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Telecoms Boom to Drive MENA Infrastructure Development Programmes

As GCC states embark on their massive USD3tn infrastructure development journey, the arrival of Amazon, Oracle and other global tech giants could push the telecoms sector into the frontline of that programme. But finding the funding for this costly venture at a time when oil prices are still low and coffers are thinning could prove challenging for the region.

Nov 20, 2017 // 1:55PM

As Middle Eastern economies push ahead with diversification and sustainability, transitioning from emerging to developed status, infrastructure is set to play a crucial role in enabling that process. The telecoms sector is one of the fastest growing and most strategically significant as it not only provides further incentive for infrastructure growth, but also helps to optimize and make more efficient existing facilities, as well as those in the making, especially in the renewables sector.

“Earlier this year Moody’s stabilized the ratings outlook for Abu Dhabi, the UAE and Kuwait, and KSA is on stable outlook, and that was driven in part by some of the reforms these governments have taken in response to the oil price shock,” Christopher Bredholt, a Moody’s Vice President and Senior Analyst, told Bonds & Loans.

The buzz around the IT and telecoms sectors in the region is very encouraging. Global tech giant Amazon has recently announced plans to place a foothold in GCC after it agreed to build three data centres, or so called “availability zones”, in the Middle East with support from existing power and communications networks.

Earlier in 2017, Jeff Bezos’ company inked a deal to acquire Dubai-based, one of the largest e-commerce companies in the Middle East, for an undisclosed amount, thought to be around USD580mn. As part of the deal with Bahrain, the GCC country will get full access to Amazon Web Services, with three availability zones offering a comprehensive collection of cloud services by early 2019. Amazon will also launch its first AWS Edge Network Location in the Gulf, specifically in the UAE, in early 2018.

“As countries in the Middle East look to transform their economies for generations to come, technology will play a major role, and the cloud will be in the middle of that transformation,” said Andy Jassy, CEO, Amazon Web Services, Inc.

The move indicates that competition for this market among cloud computing service providers is red hot, with other multinational giants like Microsoft, Oracle, Alphabet and Alibaba having already establish cloud nodes in the region. There is growing competition from some of the local players, which admittedly tend to resell localized versions of Google’s or Microsoft’s cloud services.

Earlier in October, another local firm – Khazna – announced plans to double its data centre capacity by end of 2019, with its facilities in Abu Dhabi and Dubai expected to deliver a combined 24MW+ of IT power and cover a build-up area of around 31,000 sq m across the existing facilities in in the country.

Industry analyst Gartner concludes that demand for cloud services in MENA is stronger than the global average, with the market set to grow 22% this year to USD1.2bn, compared to a global rate of 18%. And this growth spurt is not limited to data capacity, but includes other aspects of the IT and communications ecosystems.

Zain, Kuwait’s mobile provider, has agreed to sell and leaseback some of its physical infrastructure in the country to IHS Holding for USD165mn million. In early October, Omantel made a bid to buy a 12% stake in Zain (thought to be worth USD960mn), after purchasing a 9.7% stake in August.

Meanwhile, governments in Oman and Qatar are investing in national Fibre Broadband projects and trialling cloud hosting, while continuing to pour cash into the region’s telecoms providers. Last week Oman’s government scrapped a tender to invite a third mobile networks operator into the country in favour of launching a local telecoms firm backed by its sovereign wealth funds and some global investors.

The decision was taken to reinforce the role of wealth funds and have them contribute to economic growth, it said. Qatar, despite its current estrangement from its Gulf neighbours, is fast becoming one of the regional leaders in telecoms, a sector it hopes to expand as part of its mammoth USD200bn multi-year infrastructure upgrade ahead of hosting the World Cup in 2022. According to a Business Wire report, the country already has a vast array of networks and services on offer, such as 4G, M2M and fibre-based technologies (which already have a 99% coverage of Qatari households), and is also working on developing 5G networks.

“Manhattan of the Middle East”

All these developments paint a broader picture of rapid technological advancement sweeping across the region, with governments leading the way in attracting innovation as part of the wider reform agenda. According to Anita Yadav, Head of Fixed Income Research at Emirates NBD, the Middle East has circa USD3tn of infrastructure spending needs over the next two decades. Currently the total value of GCC projects which are either in pipeline, approved, planned or under construction stands at USD2tn, half of that is in infrastructure. A lot this relate to UAE (Expo2020), Saudi (Vision2030) and Qatar (WC2022).

Funding such a huge undertaking is challenging in the best of times – and those are long gone for the GCC with oil hovering above USD50, even as reserves are still ample. Yadav outlined several key sources of capital that the Gulf states are expected to rely on in the short to medium term.

“One is the PPP schemes. UAE recently approved the legislative measures / law relating to PPP projects which is likely to facilitate investment by Asian banks (from Japan, Korea, Taiwan etc) that have a lot of liquidity as well as experience of funding telecoms, into projects here. The second way is through the bilateral borrowings from the regional banks”, she noted.

“A third way is through the debt markets – conventional bonds and sukuk. So far this year we have already seen around USD80bn of new issuances. Also, a fourth potential avenue is privatization of government assets to beef up the sovereign coffers. Government capital could then be used to fund socioeconomic projects in the region. Effectively, all four of these sources are currently being used in the region.”

Building, expanding and streamlining telecommunications networks and infrastructure provides multiple advantages to Middle Eastern countries. It allows for cooperation between local providers and developers with experienced global players, as seen in the cases of IHS Holding and Zain or Bahrain and Amazon mentioned earlier. Many of the Western multinationals have sufficient resources, expertise and scope to modernize or build facilities from scratch, including the data centres and communication lines they require to introduce their service to the local population, setting a template for the local governments to boost private sector involvement in other industries. Importantly, these companies are prepared to work on greenfield projects too: as Yadav pointed out, cities in this part of the world are relatively new and are not burdened by “legacy” planning issues and structures.

They are not burdened with existing city borders, narrow roads or crumbling communication networks, everything is newly developed. “The governments in GCC are very progressive about adopting new technology and picking up future trends – just last month the Dubai authorities pioneered and tested flying taxis. It’s the Manhattan of the Middle East. It is easier for the government and local players here to adopt newer systems and technologies. However, low population density means project breakevens are higher, which makes infrastructure project funding a little bit more expensive. Another common challenge, as Yadav noted, is evolving regulation.

“A regulatory environment with no established track record of investor protection generally slows the investment cycle.” The multiplier effect – in terms of its value to the wider economy – is also important to bear in mind; newly built data centres and networks bring the region a step closer to creating “smart cities” running all sorts of interconnected devices, a concept tech junkies and technology marketing departments call the Internet of Things. Saudi Arabia and the UAE are looking to invest around USD49.3bn in smart city projects until 2025, according to Frost & Sullivan research.

Aside from improving the urban environment and people’s lifestyles, “smart cities” also provide a base for implementing digital solutions, like cloud based data monitoring and automation, which unlock a range of efficiency optimisation options for a host of sectors – power plants, cooling and water purification facilities, transport networks and hospitals, transforming communities into seamless interconnected ecosystems. Ultimately, this also benefits the state budget, helping governments reduce and streamline spending. Take the power sector as an example: according to Apicorp, GCC power capacity demand is required to grow at an average annual pace of 8% between 2016 and 2020 to meet demand, and Saudi Arabia is expected to invest USD133bn in electricity projects over the coming decade.

Yet, as Ghassan Barghout, president and CEO of GE Gas Power Systems for MENA, pointed out in a recent article, just 2% of data in the power markets is currently analysed and applied to improve operations, despite there being more than 3,100 sensors generating data in a single gas turbine with a power plant. Ironing out these inefficiencies could provide a huge economic boost, but they require more integrated communication grids and huge data centres.

Funding Innovation

The scale and number of individual parts that make up such a project also create an opportunity to diversify funding sources and structures, making a country’s capital markets more sophisticated. Focussing on the North American experience, Frost & Sullivan in their research outline a range of financing options that have been used to fund similar projects with some success.

Among them are state financing, including via debt markets, land monetization and sovereign wealth funds; institutional funding, either via structured finance or PPPs; and revenue based approach, such as through user or tap fees.

While not all of these are necessarily available or applicable at this stage in MENA, some are a good fit – and have already been implemented with relative success, sukuk being a prime example.

“If you look at telecoms, in general, those companies have been successful in issuing sukuk due to the provision of an innovative structure that involves mobile airtime vouchers, somewhat like airlines have been using passenger revenues for as the underlying asset for the sukuk. It is a type of asset that allows investors to go beyond the typical large assets on offer, in an instrument that is in principle asset heavy. And we expect this asset class to develop further in the next few years,” Bashar al Natoor, Senior Director and Global Head of Islamic Finance at Fitch Ratings, pointed out.

And cases seen in other sectors recently could provide an off-the- shelf solution for telecoms: for example, ACWA Power’s USD814mn 22-year bond secured by cash flows and other securities from 8 of its power generation and water desalinisation projects, or various airlines securitizing passenger seats.

“The project bond market in the region is still nascent, compared to say Western Europe, but deals like ACWA power set an important precedent, and the rounds of renewable energy tenders will likely contribute to development of nonrecourse project-bond type structures, both Islamic and conventional,” said Adam Muckle, a Moody’s Assistant Vice President and analyst.

As the digital revolution knocks on GCC doors, governments will be wary of the dangers that come with such rapid changes and innovation. For the likes of Amazon and Google, traditional regional hurdles are inevitable.

The region’s governments will likely look to maintain their grip on the key projects via 51% ownership rights. Another common challenge, as Yadav noted, is the low population density in this part of the world. The higher the population density, the higher the user base (and the less costly it is to connect that user base), so the cash flows are more consistent and reliable. That may not only thwart investment flows, but could also lead to underused facilities and services failing, which exposes another problem: regulation.

“A regulatory environment with no clear bankruptcy laws (aside from the UAE), means there is no safety net for investors. It is an evolving legal situation in the rest of GCC, so those aspects will need to be clarified.”

Finally, as Al Natoor pointed out, even if all the boxes are ticked, we are not going to see a sudden boom of project bonds and private investment around the tech sector.

“In trying to become an incubator for international players, you have to understand that these are new initiatives, and they require a level of education and a track record, perhaps not seen yet even in developed markets, to really take off,” said the Fitch expert.

Nevertheless, governments’ commitment to these initiatives, ample FXreserves, relatively strong credit profiles, and the regions proximity to Africa – on the doorstep to potentially the most lucrative market of the twenty-first century – mean that the Middle East is well placed to become a regional hub of innovation and technological advancement.

Middle East Policy & Government Macro CEEMEA CEE & Turkey

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