Perspective. Karim Sabbagh Chady Smayra Amr Goussous Nans Mathieu. Managing Telecom Portfolios for Sustainable Growth

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1 Perspective Karim Sabbagh Chady Smayra Amr Goussous Nans Mathieu Managing Telecom Portfolios for Sustainable Growth

2 Contact Information Beirut Chady Smayra Principal Nans Mathieu Senior Associate Dubai Karim Sabbagh Senior Partner Amr Goussous Principal Irtek Uraz and Fawaz Boualwan also contributed to this Perspective. Booz & Company

3 EXECUTIVE SUMMARY Global telecom operators including several in the Middle East have been enjoying a decade-long growth spurt. Thanks to numerous rounds of mergers and acquisitions, their investments span several continents; for some, international business has emerged as a vital part of the company, accounting for more than half of total corporate revenue. Others have portfolios of far-flung business units that do not mesh with each other or with the overall goals and operations of the parent company. Operators initially looked to integrate their acquisitions by creating group level units that could mine synergies from costs, brand recognition, and services. Now, many telecom companies can unlock further value from within their portfolios by analyzing their level of coherence, a process that starts with determining their capabilities and identifying their way to play the strategic approach necessary to distinguish themselves from competitors. They can then assess whether their capabilities system supports their way to play and whether all their products and services leverage these capabilities. This strategic exercise will tell operators whether they have what it takes to succeed in each market the right to win and then enable them to focus their strategy on the right combination of capabilities and a successful way to play. As a result, operators will achieve a coherence premium, an edge over the competition that could manifest itself in a number of ways for instance, stronger profits or higher market share. There is no single solution; each operator has unique capabilities, and each market represents a different opportunity with its own set of characteristics that are distinct from others. Once a telecom company has this understanding of its capabilities and the elements that will enable it to best the competition in a market, it can then rationalize each of its investments and opportunities in a way that will allow for greater coherence in its portfolio. That will include evaluating acquisitions and divestments, entering or exiting markets, launching new products, or making other strategic moves in order to maximize the operator s value proposition to both customers and investors. Booz & Company 1

4 Key Highlights Telecom operators can unlock value in international investments by analyzing their portfolio coherence and determining how their capabilities can support their approach to market. There is a demonstrable link between portfolio coherence and sustained profitability. This process will enable operators to assess existing investments and will inform their decisions regarding future acquisitions or other strategic moves. FROM GROWTH TO FOCUS Over the past decade, many major telecom operators expanded far beyond their domestic borders, pursuing growth in new, undeveloped markets to counter slowing growth in saturated local markets. Operators pushed into new markets in Europe, Asia, Africa, and the Middle East. Today, several operators have achieved global status, deriving a significant portion of their revenue from international operations (see Exhibit 1). Some have footprints spanning multiple continents. In the Middle East, and specifically in the Gulf Cooperation Council (GCC), incumbent operators, buoyed by strong balance sheets, participated in this strategy, consolidating within their region and beyond. Many operators, however, did not keep a close eye on how each newly acquired operation fit into their overall portfolio. During the rapid growth phase, a veritable land grab of assets, capabilities and capability systems were less important than getting big fast. As growth starts to level off and a certain level of maturity is reached, competition will increasingly be won on the basis of capabilities. Over time, operators acquired some assets that appeared attractive on a standalone basis; later, however, operators realized these businesses were not adding value to their portfolio. Many international operators turned to group-level integration, intending to draw more value out of their investments, seeking to generate synergies, strengthen brands, and combine capabilities company-wide. In doing so, some divested holdings that they saw as non-strategic and others upped their stakes and took greater control of partly owned assets in an attempt to manage them more effectively. For example, Etisalat increased its stake in Atlantique Telecom, its West African operator, from 50 percent in 2007 to 100 percent in In April 2011, Saudi Telecom (STC) boosted its stake in Axis, an Indonesian operator, from 51 percent to 80 percent. And in November 2011, Qtel increased its Tunisiana stake from 50 percent to 100 percent. International investments today have reached a critical mass and contribute significantly to the value of many large operators, elevating the importance of group-level integration. In several cases, because local markets are saturated international operations are contributing to more than 50 percent of revenues and are the growth drivers (see Exhibit 2). As operators continue in their efforts to maximize the value of their portfolios, they can benefit from assessing their operations to recognize their essential differentiated capabilities the combination of processes, tools and systems, skills and knowledge, and organization that distinguish them from their 2 Booz & Company

5 competitors. At the same time and based on their capabilities, operators need to determine the way to play for each of their subsidiaries the strategy that will allow them to succeed and beat the competition in each of the markets in which they operate. These factors combine to present an operator with the right to win that, in turn, will translate into stronger profits, increased market share, or a number of other results the coherence premium that operators can achieve when their capabilities and way to play operate in concert. Along with the coherence premium an inherent advantage in focusing an entire company around a set of capabilities there also is an incoherence penalty that can grow over time as companies expand into new markets and their strategic focus broadens. Exhibit 1 Revenue Surged as Some Operators Expanded into New Markets OPERATORS REVENUES, 2002 AND 2010 (IN US$ BILLIONS) Footprint (Number of Markets) MTN TeliaSonera Telenor América Móvil FT Vodafone Telefónica DT Source: Operators annual reports Exhibit 2 International Operations Account for More Than Half of 2010 Revenues for Some Operators PERCENTAGE OF REVENUE FROM INTERNATIONAL OPERATIONS, 2010 ME Operators 49% 57% 59% 60% 63% 69% 69% 72% 74% 80% 89% 23% 24% 32% 35% Etisalat Airtel STC Batelco FT Axiata América DT MTN Telefónica TeliaSonera Telenor Zain Qtel Móvil Vodafone Source: 2010 operator publications; Booz & Company analysis Booz & Company 3

6 FINDING THE RIGHT TO WIN Companies can measure their coherence premium via a coherence index, determined by an algorithm that takes into account the different operations in a group s portfolio and the capabilities required for each one to succeed. The more overlap companies have in terms of the capabilities they require across the portfolio, the higher they will score on this index. There is a demonstrable correlation between the coherence of operators portfolios a focus on the factors that provided them a right to win and strong financial returns (see Exhibit 3). There is no single right to win formula that will apply to all operators. Each operator has a unique set of capabilities and conducts business in markets that have distinct characteristics and are at different stages of development. An operator can have a set of capabilities that enables it to succeed in one market that is very different from what enables it or a rival to flourish in another. Ideally, an operator will have a single set of capabilities that will provide its coherence premium in the markets in which it operates. However, this is not always the case; sometimes an operator has to organize itself into what we call clusters countries or regions that it can group together to leverage capabilities that are specific to those markets. Operators succeed by organizing their Exhibit 3 Analysis Reveals Strong Correlation Between Profits and Coherence EBITDA Margin 1 50% 45% 40% 35% 30% 25% Op 3 Op 4 Op 5 Op 13 Op 10 Op 12 Op 2 Op 9 Op 7 Op 14 Op 11 Op 1 Op 6 Op 8 Size of the bubble reflects group s revenues 20% Coherence Index 1 Average EBITDA margin for Notes: R² = The coherence index in this Perspective was calculated for illustrative purposes and uses comparable and publicly available criteria for the different operators, including geography, type of business, market position, and market maturity. To develop a thorough coherence analysis, operators will need to undergo a more comprehensive examination. Source: Informa; operators annual reports; Booz & Company analysis 4 Booz & Company

7 investments in clusters a grouping of investments with relative similarities such as geography, market maturity, ownership level, type of operations, and market position. That is not an exhaustive list; there are other clusters. Geography: A geographic focus provides operators with supply chain synergies, advantages in dealing with similar cultures, and the ability to provide offerings that cater to regional travelers needs. MTN is an example of a company that has used geography as a cluster to provide it with a coherent focus and augment its chances to succeed. The African operator centered its expansion on mobile telecom operators within the African continent that are, or have the potential to be, first or second in market share in their region. Market Maturity: Markets and businesses with different maturity levels require different sets of capabilities across the value chain. Among other factors, operators need fundamentally different approaches to marketing and sales in a nascent market as opposed to a mature one. A global operator with operations in markets with different maturity levels faces challenges in developing and implementing different approaches successfully. For example, Telefónica has developed robust capabilities to operate in mature markets, and 80 percent of its operations are in markets where the penetration rate exceeds 90 percent. Ownership Level: Operators need different engagement models for dealing with operations that they control as opposed to those in which they own a minority stake: Majority-owned operations require greater operational involvement from telecom groups whereas minority-held operations require financial investment capabilities. América Móvil, for example, controls 100 percent of its operations, enabling it to enforce decisions at all its subsidiaries in order to create synergies and instill common marketing approaches. Type of Operations: Several telecom groups have invested in a mix of operations, from fixed to mobile operators, from networkbased operations to service-based operations (such as MVNOs). Because each business requires a different set of capabilities, some operators have succeeded by focusing on a specific part of the business. One such example is Zain, which focused exclusively on mobile telephony in emerging markets. By focusing on this area, Zain has been able to build a strong group products and services function and enjoy synergies in the markets where it operates. Market Position: An incumbent operator needs a radically different set of capabilities from a market challenger. An incumbent, for example, might focus a lot of attention on reducing churn among existing customers, whereas a new entrant would set sights on attracting customers who have never used a phone before. Vodafone is an example of an operator with strong customer retention capabilities; more than 78 percent of its operations are in markets where it is either the market leader or quasiincumbent. The cluster approach to capabilities reveals patterns that have formed successful platforms for operators. Operators can use the same methodology for measuring their overall coherence score to measure the coherence of their individual clusters. Booz & Company 5

8 MANAGING PORTFOLIOS FOR BETTER COHERENCE Some global operators already have undertaken substantive divestitures to focus on their differentiating capabilities. For example, Vodafone recently embarked on a program to divest all minority-held assets, seeking to focus on operations in which it could better deploy its capabilities (see Exhibit 4). It is not always practical or wise for an operator to sell or spin off a unit that does not fit into its strategic strength, especially if that unit performs well on a financial basis (see Asset Sales: Myths vs. Reality, page 10). Nonetheless, operators can set aspirational targets or better understand the contribution to the company from each of its operating units by undertaking a two-pronged assessment of strategic and financial considerations. The strategic assessment measures whether an operator s investments or potential investments are a fit with its capabilities and ways to play; the financial assessment takes into account the needs of the corporation in terms of growth and profitability. Together, they give an operator the diagnostic tools to perform an ongoing evaluation of its portfolio to determine which of its operating units it should keep and which ones it might consider divesting. In addition, the methodology serves as a forward-looking tool to assess future acquisition opportunities by testing their anticipated impact on the coherence and financial performance of the portfolio. Exhibit 4 Vodafone Embarked on a Program to Divest All Minority-Held Assets MINORITY-HELD ASSETS DESCRIPTION Polkomtel June 2011, Vodafone agreed to sell 24.4% stake in Polkomtel SFR April 2011, Vodafone divested 44% stake in SFR Softbank November 2010, Vodafone sold interest in Softbank Japan China Mobile September 2010, Vodafone divested 3.2% stake in China Mobile Bharti Airtel Verizon Wireless Vodafone Egypt Divesture considerations frequently reported since 2008 Source: Reuters; Booz & Company analysis 6 Booz & Company

9 Strategic Assessment Two questions will inform the strategic assessment, which allows a company to calibrate its set of capabilities against those required to succeed in each market or cluster. Is the market relevant? And does the company have the capabilities to be successful in the market? Ultimately these questions will assist the operator to identify the fit of specific operations with the cluster in terms of the capabilities it requires for success, or the coherence of a cluster within the overall multi-regional portfolio. The analysis will lead to a clear understanding of what set of capabilities the company would need to have in order to be successful in each market. If the analysis reveals some key capabilities are missing, the company then can assess the possibility of acquiring or developing these capabilities or phasing out from the market or cluster. Is the market relevant? An operator needs to assess each market in which it operates to ensure that the market meets the company s investment guidelines, which ultimately stem from the shareholders vision and aspirations for inorganic growth. Those guidelines could include factors related to growth potential, market size, and the competitive landscape. This step of the strategic assessment process also involves developing an understanding of whether the market presents synergies with other markets. Does the company have the capabilities to be successful in the market? Operating companies should identify what they do exceptionally well their capabilities system. A company s primary source of advantage is a system of three to six capabilities that together allow it to fulfill its way to play. The process of answering this question will enable a company to evaluate its overall coherence, first addressing whether each subsidiary has the capabilities to be successful in that market. If it does, the next question to address is whether those capabilities fit the capabilities of the larger portfolio and thus contribute to the coherence of the group. Financial Assessment As with the strategic assessment, two questions provide visibility into the financial viability of a company s operating unit. What is the business s current financial situation? An operating company should have a clear view of its financial situation and priorities going forward. These priorities should then be used to rate portfolio companies. For example, a company can be looking to maximize profitability and cash. That would require it to have more mature and developed market-leading operations and fewer growing ones in its portfolio. Alternatively, an operating company could have revenue generation and growth as its top priority and thus would likely need to shift its resources to invest in growth companies in its portfolio. The strategic assessment measures whether an operator s investments or potential investments are a fit with its capabilities and ways to play. Booz & Company 7

10 Is this investment maximizing shareholder value? A company should assess each of its portfolio companies on their ability to generate cash in the future. Then it can compare the net present value (NPV) of the portfolio company to the market value of its investment in that business using different valuation techniques. The relative value of the NPV to the calculated market value determines the financial assessment for the investment. The higher the NPV is relative to the market valuation, the higher the financial assessment. The outcome of the strategic and financial analysis allows companies to plot each existing operating unit or new opportunity on a matrix that could provide guidance to management in performing portfolio decisions (see Exhibit 5). This analysis might reveal that a particular asset is financially attractive and coherent with the overall portfolio and warrants further investment to unlock additional growth or increase exposure. If it is a case of limited coherence, a telecom operator might consider divestment, especially if it can generate more value from disposing of the asset either on a stand-alone basis or by bundling it with a less-attractive asset. This is the concept of best ownership. If a subsidiary is profitable but does not fit in the wider group s capabilities system, the operator could benefit from selling the asset to a company in whose capabilities system it would really fit. Furthermore, management can rely on the assessment framework to demonstrate the appeal of acquiring new assets, as it reveals how an Exhibit 5 Companies Can Use a Matrix to Guide Portfolio Decisions Financial Value Return or Growth Potential Attractive Unattractive A. Lone Star (Milk, sell, or isolate) Low Guiding Matrix for Portfolio Decisions D. Detractors (divest, disinvest) B. Relative Coherence (integrate or sell) Coherence with Your Capability System C. Flagship (grow) E. Underleveraged (grow or divest) High A. Lone Star: Continue milking strong financial position and look for opportunities to monetize, as these units may be worth more to others. Build up to sell at the appropriate time or rethink the unit s way to play as a stand-alone small business. B. Relative Coherence: Further invest if the unit is expected to outperform competitors, if the capabilities system required overlaps with group capabilities, or if the sale price is unattractive. Divest otherwise. C. Flagship: Create ways to accentuate growth and strengthen flagship business status D. Detractors: Stop these units from hemorrhaging cash and consider divesting E. Underleveraged: Invest in order to transform into Flagship if financial capabilities allow. Otherwise, divest. Source: Booz & Company 8 Booz & Company

11 operating company would fit into an existing cluster and the overall portfolio from both a strategic and financial perspective. The process of conducting the strategic and financial assessments relies on a few considerations: The assessment should be forward looking: The assessment should not look at what has happened in the past as previous decisions do not have any bearing on future ones, other than to act as a yardstick to gauge future performance. Thus, any framework accounts for future expected returns and treats past decisions as sunk costs. The assessment should be performed periodically: The value of an investment is a moving target that shifts with changes in market conditions, as well as factors specific to each company. As a result, companies should undergo assessments regularly to maintain the relevance of their investment decisions and ensure that they are regularly able to seize attractive opportunities. Business plans should be objective and realistic: As noted above, the value of the analysis hinges on a company s forward-looking assessment of its portfolio companies. Accordingly, business plans on which the assessment is founded should be fair and realistic. The assessment should consider the value of synergies: The analysis should incorporate potential synergies that a company can capture from its operating units, a benefit financial analysis often overlooks. Capturing potential synergies ensures that a company is assessing investments that are in the right context, enabling it to maximize the value of each of its business operations. Full-fledged due diligence is mandatory: Divestment or investment recommendations are guidelines and mandate further assessment. The framework provides management with a short list of potential candidates for divestment or acquisition but requires further validation from a detailed due diligence process before a company can make a final decision. Companies should undergo assessments regularly to maintain the relevance of their investment decisions. Booz & Company 9

12 ASSET SALES: MYTHS vs. REALITY Some telecom operators are reluctant to divest assets, preferring to appear as long investors. Empirical evidence shows that some common maxims that pertain to selling assets it s bad to sell at a loss and don t sell cash cows are not always true. Selling at a Loss: It is not categorically unreasonable to sell an asset at a loss. Contrary to general perception, shareholders often are sympathetic to a company selling a non-strategic asset at a reasonable loss rather than keeping it in the portfolio (see Exhibit A). Exhibit A Stock Performance of Groups That Sold Assets at a Loss DIVESTITURE OF ASSETS Full Divestiture of Subsidiary - Vodafone Group disposed of Vodafone KK, a struggling Japanese subsidiary, in March Vodafone recognized an impairment charge in 2006 on the disposal of Vodafone KK that amounted to 4.9 billion Partial Divestiture of Subsidiary - T-Mobile merged its U.K. subsidiary and created a joint venture with Orange UK in September T-Mobile wrote down the value of the U.K. operations by 1.8 billion Disposal of License - Telefónica disposed of its UMTS license in Austria in December Telefónica wrote off all its European UMTS assets (excluding Spain) with a value of 12 billion 150 Vodafone Share Price Evolution (Rebased at 100) (Jan Jun 2006) 150 IMPACT ON SHARE PRICES Deutsche Telekom Share Price Evolution (Rebased at 100) (Jul Dec 2009) 150 Telefónica Share Price Evolution (Rebased at 100) (Nov 2003 Jun 2004) Divestment of Vodafone KK 50 Spin-off of T-Mobile UK 50 Disposal of Austria UMTS License Jan-06 Feb-06 Mar-06 Apr-06 May-06 Jun-06 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Nov-03 Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Source: Bloomberg; Reuters; Booz & Company analysis 10 Booz & Company

13 Selling Profitable Investments: It is never a poor decision to sell profitable (but non-strategic) businesses as long as a company uses the proceeds to grow more strategic operations that fit with corporate priorities. Holding on to a cash cow or a large, consistent revenue-generating operation should not be a priority by itself, especially if that business does not fit with the company s strategic focus. For one thing, the cash cow status of any unit is rarely permanent. In addition, a company can sell a cash cow at a premium and invest the proceeds in other promising businesses. Such moves might position a company to focus on another region, as was the case when Zain divested its African assets to Bharti in early 2010 because those operations presented little strategic fit with its remaining businesses. Similarly, Telefónica divested Méditel in late 2009 to sharpen its focus on other assets. Shareholders typically understand the strategic factors behind such moves and do not penalize the company for it (see Exhibit B). Exhibit B Stock Performance of Groups That Sold Financially Well-Performing Assets STOCK PRICE PERFORMANCE SELECTED EXAMPLES Vodafone Share Price Performance (vs. FTSE 100 Index, 2005 May 2010) Vodafone Index Europolitan Sweden Divestment EBITDA at sales: 20% Bharti Divestment EBITDA at sales: 22% Zain Index Zain Share Price Performance (vs. Kuwait Stock Exchange Index, 2005 May 2010) 1 Bharti Zain deal EBITDA at sales: 29% $1 = 1.61; Kuwaiti dinar 1 = $3.45; YTD is Apr 26, 2010 Source: Bloomberg; analyst reports; Booz & Company analysis Booz & Company 11

14 Conclusion A wave of expansion has transformed local telecom incumbents into regional operators, with footprints that span the Middle East, Asia, and Africa. For many of these GCC operators, migrating to group-level operating structures has enabled them to unlock value from this expansion. In the aftermath of the global economic slump and debt crisis, management and investors increasingly are clamoring for better performance. And, as international operations account for an increasing contribution to corporate revenue, investors and management continue to scrutinize and rationalize their investments outside of their borders. Telecom operators can undertake an effort to assess and manage their portfolio holdings more effectively by analyzing the concept of coherence across their footprints a process that will inform and guide their portfolio decisions going forward to generate sustainable growth and avoid the incoherence penalty. Applying the coherence lens involves determining what specifically an operator does best the ingredients that enable it to beat the competition. It also includes assessing each of the markets that an operator competes in, to ensure that the operator s capabilities will help it succeed. The analysis is not only an assessment tool for the existing portfolio but also a great driver for growth as it can guide telecom group operators in their investment decisions by helping them focus on clusters of strength, the most relevant opportunities for them. The result will leave some global telecom operators with wide-reaching investments that deliver the maximum value to customers and shareholders. 12 Booz & Company

15 About the Authors Karim Sabbagh is a senior partner with Booz & Company in Dubai and Riyadh. He leads the firm s communications, media, and technology global practice. He specializes in sector-level development strategies, institutional and regulatory reforms, large-scale privatization programs, and strategy-based transformations focused on strategic planning, partnerships and alliances, marketing, and business process redesign. Amr Goussous is a principal with Booz & Company in Dubai. He specializes in investment strategies, globalization, mergers and acquisitions, portfolio management, and business development within the telecommunications sector. Chady Smayra is a principal with Booz & Company in Beirut. He specializes in mergers and acquisitions, investment strategies, corporate strat egy, business development, CFO agenda, governance and operating models, strategic partnerships, and marketing in the communications, media, and technology industries. Nans Mathieu is a senior asso ciate with Booz & Company in Beirut. He specializes in globalization strategies for telecom operators including investment strategy development, M&A transaction monitoring, synergies realization, corporate gover nance, and operating model improvements. Booz & Company 13

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