On March 1, Vivendi reported 2009 results in line with the group’s expectations. Vivendi revenues were up 6.9% at €27.1 billion and its EBITDA up by 8.8% YoY at €5.3 billion. Although most activities but Universal witnessed revenue growth, the EBITDA growth was another story; Activision and Maroc Telecom (MT) were the only units to report an increase. Moreover, MT’s share of the group EBITDA was resilient in 2009 despite a challenging economic environment. These results confirm and reinforce Vivendi’s emerging market investment strategy.  Some takeaways:

Maroc Telecom from mere subsidiary to crown jewel

- MT reported revenues up by 3% YoY on a comparable basis and a 1.6% increase in EBITDA. By contrast, Vivendi’s other major telco operation, SFR, reported a 7.5% growth in revenues but a disappointing 0.5% decrease in EBITDA. MT’s share of group EBITDA dropped by 4 percentage points in 2009 to 23% while SFR’s contribution dropped from 57% to 46%. MT’s contribution to group revenue remained stable at around 12%. Most importantly, MT remains Vivendi’s most profitable telecom operation with EBITDA margins at 46% while SFR barely reached the 20%.   

- Vivendi expects Maroc Telecom to be a driver of growth in 2010 thanks in part to African subsidiaries.  In 2009, 57% of group mobile subscribers net additions were acquired across MT’s African operations, up from 50% in 2008.

Outlining African Investment Criteria

- Vivendi has invested nearly €550 million in acquisition across sub-Saharan Africa over the past three years. The group’s four African operations (Gabon, Burkina Faso, Mauritanie and Mali) generated an EBITDA of €83 million in 2009, up 186% from 2008. This performance has likely whetted the company’s appetite for more African acquisitions, as evidenced by a flirtation with Zain’s African assets last year, but in a context of rising African asset prices. In 2006, the median African mobile operator valuation was around 6.3x EBITDA according to our Mobile Profitability report. Two years later, that median had reached around 9x EBITDA. Bharti valued Zain at around 8x EBITDA in February 2010.

In its annual results statement, Vivendi’s board laid out key guidelines for further investments in emerging markets:  

• “Seize external growth opportunities with a focus on fast-growing regions / businesses, assessed under a selective, rigorous and financially disciplined process
• Focus on media and telecom subscription-based business models
• Profitable assets with strong growth prospects
• ROCE to exceed local risk adjusted WACC within 3 to 5 years
• EPS accretive in the short term”

On February 13, Zain’s board accepted a $10.7bn offer for its African assets from India’s leading carrier Bharti, including $1.7bn in debt. The deal is expected to close within a month, the time for Bharti to close out the financing of the transaction; at first blush, this appears to be that rare transaction that works for all parties, though perhaps not as well for Bharti’s shareholders. (Please click title – Full Analysis in PDF available at www.africanext.com)

The price: the price point is at the higher end of the $7-$9bn equity valuation we had estimated for Zain’s African assets (see “How Much is Zain Africa Worth?” an AfricaNext Research Investor Note – September 2009). It values the equity of Zain’s African operations at about 7.5x projected 2009 EBITDA, a relatively rich valuation in the current African context (public pan-African carriers currently trade at 3.5x-4.5x forward EBITDA), but hardly excessive within the historical context of similar transactions.

For Zain, it’s a good sale price for a set of operations in which the Kuwaiti company had sunk around $6-$7bn over the past five years, with a nearly non-existent dividend stream. It’s a price that allows Zain to realize a profit through capital gains that would have been hard to come through dividend upstreaming alone, on a business that was dragging down its earnings. Zain will be able to pay down debt and focus capital expenditure on more profitable Middle Eastern markets. Removing Sudan from the equation was the icing on the cake, making the deal the ultimate no-brainer.   

By our estimates, Zain realized a non-weighted return of at least 30%-40% on its African investments, potentially more depending on the structure of individual capital transactions and depending on assumptions for management fees and equity contributions to CapEx.

What is Bharti getting for its money? Our analysis in a June 2009 Investor Note is still relevant:

 “The fact that Zain would even consider selling its Africa business points to heightened concerns about the deterioration of fundamentals in African mobile markets. Competition has intensified, taxation levels have risen as tax holidays have expired, the markets are as capital-intensive as ever (at a time Zain is seeking to cut CapEx levels by half) and African currencies have plunged against the dollar. […] Excluding Sudan, Zain’s African operations accounted for about 65% of the group’s subscriber base, 56% of its revenue and 50% of its EBITDA in 2008. Perhaps more significantly, they take up more than 75% of capital expenditures, yet only account for 15% of the group’s net income. Zain’s net income rose 6% in 2008; excluding Africa, net income rose 34%. For all the lofty subscriber numbers, African operations are arguably a drag on the entire group, at least for now. “

 Please download full analysis in PDF format at www.africanext.com.

Following initial reports that Middle Eastern Group Zain had put its African operations up for sale, the company has now indicated that it was in preliminary talks with three potential buyers, including two Indian companies. In a previous Investor Note, we posited that Zain had good cause for selling its African operations. With an initial (and in our view, on the high side) valuation of $12bn floated around, the central, ultimate question now centers around the fair value of the Zain Africa business (excluding Sudan and Morocco, which would not be part of the deal). We add our own rather speculative grist to this mill, and find valuing Zain Africa somewhat of a Gordian knot.

Will investors value the African unit on the basis of what it has been, a highly profitable first tier pan-African operation? Or will they put more weight on company performance over the past 18 months, which offers some hints of vulnerability in a market whose catalysts of profitability are rapidly mutating? In the answers to these questions lie the variation between a valuation at $6bn and a valuation closer to $10bn.

 In a new AfricaNext Investor Research Note, we argue that Zain Africa has to be valued conservatively, as an operation with good upside, which faces significant internal and external challenges going forward. We estimate Zain Africa’s enterprise value at about 5x-7x 2008EBITDA, a range of $7bn to about $10bn, including a premium for extensive pan-African coverage. We also say that Zain should either sell the entire Africa unit as a whole, or not at all.

 The full Research Note is available in the Member-Only section of our web site (subscription is easy and free, but required).

Reports emanating from the Middle East suggest that Middle Eastern Group Zain has put its African operations up for sale (excluding Sudan). Kuwaiti newspapers Al Qabas and Al Watan have reported that the process is at a preliminary stage, with Zain receiving substantial interest from a variety of potential investors. Other reports point to discussions with a “French company”, for a deal that could be worth “up to $12bn”.

Consider us mildly surprised by this news.

1. The sale of Zain’s African operations would go against Zain’s oft-stated ambition of becoming a top 10 telecoms company in the world by 2011, with $6bn in EBITDA and a customer base of 110m. Over the past two years, Zain has implemented a number of initiatives to leverage its scale in the African market, from its “One Network” initiative spanning 19 countries to an ongoing operational restructuring dubbed “Drive 2011”. Late last year, Zain also indicated that it remained on the prowl for potential acquisitions or greenfield licenses in the African market.

2. Zain’s African operations are typically well positioned; the company is a market leader or a number 2 in most of its African markets. It has the widest coverage footprint in population terms among all pan-African operators, and is present in markets that, by our estimates, will generate the bulk of incremental cumulative mobile revenues over the next five years. Its subscriber base in sub-Saharan Africa rose 50% in 2008, and revenue rose 30% in 2008. Some operations have performed well (Zambia, Niger, Gabon), while others continue to struggle with the twin combination of economic downturn and intense competition complicating their ability to get better (Kenya, DRC).

3. Ultimately, the fact that Zain would even consider selling its Africa business points to heightened concerns about the deterioration of fundamentals in African mobile markets. Competition has intensified, taxation levels have risen as tax holidays have expired, the markets are as capital-intensive as ever (at a time Zain is seeking to cut CapEx levels by half) and African currencies have plunged against the dollar. By contrast, Zain’s Middle Eastern operations have become more profitable, but require more capital.

4. Excluding Sudan, Zain’s African operations accounted for about 65% of the group’s subscriber base, 56% of its revenue and 50% of its EBITDA in 2008. Perhaps more significantly, they take up more than 75% of capital expenditures, yet only account for 15% of the group’s net income. Zain’s net income rose 6% in 2008; excluding Africa, net income rose 34%. For all the lofty subscriber numbers, African operations are arguably a drag on the entire group, at least for now.

5. Selling may be strategically questionable over the long term; some operations (e.g. Nigeria) are bound to perform better. In the short term, however, and assuming a good price (and $12bn would be good), selling would help pay high short term debt and maximizes returns by re-allocating capital spend to higher-profit Middle Eastern and North African operations. Questionable though this move may be in some respects, we would certainly understand it.