I. Background on Zain
Zain Group first rolled out in 1983 in Kuwait, making it the pioneer mobile operator in the Middle East region. The Group’s expansion strategy was adopted in 2003 and it has seen tremendous growth since then.
Presently, Zain Group is a top mobile and data services operator having a commercial footprint in some 7 Middle Eastern and African countries. The company boosts of a huge workforce of 6,000 that serves the customer base of over 41.4 million business customers and active individual.
Initially, the telecommunications company was known as the MTC Group but rebranded to Zain on September 8, 2007, making it the Group’s corporate master brand. The Group is known as Zain in Bahrain, Jordan, Kuwait, Saudi Arabia, Iraq, and Sudan and MTC Touch in Lebanon on management contract basis.
Zain has made great effort to acquire or enter into partnerships. On March 14, 2009, it acquired 31% of Wana (the third largest mobile telecom operator in Morocco) in an equal partnership with Al Ajial Investment Fund Holding. Similarly in June 2010, Zain closed a 100% sale of its African outfit, Zain Africa BV to Bharti Airtel Limited (Bharti) to a tune of US$10.7 billion on an enterprise basis. As such, Bharti Airtel acquired 15 countries from Zain in Africa: Burkina Faso, Chad, Republic of the Congo, Democratic Republic of the Congo, Ghana, Gabon, Madagascar, Malawi, Nigeria, Niger, Sierra Leone, Kenya, Uganda, Tanzania, and Zambia.
Zain Shares
Zain Group is listed on the Kuwait Stock Exchange. The company’s shares are with no restrictions as its capital is 100% free float and is traded publicly. The Kuwait Investment Authority has the largest share claims of 24.6%.
Zain is committed to securing the best possible returns for its shareholders because of its high level of corporate governance. Furthermore, Zain is committed to excellence in provision of world-class mobile and data services besides an ethos of corporate social responsibility wher it supports communities, offers employment and creates business opportunities in places it operates. In this respect, Zain strives to have its economic, social and cultural projects impact positively on all people of countries it does business.
II. Input for Zain Co. Capital Budgeting
Zain pays special interest to its Capital Budgeting because it is key in evaluating the company’s long term projects undertaken in KSA, Jordan and Bahrain. The company scrutinizes the cash flows of its subsidiary companies so as to determine whether sufficient cash flows are being generated to the Parent company in Kuwait. This in turn serves to enhance the shareholders wealth. The logic for this is to compare the capital budgeting analysis of the Group’s subsidiary against that of the parent company in Kuwait together with assessment of the international risk characteristic with subsidiary companies. Furthermore, there is comparison of the present value of the projected future cash flows of the Group’s subsidiaries in Jordan, KSA and Bahrain to their initial investment. There is a demonstration of how Zain’s Co. capital budgeting can be copied to account for unique situations such as alternative exchange rate situations in the three countries along with an explanation of how the company can assess its risk of international projects.
To this effect, there are five most common ways of evaluating returns on investment opportunities: (1) net present value method, (2) internal rate of return methods, (3) profitability index or Q methods, (4) payback or breakeven period methods, and (5) the average rate of return on investment (Madura, 2012). In the budget analysis study for Zain herein, the net present value method (NPV) will be used. This is because the NPV method not only accounts for the time value of money but also provides the most significant decisions in investment analysis as well as capital budgeting situations.
Evaluation using the NPV method
The necessary information for this method is (1) expected net after the subsidiary/investment’s tax cash flows by period including a salvage value, if any, (2) correct interest rate/discount rate, (3) the duration of planning horizon, (4) terms of financing when borrowed funds are spent, (5) marginal tax zone of the borrower, and the status of taxing for individual cash flow.
III. Zain KSA Capital Budgeting Analysis
Since the KSA subsidiary is owned by the Parent company in Kuwait, its capital budgeting analysis is done from the parent’s perspective in Kuwait. The actual data on Sales and COGS has been obtained from ZAIN Kuwait. Table 1 shows actual data on the recent performance of Zain Group in KSA from 2009 to 2010.
Table 1: Capital Budgeting Analysis: Zain in KSA
Year 2008 Year 2010 Year 2009
Sales (SAR ,000) 6,934,370 4,004,052
Cost of Sales -3,403,922 -1,002,132
Gross Profit 3,530,448 3,001,920
Other Income 655 1,316
Selling, general and administrative expenses -1,163,581 -2,466,923
Non cash expense (Depreciation) -1,494,220 -1,394,310
Impairment of projects under construction 0
Provision for doubtful debts 0
Provision for slow moving and damaged items -150,000 0
Total expenses -2,807,801 -3,861,233
Operating Profits 723,302 -857,997
Finance costs and bank charges -195,511 -633,742
Adjustment for
Depreciation 1,494,220 1,394,310
Provision for doubtful debts 0
Provision for slow moving and damaged items 150,000 0
Impairment of projects under construction 0
Finance costs and bank charges 195,511 633,742
Profit before tax 2,367,522 536,313
Income tax 0 -50,000
Profit of the year 2,367,522 486,313
Other comprehensive income items 0
Total comprehensive income for the year 2,367,522 486,313
Withholding taxes (10%) -236,752 -48,631
Income after deducting Withholding taxes 2,130,770 437,682
Salvage Value
Exchange rate 0.0752
Cash flow to parent 160,255 32,914
FV of current cash flow (3% discount rate) as of 2012 180,369 35,966
Initial Investment parent 10,000,000
FV of Initial Investment (3% discount rate) as 2012
Accumulative FV as of 2012 (3% discount rate) 180,369 216,334
PV of current cash flow (3% discount rate) 138,238 27,565
Accumulative PV (3% discount rate) 138,238 165,802
PV of current cash flow (5% discount rate) 125,564 24,561
Accumulative PV (5% discount rate) 125,564 150,125
The introductory investment for the Zain KSA was started with an investment sum of KD 10,000,000,000 in 2008. The expenses incurred have been added up to give actual operating expenses of Zain KSA. Modifications for Depreciation was calculated and added to the company’s Profit before Tax. It should be noted that the resulting profit after subtracting the withholding taxes was sent back to the Parent company in Kuwait. Zain KSA is able to remit all the net cash flow to the Parent company because the initial investment given by Zain Kuwait included its working capital. However, the funds sent back to the Parent company are subject to a 10% withholding tax. As a result, the actual funds to be remitted amount to SAR 437,682,000. Given that the salvage value is unknown, it was assumed. At the time of remitting the funds, the exchange rate was 1 SAR= KD 0.0752. In 2009, the investment produced a total of KD 32,914,000 that represented an after-tax converted cash flow to Zain Co. in Kuwait and KD 160,369,000 in 2010. As such, the NPV of this project was computed as the current value of the net cash flows to Zain Kuwait less the initial investment.
NPV= – IO +?_(t=1)^n???CF?_t/?(1+k)?^t +?SV?_n/?(1+k)?^n ?
The discount rate employed depicts the correct cost of capital or the rate of return on the initial investment. Two situations of 3% and 5% for the discount rate were presented to calculate the NPV so as to establish its impact on the Cumulative NPV of the project. The cumulative NPV weighs the much of the initial investment (KD 10,000,000) recovered to that juncture in 2009 after the receipt of the discounted cash flows. In the capital budgeting analysis for Zain KSA shown below, the NPV of the project in 2009 was KD 165,802, representing discount rate of 3% and KD 150,125 at 5%. Both cases are positive. A positive NPV implies that the investment ought to be made considering that the net cash returns depicted in present KD is positive. It translates that the gains are satisfactory to refund Zain Kuwait for its asset’s cost, the cost of sponsoring the project itself, and the rate of return that sufficiently compensates the Group for the risk incurred in its cash flow values.
IV. Zain Bahrain Capital Budgeting Analysis:
The initial investment of Zain Lebanon subsidiary in Bahrain was KD 12,000,000. Table 2 shows actual information on Zain’s recent performance as retrieved from Zain Kuwait.
Table 2: Capital Budgeting Analysis: Zain Co. in Bahrain
Year 2005 Year 2006 Year 2007 Year 2008 Year 2009
Sales 20,986,508 23,856,214
Cost of Sales -14,987,563 -16,987,415
Gross Profit 5,998,945 6,868,799
Other Income 536,548 685,742
Selling, general and administrative expenses -1,030,874 -1,089,145
Non cash expense (Depreciation) -1,352,847 -1,823,654
Total Expenses -2,383,721 -2,912,799
Operating Profits 4,151,772 4,641,742
Finance costs and bank charges -968,687 -1,006,772
Adjustment for
Depreciation 1,352,847 1,823,654
Finance costs and bank charges 968,687 1,006,772
Profit before tax 5,504,619 6,465,396
Income tax -75,000 -50,000
Profit of the year 5,429,619 6,415,396
Other comprehensive income items 0
Total comprehensive income for the year 4,000,000 4,500,000 5,429,619 6,415,396
Withholding taxes (7%) -280,000 -315,000 -380,073 -449,078
Profit after deducting withholding taxes 3,720,000 4,185,000 5,049,546 5,966,318
Salvage Value
Exchange rate 0.7337 0.7337
Cash flow to parent 2,729,364 3,070,535 3,704,852 4,377,488
Initial Investment parent 12,000,000
PV of current cash flow (3% discount rate) 2,649,868 2,894,273 3,390,464 3,889,341
Cumulative PV (3% discount rate) (9,350,132) (6,455,859) (3,065,395) 823,946
PV of current cash flow (6% discount rate) 2,574,872 2,732,765 3,110,665 3,467,380
Cumulative PV (6% discount rate) (9,425,128) (6,692,364) (3,581,699) (114,318)
The expenses experienced by Zain Bahrain are added up to reflect actual operating expenses. Adjustments for Depreciation were calculated and added to the company’s Profit before Tax. After the deduction of 7% withholding taxes, all the profits were remitted to Zain Kuwait (Madura, 2012). The investment produced a negative cumulative Present Value (PV) which was discounted at 3% discount rate between years 2006-2008. In 2009, the cumulative NPV was calculated as KD 823,946, translating that Zain Bahrain subsidiary took 4 years to recover its initial investment. Computing the NPV at 6% discount rate, still gives a negative cumulative NPV value in 2009 of KD -114,318. Similarly, the cumulative NPV remains negative at a higher discount rate for the same year. If the discount rate of 6% has fully compensated the project’s risk, Zain Kuwait must scrutinize its data and then forecast and re-evaluate its project in Bahrain if the cumulative NPV stays negative in the following years.
V. Zain Co. (TSC) Jordan Capital Budgeting Analysis:
The initial investment for Zain TSC Jordan subsidiary was KD 38,000,000. Table 3 reflects actual information on Zain Company’s recent performance as sourced from Zain Kuwait.
Table 3: Capital Budgeting Analysis: Zain Co. in Jordan
Year 2003 Year 2004 Year 2005 Year 2006 Year 2007 Year 2008 Year 2009
Sales (Jordanian Dinar ,000) 95,221,880 91,131,426
Cost of Sales -78,032,596 -75,167,743
Gross Profit 17,189,284 15,963,683
Other Income 2,374,335 2,338,596
Selling, general and administrative expenses -13,964,439 -13,248,033
Non cash expense (Depreciation) -2,694,248 -2,424,077
Impairment of projects under construction -235,289 0
Provision for doubtful debts 0 -42,688
Provision for slow moving and damaged items -150,000 0
Total Expenses -17,043,976 -15,714,798
Operating Profits 2,519,643 2,587,481
Finance costs and bank charges -2,468,687 -2,136,772
Adjustment for
Depreciation 2,694,248 2,424,077
Provision for doubtful debts 0 42,688
Provision for slow moving and damaged items 150,000 0
Impairment of projects under construction 235,289 0
Finance costs and bank charges 2,468,687 2,136,772
Profit before tax 5,599,180 5,054,246
Income tax 0 -50,000
Profit of the year 5,599,180 5,004,246
Other comprehensive income items 0
Total comprehensive income for the year 3,000,000 3,500,000 4,000,000 4,500,000 5,599,180 5,004,246
Withholding taxes (10%) -300,000 -350,000 -400,000 -450,000 -559,918 -500,425
Income after deducting Withholding taxes 2,700,000 3,150,000 3,600,000 4,050,000 5,039,262 4,503,821
Salvage Value
Exchange rate 0.3898
Cash flow to parent 1,052,460 1,227,870 1,403,280 1,578,690 1,964,304 1,755,590
Initial Investment parent 38,000,000
PV of current cash flow (3% discount rate) 1,021,806 1,157,385 1,284,200 1,402,646 1,694,426 1,470,279
Cumulative PV (3% discount rate) (6,978,194) (5,820,809) (4,536,609) (3,133,963) (1,439,537) 30,741
PV of current cash flow (5% discount rate) 1,002,343 1,113,714 1,212,206 1,298,792 1,539,084 1,310,048
Cumulative PV (5% discount rate) (6,997,657) (5,883,943) (4,671,737) (3,372,945) (1,833,861) (523,813)
The expenses incurred by Zain Jordan are added up to reflect actual operating expenses. Adjustments for Depreciation was calculated and summed to the Profit before Tax. The Withholding taxes in Jordan was put at 10%. All the Profits after subtracting the withholding taxes was sent back to the Zain in Kuwait. A constant exchange rate scenario for the years was assumed in the computation of the remitted cash flow to Zain Kuwait. At a 3% discount rate, the investment produced both fluctuating positive and negative cumulative Present Values (PV) resting at an NPV of KD 30,741,000 in 2009. The same trend was noticed in NPV at a 5% discount rate but finally giving an NPV of KD -523,813,000 in 2009. The cumulative NPV still remained negative even at a higher discount rate up to year 2009. If the discount rate of 5% fully accounts for the project’s risk, Zain Kuwait must scrutinize its data and forecasts and then re-evaluate its project in Jordan if the cumulative NPV stays negative in the years to follow.
VI. Zain Jordan Sensitivity Analysis:
there is need to consider the other factors that can affect the capital budget analysis such as exchange rate fluctuation, inflation, blocked funds, and financing arrangements. Herein, there is a sensitivity analysis relating to the exchange rate factor along with examination of its implications on Zain Jordan’s capital budgeting. Sensitivity analysis is critical and instrumental in assessment of the project basing on a number of circumstances. Exchange rate fluctuations provide extra source of uncertainty as it affects the cash flow obtained by the Parent company (Madura, 2012). From the parent company perspective, it would be favorable to have an appreciation of the exchange rate currency at the subsidiary because the earning received by the latter and remitted to Zain Kuwait would be converted to more KD. Conversely, it would be unfavorable to have depreciation because the earnings received by the subsidiary and sent to Zain Kuwait would be converted to fewer KD. Table #4 depicts two scenarios relating to the fluctuation of the Jordanian exchange rate currency measured against KD along with its implications on the cash flow values remitted to the Parent company.
Table 4: Zain Jordan – Sensitivity Analysis on Exchange rate fluctuations
Scenario-1 ( Jordanian dinar appreciate 5% every year) Year 2003 Year 2004 Year 2005 Year 2006 Year 2007 Year 2008 Year 2009
Exchange rate 0.4093 0.4298 0.4512 0.4738 0.4975 0.5224
Cash flow to parent 1,105,083 1,353,727 1,624,472 1,918,908 2,507,005 2,352,658
PV of current cash flow (3% discount rate) 1,072,896 1,276,018 1,486,622 1,704,925 2,162,565 1,970,314
Initial Investment parent 38,000,000
Cumulative PV (3% discount rate) (6,927,104) (5,651,086) (4,164,464) (2,459,539) (296,974) 1,673,340
Scenario-2 ( Jordanian dinar depreciate 5% every year)
Exchange rate 0.37031 0.3517945 0.3342048 0.317495 0.3016198 0.2865388
Cash flow to parent 999,837 1,108,153 1,203,137 1,285,853 1,519,941 1,290,520
PV of current cash flow (3% discount rate) 970,716 1,044,540 1,101,041 1,142,464 1,311,114 1,080,790
Initial Investment parent 38,000,000
Cumulative PV (3% discount rate) (7,029,284) (5,984,744) (4,883,703) (3,741,239) (2,430,125) (1,349,335)
Exchange Rate PV
JD=.3898 KWD 30,741
APPRECIATE 5% KWD 1,673,340
DEPRECIATE 5% -KWD 1,349,335,000 -380,073 -449,078
Profit after deducting withholding taxes 3,720,000 4,185,000 5,049,546 5,966,318
Salvage Value
Exchange rate 0.7337
Cash flow to parent 2,729,364 3,070,535 3,704,852 4,377,488
Initial Investment parent 12,000,000
PV of current cash flow (3% discount rate) 2,649,868 2,894,273 3,390,464 3,889,341
Cumulative PV (3% discount rate) (9,350,132) (6,455,859) (3,065,395) 823,946
PV of current cash flow (6% discount rate) 2,574,872 2,732,765 3,110,665 3,467,380
Cumulative PV (6% discount rate) (9,425,128) (6,692,364) (3,581,699) (114,318)
Evidently, the appreciation of Jordanian Dinar depicts a positive NPV favored by Zain Kuwait.
VI. Country Risk Analysis
Country risk alludes to the potentially adverse effect of a given country’s environment on the cash flow of a multinational company (Phung, 2006). Country risk analysis is utilized to keep track of countries where the multinational company is presently conducting business, as a screening instrument so as to avert doing business in those countries having excessive risk as well as rethink investment and/or financing decisions based on recent events. Herein, there is examination of the country risk factors facing Zain in Jordan, KSA and Bahrain together with explanation of how Zain Kuwait can use this analysis when making its financial decisions in the these three countries.
Categories of country risk
Political risks
These include such factors as Wars, Inefficient bureaucracy, Corruption, Attitude of consumers in the host country, Currency inconvertibility, blockage of funds transfers and Actions of the host government (Phung, 2006). Multinational companies often stand to lose great sums of money if they are caught unawares by such adverse situations. In the case of KSA, because of the unending war situation, inefficient bureaucratic system and corruption, Zain Kuwait made sure to take some measures before investing in the country (Madura, 2012). The Parent company did background research on the dangers of setting up Zain KSA. Consequently, Zain Kuwait purchased itself a political risk insurance policy so as to compensate it in case an adverse event happens.
The most common and severe country risk the Group faces is a change of administration in the host country through a government takeover (Phung, 2006). To this effect, Zain has made sure to borrow local funds in all of its subsidiaries because local banks will stand concerned about its future performance (Phung, 2006). This has been an overly effective strategy on the part of Zain.
VII. Summary
In order to increase the business value of Zain Group over time, effective capital budgeting which provides for all capital requirements along with controlling operating costs play a big role. In this respect, the company’s annual procedure of creating operating and capital budgets is worth being regarded as an opportunity to test and tune the company’s strategies and tactics. Likewise, Capital budgeting is a key process which should address issues pertaining to both effectiveness and efficiency. For the Zain Group, Capital budgeting is by no means a stand-alone process. Zain Kuwait established international subsidiaries and accordingly made investment decisions as a result of its effective integration of capital budgeting with the vital operational budgeting, testing of strategic plans as well as operating tactics. As it is, Zain boasts of a functional multi-year interactive planning model, operational grouping of capital assets for thorough review and control, together with precise grouping of operating accounts to boost its monthly budget reports. Furthermore, Zain Kuwait makes sure to implement appropriate trend analysis, which enable for period-to-period comparisons so as to provide extra impetus for both timely decision making as well as desirable planning of its subsidiaries.
To summarize the Zain Group subsidiaries capital budgeting performance in the three countries (Jordan, KSA and Bahrain), an evaluation on its actual capital budgeting and performed situation analysis of its recent performances was done. It is recommended that Zain Kuwait should make immediate efforts to scrutinize its data along with forecasts and then re-evaluate closely its operations in Jordan, Bahrain and KSA if there would be a fluctuation in the discount rate, exchange rate. The Group should reassess its NPV in any of the subsidiaries if it remains negative for the upcoming years. Given that the subsidiary companies are quite new projects it will take some time to regain the asset’s cost of Zain Kuwait together with the cost of financing the individual projects (Madura, 2012) . Lastly, it is evident from the three subsidiaries that the cash flow they remit to the Parent company Zain Kuwait is generally increasing over the years serving as a positive sign for future performance of the subsidiaries and the Zain Group at large.
References
Phung, A. (2006), What is political risk and what can a multinational company do to minimize exposure? Available from: http://www.investopedia.com/ask/answers/06/politicalrisk.asp#axzz1r3tp9hCu [Accessed: April 2, 2012].
Madura, J. (2012), International Corporate Finanace, 11th ed, South Western, Canada.
