You cannot fault the group, really; this is in its DNA, like the child rewarded with an ice cream after throwing a tantrum; It knows no other way of getting results and recognition.
However, at this juncture we are not researching the hormones that drive Econet, but rather celebrating and looking closely at the latest numbers from the group. The company’s aggressive network expansion drive since dollarisation, which has seen a total of US$614 million being pumped into network infrastructure, seems to be paying off. Econet is now the market leader in telecommunications in Zimbabwe – since the fixed line network is slowly wasting away. Econet commands more than 70% market share in this sector, with its subscribers having grown from less than one million in 2009 to the current 6.4 million.
No doubt Econet’s investment in network expansion has contributed immensely to the increase in Zimbabwe’s mobile penetration rate which now stands at 74% from 21% in 2009. Whilst everything else seems to be going northward, the share price has instead moved in a contrary direction. This has been a thorn in the flesh for the company, and management has been at pains to stress their ‘compelling investment case’. A lot of reasons have been forwarded as being the cause of the disparity between company’s performance and share price.
This story has been overplayed and has become like a broken vinyl record. But should investors continue to hold on? Whilst one might forgo the capital gain as long as they receive a dividend, the inconsistent dividend policy evidenced by the company passing its final dividend has also added to its being unattractive.
Revenue for the year stood at US$611,1million, a growth of 24% from the previous year, propelled by strong growth in voice and data revenue. Voice was buoyed by increased usage and subscriber intake, which saw subscribers increasing by 16% to 6,4 million. Average Revenue per User consequently recovered by 6% to US$10,33 from US$9,78 in 2010. EBITDA rose by 20% due to operating efficiencies and cost minimisation initiatives.
The EBITDA margin at 48%, however, dropped one percentage point from the 2010 figure but still remains attractive. There was no disclosure on how much the company is owed in interconnect fees by other networks and whether these amounts were provided for in the accounts. Operating costs rose by 31% owing to costs of increasing the capacity and improving the reliability of the network. Network operating costs also rose sharply as a result of increased power outages that saw the company resort to using costly generators.
Profit after tax was US$165,7 million, translating into an EPS of US$1, an increase of 21% over the previous period. However, the profit after tax margin dropped two percentage points to 27%. Cash generation remained strong, with EBITDA/OCF of 115% and the majority of cash being spent on Capex. Worrying though was current liabilities growing ahead of assets, resulting in a weak current ratio of 0,83x. It also appears that most of Econet’s financing activities were funded from borrowings as evidenced by a net positive movement of US$76,7 million in the cashflow statement.
Despite the supposedly good numbers, no dividend was passed. The reason advanced for the non-payment of a dividend was that the group was in the final stages of concluding a syndicated US$307 million loan facility with a group of international banks. Full details of what the loan will be used for was not provided but if cashflows were strong, surely the loan negotiations should not have stopped the group from paying a dividend? For the interims, the dividend was paid in instalments, which could also signal a cashflow strain or that the company wanted to lock in investors whilst they waited for the dividend. It will be interesting to see the terms of the loan agreement as previous corporate transactions have been linked to the major shareholder and have not been viewed favourably by investors.
A total of US$28 million was spent in share buybacks. Cumulatively, since dollarisation, the company has spent $85 million on share buybacks. Whilst finance theory suggests that share buybacks or price support are just as good as paying a dividend, it appears the money would have been better spent elsewhere as the strategy seems to be failing. The share price has continued to go southwards and currently, at 385 cents, has dropped by 31% from its peak of 555 cents on 21 October 2009. Even during the financial year under review, the share price lost 18% from 490 cents to 400 cents. We can only wonder how much the share price would have fallen in the absence of these treasury activities. Probably investors would have benefitted.
So what could be the way forward for current and future Econet investors? Someone taking a long term view could be happy to forgo dividends now if it means that Econet will still dominate the market in the future and still make huge profits. Management indicated that investment in network infrastructure will now slow down significantly going forward and cashflows should be freed up. This is also assuming the infrastructure is able to keep up with the rapidly changing technology. Buying at today’s price may translate into a very decent dividend yield in the future provided the company adopts a consistent dividend policy.
Their strategy of using debt to make the necessary investments in network infrastructure seems to be working as they have managed to secure significant market share. The problem with debt is that it is costly and management indicated their intention to restructure some of their loans to a longer tenure, which might indicate the strain of finance costs on cashflows and that probably some of the debt could not be honoured at maturity.
The risk factors are that concentrating on infrastructure growth to increase subscriber intake is not very long term as technology changes quickly. It also depends on whether Econet will be able to retain and keep its subscriber base and also improve on network performance. If other networks up their game or a new player comes in, we might take a different view. Mobile phone operators never really lock in customers. In other countries, customers can move to other networks with their mobile numbers. The only way forward for Econet would be to improve service to world class standards, which has been a big challenge for them partly due to a combination of factors, some of which are beyond their control.
As banking goes mobile, perhaps this is where Econet’s future lies. There can be tremendous growth to come through the Ecocash offering. The numbers moved by Safaricom’s M’Pesa are amazing but Econet seems to be making the mistake of making the product costly. The unbanked are shunning banks because of exorbitant charges and Econet needs to take advantage of this and make their product less costly. They may rue this in future if someone offers a better product.
They have the potential to outcompete other mobile money transfer platforms due to their higher subscriber base but they seem to not to be taking advantage of it. Management’s unwillingness to disclose information on Ecocash could indicate results below expectations. Most probably the 1 million plus customers registered are not using the platform. From an investor perspective, failure to disclose pertinent information about a newly-launched product which has chewed up a lot of capital just does not cut it.
How then is the investor supposed to share in the excitement of new products to come?
The same can also be said about their broadband. Despite teething problems, the network performance has significantly improved but affordability has been an issue prohibiting the company from taking a significant market share.
Valuation wise the group appears cheap at an EV/EBITDA multiple of 2.61x against regional comparatives of 7,35x for Vodacom; 4,68x for MTN and 3,93x for Safaricom. A fair comparison for Econet would probably be Safaricom as SA companies might not really be so comparable due to the differences in the mobile penetration rates (SA over 100%).
There is a 34% difference between Econet’s EV/EBITDA multiple and that of Safaricom, which might highlight the risk premium attached to Zimbabwe justifying the current trading levels. But there is more potential if our economy improves. Who knows? It could also be the end of Econet’s reign in the mobile telecoms space as competition increases.