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Ovum: Africa threatens to sink Zain

Vivendi's confirmation that it has broken off talks with Zain about the sale of the latter's African operations lays bare the likelihood that Zain is seriously considering selling up, according to a statement from analyst group Ovum...

Developing Telecoms has published several reports about the activities of Zain over the past two years. Most reports have been favourable. We publish this commentary from Ovum in full and without any comment of our own. 

Vivendi's confirmation that it has broken off talks with Zain about the sale of the latter's African operations lays bare the likelihood that Zain is seriously considering selling up, according to a statement from analyst group Ovum. While several reasons have been adduced for Zain's intentions, a sale would ultimately dismantle Zain and threaten the survival of the entire group. 

Zain's sudden change of heart is surprising

For a company that wowed the market with its ambitions to be a top-ten global mobile operator by 2011, the potential sale of Zain Africa is a U-turn. When Zain outlined its "3x3x3" strategy in 2003, it set a three-year timetable to become a regional, an international and then a global leader. To suddenly abandon that ambition unfortunately seems like an admission of failure.

But why would Zain sell? In our forthcoming report on Zain Africa, we will probe into the operations of Zain to find out why it wants to sell. Admittedly, its African operations are underperforming. Africa accounts for about two-thirds of the group's customers but less than 20% of the group's profits. In fact, in 1Q09 seven operations in Africa made a net loss.

But such is the case for other global players. Indeed, what is the point of having a global footprint if not to enjoy economies of scale and offset poor performance in struggling units? When we compared Zain Group with its peers, we could not find any discernable rationale why it should sell its African units. Its EBITDA margin is neither the best nor the worst, as is its debt/EBITDA ratio.

However, Zain spent less than US$5 billion to amass the assets, and if reports of a valuation of over $12 billion are true then "silly money" could be driving a sale. Ultimately, if a sale proceeds, a decimated Zain group will have to worry about its own survival as an independent telecoms group.

Vivendi is out but other suitors are lurking

With Vivendi out of the race, the road is now clear for other interested parties to show up. Vivendi said talks broke off because a deal would not meet its "financial criteria" for acquisitions - in effect suggesting that Zain was asking for too much money. However, Vivendi has other underlying financial issues of its own to sort out (its credit ratings and its dividend commitments) and is not really an ideal owner for Zain Africa.

In our report, we profiled other Western operators that could wade in. But for each of them, there are underlying obstacles. Orange and Vodafone have already built up an extensive African footprint piece-by- piece and an acquisition would overlap with their existing footprint. Others such as Telefonica and T-Mobile are so far removed from Africa that it would represent a new path in their strategy.

Without the Western players or a private equity fund, the most likely owners for Zain Africa will be fellow Middle Eastern players or Chinese and Indian operators.. Both Bharti and Reliance in India have flirted with MTN as they seek entry routes into Africa. Likewise, China Mobile has long wished for a global footprint. Could Zain Africa give it its first major breakthrough on the international stage? Other Middle East players such as Etisalat and Q-tel could also snap up Zain Africa to solidify their African presence.

A sale by Zain punctures the hype around emerging markets

Regardless of the reason Zain proffers for selling up, a sale would indicate to the markets that emerging markets are not a must-have asset at whatever cost. Investors (eg, Vodafone) always justify their foray into emerging markets by saying that such markets have high growth potential and will be worth far more in the future.

If Zain is to now admit that it has struggled in Africa, the lesson would be that a blind land-grab strategy in a maturing industry can no longer be taken for granted. Just as the markets penalised Vivendi's share price recently, any publicly owned company embarking on an emerging market acquisition jamboree will now have to work harder to convince its shareholders.

Developing Telecoms welcomes any comments on this report. Anonymity is, of course, available.

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