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Bet on MTN buying Reliance in India

Why this deal makes more sense now than it ever did….

JOHANNESBURG – It’s almost too simple. Phuthuma Nhleko, who ran the African and Middle East mobile giant for close to a decade is back in the fold, this time as chairman (replacing Cyril Ramaphosa who has his sights set on a different leadership position altogether). Days before his appointment, rumours surfaced on Bloomberg about the operator “exploring a potential acquisition in India.”

Nhleko, of course, was central in the talks to combine MTN (JSE:MTN) with first Bharti Airtel, then Reliance Communications and then Bharti again in 2008 and 2009. Current CEO Sifiso Dabengwa was also involved (he was COO at the time) and in many ways is cut from the same cloth as Nhleko. There were many reasons those deals floundered.

Chief was government’s objections (through Treasury) about the need to preserve the ‘national character’ of MTN. After all, we couldn’t have our prize ‘national’ asset disappearing overnight!

In 2009, the closest the companies ever came to a tie-up, the Bharti-MTN merger would’ve been worth $24bn. In a complex transaction, Bharti would’ve taken a 49% stake in MTN for $14bn in cash and shares, while MTN would’ve take a 36% interest in Bharti for around $10bn.

In many ways, this wasn’t to be a merger of equals. Bharti had the upper hand.

A lot has changed since the months following the Lehman Brothers collapse.

A year after the collapse of the MTN deal, and days before the FIFA World Cup kicked off, Bharti bought Kuwait-based Zain’s African operations for $9bn. Bharti boss Sunil Mittal called the deal “a second chance, a better chance” [than MTN]. You can bet that didn’t go down well at MTN.

The Zain deal gave Bharti a much larger presence across the continent, adding operations in Burkina Faso, Chad, the DRC, Gabon, Ghana, Kenya, Madagascar, Malawi, Niger, Nigeria, Sierra Leone, Tanzania, Uganda and Zambia.

Today, it competes head-to-head with MTN in six countries in Africa (Congo, Ghana, Nigeria, Rwanda, Uganda and Zambia).

So, there’s no way MTN and Bharti could even contemplate a deal. This is why the rumours about a Reliance Communications tie-up make so much sense. There’s no overlap. That, and the fact that telecom empires revolve around egos. You can be sure Reliance boss Anil Ambani isn’t content with second-place. The pesky dispute between the Ambani brothers which foiled the talks in 2008 seems to be settled.

But there’s a far bigger reason why any deal might make far more sense today than five years ago: economics.

Reliance Communications (traded on the Bombay Stock Exchange) is valued at 232bn rupees, or around R40bn. And MTN? R327bn. Guess who’d be acquiring who? (And I doubt Treasury would be complaining about MTN diluting or disappearing from view, in fact, this would probably be spun as some ‘defining’ deal in the BRICS). (As an aside, Bharti is valued at R210bn.)

Also, it’s the third-largest operator in India (after Vodafone and Bharti). MTN doesn’t buy upstarts or operators down the foodchain. Number one or two or three. And remember that in April (just two months ago), Dabengwa said MTN could spend up to $8bn on an acquisition.

I’m not going to get into valuations or what this would mean for MTN’s dividend. There are far smarter and better-paid people than me who would be advising both sides. My hunch would be a purchase or a majority stake (>51%), with that amount increasing over time. At R20bn-R25bn (with a premium), it’d easily be palatable to MTN (and its shareholders) and probably won’t put the dividend at risk.

That’s not to say the Indian market is easy. It’s unforgiving. There are more than a dozen operators, some with only regional presences. Tariffs are low, and likely to continue trending downward. But Vodafone’s finding increasing success in that country – in the 2013 financial year, service revenue grew 10.7% and the EBITDA margin has crept up to almost 30%.

If there’s one thing MTN knows well, that’s operating in true emerging markets. Frontier-type stuff. Warzones. Starting from scratch. Give it 18 or 24 months running the Reliance business in India, and I’m willing to wager that even the sceptics will be surprised. Beyond just operational efficiencies, the opportunities in India are truly immense. It would surely be able to address the recent subscriber growth trends (not exactly positive), and arrest the declining ARPU in that market. Plus it would give MTN the growth it craves.

There’s another clue too. The head of MTN’s South Africa business Karel Pienaar (effectively employee number one at the operator) shifted to the group-wide chief strategy officer role last month. This precipitated the separation of its mergers & acquisitions and strategy functions. Khumo Shuenyane now has only the M&A responsibility. What would MTN do this if Shuenyane didn’t have a full plate? One wonders how many frequent flyer miles he’s racked up in the past few months…

Beyond the appeal of the world’s second largest mobile market, there’s one final reason why MTN wants Reliance. It needs to become big enough to not be a takeout target. Don’t think companies like Vodafone (it’s not like Vodafone is married to Vodacom (JSE:VOD) forever), América Móvil, Telefónica and any number of Chinese operators aren’t doing the sums. Mobile operators work at scale: the bigger, the better.

MTN will cross the 200m subscriber mark this month. With Reliance’s 122m subscribers (as at March 31), it would comfortably exceed 300m subscribers. That would make it the third biggest in the world (behind China Mobile and Vodfone) and definitely out of reach.

It would also put MTN around 50m subscribers ahead of Bharti.

Don’t for a second think that this isn’t occupying the minds of Dabengwa and Nhleko.

* Hilton Tarrant contributes to ‘Broadband’, a column on Moneyweb covering the ICT sector in South Africa. All that remains is for him to figure out how an investor could profit from a deal in India…


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