Deep pockets and a superior ability to manage regional risk have prompted telecommunications companies from the Gulf Cooperation Council (GCC) states—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE)—to launch aggressive expansion strategies, such as investing in African and Asian countries while most Western companies have hesitated. In some markets, these efforts are starting to pay off as potential growth turns into real revenues. But to build on this initial success, GCC telcos must enter a new phase and become masters of execution.

The GCC’s integrated and wireless telecom companies have grown rapidly over the past three years under near-ideal conditions at home. Typically, only one or two operators are licensed to compete in each of the GCC’s markets, which boast high penetration rates (in certain cases, blanket coverage) and affluent subscriber bases. Average revenues per user and pretax margins are some of the highest in the world. GCC companies also rank high among global competitors by such measures as market capitalization, despite the relatively small size of their home markets, which range from 0.8 million to 18 million subscribers.

With substantial cash flows and saturated markets at home, GCC telcos have started looking abroad for growth opportunities. Kuwait’s Mobile Telecommunications (MTC), for example, bought Celtel, Africa’s third-largest mobile-phone operator, for $3.4 billion in 2005. The deal gave MTC licenses in 13 African countries, most with mobile-penetration levels well below 20 percent; since then it has added two more African licenses to its portfolio. GCC players have focused on expanding into neighboring regions in Africa and Asia for a number of strategic reasons. Cultural affinities and existing relationships, for instance, have helped make such acquisitions less risky (and therefore more valuable) than similar moves by European or North American telcos might have been.

Low penetration rates in these new markets make it likely that leading GCC players will pursue organic growth and further acquisitions throughout Africa and South Asia. For those that venture into foreign markets, the key to long-term success will be focusing aggressively on execution. In addition to being careful not to overpay for acquisitions and wireless licenses as the appetite for growth rises, such companies must implement effective governance models to control their new multinational operations, master cost reduction strategies, and create performance-based meritocracies to attract and advance the best talent. For many GCC telcos, these will be new skills, but they will be crucial for any company that hopes to thrive in the new territories.

As opportunity beckons . . .

Africa, the countries of the eastern Mediterranean, and South Asia—markets abutting the GCC—have substantial pent-up demand for telecommunications services, and fixed-line networks in these countries cannot meet this demand. By and large, their domestic public telecom monopolies, strapped for funds and hindered by slow-moving bureaucracies, haven’t built the infrastructure needed to connect all of their populations to wireline services.

Mobile phones have addressed some of this demand, but so far mobile services have been too expensive for large numbers of low-income consumers. Handset costs and subscription fees are particular obstacles for this segment. (Airtime charges are less significant, since subscribers feel they can control their own usage, and in most markets in these regions the calling party pays.) As a result, mobile-phone penetration levels are significantly lower than 20 percent in many markets, particularly in sub-Saharan Africa.

Another driver of potential demand, though still in its initial stages, is the promise of mobile data applications that enable Internet access, e-mail, and other functions. With underdeveloped fixed-line telecom and cable networks in many of these markets, wireless solutions are required to fill the digital gap. For many customers in the region, their first experience with the Internet and other data services will be wireless. In Pakistan, for instance, mobile data technologies are already in the early stages of deployment, while DSL and cable data offerings have never reached their full potential, primarily because fixed-line services lack the reach and network quality is poor even in penetrated areas.

The potential for growth that these conditions imply is attracting interest from telcos around the world, but those in the GCC have inherent advantages over their Western competitors. To Western telcos, for example, future earnings from a company in North Africa may be uncertain because of the risk of political disturbance or expropriation. The boards of Gulf companies may be less worried about that prospect, however, since in many cases they know more about the legal systems and cultures of neighboring markets. Also, since both the GCC acquirer and the African or Asian target company are typically linked to their home governments, negotiations could take place in a broader regional context, giving GCC executives easier access to the real decision makers and, perhaps, assurances that investments will be protected. During the negotiations between the UAE’s Emirates Telecommunications (Etisalat) and Pakistan Telecommunication (PTCL), for example, the governments of both countries were deeply involved.

. . . competition rises

Tempted by the opportunities, GCC telcos have been busy acquiring assets in Africa and Asia, as well as in Middle Eastern countries outside their home markets (exhibit). Besides taking control of Celtel, for instance, MTC has bought controlling stakes in companies in Jordan, Nigeria, and Sudan. Meanwhile, Etisalat has acquired mobile licenses in Egypt and Saudi Arabia, as well as 26 percent of PTCL and 50 percent of Atlantique Telecom, which has operations in West Africa.

Although the opportunities are real, GCC telcos—flush with money that is pouring into their home markets from high oil prices—must be careful not to let their enthusiasm get the better of them. Following the telco bust of 2000, the industry surely needs no reminder of the costs of excessive exuberance. But if it does, consider the case of Pakistan. In 2004 it auctioned off its fifth and sixth mobile licenses for about $300 million each—more than twice the amount some analysts expected. But while penetration has grown to 15 percent, from 5 percent, over the past two years, frantic competition has pushed prices down by 60 to 80 percent, straining margins for all players.

In the frenetic land grab now under way, the leaders of GCC companies will have to exert significant discipline not to overbid for acquisitions. One way might be to avoid head-to-head bidding wars for high-profile targets and, instead, to look for opportunities to consolidate fragmented markets where intense competition might drive out smaller players. Some of the players in Pakistan, for example, may be exploring opportunities to exit. The Pakistani market could offer the consolidator an opportunity to shape the market and introduce structural improvements that could raise margins.

Focus on execution

Barring unforeseen disruptions—such as a collapse in oil prices or a broad regional conflict—we expect two or three leaders to emerge in the GCC telco industry over the next five to ten years. In many mature markets, high prices for telecom licenses and acquisitions have led to intense competition and inadequate returns, sparking a round of consolidation to restore profitability to sustainable levels. A similar trajectory in the GCC is likely to yield a small number of companies with operations that span the Middle East, Africa, Central and South Asia, and perhaps even Eastern Europe. The best may have market caps that put them among the top ten global telcos.

To reach this pinnacle, however, Gulf telcos must execute more efficiently than they have in the past, focusing specifically on three challenges.

Corporate governance and control

GCC telcos must protect their substantial overseas investments by ensuring that they have the organizational structures and processes in place to manage acquired assets. Too many companies focus heavily on deals but overlook the challenge of postmerger management. In several instances we’ve seen, governance models at the acquired company remained undefined two or three years after a deal was completed. As a result, parent companies have limited insight into the finance and operations of the acquired companies and less ability to set performance targets.

Further, the absence of strong monitoring and control mechanisms means that parent companies must rely on trusted, tenured managers—often sent from headquarters—to oversee acquisitions. This approach not only drains off talent in the home market but also makes it harder to retain and promote the best managers of the acquired companies.

To avoid this trap, GCC telcos must begin planning for postmerger governance well before a deal is completed. One necessary step is to undertake a careful assessment of the quality of managers at the target company to determine whether it should be integrated closely into the parent or allowed to continue with little interference; a governance model between these two might also be appropriate. With each acquisition, the parent must determine how often to set performance targets and evaluate them, as well as establish clear procedures for defining strategies and allocating capital, among other key decisions.

Unless the acquirer addresses the problem of governance in a timely way, the inherent uncertainty generated by a takeover could also prompt the target’s top talent—the people most likely to have alternative offers—to leave. That would increase the burden on managers who stay and reduce the likelihood that the acquirer can earn adequate returns from a deal.

Talent management

In most instances, competition in the new markets will be more intense than it is in a GCC company’s home base, where many telcos have enjoyed a monopoly. As attackers, they will find that efficiency and productivity are crucial, requiring them not only to improve the skills of their current managers, but also to attract and retain talent in new markets.

To groom enough talented managers, GCC telcos must abandon the unwritten policies that favor GCC nationals, especially at top-management levels. Like uncertainty linked to gaps in governance, this long-standing practice makes it hard to retain able foreign managers. Favoring nationals does provide welcome training and opportunities for the Gulf workforce, but a glass ceiling for foreign managers creates significant obstacles when a company tries to recruit expatriate managers or to retain the best talent at a company it acquires.

Gulf telcos should implement transparent, performance-oriented systems that base promotion and pay raises on merit rather than on tenure or national origin. A performance culture will open the door for foreign talent to advance and pressure all managers to raise their skills and contributions. Some GCC telcos have successfully used large paychecks as an incentive, but competition for talent is heating up. From 2004 to 2006, salaries for managers with specialized skills (such as managing relations with regulatory authorities) have doubled, and further increases are expected. The career-advancement opportunities that a performance culture creates would supplement financial incentives and relieve some of the upward pressure on salaries.

Organizations should also introduce mechanisms that allow top managers to rotate among divisions and national units. This approach helps spread best practices throughout the parent company and also allows top performers to build their internal networks and increase their exposure within the company. Managers who have led a successful initiative in their home country, for example, could move around a company’s other operations in order to launch or guide similar initiatives there. Top performers could also receive multiyear assignments in other units or locations or even permanent transfers.

Mastery of the low-cost strategy

In the new markets, GCC telcos must also serve low-income users profitably. While companies from East Asia, India, and Latin America may have more experience with low-income users, executives at Gulf telcos are hardly starting from scratch. GCC operators, for example, have served low-income foreign laborers working in the GCC states, and that experience could provide insights into this customer segment’s usage patterns and needs. (A key difference, however, is that many calls by low-income foreign workers in the Gulf are made to their home countries, while most of the traffic for low-income segments in the new markets would be domestic.)

The minimum cost of ownership—the monthly amount required to maintain an active mobile subscription—is a crucial barrier to increased market penetration in low-income environments. The price of handsets is a major component of the total cost of ownership, but GCC telcos can work to make them less expensive. Many subscribers in emerging markets are interested in a phone’s basic functions—voice calls and SMS (Short Message Service) text messages—and little else. For them, battery life (especially in regions with unreliable electricity) is more important than high-quality ring tones. GCC telcos are working with branded manufacturers to develop inexpensive handsets, some for as little as $17 each, to meet these basic needs. Refur-bished handsets, recycled from other markets, can help reduce up-front costs further.

Another way to lower the cost of ownership is to eliminate the need to own a handset altogether. One example: “mobile pay phones” carried by individual street vendors who sell airtime on their own handsets. The charges are usually tracked with a stopwatch and vary by the time of day. Applications such as Celtel’s One4all help monitor airtime, cut off a call after a set period, and display preset charges. Such applications can give the vendor an efficient way to resell airtime in the smallest denomination possible, thus allowing operators to reach out to the market’s lowest-income segment.

GCC telcos must overcome many challenges if their experiment with expansion is to succeed. If they fail, private equity players will probably seize the missed opportunity (as they have in some parts of Western Europe), picking up acquisitions at relatively low prices and capturing the value that the GCC telcos couldn’t harvest.