operational efficiencies. Vodafone’s choice to exit Japan, yet to enter Turkey and more recently India seem clear indications of this.

 

In this whitepaper, an overview is given on the global players and the expected evolution of the industry landscape, understanding implications for all, especially zooming into the high growth markets and expected scenarios. This will present interesting challenges but also opportunities for the leading regional players in emerging markets like e.g. Africa and Middle East.

 

 

The players and expected movements

 

When trying to segment the global market, broadly 4 to 5 types of larger players can be identified. Geographical scope, sheer size as well as overall expansion ambitions have been the main drives of the categorisation

 

 

First there are the truly global titans who are generally seen as the true industry leaders, dominating broad range of markets and leading the overall industry development. Secondly there is a second tier group of mainly European players who did not grow as aggressive as some of their titan counter parts, yet have been able to develop a strong position across a range of markets, typically building from an incumbent, traditionally government owned, home market.

 

Apart from the more globalized larger groups, another type of geographically diversified player can be identified, even though they are somewhat smaller, yet really dominant in one or two regions in the emerging markets. These are the players that are currently in the sweetspot of where the industry growth is going to come from in the next few years, and definitely a category to watch and where to expect significant movement in many different directions.

 

Finally, next to the large, geographically diversified players, two significant groups of national players can be identified. First group consists of national champions, typically operating in large of very wealthy markets, having allowed them to build up a large size and related market capitalization. From this Group we separate a specific subgroup which are the Asian tigers, which because of their size and future growth and industry dominance potential merit a category of their own.

 

 

Global Titans

 

The global titans are limited to 4 or 5 mainly European players, who have expanded across this region and are increasingly positioning themselves as the global players, not only from a presence perspective but also from an operating perspective (one brand, integrated organisation and governance model, global products and services …)

 

 

While already being true industry moguls, the ambition is clearly to continue to grow and expand. Few believe these players will stand still and becomes more utility-like value stock type of plays. Rather, they will continue to be pushed for ongoing top line growth. Significant acquisitions seem to be the preferred option for growth. Telefonica’s acquisition of O2 consolidated its European position while more recently Vodafone and Orange have turned their focus on higher growth markets including Turkey and India as well as Africa.

 

When looking at the current financial muscle of these players and ongoing cash generation it can be expected that even more significant deals are yet to come. What once was a debt loaded industry with highly indebted players is now ruled by cash rich companies, ready to drive further consolidation.

 

As pressure from the investment community for exposure to high growth market continues so will the focus on emerging markets increase. Titans are potential consolidators of some of the local or regional players. Especially Africa, Middle East, parts of Asia as well as former Soviet and Eastern European countries draw the attention. Another high potential growth market being Latin America is already highly contested by some of the titans, although some opportunities for larger players shall exist.

 

 

European Indecisives

 

One level down from the global titans are some of the larger European players who didn’t make the big league yet

 

These players have expanded internationally, beyond their national borders, yet their future is not necessarily clear. Some will certainly be able to make it into the big league; others are restricted by their capital structure, expansion ambitions, even merger limitations imposed by shareholders (for example governments in some of them). Ongoing speculation exists that some may be absorbed by one of the larger players (O2 was probably the best example of this happening recently).

 

 

One thing that does seem clear and common amongst most of them though, is also their continued and even increased focus on emerging markets. These players look to find more “cheaper” deals there allowing them faster growth to catch up with the titans, or if nothing else change their profile towards more growth to justify a higher valuation in case they would be put up for sale. PT’s continued, be it somewhat disperse, focus on Africa, Telenor’s push in Eastern Europe and continued focus in high growth Asian markets are only some examples.

 

When looking at their current valuations as well as financial capacity, it is clear that they could be sizeable yet digestible targets for some of the titan. Projected resource availability (cash and debt) for the titans outlined above in many cases exceeds the markets caps of these players.

 

Alternatively, the cash the European indecisives will actually have available would allow them to be further consolidators themselves be it on a smaller scale.

 

 

Asian Tigers

 

Apart from the larger European players, some of the other larger industry players can be found in some of the larger Asian countries like India and China

 

 

China actually holds the largest industry players in terms of subscribers. China Mobile far exceeds anyone else with its 200 plus million subscribers and still growing aggressively. While very large already and with and impressive war chest, the larger Asian Tigers could potentially become global titans in a relatively short period of time, They are already competing for deals, again focused on emerging markets. Success in deal closure has been limited so far, widely attributed to cultural issues, lack of deal experience and sometimes lack of decisiveness at moments of truth throughout the process.

 

Let’s say the last two years have been a learning process but in the next 6 to 12 months players like the bigger Chinese and even Indian players can be expected to make significant moves. On the other hand, the second tier players in their home markets can be expected to increasingly become targets for the titans, Vodafone’s entry in India as well as Telefonica’s minority participation in the Chinese markets are only the beginning.

 

When reviewing the available funds as well as the continued accumulation of cash by China Mobile, the amounts are starting to look astronomical, allowing it to bid for any deal or player of any size in any geography.

 

 

Emerging Market Regional Players

 

What can be expected to increasingly happen on a global scale, already happened in mature markets, and is happening today in emerging markets

 

 

When looking at e.g. Africa and Middle East, the level of consolidation in the last two or three years has been tremendous, driven by four or five strong and committed regional players.

 

Their strong expansion drive has been supported by a better understanding of the potential of these regions at times when no one foresaw the explosive growth to come. Other drivers have included highly committed boards and aggressive shareholders as well as highly driven CEOs and management teams. All clearly supported by a significantly different view and perception of risk in some of the especially larger and less politically stable

 

These players still have room to grow and expand into new countries within their regions. The bigger players in Africa and Middle East are present only in 20 of over 70 countries, covering a maximum of 30% to 40% of population. All are generating increasing EBITDA’s providing cash for further acquisitions or to finance further upcoming Greenfield opportunities. Deals are becoming more and more expensive though as proven by Q-Tel’s recent Watanya acquisition, paying hefty per subscriber price over $1000 or MTC’s US$6.1 billion paid for the third mobile license in Saudi (be it as minority participant in a broader consortium). The bigger question beyond all the numbers though, is what is next for these players? Again eat or be eaten seems the choice. In terms of size all represent reasonable acquisition targets for the titans. On the other hand they could continue their own expansion drive as all are generating significant cash and have relatively low leverage on their balance sheets.

 

 

The Big National players

 

The big incognitos in the global playing field are still some of the very large local players in some of the emerging (excluding China and India which merit their own category - see above) as well as wealthier markets in the World.

 

These include the larger players in markets like the US, where decades ago the government forced a break-up of the incumbents into the baby-bells, and recently consolidation has again driven to emergence of really large players with large potential to go and acquire international market presence.

 

AT&T’s widely commented interest in Telecom Italia could have catapulted it straight into the titans league if an initial minority stake would have been expanded into a controlling stake in the future. As in many industries a leading player from the largest economy of the World can and should be expected on the global scale.

 

Other cash-rich, strong national players can be found around the globe as e.g. in Saudi-Arabia. STC is a case in point with a market cap around US$50 to 60 billion making it a far larger player than many of the other international (e.g. regional) players above. This cash generating machine is another example of a significant national player who can become an active participant on the regional or even global scene. Their current available cash is over $20 billion which could be used to make a very aggressive acquisition and totally change its profile overnight.

 

The biggest challenge for the national players looking to participate on the global scene will be speed, true board commitment and ability to execute on deals in a heated market with experienced players ready to move very fast.

 

 

Summarizing expected movements

 

When evaluating the overall map, M&A activity in the telecom space on a global, as well as regional basis can be expected to be significant. It is clear that a lot of cash is being built up, balance sheets are clean again and a continuous urge for growth exists.

 

 

There is no doubt the titans will continue to get bigger. Key question is if anyone from the second tier players can stand up and join this exclusive club and in which way. Reviewing expected movements, it is clear that the emerging markets will become a key battle ground for local consolidators, second tier players with titan ambitions and the titans themselves looking for the next growth engines. Question is really for the players in those markets on how to deal with this, as it can be perceived as both a threat as well as an opportunity.

 

 

Industry evolution towards global titans:

 

Implications and alternative strategies for the regional players in the Middle East and Africa

 

The increase of the recent consolidation waves in Middle East and Africa are known. MTC, Etisalat, MTN and Orascom seem to top the list. A couple others like Q-Tel and Vodacom will keep pushing to join them as size will become a more and more important basis or driver to compete on even within these regions.

 

 

As markets grow and become more competitive, larger players will be the ones to have the bigger purchasing muscles to keep costs down and manage more efficiently. But more importantly scale will help drive revenues, through faster product development, cross border service offerings and cross-country integration will increasingly become critical in more and more competitive markets. As such for smaller, especially local, players to hold out and try to compete with the large regional players, will become increasingly difficult and probably lead to several of them coming to the conclusion that selling out now with valuations at a high is probably the best option.

 

So what will the focus of the top 5 regional players be? Apart from improving their competitiveness through growing scale, it seems like they will either continue to be platforms for consolidation in their regions or be a really attractive target for some of the titans. Some alternatives:

 

a) Become a titan themselves by continued aggressive acquisitions and organic growth

 

As outlined above, the regional players do have further room for leverage as well as some cash in the bank and ongoing cash being generated from current operations to continue to feed their expansion hunger.

 

A high level analysis shows though that converting a regional player into a global titan can not be done overnight, unless significant capital increases are asked from existing shareholders.

 

A more realistic scenario is to continue to acquire operations in high growth countries providing significant growth in EBITDA annually, bringing further cash and leverage potential to continue the acquisition drive.

 

Even when looking at aggressive growth and M&A scenarios, it is doubtful that any player will be able to make the big league before 2010. This seems to be consistent with intentions stated by the bigger players like Etisalat and MTC who see themselves reaching global top 10 sizes by around that time frame.

 

The critical question here though is whether existing shareholder will be willing to hold out on attractive offers which will for sure increasingly come towards them in the near future.

 

Furthermore the success and ability of these operators to continue to acquire other players at reasonable prices and to achieve successful integration of many deals in a relatively short time frame will be critical.

 

 

b) Team up to form a regional titan so as to be too big to be absorbed by others

 

One way to defend from a potential take-over and to speed up the consolidation would be a merger by some of the larger regional players. When combining the market caps of any of the Middle Eastern and African players, a merged entity valuation comes out around 35 to 45 billion market cap. This could be sufficient to block any easy take-over bids by some of the titans or definitely from some of the second tier players, and could form a better platform from where to create a global titan in the future.

 

Increasingly though several players are having significant overlap in their portfolio of country operations. Where MTC and MTN for example were only competing in 2 or 3 markets some 18 months ago, today almost half their subscribers are in markets where they compete.

 

Having said that, some combinations still seem possible though. Orascom and even Etisalat’s relatively low exposure to Africa could make them good partners for MTN. While for example MTC and Orascom could really create the dominant player in the Middle East and Africa by teaming up. Even a tie up between MTC and Etisalat, often considered archrivals, should not be totally excluded.

 

 

Described examples are in a way theoretical though, as many issues will come into play. These ranging from pure political, to shareholder goals and intentions, to management team chemistries, etc...

 

 

c) Sell out to one of the titans and benefit from current high valuations

 

Most of the regional players have had a tremendous run over the last three to four years, typically growing from a single country presence (E.g. South Africa for MTN, Kuwait for MTC, UAE for Etisalat) to operations in over 10 to 20 countries. With it, market caps and shareholder value has increased not by double but triple digits. Key question now is how long shareholders will hold out and stick to existing plans and strategies to conquer the region if not the world. There could come a time where they will actually be tempted to sell out and divert the proceeds to either more global telecom plays, or even other industries in these economically booming regions. From a pure financial perspective timing may be just right. Valuations and multiples for emerging market players are significantly higher than for mature market players or more diversified titans. So which of the titans are likely to make a move? Telefonica has made several (unsuccessful) attempts to move into the Middle East (Saudi, Turkey...). Once having digested the O2 acquisition it could actually be interested in re-enforcing its growth profile through exposure in Africa and the Middle East. This will depend eventually also on what happens with its VIVO-JV in Brazil, which seems to be the short term priority. Also its recently announced investment in Telecom Italia does not seem to indicate its immediate interest in, or prioritization of, emerging markets.

 

 

Vodafone’s love-hate relationship with Vodacom can take different twists in the future in Africa while its positions in Egypt as well as Turkey can be the bases for further consolidation in the Middle East. Although a cherry pick approach is probably an as likely scenario as a major group acquisition by Vodafone. France Telecom (Orange) is continuing to push in Africa with some smaller acquisition yet seems to have fallen behind a bit in the overall race. Still, they are familiar with the continent and a larger acquisition could make sense for them.

 

Deutsche Telecom and Telecom Italia at the moment seem to have plenty of issues with shareholders and with their home markets. As such they are unlikely to make major moves in the short-term. This could change quickly though as also they increasingly face demand for more growth by shareholders.

 

So what about the second tier players including the European indecisives or some of the Asian Tigers? For them the question will be if they can absorb this size of a deal. Definitely interest and some movement should be expected though. Especially someone as cash rich as China Mobile can at some point be expected to make a big move rather than to continue trying to build up the empire operation by operation.

 

Wild cards could include players like STC which certainly from a cash perspective have all the ammunition to make a major move.

 

 

Conclusion

 

It seems clear that the industry is ready for further consolidation. The emerging markets and especially the Middle East and Africa seem key targets. Regional players need to fully assess the potential impact of this trend on their own future. From there-on shareholders and management teams should better align themselves and start to clearly define intentions and strategies so as to be ready for a heated, be it interesting battle coming up.