Telkom, Airtel merger in peril hours to D-Day

The planned merger between telecommunication firms Airtel and Telkom Kenya is hanging in the balance as an ongoing investigation by the anti-corruption watchdog stretches beyond the completion deadline agreed between the two companies.

Airtel and Telkom, which are Kenya’s second and third-largest telecommunications firms respectively, had set tomorrow, September 27, as the final date by which they were to have negotiated and signed the merger agreement that they first announced in February.

The Ethics and Anti-Corruption Commission (EACC) however instructed regulators to suspend the merger pending conclusion of investigations into how the transaction was conceptualised, and how the Treasury ceded further ownership of Telkom Kenya to Orange, the French multinational which later sold its stake to private equity fund Helios. The Treasury has a 40 percent stake in Telkom Kenya, initially a fully State-owned corporation, while Helios controls 60 percent shareholding.

“There is no chance it (the merger) will happen by Friday and there is no guarantee that Airtel will agree to a new signing date especially with the uncertainty of the ongoing investigations,” said a source familiar with the ongoing transaction.

The EACC investigation has thrown a spanner into the works that was intended to hand the two telcos a lifeline by increasing their subscriber base, reducing their average operating costs and increasing their economies of scale. In turn, these were expected to increase the competitive edge of the merged entity.

People involved in the negotiations have said that if the deadline is missed, this could possibly lead Airtel to walk away from the deal, weakening the two operators’ chances of challenging Safaricom’s dominance of the market on the one hand and making it difficult for them to leverage their respective strengths in the merged entity on the other.

“A board meeting has been called next week where the issue of the merger will be discussed with a view of negotiating new timelines with Airtel,” said another source with knowledge of the matter.

EACC last month instructed the communications regulator and the Competition Authority to suspend their approval of the merger to allow investigators review a 2012 restructuring that whittled down the government’s stake in Telkom Kenya. The investigation has been going on without clarity on when it will be completed.

Telkom Kenya, which has been making losses for the past ten years, has been surviving on asset sales, making the merger urgent for its survival. Airtel Kenya, on the other hand, is keen to grow its revenues by leaning on the economies of scale expected from the merger.

EACC has been questioning both former and current officials on how the government shareholding was diluted during a restructuring in 2012.

Telkom was privatised in 2009 when France Telecom bought a 51 percent stake from the government, which held on to the other 49 percent. Between 2009 and 2016, France Telecom invested $900 million (Sh90 billion) into the business while the governed put in $100 million (Sh10 billion).

In 2015, France Telecom sold its stake to Helios, a Private Equity firm that agreed to put money into the business on condition that the regulator would review mobile termination rates (MTR), a fee charged on calls and texts completed on rivals’ networks. Helios was also promised regulatory interventions on inter-operability and national roaming services. In exchange, the government, got a 10 per cent stake that raised its shareholding to 40 per cent under the Helios deal and also got interest in 40 per cent of shareholder loans advanced by France Telecom to the company.

In the intervening period, Helios has reportedly invested $50 million (Sh5 billion) that went into network rolling, rebranding, T-Kash (mobile money service) and leveraging debt. The government on its part gave Telkom a 4G license valued at Sh2.5 billion, a payment in kind for its commensurate stake.

Despite the investments, Telkom Kenya is still deep in the red, a factor it attributes to the high costs of running the mobile telephone business.

Management consultancy firm McKinsey, which studied the viability of the business last year, concluded that its mobile business unit could neither keep up with the required investments in technological advancement nor carry the costs and compete with global players with economies of scale and with operations in more than one country. The study recommended a merger with Airtel and regulatory interventions to allow the firm to compete.

The report said that even with significant inflow of shareholder funds, the mobile business structure was untenable. Telkom was making about Sh3 million per base station but incurring twice as much in costs. Both Airtel and Telkom are running 1,600 base stations each. Safaricom, with 5,000 bases stations, serves 31.8 million subscribers and makes 20 times Telkom’s revenue, which brings down its average operating costs.

A merger between Telkom and Airtel would result in a combined 17.3 million subscribers and 3,200 base stations, but which would be cut down to about 2,500 once the two companies bring down those in close proximity to each.

The merged entity would also have an edge with economies of scale in procurement, sales and distribution. For instance, while Safaricom normally leverages on Vodafone and Airtel on its mother company while making capital expenditures, Telkom has to go to the market alone, missing out on quantity discounts.

According to a letter that Safaricom wrote to the regulator, the merged entity may even have a superior network with a bandwidth of 77.5 for its 17. 3 million subscribers while Safaricom will have 57.5 per cent spectrum for its 31.8 million subscribers. The merged entity will take up the mobile subscribers, fiber and part of Telkom’s enterprise business that is not linked to government and security services, base stations and the distribution network.

Telkom Kenya could shrink to about a tenth of its size, and be left with managing services for government and security organs. It will also be allowed to keep real estate whose valuation is estimated at about Sh10 billion. However, sources say that if the merger is not concluded in good time, Telkom’s thinning real estate portfolio is unlikely to sustain the company over the long term given its accumulated losses and mounting debt.