What Future for Zain? A Rosy One (Part I) – Is the Etisalat-Zain Deal Definitively Over?

May 19, 2011

Last March U.A.E.’s Etisalat decided not to bid for the takeover of Zain’s 46 percent stake valued at around $12 billion (1.7 Kuwaiti dinar the share). The reason for this pull back  was due to four different factors: Zain’s divided board, the extended due diligence, regional unrest in the MENA area and the new Kuwaiti capital markets legal framework (Law No. 7 of 2010, a.k.a. C.M.L., and C.M.L. Bylaws of March 13, 2011) related to takeovers. According to the new law the buyer of more than 30 percent of a Kuwaiti listed firm is obliged to bid for the remaining outstanding shares. “The main reason was the mandatory tender offer … that would mean we would have to tender offer to all shareholders that would make it more than $12 billion” pointed out the chief international investments officer of Etisalat, Jamal al Jarwan.

Right now it’s not clear whether Etisalat will bid a second time for Zain. For the Emirati company it would be much better trying to bid for Zain, which is present in seven MENA markets (Kuwait, Bahrain, Iraq, Jordan, Lebanon and Saudi Arabia, although Etisalat’s offer could not encompass Saudi Arabia). In this way, Etisalat could create a powerful synergy without bidding separately in every country.

With the purchase of Zain, Etisalat could save both economic resources and time.  A consideration stands out immediately: One thing is acquiring a new license with operations to be launched from the scratch (for instance in the case of Syria’s third mobile license), other thing is acquiring the 46 percent of a company already operating in cherry-picked MENA markets and having in all of them a highly estimated goodwill.

Analysts are divided between those who believe that a sale could follow briefly and those who think that the moment has gone. But occurring a sale, the price would be below the price previously envisaged that corresponded to 1.7 Kuwaiti dinar per share ($6.15). To begin with, the price reduction is partly due to the fact that shareholders have already received the 2010 dividend payout in the amount of 200 fils per share ($0.72. This price is due to last year’s sale of Zain’s African assets to India’s Bharti Airtel for $9 billion).

Mr. Al-Jarwan said that at a certain point Etisalat could still bid for Zain’s assets, but that it was important to first understand how events would develop, hinting probably to the diverse positions present within the Zain board of directors. It was a consortium led by the Al-Kharafi Group that wanted to sell the 46 percent stake in Zain. The Al-Kharafi Group — thanks to one of its units the Al-Khair Group — owns directly a 12.7 percent stake in Zain, but analysts estimates that in reality through other companies the Al-Kharafi Group should own or control a 20 percent stake in the Kuwaiti telecom company.

A few weeks after the collapse of the Etisalat-Zain deal two events materialized in April 2011, and both could now have a relevant impact on Zain’s future at least in relation to its shareholding structure.

First, the Al-Kharafi Group has improved its position in Zain's newly elected board of directors. In specific, the Al-Kharafi Groups vice-chairman, Bader Al-Kharafi has joined the board. Second, on Sunday, April 17, 2011, the chairman of the Al-Kharafi Group, Nasser Mohammed Abdul Mushin Al Kharafi (father to Mr. Bader Al-Kharafi) died in Egypt of a heart attack. He was a skilled businessman and the mastermind of the Etisalat-Zain deal. Notwithstanding his death, it could still be possible, although not sure, that the Al-Kharafi still-to-be-appointed new chairman could also push for divesting from Zain. In fact, the Al-Kharafi Group “borrowed to get the Zain shares and borrowed to speculate in other investments. Kharafi has a lot of debt and Zain is a big liquid asset and some of its assets are not so liquid” said Nasid Al-Nafisi, general manager with the Kuwait’s Joman Center for Economic Consultancy. It’s currently estimated that the group has direct and indirect liabilities worth at least $5 billion and selling the Zain’s share could be a means in order to repay its debts.

The negative drawback for the Al-Kharafi Group is that by selling to a purchaser only its 20 percent stake, the buyer will not be able to conquer management control in Zain. Only owing 46 percent of Zain’s outstanding shares may provide a 51 percent stake after excluding Treasury shares.  By selling just a 20 percent stake, the Al-Kharafi Group will be forced to request a consistently reduced price than what it has previously requested.

Another viable option for the Al-Kharafi Group could be to sell some of the assets belonging to Zain, similarly to what happened last year with the sale of Zain’s African assets to Bharti Airtel. “Selling assets would be a way for shareholders to raise money without triggering a buyout of the whole company” affirms Nomura’s telecom analyst, Martin Mabbutt. And a step toward this direction has already been taken with the decision to sell Zain’s 25 percent stake in affiliate Zain Saudi Arabia to two joint bidders: Saudi Arabia’s Kingdom Holding and Bahrain’s Batelco. The agreed price is $950 million. Probably, by Q3 2011 this Saudi deal will be closed. This Saudi deal was also a precondition for  Etisalat’s failed acquisition of Zain’s 46 percent stake.

If Etisalat had acquired Zain’46 percent stake, it would have been forced to sell Zain’s 25 percent stake in the Zain Saudi Arabia subsidiary, which is currently competing with Etisalat’s Mobily in the Saudi Arabian telecoms markets. Saudi Arabia’s I.T.C. regulator, the Communications and Information Technology Commission (C.I.T.C.) could have never accepted to have two out of three mobile licenses controlled by the same operator (in this case Etisalat).

Moreover, in the wake of the last global financial crisis Kuwait has introduced a new legal framework for capital markets. This framework — whose aim is to regulate the financial markets and the mergers and acquisitions sector — is based upon Law No. 7 of 2010, a.k.a. C.M.L., and C.M.L. Bylaws of March 13, 2011. According to article 271 of the C.M.L. Bylaws, any person (or his affiliates of alliances) having an ownership interest (directly or indirectly) of more than 30 percent of the total share of a company listed on the Kuwaiti stock exchange (K.S.E.) is obliged to produce an offer to purchase the remaining outstanding shares (70 percent).

So, if Etisalat decides to bid for a stake in Zain, two are the available options. The first option for Etisalat means not getting management control. The second option means bidding for more than Zain’s 30 percent shares.  But as a consequence, the second option would mandatorily force Etisalat to bid for the entire company. Indeed, the second option requires many more economic resources. All this said, it is unlikely that the government of Kuwait sells its estimated 30 percent stake in Zain, so when trying to get management control, Etisalat would be obliged to fund up to 70 percent of Zain’s share (leaving aside the Kuwaiti government’s 30 percent stake.

The price proposed some months ago was 1.7 Kuwaiti dinar per share when at the beginning of October 2010 the price at the Kuwait Stock Exchange was around 1.4 Kuwaiti dinar. The selling shareholders would have received a premium of around 0.3 Kuwaiti dinar or an 18 percent price increase in trading their shares. Assuming that the proposed price was still right, acquiring the additional 24 percent (70 percent—46 percent=24 percent) would require additional $6.2 billion, which  would increase the whole investment up to $18.2 billion. With no doubt a lot of resources also for a cash-rich company such as Etisalat, which since 2006 has spent on acquisitions around $33 billion, according to Dealogic, a data provider.

The price proposed last year is not anymore reliable because two factors contributed to reducing its entity: the consistent dividend already passed to the shareholders and Zain’s share value that is in mid-May 2011 around 1.06 Kuwaiti dinar versus 1.4 Kuwaiti dinar in October 2010. Today’s current market capitalization is $16.4 billion, while on October 13, 2010, it was $21 billion (6.1 billion Kuwaiti dinar). If Etisalat decides to bid a second time — no matter what available option it chooses — the price will be consistently lower than 1.7 Kuwaiti dinar per share. Moreover, for some analysts also the current price is still too high. “… Zain is an expensive stock, and so we are cautious because we think it’s trading at too high a multiple compared to the rest of the sector” points out Mr. Mabbutt.

Apart from its board of directors’ divisions about the ownership of the company, Zain is operating in quite interesting markets, namely in Iraq, Kuwait and Sudan. It was before, and it is still a very expensive target notwithstanding the additional share price reductions.

The only regional alternative to a purchase by Etisalat could be a bidding offer from Saudi Arabia’s Saudi Telecom Company (S.T.C.), which overlaps its assets with Zain’s only in Kuwait and Bahrain, but not in the two most promising Zain’s markets: Iraq and Sudan. As the table above shows, the problem is that S.T.C. has a lot less cash and cash flows equivalents (73 percent less) than Etisalat’s in order to guarantee a financing plan with banks. In this regard, given the volatility of the MENA region’s capital markets, also Etisalat’s proposed financing scheme for the failed acquisition would have probably been revisited forcing the U.A.E. company to pay more. In addition to this, S.T.C. did not show interest in Zain, while it’s currently refining and consolidating its overseas portfolio (see Indonesia) or bidding for single licenses (for instance in Syria). Telecoms firms not belonging to the MENA region (but already operating there) could also be tempted by the possibility of creating related synergies, but the problem is always the same: Zain is a big and valuable company. Purchasing it means only one thing: borrowing huge economic resources.