The Arab uprisings have become a convenient scapegoat for regional economic projects that struggle to get off the ground. When UAE telecom major Emirates Telecommunications Company (Etisalat) pulled out of its $11.7bn bid for a controlling stake in Kuwait-based group Zain in March, it came as no surprise that the regional unrest was cited as a key contributing factor.

Political unrest has clearly had a hand in stalling merger deals across the Middle East and North Africa. According to consultants Booz & Co, deals involving regional operators raised $7.7bn in the first quarter of 2011. It underscores the potential for a revival of the sector’s merger and acquisition (M&A) activity after three dismal years.

In 2009, announced deals amounted to $1.2bn. The following year, it slumped to $100m as companies yielded to shareholder pressure for more risk-averse approaches to weathering the economic downturn.

Few deals

The early indications suggest the region’s telecoms sector may be preparing to pick up where it left off in 2008. Inorganic growth is propelling ambitious operators such as Etisalat to position themselves for expansion into some of the region’s strongest growth markets.

So far, the first-quarter spike in deals has not been followed up by a flood of acquisition activity. The impressive $7.7bn that was raised was part of one large deal. Russia’s VimpelCom merged with Egypt’s Wind Telecom in a $6.5bn deal. The buyout created the world’s sixth-largest telecom group.

The only other significant deal announced this year was the joint Bahraini/Saudi Arabian Batelco-Kingdom Holding Company bid for a 25 per cent stake in Zain Saudi Arabia. The deal is expected to be worth about $950m-$1.2bn when finalised in mid-September.

“Regional developments will create some pause in M&A activity because shareholders want to see how things develop”

Karim Sabbagh, senior partner, Booz & Co

“There’s a need for operators to start consolidating, but while the intent is there, the conditions haven’t been permissive of major deals,” says Nadine Ghobrial, telecoms analyst at Cairo-based EFG Hermes. The Arab uprising is one factor undermining buyers’ willingness to invest in the M&A market. Telecom firms based in the epicentre of the uprising have seen huge losses. Telecom Egypt saw its net profit decline by 10.2 per cent to £E1.7bn ($284m) in the first half of 2011. Syria, shaken by anti-regime protests and a violent government crackdown, has postponed an auction of mobile licenses originally set for 27 April.

Against this turbulent backdrop, it is perhaps not surprising that firms such as Etisalat have had second thoughts about proceeding with acquisitions.

There are different dynamics at play beyond political uncertainty. “Some of the developments in the region are going to create some pause in M&A activity simply because shareholders may want to wait and see how things develop,” says Karim Sabbagh, a senior partner with Booz & Co in the Middle East.

Equally important is an ongoing effort by all telecoms firms in the region to make sure they fully leverage their portfolios and make the best use of their existing assets, before they pursue new ones. There is little sense in rushing into deals unprepared. “When you’ve been on an acquisition path for a number of years, it’s perfectly reasonable to focus for a short period of time on your existing assets before you move onto another set of M&A opportunities,” says Sabbagh.

Though mergers remain on the agenda of the more financially powerful mobile operators, the problem for many is finding a suitable match. According to Ghobrial, there are still substantial challenges in finding suitably sized operators to merge with.

“I don’t see any more deals in the Mena region until the end of the year,” says Ghobrial. “With local markets maturing and a high utilisation of regional voice markets, operators will still be looking to consolidate, pending more favorable circumstances.”

Smaller acquisitions

The fundamental drivers for inorganic growth strategies are compelling. The telecoms industry remains highly fragmented compared to other industries. The largest operators earn a far smaller percentage of total industry revenue than peers in other industries do, says Booz & Co, in a new report on Mena telecoms mergers. The report suggests that the sector is primed for further consolidation.

Operators have limited choices other than to acquire smaller players as they resume their search for growth following the economic downturn. They will face mounting competition and slowing growth in domestic markets.

With a limited number of new licenses being made available, mergers and takeovers represent the best way for companies to expand.

Many markets demonstrate penetration levels that exceed 100 per cent in mobile and more than 50 per cent in broadband. Offering new licenses is not the best way to serve these markets. “Given the state of maturity of the industry, the likelihood of new licenses being offered is going to be much smaller,” says Sabbagh. “Even if they are offered, their relevance and value is not going to resonate in the way we’ve seen in previous years.”

Fully saturated

In some of the smaller Mena markets, saturation point has been reached. Newcomers would struggle to deliver strong returns in a market where competition has intensified.

In Palestine, a 4.2 million population market, the two incumbent operators Paltel and Wataniya Telecom retain a vice-like hold on the cellular market. “Palestine is good with two operators,” says Wataniya CEO Bassam Hannoun. “If I was a third operator coming in, I would probably hesitate to enter the market as it’s small and I’m not sure if there is room for a third operator.”

Any operator looking to penetrate a potentially lucrative market like Palestine would be forced into buying one of the existing players - a potentially tricky and expensive strategy.

Even viable single-market M&A opportunities are diminishing, notes Booz & Co, as operators compete fiercely to stall rivals on attractive deals. National consolidation plays may nonetheless outpace the more ambitious cross-border transactions, since merging operations within the same market is easier. There are also advantages to staying within borders, from enabling operators to boost subscriber levels to building up market share.

National markets also offer opportunities to expand beyond mobile, providing access to lucrative relative market segments. When Etisalat Misr, the Egyptian unit of Etislat, acquired internet firms Nile Online, EgyNet, Soficom and Internet Egypt in 2008, it cemented its presence in the broadband sector.

Consolidation within national boundaries still presents challenges for potential acquirers. It can affect competitiveness and be regarded unfavourably by regulators.

“When Telecom Egypt [TE] was interested in getting a fourth mobile licence, we anticipated it would create a lot of regulatory problems and negative reaction from its competitors, given TE’s existing stake in Vodafone Egypt,” says Ghobrial.

More power and infrastructure sharing may become dominant within Mena telecoms, given its popularity in Asia.

“This entails cost reductions that will be beneficial for operators’ margins,” says Ghobrial. “Such an initiative has already been introduced in the UAE, with talks of tower sharing between Mobily and STC [Saudi Telecommunications Company] in Saudi Arabia.”

Despite the attractiveness of national consolidation, Booz & Co anticipates that the majority of M&As will be cross-market deals. Here, major telecom firms will acquire controlling stakes in companies involved in many markets.

Cross-border megadeals enable operators to reinforce their presence in their operating regions, or augment their business by entering new markets.

Large multi-market transactions also allow operators to enter into multiple markets at a single stroke, says Booz & Co. This will hence eliminate the complexity, cost, and time lag entailed in identifying and completing multiple transactions.

India-based Bharti Airtel’s $10.7bn acquisition of Zain’s African operations in 2010 is a case in point. Overnight, the firm morphed into a key regional player able to leverage a low-cost operating model from India to similar markets in Africa.

But cross-border deals may be more challenging to execute within Mena markets. A number of other considerations come into play that go beyond the purely commercial and technical. Regulatory issues will confront incumbent-to-incumbent plays. The increased complexity and scale of deals like the failed Etisalat-Zain Saudi Arabia merger clearly make them more vulnerable to disruption.

Having the size and financial firepower to digest large cross-border transactions is essential to success. “Acquiring an asset in new territory has to fit a cross-regional strategy,” says Sabbagh. “If operators have capability systems that allow them to work successfully in low-cost markets, these could be relevant in markets like Asia or Africa. But they might not be replicable, lock, stock and barrel in more mature markets.”

Lofty ambitions

Though the prize of a multi-market footprint is substantial, some Mena operators have come unstuck in their attempts to penetrate markets well beyond the region.

STC’s expansion into Asian and African markets such as India, Indonesia, Malaysia, Turkey and South Africa placed a burden on the company’s financial resources.

“It’s become very competitive for operators looking for such exposure, and can be a major drain on resources,” says Ghobrial. “For example, when Qtel bought a stake in an Indonesian mobile operator, it took a long time to deal with legacy problems at the Indonesian operator, before it could fully contribute to the company’s consolidated financials.”

If the financially fittest in the Mena telecoms jungle can make the economics of cross-market penetration work, regional mobile markets may ultimately see further waves of consolidation that leave them as three or four player markets.

With European markets like Germany and the UK following this model, it is one that may yet be pursued across the Middle East. Some markets are already getting there. Egypt, for example, is now a four-player market - three mobile and one fixed-line.

Before that day arrives, the more cash-rich mobile operators will have to brave the market with ambitious cross-border acquisitions. A more aggressive approach to M&A may be back on the agenda - but few would bet on it happening anytime soon.