Nigeria unit’s default poses questions for Etisalat

Etisalat Nigeria, a Nigerian telecoms company owned 45 per cent by Mubadala and 40 per cent by Etisalat, was reported to be effectively bankrupt over a US$1.2 billion default and was taken over last week by a syndicate of Nigerian banks. There are two broad themes that this represents that I think are instructive and they are the entry into the investment as well as its operation followed by the exit from the investment.

Let’s start with the exit. I have never seen research on the use of capital injections to support SWFs or their underlying portfolio but I was under the impression that this was usually always provided. The fact that Mubadala and Etisalat were willing to let go of egos and allow what they believe to be a bad investment to go is quite welcome. As we say in the region, they didn’t try to save face. This is the professional route. Only history will show whether this is an underlying philosophy for these companies or a one-time event.

The question on the exit would not be complete without also looking at whether standing back made commercial sense, as opposed to investing further funds. I will not do an economic analysis but suffice to say that a World Bank report states that due to the drop in oil prices (Nigeria is an oil exporter) Nigeria went into recession in 2016 and inflation reached 19 per cent. You don’t need to delve further to realise that there were sound economic decisions for Mubadala and Etisalat to back away.

I am not so optimistic about the performance of the two in entering and operating the investment. The company was established in 2008, which was the beginning of the global financial crisis. But nobody would be expected to forecast that and certainly it does not seem like it had a materially adverse effect on Etisalat Nigeria. The problems appear to stem from the collapse of the oil price in mid-2014, which subsequently led to a recession in Nigeria with high inflation. Under such circumstances it is understandable that the business environment deteriorates.

What is difficult to understand is why companies already based in an economy with a high exposure to oil prices would increase their exposure to oil. Especially since they each independently had already increased their exposure to oil – Mubadala via direct investments in the sector globally and Etisalat via operations in countries such as Saudi Arabia, which is even more dependent on oil.

I tried to get some insight by looking at Etisalat’s 2016 annual report. The problem is that since Etisalat owns such a large percentage of the company the financials are consolidated, ie combined with all the other operations of the group. To its credit, Etisalat does talk about each subsidiary separately. The annual report begins the Etisalat Nigeria section with “in 2016, the Nigerian telecommunications sector was confronted with considerable challenges, as the country’s economy slipped into recession and regulatory constraints persisted”. After those 22 words the next 490 words of the review are optimistic about the Nigeria operations. There is no direct warning that Etisalat would lose the company due to a default in a mere six months.

Remember, Etisalat is a listed company and has reporting standards as part of its fiduciary duty to it public shareholders. Mubadala of course has no such reporting duty to the public. Now, I said that there was no direct warning, but there certainly is at least one indirect warning. Etisalat, using large icons and large font in the margins, disclose the revenue, Ebitda and capex of Etisalat Nigeria. Here’s the warning: for its Morocco operation, reported right before Nigeria, and Pakistan, reported right after Nigeria, Etisalat additionally reports the P/L and the Ebitda margin. Why did Etisalat withhold these important numbers from the public? How can Etisalat not have known that within six months its subsidiary would default? Was it incompetence? Was it neglect? Was it an ethical issue? It is important to understand the answer.

One clue is what happened with Saudi unit Etihad Etisalat, also known as Mobily, in which in addition to holding a sizeable equity stake it also had a management contract with. A restatement of the financials at the firm for 2014 led to about Dh1.7 billion in profits subsequently being cut. This led, at least in part, to Deloitte, one of the big four audit firms, being banned by regulators from auditing listed companies in Saudi for two years. Etisalat’s management contract for Mobily was not renewed.

Given the public information available there seem to be operational weaknesses within Etisalat, at least in terms of its international operations. If a unit misstating Dh1.7bn in profit is reported as a scandal, then what do you call losing a whole ­subsidiary in a default? Worse, what do you call it when you don’t warn your shareholders?

Earlier this year, Sheikh Mohammed bin Rashid, Vice President and Ruler of Dubai, spoke at the World Government Summit and of the many points that he emphasised two relevant ones here are “We don’t tolerate corruption. We have zero tolerance here” and “Arab leaders are surrounded by officials who keep saying everything is fine”. I agree. I would, however, respectfully and humbly add one more point.

Incompetence costs us far more than corruption. We should also have zero tolerance for incompetence and when managers say everything is fine, they need to be challenged as to whether the issue is exogenous events or incompetence.

This article was originally published in The National.