Zain’s annual general meeting convened yesterday, where major change occurred to the board, and the company in general. Khalifa Ali Al Khalifa and Aida Salem Al Ali departed the company’s board, and were replaced by Bader Naser AL Kharafi and Shaikha Al Bahar. The implications of the change in Zain’s board has the following implications:

More Homogenous Board:

With talks of Etisalat buying 46% of Zain and the sale of Zain Saudi, opposition voices grew. These voices were coming from the Salem Al Ali and Ali Al Khalifa blocks. With their representatives out of the board, being replaced by individuals loyal to the Al Kharafi block, such deals can go through with less hassle, as the board members now are all on the same page.

The Quarrel of the Economic Elite:

Three of Kuwait’s economic elite quarreled over Zain: Al Kharafi family, Ali Al Salem, and Ali Al Khalifa. Al Kharafi emerged victorious, which may prompt certain repercussions. It has created “bad blood” between the economic blocks, which may lead to further quarrels in different areas.

Overall Implication of Kuwait’s Economy:

As Zain is the biggest company listed on the Kuwait Stock Exchange, it has become a bellwether of the overall economy. As we have seen in the past, the company’s stock can lift the stock market, and vice-versa. If Zain decides on selling more of its assets and distributing the proceeds (which is now an easier task after the departure of the opposition), the extra liquidity will be positive on the overall market.

Zain’s Future:

Zain’s board will serve for three years. These three years are crucial, as now Al Kharafi have no barriers to fulfill their strategy and goals. They can either grow the company and create value to investors or sell off the company’s assets, distribute the proceeds, and shrink the company.

Today’s Zain Annual General Meeting was held with much attention from investors, major shareholders, media members, parliament members, and the general public. The reason for the hype was that Zain’s Africa deal was being discussed, as well as the biggest dividend in Kuwait’s private sector history (KD 800 million) was going to be approved. There was speculation (proved to be correct) that the make up of the board of directors would change, as members of the Salem Al Ali and Ali Al Khalifa blocks were overthrown by Al Khrafi affliates, paving the way for the Zain Saudi deal.

Another major point that came up was the executive compenstation. Nabeel Bin Salamah was supposed to get a certain percentage of Zain’s profits, which equates to KD 27 million (Zain’s profit had an extra KD 2 bn due to the Africa sale). The bonus was reduced to KD 3.8 million, while 20 other managers received a total of KD 3 million, and the sum of KD 2.7 million went towards executive expenses. Even the reduced executive compensation amount seems absurd. Bin Salamah has been the CEO of Zain for a year now, meaning that the Zain Africa deal was being cooked before he joined the company. Even on an international level, such a compensation seems ridiculous. Wall Street executives are known to be the highest paid in the world, and Bin Salamah ranks up there with them.

Zain followed an ambitious growth strategy in the last decade to become one of the ten biggest telcom companies in the world. They acquired contracts and companies throughout the Middle East and Africa. Then came the global financial crisis. Debt started to be a big problem, and certain shareholders needed some cash. These conditions altered Zain’s strategy, and the company become a recurring subject in the news with regards to either sale of assets or sales of a stake in the company. Zain Africa was first sold, shrinking the company’s size by a half. Then Etisalat proposed buying 46% of Zain, and now Zain Saudi might be sold.

The question I have is why is Zain selling its Saudi associate? Intially, when Etislat offered to buy Zain, the company had to dump its Saudi operations due to Etisalat’s presence in Saudi through Mobily. But the Etisalat deal didn’t go through. They issued a statement stating that under the next CMA rules, such an acquisition is not feasible. So why sell Zain Saudi? Where will future growth come from? The remaining operations of Zain are in (barring Saudi) Kuwait, Bahrain, Lebanon, Jordan, Iraq, and Sudan. The first four countries are small markets with high mobile penetration rates, yielding low growth rates. Although the last two countries offer large telecom markets and promising growth, the political instability in both countries create many uncertainties. Saudi Arabia is a very promising market that will create lucrative growth opportunities for Zain.

It seems that Zain are liquidating its assets and paying out dividends to its investors, rather than paying out dividends from its operations. I would be seller of the stock in the long-term, as the concerns of lack of growth overweight the dividend payouts.

Yesterday, after the end of the trading session, NIC issued a statement in Kuwait bourse stating that their commitment to sell 46% of Zain was over. The statement ended a USD12 billion deal talks which began in September when Etisalat first announced their interest in acquiring a stake in their Kuwaiti rival Zain. The deal has faced many difficulties, most importantly was the opposition of other key shareholders of the company and the difficulties they faced in trying to sell their stake in Zain Saudi.

What’s next?

When the deal was first announced on September 29^th Zain was trading at KD1.260, then it rallied after the announcement to KD1.360, up 8%. It also ended the year by increasing its’ market cap by 25% since the day prior to announcement.

Zain has fallen 15.8% YTD and broke both its’ 20 and 40 day moving averages; yesterday it broke its’ 200 day moving average.

The Chart above shows a rebasing price graph of both Zain and Etisalat since the announcement of the deal to date. Zain is currently trading at a EV/EBITDA multiple of 6.7x as opposed to its peers of 5x, a 34% premium to its’ peers. Also, it’s trading a P/E 15.4x, against an average of 8.4x- 83% premium. Some might say that this premium was justified as Zain was an acquisition target- but what about now will it fall to match its peers since there’s no acquisition? Using a 2011 EPS estimate of 83 fils and multiplying it with the current average multiple of 8.4x Zain should fall to 0.700.

According to a recent press release by Etisalat, the company reiterated its stand towards Zain acquisition and that it’s still interested in the Zain deal. Bin Ali added that pertinent and suitable information related to the due diligence have been collected and “Etisalat” is in the process to study and analyze the collected information. Consequently the results will be discussed with the sellers in a later stage, and the final results will be presented to Etisalat`s Board of Directors to make a decision in this regard.  Etisalat will inform its stakeholders with the progress of the Proposed Transaction in due course.

The graph above shows the weights of the different companies listed on the Kuwait Stock Exchange and their weights within the two indices and the difference in weights. (Click on the graph for a better view)

This table shows the top 10 companies that are under/over represented in the Price Index. We find that the biggest companies listed on the Kuwait Stock Exchange are under represented, including Zain, Agility, NBK, KFH, and other banks. The stocks that are over represented are ones that have a high price, but their size is not as big as other companies. Gulf Insurance has a stock price of 600 fils and a market cap of KD 101.8 million, which is substantially lower than Zain’s KD 5.8 billion market cap.

The following is a table of the weights of listed Kuwait companies in both the Price and Weighted Indicies:

Over a year ago, Saud wrote a very informative post explaining the differences between a weighted index and a price index.  A weighted index places value on shares based on their respective  market capitilizations relative to the overall market capitalization of the the stock market. For example, Zain (KD 1.460 ) would have a bigger weight in the index and affects it more than Wataniya Telecom (KD 1.860). Why? Because Zain’s market capitalization stands at KD 5.7 billion vs Wataniya’s market capitalization of KD 0.9 billion. Do you know what a price index would do? It would simplistically place more value on the higher priced share. Although Zain is 6 times bigger than Wataniya, Wataniya would affect a price index more than Zain!

Yesterday something unacceptable occurred at the Kuwait SE as Tas’heelat, which is a small company that last traded a month ago, fell more than 50% yesterday from 345 fils to 160 fils. Blue chips in the Kuwait SE were trading up and the weighted index continued to reflect a positive bias even after the massive decline in Tas’heelat’s share price because the company’s market capitalization is minuscule. However, the price index instantly declined and closed down for the day. Talk about wrong signals and a failed index!

Most developed nations adopt a weighted index and the Kuwait SE must do the same for the aforementioned reasons. Some people may argue that the famous Dow Jones Industrial Index is an example of a price index that works well in the U.S., however, one has to realize that the reason it works is because it is comprised of only the 30 largest companies in the US. It doesn’t include any small companies! The Kuwait SE has to adopt the weighted index as its main index because it is very reliable, more representative of the market, and is adopted by most developed markets.

How did the Saudi Market, Tadawul, react on Zain’s news? After the announcement of Etisalat’s bid, the market turned around and Zain started trading back in the green zone as soared approximately 8% in the Kuwait SE.

In our last post The Bid, Again we mentioned that the Saudi regulators don’t allow one owner to own two operators, implying that they will have to probably sell Zain Saudi instead of Mobily. The market received this as good news, as volume on the stock increased by four times and the stock went up by 3%.

To me I don’t see how this deal will affect Zain Saudi valuations. However the only positive catalyst to this story is that obviously there is some appetite for acquisitions in the telecom sector and acquirers are willing to pay extra. If acquirers are willing to pay 90% premium as Etisalat did, then the stock should surge.

The chart below shows the movement in both Zain and Zain Saudi share prices since the announcement of the deal.

Last week, UAE’s Emirates Telecommunications Corp (Etisalat) has made a preliminary and conditional offer to buy a major stake in Zain. Etisalat offered to buy 46% of the company at a price of KD1.7 per share, a 25% over last closing price and 35% over Tuesday’s price- the day before the announcement.

Based on the calculations in the table above, the KD1.7 per share offer seems attractive given that it’s a 35% premium over Tuesday’s closing price. Also, the offer implies a 2011E EV/EBITDA multiple of 10.5x and 2011E P/E of 19.8x, a 89% and 118% premium vs the CEEMEA peer average, respectively.  

One drawback of the deal would be Etisalat’s ownership in Mobily Saudi Arabia. The regulation in Saudi Arabia doesn’t allow one owner to own two operators. Hence, they would have to sell one of their stakes in either Mobily (27.5% owned by Etisalat) or Zain Saudi (25% owned by Zain)- they would probably sell Zain Saudi. 

Kharafi Group, the second largest shareholders in Zain, are inviting the minority shareholders to join in this deal through National Investment Co. All shareholders who own no more than 300,000 shares have the opportunity to join in this deal.

The stock traded heavily on the day the news was out, as 27 million shares traded as opposed to 6.5 million the day before and the price increased by 8%. The stock was halted from trading on Thursday, however all Kharafi’s stocks rallied. Investors who are not joining in the deal should be careful as the price could plunge after the deal.

Whenever news hits about Zain being bought by another entity, and Al Kharafi being on the selling side, the whole market reacts. We witnessed this today, as reports emerged yesterday that Etisalat of the UAE offered to buy 46% of Zain (including Al Kharafi’s stake), leading the market to soar, especially stocks of Al Kharafi associate companies.

One of the theories of economics is that if a government lowers corporate taxes, the broader population will also benefit, through lower prices of goods, extra wages, etc. This phenomenon is known as the Trickle Down economics. The Trickle Down economics works differently here in Kuwait, for as Al Kharafi sell their stake in Zain at a premium, all their group of companies will benefit, leading to an appreciation of their stocks, which in turn benefits the thousands of shareholders in these 15 companies or so. Happier shareholders will spend more, thus benefiting the whole economy.

I am not trying to be a protectionist in any way but clearly Kuwaiti investment houses and merchant families were badly hit during the financial crisis and have started to offload their assets. The government, famously renown for staying at the sidelines, seems to be enjoying that scenery very much!

At a point in time, Kuwait used to be a leader in all aspects and that included telecommunications. MTC, was the first mobile telecommunications company in the region and the first to introduce GSM. The government reduced its share, the company started its expansion phase and enjoyed significant growth until June 2010, when Bharti Airtel completed a deal to buy Zain’s businesses in 15 African countries for $10.7 billion. Zain became structurally impaired as its focus was changed from a global to regional reach. Currently, Zain could be nearing the end of a year-long stake sale saga, with Abu Dhabi-listed Emirates Telecommunications thought to be running the rule over its regional rival for part or all of Al- Khorafi’s 14% direct stake in Zain. Moreover, in 2007, Qatar Telecom (Qtel) acquired 51% of Wataniya Telecom shares from Kuwait Projects Company Holding KSC (KIPCO) group and 2008 marked the arrival of Saudi Telecom’s Kuwait unit, VIVA, which is still not wholly owned by Kuwait.

A couple of weeks ago, rumors spread that Madam Mouza of Qatar showed interest in NBK and was building a stake that would make her eligible to participate in the upcoming capital increase. More lately, rumors have spread  that Al Kharafi have placed half of their 67% stake in Kuwait Food Co (Americana) for sale. Not to mention the sudden appearance of Mr. Mahmoud Haidar and his spending spree.