Egyptian telecoms sector moves towards 4G

The fundamental demand drivers of Egypt’s telecoms sector are very appealing, by any measure. The country has a large and growing population, increasing purchasing power and high media consumption. However, operators still have had to navigate some tricky challenges. Price competition in the voice market has eased after aggressive discounting in recent years, but data usage and value-added services, which are seen as key revenue earners, still remain modest.

Change is afoot and operators are preparing to move adeptly in the years to come to take advantage of new opportunities and face new challenges. Yasser El Kady, Egypt’s new minister of communications and technology, has outlined a number of new policies for the sector, which include investing in telecoms infrastructure and widening access to mobile services in rural communities across the country.

In line with this, the Ministry of Communications and Information Technology (MCIT) has announced plans to offer 4G spectrum in 2016, as part of a broader plan to increase internet penetration that includes fixed-line ADSL in the national market. The government has also expressed its intention to offer a variety of licences, so that the three mobile operators and the fixed-line monopoly, Telecom Egypt (TE), can compete evenly across all segments of the market.

Operators’ Performance

In spite of the uncertainty over the short-term regulatory framework, the market is currently stable and predictable. In the mobile segment, business has been ticking along with revenue growth in the low single digits, and while the current revenue levels are less than ideal, the outlook in the next 12 to 18 months should improve noticeably, as data services increase. In 2014, for example, the combined revenue of the sector grew by approximately 2.8%.

Beltone Financial, a local investment banking and research firm, predicts that the decline will be arrested in the next half decade on the back of growing mobile data revenues. The company forecasts growth ranging from -0.2% to 1.6% up to 2019, while the government envisages growth rates of a minimum of 3% in 2016 due to ongoing developments in the sector.

Penetration Figures

While the sector’s underlying demand drivers are encouraging – population growth is robust, at 1.6%, and household consumption is recovering after the post-revolution turbulence – customer growth, in terms of raw numbers, is plateauing.

This is largely intentional, and indeed beneficial, and is primarily a result of the National Telecommunications Regulatory Authority’s (NTRA) intervention to ensure that all SIM cards in the market are fully registered. As a result of this initiative, all the mobile operators have been obliged to wipe clean their subscriber lists of any and all unregistered SIM cards.

Although they have since recovered, mobile subscriptions have actually fallen over the last 12 months. The market lost just over 5m subscriptions between the first quarter of 2014 and the first quarter of 2015. Subsequently, the penetration rate fell by 8.27 percentage points to 111.18%, or 95.99m subscriptions.

Even with the NTRA’s intervention, figures have since stabilised. By May 2015, the number of subscribers had crept up to the 96.03m mark, however, this still represents a significant decline on 2014 figures. More importantly, there is plenty of room for future growth, given that the 96.03m figure does not distinguish multi-SIM ownership, a common feature in emerging markets.

Market Share

In terms of the three GSM operators, steady competition has begun to level the playing field – the most recent entrant arrived six years ago – and the disparity in performance has contracted. According to Egypt Independent, Vodafone Egypt holds the largest share of subscribers and revenue at 41.8% and 39.7%, respectively. Mobinil follows with shares of 35.4% and 32.5%. And then it is Etisalat, the latest entrant to the market, with a subscriber share of 22.8% and a revenue share of 27.8% as of the end of 2014.

Mobinil, which is 98.92% owned by Orange of France and 1.08% free float, was the first operator in the market when it was awarded a licence in its former guise as the national incumbent in 1996. In March 2015 Egypt’s Orascom Telecom sold its 5% stake in the company to Orange for LE1.4bn ($190.8m). The second GSM licence was awarded in 1998 to Vodafone Egypt, under its former brand name, Click GSM. The Vodafone Group currently has a 54.9% share in the company, with the rest held by the state-owned TE at 44.7% and public, free-float shareholders holding another 0.2%.

Etisalat Misr was the last entrant to the market, when it won a GSM licence in 2007. Its parent company, Etisalat in the UAE, holds a 66% stake in the company, with the remaining shares held by the Egyptian National Post Authority (20%) and a number of private investors (14%).

Performance Indicators

Operators have seen fairly steady performance overall, and the long-term outlook is favourable, but they are nonetheless having to navigate an increasingly complex market, which is affecting some key indicators. Revenues have been impacted by currency devaluation and margins have been put under pressure by growing network costs associated with the rising price of energy in the country.

Beyond these cost implications, which are affecting a number of industries in Egypt, the mobile operators are having to come to terms with an increasingly mature market in which revenue growth from traditional services is becoming more and more difficult.

Still, by and large, mobile companies are in rude health. Vodafone Egypt achieved a net profit of LE513m ($69.9m) in the fourth quarter of 2014, a 1.2% increase on the previous quarter. For the full year, net profits reached LE1.85bn ($252m). The company recorded revenue growth of 1.4% to LE13.3bn ($1.8bn) and a blended average revenue per user (ARPU) figure of LE27.20 ($3.70) in 2014. The net profit margin was around 14%, a 10.8 percentage point decline since 2010.

Mobinil’s recent performance has in many ways mirrored that of the sector at large. Revenue growth hit 3.2% in 2014, the largest increase in the last five years, bringing total revenues to LE10.9bn ($1.5bn). However, the company has loans worth LE8bn ($1.1bn) – the result of an infrastructure expansion – and, although losses declined by 90.6% on an annual basis to LE30m ($4.1m) in the first half of 2015, debt remains an issue.

For the third operator, Etisalat, revenue in Egypt reached $1.3bn in 2014, an increase of 2% on 2013. Earnings before interest, taxes, depreciation and amortisation (EBITDA) reached $490m, with an EBITDA margin of 37%, three percentage points higher than in 2013. By the second quarter of 2015, Etisalat had a 24% market share and the company’s EBITDA margin was 38%.

Pricing Sustainability

The arrival of the third operator in the market six years ago has had a substantial impact on operator performance. Aggressive competition has led to a stark decline in ARPU and profitability. However, now that the latest entrant has gained a firm foothold in the market, the impulse to undercut the established operators is beginning to dull.

Overall, the operators are working on tight margins. “Etisalat Egypt is trying to increase profitability. They entered the market at a late stage and have been pushing competition for three years. So I think they are trying to rationalise now,” Ahmed Adel, senior analyst for telecoms at HC Securities, told OBG. “Mobile operators are not paying much attention to data. They are still trying to milk the voice market rather than paying attention to data.”

Voice ARPUs declined significantly after 2009, when Etisalat entered the market and started slashing prices. However, the rates have stabilised and now there is little price competition on voice services among the three mobile operators. “The market is a bit organised in terms of pricing,” Adel said. “I think it has reached a level where fighting each other [on pricing] is not useful.”

It is clear that in the short to medium term, the mobile operators will need to turn their attention to the data market, as increasing demand for data becomes a driver for future revenue growth. “In terms of voice ARPU, we might see additional downward pressure. Mobile data will provide the growth in ARPU going forward,” Karim Riad, telecoms analyst at Beltone Financial, told OBG.

Capital Expenditure

On the plus side, operators are still spending heavily on network infrastructure. Vodafone has already managed to upgrade as much as 80% of its network to enhance service quality. Etisalat is also investing heavily in this regard. Adel estimates an average annual capital expenditure for a mobile operator in the country would be LE2bn ($272.6m); Vodafone, for example, has recently increased its capital expenditure to LE3bn ($408.9m) per year.

Capital Expenditure

In June 2015 a social media campaign called for a boycott of the three mobile operators. The movement, “Internet Revolution Egypt”, was campaigning against low service quality and high prices and called for a five-hour boycott of the internet. The movement was not without merit, though at the time operators were paying closer attention to service quality and reliability. “Since the 2011 revolution, we have seen call quality go down,” Riad said.

The regulator has been vocal on this issue and implemented a number of quality reviews, although so far no sanctions have been taken against any of the operators.

Meanwhile, TE has moved on with its plans to upgrade telephone exchanges, which should result in improved quality.

“Lack of clarity is one of the main reasons operators have not been spending and it’s also a general sentiment because of what’s going on at the macro level,” Riad said. However, capital intensity ratios for the operators look relatively strong. In the last two years, the ratio has been hovering close to the 20% mark for Vodafone and Mobinil, with Etisalat increasing capital spending from 13.2% of revenue in 2013 to 18% in 2014.

Network Effects

Despite the high level of spending, some challenges remain in the field of network maintenance and expansion. One of the biggest constraints is the requirement for several administrative approvals to build new base stations. This is a slow and laborious process that inhibits network growth. Given this situation and the generally narrow margins experienced by operators, there are signs that the mobile companies may begin to shift to a leasing model for infrastructure, moving away from a burdensome capital expenditure model to an operating expense model which is focused on service provision.

In April 2015, for example, Mobinil sold a 99.99% stake in its infrastructure subsidiary, the Egyptian Company for Mobile Towers Services, to the UK shared infrastructure provider, Eaton Towers, for approximately LE1bn ($136m).

The move could signal a broader move towards leasing in the market. The deal gives Eaton 2000 mobile towers that will now become available for leasing, according to Towerxchange, and represents the first foray into this operational model in the Middle East region.

Meanwhile, government-led efforts to increase the provision of telecoms services to all of Egypt’s citizens continue, especially in those regions less economically viable for operators. If needed, the NTRA intends to support coverage extension to remote and underserved areas, through the utilisation of the Universal Service Fund, which was established by the NTRA in 2005. This policy was put into action most recently in a project to better connect areas near the southern border, a substantial undertaking which is expected to be completed by February 2016.

Data Capacity

Infrastructure quality and service provision are only likely to grow in importance over the coming years, as data services take centre stage. Data traffic in the Middle East and Africa region is forecast to increase by 70% per year between 2013 and 2018, according to Ericsson. While much of this will come from sub-Saharan Africa, the Arab world, and Egypt specifically, is also likely to see a major jump. The number of mobile internet users as a percentage of overall mobile subscriptions has already increased substantially. By May 2015, it had reached 25.24%, a 6.34 percentage point increase on the same month of 2014, according to the MCIT. Mobile internet subscriptions increased by a little more than 35% on an annual basis in the first quarter of 2015, the MCIT reported.

There is still ample room for growth. Egyptian smartphone connections had reached just 12% in 2013, below the regional average and well below the Middle East’s best performer, the UAE, where it was 80%, according to GSMA Intelligence. The challenge for Egypt’s operators is not only to capture a significant share of future growth, but also to turn it into higher revenues. The current uptick in data usage has not translated into substantial revenue gains for the operators thus far. Vodafone Egypt, for example, saw its data traffic double to 18.8 petabytes in 2013, according to GSMA Intelligence, although it has only had a modest impact thus far on overall revenues.

Arrival Of 4G

The introduction of 4G spectrum could shift market dynamics. The regulator has committed to offering the spectrum in 2016, though details are as yet unclear. The NTRA had planned to introduce an array of new licences under which the fixed-line incumbent, TE, would be able to compete in the mobile segment, while the existing GSM operators could compete on fixed-line voice and internet services. The MCIT has tasked TE with building, expanding and upgrading the existing infrastructure to create a more level playing field, working actively with different stakeholders to ensure the availability of required spectrum as well as the quality of infrastructure.

Riad told OBG that, working from precedent, the 4G licence could be offered for around LE4bn ($545.2m). For the sake of comparison, in 2010, Vodafone paid LE3.4bn ($463.4m) for a 3G spectrum licence, while in Morocco, a recent 4G licence was sold for $260m. The MCIT differentiates between license fees and spectrum fees, for which the final modality of offering has not yet been decided due to the inaccuracy of comparing 3G and 4G spectrum prices.

All of the mobile operators – Vodafone, Mobinil and Etisalat – have expressed interest in 4G for the benefits it would provide in terms of revenues, as has TE. Should TE bid, it will mean that the fixed-line incumbent will have to build a mobile network from scratch. While this will require substantial capital expenditure, it should not be too burdensome. “The 4G infrastructure and equipment is much more efficient, so infrastructure costs will not be huge,” Riad said. One basic estimate suggests one 4G base station will do the work of five 3G base stations. “The fixed-line business is a dying one, so it would be good for operators to bid for a mobile licence,” he told OBG. The other great unknown is what the 4G licence will mean for operators’ ARPUs and their bottom lines. The new spectrum is unlikely to provide a silver bullet to rapid ARPU growth.

“It is not like the operators are experiencing huge demand on data. It is a tool for long-term growth, so it will not happen overnight,” Riad told OBG. “On data, I would assume double-digit growth, especially with the 4G licence. But I do think under-investment in infrastructure is an issue and I do not think spending patterns of Egyptians will be focused on telecoms, so I do not think there will be a huge spike as soon as 4G comes.”

Fixed-Line Services

The unified licence regime and 4G will have noticeable impacts on the mobile operators, but the consequences for TE are potentially even bigger. TE provides the entire infrastructure in the fixed-line segment and thus has a monopoly on wholesale services. There are five main internet service providers (ISPs) – but 220 in total – that lease capacity from TE, including the country’s three mobile operators. For TE, more than 50% of its revenues come from the wholesale market, an area in which it dominates domestically. It recently cemented its position in the international segment of this market by signing new deals with Vodafone and Mobinil for access to its international gateway. In January 2015 it signed four-year deals with the two operators, under which TE will receive 35% of the revenues generated. The company’s goal is to achieve a minimum profit of around LE3bn ($408.9m) through these deals. The third mobile operator, Etisalat, has its own international gateway licence.

TE has been looking to bulk up fixed-line broadband infrastructure, and is currently in the process of replacing its copper wire infrastructure with fibre. In March 2015 it announced that it would spend LE3.4bn ($463.4m) on its infrastructure, the majority of which would be channelled into its new fibre network. This figure represents a capital expenditure record for the operator. TE announced that 4m of its 7m customers will be able to access services through the fibre optic network by the end of 2015.

The move is central to TE’s efforts to ensure fixed-line competitiveness against the rollout of mobile broadband. Fixed-line subscriptions fell by 9.14% on an annual basis in the first quarter of 2015. Consequently, the fixed-line penetration rate fell to 7.26%. One positive development for TE is that the ADSL subscriber base increased by 17.8% to as much as 3.27m in the same period. However, with USB modem (dongle) subscriptions growing by 11.48% and mobile internet subscriptions rising 35.05% in the same period, ADSL services face substantial competition.

Access vs Profits

TE’s prominence in the domestic wholesale market and the headwinds it is now facing have led to discussions over the company’s role. While the TE is protecting its shareholders’ returns, the government is at the same time making efforts to improve both pricing and access. The company’s board states that its obligations are to their minority shareholders (who hold a 20% stake in the company).

“The government claims that there is not good use of the infrastructure the company has because of the pricing they have set,” Adel told OBG. This led to protracted negotiations over the pricing structure for wholesale ADSL capacity in the summer of 2015, as the government sought to reduce the end-price of internet services to the consumer (see analysis).

Outlook

The continued negotiations over pricing and access are likely to be a defining issue for the sector moving forward. In terms of increasing penetration and developing new services, the operators will want to be assured of a transparent and competitive landscape before making further investments. However, the operators are in regular discussions with the regulator and ministry to address these issues and harmonise their strategies. A number of important measures have already been taken in this respect although still more remains to be done.

Nonetheless, the upcoming 4G licences are expected to bring about significant changes within the industry when they come into effect.

The introduction of this spectrum should present opportunities for the mobile operators to build ARPU on the back of new value-added services. Moreover, transparency regarding the terms of engagement will be increased and operators will begin to have a clearer perception of their relationship to TE in terms of access to existing infrastructure as well as pricing for interconnecting to their competitor’s network. This development will not only be to the benefit of the telecommunication companies, but also to the consumer.