Vimpelcom Dials Up a Deal

http://www.investmentu.com/2010/October/vimpelcom-dials-up-a-deal.html

Investors may recall Vimpelcom ADR (NYSE: VIP) for the long legal battle over ownership of its Ukrainian telecoms assets. The contestants are its two biggest shareholders: Mikhail Fridman, the Russian oligarch behind the Alfa group, and Jon Fredrik Baksaas, CEO of Norway’s Telenor ADR (PINK: TELNY).

But now, Vimpelcom has gained attention for much more positive reasons: a merger. And one that will create the world’s fifth-largest mobile phone carrier as ranked by customers.

It plans to combine with most of Egyptian entrepreneur Naguib Sawiris’ telecommunications assets. That $6.6 billion deal will open further doors for Vimpelcom across the former Soviet Union, Asia, Africa and Italy.

By combining with Sawiris’ Weather Investments, it also secures a 51.7% stake in Egypt’s Orascom Telecom group and full ownership of Wind, Italy’s third largest mobile operator. In return, Weather Investments gets $1.8 billion in cash and a 20% stake – 18.5% of the voting shares – in the enlarged Vimpelcom… worth about $4.8 billion.

After the merger finalizes, Telenor will have 29.3% of the voting shares and the Alfa Group will have 36.4%.

Vimpelcom Likes the Weather in Russia

While Vimpelcom is Russia’s second-largest mobile operator, that country has a relatively mature mobile market. So it can definitely use the extra boost.

It does already have businesses in eight other countries in key areas such as central Asia. Vimpelcom gains significant growth potential from such countries, including Kyrgyzstan.

But this new merger gives it so much more…

It doesn’t give Vimpelcom access to Orascom’s Egyptian assets. But it does include the Cairo-listed company’s seven mobile businesses in Africa and Asia.

Those in Algeria, Pakistan and Bangladesh are especially significant. Orascom has operations where tremendous growth opportunities exist, including in the Central African Republic, where less than half the population owns a mobile phone.

The enlarged business will benefit from the near doubling of the number of its customers, since the mobile phone operator industry’s profitability rests largely on size: economies of scale.

It also enables Vimpelcom to expand into Africa and beef up its presence in Asia, where the company already has operations in Vietnam and Cambodia.

And Vimpelcom’s move into western Europe via Wind in Italy should help it gain valuable knowledge of the fast-growing consumer appetite for smartphones.

Vimpelcom Shares Tank on Rumors

Despite all that, investors don’t like the deal so far. Vimpelcom shares have tanked 10% since rumors about it leaked this summer.

Some think it can’t handle such a big shift away from its traditional base. Others worry about it taking on Weather Investment’s large debts.

Under the terms of the deal, Vimpelcom will accept $14 billion of Weather’s debt and issue an additional $2 billion. This means its net debt will increase from $4 billion to $24 billion… hardly desirable.

Additionally, Orascom’s Algerian mobile phone business, Djezzy, has an ongoing dispute with the local government, partly over taxes.

Djezzy, which generates about half of Orascom’s earnings, got hit with a $597 million 2009 tax bill. Since then, Orascom has struggled to get any of the cash it generates.

The larger company even tried to sell its African assets to South Africa’s MTN Group ADR (PINK: MTNOY) earlier this year. But discussions broke down after the Algerian government interfered.

In Vimpelcom’s favor, however, Russia has excellent relations with Algeria. So Russian President Medvedev is trying to broker a deal to the satisfaction of all right now.

The Merger Makes Sense for Vimpelcom

In the end, the merger actually does make sense for Vimpelcom and its shareholders.

Net debt will start out at 2.5 times earnings before interest, tax, depreciation and amortization. But with combined annual revenues of $21.5 billion, that should easily fall over the coming years.

Besides, Vimpelcom’s main telecoms market in Russia is stagnating; it needs to find growth elsewhere. And the smaller emerging markets of Africa and Asia offer just that.

In addition, while Orascom is a leading emerging markets player, it doesn’t have a prayer against giants like Vodaphone ADR (NYSE: VOD). Neither does Vimpelcom.

But together, they can really compete in the scale-oriented industry.

It might not be the ideal solution considering the uneasy alliance between Vimpelcom’s biggest investors. But it’s still not a bad one.

Good investing,

Tony D’Altorio