MTN Group: A High-Quality Play On Africa's Potential

Jan.10.12 | About: MTN Group (MTNOY)

Africa really is the dark continent when it comes to investment options for American investors. While there are growing stock exchanges across the continent, there are few cross-listings in the United States and few liquid ADRs. While direct investment is always an option for the especially brave and ETFs like Market Vectors Africa (NYSE: AFK) or S&P Emerging Middle East & Africa (NYSE: GAF), I would suggest risk-tolerant investors take a look at MTN Group (Nasdaq: MTNOY.PK). Not only is MTN Group a well-run company in its own right, it's a potential direct beneficiary of rising incomes and standards of living across Africa.

The Basics

What MTN Group does is not very complicated. MTN is the dominant wireless service provider in much of Africa. It is an African version of Verizon (NYSE: VZ), America Movil (NYSE: AMX), or Vodafone (NYSE: VOD). MTN Group is presently licensed to operate in 21 countries and is further authorized to offer internet services in 13 countries.

MTN is a #1 or #2 provider in most of its markets, including Nigeria, Ghana, and Syria (where it is #1) and South Africa and Iran where it is #2. Nigeria contributes more than 40% of MTN's EBITDA, while South Africa chips in about 25% and Iran and Ghana 8% and 6% respectively. Although many additional markets like Cameroon or Uganda are small in terms of their contributions, they are profitable for the company.

Uncommon Growth Opportunities

In many markets, cell phone companies are faced with near-100% saturation, brutal competition, and little potential of growing revenue much faster than local GDP. Not so in Africa, where cell phone penetration is still below 75% in many markets and where there is considerable potential in terms of usage (minutes) and services. For instance, Verizon gets about 25% of its revenue from data – for MTN that percentage is about 6%.

Perhaps counter to many investor assumptions, Africa is actually pretty forward-thinking when it comes to new technologies and services. Mobile payments have been a much-talked about opportunity in North America for years, but it's already a reality in Africa where MTN partners with the likes of Visa (NYSE: V) and Western Union (NYSE: WU) in its MobileMoney venture. It hasn't changed the world yet, but it has already been successful enough for MTN Group so as to attract the ire of banks in some of its operating areas.

Executing On The Details

Although there are still plenty of greenfield opportunities for MTN to grow (it doesn't operate in Kenya, Ethiopia, Egypt, or the DRC), management is not so focused on growth as to ignore profits and cash flow. To wit, the company has come to terms with American Tower (NYSE: AMT) on deals in both Ghana and Uganda that monetize some of its infrastructure and lower its future burdens. As some of the governments in MTN's operating regions are twitchy about operators also dominating infrastructure, it solves multiple problems at once and returns cash back to the parent company.

Plenty Of Risk Remains

MTN has risks aplenty. For starters, there are risks simply inherent to operating in areas like Iran, Syria, and Nigeria. These are not exactly textbook examples of counties with good governance or long-term histories of rule of law and pro-business policies.

This in fact is part of the reason why these shares have been weak at the start of the year – not only has the Western world ramped up sanctions on Iran (which hurts personal income and foreign exchange), but Nigeria is experiencing another bout of internal unrest in the wake of scrapped fuel subsidies. It also doesn't help matters that MTN contends with a dizzying array of currencies and the movements can be quite volatile from quarter to quarter and year to year.

Competition is likewise still very much a threat. For the most part, MTN competes with large corporations like France Telecom (NYSE: FTE), Millicom, and Vodacom (co-owned by Vodafone and Telkom (Nasdaq: TLKGY.PK)) and they are not especially apt to get stupid about pricing. Still, they can be fierce competitors all the same and growth-oriented rivals like Bharti Airtel can disrupt a market for years upon entrance.

It's also very much worth noting that MTN Group has to abide by an ever-shifting regulatory burden. Governments can (and do) cancel licenses and governments likewise are free to change the rules when it suits them – particularly to support their own favored competitors. Likewise, while 3G, data, and 4G are big opportunities for the company, many countries are still working out their policies regarding spectrum and operating rules – and there is no guarantee that future policies will be so favorable to MTN.

One other note on regulation. MTN was once in play as a buyout candidate, but regulators in South Africa turfed a bid from Bharti; there can be no assurances that another bid would fare any better and Western telcos may be uneasy in approaching a company that deals with the likes of Syria and Iran.

The Bottom Line

There are relatively few options for investors who want to own shares in a real operating company that conducts its business in Africa. All too often, investors have to own broad-based ETFs (that buy based on size more than on quality) or commodity-driven companies that are basically gold or platinum proxies with a little extra political risk piled on for good measure.

For investors who have the means and fortitude to invest directly in Nigerian Breweries, Attijariwafa Bank, or Unga Group, by all means go for it. For the rest of us, it's about trying to find the occasional liquid ADR like MTN Group, Naspers (OTCPK:NAPRF), or Sasol (NYSE:SSL).

If MTN Group can continue to grow revenue at a high single-digit rate (which would be a slow down in growth from past years) and continue to lift its free cash flow margin into the high teens, these shares would appear to be at least 40% undervalued at today's prices, even with an Africa-appropriate elevated discount rate.

Fortunately, investors in MTN Group are not being asked to sacrifice quality for opportunity. MTN has legitimately impressive returns on capital, a solid dividend, a clean balance sheet, real growth prospects, and an undemanding valuation. Even with the political and operating risks inherent to Africa and the Mideast, I just don't accept that MTN Group should carry a valuation similar to AT&T (NYSE: T) or France Telecom, or below that of Vodafone.

Disclosure: I am long OTCPK:MTNOY, AMX.