Across the developing world, telecom companies battle to provide populations with the most efficient services. Combining price, service, and convenience, mobile telecom firms and fixed-line businesses are looking for new ways to penetrate these nascent markets and consolidate their share to out-compete rivals. Telecom markets, especially in the developing world, present an interesting case study and a concrete example of how private equity can revamp businesses through their infusions of capital and of knowledge.
Market motions
Vying for market share has created a host of privatizations by governments in the region and has led to a series of mergers and acquisitions within the telecoms, media, and technology (TMT) industries. A. Shabu Qureshi, director at EMP Global, explained that “liberalization points to more opportunities and market efficiencies in the short, medium and long run. It removes the barriers and constraints posed by public ownership. Positive developments brought about by liberalization translate into new services, new opportunities and growth prospects.”
The case for competition is stronger in the developing markets of the Middle East and North Africa (MENA) where penetration rates and convergence are low. This leaves a huge opportunity for private equity firms to assist companies with expansion and improvements to existing models of their corporate governance. Izzet Güney, managing partner at Millennium Private Equity, thinks that TMT private equity deals will target mobile operators “mostly in Africa and South Asia, where you still have countries with only two operators and a low penetration level.”
He attributes the low level of penetration to the existence of several small operators in countries which have escaped the radar of larger conglomerates and who are focused on buying mid-sized to larger operators. The larger firms might penetrate new markets once local telecom operators are “actually larger in size.”
Güney’s experience from one North Africa deal is “to buy one small operation, maybe bring in one or two management executives, maybe on the finance side, maybe on the IT side, maybe on the tech side, and grow the operations from 50,000 subscribers to 200,000 subscribers, at which point in time it becomes a critical mass interesting enough for companies such as Vodacom or MTN.”
For local players, private equity capital offers the chance for a growth-oriented business with a strong possibility for success to become a regional player. While TMT firms are not tip-toeing around owners, they are certainly not hesitant to indicate the points at which efficiency can be improved. According to Güney, “we actually know what they want to see in place before they do an acquisition. They are interested in making sure the numbers are clean, so that is an issue of corporate governance. There is also a critical mass of subscribers, which is extremely important, because dealing with small numbers is not very helpful.”
Instead of working with very small firms, he believes “it’s more effective once you have a critical mass to get discounts on scale in terms of ordering, etc. This area of investment is going to take a large chunk of the fund’s capital.”
For Millennium and other TMT fund managers, the time to act is now and as within the coming year or two the time for investment would have passed. Güney said that, “emerging markets are growing very fast and penetration levels are growing very, very fast. What’s happening now is that the penetration in most of the emerging markets in cities is already quite high.”
Fixed-line penetration in the Arab World
Restructuring infrastructure
“The infrastructure within mobiles is also another play,” according to Güney, especially for “people who are very conscious of the bottom line and they are trying to figure out ‘how can I squeeze more money’.”
Private equity firms are quite engaged in restructuring the way telecom infrastructure is operated, from changing management and personnel, to specializing in pure telecom by selling off infrastructure to be run by separate entities with more experience and better efficiency.
“Some operators want to just sell a service, sell a phone, one can squeeze some money on the marketing side, maybe some on the acquisition cost, but maybe you should not own the tower” advises Güney, because “the tower is just a building that somebody else could actually run for you much more efficiently. You could lease the space, etc. That would make a lot more sense and that squeezes the costs, so it creates more free cash flow, which is what everybody is moving towards. So infrastructure to us is extremely important.”
Güney believes private equity is best to revamp telecom infrastructure because “they don’t personally have any affinity or love in keeping a tower, for example, in the mobile business. They only look very rationally at where it makes most sense in owning that tower and what the costs associated to it are.”
For telecom operators in love with their towers and network, the idea of de-merging infrastructure from operation is anathema, especially to someone who spent their whole life in telecoms and understanding the sector partly through the physical representations of its infrastructure. Pointing to Western Europe, he shows evidence of people taking issue with demerging their businesses, “but if you go to India, Indian operators are much smarter and they understand exactly where the cost-benefit will be. And they have decided, Reliance, Bharti, Vodafone, and Idea Cellular have all decided that owning a tower doesn’t make sense. Pooling and sharing makes more sense. Let somebody else run that specific area with a specific knowledge while you can concentrate on marketing your services.”
Through demerging and redistributing industry functions, private equity might be able to increase efficiency through investments in telecom’s down-market industries, including logistics and supply-chain management. Rami Bazzi, principal of private equity at Injazat Capital, believes “Telcoms are offering products for which they need support. They need to focus on coming up with the right product, the right service and make sure that they do it right, that they do it profitably. However, they need support on the operational and business side and it is very challenging to get all the support they need built in-house.”
Fixed-line subscriber base in the Arab World
Thumbnail of the telecom sector in KSA
To which telecom markets should private equity move?
According to Millennium’s Güney, there is a “big swath in the middle” of the African continent “where you do have some of the large operators that have a presence there, but not in all the countries. And what you’re hoping for is that area of Africa will grow over time, just like every other emerging market will grow and has grown so far.”
In addition to Africa, South Asia remains a particularly attractive market for private equity capital in telecom operations. In Pakistan and India, particularly, there are a number of fixed mobile operators, while penetration rates remain low. However, the challenges to increasing penetration rates from simple due diligence techniques are not the only consideration.
Because of the nature of the market and its lack of development, “even if you have been able to get a license, maybe there is still not enough frequency available because there are so many operators,” according to Güney. He believes, then, in the “physical restrictions in the ability to have additional players. But other countries exist in Asia where you might have only two operators or three operators and judging from your macroeconomic study of that country, you might have a growth there.”
