Vodafone's (VOD) Kenyan affiliate, Safaricom, may account for a mere fraction of its parent's total earnings, but there's little doubt that this far away corner of the world is where the company does its most innovative business.
During a recent Africa Capital Group research trip, I visited the Nairobi-headquarters of Safaricom, Kenya's largest mobile phone company, and had the opportunity to sit down with CFO John Tombleson.
Tombleson began by apologizing for being late. It was two days after Kenya's general election, and Safaricom, which had been contracted by the electoral commission to transmit the ballot results, was trying to put out a fire related to the delayed vote count. He assured us the failure was not Safaricom's fault and that they were just trying to get ahead of the story, in order to avoid negative publicity.
It was interesting to get an inside look at the nuts and bolts of the democratic process. I was a little surprised he even showed up for the meeting, considering how much was at stake for Safaricom that day.
It Ain't Easy Being King
Safaricom owns Kenya's wireless market with a 78% market share and the nation's largest 3G network. Its closest competitors are Airtel with 12% of the market, YU at 6-9%, and France Telecom's (FTE) Orange at 1%.
It wasn't easy for the company to win such a dominant position. Recently, Airtel slashed its prices to loss-making levels in a bid to capture a larger share. Safaricom opted not to match its competitor's unprofitable pricing schemes. This decision resulted in them losing some customers, particularly in the value and mid-tiers of the market, where revenue per user is less than KES500 (roughly $6.00) per month.
But the strategy ultimately paid off. Airtel was forced to raise its rates to a sustainable level, and Safaricom is happy with its new customer mix, which includes a greater proportion of higher-revenue clients. The brutal price competition also forced Safaricom's counterparts to burn cash to subsidize their low rates, which prevented them from reinvesting in their transmission networks. This allowed Safaricom to further strengthen its technological advantage.
To the Victor Go the Spoils
Tombleson believes that the price war is mostly over, and that the market has reached a cyclical bottom with calling rates at four shillings (five US cents) per minute. The company pays out 85% of its free cash flow as dividends, and the expectation is that dividends will increase meaningfully. On the Capex side, they plan to invest KES10 billion ($120 million) to expand their fiber-optic network. A previous foray into fiber resulted in frequent disruptions because the cable wasn't laid deep enough and people were digging into it. This time, they plan to dig a little deeper.
Not Resting On Its Laurels
M-Pesa, the system that revolutionized mobile payments in Kenya and beyond, is not capital intensive for Safaricom, but the company has to pay 10% of revenues to Vodafone, which runs the system's technology backbone. Safaricom is planning to take this job on itself going forward, which should increase profitability, though there would be some operational risk if they can't deliver the same level of service. M-Pesa has now spawned M-Shwari, which is the same concept but adds mobile banking services such as the provision of credit. This new service is delivered in partnership with the unlisted Commercial Bank of Africa (CBA).
Another interesting development on the technology side, is the introduction of Yolo by Intel (INTC). Kenya's foray into smart phones for prepay customers. Priced at 10,999 Kshs (about $125) it is pricey for the average customer, but holds great promise considering a current penetration rate of near zero for non-corporate/wealthy customers.
Happily Ever After?
The prospects appear bright for Safaricom. Though their market share can't grow much per se, the demographics are favorable as a bigger crop of Kenyan teenagers reaches cellphone-using age every year. One should also keep in mind that the shadow economy is not accounted for in Kenyan employment and GDP statistics, but it's a strong source of demand for cellphones.
Additionally, through its extensive independent dealer network, Safaricom's reach is extensive and future growth can be easily scaled. And any worries about Safaricom's size making it prone to government interference should be tempered by the fact that the company pays 5% of all taxes in Kenya and the government is not likely to kill the goose that lays the golden eggs. All told, this looks like a company set to dial up profits. It is a popular stock, however, so one should weigh its valuation relative to these growth prospects. Any pull back in what has been a very strong Kenyan market (+63% trailing 12-month), might provide a nice entry opportunity.
How Do You Buy It?
Unfortunately, Safaricom is not one of the African stocks that trade on Wall Street. Investors could get some exposure to this ground-breaking Kenyan telco by buying shares of Vodafone, but that would be a rather strong dilution of Safaricom exposure. A better way to gain exposure might be through the purchase of a frontier market exchange traded fund such as the iShares MSCI Frontier 100 Index (FM). Of course, your exposure would still be diluted, but at least the dilution is into many Safaricom-like growth stories in Frontier Market economies.