Jan Schalkwijk, CFA, portfolio manager at Africa Capital Group, recently visited the Nairobi-headquarters of Safaricom (SAFCOM:KN), Kenya’s largest mobile phone company, and had the opportunity to sit down with CFO John Tombleson. Here, he briefs us on the meeting.
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 Orange at 1%.
It wasn’t easy for the company to win such a dominant position. 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. 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.
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 (VOD:US) (its largest shareholder), which runs the system’s technological backbone. Safaricom is planning to take this job on themselves 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).
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.
What Do You Think?
How profitable do you think Safaricom will be in future years? Are you a Safaricom customer or M-Pesa user? What do you like best about the company? And the least?
[Disclosure: Neither Jan Schalkwijk nor Africa Capital Group have a beneficial interest in any stock mentioned in this article.]