Dynamic and competitive: Growth in mobile communications continues apace

The telecoms sector is one of the most competitive and dynamic parts of the Egyptian economy. It has also proved one of the most resilient to the political turbulence and economic slowdown of the past three years – Egyptians have continued to make calls, and increasingly use their handsets to go online. The market is internationalised – the three existing GSM operators are all majority foreign-owned, all by large global players, indicating the appeal of the market to the world’s biggest telcos.

UP & COMING: The coming year is likely to see the launch of a fourth mobile brand, with interest in the licence expressed by legacy fixed-line operator Telecom Egypt (TE), a majority state-owned firm. The new competition may put further pressure on prices, already among the lowest in the world. But it should also spur further maturing and development of the market, with operators looking to boost what are relatively low levels of data and value-added service (VAS) usage and enhance service quality.

The country’s rapidly increasing data and voice traffic will be supported by the development of a long-term evolution (LTE) network, licences for which are expected to be issued in the next two years. LTE investments will be capital-intensive, which may drive greater cooperation between operators.

SECTOR REGULATOR: The National Telecommunication Regulatory Authority (NTRA) is responsible for overseeing all aspects of the communications sector, including competition, tariffs and termination rates (the cost of moving from one network to another), spectrum allocation and management, service standards, legal issues, and consumer protection. It also oversees the imports of all telecoms products to the country to ensure that they meet standards.

The minister of communications and information technology is also the chairman of the NTRA board, but the organisation remains theoretically financially and structurally independent from the ministry. In the second half of 2013, the NTRA is expected to offer universal licences to all Egypt’s four main telecoms companies – the three mobile operators and TE, the legacy fixed-line operator. TE is expected to take up a licence, allowing it to launch a fourth GSM company and offer “triple-play” services comprising internet, television and phone services. Mobile operators taking universal licences will also be able to enter the fixed-line market, although given the high capital costs associated with installing a such a network of their own, this may happen initially through a fixed virtual network operator model, using TE’s infrastructure to provide services.

MARKET STRUCTURE: As of the mid-2013, however, licence changes had not yet taken place and Egypt’s mobile market had three operators: Vodafone Egypt, majority-owned by UK-based telecoms giant Vodafone, with TE having a 45% stake; Mobinil, in which France Telecom-Orange secured a 94% stake in May 2012, with 5% in the hands of previous owner Orascom Telecom Media and Technology Holding (OTMT) and the remainder freely floated; and Etisalat Misr, in which UAE national telco Etisalat has a 66% share, with the remainder held by investors including Egypt’s national postal company (20%) and various private institutional investors.

The fixed-line market has until now been dominated by TE, which is 80% owned by the state, with the remainder on the London Stock Exchange. TE has suffered from a decline in fixed-line subscriptions in recent years, which it is trying to offset by building up its business in internet services – and potentially expanding its offerings in the mobile market through a new standalone operator (see analysis).

As of the end of 2012, Egypt had around 94.5m mobile subscribers, indicating population mobile penetration of 113.5%, according to the Ministry of Communications and Information Technology (MCIT). Vodafone had a market share of 41%, Mobinil 35% and Etisalat 24%, according to Cairo-based investment bank HC Securities. The most recent entrant is Etisalat, which joined the market in 2007, announcing targets to attain a 33% market share. Given the large presence of existing operators Vodafone and Mobinil, it resorted to an ambitious pricing model, benefitting in part from lower international connection fees thanks to an exclusively owned international gateway (TE owns the country’s other gateway).

This approach has generally tightened margins throughout the sector and lowered average revenue per user (ARPU) – although it has also allowed the new entry to expand its client base – something which the fourth operator may compound.

HEALTHY FIGURES WITH TIGHT MARGINS: Despite low ARPU, the margins on earnings before interest, taxes, depreciation and amortisation (EBITDA) for operators remain relatively healthy, standing at 44% for Vodafone, 40% for Etisalat Misr, 37% for TE, and 33% for Mobinil as of early 2013, according to Mohamed Zein, a senior analyst at HC Securities.

As of mid-2013, the mobile operators were feeling a squeeze from a number of directions, not only aggressive price competition. Economic and political factors combined made the going more difficult. On one hand rising inflation was putting pressure on wages and overall costs, while the falling Egyptian pound was pushing up the price of importing already costly equipment. Regular power outages required companies to rely on expensive backup power all too often. The political situation made insurance premiums more expensive, while the shortage of dollars made paying suppliers more difficult. Finally, the deteriorating security situation led to a number of attacks on base stations, requiring expensive repairs and higher spending on security.

GROWTH PERSISTS: Despite these challenges, the sector continues to expand. “We are building a lot of new sites, and expanding existing ones, but we can barely keep pace with huge demand,” Tony Dolton, chief technical officer at Vodafone Egypt, told OBG. “But the environment is getting tough for getting permission for sites, and the biggest challenge is ensuring regular power supply. The current political and market environment makes it much harder to keep the network running and deliver quality. We have plans to increase investment in 2013 and 2014, but the availability of foreign currency and cost factors will affect our ability to do so.”

PRICE COMPETITION: The emergence of a fourth mobile operator is expected to make consumer cost factors even more competitive. Egypt already has one of the world’s most price-competitive mobile telecoms markets, following several years of aggressive competition between the players. The market is sensitive not only to tariffs, but to the free minutes offered by operators. Price competition among players has driven down call costs to LE0.11 ($0.02) per minute, according to Zein. But demand has proved fairly price inelastic, perhaps unsurprisingly, at such low costs. That is, lower prices have not led to a greater level of usage, and with revenues from VAS, mostly mobile-internet-based, not yet fully offsetting declining voice earnings, ARPU has fallen to some of the lowest levels in the world.

As of the second quarter of 2013, ARPU averaged LE22-26 ($3.14-3.71) per month, below the regional average. “If the government does not move to regulate pricing, ARPU could fall to LE10-15 ($1. 42-2.13),” Zein told OBG. “The market would be better off with a price floor, and the operators are likely to be happy with it.” However, Amr Badawi, former executive president of the NTRA, told OBG that price controls were unlikely to be introduced, and that the organisation would use other methods first to prevent unhealthy price competition.

“We liberated the market and do not want to be in the position where we are setting prices again,” he said. “There are other tools that we can use to make sure that the market does not collapse.”

The fourth licence could bring ARPU levels under even greater pressure. According to local press reports, TE has expressed extensive interest in the licence and is gearing up to launch its own mobile operator as of mid-2013, initially via a mobile virtual network operator (MVNO), which involves relatively low capital costs as it makes use of an existing provider’s network infrastructure. Maria Samir, an analyst at Cairo-based Beltone Financial, expects TE to “go low” in terms of pricing.

Vodafone Egypt’s chief technical officer Tony Dalton, told OBG that operators would probably have to start cutting back on the number of free minutes that they offer in order to save money to invest in infrastructure necessary to improve customer service and increase VAS, areas that are expected to drive growth going forward. He added that a broader “restructuring” of price plans might be necessary, but that it would be difficult for an operator to take the lead in doing so without losing subscribers.

The government’s proposal to raise taxes on mobile calls from 15% to 20% may also have an effect on pricing. Operators used to absorb much of the tax costs, given how price-sensitive the market is, but with margins narrowing, the latest tax rise, and those in the future, may be passed on to consumers. Another levy, of LE25 ($3.56) on each new SIM card purchased, might have the effect of trimming growth of new subscriptions, though the cost is hardly onerous for all but the lowest-paid. But neither are expected to have a radical impact on the market.

HEALTHY DATA POTENTIAL: However, there is still sizeable potential for increased revenues as operators shift to VAS. In fact, such is the scope for growth in improving data usage that some believe the arrival of a fourth operator will have only limited impact on price competitiveness. Opportunities in data – as well as in developing niche services – opens space for a new operator, according to some sector players.

“Many believe the market is too saturated for this, but I disagree,” Khaled Rabie, the vice-president for public and economic affairs in north-east Africa at Swedish telecommunications provider Ericsson, told OBG. “First, the population is not stable; it’s growing, and therefore there is room for more players. Second, new marketing could help tap new segments. Third, there are further opportunities for different technology using mobile networks, such as machine-to-machine communication. A fourth licence still has a place on the market.”

Given ongoing pressure on prices, high voice penetration, and rising costs, operators’ efforts to bolster value are likely to intensify over the coming years. This particularly involves encouraging greater take-up of data services (see analysis). Fortunately, demand for VAS (including internet-accessed applications on smartphones) is rising. But the remaining price-sensitivity of the market means that growth is incremental rather than stratospheric.

“The days of 30% growth are over,” Beltone’s Samir told OBG. “There is some voice growth, but it is decelerating.” Samir pointed out that the UAE and Saudi Arabia both have mobile penetration of over 150%, but are seeing continued revenue growth as data usage expands. However, both countries have significantly higher average income levels than Egypt.

For middle-class and affluent customers, for whom a few piasters a minute does not make a great deal of difference, better quality connections of voice and data, as well as customer care, could also prove to be important selling points in choosing a provider.

LTE COMPETITION: Key to boosting data usage will be the roll-out of faster connection spectrum and LTE licences. The NTRA has suggested a timeframe of 2014 for the first LTE licence tenders, though analysts suggested that it may be the following year before the first services are offered – and the political uncertainty of mid-2013 could cause a further delay. While there is currently sufficient capacity on the 3G spectrum for voice and data volumes, over the medium to long term, increasing amounts of traffic will shift to LTE. Badawi told OBG that the LTE network would initially just be used for data traffic, but over the longer term it would also take voice, as the legacy network would be phased out.

FIXED LINE: As in dozens of emerging markets around the world, fixed-line usage in Egypt has been affected by increase mobile usage – something that has had an impact on TE. Still, in numerical terms, it is in relatively good shape compared to many other fixed-line incumbents in the Middle East and North Africa. TE currently has around 7.2m subscribers, with 900,000 business lines and 100,00 government lines on top of its domestic connections. Furthermore, growing revenues from internet business, the opportunities presented by a new mobile subsidiary, and the triple-play potential of combining these services with fixed-line connections, offer new directions for expansion for the operator.

TE’s CEO and managing director Mohamed Elnawawy has said that he expects to see 3-4% revenue growth in 2013, doubling the rate achieved in the first quarter of the year. Net profit fell 6% year-on-year to LE858m ($122.1m) in the first quarter of 2013, though this was above expectations. EBITDA slid 32% to LE947m ($134.8m), but the company’s EBITDA margin stood at 34.8%, a healthy level and one that the company expects to maintain for the full year. Revenues generated by TE Data, the operator’s market-leading internet arm, rose 28.9% in the first quarter of the year on the same period of 2012, another sign of strength.

TE is relatively cash-rich, with LE5.8bn ($825.3m) on its books, according to Zein. The company is targeting significant capital investments of LE1bn-1.2bn ($143m-171m.) for 2013. According to local press reports, some of this may go towards a new mobile operator, though TE officials have said that they want to keep such a project capital-light for the time being, and the use of an MVNO model should keep investment costs down. TE will be faced with the question of what to do with its Vodafone stake, as it is unlikely that the regulator would allow it to retain interest in two LTE licence holders. As it currently stands, according to Samir, two options are likely: either TE sells its share in Vodafone Egypt, or bids for a majority stake and merges the two mobile companies. TE had lined up a bid for majority ownership of Vodafone several years ago, but there was no agreement on pricing at the time.

FOREIGN INTEREST: According to local media, a number of regional players have expressed an interest in Egypt’s large, if competitive market, including Qatar’s Qtel and Saudi Arabia’s STC. In spite of tight pricing, the boost to margins of acquiring a stake in an existing mobile operators could repay a hefty upfront cost – recent mergers and acquisitions in the regional market have averaged an earnings-to-value ratio of 5.9, said Zein.

INFRASTRUCTURE & SHARING: The cost of upgrading network infrastructure for LTE – on top of the substantial fee that the government is likely to charge for the licences – may encourage greater sharing of towers and other equipment between operators, a trend that until recently was rare in Egypt, but is quite advanced in other markets around the world. “We are doing a lot of sharing at all levels now,” said Dolton. “It’s a key part of our business model to look where other operators have sites before we build a new one. More than half the new sites we’ve established in the past year are shared; we’re sharing rooftop sites as well as greenfield ones, and we’re looking at active sharing of 3G interface, though there are legal barriers to this at the moment.”

The development of an MVNO could make the concept more acceptable to Egyptian operators, who have thus far shied away from cooperation on infrastructure due to the fierce competition between them. However, this competition may actually drive them to greater collaboration, as pooling some of the capital expense of building and maintaining network equipment would help cushion margins that are being narrowed by falling ARPU.

OUTLOOK: While other sectors have been hard hit by Egypt’s tumultuous post-revolutionary years, telecommunications companies have continued to invest and expand. Mobile usage is probably as near universal as it can be, and low costs make demand resilient to slower economic growth.

The major development of the next year is likely to be the issue of universal licences, which at the time of writing was going ahead despite political uncertainty. If press reports are to be believed, TE seems set to move into the mobile market, adding a new element of competition, and offering the prospect of bundled services, a model that other operators may follow. Firms will be keeping an eye on prices, but with tariffs already low, there may not be more space for competition on this front.

Therefore, operators will focus on increasing data usage and improving service quality. Doing so will require significant capital investments, although with financing harder to source and equipment imports affected by currency fluctuations, it will be a challenge. The roll-out of LTE in the medium term will help support rising traffic, particularly of data, and may encourage greater cooperation between operators. For the short term, however, the name of the game is getting more Egyptians to use VAS.