Neotel To Give Vodacom The Edge

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Neotel to give Vodacom the edge

By Warren Dick >6 Comments >Twitter >Facebook >Google+ >LinkedIn >WhatsApp

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A competitor with a sharp edge. That appears to be the conclusion if the R7bn tie-up between Vodacom and Neotel goes ahead. While this will be good for investors in Vodacom, it might also be positive for the man in the street.

The deal is going through due process at the Competition Commission. So how will it change the competitive landscape in the ICT sector if approved? And what are the chances of a similar deal being done between MTN and Telkom?

David Lerche, the telecommunications analyst at Avior Research, thinks the deal is likely. “We think it will go ahead, with perhaps one or two conditions attached by the regulator.”

Regardless of the compelling reasons for Vodacom (which we will delve into later), Neotel simply doesn’t have many options: it needs money.

Neotel is owned by India’s Tata Communications (the majority shareholder), CommuniTel and Nexus Connection (a black-owned consortium) and has battled to gain traction against Telkom.

“They were always going to be fighting an uphill battle as an under-capitalised late entrant,” says Lerche. “You can say what you like about Telkom, but it still has an incredible network.”

By Lerche’s estimates, Telkom has as much as seven times the fibre-optic cable in the ground as Neotel. In the absence of any deal with Vodacom, Neotel would require further capital injections, something its owners appear unwilling, or unable to do.

Besides access to fixed-line fibre optics, Neotel would give Vodacom access to precious spectrum that would allow the mobile operator to expand its data offerings with far less capital than might be required without it.

Bone of contention

The spectrum has been a particular bone of contention for Vodacom’s direct competitors, MTN and Cell C. Cell C CEO Jose Dos Santos believes the spectrum needs to be returned to Icasa, who should then reallocate it to all operators. Neotel would provide access to spectrum in the 800MHz, 1,8GHz and 3,5GHz bands.

Lerche explains the importance of access to spectrum. “Spectrum is valuable because when your network gets full you either have to increase the number of base stations or get access to more spectrum in order to expand network capacity. In Vodacom’s case (in which they are particularly constrained), they would have to spend a huge amount of money to expand their data services by increasing the number of base stations, which can be much more expensive than buying spectrum.

“So, from Vodacom’s perspective, the deal bodes well for greater network capacity, and this should translate to higher speeds and lower data pricing for consumers,” he says.

Cell C CEO Jose Dos Santos

Cell C CEO Jose Dos Santos

If access to the spectrum was excluded as part of the deal fashioned by the Competition Commission, Lerche thinks it would not be consummated anywhere near the current R7bn price tag.

But if successful, the result will be a huge advantage for Vodacom. It will have the room to grow its dominant data business as well being able to cross-sell services in both directions by providing converged solutions. It will also give Vodacom a first-mover advantage in rolling out 4G/LTE broadband.

For Telkom, the deal would mean the entrance of a well-capitalised competitor that can go toe-to-toe with it. Vodacom has already said it would seek to roll out fibre-optic lines to over a million households in a few years. So the gloves will be off. While that might have scared the pants off of Telkom a year ago, the state-owned company is a different animal now. It has also been the subject of speculation of a potential tie-up with MTN.

The rationale for MTN acquiring Telkom would not be dissimilar to Vodacom’s in acquiring Neotel. There is an established fixed-line business, and access to spectrum. A potential combination has become all the more intriguing due to government’s need to support Eskom financially. This became evident in light of comments made by national treasury alluding to the sale of certain noncore assets that will provide funds with which to prop up the beleaguered parastatal.

Strategic asset

But Lerche is not convinced Telkom is non-core. “I don’t think so. [Government’s] actions over the last few years suggest Telkom is a strategic asset. [Korea’s] KT Corp could not acquire control. So I don’t think the government wants to sell Telkom. And when it comes down to the details, how would MTN approach some of the legacy issues — like Telkom’s obligations to service unprofitable areas?” says Lerche.

The company is also undergoing a revival since the board was reconfigured, and since CEO Sipho Maseko took the helm in April 2013. While probably having double the amount of employees it requires — a problem that has been (and will continue to be) addressed by successive rounds of retrenchments, Maseko has started to box the company into shape.

“With Telkom now being run much better, and the share price approaching R80/share, I’m not sure MTN could earn a suitable return on capital even if they could get their hands on the business,” says Lerche.

Which begs the question: where was MTN when Telkom was at R11/share? If the addition of a fixed-line operator with access to spectrum gives your competitor such a big advantage that it should be rejected by regulators, why wasn’t MTN scheming to do the same thing?

This all does not bode well for Cell C. Lerche says: “I don’t think they are making enough cash to fund the reinvestment required in the network. This relates to the upgrading of infrastructure required to meet the data needs of their clients that would keep them competitive.”

While government intends to make more spectrum available to all three operators later this year, the newest addition to the family has a long road ahead of it

Time to buy?

Looking at the table below, it appears  little of the growth offered by the Neotel acquisition has been priced into Vodacom. When factoring growth into the value of a company, it’s worthwhile dividing the price:earnings ratio by the expected earnings growth rate to get a price:earnings to growth (Peg) ratio with which to compare companies.

vodacom-moneyweb-table-640

Vodacom’s paltry 6,5% forecasted growth in earnings for the 2015/2016 financial year is lower than that of MTN. But it has a slightly higher price:earings ratio, so Vodacom’s Peg ratio is slightly higher than MTN’s. The implication is that MTN appears to offer the best value at the moment — but not by much. Telkom’s short march from R11/share to R80/share appears to have been a little overdone if its Peg ratio is anything to go by.

Looking even further out at forecast earnings for Vodacom (not shown here) suggests little growth has been priced in either. So the acquisition of Neotel may usher in a new phase of growth for a mature-looking business.

  • This was republished from Moneyweb with permission
Avior Research Cell C Communitel Competition Commission David Lerche Icasa Jose dos Santos KT Corp MTN Neotel Nexus Connection Tata Communications Vodacom >Twitter >Facebook >Google+ >LinkedIn >WhatsApp
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  • Steve Song

    So giving an additional edge to an operator that already enjoys market dominance is a good idea because…. ok, help me here.

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    In the fixed line market, in which Vodacom is currently more or less a non-entity, Telkom is hugely dominant, occupying a space that is equivalent to more than a combination of both Vodacom and MTN in the mobile market (imagine that!). Describing Vodacom as “dominant” in that context is simply illogical. Creating a serious contender for Telkom in the broadband market is going to have a hugely positive effect on competition, with the rollout of fibre to the home, quite apart from the choice this gives national business customers.

    Do not confuse quantity with quality. Having lots of tiny players in the fixed line market feels warm and fuzzy, but it doesn’t begin to threaten Telkom’s dominance. In purely economic terms, a smaller number of more substantial players (such as Neotel, with more capital) will create a much more effective fixed line and broadband market.

  • Steve Song

    If your goal is to create competition in the fixed line market, then following through with local loop unbundling makes sense, not this. Where Vodacom really stands to gain with this acquisition is in access to more spectrum, namely 2x12MHz of 1,800MHz spectrum, 2x5MHz of 800MHz spectrum, and 2x28MHz of 3.5GHz spectrum. That would result in giving a veritable treasure trove of spectrum to a *dominant* operator.

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    LLU a decade ago would have made sense – now it’s largely pointless, given that Neotel and others are making Telkom’s copper redundant. Far too much is made of the value of spectrum in isolation. Spectrum without investment isn’t any good for consumers. Given that Neotel is already using that spectrum, where it has rolled out services, more investment in rollout can only be a good thing – unless you think that limiting access to wireless broadband to some areas is a good idea.

    The real treasure trove of spectrum is the one that the government is withholding from the market for its mythical National Broadband Network (aka Telkom, presumably). Oh, and then there’s the Nkandla-sized trove of spectrum that Telkom already has.

  • Steve Song

    I agree that the real opportunity for LLU has past but, to be fair, you were the one who brought up fixed line service.

    Regarding the value of spectrum being overstated, I am pretty sure you are mistaken. I offer the 45 billion dollar result in the AWS3 auction in the US as evidence.

    Regarding Neotel and expanding their roll-out. You cannot possibly be suggesting that Vodacom is going to expand Neotel’s fixed-wireless CDMA offering? That technology is a dead end now. They will use the spectrum for LTE plain and simple. Which brings us back to the point that they are already a dominant wireless operator and handing them all this spectrum is unlikely to improve market competition.

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    The point about LLU is that the lack of LLU is one of the primary reasons why there is now so much access fibre – an unintended consequence, perhaps, but good for end users. Right now, it wouldn’t add substantially to competition.

    I am still not seeing what is so evil about more broadband wireless rollout. Neotel itself has rolled out LTE as the successor to CDMA. It’s not as if Vodacom + Neotel would have more actual LTE spectrum than Telkom already has, or (imagine) MTN + Telkom (that other little matter for the Competition Commission to deal with). If spectrum alone were a remedy to increase competition (which seems debatable, given the relative market positions of the aforementioned players), then clearly there is plenty available, but quite a lot is being withheld for political reasons. What is really going wrong here is a clash of ideologies – competition vs communism – we cannot have a centrally-planned economy where serious investors are starved of resources, and still debate who is dominant.

    Source : https://techcentral.co.za/neotel-to-give-vodacom-the-edge/54730/

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