Mobile telecommunication firms (telcos) across sub-Saharan Africa are likely to play a more significant role in consumers’ adoption of digital financial and other services in the future. This will be more the case than in developed markets because of their relationships with large groups of subscribers and established cash- collection operations. We discuss why MTN, Africa’s premium telco, is particularly well positioned to benefit from this.
While telcos service our essential need for communication – as particularly well demonstrated during early 2020 with the provision of data to enable remote working – their financial returns track record is less compelling.
Highly capital-intensive by nature and requiring significant upfront investment in physical network infrastructure, telcos worldwide have historically struggled to generate sustainable, attractive returns on shareholder capital. The deterioration of the returns of South African listed network operators Vodacom, MTN and Telkom is clearly apparent in the left chart below. This is a consequence of industry trends, such as:
• the shift from highly profitable voice (airtime) revenue to less profitable data revenue;
• regulatory pressures to materially lower prices;
• ongoing capital expenditure to upgrade networks to carry the exponential growth in traffic; and
• company specific factors including currency movements, regulatory fines and acquisitions.
The low and declining returns on capital have generally led us to value these telcos below market prices, but looking ahead, it appears there are reasons to believe this may be changing.
Gatekeepers for the connected customer
Smartphones have enabled an explosion of service and distribution opportunities and there are many global examples of digital tools enabling large numbers of consumers to access valuable new services. Two examples with relevance to South African investors are: WeChat offered by Chinese technology conglomerate Tencent and mobile money service, Mpesa, offered by Safaricom in Kenya (in which Vodacom holds a significant stake).
Although to date there is no single model for success, winners establish a large customer base for a narrow set of services (instant messaging for WeChat, money transfers at Mpesa) and then use this network to offer additional services that enable further monetisation opportunities. A growing list of examples includes lending products, media content (music or video streaming), games, transport services, ecommerce and government services.
The right chart below shows that sub-Saharan Africa typically has far lower penetration rates for many of these product categories compared to other developing or developed markets – contextualising the opportunity across the continent.
The returns for successfully capturing large markets are significant, as evident in the notably high public and private market valuations placed on companies throughout the world that have been successful in offering valuable online services to large customer groups. Rich valuations anticipate high profitability and massive growth potential. Safaricom provides evidence of this with its high market rating and increasing returns on equity (left chart below).
In palm position
We believe MTN is strongly positioned to successfully capitalise on the financial and digital services opportunities across the African continent, for a number of reasons:
• it has a large subscriber base;
• it has an established cash collection infrastructure; and
• it displays competency in making services affordable to low-income customers.
MTN is one of the largest mobile operators in Africa, with dominant positions in many of its markets. The chart below indicates their subscriber base and market positioning across the 15 African countries in which they operate. For the purposes of this discussion we exclude South Africa, where the market for digital and financial services is well established, and the Middle East operations, due to the group’s recent decision to exit these markets over the medium term.
MTN currently has 150 million customers across the continent, with a large number concentrated in Nigeria. Outside of Nigeria, the aggregate remains substantial and a considerable number of customers have a device in the palm of their hand through which they engage MTN daily. The resulting positive effect is that the value of the network grows as more people join. With the enormous pan-African customer base, the value potential is momentous, especially when contemplating additional services (money transfers or merchant payments) being made available to this network.
Perhaps the most compelling argument for MTN’s success in digital and financial services is its established cash collection infrastructure. This distributes airtime vouchers (largely informally) in African markets with low banking penetration. Developed over many years, this infrastructure entails hundreds of thousands of agents across each country who collect small denominations of cash in exchange for airtime vouchers. In addition to other commercial activities, this offers many of these agents critical short-term funding and is, therefore, an important component of their business. Collectively, this network of agents and the trusted MTN brand are an enormous barrier for other competitors to overcome in these markets.
Despite the challenges of introducing new services in markets where incomes are low and traditional pricing strategies (monthly subscriptions) are unaffordable, MTN has been actively engaged in improving the affordability of its existing voice and data communication services. For data products, this manifests in small denomination bundles that are valid for short time periods at varying data limits (eg R2 for 15MB of data if used within an hour of purchase). The company, therefore, has a deep understanding of affordability levels for different customer groups and has established competencies in structuring products across smaller time and quantity dimensions. The same approach has been applied to other services, such as MusicTime (music streaming service), where access can be purchased for a specific number of minutes, valid for a certain number of days. In South Africa, users can pay R5 for 120 minutes of cumulative listening time plus the data to stream the music – to be used within seven days of purchase.
The success of MTN’s strategy is already evident in a number of their markets, such as in Ghana and Uganda. These stand out as markets where mobile money revenues already contribute a meaningful portion of the overall MTN revenue of the country and are growing rapidly. Company disclosure prevents a full comparison of mobile money across the countries in which they operate, but it is apparent that mobile money users make up more than a third of the total subscribers in the 13 countries where it has been rolled out thus far.
The chart below compares the average revenue earned by MTN for each mobile money subscriber across its largest markets and as a group across Africa, compared with a similar metric for Mpesa in Kenya. Although there are nuances in the numbers that restrict comparisons between the two companies, it is clear that MTN earns far less per mobile money user and that the opportunity to increase the number of users, relative to mobile subscribers, is sizeable. This suggests a growing business within MTN that has plenty of opportunity for expansion. Despite its relative immaturity, this segment already generates 65% more operational cash flow per rand of revenue than the traditional, capital-intensive mobile business.
Nigeria is MTN’s largest market, with immense potential for the operator to take a leading position in digital financial and other services. The Nigerian government recognises the significance of financial inclusion for economic growth and social development, putting forward regulations that will enable companies, including MTN, to offer financial services that up until now have been exclusively available to banks. The awarding of such licencing to MTN and other operators has taken longer than expected. However, the likelihood of receiving a licence is high given MTN’s share in the mobile market.
While we have purposefully not focused on MTN’s traditional mobile operations in this discussion, the value we derive for the future expected cash flows from these services offers reasonable upside compared to the current share price.
The possibility of MTN establishing itself as a leading financial and digital services provider across the continent over the next decade is much harder to value. However, successful operators in other markets have been very profitable and we argue that MTN has important advantages that significantly improve its chances of success. The optionality, or potential future value that these prospects represent, is incremental to the compelling valuation for the traditional mobile business and adds substantially to MTN’s attractive investment case at its current market price.