Saudi Zain Financial and Business Plan for 2010 - Conversion of US$577 Million Debt to Equity

Saad AlBarrak gave an interview in Riyadh today.  I haven't found anything in the Saudi Press.  The best account so far is from Zawaya Dow Jones.  Unlike other reports like this one from Reuters, ZDJ has much more detail.

Here are the highlights from the article:

1. Saudi Zain wants to convert US$577 million of its outstanding debt to equity with the goal of finishing the process before the end of 2010.  Calyon, Samba and AlRajhi Bank have been engaged as advisors.
2. The ultimate goal is leverage of 50:50.  A structure he described as "the best financial structure". No further loans are being sought at present. 
3. Conservative projections are for an 80% increase in revenues and 1.5 million new subscribers taking SZ to 7.5 million at FYE 2010. 2010 EBITDA is expected to be positive. 
4. Mentioning his resignation from Zain (Kuwait), he noted that he will remain as CE of SZ as he is personally committed to the firm.
5. The US$6 billion license fee paid by SZ is small in consideration of the opportunities in the Kingdom and when scaled for market size a bargain compared to other regional license fees.
6. SZ will abide by the Saudi Telecoms Authority's prohibition on providing free connections on incoming calls to SZ's customers when they have switched to international roaming.  However, SZ intends to pursue all legal channels to overturn this prohibition.

And now for the usual comments.

As a reference points, a link to SZ's 31 December 2009 financials.  Here's the updated financial link. You will notice that some of the numbers below do not match those in the financials and that's because I was working with an earlier preliminary set which as you'll notice from the first link no longer are posted.

First, Uncharacteristically for a self-proclaimed "cashflow guy", let's start with the Balance Sheet.

1. Over 79% of assets are represented by Intangibles, almost all of which represents the US$ 6 billion (SAR 22.5 billion) license fee.  This is being amortised over the license term.  25 Hijri years (roughly 24.3 Gregorian years).  The license fee is a flat fee, which imposes the same burden whether or not the company is successful.  I don't follow the telecoms market but I do recall that at one point, some countries' license fees were scaled by number of customers the firm got.  The more customers the higher the fee.  The point here is that SZ starts off with a very high fixed cost base.  And note the components of operating leverage - the license fee is 85% of non-current assets. If you're wondering, the Saudi Government has already collected the fee from SZ.
2. Notes Payable reflect "supplier credits" from Nokia/Siemens for SAR1.6 billion (US$427 million) and Motorola SAR0.6 billion (US$160 million) due within 12 months from 31 December 2009.
3. Syndicated Murabaha Loan of SAR9.4 billion. SAR7.1 billion in Saudi Riyals and US$710 million in USDollars (SAR2.66 billion).   Arranged by Banque Saudi AlFransi ("BSF").  4.25% over the respective benchmark rate. Bullet (single payment) maturity on 12 August 2012)  This loan refinances a SAR9.1 billion loan which matured 27 July 2009 also be BSF.  One might look at the increase in the loan as providing financing for roughly 50% of the interest due during 2009.  SZ has about 2.5 years before maturity to demonstrate significant progress in its business (particularly in getting additional subscribers) to roll over the loan.  I say that because I expect it won't have the cash flow to repay the loan by then.
4. From the accumulated losses account under shareholders' equity we can see that the company has yet to be profitable.  Some 38% of original capital has been lost.  One would expect a start-up to have a loss particularly in this business.  The amortization of the license fee is some 34% of the loss so the rest of the losses are from operations.

Next the income statement.

1. Let's look at AlBarrak's statement that 2010's EBITDA will be positive.  For our crude estimate, we'll use 4Q09 figures as these probably more accurately reflect the revenue efficiencies associated with reaching 6 million subscribers at FYE 2009.  The Gross Operating Profit Margin is roughly 39.5% (SAR355 million/SAR895 million).  Distribution/marketing and G&A expenses annualized are running SAR1.7 billion.  To break even revenues would have to be SAR4.3 billion.  Annualizing 4Q09 revenues of SAR895 million, we get SAR3.6 billion at a 6 million subscriber level.  Assuming that the additional 25% have a similar spend pattern we get SAR4.5 billion in revenues.    So this doesn't seem like an impossible task.  Of course, seasonality in revenues, increased price competition, etc could throw these calculations off.
2. When we look at AlBarrak's prediction for an 80% increase in revenues over the full year 2009 figure and using the same assumptions in the point immediately above, SZ would show EBITDA of some SAR 355 million.  A couple of additional comments.  Full year 2009 revenues were SAR 3 billion.  Using 4Q09 revenues, SZ has a SAR3.6 billion run rate so projected 2010 revenues are roughly 151% of the current run rate.  That may make the projected jump a bit more credible.
3. Net income profitability will take more.  First there is the SAR1.5 billion a year in license fee amortization.  Then the SAR 880 million in financing charges.  
4. Based on that, I'd guess that profitability is a few years off at the least.  
5. This explains of course the focus on the debt to equity swap to reduce the interest burden.  The proposed conversion of US$577 million to equity should bring the annual financing charge down roughly 18% or so (based on the assumption of a 6% cost of debt).  By itself this does not solve the company's income statement issues.  Getting more subscribers will.  This probably explains the issue regarding roaming charges.  SZ is competing on price in an effort to snare more subscribers. 

And finally the cashflow statement.

1. A key issue will be the need for and amount of  continuing capital expenditures.  Right now SZ is obtaining supplier credit, shareholder support and as well there is a buildup in payables and accrued liabilities.
2. The issue to watch here and on the balance sheet is whether SZ is riding the trade on these latter two categories and how long it can continue to do so.
3. Why?  Let's look at how SZ is financing its expenditures.
4. First, it has net cash from operations of SAR983 million. But this was dependent on increases in payables and accrued liabilities - some SAR2.8 billion.  If this amount comes due for cash payment or further increases are not possible, what other sources of financing does SZ have?
5. That suggests a look at cash generated from net financing activities.  A positive inflow of SAR817 million in 2009.   But, I'd expect that banks are unlikely to lend more, particularly since SZ is requesting a debt conversion.  Can shareholders continue to provide cash in the form of  additional loans?   Or new equity?  Now that Saad is not on the Board of Zain, will they be as eager to support a company in which they have only 25% equity?  Note that shareholders provided a cool SAR1 billion in 2009 between loans and new equity.   And Zain represents the lion's share of the Shareholder Loans - some 64% of the total and almost all of the increase in 2009.

The company's financial situation remains fragile - as one would expect of a start-up in a capital intensive business (I'm including the license as a capex).  The solution is growth in subscribers.

With 25 million or so people in the Kingdom and three other competitors - two of whom -- Saudi Telecom and Mobily have upwards of 80% of the market, SZ has its work cut out for it.  And there is a hungry newcomer on their tail --Bravo.

Hard for me to see how more than 2 companies can make a profitable "go" in the Kingdom - especially given the license fees.  Profitable in the sense of a good return on equity.  It's that license fee which is the "rub" on that topic.