Etisalat agreed to buy a majority stake in Zain, valuing the company at close to $12bn. We believe that this is an excellent deal for the al-Kharafi family, a key shareholder in Zain, which earlier sold Zain Africa to Bharti Airtel for $11bn. Like Orascom, which was recently acquired by VimpelCom, Zain was clearly a financial investment rather than a strategic play, which companies such as Etisalat, STC, and Qtel have all focused on.
The deal will propel Etisalat into the leading position among the major Middle Eastern operators, and it will be interesting to see how STC and Qtel respond. By purchasing Zain, Etisalat will gain a growing, well run, and highly profitable business.
However, it is also adding significant complexity to its already diverse operations which span Asia, the Middle East, and Africa. Managing its diversity effectively will be important to Etisalat realizing synergies across its operations, but it could also become a significant distraction to senior management.
Zain: a financial, rather than strategic investment
We believe that the sale of Zain to Etisalat and the recent acquisition of Orascom by VimpelCom marks the beginning of the M&A end-game in emerging markets. Most investors are aware of the increasing competition and slowing customer and revenue growth that are continuing to put downward pressure on the growth prospects of emerging market telcos such as Zain.
This is usually the time when financial investors exit the market, cashing in on the attractive valuations of their investments. These financial investors are then replaced by strategic investors that take a longer-term view and look for synergies with existing operations.
The sale of Zain and Orascom indicates that the leading investors of both companies are financial investors, while buyers such as Etisalat, Bharti (which bought Zain Africa earlier this year), and VimpelCom are clearly strategic investors.
Etisalat has of lot of diversity on its plate
By purchasing Zain, Etisalat will be getting a well-run, fast growing, and highly profitable operation, which has 35 million customers, annualized revenues of $4.7bn, and a healthy EBITDA margin of 44%. The company also has a good growth curve, with subscribers up by 25% and revenues up by 8% in the year ended September 2010.
However, the key challenge for Etisalat will be to manage the significant diversity in its operations. It is already present in 18 markets including: Pakistan, India, and Indonesia in Asia; Nigeria and Tanzania in Africa; and its home market in the UAE. While this deal vastly strengthens its Middle Eastern presence, it also increases the complexity of the business by adding operations in markets such as Iraq and Lebanon.
Etisalat is also examining its strategic options for its operations in the Indian market, which it launched earlier this year. Possible deals with Idea Cellular and Reliance have been mentioned in the press.
If deals such as these are signed, it could add yet more complexity to what is already a mixed bag of operations which includes former incumbents, established mobile operators, and new entrants.
A new balance of power in the Middle East
With this deal, Etisalat is emerging as the undisputed leader among the major Middle Eastern operators that have emerged in the last five years, including STC, Qtel, Batelco, and formerly Zain and Orascom.
It will be interesting to see the reactions to Etisalat’s purchase of Zain from other operators, particularly STC and Qtel. Both companies have strong backers with deep pockets and have played a similar strategic investor role to Etisalat in the past.
Will they be content with their current operations and try to gain an advantage over Etisalat/Zain while their staff are busy with integration and synergies? Will they try to outdo Etisalat with a large move of their own? Or will they consider the Orascom and Zain financial investment strategy and look to sell some of their own assets while valuations are high? It is too early to tell which way things will move – but move they will.