Monday, March 01, 2010

Nigeria: Is Nitel's Sale Dead On Arrival?

[this day] Two weeks ago, when the Bureau of Public Enterprises (BPE) announced the preferred bid made for Nigerian Telecommunications Limited (NITEL), my initial reaction was to ask: Why would anyone or company be willing to pay so much for the troubled telecoms operator? $2.5 billion was ridiculously astronomical. On what basis did this so-called winning consortium undertake its valuation of NITEL, I wondered.

But then again, those with an inking of the psychology of auctions, especially for telecoms assets and licences, would agree that often enough bidders throw all caution to the wind, discountenance the sound counsel of their advisers/consultants, and let their egos hold sway. This was glaringly evident during the European auctions held for 3G licences in 2000/2001 when telecoms companies borrowed heavily to pay for mere slips of paper to roll out third generation networks.

Several of those companies such as BT never recovered from those auctions and had to hive off its mobile and directory business units to survive. Others like NTT DoCoMo, Hutchison and KPN Mobile were forced to restructure their debt-ridden balance sheets by divesting from some of their overseas operations. The European experience was a crucial lesson in how not to rush headlong into acquisitions factored on futuristic hype as opposed to sound commercial and market considerations.

Aside from the $2.5 billion bid made for NITEL, the transaction even before its endorsement by the National Council on Privatisation (NCP) has been marred by denials from members of the consortia pre-qualified by the BPE. Several conflicting reports have been attributed to Unicom China, the Minerva Group of UAE, Telkom South Africa and Telecom New Zealand. Although the BPE and the technical committee of the NCP have tried desperately to defray the denials, the doubts that have been raised are impossible to dismiss.

So as the NCP prepares to meet and take a decision on its latest effort to privatise NITEL, it may be necessary to bring some questions desperately needing answers to the fore:

Bid Price

As already indicated, the $2.5 billion and $956 million bids submitted by New Generation Telecommunications and Omen International consortia respectively to emerge the preferred and reserve bidders during the financial opening round cannot be justified. Although the federal government has committed to assuming the liabilities of NITEL, its EBITDA (earnings before interest, tax, depreciation and ammortisation) was estimated at $13 million. A bid, wrote a foreign based analyst, of $2.5 billion for 75 per cent of NITEL would be equivalent to more than 100 times its current EBITDA.

A professional investor uses EBITDA to approximate the fundamental earning power of the company's operations while separately factoring in the projected capital expenditure needed to maintain those operations. This is necessary because of the time value of money principle. Failing to do so ignores a very important company fundamental.

Even if we were to sidetrack NITEL's balance sheet, history has shown that the NCP should be circumspect about accepting unrealistic bids for NITEL. In 2006, I wrote in this same column that the $750 million offered by Transnational Corporation for NITEL was too high. This was based on rapidly changing market fundamentals and the fact that its non-core assets comprising pricey real estate assets that might have attracted the $750 million price tag, had been hived off.

By this time, NITEL's market share had already been eroded by the competition and its mobile subscriber base was down to less that 250,000 from a peak of 1 million it had the year before. In the end, Transcorp was only able to pay $500 million under a leveraged buyout but could not raise additional capital to inject into the operator.

Prior to Transcorp, the first attempt to sell NITEL in 2001 also went belly up. A $1.317 billion bid was submitted by Investors International (London) Limited that it could not pay. At the time, NITEL was offered along with its impressive portfolio of real estate assets. It was also still competitive, as new entrants like MTN and Econet had only just been licensed and were still struggling to roll out networks nationwide.

However, that was nine years ago. Today, NITEL's subscribers (mobile and fixed lines) are down to a few thousand and boasts less than 1 per cent market share; ARPUs (average revenue per user) of stronger competitors are dropping which is indicative of high operating costs and the economic downturn; it no longer owns the non-core assets which once made it seemingly humongous; and, the only assets of significance it has to offer is its transmission capacity comprising the SAT 3 submarine cable and the fibre optic transmission backbone covering southern Nigeria. It may also be cheaper to pay for a fresh licence (if NCC has any to spare) and roll out a network from scratch than take on NITEL with all its problems and complexities.

But let us presuppose that I am too hasty in my assessment of the preferred and reserve bids made for NITEL. If by some stroke of good fortune the Minerva Group, which is the lead member of New Generation consortium is able to meet the payment criteria as and when due, how certain is the BPE/NCP that it has the capacity to inject fresh capital into NITEL. (New Generation claims it will inject an additional $2.5 billion into NITEL to upgrade and roll out a network, bringing its total investment to $5 billion.)

The last thing the BPE needs is another Transcorp on its hands. It should note also that one of the reasons the Kharafi Group of Kuwait is eager to dispose of its Zain Africa operations is because its diverse business has been hit by the global financial crisis and is saddled with a huge debt overhang. Several Dubai-based companies are in the same dire straits as the Kharafi Group.

Bid Rules and Processes

A review of the Request for Proposal which was sent out to investors shows that the BPE altered or waived its own rules mid-stream without making it public. Section 3.1.2 of the RFP in my possession stipulates: " No entity (including for this purpose its shareholders, subsidiaries or associated companies) may be a member of more than one consortium."

That being the case, on what basis was the New Generation and Omen consortia pre-qualified to proceed to the financial bid stage of the transaction? BPE and NCP have publicly announced that Unicom China is a member of both consortia. Were they not conversant with their own rules? BGL, the financial adviser to New Generation, has tried to dismiss the circumvention of the RFP on the grounds that BPE extended the submission deadline for expressions of interest and was able to harvest more bidders to participate in the bid.

BGL is right. But when the BPE extended the deadline for the submission of EOIs to enable more bidders participate, it made this public. On the same note, if BPE was going to waive or set aside its prequalification criteria, should it not, at the very least, have informed all the bidders involved in the process so they would have had equal opportunity to realign and strengthen their consortia?

The same RFP also allowed bidders to submit proposals for a 75 per cent stake in the NITEL Group or a 75 per cent stake in one or more of its units, namely: SAT 3, NITEL Landline, MTel, Fibre Optic Transmission Backbone and NITEL CDMA Network System. Whoever thought up this privatisation strategy was plainly stupid. If BPE was advised by its advisors, then they should be sacked and the money paid for their services recovered.

First, it is impossible to offer NITEL and/or each of its subsidiaries simultaneously as one transaction. The BPE should have taken a decision to either sell the entire group, or the subsidiaries as independent legal entities. The strategy should have been to adopt one or the other, and not both transactions simultaneously. In the event, the BPE elected to balkanise NITEL and sell its units separately, the entity should have been unbundled and each of the units corperatised. Other than MTel, no other unit of NITEL operates as a corporatised limited liability company. Neither were the assets and liabilities of NITEL assigned to the new companies and valuations undertaken for them to establish their reserve prices.

So on what basis was the RFP developed to offer bidders the option of bidding for the NITEL Group or its subsidiaries on the same platform? Even when assets and liabilities are assigned, it is inevitable that the shell company is going to be left with stranded assets. Who was going to assume those? Where all these issues factored into the data room documents that were made available to bidders?

These posers bring to surface another critical issue: Realistically, can NITEL, MTel and the other subsidiaries be physically separated? The way a significant portion of the NITEL network, comprising its landline switches, transmission backbone and mobile network, was built is such that the infrastructure is co-located in the same premises, and is therefore interdependent.

Even though there's been talk among other network operators in Nigeria of co-locating their infrastructure as a way of cutting costs, no telecoms company has adopted co-location as a network roll out option. This is because cut throat competition and the grab for market share remains very fierce in a country with only 50 per cent penetration. Besides, in this era of broadband data services, the fate of NITEL's landline business is linked to its transmission backbone, so why would anyone sell or want to acquire a landline subsidiary independently of SAT 3 and the optical fibre transmission backbone?

Who Can Vouch for the Chinese?

Despite BPE and NCP's best efforts to paper over the denials that followed the financial bid round, they cannot conceal the fact that the move by foreign firms to distance themselves from the transaction has created an air of uncertainty. Unicom's back and forth statements with respect to their membership of the winning consortium have been the most difficult to fathom.

Based on information made available by sources with a tab on the transaction, Unicom's European unit has committed to be the technical partner to New Generation and Omen International. In the same breath, the same European unit has committed to taking up a 20 per cent stake in the New Generation consortium should the consortium succeed during the financial bid process. It is uncertain if the commitment shall be met during the payment stage of NITEL's acquisition or at some future date.

If it is assumed, however, that it decides to take up to half of the 20 per cent of $2.5 billion, Unicom Europe would therefore have to cough up $250 million, and possibly more if it elects to defer the subscription of its shares. $250 million, at the minimum, is not chicken change. The question is can a wholly owned European unit make this kind of commitment without the knowledge and approval of its parent company in Hong Kong? Or was the letter written just to satisfy BPE's preference for bids whose members are committed financially to the transaction?

The NCP, when it meets, certainly has its work cut out. But if you asked me, the NITEL transaction, once again, is set for failure.

Nigeria: Is Nitel's Sale Dead On Arrival?

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