MTN | The growth journey has just begun
Live webinar broadcast 22 February | Recording available
Mar 23, 2022
MTN has garnered a lot of investor and media attention recently after its strong share price performance over 2021 (rising 186%). Operational results by the group have exceeded expectations over the last two years, which has led to consistent positive earnings revisions. In line with our philosophy of investing in companies receiving positive earnings revisions and which trade at a reasonable valuation, we have had an active overweight position in MTN since 2020.
Despite the share price rally, we believe there is still more upside to the stock and maintain our overweight position.
Whilst the last two years have been operationally stellar for the group, it is important to bear in mind the context in which this performance has arisen. The six years prior had proven to be difficult, due to both poor strategic decisions made by the prior management team, as well as external macroeconomic and political events. Addressing operational weaknesses and changing the strategic approach to external risks has required patience by the current management team to achieve what we all see today. As Figure 2 depicts, while we are large shareholders in the company today, prior to 2020 our underweight position reflects a company at the start of a turnaround strategy that has taken years to come to fruition.
In the period between 2010 and 2014, MTN’s then management team had made poor operational choices:
At the time MTN chose to reduce its capital expenditure (capex), the group was still in the early stages of expanding its network coverage across the new countries it had entered. As at the end of 2013, outside of South Africa, 3G coverage was on average a lowly 34%, far too narrow to add new subscribers to their network. This was the period where capex intensity should have remained high (above 20% in our opinion) to solidify market leadership and enable the freedom of economies of scale to take effect as mobile adoption took off across the continent. Instead, they focused on increasing dividends (pay-out policy ratio quickly jumped from 15% to 65%) over 2010 to 2012 – far too soon for a relatively young business.
The above soon resulted in quickly deteriorating operational performances and a vulnerable balance sheet and was a clear indication of what we believed to be poor management of the business at the time. However, it was the lack of regulatory compliance and geopolitical risk awareness that was more damaging to the group, in our opinion, as it severely hampered investor perceptions of the company’s risks, which seemed to outweigh its operational potential. This is understandable, given the sheer size of the now infamous $5.2bn regulatory fine Nigerian authorities levelled at the group in 2015 for not adhering to regulatory requirements. MTN faced other regulatory and legal problems in Cameroon, Benin and Ivory Coast, but these were overshadowed by the Nigerian events.
Our investment philosophy of investing in companies receiving positive earnings revisions that trade at a reasonable valuation guided us away from MTN. Weak operating results were beginning to impact earnings expectations, which began faltering as early as 2014 (staying flat) and turned negative over 2015. This occurred before the negative impact of the regulatory fine, which impacted the 2016 earnings expectations. That aside, weak operational results persisted in 2017 and 2018, and these negative earnings revisions were a result of prior years’ underinvestment in the network and the rising debt burden (though we acknowledge that macroeconomic factors also played a role in depressing earnings).
Figure 5: MTN Group share price and earnings revisions profile (2013 to 2017)
Source: Bloomberg, February 2022.
In our opinion, the correct decision was taken by the board over 2015 and 2016 to replace many key management roles, including group CEO and CFO. The new management team, headed up by Rob Shuter and Ralph Mupita, began to implement the correct remedial decisions to stabilise the business. This involved a network reinvestment programme, focus on reducing hard currency debt, selling of non-core assets and reducing, then suspending, the dividend. However, telecommunication networks take years to build out. Given the sheer size of the company’s footprint (at the time operating in 21 geographies across Africa and the Middle East), this understandably had a long lead time before investors began to see the benefits of the capex programme.
Figure 6: Capex reinvestment began in 2015 with a large bias to the core network infrastructure
Source: Company data, Ninety One, February 2022.
The benefits from the reinvestment programme, as well as improvements in its quality of service offering across its operating companies began to show improvement two years later, from 2017. The expanding operating margins, which the market had underestimated, led to positive earnings revisions over the last two years.
Figure 7: MTN’s EBITDA margin (2019 onwards under IFRS16 accounting standards) versus capex spend
Source: Company data, Ninety One, February 2022.
The operational efficiencies have been paired with a decreasing debt finance cost burden as the group simultaneously focused on reducing debt. An asset realisation programme was launched and the proceeds of those sales were used to pay down US$-denominated debt. This has further increased earnings upgrades, to such an extent that MTN has seen earnings grow faster than EBITDA, which has in turn grown faster than revenue.
Figure 8: MTN’s earnings revisions to date have been driven by operational repair and debt reduction
Source: Bloomberg, Ninety One, February 2022.
Thus, most of MTN’s positive earnings revisions to date have largely been driven by operational repair of the prior six years. Looking forward, the group is now adding new revenue streams, which will drive the next phase of positive earnings revisions, and why we believe there is still a lot of growth potential to come.
At present, only 42% of MTN’s subscribers are active data users. That is a very small portion by global standards and speaks to the growth potential the company has as more of the existing subscriber base begin to adopt data. These subscribers are expected to nearly double to 200 million in the coming four years, up from the current 115 million. This equates to ~20 million new data subscribers coming onto MTN’s network for each of the next four years. This is a faster rate than the average 15 million new annual data users of the last three years.
About 50% of MTN’s total group revenue is still from voice, yet it is data that will drive revenue growth in the coming 18 months. Data revenue currently contributes 30% to group revenue, which will quickly rise to be the largest portion of group revenue, as it is growing at 30% as data adoption begins to reach an inflection point across the continent.
MTN’s 3G network coverage (by land) currently stands at 84%, which is reaching about 520 million people who live in areas with access to this 3G broadband but remain unconnected.
Economies of scale is a very powerful operating force in telecommunications. As more people get access to smart phones or smart feature phones, not only is there revenue uplift, but operating margins expand as there is more usage and revenue turnover on a pre-existing asset base fully capable of carrying the traffic, but not yet doing so.
However, this obvious benefit needs to be weighed up against the risk of falling prices per megabyte of data used. Thankfully, data prices have already come down dramatically, and in some countries, data price floors have been introduced. We see limited downside to significant price declines, and in countries where this may come about, price elasticity and volume uptake will offset this.
MTN’s success in data rollout will be critical in setting up the infrastructure and distribution network for the next exciting phase of growth: financial services.
Mobile money services in Africa has been a proven successful business model through Kenya’s MPesa service, launched by Safaricom. MTN has already achieved great success in mobile money services in Ghana, Uganda and more recently, Rwanda. The group has only just begun to launch at widescale across West Africa and, with the recent approval-in-principle license granted in Nigeria, MTN may get final approval to launch mobile money services in its largest operating company later in 2022 or early 2023.
Despite having fintech services launched in four countries (including South Africa, but this is mostly in advancing airtime to pre-paid subscribers) fintech services already comprise 8% of service revenue. MTN believes they can reach 100 million mobile money subscribers by 2025. This may be half of that of data subscribers, but the average revenue generated per mobile money subscriber has much higher value (and value potential) as services expand from simple peer-to-peer transactions and money withdrawals, to shopping with merchants’ point-of-sales terminals and microlending. As fintech services begin to expand, this can trend towards a 20% contribution to group service revenue (which is MTN’s target in 2025), all the while data revenue continues to grow. In Kenya, mobile money contributed 34% to Safaricom’s service revenue prior to COVID and in MTN Ghana, already contributes 22%.
The group has taken the strategic decision to structurally separate its fintech business from the traditional telecommunications business. This process is expected to be completed in the first quarter of 2022. By separating the entities there is better ringfencing between the inevitable rising regulatory standards to navigate. Mobile money will be regulated by the financial/banking sector regulators and require close work with central banks, while the telecommunications business remains under communications regulators.
Figure 11: Mobile money and data subscriber growth, and targets for 2025 ('000s)
Source: Company data, February 2022.
Not too far behind the structural separation of the fintech business is the fibre infrastructure business, which is expected to be structurally separated by 2024. The result of operating in 19 countries means MTN has built a substantial footprint of connectivity infrastructure across the continent. This footprint includes 85 000 kms of fibre, which is expected to grow to approximately 135 000 km, 60 data centres and over 50 000 towers. MTN already generates approximately R4.2 billion revenue per annum in wholesale revenue (still a very small 2% contribution to group revenue of R176 billion) but has only just started rolling out its network services in earnest in the last 18 months. The business looks to allow roaming use of its fibre network to strategic partners (such as Google and Facebook) to aid their access across the continent, provide data centre storage services as well as introduce fixed broadband subscribers in targeted cities across the continent.
Figure 12: MTN’s Fibre network and opportunities across Africa
Source: Company Capital Markets Day presentation, 2021.
With Ralph Mupita at the helm, MTN has taken important steps in reducing group risk. Exiting Middle Eastern countries (Yemen and Syria) greatly reduces geopolitical, macroeconomic and regulatory risks for assets that contributed less than 2% of group EBITDA. There has also been an increase at head office and local operations of the regulatory and legal teams, as well as appropriate directors appointed to the board. Their new regulatory framework approach has seen the group navigate many new regulations that have been introduced across many countries over the last three years without the negative impact to operations.
Disclosures have also improved noticeably, sustainability targets have been announced and remuneration has recently introduced ESG targets as part of directors’ pay assessment. The improvements made by the company are reflected in MSCI recently upgrading MTN to an A rating (previously BBB) off the back of the above.
We believed that MTN’s valuation derating in 2020 (reflected in the chart below), which reached levels below the group’s prior crisis points, was unjustified and was an attractive entry point into the stock. Operational delivery was already being demonstrated, earnings revisions were positive, and all the risks related to the company (balance sheet, currency exposure and unsustainable dividend policy) had been addressed or were being improved.
With higher earnings growth to come in the next two years, higher quality earnings due to operational efficiencies and new revenue streams, while geographic risks continue to fall, we believe a rerating to levels above the averages seen from 2012 to 2018 is entirely justified. Despite the strong share price rally witnessed over 2021, we believe there is further upside to come.
Figure 13: MTN’s price-to-earnings multiple remain attractive considering strong growth potential
Source: Bloomberg, February 2022.