Induvidual Assignment Submission Form

Course Name: Merger and Acquisition

Assignment Title: Bhart Zain merger

Submitted by: Sahil Kapoor

Roll no Gnov09ibwm026

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_________________________________________________________________________________

Signature: sd/- Date: Sept 2, 2010

Introduction

This agreement is a landmark for global telecom industry and game changer for Bharti

Sunil Mittal

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*:

Deal Structure

Acquirer Bharti Airtel Limited

Seller Mobile Telecommunications Company KSC

Target Zain Africa International BV

Consideration USD 10.7 billion

Mode of Payment Cash – 9 billion , ZAF Debt – 1.7 billion

Mode of acquisition Security (Share) Sale

May 5, 2008 BAL approaches MTN

May 24, 2008 Discussions discontinued due deal structuring issues

May 25, 2009 Renewed potential merger discussion

July 31, 2009 First deadline for exclusivity talks period ends

August 3, 2009 Extended till August 31 due to issues regarding deal pricing

August20, 2009 Deadline extended till September 30 due to issue dual listing

September30,2009 Talks called off

February 14, 2010 Zain announces board meeting to discuss potential merger

February 15, 2010 BAL gets into exclusive talks with Zain for acquiring its 15 country African operations

March 21, 2010 Bharti Airtel says has tied up $8.3 billion from a clutch of foreign banks and State Bank of India to fund the acquisition of Zain telecom's African assets

March 25, 2010 BAL announces definite merger as it completes due diligence

March 30, 2010 Bharti Airtel signs deal to buy African assets of Kuwait-based Zain Telecom for $10.7 billion.

Bharti Airtel Ltd ( henceforth referred as BAL) finally managed to the enter the African telecom market after it managed to acquire Zain’s African operation (henceforth referred as ZAF) including Sudan and Morocco for a whooping 10.7 Billion (total enterprise value). This is the second largest Indian acquisition after the Tata Corus deal and the largest in the Indian telecom sector making BAL as the sixth largest telecom provider in the world. This was BAL third attempt to enter into the African market after its earlier attempts to strike a merger with South Africa’s MTN failed, ironically MTN will be its main competitor in the African markets.BAL will expand its operation in 15 African countries by Oct 2010.

Chronology of BAL ticket to the African Safari

Bharti Airtel India

Singapore SPV

Bharti Airtel Netherland BV Bharti Airtel India

Zain Africa International BV Operation in 15 countries

Company Profile

Bharti Airtel

BAL, the flagship company of the Bharti Group was incorporated on July 7, 1995 and since it has grown to be the largest integrated telecom service provider. It commands a market share of 24% in the Indian Telecom sector and has its presence in all the 23 telecom circles. It’s has been a pioneer in the Indian telecom industry providing world class products and services. The shares of the company are listed on NSE (national stock exchange) and the BSE (Bombay Stock exchange).BAL also has the License to operate in Sri Lanka and Seychelles. It a Dhaka based Warid Telecom for 300 million

The operation are Sub divided into 3 SBU (Strategic Business Units)

Mobile Services – Provides GSM services in all the telecom circles and has the largest customer base in India

Airtel Telemedia services – Broadband and telephone service in 94 cities

Enterprise services –End-to-end telecom solutions to corporate customers and national & international long distance services to carriers

BAL also offers DTH and IPTV services. All these services are rendered under the brand name of “Airtel”

Zain

Zain established in 1983 was Kuwait’s first mobile operator. Provides Mobile telecommunication and data services, including purchase, delivery, operation, Installation, management and maintenance of mobile telephone and paging system in Kuwait and 21 other countries in the middle east and North Africa. Mobile Telecommunication company lebanon(MTC) SARL, Lebanon and Sudanese Mobile Telephone (Zain) Company Limited, Sudan are its wholly owned Subsidiary. The proposed merger reflects a shift in the company’s strategy which earlier targeted to be one of the top ten telecom operators in the world with more than 150 million customers.

($mm) CY06 CY07 CY08 9m,CY09Revenue 2,486 3,164 4,160 2,732EBITDA 1,055 1,129 1,397 870PAT 330 374 122 -112Capex 1,136 1,519 1,882 844Subs 16,871 26,818 41,018 42,190

Margins %EBITDA 42.4 35.7 33.6 31.8PAT 13.3 11.8 2.9 -4.1

Growth %Revenue 27.3 31.5 -12.4EBITDA 7.1 23.7 -17PAT 13 -67.3 -221.8

Zain Africa

Zain International BV, incorporated in Netherlands, is a wholly owned subsidiary of Zain. It holds its African operation and was acquired by Zain in 2005

Subs 59 52.9 3

Indian Telecom Sector

India continues to be the most sought after destination for the telecom sector. It set a new world record in Jan 2010 by adding 19.9 million new subscribers. This is equal to 1.5 times the annual subscribers added in the US. In the year 2009 India continues to outpace China by adding 177 million subscribers’ vs 106 million in China.

Growth opportunities in the rural India are huge. The ARPU for data service in India is extremely lo at $ 0.5 cents compared to China (data ARPU is 32%) and other developed markets. The nest spurt of growth is expected from rural India and the data segment. The 3 G services are also at a nascent state in India and will provide good growth opportunity.

BAL holds a dominant position in the Indian telecom market and has a strong hold in rural region but is now facing stiff competition from new and existing players. The Industry is becoming extremely competitive. The recent price war among the players has adversely effected the margins of the telecom players. They have underperformed the broader market.

The competitive landscape of the Indian market leading to declining profitability, it’s already large market share has forced it to look out for higher growth regions like Africa.

Rationale for the Acquisition

Geographical Diversification

Indian telecom market has become highly competitive with 13 service providers battling out for a chunk of the revenue. BAL will experience a number of speed breakers along its growth path in India. The Indian telecom sector seems to have reached its saturation point with scope of expansion left only in the inner part of rural India.BAL is a core telecom company and will engage in product diversification leaving geographic expansion as the only strategic alternative to counter slowing profit growth in India.

The Lure of Africa

Africa is where the next destination which will experience a revolution in the telecom Sector. Factors which make Africa the hottest destination are

Favourable Demographic

Aggregate population of 470m .The African population is expected to double to 2 billion people outpacing India and China which are expected to grow to 1.6 billion and 1.4 billion respectively

The median age is 17-18 compared to the Indian median age of around 25-26.It is forecasted that 25% of the world youth will reside in Africa.

Spending Power

Consumer spending potential is estimated to be around $1.4 trillion. The GDP is growing at rate of more than 5% in 27 of the top 30 economies in Africa. Social ad Democratic reforms are further cementing the growth potential of the continent

Huge potential

Also the industry teledensity is only 20% with some countries as low 10-12%, BAL managements expects to grow this to around 60%.

MoU at 50 – 60 min vs Global average of 300 min and Indian Average of 450 min but ARPU (Average revenue per unit) is higher than India (7 US cents vs 1 US cents). MOU elasticity has played out in BAL current existing markets like India and Seychelles.

Low competition, only 4 or less telecom operators in 12 countries (out of the 15 countries in ZAF operation).

Strong market position of ZAF, it is the biggest operator in 10 countries, the second largest in the remaining 4 out of the 5 operators. An opportunity to increase it’s presence in Africa by venturing into other markets using ZAF’s exiting infrastructure.

ZAF African Operation

Country Stake (%)

Sub (Mn)

Mkt Share(%)

Total Mkt (Mn)

Pop (Mn)

GDP/Capita ($ PPP)

Penetration (%)

Peers Rank ARPU (US$)

Burkin Faso 100.0 1.4 51 2.8 15.8 1,259 23 2 1 7

Chad 100.0 1.2 70 1.7 11.5 1,670 19 1 1 10

Congo 90.0 1.4 53 2.7 4.0 4,044 75 2 1 12

DRC 98.5 3.6 45 7.9 67.5 340 14 4 1 8

Gabon 90.0 0.9 62 1.4 1.4 14,747 123 2 1 25

Ghana 75.0 1.2 9 13.4 24.5 1,513 61 4 4 3

Kenya 95.0 2.2 17 12.9 39.9 1,735 48 3 2 4

Magadscar 100.0 1.4 38 3.8 20.9 995 23 2 2 5

Malawi 100.0 1.7 72 2.4 14.8 850 17 1 1 8

Niger 90.0 1.4 67 2.1 15.4 691 16 4 1 10

Nigeria 65.7 14.9 25 59.7 155.8 2,142 45 3 2 7

Sierra Leone

100.0 0.6 46 1.2 6.1 6,095 39 3 1 7

Tanzania 60.0 4.8 39 12.2 45.8 1,352 33 3 1 5

Uganda 100.0 2.2 37 6.1 33.3 1,148 35 3 2 4

Zambia 78.9 2.9 70 4.2 12.5 1,397 33 2 1 8

Country Competition

rkin Faso Telemob (35%; Moov (14%)

Chad Tigo 30%

Congo MTN (40%); Warid (7%)

DRC Vodacom (30%); Tigo (14%);CCT (11%)

Gabon Libertis (22%); Moov (16%)

Kenya Safaricom (78%); Orance (4%);Yu (1%)

Magadscar Orange (40%); Telma (22%)

Malawi TNM (28%)

Niger Orange (14%); Moov (13%);

Nigeria MTN (45%); Glomobile (19%);

Sierra Leone Africell (34%); Comium (15%);

Tanzania Vodacom (33%); Tigo (23%);

Uganda MTN (50%); UTL (8%);

Zambia MTN (23%) and Zamtel (7%)

Headroom to implement its successful low cost high usage model

African markets BAL the opportunity to leverage its management which has the expertise to operate effectively in Indian markets characterised by low income, low tariffs (but high margins) and a large rural population – these characteristic are shared by the African markets.BAL should be successful in scaling its business model in Africa as efficient telecom business models are highly scale able. Vodafone has displayed this India.

Replicating BAL’s “Match Box” strategy. A distribution model which ensures that Sim cards and recharge voucher are available in every possible store. Such a distribution mechanism is unheard of in Africa but if successfully replicated it could boast sales for BAL.

Operational synergies can be obtained by rationalizing operation and capital by implementing BAL’s outsourcing strategy. BAL has outsourced it entire network to IBM.

Passive sharing on the same lines as that of Bharti Infratel/Indus

Valuation

Expensive at Prime facie

BAL acquired ZAF at an enterprise value of USD 10.7 Billion which is at an EV/EBITDA of 9.8x making it one of the most expensive valuation for a emerging market telecom player.USD 8.3 billion will be paid in cash three months after the deal closes and the remaining 700 million will be paid one year after the closure of te deal.BAL will assume debt of 1.7 billion on the books of ZAF. The valuation looks extremely expensive when you take in account the BAL was quoting at an EV to EBITDA of 7.2 times and it paid an EV to EBITDA of 9.8x for ZAF. The price appears ridiculously high if we consider that seven units are loss making. The cumulative losses in these segment till CY03 are $ 248 million offsetting the profits from the other segments. Nigeria poses a great threat as its a large revenue earner but the current operati[Type a quote from the document or the summary of an interesting point. You can position the text box anywhere in the document. Use the Text Box Tools tab to change the formatting of the pull quote text box.]

on are not profitable , a possible turnaround will be difficult as ZAF is not the market leader in this region. The huge incurred for the acquisition will increase the financial risk of the company and servicing this debt will reduce it profits.BAL will also be exposed to foreign currency risk as capex expenditure will be incurred in dollars but revenues will be earned in the local currency. The African region is marred with political instability, high Inflation and volatile currency

($mm) Full Value Adj for MICY08 CY09E* CY08 CY09E*

Enterprise value

10,700 10,700 10,700 10,700

EBITDA 1,397 1,159 1,087 923EV/EBITDA 7.7 9.2 9.8 11.6Revenue 4,160 3,643 3,310 2,936EV/Sales 2.6 2.9 3.2 3.6Subscribers ('000)

41,018 42,190 32,416 33,742

EV/Subscriber 261 254 330 317

A gamble worth taking

A few important consideration before using the EV multiple to pass a judgement on the deal

Start up operation such as Ghana have negative EBITDA which distort the EV/EBITDA to some extent

The African operation deserve a higher multiple as the effective tax rate in Africa is less

The valuation should take into account the control premium

ZAF has made cumulative capital investment to the tune of US$ 9 bn.BAL will require a capital expenditure of only 800 million to kick start its operation in the highly densely populated in Africa region

EV to subscriber multiple

Looking at the EV per subscriber multiple the deal looks fairly valued if compared to some deals in the past. Tata Tele acquisition by DoCoMo and Vodafone in Hutch Essar were at similar valuation

.

The huge reported losses may be misleading as the financial crises lead to significant devaluation of the African currency as the African economy is highly dependent on crude and remittance. The sharp currency devaluation contributed majorly to the revenues declining by 12.6% and the company reporting a negative PAT but with the global economy showing signs of revival we can expect stable currency. Performance in the previous years has been exceptional. The company reported a revenue growth of 86% and maintained an EBITDA margin of 35% in CY07-08.

Revenue local Currency (mm) Growth %CY06 CY07 CY08 CY09* CY07 CY08 CY09*

Burkin Faso 31,998 48,167 57,668 57,130 51 20 -1Chad 34,194 43,853 55,605 63,401 28 27 14Congo 66,683 117,387 127,529 164,786 76 9 29DRC 117,660 164,830 213,125 261,751 40 29 23Gabon 86,060 111,718 122,286 120,217 30 9 -2Ghana 0 0 14 66 N/A N/A 370Kenya 12,560 13,077 11,232 12,097 4 -14 8Magadscar 77,113 93,078 141,491 149,104 21 52 5Malawi 5,737 9,954 17,917 20,950 73 80 17Niger 31,946 44,332 57,937 71,052 39 31 23Nigeria 78,367 147,308 195,684 196,329 88 33 0Sierra 131,058 129,213 143,398 150,342 -1 11 5Tanzania 1,283 1,541 1,564 1,081 20 1 -31Uganda 72,863 157,576 235,684 206,356 116 50 -12Zambia 682,792 1,007,116 1,327,276 1,431,215 47 32 8

Country Currency Devaluation

BurkinFaso

-5

Chad -5Congo -31DRC -31Gabon -5Ghana -24Kenya -10Magadscar -13Malawi -Niger -5Nigeria -20Sierra -12Tanzania 22Uganda -15Zambia -26

The deal will be fully financed by debt which will improve the capital structure of BAL. Unlike other Telcos BAL is comparatively under levered and has a net debt- equity ratio of 0.11x compared to the global average of 0,44 x this has helped BAL borrow at a cheap rate. The deal has been structured as an LBO .BAL has created 2 SPV at Singapore and Netherland. The cost of debt is Libor+195 bp which will result in a annual interest cost of USD 200 million. The company can also further leverage the African operation which also acts a hedge against currency fluctuation. The company has given guidance that it will be able to pay up most of its debt by FY 16/17 backed by its strong FCFF generating capacity and the deal will be EPS accretive by FY13

Considering the growth opportunities and huge scale presented the acquisition may be slightly expensive but will prove beneficial in the long run and will increase shareholder value.

($mm) FY11E FY12E FY13E FY14ERevenues 9,082 10,223 11,208 12,148EBITDA 3,683 4,097 4,529 5,008PAT 2,101 2,411 2,834 2,849EPS 24.9 28.6 33.6 33.8PAT 178 277 310 347Interest 642 514 385 257Interest 514 411 308 205Adjusted 1,765 2,277 2,835 2,991Adjusted 20.9 27 33.6 35.5O/s Shares 3,796 3,796 3,796 3,796Accretion/(dilution) %

-16 -6 0 5

Market Reaction

The market reaction to the acquisition was not positive and BAL’s stock corrected by 11% post the announcement as the deal was considered expensive and the market was sceptical if BAL will be able to turn around a loss making company but as more clarity emerged on the deal structure the market has bee divided.

CRISIL placed a rating watch with negative implication on BAL long term debt on Feb 19 2010. The debt being financed by debt will affect the gearing ratio adversely increasing the financial risk of the company. CRISIL also believes that the deal is good in hte long term as it will improve the business profile due to

the diversification of revenues.

Post Merger Integration and Challenges

Bal has a fully staffed integration team. They have already made changes in the existing management and a few Africans have been bought to work in India to understand the operation of BAL and scale at which they operate. Nairobi has been designated at the Head quarter and around 40 to 50 people from India have been moved to Africa.BAL is mainly encouraging local talent.

BAL wants to go for Re branding in October but before that they working to improve the quality of their network as well as their service and distribution. They are keen to replicate their low cost high usage model, ”Match box” (distribution strategy) and outsourcing strategy in the existing countries before they plan to leverage their existing African asset to expand further in the region. Initially they want to concentrate on higher income and commercial areas , they want to increase penetration in these areas.

BAL realises that the opportunity in Africa is huge and is even greater than that in India. They are viewing the African assets in an independent fashion.

There will significant amount of challenges BAL will face in order to achieve successful post merger Integration

Firstly handling 15 regulatory will be a challenge. Addressing cultural misfits in a cross border deals is of paramount importance. Failed

negotiation with MTN can attributed to some extent to cultural misfit between the two parties. Language barriers will cause be a major road block as they replicate their “Match Box” Strategy and increase penetration through the masses.

Macroeconomic environment is not exactly welcoming for business, the continent has faced political instability and corruption and high crime rate. Theft of equipment and inadequate electricity would slowdown the operations.

Competition in Africa will only grow as it is the most sought out destination for companies chasing growth

Interacting and managing local talent will something new and challenging for the BAL management

Zain Nigeria may cause legal hassle for Bal as Econet a major telecom player in Nigeria claims that it has the first right of refusal was breached when V mobile was sold to Zain in 2006.A legal battle is on in the UK court. Nigeria is one of the highest revenue grosser in ZAF operation

Conclusion

BAL cross border acquisition of ZAF has made it one of the top global players in the telecom industry. Though the acquisition was not cheap and the stock price corrected post the merger announcement there is huge potential in Africa and if BAL is able to leverage it management team capability and experience to replicate its successful business model in Africa the deal will be able to create shareholder value in the long run. Cross border acquisition was also the best strategy for BAL

to counter the hyper competition India. It also provides it the much needed diversification in revenues. The funding of the deal is strategically done through an LBO providing BAL the levy to consolidate it operation in rural India and in the 3G space. Though the potential is huge the road ahead is not easy BAL will have to turn around the ZAF’s current loss making operations and grow at the rate of 22 to 25% to justify the valuation behind the deal. Given the cultural differences, challenging macro and business environment the turnaround will no be easy for the BAL management.

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