OSN: Middle East’s First Tech Victim

It’s incredible what can happen when a leading technology company decides to enter your market. We’ve seen what Facebook and Google have done to the advertising industry. We’ve also heard tales of Amazon and Net-A-Porter hurting local retailers. As most GCC businesses are privately owned however, empirical evidence is usually impossible to come by.

In our quest to measure the impact of disruptive technology companies on GCC enterprises we’ve uncovered a local business which – due to its ownership – publicly reports every quarter.

Say hello to OSN, the leading MENA Pay-TV service.

OSN is 60.50% owned by KIPCO, a diversified holding company controlled by the ruling Al Sabah family and listed on the Kuwait Stock Exchange. KIPCO prides itself on shareholder transparency and has a history of publishing a supplementary “Equity Investor Presentation” each quarter. The presentation includes a Net Asset Value (“NAV”) breakdown of its holdings (banks, insurance companies, real estate developers and asset managers) as well as some key operating metrics.

Below we can see OSN’s subscriber base breakdown as of Q1 2016, the last time it was reported.

The table below shows a key OSN KPI that KIPCO has regularly shared, also up until Q1 2016. From Q2 2016 onward both the pie chart above and the subscriber count below have mysteriously disappeared, as has their subscriber growth.

From 2012 to 2015 subscriber growth had a CAGR of 11.95%. But in the first quarter of 2016, OSN lost around 10.50% of its total subscriber base. Ideally if we had the data for the rest of 2016 it would be clear whether subscriber losses were a new trend, or just an aberration of that quarter.

Sadly KIPCO has decided to take back some of its transparency, just as things were getting interesting. We can though compare Q1 2016 with Q1 of 2013 and 2014 when KIPCO was still reporting quarterly subscriber numbers. In both those quarters we saw positive subscriber growth, which rules out the likelihood of the drop in Q1 2016 being due to seasonality.

Furthermore, between 2016 and 2017, the Equity Investor Presentation replaces the phrase “Subscriber base of over 1mn+” with “Subscriber base of around 1mn”, suggesting the number continued to fall post Q1 2016.

Could this be the reason?

TheNational: Netflix Launches in the UAE

Netflix opened for business on Wednesday the 6th January 2016. At that time, the UAE comprised 37% of OSN’s total subscriber base, equivalent to 426,000 subscribers. The 10.50% drop-off in Q1 2016 equates to 121,000 subscribers. If we attribute this all to the UAE it implies a loss of 28% of their UAE subscribers!

We know that Netflix isn’t the only internet video streaming service out there. Roku, Amazon Fire TV and Apple TV are all used in the Middle East, often from behind VPNs. In 2015 Netflix was actively cracking down on VPN access to its content from countries where it wasn’t officially available. In Q1 2016 that changed and UAE residents could finally subscribe directly to Netflix and pay in AED.

Financial Repercussions

KIPCO’s stake in OSN is held  through an entity named Panther Media Group Limited (“PMGL”), incorporated in Dubai. This stake is accounted for in KIPCO’s financial statements as a Joint Venture and the Equity Method is used when reporting performance. This allows us to look directly at how OSN is performing.

Although we can’t see quarterly subscriber figures, we have access to quarterly top line and bottom line numbers and snapshots of the balance sheet. Because OSN’s core operations are in the UAE and 64% of its subscribers are in dollar pegged currencies (SAR and AED) we presume OSN’s financials should be evaluated in USD. We have adjusted the KWD numbers in KIPCO’s financial statements to reflect the prevailing USD exchange rate at the time (KWD is pegged to a basket and hence FX fluctuations affect results). The chart below shows quarterly performance from 2015 to date in USD terms.

As of Q2 2017, Revenue is down -17% from peak, and -11% yoy, with the decline accelerating as shown below.

Whilst expenses have continued to grow.

The combined fall in Revenue and growth in Expenses has destroyed OSN’s bottom line.

Accelerating Losses

The $43mn loss in Q2 2017 alone is larger than the $35mn Net Loss of 2016 full year. We don’t understand why expenses have continued to grow at double digits. Our guesses are that its either related to higher media licensing costs (which could be a structural business problem), or aggressive marketing to take back market share (though this hasn’t resulted in Revenue growth).

We noticed OSN’s Churn Rate began ticking up from 2014, perhaps an indicator of a more fickle consumer or dissatisfaction with the service.  OSN’s last reported churn rate in Q1 2016 was 30%, significantly higher than current averages in the US. 

As the pressure mounts we expect KIPCO to step in. As Arqaam Capital in Dubai recently wrote:

Sale of 8% of OSN to Kipco’s main shareholder has improved financial flexibility temporary, but operational losses of OSN and other associates are putting pressure on interest cover.

We wonder how this sale was valued and whether its temporary. This kind of behavior raises all kinds of governance questions around related party dealing etc.

Perhaps OSN can mitigate the rising costs of media content assuming that is the main issue. The competition however is only going to increase as Netflix’s offering grows and traditional Pay TV monopolies are broken down. We’re already seeing it at Sky in the UK, where they are reducing the number of sports channels and slashing prices. Alternative mechanisms for delivering premium content are also emerging, and are not constrained by geography. In 2016 we saw Twitter sign a deal to stream 10 NFL games and Sling TV started delivering ESPN live across the US.

OSN’s challenge isn’t local, its global. We believe we’re witnessing an existential battle for survival. When we hear about “disruptive technology”, this is what it looks like. OSN is a case study in how you can go from peak profitability to catastrophic losses within a single year when an international technology rival decides to flick the switch and enter your market.

KIPCO must be longing for the good old days…