A BRIEF ANALYSIS
This report was written on 5 Dec 1998, as a comment on the then imminent privatisation of Qatar Telecom QSC. At the time there were no readily available reports to explain to interested laymen this potential investment. Staff in my company repeatedly came asking for advice, and rather than keep repeating the same answer, I decided to write this report and send it electronically to all employees.
It is published here because there is still very little publicly available comments on QTel.
A .rtf version is available here.
If you have any comments, please email me Emad Khader.
To buy QTel or not to buy QTel, this is now the question. Too many unknowns and uncertainties complicate the decision. To the expatriate, the uncharted waters of being able to own assets in Qatar and the potential risks (real or imaginary) of doing so adds a further question mark.
To help you make an informed decision; I will briefly review the global telecommunications environment, analyse QTel business numbers and try some crystal ball gazing. However, be warned. I am a Communications Engineer and not a licensed financial adviser. I will not make recommendations on what you should or shouldnít do. This is, as always, your decision.
GLOBAL TELECOMMUNICATIONS ENVIRONMENT
I will not try to show how important telecommunications is to the global economy and our way of life. This is now a given and is illustrated by global telecom service revenues in 1996 of almost QR2.5 Trillion! Instead, I will discuss the rapid growth of lines and revenues and the impact of global privatisation of telecommunications services. Let us start with the rapid growth of mobile telephones.
Mobile telephone numbers have grown from about 15m in 1991 to 150m in 1997 and are expected to reach 300m by 2000! The chart below shows this has not been at the cost of fixed telephone lines. Rather the whole market has grown.
In addition, the rapid decline in call charges has not affected the phenomenal growth in revenues as illustrated by the chart below.
Last August in Finland, mobile phone penetration had reached 50% of the population and was still growing. In other words there was more than 1 mobile phone for every adult in the country. If this trend is copied in some of the major economies, all growth predictions will have to be revised upwards in a major way.
Internet growth has been explosive and shows no sign of slowing down. If one considers that 70% of US corporations are on-line, compared with 10% in Europe and a very low 1% in Asia, the potential for further growth becomes self-evident. There were 29 million hosts in February 1998, with an expectation the number will rise to 90 million by 2000. The following chart illustrates Internet growth over the past few years.
Internet will prove a gold mine for telecom companies. Not only they will earn money for providing links to Internet service providers, but also they will earn from being service providers themselves, from the expected growth in telephone lines and additional telephone calls Internet users will need and make.
Over the past few years video-conferencing (the ability to have a conference between two or more parties with both voice and video) has taken off. While global numbers are not available, it is becoming increasingly clear that it is the Ďnext big thingí. Better still from the point of view of telecom companies, it does not cannibalise their existing business. It is seen as a replacement for air travel and not for the phone or fax.
Electronic commerce allows customers to check stock, order, acknowledge delivery and pay by using computer-to-computer links. Transactions are thus faster and cheaper. E-commerce is becoming essential for Ďjust-in-timeí manufacturing. Electronic commerce is predicted to grow from about QR30 Billion in 1998 to QR1.2 Trillion in 2002. Mind boggling numbers indeed.
Telecom companies can derive huge income from this growth. They will provide the infrastructure, secure means of transactions, consulting services and if they are enterprising enough one-stop-total-service-shops, earning commissions on the huge amounts of money going through their networks.
Other communications services and revenue increases for telecom companies will result from the explosive growth in intranets, extranets, call centre services, Centrex services and so on. Figures for these run into the Billions of QRs and are rising. Suffice it to say, these will just mean additional huge profits for telecom companies.
Privatisation of government telecom monopolies has been a feature of the 1980s and 1990s. In rich countries and poor, governments hungry for cash or needing private sector investments and expertise have been privatising their telecom monopolies. The results have been dramatic, as the above sections have shown.
The chart below shows the number of telecom privatisations over the last few years.
The above chart shows conclusively that privatisation is here to stay. With the emergence of a global market place of telecommunications and with cross shareholdings between the major players, it should prove almost impossible for any one government to reverse track and renationalise telecom service providers.
Impact of Competition
The liberalising of telecom markets that went with privatisation has allowed competitors to emerge for the ex-government monopolies. This competition did mean that these ex-monopolies have lost market share (as they must, considering they started with 100% share). Competition by providing better and cheaper services has helped expand the overall market. Paradoxically, the revenues and profits of the ex-monopolies have soared as their market share shrank. A case in point is Telstra in Australia. When Telstra was privatised, the government introduced a regulatory regime that was very much against Telstra in the hope of encouraging viable competitors to emerge. Even so, Telstraís revenues have soared from QR16 Billion in 1990 to QR27 Billion in 1996. This is an increase of 9.1% pa. Quite impressive for a company operating in a regulatory regime designed to limit its advantages in a country suffering from the effects of a major recession!
Putting it in Perspective
Telecommunications services have recently grown far faster than world gross domestic product (GDP). Since 1990 telecom services has shown consistent and accelerating growth while GDP growth has been patchy. Impact of new technologies will mean this growth differential will, if anything, increase. Telecommunications is the service industry of the future. The chart below illustrates this point very well.
QTel (and its predecessors) has been the monopoly service provider in Qatar. Since 1987 it has been totally under government control. Government control and resultant emphasis on providing a national infrastructure have resulted in large investments to provide a high quality communications service throughout Qatar. On the negative side it has deprived QTel from access to international management and technical expertise with the result it no longer meets international best practice yardsticks for efficiency and responsiveness to customer needs. However, total lack of competition have shielded QTel from market pressures and allowed it to grow at an impressive rate.
Details of QTel operations are provided in the prospectus. I encourage you all to read it carefully. What I will do is summarise some relevant points and try to guess at future numbers. I will use linear regression of QTelís numbers from 1993-1997 to estimate the next 5 years. It is very unlikely that future growth will be linear. The following numbers should, therefore, be treated as very conservative.
Fixed Telephone Services
Fixed telephone lines, ie, those connected to the customer premises via copper or fibre-optic cables have grown to almost 142,000 lines in 1997. The following chart estimates a linear trend future growth.
QTelís wireless services; GSM, pagers and Pay-TV have also shown very robust growth and are expected to continue to do so. GSM in particular should more than double in the next 5 years.
The above chart assumes existing growth rates will continue in the future. A more likely scenario is the pager service will stop growing and that GSM growth rate will increase correspondingly. As GSM is a higher margin service, this can only be beneficial to QTel. A revised chart for this scenario is shown below.
QTel Internet service has grown from 2145 accounts in 1996 to 5293 accounts in 1997. That is, in its first full year of operation growth was a phenomenal 147%. It is difficult to predict Internet growth in Qatar based on international experience. The demographics (a large number of unskilled low paid expatriate workforce), local culture and sensitivities all militate against Qatarís numbers faithfully following western patterns. However, the future belongs to the Internet and QTelís income growth from that stream is assured.
The point of any investment is making money. So how do QTelís numbers look? What can we expect in the future? For my version of the future, please read on.
The prospectus has QTelís accounts for the last 5 years. Using linear regression and extrapolating for the next 5 years is straight forward. The chart below shows QTelís projected operating revenue and expenses for the next 5 years.
Let us at look at the more important numbers of PE (price earning ratio) and dividend yield (assuming same payout ratio as that proposed for 1999). These numbers are based on the issue price of QR60 a share and allow an estimated 1% directorsí remuneration (from 1999) and 25% royalty (from 2002). The 26% hit on profits due to these items is painful. However, the numbers still look very healthy. For a communications company they look very impressive.
The ĎNo-Changeí case above establishes an ultra conservative position, which may be viewed as a worst case scenario. More realistically, we expect QTel to benefit greatly from being given a commercially oriented board and management team.
I believe it safe to assume that QTelís revenues will grow at least as fast as Telstra. QTel is not as efficient as Telstra was before deregulation (I was shocked when I first went to QTelís offices to apply for service!), and therefore its room for improvement is much larger. Also, QTel still has an absolute monopoly and therefore can manipulate its market almost at will. The numbers are not that different from the 'No Change' scenario where average growth rate over the same period is 7.7%. The charts below reflect an operating revenue increase of 9.1% from 2000 (to give management time to have an impact).
On the expenses side, QTel has too many staff for the number of lines and its decision making is too concentrated at the top management layers. A ruthless drive for efficiency should result in staff number cuts of at least 30% (which seems to be the benchmark normally touted as easily achievable by a restructuring organisation) and in savings across the board. However, to be on the safe side, we assume a 10% reduction in staff costs and a 15% reduction in administration costs. We allow for these from 2000 onwards.
When we apply the analysis as before, we obtain the following chart for PE and dividend yield.
Blue Sky Case
When we consider the explosive growth of the Internet, the mind boggling numbers of electronic commerce, the 50% (and rising) penetration of mobile phones and Qatarís predicted economic growth from 2002 onwards, it suddenly appears possible that QTel revenue and profits can easily show double figure growth rates for the foreseeable future. I will not attempt to put figures on this case (my crystal ball suddenly got clouded). It looks imminently feasible that unless QTelís new management proves particularly inept, QTel profit could reach QR1 Billion before 2005.
Risk factors are covered well in the prospectus. The one factor I am consistently asked about which is not in the prospectus is the potential for the Government to suddenly reverse direction and re-nationalise QTel. This in my view is extremely unlikely. Qatar has a bright future because of its huge gas reserves. However, to get the gas out of the ground, billions of Riyals worth of investments are required for the next 3 years. These can only be raised by further privatisations. Privatisation is the wave of the future and there is no turning back the clock.
A change in the regulatory regime where QTel loses its monopoly will actually be beneficial to the company. The 25% royalty disappears giving QTel a significant windfall. Also, if other markets are any indication, competition will increase the overall size of the market, thus increasing QTelís profits. Let us remember that QTel will still own the cable network into all our homes. This will give it a dominant market position for at least the next 10 years (until wireless local loop technology matures).
As stated at the beginning, I am not a licensed financial analyst and cannot make recommendations. What is a good investment for you depends on your particular circumstances. How far away from retirement are you? What are your financial commitments over the next few years? How much you can afford to lose? What is the profile of your other investments? Etc.
As a Communications Engineer, I believe QTelís numbers are impressive. I believe it is still good value as a communications company at a PE of 17 (about QR90 a share).
Any decisions you make are yours and yours only. Just as I do not expect you to hand me back any profits you may make, I will not accept any blame for any losses either.
International Telecommunications Union, British Telecom, The Economist
©1998, Emad Khader