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.