1.41 AM Friday, 29 March 2024
  • City Fajr Shuruq Duhr Asr Magrib Isha
  • Dubai 04:56 06:10 12:26 15:53 18:37 19:52
29 March 2024

GCC operators eye new markets despite local heat

New entrants have had a substantial impact on market shares in the first few years of operation. (PATRICK CASTILLO)

Published
By Nancy Sudheer

Gulf-based telecom operators will continue to remain acquisitive in emerging markets in the next 18 months despite the stiff domestic competition negatively affecting their profitability and market share, according to global rating agency Moody's Investors Service.

The outlook for the integrated telecommunications industry in the Gulf countries remains stable, as companies continue to demonstrate above-average credit metrics, clear conservative financial policies and solid liquidity backed by strong cash flow generation, Moody's said in its telecom industry outlook report.

The industry is expected to benefit from moderate positive revenue growth, partly driven by the roll-out of broadband capacities, and a benign regulatory environment. The incumbents are expected to retain leadership as Ebitda margins are estimated to be in excess of 50 per cent in the medium term.

Most GCC operators will also remain acquisitive over the medium- to long-term. M&A activity is likely to comprise mostly small- to medium-sized acquisitions in emerging markets in the next 18 months, but large transformational transactions cannot be excluded. Analysts expect companies to adhere to their financial targets in choosing the funding mix for acquisitions.

Capital spending is another area, which will continue to support the stable outlook if moderately leveraged capital structures, conservative financial policies and an ability to generate solid cash flows is maintained according to analysts.

As far as Moody's-rated entities and other incumbents are concerned, two main negative implications are a threat of gradual loss of market share and pressures on operating margins and revenue growth.

New entrants have had a substantial impact on market shares in the first few years of operation. For instance, Zain and Qatar Telecom (through Nawras) had each managed to capture a market share of around 50 per cent in Bahrain and Oman respectively, at year-end 2008. They had launched operations as greenfield operators in 2004 and 2005, respectively.

In Saudi Arabia, Kuwait and the UAE, recipients of second licences have also managed to seize significant market shares (between 10-35 per cent) over a short period of time.

"Although Moody's takes the absolute numbers of subscribers serviced by each company and churn rates into account, we believe the market share based on revenues is more relevant, as the majority of GCC subscribers are prepaid customers that generate significantly less average revenues per user (ARPU) than postpaid customers (ratio of two to three-to-one in terms of revenues). On this basis, we expect incumbents to retain leading revenue market shares, as they will continue to service the vast majority of the high-end prepaid segment and they have put commercial strategies in place to retain and attract prepaid clients; they will also accelerate prepaid to postpaid migration," the report said.


Revenue mix

Domestically and abroad, revenues and operating margins will be driven by two different dynamics. While operators will rely on value-added services and the broadband segment to prop up revenues and margins in home markets, network roll-outs and top-line growth of mainly 2G and 3G mobile services will be key in foreign operations.

On a consolidated basis, mobile revenues will continue to dominate the geographically diversified groups' revenues and Moody's expects Ebitda margins to remain above 50 per cent across the region. Compared to peers, GCC operators have a high degree of concentration in the mobile segment, typically at 70 per cent of consolidated revenues and above. Downside risks are mitigated because the revenues are mainly from higher-margin domestic operations and the untapped Internet and data segments leave room for future growth.

Analysts expect competitive pressure to be the greatest in Saudi Arabia and Kuwait, where three players are active in the mobile segment, while the other four markets have so far essentially remained duopolies – with Vodafone Qatar only having started commercial operations in the second half of 2009.

More aggressive commercial strategies to retain subscribers will impact operating margins by increasing marketing costs. A higher share of new subscribers will be also be captured by competitors. More positively, operators have the ability to take action domestically to compensate for this negative trend, as site sharing and interconnection become options.

Pending regulator approval, these options would allow companies to extend coverage and generate wholesale revenues while streamlining operating costs by avoiding the duplication of equipment.

Qtel and Vodafone Qatar signed the first outside site sharing agreement in the region in 2009, while others across the GCC, such as du and etisalat in the UAE, are in advanced talks.


Continuing expansion

To compensate for the loss of monopoly positions and increasing domestic penetration rates that currently exceed 100 per cent in all GCC countries (users have more than one Sim card in most GCC countries), most integrated operators have engaged in rapid and significant international acquisitions. They have adopted similar strategies to increase their revenue base and diversify cash flow streams.

Integrated GCC operators have acquired established companies or purchased licenses mainly in the Middle East, North Africa, South Asia region (Menasa) and in Africa in countries that have large populations, low penetration rates, and offer essentially 2G mobile services with significant growth prospects for 3G and broadband services.

Around $25 billion (Dh92bn) of cash outflows have been earmarked by the six incumbent GCC operators for investments in associates and licenses, as well as acquisitions of subsidiaries from 2005 through 2008. Qtel and Zain have been the most active in terms of acquisitions. Zain itself has become the target of a takeover, as key shareholders are in negotiations with a consortium regarding the sale of a combined 46 per cent in Zain.

This would constitute the first sizeable acquisition in the telecommunications sector of a significant stake by a foreign company in the region; to date, intra-GCC investments in competitors or licenses have been made exclusively by regional operators.

High ARPU observed in domestic markets has provided operators with a strong source of cash flow, which operators have partly relied on for funding acquisitions. Over the same period, operators have generated an aggregate of around $43bn of cash from operations. This enabled operators to cover the vast majority of their capital spending requirements and shareholders' returns from internal sources. Moody's expects external growth to be sustainable, as long-term objectives require an increase in operating assets that cannot stream from organic growth only, however, near-term acquisitions are expected to be made in the small- to medium-sized bracket ($300 million) in emerging markets.

For the first six months of 2009, Moody estimates about $2 billion of outflows were related to acquisitions that concluded in 2008, including Qtel's payment for an increase in its share in Indosat. Some transactions have been transformational in nature and scope, and it is expected that a phase of integration will occur in the coming 18 months.

Efforts will also be dedicated to extracting synergies in the form of centralisation of procurement, shared services or vendor financing relationships on a group-wide basis similar to that of etisalat with the telecommunications equipment supplier Huawei in July 2009 and the agreement signed in June 2009 with Ericsson to collaborate internationally to help bring services to new markets faster.

A cross-border presence could positively impact inter-connection costs, while large expatriate populations in the GCC from the Menasa region could allow savings on roaming revenues, all helping to sustain operating margins, Moody's said.

Large transformational transactions cannot be ruled out, especially if a strong strategic fit is anticipated and if the deal has characteristics of a one-off opportunity. While its expected that isolated small- and medium-sized acquisitions (under $300 million) to be credit neutral, larger transactions could significantly impact the credit profiles of buyers. However, the event-driven rating migration risk must be viewed in the context of government support and interaction.

Moody's believes the funding mix of any large acquisition, which could jeopardise current public financial guidelines and capital structures, is likely to include a form of support from government-majority shareholders. Given their relatively restricted shareholder base and very high level of government ownership, we expect funds to be readily issued to provide timely support.

Precedents exist, such as with Qatar Telecom, which raised over $1.6bn of equity in June 2008 (the government oversubscribed to the new issuance) to shore up the funding of Indosat's investment.

Through large acquisitions, Zain and Qtel have diversified their revenue streams and have the greatest portion of revenues sourced internationally of all their peers – around 80 per cent on a consolidated basis. Other GCC operators are more focused on domestic markets.


Capital spending to stay high

Large networks are being rolled out at home and abroad in an effort to increase revenue growth and maintain competitiveness. Furthermore, these large networks will help broaden and deepen product offerings, as differentiation is becoming vital in this increasingly competitive market.

All operators are engaged in roll-outs and domestic upgrades, which may contribute to increased capital expenditures by strategic subsidiaries. Capital spending should therefore remain high, especially for those companies that invest in more costly technology, such as fibre optic cable to enhance speed and capacity. For instance, etisalat completed its first phase of Fibre to the Home (FTTH) in 2008 – an all-fibre voice, data and video network – and will roll out the same technology to the whole of the UAE.

Whether for maintaining their current market shares or increasing them, GCC telecoms companies are expected to spend between 15-20 per cent of their full-year revenues on capital expenses in the future. Zain and Qtel have the highest need for capital expenditures on a consolidated basis, as subsidiaries in emerging markets require a high level of capital spending to fulfill the revenue potential (new networks require a higher share of non electronic works that are more costly).

Indosat's 2009 capex levels were roughly cut in half as a response to weaker growth potential and in an effort to keep leverage metrics under control. Zain revised its capital spending plans in 2009 to $1bn to 1.5bn, half the previous targeted amount. Other less geographically diversified GCC operators have reported spending 15-20 per cent of revenues, similar to most European operators, as capital requirements for established domestic networks are relatively low.

However, it does not imply immediate pressure on cash flows under current assumptions. Moody's expects rated GCC operators to be free cash flow positive or neutral in 2009 and positive from 2010, as major capital expenditure programmes are likely to be concluded.

Companies could lower shareholder returns and dividend outflows to government shareholders if such measures are needed (although this is highly unlikely), demonstrating support by their government owners.

Site-sharing has and will be used to relieve pressure on capital spending in foreign operations to extend coverage in a cost-efficient manner, especially in geographically large countries. In July 2009, etisalat signed a long-term passive infrastructure-sharing agreement with RCom in India, whereby RCom grated etisalat the use of approximately 50,000 towers for its start-up Indian operations, which will help etisalat accelerate its Indian operations.


Benign regulatory environment not expected to shift dramatically

GCC regulators were established to implement competition at a national level. They will ensure a smooth transition that will create a balance between firmly establishing new entrants and preserving operators' historical interests. Hence, a threat from aggressive/restrictive policies such as tariff fixing is remote.

Some differentiation exists between the degree of regulation and oversight in the various GCC countries. This has led some regulators to open their respective domestic markets more aggressively (Saudi Arabia, Kuwait), mainly where the network enhancement needs have been the most pressing. The expectation is that no mobile license will be granted in the near term in the GCC, although fixed licenses could be awarded. There is no dramatic change expected in the regulatory framework in the near term and view it as largely credit positive, Moody's said.

 

Keep up with the latest business news from the region with the Emirates Business 24|7 daily newsletter. To subscribe to the newsletter, please click here.