The chal­lenge faced by the tele­com­mu­nic­a­tions com­pan­ies

Collage of Internet, communications and network equipment. Concept of data and mobile information technology

Over the past year, we’ve seen a lot of action in the tele­com­mu­nic­a­tions sec­tor. Aside from Telkom des­per­ately try­ing to fig­ure out how to unlock value, we’ve seen Blue Label Tele­coms execute a com­plic­ated trans­ac­tion to recap­it­al­ise Cell C. And it is upset­ting news that Ghana is the new Nigeria for MTN, with a huge tax dis­pute under way.

Share prices in the sec­tor have per­formed poorly in the past year. Voda­com is down about 6% but does have a strong dividend yield, so that’s not as bad as it looks. MTN has lost 17% and Telkom is down 29% even after the post-Rain rally owing to the mar­ket being excited about that deal fall­ing over.

Blue Label Tele­coms has been on a spec­tac­u­lar roller­coaster, with a 52-week high of R7.20 and a 52-week low of R4.27. You need a strong stom­ach for that one. You’ll need an even stronger stom­ach before draw­ing a long-term chart, with the share price hav­ing lost nearly two-thirds of its value over five years.

There are import­ant les­sons in this industry for investors. It’s easy to assume that because “every­one uses these ser­vices” or “every­one knows these com­pan­ies” (espe­cially MTN and Voda­com), they must be great invest­ments. This isn’t how invest­ing works. Brand strength is only part of the story, and a rel­at­ively small one at that.

The Capex bur­den

Invest­ing is about unit eco­nom­ics (the prof­it­ab­il­ity of selling one more item) and about under­ly­ing trends, com­pet­i­tion and cap­ital alloc­a­tion. Once you under­stand all these things it’s about the valu­ation of the com­pany. You can’t pick stocks based on last year’s win­ners at the Loer­ies.

The chal­lenge faced by the tele­com­mu­nic­a­tions com­pan­ies is that the cap­ital expendit­ure bur­den is incred­ible. Build­ing a net­work is expens­ive and the tech­no­logy keeps chan­ging, so oper­at­ors simply can­not afford to be left behind, or con­sumers will switch to whichever oper­ator has the bet­ter net­work. Switch­ing costs are low in this space, espe­cially as you can port your num­ber. It’s not a sus­tain­able solu­tion to com­pete on cheap ser­vices if the infra­struc­ture can’t sup­port those ser­vices.

Invest­ment in tech­no­logy such as a 5G net­work rol­lout is a drag on free cash flow, meas­ured by met­rics like capex intens­ity.

Com­pan­ies that have a greater cap­ital bur­den to con­tinue oper­at­ing are always going to trade at rel­at­ively lower mul­tiples than cap­ital-light busi­nesses.

The prob­lem isn’t unique to local tele­com­mu­nic­a­tions com­pan­ies, as many global play­ers have been dis­ap­point­ing for investors in recent years.

Voda­com is down nearly 14% over five years and MTN is up just 1.6% with a far more volat­ile share price chart. Voda­com is seen as the steady dividend payer and MTN as the crazy uncle in the fam­ily who races clas­sic motor­bikes, some­times without a hel­met. Such is the joy of oper­at­ing in fron­tier mar­kets in Africa. This doesn’t mean that Voda­com is without risks, as the dividend has come under sub­stan­tial recent pres­sure.

Load-shed­ding is a huge issue here. On the rev­enue side, it puts pre­paid under con­sid­er­able pres­sure. If towers go down, people can’t use them. In MTN’s pre-close update, CEO Ralph Mupita con­firms that voice pre­paid in South Africa fell by double digits in the third quarter and by single digits to the end of Novem­ber. Some of this is tech­no­logy, of course, like What­s­App call­ing. Still, load-shed­ding is a factor and so are gen­eral pres­sures on con­sumers. And con­tract cus­tom­ers are pay­ing regard­less of whether they use the towers between 2pm and 4.30pm on a Tues­day.

On costs, load-shed­ding neces­sit­ates sig­ni­fic­ant expendit­ure on bat­ter­ies, gen­er­at­ors and secur­ity. I’m loath to think of this as cap­ital expendit­ure, as this is the fin­an­cial equi­val­ent of tak­ing the busi­ness to the emer­gency room for stitches. There is an open wound thanks to Eskom that needs to be closed.

A lot is going on in this space. This includes the intric­a­cies of leases with tower com­pan­ies and diesel pass-through nego­ti­ations. There is also the poten­tial split of fintech and mobile ser­vices oper­a­tions within MTN, for example, and the mobile vir­tual net­work oper­ator push that is now com­ing through the sys­tem, with Cell C being chased down by its com­pet­it­ors. Though Cell C was the part­ner for Shop­rite’sK’nect Mobile, it was MTN that Pick n Pay chose to part­ner with.

What does the future hold? Well, global giant Amer­ican Tower is now acquir­ing data centres to com­ple­ment the exist­ing tower net­work that is leased to tele­coms oper­at­ors. Per­haps that gives us a clue, though con­tem­plat­ing edge com­put­ing is dif­fi­cult when we can’t even get elec­tri­city for a full day.