Vodacom is a perennial constant in an otherwise uncertain environment
Regulatory headwinds and changing consumer trends have negatively impacted the South African mobile telecommunications sector with all four operators feeling the effects of a sector-wide derating over the last year. While investors have become increasingly negative and are likely to apply a higher risk premium in valuing these businesses, we feel important company specific characteristics are being neglected.
We are of the view that there is quality to be found in the telco space and Vodacom is the perfect example of a consistent high quality business operating at a scale advantage to competitors.
Vodacom’s leading market position stems from scale and the quality of its network
South Africa’s mobile telecommunications industry has been in a state of flux over the past few years and although competition has been intensifying, Vodacom has been able to successfully defend market share (Figure 1). Recent consumer surveys (Figure 2) highlight that Vodacom’s higher consumer satisfaction and lowest likelihood of switching scores, relate strongly to the quality and coverage of its network and not solely to product pricing. In fact, SA consumers have increasingly shown a low propensity of switching away from Vodacom in light of its perceived higher pricing versus peers.
Figure 1. A high value subscriber base translates into market dominance. Source: Company Financials. Northstar Asset Management.
Figure 2. Network quality is of the utmost importance and Vodacom has attracted the most discerning subscribers. Source: UBS Evidence Lab.
In a world where data demand is surging, network quality in our view is becoming an even more important differentiator and enabler for telcos to maintain and grow subscribers. Vodacom’s market dominance has been a combination of strong strategic execution, scale advantage and a sound value proposition as evident from the company’s higher returns on invested capital (ROIC) relative to sector peers (Figure 3).
The way forward as data prices fall
While data demand has been rising, the industry has experienced an overall contraction in service revenue as data prices have been cut by operators. Although higher price competition and regulatory pressures have depleted industry returns over the past few years, we believe data volume will start growing ahead of pricing tariff reductions as consumer data requirements surge. Increased use of instant messaging, streaming and other value-added services will in our opinion drive strong data growth over the next decade.
Among South African operators, Vodacom has been particularly good in capturing new subscribers (Figure 4), having added approximately five million new SIMs to their network in 2017, and is set to add a similarly large number of new SIMs into 2018. We believe Vodacom’s scale advantage and network quality will enable it to capitalise on these market trends and continue to deliver strong returns over the medium term.
Valuation
We believe Vodacom is attractively priced at current levels, trading at a 20% discount to its long-term average forward EV-to-EBITDA as the share price, in our opinion, is discounting an overly bearish scenario. Furthermore, the business is highly cash flow generative and we see significant upside based on our discounted cash flow valuation.
Figure 3. Consistent sector-beating returns on capital. Source: Company Financials. Northstar Asset Management.
Figure 4. Vodacom has been aggressively adding to its subscriber base. Source: Company Financials. Northstar Asset Management.