Manuel Bueno

The First Consolidation Wave of Mobile Phone Operators in Emerging Countries: The Battle for MTN

Mobile phone consolidationMany regular visitors will have noticed that the News Section has been nearly monopolized of late by news about the takeover battle surrounding mobile operator MTN, followed by a lull in events. For those who have not had the time or patience to track this news, what follows is a summary of what has happened and why it is so important to those of us interested in the base of the pyramid.

MTN is a mobile phone operator backed by the South African government, with 68.2 million customers in more than 20 countries and a market value of $33 billion. Its largest operations are in South Africa, Nigeria and Iran. On March 20th, MTN announced that it was looking for acquisitions and would consider targets outside its existing territories in Africa and the Middle East. That same day, MTN reported revenues of $9 billion for 2007 and an EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization) of $3.9 billion, both of which were 42% more than the previous year. The group’s total number of customers increased 53% year-on-year to 61.4 million.Why did MTN start seeking a potential acquisition? Although MTN is originally a South African company, Nigeria is its largest mobile phone business, with 16.5 million customers. Unfortunately, MTN has several problems there, mostly because of poor infrastructure, which is making it difficult to increase its customer base. Since MTN’s operations are very profitable, it is generating a lot of cash while struggling to invest it.

However, a company with un-invested cash is a juicy takeover target, too. Bharti Airtel, India’s largest mobile operator (by subscribers), liked what it saw in MTN and made its move on April 25th. Bharti’s growth had largely been organic to date, but, like MTN, it felt that the time was ripe to make the jump from being a strong regional player to a multinational company.

Other companies such as Vodafone (which closed a $10.9 billion deal in 2007 to take control of Hutchison Essar, India’s fourth-largest mobile phone group), China Mobile (which in 2006 came close to buying Millicom, with 20 million customers in 16 emerging markets in Latin America, Africa and Asia) and Etisalat (controlled by the oil-rich UAE government and have been expanding overseas for the last 5 years), were touted as other potential bidders.

One of the issues for any possible deal would be the full sale of one of South Africa’s flagship companies to foreign bidders. In fact, MTN’s chairman, Cyril Ramaphosa, is a former Secretary-General of South Africa’s ruling African National Congress. A solution to this issue would have to include an integrated management structure with dual headquarters and dual listing, which might be unpalatable to many foreign corporations. Mr. Ramaphosa was said to be determined that any deal with Bharti should be seen as a merger rather than a takeover.

On May 5th, Bharti made an indicative (read, informal) offer: a $19 billion bid for 51% of MTN. The combined group would have more than 120 million subscribers spread over 22 countries in Africa, the Middle East and South Asia. This new entity would join the top tier of telecoms groups, which include China Mobile, the world’s largest mobile operator by market capitalization, and Vodafone, the largest wireless company by revenue.

It rapidly became clear that Bharti might not be the ideal suitor for MTN, since on some measures it was smaller than MTN. Additionally, the premium over the share price before the offer was 20%, while MTN’s board was said to have been looking for a 30% premium–or at least encourage a bidding war with other operators such as Vodafone.

However, Vodafone quickly rejected the possibility of bidding for MTN on May 12th. Vodafone already owns a 50% stake in MTN’s larger domestic rival, Vodacom. The remainder is held by Telkom, South Africa’s leading fixed-line phone company, which last year discussed selling its stake to Vodafone, although to no avail (it is worth noting that the South African government is Telkom’s largest shareholder). Arun Sarin, Vodafone’s chief executive, stated that the group wanted to use Vodacom as a springboard to launch further mobile businesses in Africa. Therefore, Vodafone would only consider bidding for MTN if it saw no possibility of gaining control of Vodacom, in spite of the fact that a Bharti-MTN alliance would be a competitive threat to Vodafone Essar. Etisalat and China Mobile also decided not to bid (for the time being, at least).

By May 15th, there were rumors that the takeover-merger was finding difficulties among South African politicians. MTN demanded that Bharti share key executive positions as well as cash and stock payments to leading MTN shareholders. MTN also proposed that the major shareholders of both parties have roughly equal holdings in the enlarged entity. The problem was that this arrangement would have increased overseas holdings in Bharti above India’s foreign direct investment limits of 74% in telecoms (Bharti is 65% overseas owned, with Singapore Telecom holding 30.5%).

On May 24th Bharti broke off talks with MTN due to the structure of the proposed deal rather than funding issues. According to Bharti, MTN was proposing that Bharti became a subsidiary, which was unacceptable for Bharti’s main shareholders, and it indirectly blamed MTN for the collapse of talks. At any rate, it was regulatory risk and political risk that killed the deal in the end. Bharti left no doors open for further talks in their public statement: ?Bharti Airtel wishes MTN the very best.?

Coincidence or not, the next day Reliance Communications signaled that it was interested in MTN and that it would be holding exclusive talks with MTN around a potential merger. This was not a surprise since Reliance Communications is India’s second largest mobile phone operator by subscribers (it has 48 million subscribers versus 64 million from Bharti; both companies? are adding about 1 to 2 million subscribers every month). Reliance had already held talks with MTN about a possible merger last year (and abandoned them for undisclosed reasons, but probably due to the same issues that Bharti ran into).

MTN proposed the same structure rejected by Bharti Airtel. In this case, Anil Ambani, Reliance Communications’ chairman, would, in exchange for his 66% holding in the Indian company, become the biggest single shareholder in the enlarged MTN (approx. 30-35% of the company, representing 20-25% his shares of Reliance and rest paid in cash)–a possibility that was not available with Bharti, since Sunil Bharti, founder and chairman of Bharti, owned only 26% of his group and would have ended up with a significantly smaller stake in the new group. Anil Ambani could also become the co-chairman with Mr. Ramaphosa. Existing leading investors in the South African company would collectively hold about 25% after the deal. Additionally, the regulatory 74% rule would be avoided since Reliance currently is only 10% foreign held.

Why did Reliance decide to give it another try with MTN at this particular moment? It is believed that after losing to Vodafone in last year’s keenly contested takeover of Hutchison Essar, its management felt that Reliance needed to raise its game or it risk becoming an also-ran among global players. MTN’s opening could be Reliance’s last train.

On June 2nd, the two companies announced that they were commencing 45 days of talks for the takeover and began doing due diligence on each other (due diligence on a business transaction entails researching the financial, legal, labor, tax, environment and market/commercial situation of the company usually including, such as in this case, access to confidential records and book-keeping from the company).

On June 3rd, Vodafone decided to make its move in the South African market by offering Telkom $2.5 billion for a 12.5% stake in Vodacom. This would bring Vodafone’s holding up to 62.5%. Management at Vodafone is understood to be nervous that the company may be failing to take full advantage of Vodacom as a springboard from which to spread the company across the continent (its emerging markets? businesses contribute about a quarter of its market capitalization). MTN may be the second largest mobile operator in South Africa, but it is already much bigger than Vodacom on the continent. Vodacom has 34 million mobile customers in five African countries. MTN has 68 million customers in 21 countries, including 15 in Africa. Also, bidding for Vodacom instead of MTN makes sense for Vodafone in so far as that it avoids a forced sale of its 50% of Vodacom (due to competition regulations). The ruling African National Congress seems to be in favor of such a move this time too, since Vodafone wants to use Vodacom as a hub to expand into Africa at a time of market consolidation.

In another part of the continent, Safaricom, a Kenyan mobile phone operator (and leading mobile phone banking operator) began trading on Nairobi’s stock exchange following the government’s sale of a 25% stake in the group. Vodafone – with 40% of the company – has full control of Safaricom which holds 80% of the Kenyan market share. Having only 10 million customers, it is a small fish compared with other regional players. If Vodafone succeeds in gaining control of Vodacom, it might decide to merge both operators in some way. If it fails to control Vodacom, it could, decide to use Safaricom as a launching pad instead.

We are now entering the third week of due diligence of the MTN-Reliance deal. The due diligence is likely to be completed sometime between the 3rd and the 4th week of July. An announcement about the deal is expected early next month.

Odds are that the deal will fall through and that we will soon see the birth of two big players in emerging mobile phone markets, namely Vodafone-Vodacom-Safaricom and MTN-Reliance. Stay tuned – the game is coming to a close!

Looking to the future, where might the next mobile phone consolidation wave happen? My bets are on China. Speculation is rife that China’s state-controlled telecoms industry is on the cusp of a government mandated restructuring. China Mobile with a 69% market share in the mobile phone sector and 369.3 million customers, having won 68.1 of them in 2007, is at the very center of these rumors.