Frankly, he was pushed. Six months ago, it looked as if Sunil Bharti Mittal’s play for MTN, Africa’s largest mobile operator, was an act of great strategic choice. On February 15, when Bharti said that Zain, the third-largest telecom operator in that continent, had accepted its bid, it was clear that there wasn’t much of a choice left in such matters.
Bharti Airtel’s home market is bleeding after the latest price war. Revenues have been falling for all operators. Fresh spectrum to improve quality of services isn’t available. Bharti’s new ventures are nothing much to write about today. “Telecom has kept Mittal so busy that he has missed the boat in insurance. In retail, everybody is struggling including him,” says a telecom industry veteran.
Mittal has to stick to what he knows best and that’s telecom. The only emerging market that can offer scale and future growth is Africa. The 53 countries that make up Africa have a combined population of a billion people. That’s almost as big as India and only a little smaller than China, where Bharti can’t go. Only two out of five Africans have access to mobile services. The demand for mobile services is growing at an average rate of 25 percent across top 16 African markets. African countries are poor as well, just like large parts of India.
HIS BRAVE NEW WORLD: Sunil Bharti Mittal plays for MTN, Africa’s largest mobile operator.
Here is the question: if it is such a good idea, why are the Indian stock markets so pessimistic? Bharti’s share fell 9.22 percent on February 15, the day it announced the Zain deal. The reaction was quite opposite in Kuwait, the home country for Zain, where the market soared 126 points, the largest single day gain in over six months. The markets don’t understand anything, do they now? Actually, they do.
They know that it will be easier for Sania Mirza to win the Wimbledon than for Bharti to make money in Africa in the short-term. This is not going to look pretty, but try to watch. One large fund manager had this to say: “Regulatory difficulties of operating in so many African countries, repatriation of money from these countries, lack of clarity on mobile technology in Africa [are all] worrying the market.”
Investors are also concerned over the price Bharti is seeking to pay Zain for the African operations. “Valuation of nine-times EBITDA is too high; six-times would have been more appropriate,” the fund manager says.
After being the king of the hill in India for almost 15 years, Bharti will for the first time (not counting its Bangladesh investment) learn to be a challenger in a major market. Zain is present in 17 African countries and is a market leader in two: Tanzania and Congo. In two others, Kenya and Nigeria, it is a distant second. “In Africa, the three big markets are South Africa, Nigeria and Egypt. Zain is present only in Nigeria,” says Dobek Pater, partner, Africa Analysis. Even in Nigeria it has an ownership dispute with Econet Group, but let’s assume that to be a minor niggle.
The major issue will be to turn around Zain, whose African operations are in losses right now. And it is not because Zain is a laggard. But it is no MTN either, which is the market leader by far and quite profitable too. And that begins at getting the organisational culture right.
Fixing the interiors
Unlike MTN, Zain has had a centralised command-and-control structure but most of its presence in Africa has been built through acquisitions, biggest being that of Celtel. The model hasn’t worked. Its outgoing CEO Saad Al Barrak led the telco’s acquisition drive. He paid $3.4 billion for Netherlands-based Celtel in 2005 to enter sub-Saharan Africa, as he wanted to turn Zain from a local company with 600,000 customers in 2002 into a top-10 global operator by 2011.
All of these acquisitions will be diverse companies and to lash them together into a composite corporate culture will be perhaps the toughest task. “If you look at the deal itself, you have two independent entities — Zain Africa and Bharti — both of which are struggling in their own markets. When they merge, it will be a tall order,” says Angel Dobardziev, analyst, Ovum, a telecom research firm.
This is where Sunil Mittal will be hoping its top team will deliver. As a first step, Mittal has recently entrusted the responsibility of managing the international business to his trusted lieutenant, Manoj Kohli. The domestic business is now led by Sanjay Kapoor. At the same time, in preparation for its global surge, Bharti group human resources head Inder Walia had already begun to build up a global cadre of senior managers who have worked in different geographies. There is Shireesh Joshi who is from Pepsi China. Chief Financial Officer B. Srikanth is from Unilever, UK. Joachim Horn, director - networks, was the CTO of German Telecommunication major T-Mobile. None of these guys has any Africa experience but each understands how multinationals build their presence in a new market and that should help.
Actually the way to understand is to analyse MTN’s approach. It has a strong culture that encourages the understanding of local culture. Best practices from one location are transplanted into other geographies. “Secondments were routine and that helped bring in best practices from different parts rather than [being] just HQ driven,” says Pater of Africa Analysis. That also makes MTN’s local units better run and more empowered to tailor the product etc. to the local market.
Till now, Zain has had a very top-down approach and its local units are not empowered. This is revealed in the company’s name itself. “Zain’s culture is not quite equipped to understand Africa. In fact, even the brand Zain has no meaning in Africa. It is primarily a middle-eastern name that was brought in here underscoring the point that headquarters play a big role,” says Pater.
Mittal’s team will have to find a solution to these seemingly touchy-feely issues but which will determine how employees see themselves and how customers connect to the brand. “Different Zain businesses have been run like a loose entity, so processes are weak. This cuts both ways as it may be easier for Bharti to bring in its own processes etc. and knit it closely together,” says a telecom analyst from an accounting firm. Mittal, on the other hand, is simply too canny to thrust his own cadre of managers in the difficult markets of Africa. While there is no official word, senior officials in Bharti reckon that he will initially rely on Zain’s local managers. Kohli is likely to provide the overall supervision, supported by a few key corporate finance and technology professionals.
Fixing the Fundamentals
Once it has the governance issues under control, the team will face the next set of challenges. These will be the core business issues of pushing up profitability. As of now, Africa accounts for 60 percent of the subscriber base but less than 15 percent of the core profits of Zain Telecom. “Most of Zain’s profits come from its middle-east operations,” says Dobardziev of Ovum.
There are five key markets in Africa. Out of these five, Zain has a presence in only Nigeria. Now consider the top ten markets (see graphic on page 38). Apart from Nigeria, it has presence in Kenya and Tanzania. This clearly means the top spenders are not with Zain. This poses its own challenges but its more serious problem is that it doesn’t have a leadership position in many of the markets where it is present. This is the main reason for its low profitability.
“ARPU [average revenue per user] and profitability do not have a direct correlation. Market share and profitability do,” says Dobardziev.
To provide mobile services in a country a certain amount of fixed cost has to be incurred, whether you have one subscriber or a million. For instance, a new entrant (assuming all regulatory clearances and spectrum come through) would need at least $1 billion launch a pan-India service. Building scale will be crucial to recover that money. In Africa, Bharti will need to build market share for Zain businesses because the fixed costs meter is constantly ticking. That will be easier said than done.
The two competitors, MTN and Vodacom, are tough nuts. How hard can it be to take away market share from the leaders? “I can’t remember a single instance where a number four player has been able to break into the top two of a key African market,” says Dobardziev.
The easiest thing will be to launch a price war. The structure of the present African market makes such an option tempting. It is the way Indian market was 10 years ago. The penetration of services is less and growth is there. There are a lot of people who work in the informal sector and they don’t have access to fixed lines and the literacy rate is low. Just the way a Bihari working in Punjab or Maharashtra finds the mobile to be the easiest way stay in touch with relatives; Africans could use the phone as their life line to home. African telecom tariffs are one of the highest in the world. For instance, it costs Rs. 70 per minute to make call from Ethiopia to India.
Naturally, then, Bharti would have tremendous scope to bring down costs and exploit the synergies. The opportunity is in the undersea cables (international calls), data and Internet services. In fact, everything in Africa is up for grabs because all the services are more expensive than even some of the developed countries. “As a third entrant in many of its markets, there is a possibility of price cutting,” says a senior telecom executive.
This is where regulations will have to be managed. Telecom is very tightly regulated in Africa. Governments control tariffs. There are licensing authorities and they will vary from country to country, unlike India where you have one TRAI. The regulations will make cutting tariffs difficult. “Though it is a legitimate form of market entry, Bharti is already reeling from a price cut in India. Do they want to hammer down profitability in Africa as well? I am not sure,” says a senior Vodafone executive.
This is where Bharti can try and attack the cost side of the business. There is a lack of resources within the African continent. “Apart from all the other things, there is an issue of management bandwidth there,” says Subhash Menon, CEO of Subex, which sells a lot of telecom software in Africa. The market needs several highly skilled managers with great execution capabilities. Bharti can bring them.
Apart from people, the cost of infrastructure too is very high. The cost of operation in Africa is also among the highest in the world. “It costs almost three times more than a developed country to build out a network infrastructure in Africa,” says Pater of Africa Analysis.
The key reason for the high costs is the lack of physical infrastructure. Sometimes, mobile companies have to build roads when setting up infrastructure to be able to transport equipment or they might have to clear a jungle. “A lot of transport here is by air or by ship, so it costs you lot more and customs duty is high,” says Pater.
This is where Bharti will have to implement its minute factory model ruthlessly. The classical telco model will be virtualised. Some part of the operation will go to tower companies, some part to BPOs and some to networking companies. Bharti can also create a market ecosystem like India. For instance, rivals could come together for a tower joint venture. The trick will be to move from a fixed cost model to a variable cost model, which will kick-start the virtuous cycle of lower prices and higher subscriber growth.
“In India they have an EBITDA of 40 percent or so and in Africa it is far less. If Bharti brings down the costs and even marginally grows the base, Zain’s profitability can change overnight,” says a telecom analyst. This is exactly how the Essar group has gone about its strategy in East Africa, particularly in Kenya and Uganda, albeit on a much smaller scale.
After taking care of the costs, Bharti can bring in some of the marketing muscle to Zain’s operations. And Zain is no slouch here. Two of its marketing plans have a fair degree of recall. The first is called “One Network”. In 2006, Zain became the first mobile operator to allow subscribers to roam across different country networks at local call rates. It allows Zain subscribers across 17 countries to enjoy local call tariffs instead of roaming rates. It allows free incoming calls and the ability to recharge locally in any country and seamless value added services like mobile commerce. Some of Zain’s big competitors have already implemented similar schemes by now though. The other marketing move is “Zap” which was launched in February 2009. Zap was Zain’s alternative to Safaricom’s hugely successful M-Pesa m-commerce offering. It was initially launched in Kenya, Tanzania and Uganda and now has over 10 million subscribers and has expanded into Niger, Sierra Leone and Malawi.
Bharti would do well to crack large businesses as customers. The one big difference between MTN and Zain is that unlike the former, Zain has not built its business in the more sophisticated service in the business enterprise segment, in providing broadband or managing networks. Bharti has that experience and can easily add that piece to the puzzle.
With clever cost management and more marketing muscle, Bharti should be able to change the financial health of the company for sure. “African markets are not competitive. An incumbent with a high market share just shows that some operators have had a good time,” says Alok Shende of Ascentius.
So what happens next? After its MTN setback, Bharti is trying its best not to raise hopes and keep things as low-key as possible. By all indications, its initial offer — nine times EBIDTA — for Zain’s African assets comes at a significant premium. In return, it gets a five-week exclusivity to study the asset in some detail. “It has pitched the price on the deal high to get the exclusivity - then after the due diligence it will try to bring down the price,” says Rishi Sahai, director, Cogence Advisors, M&A advisory firm. So while it may look a trifle expensive, think of it as a strategic premium to enter the market.
If it eventually snags Zain, Bharti will look to first stabilise Zain’s current operations by putting in place its much-vaunted decapitalised business model. Once that is done, it is bound to start expanding its presence across all the other lead markets in Africa, where it is not present. And that will bring it into direct competition with MTN and Vodafone.
The fight will be a long and arduous one. “Bharti has the advantage of knowing how to drop prices and costs aggressively in a market like India. If you take away the top 200-300 million people from India, we are an Africa,” says Shende. Mr. Mittal’s safari is under way yet again.