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Table of Contents

Management Report
Published: April 2009
Pages: 107
Tables: For full details, please email keithw@cmsinfo.com
From: GBP 1000.00  Buy Now!
Research from: AfricaNext
Sector: Mobile Markets

OVERVIEW

African mobile operations have long been extremely profitable; stories abound of triple digit subscriber growth, seemingly boundless potential, and an overall environment in which operators need only build it and profits will come. If only things were that simple.

The reality is more complicated, according to a new report by AfricaNext Investment Research, The Future of African Mobile Profitability: Stupendous Value, Mobile Darwinism & The Next Phase of Growth. Building on a comprehensive analysis of mobile operator performance in 40 African markets, the report reveals a market that “offers a remarkable blend of stupendous value creation alongside ostensibly misguided value destruction, can’t miss profit machines at the top versus volatile opportunities at the bottom, and pervasive premium valuations for what is increasingly a Darwinist, commodity business.”

In The Future of African Mobile Profitability, the AfricaNext research team goes beyond gaudy top line subscriber and revenue numbers, to provide in depth analysis of the drivers of African mobile profitability, including pricing and usage, OpEx, CapEx, EBITDA and free cash flows dynamics in an increasingly competitive environment and in the face of a severe economic downturn.

The report argues, among other points, that many African markets will break the 100% mobile penetration mark, that the focus on subscribers and ARPU numbers overstates their actual importance and that too many models are built primarily on the hope of potential returns from capital gains rather than intrinsic value. In addition, the report notes that the depression in mobile asset values over the past few months offers the best opportunity to acquire assets at a price closer to fair value, rather than the inflated rates of only a year ago.

The Future of African Mobile Profitability provides perhaps the most in-depth independent analysis of African mobile economics and long term return prospects, a must have for any would-be large investor in the African mobile space.

Number of Pages: 107

KEY QUESTIONS EXAMINED IN THE REPORT (SAMPLE)

> How large is the African mobile market over the next five years? How high can African mobile penetration go?
> How many mobile operations can African markets support?
> What, if any correlation is there between ARPU and EBITDA margin in the African context? Does ARPU matter? Afcre subscriber numbers credible?
> Is the African mobile market a premium or a commodity business? What are the chances of
> African markets moving to flat rate pricing?
> What are the key drivers of mobile operating expenses? How will mobile broadband impact OpEx?
> What are the long term prospects for interconnect revenue and costs?
> What is the median EBITDA margin in the African mobile market?
> Who are the 50 largest operators in Africa (in revenue terms)?
> What is the projected CapEx allocation over the next five years?
> Is there a correlation between CapEx share and revenue share?
> How many African mobile operators can cover CapEx requirements without resorting to debt and/or equity capital?
> Are African mobile licenses overvalued? Are mobile operator valuations too high?
> How will the credit crunch and the downturn impact competitive and operational dynamics?
> What will be the impact of players such as Warid, Lap Green, Comium?

TARGET AUDIENCE
SERVICE PROVIDERS

> Benchmark the economics of African mobile by line item and compare to your own Benchmark market size and operational projections
> Assess market potential Benchmark operational expenses at African level
> Get tools to assess mobile license values and valuation of potential targets
> Assess market potential for mobile or operator acquisition

INVESTORS

> Assess the economics of mobile in the African environment
> Separate winners from potential losers
> Get transaction analysis on key African mobile deals
> Identify the markets and operations more likely to generate some meaningful returns and those less likely to do so
> Get useful data points to build your own financial model
> Get market projections to help you assess the African mobile opportunity in 30+ markets
> Benchmarks the economics of African mobile by line item and compare to your own.

INFRASTRUCTURE SUPPLIERS

> Get some extensive and independent projections of African mobile CapEx over the next five years
> Get independent assessment of the impact of network expenses on EBITDA
> Get useful data points to build your own financial model
> Get market projections to help you assess the African mobile opportunity in 30+ markets
> Benchmarks the economics of African mobile by line item and compare to your own.

EXECUTIVE SUMMARY(EXTRACT)

The dramatic growth of mobile services in Africa has been well documented and outstanding enough to make us run out of superlatives to describe it. The expansion has continued unabated over the past three years, with a number of net subscriber additions consistently higher than the previous year’s.

The boom is not over, despite the global economic downturn. We expect African mobile operators to add another 300m subscriptions between 2008 and 2013, taking Africa’s mobile subscription base to 700m. Most markets will increase their mobile penetration by a factor of at least 1.5x. Ten markets will have a penetration rate above 100% by 2013; some will double their penetration levels and at least one (Rwanda) will quadruple it by 2013.

Nonetheless, there is more to the African mobile growth story than gaudy top line revenue and subscriber growth figures. A third to half of all African mobile operators are not profitable on a net basis; at least a third are unlikely to see net profits over the next 2-3 years. Our analysis lays bare a market that offers a remarkable blend of stupendous value creation alongside ostensibly misguided value destruction, can’t miss profit machines at the top versus volatile opportunities at the bottom, and pervasive premium valuations (at least until recently) for what is increasingly a Darwinist, commodity business.

Our analysis of African mobile market economics and long term prospects has led us to make the following points:

THE BASELINE - SOLID TOP LINE GROWTH ALL AROUND

> By our estimates, the African market reached about 375m subscribers in 2008, up from about 280m in 2007. The overall subscription base is nearly three times larger than it was in 2005. It has grown by a compound annual average around 40% over the 2005-2008 period.

> The pattern of growth is widespread; the median subscriber CAGR for individual markets over that 2005-2008 period was around 55%. Median African penetration was about 40% in 2008, and two thirds of African markets have a mobile penetration higher than 30%. The overall subscription base has a number of characteristics: it is heavily prepaid, churn is high and data adoption remains SMS-focused.

> Our projections for the next five years suggest continued subscriber growth, even with slowdowns driven by tightening addressable markets and the law of big figures. Half of all African markets have nominal penetration rates lower than 40%; a dozen have penetration rates lower than 30%, leaving ample room for growth over the next five years. Further, the decline in the cost of 2G radio infrastructure has made deployments more affordable and network coverage continues to expand into rural areas, expanding the addressable market.

> Finally, African mobile business models now put a premium on scale building, leading new operators to flood the market with SIM cards and driving up top line figures.

THE MODEL: A BUSINESS IN TRANSITION - COMMODITIZED REVENUE, TOUGH OPEX, HIGH CAPEX REQUIREMENTS

Behind the solid top line numbers, we see a business that is undergoing a dramatic transformation from premium, value-based models to the scale-focused approaches more typical of commodity businesses. The African mobile model has long ceased to be about skimming profits from the few; it’s now about building volumes and driving profits through scale efficiencies and the sheer power of massive numbers. Today’s models evolve in three main steps: initial focus on scale (for this is the price of market relevance), build-up of a loyal base (a “club”) and the leveraging of the club to raise ARPU levels, primarily through an expansion of the application portfolio.

OpEx remains a problem: Operating expenses are growing faster than revenue in most cases, partly a result of cost of sales keeping up with revenue and high fixed costs that rise with inflation (e.g. salaries) or fuel prices. Average OpEx per subscriber is around $90 on an annualized basis, with a median of $80. With marginal ARPUs already around $5, late entrants face the challenge of bringing their OpEx/sub below $50 over the long term, a tough proposition.

The importance of CapEx further comes to the fore with the tightening of credit markets anticipated in 2009. We estimate that at least a third to half of all annual CapEx is financed through debt and equity injections. With those channels tightening up, operators that are able to finance capital growth with internal cash are in a stronger position. The others will require debt and/or equity funding. With half of Africa’s operators being third entrants and beyond, a severe financing crunch will compel budget cuts or at worst, drive some players out of business.

THE BOTTOM LINE: GREAT AT THE TOP, NOT SO GOOD AT THE BOTTOM

On the surface, African mobile operations are extremely profitable; stories abound of triple digit subscriber growth, seemingly boundless potential, and an overall environment in which operators need only build it, have customers flow in and print the money. If only things were that simple.

The reality is more complicated, a singular blend of can’t miss opportunities and a smorgasbord of operations with questionable return potential. Median EBITDA margin in our market leader and challenger sample was 43% in 2008, a fairly high level. Including third operators and other late entrants, we estimate that median African EBITDA margin falls to about 25%.

We see ARPU as a poor indicator of operator performance in African markets - that is once it falls below $10. To be sure, there is some relationship between ARPU and bottom line performance. The median EBITDA margin for operators with ARPUs above $15 was 46%, an indication that ARPU does matter at some level. Nonetheless, upper $15 ARPUs are not the norm, with the African average at $11. At sub-$10 levels, there is substantial dispersion in EBITDA performance, with margins ranging from 0% to 45%. The point isn’t that ARPU is useless; it is that it should be given its proper weight given the market environment.

Finally, long term consolidation is inevitable, in our view. The combination of high initial capital requirements and low returns virtually guarantee that equity holders will be keen to cash out within that initial five year period when the operation eats more cash than it generates.

Further, the market now seems awash with 'build and flip' models, operations built to generate investor returns through capital gains: get license, maximize number of SIM cards, sell.

THE PLAYERS, VALUATION AND M&A: INFLATION, DEPRESSION, CONSOLIDATION

In a business largely defined by scale, multi-country players such as MTN, Zain, Orange or Vodacom are the best investments around, in our view –though there certainly are exceptions. To reach the cost and price sweet spots that make the business attractive and allow to raise service penetration levels, operators need to generate economies of scale; yet, few markets (fewer than 10 out of Africa’s 53, by our count) are large enough to provide such scale.

In turn, operators look to build it through multi-country presence. Pan-African players account for 73% of the African subscriber base, nearly 70% of generated revenue and almost $0.70 of each dollar invested in African mobile markets. Their share of EBITDA is difficult to estimate, but is higher than their share of revenue.

African mobile assets have witnessed substantial inflation over the past few years, owing to a mix of factors; the overall sense of mobile as a “can’t miss” business opportunity as more first tier operators report strong profits, supply and demand dynamics, the influx of financing from oil-rich regions, first tier operators (e.g. Zain, MTN, Orange) with cash to spend and few obvious places in which to spend it, and the “Benin precedent”, in which governments unilaterally decide to up prices.

The global economic downturn, combined with some overselling of mobile operator shares on a number of African stock exchanges have now contributed to depress mobile asset values, with some assets trading for 20% to 50% of their 2008 IPO prices. The tide now appears to have turned too hard the other way.

REPORT STRUCTURE

This report is organized into seven main related, but independent sections: The first section provides to line subscriber performance at African level and for 33 individual markets, as well as our long term projections. This section lays out the general supply and demand framework at the core of our forecasts, and outlines the key assumptions guiding our projections on a market-by-market basis.

The second section focuses on drivers of revenue and overall ARPU dynamics: Pricing models, elasticity, usage patterns and traffic volumes are reviewed here, along with the dynamics surrounding interconnect and mobile data revenue.

Section 3 breaks down operating expenses, reviews the main OpEx items including cost of sales (SIM cards, commissions, etc.), network costs, staff costs and G&A. The overall focus is on their current level and projected evolution in light of anticipated market conditions.

Section 4 is our CapEx section - it provides a review of the drivers of CapEx, as well as estimates of CapEx allocation by network item. We also provide an analysis of the true impact of CapEx on operational performance, as well as the implications of the global credit crunch for African operator spend.

Section 5 provides an analysis of operator current EBITDA levels as well as our analysis of African mobile profitability. In many respects, this is the heart of the report, building on insight from the previous sections to provide the AfricaNext Research view on a number of key questions: what are the main drivers of EBITDA? What do the most profitable players have in common? How many operators can African markets support? How relevant is ARPU to the bottom line in the African context and more..

Section 6, is the Valuation and M&A section - we review the evolution of mobile license values in Africa, as well as the value of M&A transactions in the mobile space and the outlook for 2009.

Section 7 provides our review of the Continent’s Pan-African players, including market presence, revenue, profitability levels, strategic issues and medium term outlook.

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