Emerging markets: The balance of power

With subscriber growth increasingly restricted to emerging markets with a huge collective population, the operators able to achieve success in these regions will find themselves among the most powerful in the world. And then they’ll want to go global.

The story of international expansionism in the cellular industry has been dominated by Western protagonists. The past decade has seen the leading players from developed European markets – Vodafone, Orange, Telefonica, Deutsche Telekom, TIM, Telenor to name some – take their domestic experiences and operations and replicate them in neighbouring countries, before heading even further afield.

For several years now, the industry as a whole has eyed the world’s emerging markets in its collective quest for continued growth. And during that time, those Western carriers that have nurtured the territories into which they first expanded to the point of saturation have been taking steps to ensure their stake in the world’s remaining high growth markets is assured.

But while there have been undoubted successes for these players in emerging markets, they have no guarantee of long term triumph – because these markets have spawned their own aspiring super-carriers.

The lure of emerging territories is simple: customer acquisition in rapidly expanding markets is a far easier way to grow an international operator’s capitalisation, footprint and revenues than proposition development in existing markets, where carriers toil to produce a range of services and applications designed to persuade users to spend more money each year. As core services are commoditised this becomes even more difficult, with users expecting to spend less going forward, rather than more.

Also, of course, emerging markets are often very large. A recent study by the Altimo Foundation, a non-profit affiliate of the Russian telecoms investor Altimo, found that ‘The West’, taking in Western Europe and the US – and also Australia, for purposes of cultural convenience – accounts for 40 per cent of the global mobile communications market capitalisation. The growth markets, including Latin America, CIS, Asia, Africa and Eastern Europe, makes up the remaining 60 per cent.

The value of the mobile communications market as a share of total world capitalisation is also growing, Altimo says. Valuing the industry at $2.4tn at the end of January this year, the study found that it accounted for 3.8 per cent of world capitalisation, up from 2.2 per cent five years ago. The growth, says Alexei Orlov, deputy CEO of the Altimo Foundation, is centred on the emerging markets, which he predicts will represent 70 per cent of the world’s mobile market capitalisation within three to five years.

“If we are talking about where the current capital is registered, then it’s definitely with the companies that are headquartered in the developed markets,” says Alexei Orlov. “But if we are talking about where the real value is, then it’s in the emerging markets.”

And if those markets come to be dominated by players other than today’s leading investors, then power in the global cellular operator community is going to change hands.

Altimo’s study is just one piece of research that confirms what everybody already knew – if growth is your game, then the emerging markets are where you must be playing. But for the early expansionists, progress in these markets is increasingly hampered by the burgeoning strength of specialist and regional players.

In Africa, MTN and Celtel (soon to be rebranded Zain in line with its Kuwaiti owner) are dominant. In India, the domestic players are entrenched, although Vodafone and Singtel having holdings in leading players there. In Russia and the CIS, carriers like Vimpelcom and MTS have the market effectively sewn up. And it is these players, operating in markets that are growing very quickly, that have evolved from acquisition targets for the large Westerners to their competitors in the battle for international growth.

And it’s not just about mopping up in the home regions. Indian firms, for example, have long voiced desires to spread their influence across the globe. “They’ll do in telecoms what they’ve done in steel and in the automotive industry,” says Sean Collins, chairman of KPMG’s global communications and media practice. “I’ll be surprised if we don’t see a big European or US acquisition by one of the big Indian players,” he adds.

Collins points towards the investment that companies like Bharti and fellow Indian player Reliance are making in undersea cable as an indication of the seriousness of their competitive intent. “The money they’re putting into building greater resilience in undersea cable, particularly in the Mediterranean, demonstrates, I think, that they’re really looking to challenge the global operators.”

So this isn’t simply a scenario in which current international leaders are fighting to stake a claim on new territories, it’s about them having to defend their existing positions.

Devine Kofiloto is a principal analyst at Informa Telecoms&Media: “The constellation is changing,” he says. “In the next three years you are going to see the emergence of what we might refer to as super operators. They are going to grow beyond where they currently are and who is going to be left standing will be interesting to see. It cannot be taken as a given that the Vodafones – the entities that we know today – will be there in their current form.”

But Kofiloto is talking about the future. Today, the historical leaders retain their strength. March figures from Informa’s quarterly World Cellular Investors service list the world’s ten top operator/investors by subscriber numbers. In some cases this is misleading; China Mobile has to come out on top given the size of its domestic subscriber base, although its international portfolio is negligible. But with Vodafone, Telefonica, America Movil, Deutsche Telekom and France Telecom filling out the top seven, the boat isn’t rocking too much just yet. Only the presence of Russia/CIS powerhouse MTS in the top ten hints at a possible shift.

Subscriber numbers aren’t the only useful indicator, though. When the GSM Association, which represents operators that control 80 per cent of the world’s cellular market, remodelled itself late in 2002, it established a board of the most important carriers, shifting greater power to the already powerful.

Since the board was put in place in February 2003, 13 firms have held a seat each year. The inclusion of Chinese operators Mobile and Unicom was a major nod to the emerging markets at the outset, but they were not necessarily seen as potential international investors. Egyptian headquartered Orascom has also enjoyed a permanent seat, as has Turkcell. The other permanent members, though, are the big ex-incumbents of Western Europe and developed Eastern markets (Singapore, Japan), Hutchison and Vodafone.

The remaining seats on the board are offered on rotation. But in the four reshuffles since February 2005, India’s Bharti, Smart of the Philippines, and Russia’s Vimpelcom have all been awarded and held onto seats. Pan-African player MTN joined in 2007 and this year saw the addition of Zain and MTS. Things are changing.

The strengths of specialist and regional players are various. It might be that a particular operator has a legacy of managing a business that survives on extremely low ARPU. It might be that cultural awareness, both in terms of target market and regulatory environment, plays a key role. Extremely deep pockets and access to cheap finance cannot be overlooked either. One thing seems clear, though: like their developed market counterparts before them, these players are now eyeing up the rest of the world.

Russian headquartered MTS provides service to almost 84 million subscribers in Russia and five CIS markets. The firm is focussed first on continuing growth in its domestic market, according to Dr Michael Hecker, the firm’s VP for strategy and corporate development. While Russian penetration exceeded 100 per cent some time ago, the rapidly improving macro-economic climate means that people have more money to spend every year, and they are directing that spend in part towards mobile telephony. So while subscriber numbers may not be going up, revenues are.

The secondary focus is enlarging the international footprint. And domestic growth is a crucial weapon in the firm’s expansionist armoury. “One of the fundamentals in the power shift is that we are sitting on a still powering market. Other markets are losing in terms of revenue,” says Hecker. “If you look at the German market, its value is decreasing year to year. But we’re sitting on a powerhouse due to the macroeconomic factors.”

Some observers would suggest that managing rapid growth in existing markets makes it difficult for management to effectively oversee similarly pacy international expansion. But Hecker disagrees. “Growing at home is a motivation for growing overseas, an encouragement. We believe that it is much more difficult for a company that isn’t growing any more at home to go outside and change to a different business model,” he says.

Strong growth in domestic markets, which is an attribute of most successful emerging market players, is a benefit, says Hecker’s colleague Joshua Tulgan, director of investor relations. “For a company like ours, the growth is self financing. Our debt levels are very low, we’re still able to pay a very healthy dividend and we have one of the lowest gearing ratios of any operator in the world,” he says. “Emerging market companies are very much like this. Turkcell has no debt, China Mobile has very little debt. We have the financial resources to enter other markets.”

Furthermore, he says, companies like his – with a speciality and track record in emerging markets – have a risk profile that is less likely to be affected by exposure to more of these markets. Informa’s Devine Kofiloto highlights a similar issue when he suggests that Vodafone CEO Arun Sarin was very keen to enter the Ghanaian market, but was prevented from doing so by the caution of his board.

For other new empire builders, the key financial benefit isn’t so much being self funded by growth as it is being self funded by just having access to an awful lot of money. Kuwaiti player Zain famously spent more than $6bn on a third licence for Saudi Arabia last spring, where penetration was already at more than 80 per cent. The firm’s chief communications officer, Ibrahim Adel, concedes that many observers simply saw “crazy Kuwaitis, spending crazy money”.

The strategic justification for the Saudi Arabian licence purchase – the creation of a single Middle Eastern network, free of roaming charges, a concept the firm has also introduced in Africa – is no doubt sound. The reaction to the sum paid simply reflects a very real financial relativity between markets and between investors. $6.1bn is a lot of money to any firm, but different companies draw the line of acceptability at different places.

It is precisely this relativity that secured Zain’s landmark acquisition of pan-African player Celtel. China Mobile had investigated the possibility of acquiring the company and MTN, an African competitor to Celtel, had made a bid of its own, and was working under the assumption that the $2.7bn it had laid on the table had sealed the deal. Zain simply upped the stakes by $700m and got what it wanted.

The result of such competition is that operator valuations in many emerging markets have risen steeply. This should make the industry a little wary, says Devine Kofiloto. “Against the backdrop of declining APRU, and the capex burden as these operators move out into the more remote areas, it’s really worth questioning whether or not this is a bubble,” he says. “You can only assume that they know exactly what they’re doing.”

One of Zain’s successful decisions following the Celtel purchase, according to Kofiloto, was to leave the existing management in charge of the operation; local teams for local operations. The benefits are twofold: for further expansion into emerging markets, the Celtel operational expertise was essential and, culturally, nobody from Zain HQ could have been better placed to understand the markets.

“Playing in emerging markets is more suited to operators with the right profile or with a track record of having been present in similar emerging markets, I think that really is true,” says Kofiloto. “It is definitely not for everyone.”

Michael Hecker of MTS concurs. “We don’t have big fears when we look at opportunities in low penetration areas. We know the business model, we have the experience. We understand how to make a margin out of a $2.50 ARPU; it’s part of our game, part of our history and we’re well positioned to take further steps,” he says.

For Hecker, this is the operational currency of emerging market success. “There is no longer the traditional advantage for the big players coming out of Europe that led the first expansion wave,” he says. “It’s the other way around now; we talk to targets who say ‘ok, guys, you understand our business model’.” Emerging market players are confident that their skill sets can be exported beyond their own regions. So MTS is looking at potential acquisitions in South and South East Asia as well as markets closer to home.

Zain’s Ibrahim Adel reveals that the firm is permanently engaged in acquisition simulations, where it runs the numbers for a range of theoretical manoeuvres. These might involve Orascom, say, or MTN. But consolidation among international players from the same region is unlikely, in Devine Kofiloto’s view, because of the significant overlap in these players’ footprints.

He has identified a separate trend, prevalent in Africa, which sees smaller players building a portfolio in what he calls the ‘fringe markets’. Players like Hitz, Comium, and Pakistan’s Warid are mopping up operations in smaller markets he says, such as Sierra Leone. Kofiloto sees this activity as being motivated by a future sell-off. “Standalone players in the fringe markets, aren’t that attractive. So the smaller players are going for them, and building up scale,” he says. “I don’t believe those guys are in it for the long term, they’re trying to make themselves attractive by offering the big guys to buy into a string of four or five markets with just one acquisition.”

Sean Collins of KPMG concedes that further emerging market plays are looking increasingly difficult for the big Western players. “Regional players are creating a situation which will actually make it difficult for the Western operators to step in,” he says. Especially when those regional players have funding from other wealthy nations and organisations.

“What I’m finding particularly interesting is the development of alliances. Singtel has a stake in Bharti and, with the added investment from Temasek [the Singaporean Government’s investment arm], Bharti has been given the muscle to develop in its own market.

“Saudi Telecom has been spending a lot of money. They paid £3bn for a stake in Maxis Malaysia last year. And now Maxis, which is one of the biggest companies in Malaysia these days, is making investments in Indonesia, the Philippines and other parts of South East Asia.”

Regional dominance is one thing, but many of the players achieving success in this area have inherited a thirst for true global influence from the developed market carriers that led the first wave of expansion. Bharti CEO Sunil Bharti Mittal has hinted in the past at the possibility of a move into developed markets. The ‘3x3x3’ expansion plan put in place by Zain chief Dr Saad al Barrak stipulates that the firm becomes one of the top ten global operators by 2012. Given the absence of Greenfield opportunities in markets like Europe and the US – a presence in which is essential for a global player – M&A is the only way forward.

But can these players take the game to the birthplace of cellular telephony? Sean Collins believes it will happen – eventually. “Like in many walks of life,” he says, “it’s going to take a long time to dislodge the guys with the heritage and the huge scale. But I think it will come about, it’s just a question of timing.”

Collins suggests that it will be when growth in their core markets begins to slow, that emerging market powerhouses will begin to look to the old world – a neat mirror image of the conditions that saw the original expansionists take to the seas. “If 90 per cent of the growth in the next two years is still going to be in developing markets, why would you want to invest in a low-growth economy now? But when that growth slows, they’ll be looking for the value add and, when you look at the comparative ratings, some of the European operators actually start to look fairly cheap, because they haven’t got the growth multiples built into their prices,” he says.

Devine Kofiloto also expects such moves to be made, and his money is on the Middle Eastern players. “They have deep pockets and they’re building the scale. But it’s about ambition and I think they have that. They can do it. They’re looking beyond Africa and the Middle East. They’re looking at assets in Eastern Europe. What’s to prevent them looking at assets in Western Europe should they become available? Absolutely nothing.”

The operators themselves are more circumspect. “You can’t plan these things, opportunities come along,” says Zain’s Ibrahim Adel. “But this is the main question we’re grappling with right now. The consolidation within the industry, the experiences that the European operators had will come to our part of the world. It’s starting.”

Michael Hecker, meanwhile, offers a response that is almost cryptic when asked if his firm would make a move into emerging markets: “The things you can’t think of are the things that would make an emerging market operator think of doing that. I would say it’s a remote possibility at this point.”

It seems the global macroeconomic environment combined with saturation and core revenue depletion will mean that Western European and US carriers are going to find it tricky to make any major expansion manoeuvres in the near future – although at the time of writing, France Telecom has been making noises about a move for TeliaSonera.

In markets where growth is high, and still accelerating, and headroom is plentiful, operators are in a far better position to look beyond their existing borders. And it would be unduly hasty to rule out the possibility that Europeans or Americans will one day be buying their mobile services from a firm that made its name in distant lands.

Ones to watch

Zain

Formerly the State-owned mobile carrier of Kuwait, Zain embarked on a Middle-Eastern expansion programme that was the first of three, three-year instalments that the firm believes will see it become a top-ten global operator by 2012.

Number of markets: 22

Number of Subscribers: 45.7 million (March 2008)

Financials: Net profit of $1.13bn for FY07

Source: Zain

Orascom

Headed by Egyptian billionaire Naguib Sawiris, Orascom operates in 15 markets in Africa, Asia-Pacific and the Middle East. Orascom is 50 per cent owned by Weather Investments, which is also headed by Sawaris and all but owned outright by the Sawaris family. Weather holds 100 per cent of Wind-branded operations in Greece and Italy, but these holdings are not reported along with the Orascom properties.

Number of markets: 14

Number of Subscribers: 70 million (December 2007)

Financials: Net profit of $2.02bn for FY07

Source: Orascom

Bharti Airtel

The leading player in the Indian market, Bharti’s chairman Sunil Bharti Mittal has long been voicing ambitions to expand internationally. While these aspirations have yet to be realised, the firm is widely respected for its operational expertise and enjoys significant backing from Singapore Telecom.

Number of markets: 1

Number of subscribers: 64 million (March 2008)

Financials: Net profit of $1.67bn for year to March 08.

Source: Bharti

MTS

Russia’s largest carrier, and owner of a substantial portfolio in the CIS, MTS maintains that its principal focus remains growth and consolidation in the Russian market. Yet it clearly has an eye on the expansion of its portfolio within the region and beyond.

Number of markets: 6

Number of subscribers: 84.9 million (March 2008)

Financials: Net profit of $2.07bn for FY07

Source: MTS

China Mobile

The largest mobile operator in the world, China Mobile, has unrivalled scale. Yet so far its international expansion has been limited to Pakistan (it also has a property in Hong Kong). China Mobile had a good look at acquiring emerging market specialist Millicom Cellular recently, although the move foundered. Some observers have suggested that cultural differences and management stretch may have been deal breakers. Nonetheless, the firm has enormous muscle and successful international manoeuvres may not be far off.

Number of markets: 2

Number of subscribers: 278.5 million (December 2007)

Financials: EBITDA of $27.7bn for FY07

Source: China Mobile