Mergers, Acquisitions and Financial Results

Top Kenya Treasury officials are in London to negotiate a multi-million-dollar deal with UK mobile phone conglomerate, Vodafone plc.

The UK company wants to acquire 9 per cent of local mobile company Safaricom Ltd, the largest operator in the market with one of the largest balance sheets in corporate Kenya - worth more than Ksh22 billion ($297.2 million) as at March this year.

Representing Kenya in the negotiations will be Finance Minister Amos Kimunya, Treasury Permanent Secretary Joseph Kinyua and Investment Secretary Esther Koimett.

The managing director of Telkom Kenya, Sammy Kirui and Safaricom's managing director Michael Joseph are also in the team.

Currently, the government - through Telkom Kenya - owns 60 per cent of the company, with Vodafone owning the remaining 40 per cent stake.

The government must raise Ksh27 billion ($375 million) to modernise the ailing Telkom Kenya and pay off more than 11,000 workers being sent home in what is going to be the largest retrenchment of workers by a public corporation in the country's history.

But it neither has the money to finance the retrenchment nor the financial flexibility to borrow it from the market, hence the decision to dispose of the 9 per cent stake in Safaricom.

One of the largest corporate organisations in Kenya, with a workforce of 18,000, Telkom is in deep distress with losses ranging from Ksh3 billion ($40.5 million) to Ksh5 billion ($67.5 million) per annum, according to a due diligence audit last year by audit firm PKF Consulting.

Indeed, Telkom Kenya's only valuable asset at the moment is the 60 per cent in Safaricom. Initially, the government refused to sell to Vodafone, literally sitting on a jewel even as Telkom Kenya was tottering towards insolvency. All along, the government's argument was that no potential strategic investor will take an interest in Telkom if its Safaricom shares are excluded from its balance sheet.

The change of mind was to come in March this year when President Mwai Kibaki announced that the government had decided to sell 9 per cent of its shares in Safaricom to the UK giant.

How much is the government likely to raise from the deal ?

So far, both parties have been playing their cards close to their chests, unwilling to give even the slightest indication of what the deal is likely to be worth.

A valuation of the company conducted on the government's behalf by the International Finance Corporation (IFC) - the World Bank's private sector-lending affiliate - has remained a guarded secret, its contents and recommendations only known to a few top Treasury officials.

But it is believed that during the London negotiations, the government will be basing its negotiating position on the basis on the work by the IFC. The IFC team, led by infrastructure specialist Javier Calvo, took up the assignment early this year and handed its report to the government several months ago.

Although the UK giant will naturally be bargaining for a low price, Vodafone is not expected to go below what it quoted in April last year when it made an offer to purchase part of the company.

In a letter by its chief executive for Americas, Africa and China, Gavin Derby, Vodafone had offered the government a cash payment of $100 million for an 11 per cent stake of the company.

The offer by Vodafone implied an enterprise value of $1 billion for 100 per cent of the company. A great deal has happened in the company since then and chances are that the UK firm will accept a much higher offer than it made in April.

Indeed, Safaricom has experienced phenomenal growth both in terms of turnover and profits since Vodafone made the $100 million offer for an 11 per cent stake in the company.

In March this year, the company reported a profit of Ksh8.4 billion ($113.5 million) up from Ksh5.8 billion ($78.3 million) in 2005.

Annual revenues increased to Ksh26 billion ($351.3 million) from Ksh18. 8 billion ($254 million) in 2004 and have been rising at a fast rate in response to phenomenal growth in subscriber numbers, now estimated to be over 3.8 million lines.

The company has projected the number of its subscribers to hit the five million mark by the end of next year.

The growth rate is unprecedented in the corporate sector, considering that six years ago - in March 2000 - revenues were at a mere Ksh1.6 billion ($21.6 million).

Experts are predicting that the deal could be concluded at between Ksh10 billion ($135.1 million) and Ksh12 billion ($162.1 million), making it the biggest transaction in the history of privatisation in East Africa.

Still, the worth of Safaricom Ltd remains an open ended question, with estimates changing depending on the valuation formula which one adopts and who is valuing the company.

It must be remembered that the $1 billion enterprise value which Vodafone quoted in April last year was nothing more than a mere negotiating position floated to kick start proper haggling with the government.

According to a valuation by PKF Consulting, which was appointed by the government, last year to advise on corporate restructuring of Telkom Kenya, the value of 60 per cent of Telkom's shares in Safaricom was in the region of $471 million and $790 million.

The audit firm said it had based this valuation on an analysis of Safaricom's financial statements up to March 2004.

But under other conventions, prices of telecommunications companies are valued on the basis of the number of lines and subscriptions a telephone company has.

Under one such convention, one telephone line is valued at $400. With Safaricom's lines having increased to an estimated 3.8 million, 9 per cent of the company is likely to earn the government billions of shillings.

Apart from price, another thing which Mr Kimunya's team will be negotiating with the UK giant is control of the company.

Going by the April offer by Vodafone, it is clear that the UK giant is prepared to give a better offer to the government, depending on the amount of control which the government is prepared to cede.

Had the UK company been allowed to purchase the 11 per cent share of Safaricom as it had asked in April, it would have assumed a 51 per cent controlling stake in the company. During this week's negotiations, the UK telephone giant will most likely to bring up the issue of control again.

In April, Vodafone had informed the government that it would be willing to support a listing of Safaricom on the Nairobi Stock Exchange.

This matter is expected to feature prominently in the negotiations because the UK company would appear to be keen on situation where - after the sale of the 9 per cent stake is completed - both itself and the government will follow by selling more shares on the Nairobi Stock Exchange under an arrangement that will allow it to remain as the anchor shareholder in the company.

It is noteworthy that PKF Consulting had in its report of last year advised the government to sell only 9 per cent of the shares to Vodafone.

The audit firm suggested that with Vodafone at 49 per cent, the government can then negotiate a shareholders agreement whereby both of them can each dispose 12.5 per cent each to the public, allowing the public to end up with 25 per cent shares of the company.

Whichever way things go, whether the government succeeds in what it wants with Telkom and Safaricom will still depend on the goodwill and co-operation by the UK giant.

Under an existing shareholders' agreement signed in 1999, the government cannot sell shares of Safaricom without the consent of the UK giant, which has pre-emptive rights over the shares.

East Standard