SSA Telecoms Sector Report | February 2014 Banking on Mobility

Asset Management | Corporate Finance | Securities | Trust Services

IMARA INVESTING IN AFRICA

Table of Contents
Executive Summary................................................................................... Sector overview........................................................................................
Voice penetration, urbanisation and income levels.............................................. MOUs, tariffs and MTRs................................................................................. Data revenue growth in SSA markets................................................................ Mobile Money.............................................................................................

1 2
2 3 3 4

Sector outlook..........................................................................................
Voice subscriber growth................................................................................. Smartphone penetration and growth.................................................................

4
4 4

Valuation & Comparatives...........................................................................

SSA, MENA, EM and Developing telecoms universe................................................. Historical PER trend....................................................................................... Operator exposure to growth indicators..............................................................

6
6 7 7

Company coverage....................................................................................
Airtel Zambia............................................................................................... Econet Wireless Zimbabwe............................................................................... MTN Group................................................................................................... Onatel Burkina Faso....................................................................................... Safaricom Ltd............................................................................................... Sonatel....................................................................................................... TNM........................................................................................................... Vodacom Group............................................................................................

9
9 13 17 21 25 30 34 38

Analysts:
Kudakwashe Kadungure Addmore Chakurira Christopher Kisyombe Loyiso Hoza Kudakwashe.Kadungure@imara.com Addmore.Chakuria@imara.com CKisyombe@natbankmw.com Loyiso.Hoza@imara.com

EXECUTIVE SUMMARY
SSA mobile and data penetration remains relatively low when compared to that in global and emerging markets, implying that our SSA Telecoms (Airtel Zambia, Econet, MTN, Onatel BF, Safaricom, Sonatel, TNM and Vodacom) still have some upside in voice and more significantly in data. However, closer inspection shows that some of our SSA operators may struggle to extract value from the untapped market. Given that our SSA sector currently trades at a TTM PER multiple of 15.0x vs. 13.1x globally, we feel it is in our interest to explore our universes ability to sustainably achieve +100% mobile sim penetration. Upside in voice higher and data higher than generally indicated. Mobile voice and data penetration are estimated at 67% and 18% of the population, respectively and which compares to 93% and 37% globally, this already indicates some level of upside. For the sector as a whole, we believe there is still room for significant growth in voice usage. According to GSMA, a unique (person/individual) subscriber carries two active sim cards on average. Ultimately, unique subscriber penetration is estimated at 31% in SSA against 50% globally and 80% in developed markets. From this point of view, we upgrade our upside on subscriber growth by a factor of 1.5x. Given that a survey carried out by GSMA also showed mobile handsets were the main point of data access for 80% of the respondents, we see similar adjustment in our outlook on data subscriber penetration and usage. Looking at our universe, we see that TNM (28%), Onatel BF (56%) and Vodacom (65%) operate in markets that have relatively lower voice penetration than the rest of SSA. From a data point of view, we find that our universe bar MTN and Safaricom, operates in markets with penetration below the SSA average. The lowest are Onatel BF (3%), TNM (4%) and Sonatel (7%). Amongst others, socio-economic factors are key to determining a markets ability to increase penetration . There is strong correlation between mobile penetration against both GDP per capita and Urbanisation rates. We find that higher GDP per capita and a higher percentage of the population residing in an urban area equates to higher voice penetration, which in turn enables higher data penetration. We look at the growth in the factors and find that Onatel BF, Airtel Zambia, TNM and Safaricom operate in markets which have exhibited a relatively high combination of urbanisation and GDP per capita growth rates. Whilst some of the markets are at relatively low per capita incomes and urbanisation rates, we expect the growth in factors to translate to a more rapid increase in penetration within those markets.

Equity Research SSA February 2014 SSA Telecoms

Mobile money improves rural area value-proposition. Mobile Money has not only given access to financial services to a wider spectrum of the population, but has also generated significant revenue and increased customer loyalty for their operators. More specifically, M-Pesa in Kenya, the most successful of the platforms, was driven by urban-to-rural area, person-to-person (P2P) remittances as the service allowed income earners in the city to transfer cash to dependants in rural locations for a fee. By doing so, the service essentially increased the revenue that operators could generate indirectly from subscribers in the rural area. Given that financial inclusion in SSA is estimated at 19% against 36% globally and 58% in high income economies, demand for financial services is expected to increase as incomes rise. We expect operators in markets with low financial inclusion like Sonatel, Onatel BF and TNM to leverage off such platforms and reach deeper into rural coverage. Top picks. Whilst we find our whole universe investable, we especially like Econet, Sonatel and Safaricom as we believe that they have significant exposure to high growth markets, particularly in data and mobile money. Econet, with a strangle-hold of its majority share in a market which harbours strong data and mobile money prospects, is also the cheapest telecoms company in our universe. We believe its prospects outweigh the political risks, corporate governance issues and its exposure to a highly troubled banking sector. Sonatel will remain a steady growth, high dividend yielding opportunity in the short to medium term but offering some upside in the event data and Mobile Money take off in the region over the medium to long term. Aside for it being at a significant premium to its peers, Safaricoms potential to surprise is undeniable. We see this as the ideal long-term opportunity, particularly from data and its M-Pesa platform.
Target Price Up / downside (%)
TNM Airtel Zambia 50.0 114.5

Econet Wireless
Onatel BF MTN Group Sonatel Vodacom Group 10.6 10.0 3.5 3.2 2.9

23.0

Safaricom Ltd

Sector Overview
Penetration remains low in SSA. Given that the region still exhibits relatively lower voice and data penetration, and is forecast to achieve higher growth in per capita incomes, SSA markets generally harbour higher growth prospects than in the rest of the world. Africa as a whole is reported to have mobile and data penetration rates of 67% and 18%, which compares to 93% and 37% globally, respectively.
Figure 1: Penetration significantly low in Africa
160% 140% 120% 100%

Socio-economic factors remain the key challenge. Looking at SSA countries against developed and emerging markets, we see that a strong correlation (R2 = 0.74x) between voice penetration and GDP per capita (USD), the latter being a proxy for disposable incomes. Our view that higher per capita incomes will drive penetration therefore remains intact. Lower handset costs will also aid penetration.
Figure 2: Voice penetration shows strong correlation with GDP per capita and Urbanisation rate

80% 60%
40% 20% 0%

R = 0.6543

R = 0.7404

S.America

N.America

ME

W.Europe

Oceania

SEA

C.America

World

E.Asia

C.Asia

S.Asia

C&EE

Africa

GDP per capita

% Urban

Voice

Internet

Urbanisation rate

Source: Global Digital Statistics 2014 / IAS

Source: Global Digital Statistics 2014

Reasons for the low penetration remain the lag in the development of the sectors drivers such as i) low per capita incomes, ii) low urbanisation rates and iii) inadequate or lack of reliable power and road infrastructure. Whilst low per capita incomes limit demand for the service, the latter reasons make it more expensive for operators to service the whole market. Given that a survey carried out by GSMA showed that 87% of the respondents accessed the internet mainly through a mobile device, we also find that the aforementioned factors hold true for internet penetration. We observe that nearly every urban resident in developed markets such as Western Europe (UK, France, Germany), North America (USA, Canada), Oceania (Australia, New Zealand) and East Asia (Japan) is an internet subscriber. The reality behind mobile penetration. In its 2013 edition, GSMA reported unique and SIM subscriber penetration trends which indicated that SSA mobile subscribers carried two SIM cards on average. Ultimately, GSMA reported that unique mobile penetration across 40 SSA countries was 31%, or 253m unique subscribers against 502m active sim cards. This compares to 50% worldwide and 80% in developed markets. In this regard, the upside increases 1.6x when compared to the global average and 2.0x to the developed market average.

However, with only c.39% of Africas population living in urban areas, the vast majority, (generally with significantly lower per capita incomes) live in the relatively sparsely populated rural areas. This poses a challenge for operators who look to maximise revenues per installed base station. From a metric perspective, this alone will lead to high capex intensity, and therefore generate diminished free cash flow returns from the expansion. As such, we currently observe rural mobile penetration being about half of what it is in the urban areas in the more developed African markets.
Figure 3: Voice penetration & urbanised population vs. GDP per capita (USD)
200 100 000

180 160 140 120

100

10 000

80 60 40 20
0
Russia Botswana Germany Brazil RSA UK JAPAN US Ghana Senegal China Congo Zimbabwe Mali India Zambia Kenya Swaziland Nigeria Guinea-Bissau Lesotho Cameroon Tanzania Rwanda Conakry Burkina Faso Uganda Mozambique DRC Malawi

1 000

100

Voice

% Urban

GDP per capita

Source: Global Digital Statistics 2014 / World Bank

Figure 5: MTR outlook

We note that the USA and Japan, which are the markets with the highest per capita incomes charted above, have lower penetration rates than some markets like RSA, Russia, Botswana and Brazil. We suspect that a larger proportion of the subscribers in Japan and the USA have post-paid plans which generally lock-in a device to a single network. Furthermore, we suspect that the level of competition within these markets is quite advanced in that the variation in the quality of service and pricing is marginal, and therefore reducing the need for customers to subscribe to multiple networks. MOUs, pricing and regulatory risk. A cross-sectional comparative of SSA MOUs and rates shows that they vary significantly but generally hint to a trade-off in which a higher combination of tariffs and MTRs is associated with lower MOU. As shown in Figure 4 below, the relationship is not quite as obvious as factors unique to a particular market (market share dominance, on-net/off-net ratio and disposable incomes) play a major factor in determining the affordability of the overall service.
Figure 4: Tariffs, MTRs vs. MOUs (LHS)
140 0.60

01-Mar-11 01-Mar-12 01-Mar-13 01-Mar-14 RSA (ZAR) Peak Off peak Mkt share < 20% 0.73 0.65 0.73 0.65 01-Jul-11 Kenya (KES) Peak Off peak
Source: CCK, ICASA

01-Mar-15 01-Mar-16 0.15 0.15 0.42 0.42 0.99 0.99 0.10 0.10 0.40 0.40 0.99 0.99

0.56 0.52 0.56 0.52 01-Jul-12 1.44 1.44

0.40 0.40 0.40 0.40 01-Jul-13 1.15 1.15

0.20 0.20 0.44 0.44 01-Jul-14 0.99 0.99

01-Jul-15 01-Jul-16

2.21 2.21

The cut will be asymmetrical, allowing operators with market share less than 20% to charge dominant players Vodacom and MTN higher MTRs. In Kenya, MTRs are currently KES 1.15 (USD 0.013), which is already significantly below that of RSA and the rest of SSA, and are scheduled to decline further to KES 0.99 (USD 0.011) by 1 July 2014. We currently see limited downside risk on Kenyan MTRs and see any further cuts as being marginal. Data to carry growth into the long term. The decline in data prices, followed by the widespread deployment of mobile broadband networks and the advent of the smartphones and less expensive feature phones, has led to an explosion of mobile data services globally.
Figure 6: Data penetration vs. driving factors
100 100 000

120 100 80

0.50 0.40
0.30

60 40 20
0
Mozam bique
Cam eroon Tanzania Conakry Rwanda Zim babwe Senegal Zam bia Uganda Ghana Nigeria Kenya Congo DRC RSA Botswana Burkina Faso Lesotho Malawi Mali Guinea-Bissau Swaziland

0.20 0.10
-

90 80 70 60
50

10 000

40 30 20 10
0
UK Germ any US JAPAN Russia Brazil China RSA Nigeria Kenya Swaziland Senegal Zim babwe Ghana Uganda Botswana Tanzania India Zam bia Rwanda Congo Cam eroon Malawi Lesotho Mozam bique Burkina Faso Guinea-Bissau Mali Conakry DRC

Tariffs (USD)

MTR (USD)

MOU

1 000

Source: Company fillings, Research ICT & IAS estimates

In 2012, the global MOU average was c.280min, or more than double the 132min observed in Ghana. To the detriment of operators, regulators have in particular targeted MTRs in a bid to make call rates more affordable and increase the coverage and welfare of the consumer and economy. This has been dominating headlines in RSA as the regulator moves to cut MTRs by a further 50% to ZAR 0.20 (USD 0.018) per minute.

100

Internet

% Urban

GDP per capita

Source: Global Digital Statistics 2014 / World Bank

Looking at Figure 6, data penetration remains low in Africa relative to the rest of the world for reasons similar to those for voice. For that very reason, the observed rise in per capita incomes and associated increase in urbanisation rates combined with the continuous decline in device and data prices have seen see data penetration increase exponentially. As such, SSAs operators have been enjoying high growth in the provision of the service.

Figure 7: Latest filings show high data revenue growth of MTN, Vodacom and Safaricom
56.0% 37.4% 41.0% 45.0% 58.0%

rapidly has also been person-to-business (P2B) and business-to-person (B2P) transactions as users were able to pay for goods and services using the platform.

Sector Outlook
Going forward, GSMA expects mobile subscribers to grow at a CAGR of c.8% to 2017, slowing down from the 18% achieved over the five years to 2012. Mobile penetration is therefore expected to rise from the current 67% to c.84% by 2017.
Figure 9: GDP CAGR (%) to 2016 vs. historical urbanisation rate (%)
12.0 10.0 8.0 6.0 4.0 2.0 -

36.0% 18.1%

Nigeria

Kenya

Cameroon

Ghana

Source: Company fillings

Mobile money (MM) does more than just to improve financial inclusion. Mobile money has been an unprecedented success in Kenya, Tanzania and now Zimbabwe. These services have not only given access to financial services to a wider spectrum of the population, but have also generated significant revenue and increased customer loyalty for their operators.
Figure 8: Bank penetration (%) vs. GDP per capita (USD)
120 100 000

Ivory Coast

Uganda

RSA

Mozambique

Cameroon

Rwanda

Conakry

Senegal

Uganda

Zambia

DRC

Ghana

Nigeria

Kenya

Tanzania

Congo

Malawi

Burkina Faso

Cote d'Ivore

Zimbabwe

Liberia

Botswana

Sudan

Mali

Lesotho

Benin

RSA

100 80
60

GDP Outlook

Urbanisation rate

10 000

Source: World bank

40 20
0
Mozam bique Germ any Senegal Zam bia

1 000

100
Rwanda
Uganda Cam eroon China Ghana Brazil Tanzania DRC Zim babwe Botswana Burkina Faso Conakry Nigeria RSA Malawi Russia

Congo

Kenya

JAPAN

Lesotho

Guinea-Bissau

Swaziland

Key factors underpinning the growth in subscribers will be the rise in per capita incomes and the urbanisation rate. Though our chart shows the historaical urbanisation rate to 2011, we use the data mainly for comparative purposes. We are also of the view that economic growth drives urbanisation rates. Increased smartphone penetration to drive usage. According to GSMA, penetration of the more advanced and data hungry smartphone averages 17% globally compared to 4% in Africa. In RSA, the most advanced market in Africa, smartphone penetration per mobile subscriber is estimated at c.22% and is expected to exceed 45% by 2017.

India

UK

US

Bank penetration

GDP per capita

Source: World Bank

In Kenya, Safaricoms M-pesa was initially driven by urban-to-rural area, person-to-person (P2P) remittances as the service allowed income earners in the city to transfer cash to dependants in rural locations, which typically lack or at the very least, have inadequate traditional banking infrastructure. Safaricom with its expansive network that covered such areas, whilst other networks focused only on the coverage of high-density centers, was able to facilitate transactions into the rural areas. MM essentially increased the value proposition for operators to extend coverage to the rural areas. Growing

Mali

Guinea-Bissau

Swaziland

Figure 10: Smartphone penetration outlook

50% 40%
30%

20% 10% 0%
2010 2011 RSA 2012 2013 2014 2015 Tanzania 2016 2017 Kenya Nigeria

We see the expansion into data helping SSA operators expand or buoy EBITDA margins in the short to medium term amidst the rising competition in voice. Operators in more developed markets face a tougher regulatory environment and intense competition which has lowered ARPUs dramatically. Where SSA operations see growth prospects, particularly in data, developed market operations are competing fiercely to protect market share. Capex intensity to stabilises around current levels? Capex intensity of our SSA operators has been higher than the global average from 2005 to 2010 as the operators catered to strong growth in the sector, and more recently addressed the issue of improving quality and extending coverage to the rural areas. Globally, capex intensity stabilised around the 14% level, and trended higher as competition and investment in data accelerated. We see SSA operators substituting capex in voice for that in data.
Figure 12: Capex intensity converging with globals
30% 25% 20% 15%

Source: GSMA

Continent-wide, smartphone penetration is forecast to reach c.20% by 2017, representing a rapid CAGR of c.61% given that mobile voice subscribers will also be growing at a CAGR of 8% over that period. But even then, smartphone penetration in SSA will still be below half the global average of 43% by then, implying robust growth in usage beyond then. The increase in the constitution of smartphones alone, will certainly have a significant impact on data revenue growth. For Vodacom in RSA, average monthly usage increased 78.9% to 220MB per device y-o-y whilst the average price of data declined 16.3% over the companys interim to H1 14. Behind the surge in consumption was a 24.0% growth in smartphones to 6.6m devices over that period. SSA operators to remain more profitable than global peers in the near term. SSA operators have been more profitable from an EBITDA basis, achieving EBITDA margins of 39.0% over 2013 against 32.4% for global peers. Furthermore, SSA margins have been on a rising trajectory, gaining 90bp since 2010 whereas margins for global peers have been on a downward trend, shedding 120bp over the same period.
Figure 11: EBITDA margins stabilising at higher level than global peers
50% 45% 40% 35%

10%
5% Dec-03

Dec-05

Dec-07 Universe

Dec-09 SSA

Dec-11

Source: Bloomberg

30%
25% Dec-03

In the short to medium term, we expect operators in SSA ex. RSA to upgrade their data networks as it is still too early to spend on LTE capex and license costs. For example, Safaricom management would rather upgrade 3G to +3.5G to increase bandwidth significantly enough to satisfy current consumption. Looking into the long term, capex intensity is likely to be slightly higher, as operators look to extend coverage into more remote areas, as well as to build out new LTE networks. In RSA and Kenya there is spectrum being freed up and if utilised by the operators, this would increase wireless data transmission capacity on the existing infrastructure. This would significantly reduce the capex burden from having to install more base stations in order to increase network capacity.

Dec-05

Dec-07 Universe

Dec-09 SSA

Dec-11

Source: Bloomberg

Valuation & Comparatives

M kt Cap Coumpany M TN Group Vodac om Group Safaric om Ltd Sonatel Ec onet Wireless Airtel Zambia O natel BF TNM SSA Etisalat Etihad Etisalat O oredoo Q sc M aroc Telec om M obile Telec ommu Vodafone Egypt M ENA Americ a M ovil-L Bharti Airtel M egafon M obile Telesyst Sk Telec om Tim Part Sistema Jsfc Idea Cellular Bharti Infratel Lg Uplus Corp Relianc e Communi EM Vodafone Group Softbank Corp Deutsc he Telekom Ntt Doc omo Inc Kddi Corp T-M obile Us Inc Crown Castle Int Telefonic a Deuts Inmarsat Plc Hikari Tsushin Freenet Ag Drillisc h Ag Atlantic Tele-Ne Shenandoah Telec Amc om Telec om Ntelos Holdings Bigair Group Ltd Developed Global Britain Japan Germany Japan Japan United States United States Germany Britain Japan Germany Germany United States United States Australia United States Australia M exic o India Russia Russia South Korea Brazil Russia India India South Korea India UAE Saudi Arabia Q atar M oroc c o Kuwait Egypt Country South Afric a South Afric a Kenya Senegal Zimbabwe Zambia Burkina Faso M alawi (USDm) 33 781 16 146 5 518 4 901 1 000 483 434 50 62 313 25 292 18 222 13 036 10 332 10 065 3 143 76 946 74 249 20 218 19 648 17 825 15 415 13 144 12 138 7 346 5 058 4 208 4 150 193 401 66 025 86 719 38 517 68 653 49 904 24 011 23 599 4 923 1 916 3 811 2 125 906 927 574 554 345 147 373 657 706 318 TTM PE 16.5x 13.1x 22.6x 15.0x 7.0x 15.8x 13.0x 31.9x 15.3x 14.3x 10.2x 18.0x 12.0x 11.8x 9.0x 12.9x 14.2x 53.0x 7.8x 7.3x 11.5x 20.7x 4.9x 45.2x 29.7x 20.6x 21.7x 12.3x 6.0x 16.9x 20.6x 13.1x 13.7x 108.4x 156.4x 32.7x 29.9x 13.4x 13.0x 7.3x 119.5x 15.9x 23.8x 15.3x 26.1x 13.3x 13.1x 18.2x 11.5x 19.5x 20.7x 17.0x 12.6x 11.5x 70.5x 43.0x 130.2x 26.0x 15.2x 11.6x 19.8x 25.9x 21.3x 17.5x 13.3x 14.5x 17.6x 14.6x 5.7x 7.9x 18.3x 6.2x 11.4x 10.4x 7.8x 12.1x 1.8x 6.4x 12.4x 5.3x 8.4x 8.1x 7.4x 1.7 1.4 2.7 10.5 1.3 0.9 0.9 4.0 1.4 1.6x 1.5x 10.9x 1.5x 4.8x 0.6x 0.9x 2.7x 0.5x 2.6x 3.2x 1.6x 3.2x 2.7x 2.4x 19.5x 6.7x 18.0x 18.9x 10.5x 11.1x 21.3x 11.4x 7.4x Fwd PE 13.1x 12.1x 16.9x 13.3x 7.0x 13.8x 11.6x 7.9x 12.9x 11.4x 9.4x 12.8x 12.0x 9.9x EV / EBITDA 6.4x 7.4x 6.1x 5.3x 4.2x 4.7x 5.6x 2.7x 6.4x 7.3x 8.2x 5.2x 6.4x 6.6x 4.9x 6.6x 5.4x 7.5x 5.7x 4.8x 5.0x 5.1x 2.8x 8.5x 8.7x 4.9x 10.9x 5.8x 10.3x 9.6x 5.6x 0.1 4.7 0.2 3.3 Div Yield 4.4 6.9 2.6 6.3 3.8 8.5 4.2 5.0 EV / Sales 2.7x 2.7x 2.5x 2.8x 1.3x 1.8x 2.2x 0.4x 2.6x 2.4x 3.0x 2.2x 3.5x 2.8x 2.9x 2.6x 1.8x 2.4x 2.7x 2.1x 1.6x 1.3x 0.7x 2.3x 3.2x 0.8x 3.4x 1.8x 3.1x 3.5x 1.6x

Safaricom rerates ahead of global and regional peers. Over 2013, the sector rerated as the result of the increase in liquidity following QEIII and historical PERs hiked c.48% to 17.6x in 2013 from 14.2x in 2012.
Figure 13: Historical PER (normalized) history

current penetration and urbanisation rates and growth rates.

Figure 14: Operator exposure to voice drivers
3 500

3 000

30.0
GDP per capita (USD)

MTN

25.0

2 500 VOD 2 000

20.0 15.0
10.0

1 500 SCOM ONTBF

500

ATEL

1 000

SNTS ECOZ

5.0 Dec-09 Dec-10

Universe Onatel BF
Source: Bloomberg

TNM

20 40 60 80 100 120

Dec-11
MTN Econet Sonatel Safaricom

Dec-12
Vodacom

Dec-13
Source: IAS

Mobile penetration (%)

Urbanised population (%)

On account of a drastic improvement in fundamentals, Safaricoms historical PER increased by 115% from 11.5x in 2012 to 24.7x in 2013. On a TTM basis, the company now trades a PER of 21.0x as robust earnings growth has continued over H1 14 whilst the global sector is at 15.0x. From this point of view, Safaricom is relatively pricing at a PER premium of 28.3% above MTN which harbours significant earnings growth prospects, especially given that Nigeria alone contributes about c.50% of the groups EBITDA. The other SSA ex. RSA operators contribute a further c.27% to the groups EBITDA. We do think that Safaricom has significant scope for further growth in earnings in the short and long term given that 1) M-Pesa stands to enjoy growth from usage by subscribers from all income categories and 2) data will also enjoy high growth from the middle to upper income earners in the short to medium term. Price discovery from IAM sale to Etisalat. More recently, Vivendi agreed to sell its 53% holding in Maroc Telecoms for c.USD 5.7bn, which is a 4.6% premium above where the company is trading. This transaction prices IAM at an EV / Sales of 3.6x. Applying that multiple to our SSA peers, implies a premium of 36.9% for our peers above where they are currently trading.

From a voice perspective, we see that Econet (ECOZ) has the least prospects when it comes to expanding its customer base. Other factors aside, this would justify the companys low PER. On the other hand, this implies that ECOZ now faces reduced capex requirements going forward and this would in turn attract a higher price multiple as it implies enhanced cash flows going forward. We also see also that Safaricom (SCOM) and Sonatel (SNTS) have similar prospects in this regard whilst TNM and Onatel BF (ONTBF) have quite a bit of upside should per capita incomes rise adequately.
Figure 15: Operator exposure to data drivers
60 MTN 50 SNTS 40 30 20 TNM 10 5 10 15 20 25 30 35 ONTBF ECOZ ATEL SCOM VOD

Data penetration (%)

Source: IAS

Exposure to growth indicators

To review the pricing that our SSA universe trades relative to each other, we compare their exposure to key indicators for growth potential, primarily GDP per capita,

From a data perspective, the SSA sector also still has significant upside for subscriber growth given that the world averages 37% whilst developed (UK, Japan, Germany, USA) and emerging markets (BRICS) are 63.6% and 30.6%, respectively. MTN and SCOMs exposure to the more advanced frontier markets sees them exhibit a

penetration profile similar to that of the BRICS markets. Sonatel, and to a lesser extent, Onatel BFs markets offer significant growth upside given that only c.23% and c.11% of their urbanised population is a data subscriber. Given that the level of per capita incomes (sphere area) remains low, the recent arrival of fibre optic undersea cables should boost penetration further.
Figure 16: Operator exposure to mobile-money drivers

relatively low and this will likely hamper data growth in the short to medium term.
Figure 17: Overall exposure to economic growth outlook, urbanization rate and income levels (sphere size)
7 ONTBF 6 5 SNTS 4 3 2 ECOZ VOD ATEL TNM MTN SCOM

MTN 50 SNTS
Urbanised population (%)

ATEL ECOZ VOD

40 30 20 TNM 10 ONTBF

SCOM
1 3.0 4.0 5.0 6.0 7.0 8.0

GDP grwoth (%)

60

Urbanisation growth rate (%)

Source: IAS
0 10 20 30 40 50

Financial inclusion (%)

Source: IAS

Airtel Zambia and Safaricom show relatively balanced position with the latter being in a slightly higher income environment. Top picks. Whilst we find our whole universe investable, we especially like Econet, Sonatel and Safaricom as we believe that they have significant exposure to high growth markets, be it voice, data or Mobile Money. Econet, with a strangle-hold of its majority share in a market which harbours strong data and mobile money prospects, is also the cheapest telecoms company in our universe. We believe its prospects outweigh the political risks, corporate governance issues and its exposure to a highly troubled banking sector. Sonatel will remain a steady growth, high dividend yielding opportunity in the short to medium term but offering some upside in the event data and mobile money take off in the region over the medium to long term. Aside for it being at a significant premium to its peers, Safaricoms potential to surprise is undeniable. We see significant potential in the long term, particularly from data and its M-Pesa platform.

We see that through their highly successful mobile money platforms, Safaricom and Econets markets lead financial inclusion when compared to their SSA peers. Kenyas 42% is generally in line with the worldwide average of c.44%. With about a fifth of the urbanised population in Sonatels markets holding bank accounts, there is significant upside for MM for the operator as the remainder will surely seek access to financial services as disposable incomes rise and propensity to save increases. To a lesser extent, the same can be said for the peers, especially Onatel, TNM, Vodacom and Airtel Zambia. Mobile money to remain a key value driver in SSA. Unlike their developed and emerging market peers operating in economies with relatively higher bank penetration, SSA operators have a third revenue stream which will allow them to generate higher ARPUs from their existing infrastructure. In some cases, SSA operators will also be able to leverage off this revenue stream and expand coverage to areas that have lower voice ARPUs. Overall exposure to determinant factors. Refering to Figure 17 below, we observe that Onatel BFs market scores well with regards to benefitting from economic growth and urbanisation rates. Whilst high voice subscriber growth is expected, the income levels are still

Equity Research South Africa February 2014 Telecoms

Airtel Networks Zambia PLC, formerly Celtel Zambia, is part of the Bharti Airtel Group and is the largest mobile phone operator in Zambia with 5.1 million customers as of 3rd Quarter 2013.The Principal activity of the company is the provision of cellular radio telecommunication services across the country and it now provides coverage in all 72 districts of Zambia. Its full range of services includes voice, international roaming, pre and post-paid subscriptions, SMS, 3.5G/EDGE, Blackberry and mobile internet to individual, corporate and SME customers. Margins slightly under pressure - EBITDA margins may experience downward pressure caused by a rise in advertising expenses which are a result of increasing competition. Airtel launched two cheaper promotional packages to bring affordability to customers. Increases in excise duty the excise duty on airtime vouchers has been increased by 50% to ZMW 15. All network providers are expected to increase their airtime tariffs to compensate for the tax increase. An intensified focus on the rural population All network providers are redirecting their focus on the rural majority to help increase their subscriber numbers. The MSPs have been upgrading base stations, rolling out coverage towers and launching high broadband network systems. Along with the traditional offerings, the aim is to also provide services such as mobile money to the rural unbanked. Valuation. Using a DCF valuation, we arrive at a fair valuation for Airtel Zambia of ZMW 38.99, which implies an upside of 50.0% from its current price of ZMW 26.00. It currently trades as PER of 15.8x PBV of 1.9 and a dividend yield of 3.8%. The stock is highly illiquid trading at 4% free float, we recommend a Buy, provided there is availability.
Share price vs. S&P Africa Frontier Index
Recommendation Bloomberg Code Current Pric e (ZM W) Current Pric e (USc ) Target Pric e (ZM W) Target Pric e (Usc ) Upside (%) BUY ATEL:ZL 26.00 4.66 38.99 6.99 50.0%

Liquidity M arket Cap (ZM W m) M arket Cap (USD m) Shares (m) Ave. daily vol - 1 yr. ('000s) 2 704 485 104 20

Pric e Performanc e Pric e, 12 months ago (ZM W) Change (%) Pric e, 6 months ago (ZM W) Change (%) 28.00 -7% 29.00 -10%

Financ ials (ZM W m) 31 Dec Turnover EBITDA Net Financ e Inc ome Attributable Earnings

F2012 1 824 766 (11) 196

2013F 2 134 1 079 (21) 232

2014F 2 497 949 (19) 273

Per share data (ZM W) EPS DPS NAV/Share 3.06 1.00 13.84 4.40 1.13 15.72 7.09 1.19 17.95

Ratios RoaA (%) RoaE (%) EBITDA M argin (%) 15% 22% 38% 19% 28% 42% 28% 40% 51%

Valuation Ratios Earnings Yield (%)* Dividend Yield (%) PE (x)* PBV (x) EV/EBITDA (x)* EV/Subsc ribers (USD)

Current 12% 3.8% 15.8 1.9 4.7 118.3

2013F 17% 4.4% 13.8 1.7 3.6 103.9

2014F 27% 4.6% 11.7 1.4 2.6 96.0

120

100

STRENGTHS Still maintains largest market share, Strong parent company with experience in competitive, low margin market. Product innovation OPPORTUNITIES Mobile money Higher per capita incomes Data to take off

WEAKNESSES

Slowly losing market share to MTN and Zamtel Slow maturing

THREATS Loss of subscribers owing to poor customer service

80 May-13 Jul-13 ATEL ZL (USD)

Sep-13 Nov-13 S&P Africa Frontier Index

FY 12 Financial & Operational Review

Airtel changed its reporting period to 31 December and thus its previous financial results accounted for the 9 month period ending 31 December 2012. The financials were adjusted for a 12-month period for analysis purposes. Revenue for FY 12 decreased by 1.6% to an annualised ZMW 1.6bn due to declining ARPUs which fell to ZMW 27.00 from ZMW 30.00 due to promotional special deals for customers. In the beginning of 2012 the introduction of the more affordable club Zed and 5X promotions increased the minutes of use per subscriber but also reducing the effective rate of tariffs which impacted on revenue. Figure 1: Revenue analysis On equity, share capital and share premium were ZMW 1.0m and ZMW 24.9m, respectively which has remained flat. Retained earnings weighting 98% of equity at ZMW 1.14bn boosted by retained earnings as the dividend payout ratio was a modest of 33%. ROE was therefore 22% from 26% previously and the dividend yielding of 3.8% for the year. Airtel has excperienced drastic market share loses over the years from a market share of 80% in 2008 to a current level of 46.1%. Competition has become rife from the likes of MTN, its biggest rival which holds 40.4% market share, whilst the rest is held by Zamtel. Figure 2:

Source: Company filings Source: Company filings

Operating expenses of ZMW 468m were stable y-o-y at 33% of revenue. Selling and general admin expenses declined by 1.6% to ZMW 499m as a result of implemented effective cost management. The decline in revenues reflected in weaker EBITDA margins of 37%, a 1.0% decline y-o-y. Based on the companys strategy of increasing its rural subscribers, as competition intensifies, vigorous advertising and cheaper customer package deals could increase which will depress margins in the long run. PBT eased 4% to an annualised ZMW 432m for the same period. The effective tax rate of 30% yielded a charge of ZMW 114m, lower than the statutory rate of 40% due to deferred tax adjustments, and this resulted in PAT increasing by 7% to ZMW 318m. Total assets as at 31 December 2012 were ZMW 2.2bn, of which 77% were non-current assets, with PPE of ZMW 1.7bn. Net assets yielded a return of 14.8% for the year. In the long run there will be an intensified need to invest in expensive infrastructure to increase penetration levels in other parts of the country

Having the largest voice and data network in Zambia Airtel has expanded its 3.5G network system over 200 base stations, and recently embarked on gold-plating of over 1,000 of its towers to enhance coverage. The quality of network connections has been one of the major issues that the regulator has been advocating for. MTN and Zamtel have also taken the decision to increase their broadband network with their 4G/LTE networks. However this is not a big threat as it will take a while for the LTE systems to have a notable effect since they are mostly relaint on the capabilty of the underlying smartphone devices, the affordability of which is still a ristrictive factor for the average customer

10

Outlook
The company is intensifying its drive to gain more customers from the rural areas which has a population of 8.4m. This provides Airtel with an opportunity to increase its subscribers in the mobile money transfer segment up and above their current 1.9m subscribers. Airtel has erected 171 towers and constructed more than 350 shareable base stations as infrastructure spend to be able to maintain its dominant market share in the rural areas. There has been a call by the public for the regulator to reduce MTRs and to regulate mobile tariffs to make the cost of communication more affordable. On the other hand excise duty on airtime increased from 10% to 15%, and because of this all three MSPs have increased their tariffs as means to compensate for the hike. Internet data use is relatively low at penetration levels of 19.6% compared to South Africa, Nigeria and Kenya at 50%, 32% and 28% respectively. With an increase in smartphone usage, mobile data use by the younger generation who use mobile devices for social networking, and other downloads such as music and games will most likely boost ARPUs. In the long run with the maturation of the market growth levels will start to increase at a decreasing rate and MSPs will have to start diversifying their services from their conventional services, and provide other added services that will encourage customers to spend more money on their mobile phones. Zambias economy according to the WB is growing at a rate of 9%, it has the right platform to see increased mobile activity to the levels seen in other developing countries. Improving GDP per capita levels, longer life expectancy levels and a lower dependency ratio of the population are among the positive growth factors for the industry. Valuation Using a DCF valuation, we arrive at a fair valuation for Airtel Zambia of ZMW 38.99, which implies an upside of 50.0% from its current price of ZMW 26.00. It currently trades as PER of 15.8x, PBV of 1.9x and a dividend yield of 3.8%. We therefore recommend a BUY. The current trading price has discounted stock liquidity since its only trading at a free float of 4%, which may prove the stock very difficult to acquire.
Source: BMI

CHEAPEST PREPAID PRUDUCT BY NETWORK (ZMW)

Source: Research ICT Africa.net

11

Financial Summary
Valuation metrics PER EV / EBITDA P / Book Dividend Yield (%) EV / Sales Key Statistics Subsc ribers Base (m) Blended ARPU (ZM W) Income Statement Revenue Y-o-Y Growth EBITDA Y-o-Y Growth EBIT Y-o-Y Growth Net financ e c osts PBT Inc ome tax Effective tax rate PAT Y-o-Y Growth Basic EPS Y-o-Y Growth DPS Y-o-Y Growth Dividend payout ratio Ratio Analysis EBITDA margin EBIT margin RO aE RoAA Debt / Equity Net debt / EBITDA Interest c over Balance sheet Non-c urrent assets PPE Intangiable assets Current assets Cash balanc es Total assets Current liabilities Non-c urrent liabilities Shareholder funds M inority interest Net debt (c ash) 2008 A 2009 A 2011 A 2012 A 2013 E 2014 E 2015 E 2016 E 2017 E

20.3 5.7 7.3

2.3 2008 A 2.7 33 2008 A 1 217 0% 486 0% 402 0% (80) 322 (113) 35% 289 0% 1.38 0% 0% 0% 2008 A 39.9% 33.0% 38.6% 18.0% 0.58% 0.89% n/a 2008 A 1 248 1 248 358 196 1 606 223 218 749 (93)

31.9 5.8 7.6

1.5% 2.0 2009 A 3.2 32 2009 A 1 383 14% 476 -2% 457 14% (47) 409 (143) 35% 234 -19% 0.88 -36% 0.39 0% 44% 2009 A 34.4% 33.0% 25.5% 13.6% 0.00% 0.01% 5.7 2009 A 1 391 1 391 321 118 1 712 217 276 916 (21)

9.8 4.6 2.4

3.8% 1.8 2011 A 3.7 30 2011 A 1 584 8% 602 18% 464 -4% (14) 382 (153) 40% 297 8% 2.86 209% 1.00 186% 35% 2011 A 38.0% 29.3% 26.7% 13.4% 5.59% -10.33% 33.1 2011 A 1 741 1 738 3 480 49 2 221 603 232 1 112 (49)

15.8 4.7 1.9

3.8% 1.8 2012 A 4.3 27 2012 A 1 559 -2% 592 -2% 443 -4% (11) 285 (114) 30% 318 7% 3.06 7% 1.00 0% 33% 2012 A 37.0% 28.4% 22.1% 14.8% 8.34% 20.27% 40.6 2012 A 1 656 1 654 2 500 48 2 156 709 277 1 440 (48)

13.8 3.6 1.7

4.4% 1.5 2013 E 4.9 26 2013 E 1 824 17% 766 29% 608 37% (21) 326 (130) 40% 457 44% 4.40 44% 1.13 13% 26% 2013 E 42.0% 33.3% 28.0% 19.0% 4.84% 10.32% 29.6 2013 E 1 825 1 820 5 576 49 2 401 671 283 1 635 (49)

11.7 2.6 1.4

4.6% 1.3 2014 E 5.3 24 2014 E 2 134 17% 1 079 41% 911 50% (19) 386 (155) 40% 738 61% 7.09 61% 1.19 5% 17% 2014 E 50.6% 42.7% 39.5% 27.5% 3.91% 6.77% 48.0 2014 E 2 011 2 002 9 667 52 2 677 713 283 1 867 (52)

9.9 2.9 1.3

5.0% 1.11 2015 E 5.7 23 2015 E 2 497 17% 949 -12% 771 -15% (19) 456 (182) 40% 570 -23% 5.48 -23% 1.30 9% 24% 2015 E 38.0% 30.9% 26.6% 19.1% 3.38% 7.62% 41.0 2015 E 2 215 2 202 13 767 50 2 982 822 283 2 140 (50)

8.3 2.5 1.1

5.3% 0.95 2016 E 6.1 22 2016 E 2 921 17% 1 110 17% 922 20% (14) 541 (216) 40% 692 21% 6.65 21% 1.37 5% 21% 2016 E 38.0% 31.6% 28.1% 20.7% 2.19% 4.87% 65.6 2016 E 2 439 2 422 17 894 56 3 333 934 283 2 465 (56)

7.1 2.4 1.0

5.6% 0.8 2017 E 6.6 21 2017 E 3 418 17% 1 299 17% 1 099 19% (15) 634 (254) 40% 830 20% 7.98 20% 1.46 7% 18% 2017 E 38.0% 32.1% 29.2% 22.3% 2.06% 4.51% 72.2 2017 E 2 686 2 664 22 1 036 58 3 722 1 088 283 2 845 (58)

12

Equity Research Zimbabwe February 2014 Telecoms

Econet is the dominant player in the domestic telecoms market, commanding a value share of 74% with a subscriber base of 8.5m. In our view, Econet has a head start over other players, in terms of penetration in data, which is expected to be the next growth avenue. To us, this secures high revenue visibility. Furthermore, the relatively weak competition increases our confidence in Econets ability to maximise returns from its prospects. Strong cash generation. Although cash generation remained strong in H1 14, (net cash generated from operations up 77.1%, representing a cash interest cover of 12x), cash flows were strained on payment of licence renewal fees (USD 52.5m), increased finance costs and repayment of borrowings.

Bloomberg Code: Recommendation Current Price (USc) Target Price (USc) Upside (%) Liquidity Market Cap (USD m) Shares (m) Free Float (%) Ave. daily vol ('000) Price Performance Price, 12 months ago (USc) Change (%) Price, 6 months ago (USc) Change (%) Financials (USD '000) 31 Feb Turnover EBITDA Net Finance Income Attributable Earnings Per share data (USc) EPS DPS NAV/Share Ratios RoaA (%) RoaE (%) EBITDA Margin (%) Valuation Ratios Subscribers' 000 PER (x) PBV (x) RoaA (%) RoaE (%) Earnings Yield (%) Dividend Yield (%) EV/sub (USD) EV/EBITDA ARPU (USD) 14.4 28.4 43.7 Current 8,000 7.0 2.0 14.4 28.4 14.4 0.0 159 4.2 5.9 13.1 24.6 41.0 2014F 8,615 7.0 1.7 13.1 24.6 14.2 2.1 147 4.1 6.0 13.4 21.8 41.3 2015F 8,664 7.2 1.6 13.4 21.8 13.9 2.2 146 3.9 6.1 8.8 30.8 8.7 1.3 35.2 8.5 1.4 38.8 F2013 694,844 303,805 (25,947) 139,938 2014F 759,343 310,959 (38,720) 137,888 52.0 17.3 64.0 (4.7) 2015F 778,398 321,161 (37,979) 138,775 1,000 1,640.0 52.0 1,058.1 ECWH:ZH LT BUY 61.0 75.0 23.0

Healthy margins and ARPUs. Although EBITDA margins eased to 43.9% from 45%, negatively impacted by increased network and marketing costs, they remain healthy. ARPUs declined 10% to USD 8.00 due to the dilutive effect of lower value subscribers and new services that are still to realise their full potential. Although promotional activity saw tariffs decline by up to 30%, this was offset by a 60% increase in MOU.

Solid infrastructure to support future growth. In our view, Econet has a robust transmission backbone given its access to optic fibre. The company has invested approximately USD 650.0m in capex since 2009. The introduction of new products should continue to attract revenues for the company as well as increasing its subscriber base. Valuation remains compelling. At current levels, Econet prices at a TTM PER of 7.5x, EV/subscriber of USD 147 and EV/EBITDA 4.0x, which are at discounts of c.40% to its SSA ex SA peers. Our DCF valuation ascribes a fair value of US 77c. We rate the share LT Buy.
Econet Price vs. S&P Africa Frontier (Rebased)
250

STRENGTHS Market leader Strong brand Economies of scale 4G/LTE network in place OPPORTUNITIES New products/services

WEAKNESSES Low disposable incomes Energy disruptions High gearing High NPLs for banking subsidiary THREATS Entery of stronger players eg. MTN Resurgence of beer market as a percent of wallet

200

150

100

50

Weak competition: Telecel/NetOne Price wars Mobile banking Expansion of data services Economic recovery

21-Feb-13

12-May-13
Eco n e t (USc)

31-Jul-13

19-Oct-13

21-Jan-14

S&P AF

13

H1 14 Financial & Operational Review

Figure 1: H1 2014 Results
Income Statement (USD '000) H1 2013 339,469 152,797 (10,381) 1,708 112,279 77,941 4.60 FY 2013 1,015,110 489,405 275,158 233,933 1.2 H1 2013 123,659 (78,752) (37,576) 45.0 33.1 30.5 23.0 219,020 (206,753) (50,557) 43.9 28.2 33.5 18.7 25.1 12.3 77.1 162.5 34.5 1,135,144 563,969 224,087 290,441 0.8 11.8 15.2 (18.6) 24.2 (34.4) H1 2014 376,558 165,254 (18,212) 3,836 106,074 70,506 4.50 % change 10.9 8.2 75.4 124.6 (5.5) (9.5) (2.2)

Zimbabwes telecoms giant, Econet, reported another set of mixed interim results showing solid (+11% y-o-y) topline growth but muted attributable income, down 10% y-o-y to USD 70.5m for EPS of US 4.5c. The lower bottom-line can be attributed to higher net finance costs (+75.4%) and a higher effective tax rate (33.5% versus 30.5%) as margins were generally maintained. The cellular network operations profits grew 8.4% to USD 83.0m while other businesses posted a loss of USD 12.4m versus a profit of USD 1.4m at H1 13. The loss from other businesses was on account of the USD 22.0m loss from the banking subsidiary. No interim dividend was declared. Revenue growth was underpinned by a 22% jump in subscribers to 8.5m. Econet maintained its dominance, commanding 74% of the market. Contribution of voice revenue declined to 60% from 66% as other overlay services contribution increased. ARPUs declined by 10% to approximately USD 8.00 from USD 8.90 due to the dilutive effect of lower value subscribers and new services that are still to realise their full potential. Although promotional activity saw tariffs decline by up to 30%, this was offset by a 60% increase in MOU. EcoCash contributed USD 13.0m to revenue as the number of subscribers registered for EcoCash increased 76% to 3.0m. EcoCash handled over 50.0m transactions valued at approximately USD 1.2bn during the six months period. EBITDA grew 8.2% to USD 165.3m registering an EBITDA margin of 43.9%, some 110bp lower than the prior period. Cost pressures emanated from network costs (+7.4%), marketing (+13.6%), EcoCash (+11.4%), licence fees, staff costs and customer service costs. The number of EcoCash agents increased by 338% to over 7,000 resulting in increased EcoCash agent commission. The depreciation charge surged 40.6% to USD 45.7m and the mobile operator achieved an operating profit of USD 119.5m (-0.6% y-o-y) for the period. The jump in depreciation relates to a 34.7% increase in capex to USD 85.0m. Capex to revenue increased to 22.6% from 19%. Although cash generation remained strong, (net cash generated from operations up 77.1%, representing a cash interest cover of 12x), cash flows were strained on payment of licence renewal fees (USD 52.5m), increased finance costs and repayment of borrowings. Finance costs grew 75.4% as the vendor financing was replaced by a syndicated loan at a weighted average rate of approximately 7.3% p.a. in addition to the 6% p.a. guarantee fee paid to Econet Wireless Global (as explained in the notes of the 2013 Annual report). Total gearing improved to 40% from 54% at year end.

Turnover EBITDA Net finance income Associates profit PBT Attributable earnings EPS (USc) Balance Sheet (USD '000) Total Assets NAV Current Assets Current Liabilities Current ratio Cash flow (USD '000) Operating activities Investing activities Financing activities Ratios EBITDA margin (%) PBT margin (%) Effective tax rate (%) PAT margin (%) RoaE (%) RoaA (%)

Source: IAS, Company reports

Figure 2: Opex split

Network 34%

Interconnet & roaming 13%

Employee 18%

Marketing 12%

General Admin 22%

Source: IAS, Company reports

Figure 3: ARPU declined on subscriber growth

Sales, USDm 900 800 700 600 500 400 300 200 100 0 2010
Sales USDm

ARPU, USD 7.5 7.0 6.5 6.0 5.5 5.0 2011 2012
Monthly ARPU

2013

2014F

2015F

2016F

Source: IAS, Company reports

14

Outlook
The demand for group products remains strong especially given the weak competition. In our view, price and quality of service will be a key differentiator in the telecoms market. Management states that the future of the company lies in innovation and providing value added services to its subscribers. Econet harbours significant growth potential from its broadband and overlay services, more particularly in the latter especially, the EcoCash segment. Given the higher subscriber base, the companys incoming MoU are significantly higher than outgoing with on-net traffic comprising approximately 80% of the total. Nonetheless, we believe that ARPUs are likely to be under pressure on an expanded subscriber base compounded by the effects of multiple SIM card ownership. Data presents significant opportunities for the company. Econet has three data revenue streams: internet services, SMS (text messaging) and EcoCash. Econet has a head start over other players, in terms of penetration in data which is expected to be the next growth avenue. We believe that Econets margins are likely to ease and settle around 42%, in line with African peers. The reasons being the roll out of the retail units, network costs (use of generators), increased competition, roll out of EcoCash agents and the high base the company is coming from. In addition the banking units contribution is likely to remain negative at least in the short term given the need to clean up the balance sheet as well as the adoption of a new business model. We also note that Econets revenue from international roaming is likely to ease given the high termination rates charged by Econet as compared to its competitors. Nonetheless, higher margin revenue items include the likely growth in contribution from data traffic. The Zimbabwean mobile telephony market is almost saturated with an estimated penetration rate of 103.5% as at December 2013. Due to the near saturation we expect to see Econets subscriber base increase modestly beyond FY 2014. The company is post its peak funding period having rolled out the network countrywide. We forecast that capex to revenue will probably recede to between 15% and 20% by FY 2014 as the company focuses on sweating the existing assets. We expect Econet to generate higher cash flows from operations over the next few years. Over 99% of the companys customers are on the prepaid package, thus mitigating the companys receivables

position. Once past its peak capex funding, we expect Econet to increase its dividend payout (after passing a dividend over the last year) as the banking unit was recapitalised. Econet is focusing on growth and returns through a viable subscriber base, improved network efficiencies and a pipeline of new products. Product innovation has been key to the companys profitable growth in volume and market share gains. The introduction of new products (e.g. Eco-Farmer) should continue to attract revenues for the company as well as increasing its subscriber base.

Risks
Exposure to non telecom business - The acquisition of the bank, Steward Bank, places an additional burden on management. Nonetheless, management maintains that the banking unit offers synergies with other units although it is not yet profitable. Cost pressures - Industry wide cost pressures, especially network related, could have a negative impact on our earnings expectations. Competition a major threat to viability The mobile telephone industry is highly competitive Econet currently competes with two main rivals, Telecel (60% owned by Orascom) and Net-One (government owned). An aggressive network roll out by any of the competitors could potentially harm Econets market position, sales and margins. Although competition is set to intensify, we expect Econet to continue to do well. Our expectations are based on the solid infrastructure base and aggressive marketing initiatives. Given the higher costs for fixed lines, we do not foresee any aggressive growth in subscribers in the near term. Shrinking economy We think that the biggest risk is not specific to Econet but rather endemic to the consumer industry in general. A protracted or worsening economy would clearly negatively impact Econets sales, margins and profits as consumers cut back on spending. The current economic environment may result in increased pricing pressure.

Valuation and Recommendation

At current levels, Econet prices at a TTM PER of 7.5x, EV/subscriber of USD 147 and EV/EBITDA 4.0x, discounts of almost 40% to its SSA ex SA peers. Our DCF valuation ascribes a fair value of US 77c. We rate the share LT Buy.

15

Financial Summary
Valuation metrics PER EV / EBITDA P / Book Dividend Yield (%) FCF Yield (%) EV / Sales Key Statistics Subsc ribers Base ('000) Blended ARPU (USD) Income Statement Revenue Y-o-Y Growth EBITDA Y-o-Y Growth EBIT Y-o-Y Growth Net financ e c osts PBT Inc ome tax Effective tax rate PAT Y-o-Y Growth Basic EPS Y-o-Y Growth DPS Y-o-Y Growth Dividend payout ratio NAVps Y-o-Y Growth FCFps Y-o-Y Growth Ratio Analysis EBITDA margin EBIT margin RO aE RoAA Debt / Equity Net debt / EBITDA Interest c over Capex intensity Balance sheet Non-c urrent assets PPE Intangiable assets Current assets Cash balanc es Total assets Current liabilities Non-c urrent liabilities Shareholder funds M inority interest Net debt (c ash) 2010 A 0.9 7.4 0.6 (38.8) 3.5 2010 A 3,551.0 7.0 2010 A 362,777 NA 171,789 NA 150,679 NA 150,679 (34,912) 23% 113,210 NA 64.99 NA NA 0% 94.99 NA (0.30) NA 2010 A 47.4% 41.5% 92.4% 39.4% 0.64 0.53 67.2 44.1% 2010 A 296,875 267,537 1,573 95,794 13,924 392,669 99,723 127,461 163,169 2,317 91,763 2011 A 0.7 5.3 0.4 1.9 (46.0) 2.6 2011 A 5,510.0 6.1 2011 A 493,471 36% 240,948 40% 200,692 33% (2,557) 198,136 (55,502) 28% 137,949 22% 81.80 26% 1.19 NA 1% 172.24 81% (0.36) 19% 2011 A 48.8% 40.7% 62.3% 26.8% 0.80 0.82 33.3 54.7% 2011 A 536,440 498,861 1,309 101,074 34,691 637,514 102,997 244,039 287,637 2,840 198,520 2012 A 0.6 4.6 2.6 3.9 5.1 2.1 2012 A 7,000.0 6.0 2012 A 611,116 24% 274,678 14% 228,181 14% (8,097) 220,083 (73,389) 33% 165,741 20% 98.27 20% 2.37 100% 2% 23.18 -87% 0.04 -111% 2012 A 44.9% 37.3% 49.7% 22.9% 0.53 0.38 52.2 30.0% 2012 A 600,572 561,656 7,991 211,854 100,793 812,427 255,629 174,005 379,946 2,847 103,338 2013 A 7.0 4.2 1.9 1.3 1.8 2013 A 8,000.0 5.9 2013 A 694,844 14% 303,805 11% 232,241 2% (25,947) 206,295 (64,965) 31% 139,938 -16% 8.75 -91% -100% 0% 31.90 38% 0.01 -74% 2013 A 43.7% 33.4% 32.1% 15.7% 0.57 0.67 10.5 21.2% 2013 A 695,761 646,615 15,583 275,158 78,230 970,919 233,933 288,293 489,405 3,478 202,800 2014 E 7.0 4.1 1.8 2.1 6.6 1.7 2014 E 8,615.4 6.0 2014 E 759,343 9% 310,959 2% 235,614 1% (38,720) 196,894 (59,095) 30% 137,888 -1% 8.66 -1% 1.30 NA 15% 34.15 7% 0.05 392% 2014 E 41.0% 31.0% 26.3% 13.6% 0.52 0.63 7.7 16.0% 2014 E 748,318 694,130 18,665 305,491 94,574 1,053,808 452,238 280,181 556,610 3,478 194,688 2015 E 7.2 3.9 1.6 2.2 7.3 1.6 2015 E 8,663.7 6.1 2015 E 778,398 3% 321,161 3% 235,985 0% (37,979) 198,006 (59,475) 30% 138,775 1% 8.46 -2% 1.35 4% 16% 38.82 14% 0.06 11% 2015 E 41.3% 30.3% 23.3% 13.3% 0.35 0.58 8.2 15.0% 2015 E 780,561 727,484 18,451 251,743 34,264 1,032,304 356,951 272,394 633,181 3,478 186,900 2016 E 6.7 3.8 1.3 2.5 10.0 1.6 2016 E 8,786.0 6.1 2016 E 795,617 2% 331,707 3% 248,535 5% (35,167) 213,368 (64,203) 30% 149,808 8% 9.13 8% 1.55 15% 17% 46.40 20% 0.08 37% 2016 E 41.7% 31.2% 21.5% 13.8% 0.35 0.50 9.2 15.0% 2016 E 816,713 765,582 18,115 317,468 99,998 1,134,181 356,681 250,199 757,522 3,478 164,706

16

Equity Research South Africa February 2014 Telecoms

With its leading market positions in 16 African countries covering 43% of Sub-Sahara Africas population, c.40% of EBITDA earned from Nigeria with mobile penetration still at c.54%, MTN Group (MTN) gives investors one of the best exposures to Africas growing consumer class. MTNs footprint can enable the mobile operator to achieve higher top and bottom line growth than its peers. MTN over the past five years managed to grow its customer base at a CAGR of 25.2% to 188.6m subscribers in FY 12. Revenue, EBITDA and NPAT have grown at a CAGR of 13.1%, 12.8% and 14.3% to ZAR 135.1bn, ZAR 58.6bn and ZAR 20.7bn (before IFRS), respectively. Looking forward, MTN with its significant exposure to Nigeria, harbours the most attractive growth prospects within SSA.

Recommendation Bloomberg Code Current Price (ZAR) Current Price (Usc) Target Price (ZAR) Target Price (Usc) Upside (%) Liquidity Market Cap (ZAR m) Market Cap (USD m) Shares (m) Free Float (%) Ave. daily vol - 1 yr. ('000s) Price Performance Price, 12 months ago (ZAR) Change (%) Price, 6 months ago (ZAR) Change (%) Financials (ZAR m) 31 Dec Turnover EBITDA Net Finance Income Attributable Earnings Per share data (ZAR) EPS DPS NAV/Share Ratios RoaA (%) RoaE (%) EBITDA Margin (%) Valuation Ratios Earnings Yield (%)* Dividend Yield (%) PE (x)* PBV (x) EV/EBITDA (x)* EV/Subscribers (USD) * TTM F2012 121 867 52 637 (4 157) 20 688 2013F 138 561 58 802 (226) 25 068 ACCUMULATE MTN:SJ 200.07 1 771 210.52 1 863 5.2

369 118 32 665 1 845 65.2 5 723

177.14 12.9 191.00 4.7 2014F 158 323 72 028 (3 143) 29 381

Growth in data offsetting contraction in interconnect revenue and downward pressure from competition. The sub-theme remains intact, particularly as we observed data drive top line growth in both of MTNs key markets. Whilst interconnect revenue is inevitably on the decline (a CAGR of -2.6% since FY 09) as regulators cut MTRs, the high growth in data (55.9% over that period) has been the chief driver of top-line growth, contributing to 48% of the increase in revenue since FY 09. Voice contributed to 30.6% of the growth in revenue whilst SMS and equipment sales accounted for 20.8% and 17.6%, respectively. We expect inbound revenue to decline a further 7% to ZAR 15.0bn in FY 13. Meanwhile, we expect data revenues to grow 28% to ZAR 20.4bn.

11.19 6.34 48.13

13.50 9.60 56.34

15.82 11.62 60.54

13.8 23.7 43.2 Current 6.2 3.2 16.2 4.2 7.2 171

16.0 25.8 42.4 2013F 6.7 4.8 14.8 3.6 6.6 167

16.6 27.1 45.5 2014F 7.9 5.8 12.6 3.3 5.4 155

FY 13 HEPS to grow 20.7%. We forecasts FY HEPS and annualised DPS of ZAR 13.50 and ZAR 9.60, respectively. With a target price of ZAR 210.00, the recommendation on MTN is ACCUMULATE.

Share price vs. S&P Africa Frontier Index

140

120

STRENGTHS Best exposure to Africas growth markets Diversified markets; Strong cash position OPPORTUNITIES Ready to acquire new positions Data to take off in other markets

WEAKNESSES Operates in a politically volatile regions Rand weakness

100

80

THREATS Turkcell litigation Iran and Syria conflicts

60 Jan-13

Mar-13

May-13

Jul-13

Sep-13

Nov-13

Jan-14

MTN SJ (USD)

S&P Africa Frontier Index

17

H1 13 Financial & Operational Review

Nigeria offsets underperformance in home market. MTN at H1 13 grew revenue by 9.8% to ZAR 65.3bn (USD 7.1bn) driven by a 6.5% growth in the customer base to 201.5m subscribers accompanied by a 4.2% decline in blended ARPU.
Figure 1: Nigeria driving top-line growth
1.80 0.55 0.76 3.04 0.43 0.05 65.25

EBITDA growth underpinned by Nigeria. EBITDA margins contracted 100bp to 43.8% and EBITDA grew 7.4% to ZAR 28.9bn. This included ZAR 856m profit earned from the sale of towers. From normal operations, EBITDA grew 6.4% to ZAR 27.7bn.
Figure 3: Nigeria also driving EBITDA growth
0.12 0.14 (0.37) (1.91) 0.50 0.05 27.74

0.49
(1.07) 0.07

3.12

0.34

0.20

26.07
59.42
(0.28)

(0.52)

Ivory Coast

Nigeria

Ghana

Cameroon

Uganda

Sudan

RSA

Syria

SOC

H1 12

HOCe

H1 13

Ivory Coast

Nigeria

Ghana

Cameroon

Uganda

Sudan

RSA

Syria

SOC

H1 12

HOCe

Source: Company filings

Source: Company filings

Revenue growth was generally driven by Nigeria as South Africa (RSA), at a mobile penetration rate of c.133%, succumbed to increased competition, lower tariffs and MTRs. The home market only managed to grow subscribers by 6.2% to 25.0m whilst Nigeria, now at a mobile penetration rate of 68.1%, grew its customer base by 27.9% to 55.2m.
Figure 2: Revenue (ZAR m) performance of key markets
RSA Out-voice In-voice Data SMS Devices Other H1 12 10 227 2 485 3 502 1 349 2 605 262 20 430 H1 12 13 981 2 408 2 166 536 65 106 19 262 H1 13 9 686 1 911 4 016 1 239 3 023 271 20 146 H1 13 15 906 2 101 3 472 588 53 183 22 303 % Change -5.3% -23.1% 14.7% -8.2% 16.0% 3.4% -1.4% % Change 13.8% -12.7% 60.3% 9.7% -18.5% 72.6% 15.8%

Whilst RSA EBITDA margins came under pressure from higher device costs, on account of a weaker rand, and contracted 210bp to 32.3%, Nigeria margins expanded 570bp to 66.2%. This was mostly due to a higher contribution from data and cost management. EBITDA in Nigeria therefore grew 26.8% to ZAR 14.8bn and contributed to 53% of the groups EBITDA from operations. Group capex increased by 32.7% to ZAR 12.8bn over the period as capex rollout in Nigeria accelerated (+48.6% to ZAR 6.6bn), adding 1,083 2G and 499 3G sites. Capex also increased aggressively in Ghana (+150.9%), Cameroon (+92.7%), Ivory Coast (+100.0%) and Sudan (+247.2%). Capex for this cluster of companies increased 93.8% to ZAR 2.7bn. In RSA, capex typically increased by a modest 8.6% to ZAR 2.2bn and the operation expanded its mobile data network by a further 213 2G and 527 3G sites. Group depreciation and amortisation were in turn 19.0% higher to ZAR 9.0bn and EBIT grew 7.4% to ZAR 19.6bn. Net finance costs declined to ZAR 88m from ZAR 1.7bn in H1 12 owing to favourable FX gains on Syrian receivables. After income from JVs and associates of ZAR 1.7bn, PBT grew 10.9% to ZAR 21.2bn. H1 13 NPAT attributable to shareholders rises 19.9% to ZAR 12.5bn. The discontinuation of the STC in RSA and a reduction in WHT saw the effective tax rate decline by 510bp to 31.3%. This resulted in NPAT and EPS growing 20.4% and 20.7%, respectively.

Nigeria Out-voice In-voice Data SMS Devices Other

Source: Company filings

Voice ARPUs in both markets came under significant pressure, declining 18.9% in Nigeria and 12.3% in RSA. MTR cuts saw interconnect revenue (in-voice) decline 23.1% and 12.7% in RSA and Nigeria, respectively. Growth of voice in Nigeria was achieved inspite of the promotional ban being lifted at the start of Q2 13. In both markets, data continued to drive growth as usage increased 62.8% in RSA and 48.5% in Nigeria.

H1 13

18

Outlook
Capex intensity to decline in FY 13. With capex of ZAR 32.0bn have been spent over H2 12 and H1 13 by the group, management guides to c.ZAR 14.0bn over H2 13. In order to close the 3G gap to Vodacom, higher capex spend in RSA is expected over the latter half of the year. Overall, capex intensity in FY 13 is forecast to be c.20%, down from 24% in FY 12. Smaller markets to drive subscriber growth. The Q3 13 trading statement showed that MTN managed to add a further 2.2m subscribers over that quarter. We maintain this run-rate and see the operator conclude FY 13 with c.206m subscribers. About 40% of the new additions came from MTNs cluster of small operations which average market penetration of 56%.
Figure 4: Mobile voice subscriber CAGR to FY 17
12% 10% 9%

Figure 5: Growth in smartphone subscribers (m) to drive data usage

30 25

20
15 10 5 -

FY 13

FY 14
RSA

FY 15
Nigeria

FY 16

FY 17

Source: IAS

6% 3% 2%

ZAR weakness to boost Nigeria contribution in FY 13. With the Naira having been fairly stable over the latter half of FY 13 whilst the ZAR depreciated c.16% y-o-y, and 8.5% h-o-h, we see this enhancing Nigerias contribution to the group relative to RSA. Given Nigerias superior EBITDA margins, we also expe ct this to have a larger impact on the groups profitability. EPS CAGR of 14.6% to FY 17 to ensure dividend quality is maintained. We forecast FY 13 revenue, EBITDA and basic EPS to grow at CAGR of 11%, 13.3% and 14.5% to ZAR 205bn, ZAR 98bn and ZAR 21.90, respectively.

Syria

Nigeria

Other

Ghana

RSA

Iran

Source: IAS

Looking into the long term we see voice subscribers achieving a CAGR of 7.6% to 270m in FY 17 as handsets become more affordable and penetration rates increase in our base case scenario. However, given that the junior markets have lower per capita incomes than those of the more advanced markets, we generally expect voice ARPU dilution. Data revenue to support ARPUs. According to GSMA Intelligence, current smartphone penetration is estimated to sit at 22% and 6% of mobile subscribers in South Africa and Nigeria but is expected to reach 47% and 29% by FY 17, respectively, as the devices become more affordable whilst per capita incomes rise. Given this trend, we see significant upside for data usage as smartphones grow at a CAGR of 22% in RSA and 54% in Nigeria.

Valuation and Recommendation

We forecast FY HEPS and annualised DPS of ZAR 13.50 and ZAR 9.60, respectively. We currently have a target price of ZAR 210.58. ACCUMULATE.

19

Financial Summary
Valuation metrics PER EV / EBITDA P / Book Dividend Yield (%) FCF Yield (%) EV / Sales Key Statistics Subscribers (m) Blended ARPU (ZAR) Income Statement Revenue Y-o-Y Growth EBITDA Y-o-Y Growth EBIT Y-o-Y Growth Net finance costs PBT Income tax Effective tax rate NPAT Y-o-Y Growth Attr. NPAT Y-o-Y Growth Basic EPS Y-o-Y Growth DPS Y-o-Y Growth Dividend payout ratio Ratio Analysis EBITDA margin EBIT margin ROaE RoAA Debt / Equity Net debt / EBITDA Interest cover Capex intensity Balance sheet Non-current assets PPE Intangible assets Current assets Cash balances Total assets Current liabilities Non-current liabilities Shareholder funds Minority interest Net debt (cash) 15.8% 2007 A 43.8% 31.3% 22.4% 10.3% 0.65 0.52 10.1 19.8% 2007 A 82 085 39 463 38 797 33 501 16 868 115 586 34 970 29 114 47 315 4 187 16 789 0.90 5.69 10 608 (3 173) 19 707 (7 791) 39.5% 11 916 22 872 32 057 2007 A 35.2 12.2 7.89 0.4 3.6 5.3 2007 A 61.40 99 2007 A 73 145 2008 A 24.4 9.0 4.89 0.7 2.6 3.8 2008 A 90.70 112 2008 A 102 526 40.2% 43 391 35.4% 30 407 32.9% (1 917) 28 490 (11 355) 39.9% 17 135 43.8% 15 315 44.4% 8.20 44.1% 1.36 51.2% 16.6% 2008 A 42.3% 29.7% 24.7% 12.0% 0.52 0.34 22.6 26.2% 2008 A 115 319 64 193 45 786 54 787 26 961 170 106 54 591 34 973 76 386 4 156 14 629 2009 A 25.1 8.5 5.26 0.9 3.0 3.5 2009 A 116.07 90 2009 A 111 947 9.2% 46 063 6.2% 31 588 3.9% (5 815) 25 773 (8 612) 33.4% 17 161 0.2% 14 650 -4.3% 7.96 -2.9% 1.84 35.3% 23.1% 2009 A 41.1% 28.2% 20.2% 10.5% 0.51 0.28 7.9 24.8% 2009 A 110 213 67 541 36 064 46 024 23 999 156 237 54 945 28 426 70 011 2 855 12 918 2010 A 26.4 8.2 5.25 1.7 5.5 3.4 2010 A 141.60 74 2010 A 114 684 2.4% 47 537 3.2% 32 137 1.7% (4 042) 28 095 (11 268) 40.1% 16 827 -1.9% 14 300 -2.4% 7.59 -4.6% 3.35 82.5% 44.1% 2010 A 41.5% 28.0% 19.9% 10.8% 0.48 (0.01) 11.8 13.4% 2010 A 100 552 63 361 30 266 54 234 35 947 154 786 46 717 33 995 71 855 2 219 (619) 2011 A 18.2 7.1 4.32 3.1 5.1 3.2 2011 A 164.59 66 2011 A 121 884 6.3% 54 750 15.2% 39 260 22.2% (1 582) 37 640 (13 853) 36.8% 23 787 41.4% 20 772 45.3% 11.02 45.2% 6.16 83.8% 55.9% 2011 A 44.9% 32.2% 26.1% 14.5% 0.36 (0.10) 34.6 18.2% 2011 A 110 084 72 678 30 897 62 717 36 439 172 801 46 673 34 710 87 324 (979) (5 647) 2012 A 17.9 7.4 4.16 3.2 2.7 3.2 2012 A 188.69 57 2012 A 121 867 0.0% 52 637 -3.9% 36 685 -6.6% (4 157) 35 903 (11 835) 33.0% 24 068 1.2% 20 688 -0.4% 11.19 1.5% 6.34 3.0% 56.7% 2012 A 43.2% 30.1% 23.7% 13.8% 0.35 0.19 12.7 23.7% 2012 A 121 530 73 905 32 552 54 502 22 708 176 032 50 474 32 713 89 006 3 881 9 795 2013 A 14.8 6.6 3.55 4.8 7.3 2.8 2013 E 206.80 58 2013 E 138 561 13.7% 58 802 11.7% 40 010 9.1% (226) 43 100 (12 432) 28.8% 30 667 27.4% 25 068 21.2% 13.50 20.7% 9.60 51.4% 71.2% 2013 E 42.4% 28.9% 25.8% 16.0% 0.38 0.20 260.5 19.5% 2013 E 137 250 89 652 35 120 71 089 30 868 208 339 51 472 43 950 104 633 8 326 11 699 2014 A 12.6 5.4 3.30 5.8 8.3 2.5 2014 E 223.46 61 2014 E 158 323 14.3% 72 028 22.5% 51 737 29.3% (3 143) 52 407 (16 325) 31.2% 36 082 17.7% 29 381 17.2% 15.82 17.2% 11.62 21.0% 73.5% 2014 E 45.5% 32.7% 27.1% 16.6% 0.33 0.05 22.9 17.7% 2014 E 144 817 98 868 33 661 81 521 38 830 226 338 54 976 43 950 112 427 15 027 3 737 2015 A 11.4 5.0 3.07 6.5 10.5 2.3 2015 E 240.80 61 2015 E 170 677 7.8% 77 795 8.0% 56 870 9.9% (2 665) 58 591 (18 192) 31.1% 40 398 12.0% 32 736 11.4% 17.63 11.4% 12.93 11.2% 73.4% 2015 E 45.6% 33.3% 28.0% 17.1% 0.30 (0.14) 29.2 13.7% 2015 E 147 290 102 703 32 299 97 624 53 389 244 914 57 166 43 950 121 150 22 690 (10 822) 2016 A 10.2 4.7 2.84 7.2 11.6 2.1 2016 E 258.18 62 2016 E 184 131 7.9% 83 557 7.4% 62 082 9.2% (1 792) 65 333 (20 221) 31.0% 45 113 11.7% 36 348 11.0% 19.57 11.0% 14.33 10.8% 73.2% 2016 E 45.4% 33.7% 28.8% 17.7% 0.26 (0.33) 46.6 12.8% 2016 E 149 387 106 072 31 027 116 413 70 497 265 801 59 552 43 950 130 887 31 454 (27 930) 2017 A 8.8 4.2 2.61 8.3 13.3 2.0 2017 E 275.68 62 2017 E 197 679 7.4% 93 194 11.5% 71 241 14.8% (765) 76 276 (23 531) 30.9% 52 745 16.9% 42 307 16.4% 22.78 16.4% 16.65 16.2% 73.1% 2017 E 47.1% 36.0% 31.0% 19.0% 0.23 (0.52) 121.8 12.0% 2017 E 151 152 109 023 29 841 138 871 91 262 290 023 61 954 43 950 142 269 41 892 (48 695) 2018 A 7.8 3.8 2.39 9.4 15.1 1.8 2018 E 290.82 62 2018 E 211 412 6.9% 101 700 9.1% 79 443 11.5% 481 86 594 (26 628) 30.8% 59 966 13.7% 47 909 13.2% 25.80 13.2% 18.83 13.1% 73.0% 2018 E 48.1% 37.6% 32.2% 19.7% 0.20 (0.72) na 11.0% 2018 E 152 057 111 035 28 733 165 404 116 078 317 461 64 388 43 950 155 215 53 949 (73 511)

20

Equity Research Burkina Faso February 2014 Telecoms

Whilst Onatel BF has majority market share of c.41% in an economy with a mobile penetration of c.56%, it is faced with notably low per capita income challenges. Thus growth prospects are limited, and are set to shrink further as a fourth operator (Viettel) looks to join the fray. However, we look at long term GDP growth of 6.4% to boost incomes and the change of ownership to Etisalat to reinvigorate its pursuit of growth. Profitability on the up over 9M 13. Whilst revenue for the period grew 6.3%, likely as a result of competition from Zain (Bharti) and Telecel, EBIT and NPAT grew 28.3% and 35.5%, respectively, as EBIT and NPAT margins expanded by a further 390bp and 360bp, to a still relatively low 22.7% and 16.7%, respectively. Our take away from the results was an indication of a fairly positive development in voice given that fixed line services diluted top line growth.

Recommendation Bloomberg Code Current Price (XOF) Current Price (Usc) Target Price (XOF) Target Price (Usc) Upside (%) Liquidity Market Cap (XOF m) Market Cap (USD m) Shares (m) Free Float (%) Ave. daily vol - 1 yr. Price Performance Price, 12 months ago (XOF) Change (%) Price, 6 months ago (XOF) Change (%) Financials (XOF m) 31 Dec Turnover EBITDA Net Finance Income Attributable Earnings Per share data (XOF) EPS DPS NAV/Share Ratios RoaA (%) RoaE (%) EBITDA Margin (%) Valuation Ratios Earnings Yield (%) Dividend Yield (%) PE (x) PBV (x) EV/EBITDA (x) EV/Subscribers (USD) F2012 115 728 49 610 (2 425) 12 194 2013F 127 284 57 677 (2 977) 18 112 ACCUMULATE ONTBF:BC 6 200 1 272 6 855 1 407 10.6

210 800 433 34 26 12 397

4 500 37.8 5 500 12.7 2014F 140 498 65 335 (2 759) 23 336

Etisalat direction a boost for long term growth prospects. Vivendi will sell its 53% stake in Maroc Telecom, which in turn holds 51% in Onatel BF, for an estimated USD 5.7bn. Given that Vivendi, with a strategy focusing more on media, had been driven to simultaneously service its debts and support its share price through dividends, we think it would have been relatively conservative with regards to growing its African telecoms business. Etisalat on the other hand, is more of a voice and data focused operator and is actively seeking growth prospects in Africa. We think the shift in direction at the parent level will place Onatel BF in a better position to challenge for market share in voice and data.

359 530 2 318

533 373 2 321

686 480 2 634

5.4 15.9 42.9 Current 7.7 8.5 13.0 2.7 5.6 147.3

8.1 23.0 45.3 2013F 8.6 6.0 11.6 2.7 4.8 125.0

9.9 27.7 46.5 2014F 11.1 7.7 9.0 2.4 4.3 110.4

We rerate to ACCUMULATE. We arrive at a target price of XOF 6,830 implying upside of 10.2%. With a forward dividend yield of 6.0% to look forward to. However, dividends are at risk as Etisalalt may be more aggressive in with. We downgrade our recommendation from a BUY to ACCUMULATE.
Share price vs. S&P Africa Frontier Index
160

140

STRENGTHS Majority market share (+41%) Diversified offering widest network coverage; OPPORTUNITIES Higher economic growth driven by gold mining sector Relatively high urbanisation rate Growth in data and mobile money

WEAKNESSES Fixed line being cannibalised by mobile voice Low end GDP per capita THREATS Bharti gets more funding for price war Issue of 4th GSM license to Viettel

120

100

80 Jan-13

Mar-13

May-13

Jul-13

Sep-13

Nov-13

Jan-14

ONTBF BC (USD)

S&P Africa Frontier Index

21

9M 13 Financial & Operational Review

Competition undermines top line performance. Onatel BFs revenue grew at a pedestrian 6.3% to XOF 90.4bn as internet and fixed line subscribers declined 14.3% and 31.4%, respectively, over the period (y-o-y). Given that the fixed line segment contributed c.35% to total revenue in FY11, this was the likely cause for the slow growth.
Table 1: 9M 13 results summary
9M 12 Subscribers ('000s) Voice Internet Fixed Line Blended ARPU Financial summary (XOF m) Revenue EBIT Net income Ratios EBIT Margin NPAT Margin 18.8% 13.1% 22.7% 16.7% 85 071 15 997 11 165 90 393 20 517 15 130 6.3% 28.3% 35.5% 3 786 30 142 2 763 4 219 26 97 2 483 11.4% -14.3% -31.4% -10.1% 9M 13 % Change

FY 11 was a near zero-sum outcome (+23.9% in subs vs. -23% in ARPUs), whilst FY 12 saw blended ARPUs decline a marginal 0.6%, subscribers grew 30.3%. We therefore believe that voice ARPUs must have been reasonably stable over 9M 13 in order to offset the underperformance of the fixed line segment over the period. Burkina Faso also experienced a mining boom over FY 13 whilst the GDP is estimated to have grown at 6.4%. We think that the rise in disposable incomes from a low base, particularly within mining which is fairly labour intensive, and the increase in economic activity would have led to an improvement in MOUs. Profitability continues to recover. EBIT and NPAT margins for 9M 13 expanded by a further 390bp and 360bp to 22.7% and 16.7%, respectively. This was a continued improvement in margins from FY 12 which were a respective 18.3% and 10.5%. EBIT and NPAT therefore grew 28.3% and 35.5% to XOF 20.5bn and XOF 15.1bn, respectively, over 9M 13.
Figure 2: Revenue, EBIT (XOF bn) and EBIT margin history
140 120 100 80 60 40 20 FY07 FY08 FY09 FY10 EBIT (LHS) FY11 FY12 5% 0% 15% 10% 25% 20%

Source: Company filings

Voice subscribers grew 11.4% to 4.2m, which is quite a slow down given that Onatel BF managed to grow its subscribers by 30.3% over FY 12. We suspect that this was likely as a result of competition. Voice ARPUs stabilising...? Faced with relatively low GDP per capita (c.USD 630), infrastructureal challenges and an increase in competition, blended ARPUs for Onatel BF tumbled at a CAGR of 20% from FY 07 to FY 12 as subscribers grew at a CAGR of 44% over that period.
Figure 1: Subscriber (m) and ARPU (USD) history
5.0

Revenue (LHS)

EBIT Margin (RHS)

Source: Company fllings

4.0

3.0

Onatel BFs profitability has been recovering from the low reached in FY 11, a period in which it incurred significant impairments and maintenance costs following vandalisation of the fixed line infrastructure and equipment. In its deplorable state, requiring significant outlays to refurbish and upgrade, we think the fixed line service is highly vulnerable to competition from the recently rolled out 3G networks. We think that this is also one of the reasons Onatel BF continues to see a decline in fixed line subscriptions.

2.0

1.0

FY07 FY08 FY09 Subscribers (LHS) FY10 FY11 FY12

Blended ARPU (RHS)

Source: Company filings

22

Outlook
Base effect to boost FY 13 performance. We see Onatel BF adding another 330,000 voice subscribers over Q4 13 to 4.5m by FY 13 as its new offerings and continued investment in its voice network attracts more users. However, given the decline in fixed line contribution, we see FY 13 revenue growing at a slow 4.6% to XOF 121.1bn. The increased contribution from voice is expected to see EBIT margins for the year close at 23.3%, thereby growing EBIT 33.0% to XOF 28.2bn. We in turn see NPAT and EPS ending the year 45.0% higher at XOF 17.7bn and XOF 520, respectively. Capex intensity expected to taper off later than in other similar markets..? Continued investment in its networks will be key for Onatel BF to maintain or gain market share in voice and data. Given that Vietnams Viettel is looking to become Burkina Fasos fourth mobile license operator, we expect this to increase competition further, and hence emphasises the need for Onatel BF to invest in its network. With Vivendi reported to have agreed to sell its African assets to UAEs Etisalat (a mobile telephony purist relative to Vivendi) for c.USD 5.7bn, we consider that the new owners may take a more aggressive stance than Vivendi did. We believe this would delay the capex intensity glide path. In our view, this is a positive outcome as it will increase Onatel BFs competitiveness in voice and data. The above development, though, may negatively impact the quality of the FY 13 and FY 14 dividends. We see the dividend payout ratio reverting to historical levels (c.70%) as we believe the FY 12 dividend (payout ratio of 147.7%) was mostly extraordinary as Vivendi needed to raise cash. In this regard, we see FY 13 DPS declining by 30% to a still attractive XOF 375. Mining sector to remain a critical factor. According to the World Bank, Burkina Fasos economy will continue to grow at 6.4% into the long term, making it one of the continents faster growing economies . However, propelling this hope for higher per capita incomes is growth of the mining sector, which in turn is largely driven by rising gold prices. Given the underperformance of the precious metal recently, there has been recent news flow stating that international mining companies operating in Burkina Faso will cut production by 7% in the current year. We certainly expect economic growth and consumption expenditure to be depressed in FY 14.

Figure 3: Outlook on subscribers (000s) and ARPU (USD)

8 000 6 000 4 000 2 000 FY12 FY13 FY14 FY15 FY16 FY17 Subscribers (LHS)
Source: IAS estimates

5.0 4.0 3.0 2.0 Voice ARPU (RHS)

Overall, we expect revenue to grow at a CAGR of 8.8% to FY 17 in our base case scenario. We think Onatel BF will take a more aggressive stance in winning mobile data market share.
Figure 4: Revenue, EBITDA and EBITDA margin evolution
200 50%

160

48%

120

46%

80

44%

40

42%

FY12 FY13 FY14 FY15 FY16 FY17

40%

Revenue (XOF bn)

EBITDA (XOF bn)

EBITDA Margin (RHS)

Source: IAS estimates

Given that mobile data achieves EBITDA margins of c.55% in Kenya for example, we see growth in the services contribution to revenue offsetting contraction in voice margins. Overall, we expect EBITDA margins to expand 40bp y-o-y on average to FY 17, and thereby growing EBITDA at a CAGR of 9.8% over that period. Declining capex intensity will then see free cash flow achieve a CAGR of 17.4% to FY 17.

Valuation and Recommendation

We arrive at a target price of XOF 6,830 implying upside of 10.2%. With also look forward to a dividend yield of 6.0%. However, dividends are at risk as Etisalalt may be more aggressive on capex. We downgrade our recommendation from a BUY to ACCUMULATE.

23

Financial Summary
Valuation metrics PER EV / EBITDA P / Book Dividend Yield (%) FCF Yield (%) EV / Sales Key Statistics Subscribers (m) Blended ARPU (XOF) Income Statement Revenue Y-o-Y Growth EBITDA Y-o-Y Growth EBIT Y-o-Y Growth Net finance costs PBT Income tax Effective tax rate NPAT Y-o-Y Growth Attr. NPAT Y-o-Y Growth Basic EPS Y-o-Y Growth DPS Y-o-Y Growth Dividend payout ratio Ratio Analysis EBITDA margin EBIT margin ROaE RoAA Debt / Equity Net debt / EBITDA Interest cover Capex intensity Balance sheet Non-current assets PPE Intangible assets Current assets Cash balances Total assets Current liabilities Non-current liabilities Shareholder funds Minority interest Net debt (cash) 29.1% 2007 A 43.2% 13.0% 21.1% 4.3% 1.35 2.34 12.0 20.9% 2007 A 99 170 77 400 320 64 610 8 640 163 780 72 210 51 390 33 016 31 721 79 040 60 205 6 965 (2 812) 7 314 (349) 4.8% 6 965 10 126 33 737 2007 A 30.3 8.2 6.38 1.0 (8.4) 3.6 2007 A 0.63 10 391 2007 A 78 024 2008 A 25.2 7.8 2.84 1.3 3.8 3.4 2008 A 0.98 8 562 2008 A 82 350 5.5% 35 715 5.9% 11 878 17.3% (3 289) 8 589 (229) 2.7% 8 360 20.0% 8 360 20.0% 246 20.0% 80 34.0% 32.5% 2008 A 43.4% 14.4% 15.6% 4.8% 1.45 2.75 10.9 27.9% 2008 A 98 170 76 640 180 83 330 10 040 181 500 85 170 56 180 74 280 130 98 070 2009 A 19.3 5.4 3.26 3.1 (4.1) 2.9 2009 A 1.57 6 265 2009 A 95 725 16.2% 51 695 44.7% 18 249 53.6% (3 046) 15 203 (4 290) 28.2% 10 913 30.5% 10 913 30.5% 321 30.5% 193 140.8% 60.0% 2009 A 54.0% 19.1% 15.7% 5.6% 1.28 1.38 17.0 24.9% 2009 A 132 353 125 604 4 524 73 050 11 635 205 403 91 704 48 981 64 718 71 524 2010 A 19.0 6.1 2.80 4.2 22.2 2.7 2010 A 2.40 4 366 2010 A 103 909 8.5% 45 224 -12.5% 22 676 24.3% (2 378) 19 521 (8 413) 43.1% 11 108 1.8% 11 108 1.8% 327 1.8% 263 36.3% 80.3% 2010 A 43.5% 21.8% 15.9% 5.1% 1.34 2.02 19.0 17.2% 2010 A 150 247 127 760 19 616 78 798 9 880 229 045 111 586 42 044 75 413 91 267 2011 A 84.0 7.9 2.81 4.0 (8.0) 2.9 2011 A 2.97 2 998 2011 A 96 568 -7.1% 35 010 -22.6% 8 726 -61.5% (2 156) 6 916 (4 408) 63.7% 2 508 -77.4% 2 508 -77.4% 74 -77.4% 245 -6.7% 332.1% 2011 A 36.3% 9.0% 3.3% 1.1% 1.12 2.22 16.2 44.7% 2011 A 147 903 127 804 17 228 79 776 6 185 227 679 119 840 32 899 74 938 77 569 2012 E 17.3 5.6 2.68 8.5 5.6 2.4 2012 E 3.87 2 819 2012 E 115 728 19.8% 49 610 41.7% 21 221 143.2% (2 425) 19 065 (6 871) 36.0% 12 194 386.1% 12 194 386.1% 359 386.1% 530 116.2% 147.7% 2012 E 42.9% 18.3% 15.9% 5.4% 0.67 1.36 20.5 20.8% 2012 E 153 543 135 541 15 131 66 347 (14 254) 219 889 108 186 32 899 78 802 67 223 2013 A 11.6 4.8 2.67 6.0 6.8 2.2 2013 E 4.56 2 514 2013 E 127 284 10.0% 57 677 16.3% 28 852 36.0% (2 977) 25 874 (7 762) 30.0% 18 112 48.5% 18 112 48.5% 533 48.5% 373 -29.6% 70.0% 2013 E 45.3% 22.7% 23.0% 8.1% 0.76 1.15 19.4 24.0% 2013 E 155 266 139 106 13 289 71 530 (6 446) 226 796 114 988 32 899 78 907 66 415 2014 A 9.0 4.3 2.35 7.7 7.8 2.0 2014 E 5.17 2 406 2014 E 140 498 10.4% 65 335 13.3% 36 096 25.1% (2 759) 33 337 (10 001) 30.0% 23 336 28.8% 23 336 28.8% 686 28.8% 480 28.8% 70.0% 2014 E 46.5% 25.7% 27.7% 9.9% 0.66 0.88 23.7 22.0% 2014 E 156 936 142 394 11 671 87 662 1 591 244 598 122 132 32 899 89 565 57 378 2015 A 7.9 4.0 2.11 10.2 9.4 1.8 2015 E 5.88 2 273 2015 E 150 704 7.3% 70 330 7.6% 40 879 13.2% (2 534) 38 345 (11 504) 30.0% 26 842 15.0% 26 842 15.0% 789 15.0% 632 31.5% 80.0% 2015 E 46.7% 27.1% 28.3% 10.6% 0.58 0.68 27.8 20.0% 2015 E 157 626 144 505 10 250 102 769 10 446 260 395 127 422 32 899 100 072 47 523 2016 A 7.0 3.7 1.94 11.4 10.9 1.7 2016 E 6.56 2 176 2016 E 162 393 7.8% 74 753 6.3% 45 280 10.8% (2 286) 42 994 (12 898) 30.0% 30 096 12.1% 30 096 12.1% 885 12.1% 708 12.1% 80.0% 2016 E 46.0% 27.9% 28.8% 11.2% 0.52 0.52 32.7 18.0% 2016 E 157 383 145 510 9 002 117 839 18 355 275 223 133 627 32 899 108 694 38 614 2017 A 6.3 3.5 1.78 12.7 12.5 1.6 2017 E 7.18 2 136 2017 E 176 051 8.4% 79 273 6.0% 49 961 10.3% (2 064) 47 897 (14 369) 30.0% 33 528 11.4% 33 528 11.4% 986 11.4% 789 11.4% 80.0% 2017 E 45.0% 28.4% 29.6% 11.8% 0.47 0.35 38.4 16.0% 2017 E 156 240 145 462 7 906 135 852 28 001 292 092 141 045 32 899 118 145 27 968

24

Equity Research Kenya February 2014 Telecoms

Safaricom Ltd has undoubtedly established itself as a quality telecoms offering, especially after its H1 14 performance which showed a highly encouraging increase in service ARPUs. Furthermore, a highly capable and reliable management, particularly where meeting targets is concerned, has given guidance that has seen us upgrade our views. H1 14 performance highly encouraging. Service revenue, EBITDA and basic EPS were 6.5%, 14.9% and 16.0%, respectively ahead of our forecast performances to FY 14. Key to the outperformance was a higher than expected blended ARPU and an effective cost containment program with saw EBITDA margins 170bp better than anticipated. Analysis of this performance has indicated 1) that the economys ability to spend on voice is higher than previously anticipated and 2) has helped us quantify the value in having a quali ty network. We revise our outlook for FY 14 and see service revenue, EBITDA and basic EPS growing 14%, 27% and 30% to KES 135.9bn, KES 60.4bn and KES 0.57, respectively. High earnings growth expected to FY 18. The combination of an 11.7% CAGR in top line, changes in revenue mix favouring EBITDA margin expansion and increasing scale are expected to see EBITDA margins expand by c.700bp to FY 18. EBITDA is expected to achieve a 5 year CAGR of 16% whilst deleveraging will see basic EPS achieve a 5 year CAGR of 22% over the period. Declining capex intensity will in turn see free cash flow and DPS achieve 5 year CAGRs of 30% and 28%, respectively.
Recommendation Bloomberg Code Current Price (KES) Current Price (USc) Target Price (KES) Target Price (Usc) Upside (%) Liquidity Market Cap (KES m) Market Cap (USD m) Shares (m) Free Float (%) Ave. daily vol - 1 yr. ('000s) Price Performance Price, 12 months ago (KES) Change (%) Price, 6 months ago (KES) Change (%) Financials (KES m) 31 Mar Turnover EBITDA Net Finance Income Attributable Earnings Per share data (KES) EPS DPS NAV/Share Ratios RoaA (%) RoaE (%) EBITDA Margin (%) Valuation Ratios Earnings Yield (%)* Dividend Yield (%) PE (x)* PBV (x) EV/EBITDA (x)* EV/Subscribers (USD) * TTM 13.6 21.9 38.4 Current 4.5 2.6 22.3 5.9 8.5 287.9 16.4 24.3 42.8 2014F 4.6 3.8 21.6 5.2 7.6 258.1 19.0 26.6 43.2 2015F 5.5 4.8 18.1 4.8 6.7 238.2 0.44 0.31 2.01 0.54 0.45 2.24 0.65 0.56 2.44 F2013 124 286 47 723 (1 640) 17 548 2014F 142 074 60 773 (518) 21 732 5.40 117.6 7.70 52.6 2015F 159 134 68 694 (87) 25 907 470 000 5 529 40 000 25.0 16 020 HOLD SAFCOM:KN 11.75 13.82 12.09 14.22 2.9

We upgrade our recommendation to HOLD. Whilst we see that the companys share price may be prone to a correction in the short term, we note that the company offers significant value in the long term. Using a DCF model we arrive at a target price of KES 12.09 and therefore change our recommendation from SELL to HOLD.
Share price vs. S&P Africa Frontier Index
220
200 180 160 140 120 100

STRENGTHS Majority market share (+66.5%) in Kenya Support from Vodafone Plc M-Pesa Innovative and highly capable management OPPORTUNITIES Lipa Na M-Pesa Proprietary M-Pesa platform Rising per capita incomes to drive MOU growth and data usage M-Pesa Interoperability

WEAKNESSES Exposed to single economy Regulatory scrutiny

80 Jan-13

Mar-13

May-13

Jul-13

Sep-13

Nov-13

Jan-14

THREATS Regulatory action Adverse economic shocks in the short term

SAFCOM KN (USD)

S&P Africa Frontier Index

25

H1 14 Financial & Operational Review

Rising blended ARPUs result in H1 14 outperformance. Safaricom total revenue for the interim to H1 14 grew 17.1% to KES 69.2bn (USD 814.2m), ahead of the 10.3% growth rate we had forecast for FY 14. Voice revenue grew 12.0% to KES 41.9bn over the interim, notably ahead of the 6.7% we expect to FY 14. SMS was even more impressive, growing 48.7% to KES 6.4bn over the period, significantly ahead of the 10.2% we expect to FY 14e. M-pesa revenue was in line with expectations and grew 19.9% to KES 12.5bn. Data was slightly ahead of expectations, growing 37.4% to KES 5.5bn (vs. 26.8% expected for FY 14e).
Figure 1: Service revenue (KES bn) growth by revenue stream
66.24
1.49

Voice prospects looking brighter. Safaricom managed to grow its voice subscribers by 8.32% to 20.8m in H1 14, already beating our previous FY 14e target of 20.6m. Despite being the premium network in a competitive environment, Safaricoms subscriber market share increased from 63.2% at H1 13 to 66.0% in H1 14.
Figure 1: Recovering market share
70% 90%

65%

85%

60%

80%

55%

75%

2.07 2.08 4.50

50% Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Q2 13 Q3 13 Q4 13 Q1 14 Q2 14 Subs. Voice traffic (RHS)

70%

56.10

Source: CCK

H1 13

Voice

SMS

M-Pesa

Data

H1 14

Source: Company filings

With blended ARPU rising 12.5% which was faster than the 4.4% increase in average costs per user (before depreciation), Safaricoms EBITDA margin improved 399bp to 41.7% in H1 14 and EBITDA for the period grew 29.4% to KES 28.9bn. EBIT was 30.8% higher to KES 16.2bn as total non-cash charges for depreciation, impairments and amortisation were 28.2% higher at KES 12.7bn for the period of which KES 2.1bn was for network impairments owing to the network modernisation program. Net finance costs declined 72.4% to KES 240m as Safaricom achieved a net cash position of KES 7.8bn at H1 14 from a net debt position of KES 5.8bn at H1 13. PBT, therefore, grew 38.3% to KES 15.9bn. Income tax was 29.2% of PBT, 327bp lower than in H1 13 and NPAT grew 45.0% to KES 11.3bn. Owing to favourable creditor terms over H1 14, working capital movements increased free cash flow by KES 2.1bn during the period, KES 7.9bn more than in H1 13. Cash generated from operations therefore grew 77.2% to KES 24.3bn. After capex, free cash flow surged 167.3% to KES 13.7bn. Total debt was reduced by KES 8.2bn to KES 12.0bn and the company ended the period with a cash position of KES 19.8bn.

The company has actually been winning market share for both subscribers and traffic since Q2 13, the period during which its competitors ended the price war and adjusted tariffs upwards, narrowing the discount to Safaricom. Whilst a gain in market share is generally associated with a decline in ARPUs, we observed that voice ARPU increased 5.6% to KES 347, also ahead of the KES 342 we had expected for the year. Behind the strong performance in voice ARPUs has been Safaricoms MOUs which have been trending hi gher, despite achieving deeper penetration and increased competition from SMS.
Figure 2: MOU (On-net) on a rising trend
96

92

88

84

80

76 Q3 12 Q4 12 Q1 13 Q2 13 Q3 13 Q4 13 Q1 14 Q2 14

Source: CCK

Owing to the network upgrades and modernization which reduced the rate of dropped calls and increased call quality, on-net MOUs have been on the rise, reaching 94min at Q2 14 from a low of 83min at Q1 13. Given the observed effective tariff, we expect FY14 voice ARPU to rise 4.7% to c.KES 352 and voice revenue to grow 10.1% to KES 85.5bn over the period.

26

We essentially expect voice ARPUs to be stable over the long term, declining at a CAGR of 1.5% after FY 14. We also see mobile subscribers growing at a CAGR of c.8% to FY 18 as a result of mobile penetration hitting 99% by FY 18 and combining with Safarico ms rising market share. Non-voice continues high double-digit growth. SMS revenue continued to surprise as the service became extremely popular, especially amongst basic handset users.
Figure 3: On-net SMS rates Normal
Number of SMS Price (KES) Rate
Source: Safaricom

With P2P, P2B and B2P earning fees averaging 2.20%, 0.89% and 0.32% per transaction, revenue from transactions is estimated at KES 10.9bn with the remainder of KES 1.6bn earned from others which include M-Shwari (KES 70m).
Figure 5: M-Pesa transactions rising as % of GDP
35% 30% 25% 20% 15%

Bundle (per day) 20 5.00 0.25 200 10.00 0.05 500 20.00 0.04

10% 5% 0% H1 12 H2 12 H1 13 H2 13 H1 14

1 1.00 1.00

Source: Safaricom & IAS

With bundle rates as low as KES 0.04 per SMS, per day, from the normal KES 1.00 per SMS, combined with the introduction of SMS based 1 Millionaire Daily promos, Safaricoms SMS texts are estimated to have increased 378.4% to c.8.0bn messages over H1 14.
Figure 4: Bundle SMS rates launch SMS usage
6 000 3.00

Amongst other things, aiding the penetration of MPesa the 73.2% increase in M-Pesa agent outlets to 78,856. We in turn expect M-Pesa transactions to be 37% of GDP over that period and see revenue for the segment growing 19.5% to KES 26.1bn in FY 14. Revenue growth surprise expected from M-Pesa. We generally expect overall price inflation and the increase in M-Pesa penetration into a fast growing GDP to grow M-Pesa ARPUs despite a declining average fee rate as P2B and B2P transactions drive growth. Through Lipa Na M-pesa (LNM), targeting a market that equals c.90% of GDP and earning a fee of 1% per transaction, we see significant revenue growth prospects for the service. So far, Safaricom has signed up EABL, BAT and Unilever to have their distributors only accept payment for their goods from retailers through M-Pesa. As such, retailers are now more inclined to accept payment from customers with MPesa as they avoid paying the fee of 1%. Safaricom has also added 41,000 LNM agents since the launch in Q1 14 though only 15,000 were active with 2,500 doing 97% of the transactions. A target of 100,000 Lipa agents by FY 14 has been set, indicating the level of confidence management has with the product. We estimate that a 20% market share by FY 18 would add a further KES 8.0bns to Safaricoms top line. Growth in the Data business surprised management as a 21% decline in the average price of data saw subscribers jump 50.9% to 8.5m and usage per user increase c.18%. Safaricom added c.1.0 million smartphones to reach 1.5 million as retail prices for the devices were negotiated to as low as USD 65. This offset the 16% rise in retail prices arising from the VAT Bill introduced towards the end of Q2 14. Handset sales decline 26% over that period but are expected to recover as the market adjusts to the prices that had actually prevailed over the past year.

2.50 4 500
2.00 3 000 1.50

1.00 1 500 0.50

Q1 13 Q2 13 Q3 13 Q4 13 Q1 14 Q2 14 -

SMS traffic (m)

ARPU per SMS (KES) - RHS

Source: CCK & IAS estimates

This more than offset the decline in ARPU per SMS, which we estimate went from KES 2.60 in H1 13 to KES 0.80 in H1 14, and SMS ARPU grew 36.5% to KES 53 for the period. According to management, promotion based SMS accounted for c.50% of SMS revenue. For FY 14e, we see traffic growing 72% to 15.5bn texts and estimate revenue going up 22.1% to KES 12.4bn. M-Pesa subscribers grew 19.2% to 18.2m at H1 14, constituting 87.2% of Safaricoms mobile subscribers from 79.2% at H1 13. M-Pesa transactions altogether increased to average KES 94.8bn (USD 1.1bn) per month, c.33% of GDP, in H1 14 from KES 75.9bn (c.28% of GDP) in H1 13. P2P transactions where c.16% higher, to averaging KES 77.3bn p.m. whilst P2B and B2P surged c.88% and c.90% to average KES 9.9bn and KES 7.6bn per month, respectively.

27

Further cuts in handset prices of USD 5 USD 10 are expect in FY 15 and that is expected to boost mobile data usage growth through increased penetration of smart and feature phones. Whilst increased usage of chat platforms such as Whatsapp is expected to cannibalise SMS usage, we expect the chat platforms to also generate data usage through increased sharing of multi-media files. Fixed data revenue growth was also impressive at 20.8% to KES 1.2bn. Whilst fixed data customers grew a marginal 3.2% to 6,931, fixed data ARPU grew 15.4% to KES 29,680, likely as a result of customers switching to higher value packages.
Figure 6: Service revenue growth drivers to FY 18
250

Airtime purchases via M-Pesa rose for the first time in two years to 35% at H1 14 from 33% at FY 13, thereby reducing airtime commissions (c.7% of total revenue). A rising trend in airtime purchases via M-Pesa would certainly boost margins. For FY 14, we expect EBITDA to grow 27% to KES 60.4bn and at a CAGR of 16% to FY 18. Free cash flow outperformance in FY 14 expected. With capex targeted at KES 27bn, upgraded from KES 22bn following the surprise in data, management has guided for depreciation of KES 26bn with impairments owed to network modernisation coming in at KES 4.3bn.
Figure 8: FY 14e Adjusted free cash flow (FCF)
60.77 (0.52) (11.16)

200

150

100

50 FY 13 Voice M-Pesa SMS Data FY 18

1.05
(26.57)

23.58

Source: IAS estimates

EBITDA margins downside risks limited in the short to medium term with prospects for expansion in the long term. Given that voice will contribute to c.51% of the growth in total revenue particularly with a higher voice ARPU expected over H2 14, we see that as support for further margin expansion in FY 14.
Figure 7: H1 14 EBITDA margins per revenue stream
60% 50% 40%
30% 20%

EBITDA

Interest paid

Tax paid

Capex

NWC

FCF

Source: IAS estimates

10% 0% Voice M-Pesa SMS Data

Given our EBITDA outlook and higher effective tax rate, as a result of the impairments, we see FY 14 free cash flow at KES 23.6bn in our base case scenario. Given management can allocate c.85% of FCF to dividends, we expect a FY 14 DPS of KES 0.45. Going forward, management says it is not likely that the company will expend capex in excess of KES 26bn, aside from a possible once-off expenditure on spectrum (c.USD 100m). Overall, we see FCF achieving a CAGR of 30% to FY 18 and this can be enhanced further if the 700 and 800 MHz spectrum is availed to the company or acquired.

Valuation and Recommendation

Whilst we expect an impressive EPS and DPS CAGR of 22.3% and 28.6% to FY 18, respectively, we think that at a TTM PER of 22.3x, the company is near fully priced in our base case scenario. Given that QEIII was a key driver for the rerating of the sector over the past year, we see some downside risk arising from tapering in the short term. We upgrade our recommendation from SELL to HOLD the stock.

Source: Safaricom

Going forward, we see margins expanding from 1) scale benefits; 2) stable voice ARPUs supporting voice EBITDA margins around 50% in our base case scenario; 3) expanding M-Pesa margins on i) the growth in contribution of P2B, B2P and LNM which do not pay commissions to agents and ii) the establishment of its proprietary M-Pesa platform hosted locally in FY 15 and subsequent reduction in license payments (10% of M-Pesa revenue) to Vodafone, which can potentially add 181bps upside on total EBITDA margins. In our base case we model payments at 5% of M-Pesa revenue from FY16 onwards.

28

Financial Summary
Valuation metrics PER EV / EBITDA P / Book Dividend Yield (%) FCF Yield (%) EV / Sales Key Statistics Subscribers Base (m) Blended ARPU (KES) Income Statement Revenue Y-o-Y Growth EBITDA Y-o-Y Growth EBIT Y-o-Y Growth Net finance costs PBT Income tax Effective tax rate PAT Y-o-Y Growth Basic EPS Y-o-Y Growth DPS Y-o-Y Growth Dividend payout ratio Ratio Analysis EBITDA margin EBIT margin ROaE RoAA Debt / Equity Net debt / EBITDA Interest cover Capex intensity Balance sheet Non-current assets PPE Intangiable assets Current assets Cash balances Total assets Current liabilities Non-current liabilities Shareholder funds M inority interest Net debt (cash) 34% 2008 A 45.7% 29.9% 23.6% 13.4% 0.28 0.14 45.4 40.2% 2008 A 36 100 32 791 2 368 7 534 2 917 43 634 10 585 6 837 24 779 3 936 0.05 0.15 1 476 19 834 (6 092) 31% 5 855 18 358 28 041 2008 A 78.2 16.1 18.48 0.4 (0.6) 7.3 2008 A 10.2 482 2008 A 61 369 2009 A 43.5 16.1 13.16 0.9 0.1 6.4 2009 A 13.4 480 2009 A 70 480 15% 27 951 0% 16 175 -12% (871) 15 304 (4 767) 31% 10 537 80% 0.26 80% 0.10 100% 38% 2009 A 39.7% 22.9% 35.4% 20.8% 0.27 0.12 98.6 33.8% 2009 A 47 502 42 732 3 611 10 150 5 888 57 652 12 390 9 235 34 789 3 347 2010 A 30.6 12.4 9.42 1.7 4.2 5.4 2010 A 15.8 452 2010 A 83 961 19% 36 431 30% 22 438 39% (1 644) 20 794 (5 819) 28% 14 975 42% 0.37 42% 0.20 100% 53% 2010 A 43.4% 26.7% 35.9% 22.8% 0.27 0.21 17.8 20.8% 2010 A 60 915 56 480 3 047 12 887 5 535 73 802 25 137 10 435 48 643 7 620 2011 A 35.0 12.6 8.27 1.7 2.3 4.7 2011 A 17.2 446 2011 A 94 830 13% 35 630 -2% 19 310 -14% (1 037) 18 273 (5 202) 28% 13 071 -13% 0.33 -13% 0.20 0% 61% 2011 A 37.6% 20.4% 25.1% 15.9% 0.24 0.24 18.7 26.9% 2011 A 73 975 69 035 3 062 16 301 4 362 90 276 35 760 6 480 55 253 106 8 655 2012 A 36.3 11.9 6.35 1.9 1.1 4.2 2012 A 19.1 460 2012 A 106 994 13% 37 856 6% 20 150 4% (2 783) 17 367 (4 741) 27% 12 626 -3% 0.32 -3% 0.22 10% 70% 2012 A 35.4% 18.8% 19.8% 11.9% 0.27 0.27 10.4 23.6% 2012 A 100 705 91 659 2 314 21 194 8 808 121 900 37 616 12 202 72 591 (509) 10 302 2013 A 26.1 9.4 5.71 2.7 3.2 3.6 2013 A 19.4 511 2013 A 124 286 16% 47 723 26% 27 099 34% (1 640) 25 459 (7 911) 31% 17 548 39% 0.44 39% 0.31 41% 71% 2013 A 38.4% 21.8% 23.0% 14.0% 0.25 0.11 16.8 20.0% 2013 A 103 500 95 296 1 641 25 356 14 997 128 856 36 591 12 000 80 265 5 231 2014 E 21.1 7.4 5.11 3.9 5.2 3.2 2014 E 21.1 561 2014 E 142 074 14% 60 773 27% 33 406 23% (518) 32 888 (11 156) 34% 21 732 24% 0.54 24% 0.45 45% 83% 2014 E 42.8% 23.5% 25.6% 16.6% 0.13 (0.09) 47.9 18.7% 2014 E 103 129 95 237 1 330 29 366 17 524 132 496 38 412 4 487 89 597 (5 524) 2015 E 17.7 6.6 4.70 4.9 6.6 2.8 2015 E 22.8 581 2015 E 159 134 12% 68 694 13% 38 811 16% (87) 38 724 (12 817) 33% 25 907 19% 0.65 19% 0.56 25% 87% 2015 E 43.2% 24.4% 27.7% 19.3% 0.05 (0.25) 71.3 17.7% 2015 E 101 413 94 283 567 35 146 21 883 136 559 39 031 97 528 (17 396) 2016 E 14.8 5.7 4.32 6.1 8.2 2.5 2016 E 24.7 600 2016 E 177 155 11% 79 026 15% 46 066 19% 829 46 894 (15 868) 34% 31 026 20% 0.78 20% 0.70 25% 91% 2016 E 44.6% 26.0% 30.5% 22.0% 0.01 (0.41) 297.7 16.5% 2016 E 97 683 90 892 229 47 922 33 157 145 606 39 517 106 088 (32 035) 2017 E 11.3 5.1 3.86 8.4 9.9 2.3 2017 E 26.6 616 2017 E 195 852 11% 88 093 11% 56 294 22% 1 658 57 952 (17 386) 30% 40 566 31% 1.01 31% 0.96 37% 95% 2017 E 45.0% 28.7% 36.1% 26.4% 0.00 (0.55) na 15.5% 2017 E 96 242 89 450 229 64 939 48 615 161 181 42 672 118 509 (48 334) 2018 E 10.0 4.6 3.64 9.8 11.6 2.1 2018 E 28.6 632 2018 E 215 873 10% 97 880 11% 62 783 12% 2 431 65 214 (19 564) 30% 45 649 13% 1.14 13% 1.13 17% 99% 2018 E 45.3% 29.1% 37.4% 27.4% 0.00 (0.63) na 14.5% 2018 E 92 446 85 654 229 80 029 62 037 172 475 46 740 125 735 (61 966) 2019 E 9.0 4.2 3.48 11.4 13.4 1.9 2019 E 30.6 646 2019 E 236 638 10% 108 165 11% 69 684 11% 3 102 72 786 (21 836) 30% 50 950 12% 1.27 12% 1.31 16% 103% 2019 E 45.7% 29.4% 39.6% 28.7% 0.00 (0.71) na 13.5% 2019 E 85 910 79 119 229 96 836 77 112 182 746 51 124 131 622 (77 095)

29

Equity Research Senegal February 2014 Telecoms

We maintain our view that Sonatel is a steady growth, high yield investment opportunity despite operating in one of Africas most volatile environments. Growth will be driven by data in Senegal and Mali and increasing voice penetration in Guinea Conakry and Guinea-Bissau (small markets). We also see the introduction of new competitive products and VAS, leveraging off the existing infrastructure, buoying growth in the more mature markets. Management seeking new growth prospects. Whilst H1 13 results showed modest growth, this was largely expected given that Senegal (64% of revenue) is currently at a mobile penetration level of c.90%. Management has in turn adapted strategies to; 1) capture the lower income categories; 2) target corporates; and 3) possibly add a fifth operation. We think the first two initiatives will add to top line growth but dilute margins whilst the likelihood of success in the third will be limited. Steady growth ahead. Given that key markets are relatively advanced voice wise, we expect revenue and EBITDA to grow at a CAGR of 8.1% and 7.4%, respectively, to FY 17 in our base case. Growth in data and smaller markets will propel growth in revenue and support EBITDA margins. We also expect an overall decline in capex intensity from 17.3% in FY 12 to 11.9% in FY 17 to see free cash flow achieve a CAGR of 11.1% over the period.
Recommendation Bloomberg Code Current Price (XOF) Current Price (Usc) Target Price (XOF) Target Price (Usc) Upside (%) Liquidity Market Cap (XOF m) Market Cap (USD m) Shares (m) Free Float (%) Ave. daily vol - 1 yr. Price Performance Price, 12 months ago (XOF) Change (%) Price, 6 months ago (XOF) Change (%) Financials (XOF m) 31 Dec Turnover EBITDA Net Finance Income Attributable Earnings Per share data (XOF) EPS DPS NAV/Share Ratios RoaA (%) RoaE (%) EBITDA Margin (%) Valuation Ratios Earnings Yield (%)* Dividend Yield (%) PE (x)* PBV (x) EV/EBITDA (x)* EV/Subscribers (USD) * TTM F2012 683 870 351 387 (6) 153 667 2013F 752 540 379 672 1 754 163 219 ACCUMULATE SNTS:BC 23 450 4 812 24 270 4 980 3.5

2 345 000 4 812 100 26 29 188

17 005 37.9 18 550 26.4 2014F 821 477 421 137 2 008 190 540

1 537 1 500 5 375

1 632 1 593 5 507

1 905 1 860 5 819

Upside for higher DPS growth. We expect DPS to achieve a CAGR of 10.0% to FY 17 in our base case as we maintain a payout ratio of 97.6%, a policy we think the company is able to observe. However, we see upside to DPS growth given that we forecast the company achieving a net cash position by FY 14. We maintain our ACCUMULATE recommendation. We arrive at a target price of XOF 24,270, implying upside of 3.2%. We consider the forward dividend with a net yield of 5.5% and maintain our recommendation. ACCUMULATE.
Share price vs. S&P Africa Frontier Index
160

17.1 28.8 51.4 Current 6.7 6.4 14.8 5.0 7.0 264

18.8 30.0 50.5 2013F 7.0 6.8 14.4 4.3 6.7 252

21.0 33.6 51.3 2014F 8.1 7.9 12.3 4.0 6.0 232

140

120

STRENGTHS Majority market share in Senegal and Mali Diversified markets; Affiliated to the Orange brand OPPORTUNITIES Orange money Take off in data
Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14

WEAKNESSES Operates in a politically volatile region Local currency vulnerable to EUR weakness THREATS Higher inflation Escalation of conflicts in markets

100

80 Jan-13

SNTS BC (USD)

S&P Africa Frontier Index

30

H1 13 Financial & Operational Review

H1 13 performance generally in line with expectations. Aside from a slightly more aggressive outcome in Mali, following its recovery from the 2012 crisis, Sonatels result for the six months to 30 June 2013 were marginally behind our expectations.
Figure 1: H1 13 subscriber and ARPU growth
61% 35% 24% 12% 3%

The effective tax rate moved up by 90bp to 32.0% and NPAT grew 5.2% to XOF 91.6bn. EPS in turn grew 5.8% to XOF 826, marginally slower than the 7.1% we expected for FY 13. Senegal in need of value-add. Sonatels flagship operation in Senegal, Sonatel SA, only managed to grow its H1 13 revenue by 7.4% to XOF 209bn as its mobile subscribers grew by 11.7% to 7.4m. This was despite the operator losing 3ppts in market share to 61% over the year as a result of the rise in competition in Senegal.
Figure 3: Slow revenue growth and narrowing EBITDA margins in Senegal
250 56% 54%

-6% Senegal -19% Mali Subs.

-11%

Guinea Blended ARPU

Guinea-Bissau

Source: Company filings

This was despite out-performances in Guinea (Conakry) and Guinea-Bissau. Overall, service revenue was up 10.3% to XOF 357.0bn (USD 714.6m), slightly behind the 12.2% growth we expect for FY 13.
Figure 2: EBITDA (XOF bn) growth by market
183 1

200
150 100 50 -

52%
50% 48% 46%

44%
42%

H1 11

H2 11 Revenue

H1 12 EBITDA

H2 12

H1 13

EBITDA margin

6 173
(3)

Source: Company filings

H1 12

Senegal

Mali

Guinea

Bissau

H1 13

Source: Company filings

With mobile penetration at c.90%, growth is understandably slow. Sonatel has had to rely on Granale offers and the Kirene MVNO targeting the tail-end of the markets. Consequently, voice ARPU declined 5.7% over the period to XOF 3,300 and EBITDA margins 530bp to a still attractive 48.4%. EBITDA margin expands despite ARPU decline in Mali. Subscribers for the segment grew 35.2% to 9.5m, well underway to surpassing our target of 9.7m for FY 13. The aggressive growth had repercussions as Malis voice ARPUs declined 21.8% to XOF 1,716 (c.USD 3.40) and revenue for the segment grew 8.8% to XOF 100.3bn.
Figure 4: Mali revenue and EBITDA margins in recovery
120

Marginal decline in profitability was expected. Group EBITDA for the interims grew 6.2% to XOF 183.7bn, also slightly short of the 6.9% we expect for FY 13. Driving profitability was the normalisation in Mali (+13.7% to XOF 59bn) and an increasingly profitable Conakry (+52.3% to XOF 14.2bn), the latter likely benefitting from increasing scale, which saw its EBITDA margins improve from 35.6% in H1 12 to 40.8% to H1 13. Senegal on the other hand was the straggler, with EBITDA declining 3.2% to XOF 105.0bn, weaker than the 1.4% decline we expected for the segment in FY 13. Overall, group EBITDA margin shed 190bp to 51.4%. Capex was a marginal 1.5% higher at XOF 39.8bn and free cash flow was 14.4% better at XOF 106.3bn. Total debt increased 46.3% to XOF 303.4bn, driven by a fourfold increase in short term loans to XOF 132.7bn. The increase in debt did not have much of an impact on finance costs as net interest income grew 78.3% to XOF 919.0m over the period. Head office costs halved to XOF 1.0bn and PBT grew 8.2% to XOF 134.7bn, slightly ahead of the 7.3% growth we expect for FY 13.

100
80 60 40 20 H1 11 H2 11 Revenue
Source: Company filings

66% 64% 62% 60% 58% 56% 54% 52% 50% H1 12 EBITDA H2 12 H1 13 EBITDA margin

The segments EBITDA margin expanded by 250bp despite the decline in blended ARPUs, indicating how much more efficient the network is when operating under a more stable environment.

31

Guinea Conakry and Bissau continue to exceed our expectations. Conakry was already far ahead of our forecast 2.2m subscribers for FY 13 having benefitted from a 56.0% increase in capex to XOF 8bn. The increase in coverage saw its market share expand by a significant 10p pts to 42%.
Figure 5: High revenue growth and expanding EBITDA margins in Guinea (Conakry)
40 35 30 25 20 15 10 5 H1 11 H2 11 Revenue H1 12 EBITDA H2 12 H1 13 EBITDA margin 60%

Outlook
Growth in mobile data in Senegal to revive segments growth in revenue into the long term . With 3G/broadband penetration across Sonatels markets averaging 7%, data revenue currently contributes c.5% of the groups revenue. Given that we see penetration rising to 11% to FY 17, we see data revenue growing at a CAGR of 25% to contribute 16% of total revenue by then. This development will also buoy Senegals contribution to the top line. Overall, we expect top line to grow at a CAGR of 8.1% to XOF 967bn. Larger data contribution and growth in junior markets to support the groups profitability . We expect FY 13 EBITDA to grow by a subdued 7.9% to XOF 379.7bn as narrowing margins in Senegal are offset by expanding margins in Mali, Conakry and Bissau. Into the long term, we expect a rising contribution from data, which achieves EBITDA margins of c.55% at current prices, to buoy margins to FY 17. Tapering capex intensity to add to free cash flow growth. Given Senegal and Malis limited expansion prospects, we see capex intensity trending to average c.11% to FY 17 for both markets. Whilst intensity tapers off in the smaller markets, we see absolute capex spend declining at an average 0.6% y-o-y to FY 17. We therefore see free cash flow achieving a CAGR of 11.1% over the period. DPS CAGR of 10% to FY 17. In our base case, we maintain a payout ratio of 97.6% as we deem the company is more than capable of doing so given its obligations. We do see upside to DPS growth as we forecast the company achieving a net cash position by FY 14.

50%
40% 30% 20% 10% 0%

Source: Company filings

Given that we estimate mobile penetration only increased by a modest 340bp, we conclude that the majority of the increase in the customer base was due to subscribers from competing networks switching to Sonatels subsidiary. It also seems that the win in market share was quality driven, seeing as voice ARPUs were relatively stable, declining a modest 3.4% over the period.
Figure 6: High revenue growth in Guinea-Bissau
8 7 6 5 4 3 2 1 H1 11 H2 11 Revenue
Source: Company filings

50% 40% 30% 20% 10% 0% H1 12 EBITDA H2 12 H1 13 EBITDA margin

Unlike Conakry, capex in Bissau declined by 36% to XOF 1bn. However, capex spend had been high in previous periods and this saw Sonatels subsidiary gain 4p pts of market share to 43%.
Figure 7: High capex intensity aids smaller markets
50% 40% 30% 20% 10% 0% Senegal Mali FY 11 FY 12 Guinea H1 13 Guinea-Bissau

Valuation and Recommendation

We use our hybrid DCF and arrive at a target price of XOF 24,270, implying upside potential of 3.2%. However, considering our forward dividend with a net yield of 5.5% and the attractiveness of subsequent dividends, we maintain our recommendation to ACCUMULATE the stock.

Source: Company filings

32

Financial Summary
Valuation metrics PER EV / EBITDA P / Book Dividend Yield (%) FCF Yield (%) EV / Sales Key Statistics Subscribers (m) Blended ARPU (XOF) Income Statement Revenue Y-o-Y Growth EBITDA Y-o-Y Growth EBIT Y-o-Y Growth Net finance costs PBT Income tax Effective tax rate NPAT Y-o-Y Growth Attr. NPAT Y-o-Y Growth Basic EPS Y-o-Y Growth DPS Y-o-Y Growth Dividend payout ratio Ratio Analysis EBITDA margin EBIT margin ROaE RoAA Debt / Equity Net debt / EBITDA Interest cover Capex intensity Balance sheet Non-current assets PPE Intangible assets Current assets Cash balances Total assets Current liabilities Non-current liabilities Shareholder funds Minority interest Net debt (cash) 2007 A 479 060 399 673 60 285 264 115 114 807 743 175 216 033 40 573 438 937 47 632 19 424 78.0% 2007 A 54.9% 40.4% 32.1% 21.7% 0.28 0.07 56 28.5% 1 100 1 410 140 967 (4 903) 197 309 (36 103) 18.3% 161 205 203 805 276 855 2007 A 16.6 9.2 5.34 4.7 5.2 5.0 2007 A 4.8 8 820 2007 A 504 668 2008 A 17.2 8.7 5.04 5.5 3.3 4.6 2008 A 7.0 7 761 2008 A 546 653 8.3% 293 097 5.9% 194 105 -4.8% 3 070 193 036 (36 211) 18.8% 156 825 -2.7% 136 578 -3.1% 1 366 -3.1% 1 300 18.2% 95.2% 2008 A 53.6% 35.5% 30.2% 19.9% 0.34 0.21 na 24.3% 2008 A 500 868 432 169 51 714 330 970 114 099 831 838 296 287 27 620 465 421 42 510 60 283 2009 A 14.3 7.9 4.69 5.8 7.2 4.3 2009 A 8.9 6 241 2009 A 593 754 8.6% 319 565 9.0% 223 884 15.3% 952 224 728 (39 700) 17.7% 185 028 18.0% 163 603 19.8% 1 636 19.8% 1 350 3.8% 82.5% 2009 A 53.8% 37.7% 33.9% 21.6% 0.36 0.14 na 15.5% 2009 A 533 582 440 439 47 225 350 522 156 644 884 104 256 521 70 697 499 956 56 930 43 525 2010 A 14.7 7.9 4.47 6.0 6.7 4.1 2010 A 10.9 5 223 2010 A 620 157 4.4% 323 520 1.2% 228 044 1.9% 2 845 220 178 (35 418) 16.1% 184 760 -0.1% 159 631 -2.4% 1 596 -2.4% 1 400 3.7% 87.7% 2010 A 52.2% 36.8% 31.2% 19.5% 0.42 0.07 na 18.8% 2010 A 556 491 458 350 39 743 457 725 226 264 1 014 216 347 444 75 365 524 488 66 919 21 490 2011 A 17.2 7.6 4.42 5.6 5.9 3.8 2011 A 14.2 4 438 2011 A 667 205 7.6% 336 330 4.0% 235 765 3.4% 486 219 846 (65 468) 29.8% 154 378 -16.4% 136 522 -14.5% 1 365 -14.5% 1 305 -6.8% 95.6% 2011 A 50.4% 35.3% 25.9% 15.0% 0.39 0.05 na 18.0% 2011 A 569 379 471 864 38 918 471 557 214 769 1 040 936 381 718 66 897 530 203 62 118 16 020 2012 A 15.3 7.2 4.36 6.4 5.9 3.7 2012 A 17.9 3 555 2012 A 683 870 2.5% 351 387 4.5% 250 918 6.4% (6) 243 141 (71 822) 29.5% 171 319 11.0% 153 667 12.6% 1 537 12.6% 1 500 14.9% 97.6% 2012 A 51.4% 36.7% 28.8% 17.1% 0.32 0.12 58 565 17.3% 2012 A 597 367 491 127 38 429 361 105 148 714 958 471 302 869 59 289 537 474 58 840 43 897 2013 E 14.4 6.7 4.26 6.8 6.6 3.4 2013 E 20.6 3 253 2013 E 752 540 10.0% 379 672 8.0% 273 522 9.0% 1 754 273 277 (87 449) 32.0% 185 828 8.5% 163 219 6.2% 1 632 6.2% 1 593 6.2% 97.6% 2013 E 50.5% 36.3% 30.0% 18.8% 0.30 0.07 na 14.7% 2013 E 594 360 491 162 35 386 420 749 167 216 1 015 109 331 326 59 289 550 692 81 450 25 395 2014 E 12.3 6.0 4.03 7.9 8.0 3.1 2014 E 22.5 3 174 2014 E 821 477 9.2% 421 137 10.9% 314 762 15.1% 2 008 314 770 (94 431) 30.0% 220 339 18.6% 190 540 16.7% 1 905 16.7% 1 860 16.7% 97.6% 2014 E 51.3% 38.3% 33.6% 21.0% 0.28 (0.05) na 13.8% 2014 E 593 623 493 228 32 585 489 919 213 160 1 083 542 346 392 59 289 581 909 111 248 (20 549) 2015 E 10.9 5.6 3.84 8.9 8.9 2.8 2015 E 24.0 3 210 2015 E 895 640 9.0% 453 166 7.6% 346 971 10.2% 5 219 350 190 (105 057) 30.0% 245 133 11.3% 214 303 12.5% 2 143 12.5% 2 092 12.5% 97.6% 2015 E 50.6% 38.7% 36.0% 21.9% 0.26 (0.14) na 12.4% 2015 E 591 232 493 416 30 005 560 010 258 265 1 151 241 362 600 59 289 610 219 142 078 (65 654) 2016 E 10.1 5.3 3.70 9.7 9.5 2.7 2016 E 25.3 3 222 2016 E 952 891 6.4% 478 861 5.7% 372 273 7.3% 8 371 378 644 (113 593) 30.0% 265 051 8.1% 231 979 8.2% 2 320 8.2% 2 264 8.2% 97.6% 2016 E 50.3% 39.1% 37.3% 22.4% 0.24 (0.22) na 12.0% 2016 E 591 505 496 065 27 629 620 462 299 429 1 211 967 375 112 59 289 633 009 175 150 (106 818) 2017 E 9.5 5.0 3.58 10.3 10.0 2.5 2017 E 26.6 3 240 2017 E 1 008 212 5.8% 502 947 5.0% 395 118 6.1% 11 248 404 366 (121 310) 30.0% 283 056 6.8% 247 788 6.8% 2 478 6.8% 2 419 6.8% 97.6% 2017 E 49.9% 39.2% 38.5% 22.8% 0.22 (0.29) na 11.9% 2017 E 595 651 502 399 25 442 677 371 337 701 1 273 022 387 202 59 289 654 354 210 418 (145 090)

33

Equity Research Malawi February 2014 Telecoms

TNM Limited is one of the leading mobile operators in the mainly duopolistic mobile telecoms industry in Malawi. The company commands a 45% market share (subscriber base: 1.9m based on 90 day usage) in an infant telecoms sector with penetration rate still low at 27%. TNM offers a range of branded subscriber and pre-paid mobile phone services, with the later accounting for about 65% of total revenue. ARPUs depressing in real terms. ARPU have shown a steady growth in absolute terms, but have depressed in real terms due to the depreciation in Kwacha. Growth in subscriber base mostly from the lower tail of the income tail and mostly are in prepaid had a diminishing effect on the ARPU. Approximately 99% of the companys subscriber base is in the prepaid segment which generally has lower MoU than post paid. ARPUs have averaged USD2.20. Margins on an upward turn. EBITDA margins are set to recover from 29.5% achieved in FY 13 and to average above 33% in the coming YEs. Margins had been depressed due to imported cost of sales and network maintanance which are sensitive to the exchange rate. Net income margins which were affected by exchange losses through the volatile exchange rate, high cost on its interest bearing debt and network expansion cost are also set to recover to 9.8% in FY13 (FY14: 12.7%) and maintain an upward trend thereafter. The company had since restructured its short term debt to long term and aligned it to its core business nature. Low penetration , duopoly industry. With a market penetration at 27%, which lags behind the regional average at c.67% the telecommunication industry is a duopoly with TNM rival, Airtel offering stiff competition which has resulted in price and product wars. However, both players are set to benefit from the infancy stage of the sector and first mover advantages. Valuation very cosmetic. With high growth prospects, our DCF valuation generates a target price of MWK
Recommendation Bloomberg Code Current Price (MWK) Current Price (USc) Target Price (MWK) Target Price (USc) Upside (%) Liquidity Market Cap (MWK m) Market Cap (USD m) Shares (m) Free Float (%) Ave. daily vol ('000) Price performance 12 months Change (%) 6 months Change (%) Financials (MWK m) 31 Mar Turnover EBITDA Net finance income Attributable earnings Per share data (MWK) EPS DPS NAV Ratios RoaA (% ) RoaE (% ) EBITDA margin (%) Valuation Ratios Earnings Yield (%) Dividend Yield (%) PER (x) PBV (x) EV/EBITDA EV/subscribers (USD) F2013 27 579 9 280 (2 494) 2 680 F2013 0.07 0.09 0.82 2014F 34 297 11 498 (2 107) 4 295 2014F 0.27 0.13 0.99 LT BUY TNM:MW 2.14 0.50 4.59 1.06 114.5

21 487 50 10 040 10.6 828

1.40 52.9 1.20 78.3 2015F 42 769 15 766 (1 904) 7 274 2015F 0.43 0.18 1.30

10.1 27.1 29.5 Current 3.2 4.2 31.0 2.6 2.7 26

15.3 33.3 33.6 2014F 12.6 6.1 7.9 2.2 2.2 22

20.0 39.7 33.5 2015F 20.1 8.4 5.0 1.6 1.6 20

5.34, while a weighted average price, after incorporating the P/E(x) and P/BV(x) of MWK 4.59. We rate the share LT Buy.
Share price vs. S&P Africa Frontier Index
160
140 120 100 80 60 40

STRENGHTS Strong brand name International geteway which enables the provision of related services a lower rate First mover advantages Strong cash generation OPPORTUNITIES Low mobile penetration Increase network coverage Population growth, higher subscriber base

WEAKNESS Domination of revenue towards prepaid services Volatile exchange rate High gearing

THREATS Increased competion, with rolling - in of new players e.g. Celcom

20 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14

Increase economic growth, GDP per capita Price wars with competitors

TNM MW (USD)

S&P Africa Frontier Index

34

H1 13 Financial & Operational Review

For the H1 13 TNM recorded a mixed set of results, with PBT margins depressed on the back of an increase in borrowing costs. Performance was generally affected by increased borrowing cost and exchange losses.
Figure 1: Results summary Income statement (MWK m) Turnover Gross profit EBITDA Net finance costs PBT Attr. earnings HEPS(t) Balance sheet (MWK m) Total Assets NAV Current Assets Current Liabilites Current ratio Cash flow (MWK m) Operating activities Investing activities Financing activities
Source: Company filings

EBITDA was also impressive with a 55% growth to MWK 3.7bn from MWK 2.4bn in the corresponding period of 2012. Attributable earnings closed the period at MWK 558m (37% growth y-o-y) while earnings per share stood at MWK 0.60 from MWK 0.40 in H112 (50% growth y-o-y). The effective tax rate was at 36%, a decline from 40% in the previous period. Cash generation retreated owing to increased debt servicing, in the form of a syndicated loan, of about MWK 5bn (H1 12: MWK 0.4bn) at a rate of 2% below the base lending rate (about 37%). Depreciation surged 40.1% to MWK 1.4bn, mainly on account of MWK 1.7bn CAPEX additions. Assets utilisation improved modestly, with the return on assets (RoA) up to 5% from 3% in the previous corresponding period of 2012, while return on shareholders funds (RoE) was higher at 15% from 13%. The current ratio improved slightly to 0.33X from 0.31X in H12012.

H1 12 7 698 4 094 2 387 (701) 671 405 400 H1 12 23 426 8 218 3 702 11 997 0 H1 12 2 349 (2 498) (581)

H1 13 % Change 11 937 55.1% 6 228 52.1% 3 703 55.1% (1 440) 105.4% 842 25.4% 558 37.8% 600 50.0% H1 13 24 208 3.3% 8 475 3.1% 4 278 15.6% 12 782 6.5% 0 2.0% H1 13 1 044 (1 564) 802

Outlook
The countrys economic outlook looks bright with real GDP growth inching to 4.8% and 5.5% in 2014 and 2015 respectively. Consequently, there will be an implied improvement in GDP per capita to MWK 238.47 and MWK 244.23 in 2014 and 2015 respectively from about MWK 215.21 in 2012. Population growth is projected to average 3% in the next five years. This combined with the current low penetration rate of 27% against Africas average penetration of 67%, poses high growth opportunities for TNM. However, management recently hinted of a limited expansion drive, as they will take a conservative approach to limit new capital expenditure.

Operationally, the top line outturn was impressive with a 55% y-o-y growth in turnover (which was backed by a 17% growth in the subscriber base and an ARPU of about MWK 1,000.00) to MWK 11.9bn.
Figure 2: Prepaid airtime dominates costs

Source: Company filings

35

We see APRUs increasing as the dilution from new subscribers is limited whilst per capita incomes of the existing subscriber base increases. We also expect this to reduce exposure from foreign exchange related to CAPEX which makes the company more vulnerable to exchange losses. The company also recently restructured its balance sheet, realigning its debt maturity profile to the long term, and in line with its business model.
Figure 3: EBITDA margins to expand
80 70 60 50 40 30 20 10 FY 12 FY 13
Revenue

Cost pressures TNMs cost base is highly sensitive to the exchange rate and inflation. Industry wide cost pressures, especially network related (of which 90% are fx. denominated), could have a negative impact on our earnings expectations if the exchange rate remains volatile. Furthermore, increased marketing expenses and administration costs to maintain brand name and presence will also exert pressure on OPEX and hence earnings margins. Despite the downside risk, we expect TNM to weather the conditions, using its first mover advantage, strong brand name and solid balance sheet to help it manage any shocks.

50%

40%

30%

Valuation and Recommendation

20% FY 14 FY 15 FY 16
EBITDA margin

FY 17

EBITDA

Source: Company filings

The demand for TNM products remain elevated, with other nontelecom business products being rolled out in by the company. TNM Mpamba (a mobile money service) was introduced in late 2013 and the reception is quite overwhelming with subscribers now at 100,000. Nevertheless, pre-paid will still constitute a huge chunk of TNM revenue in the near term.

In our view, we see unrealised potential in the Malawi telephony business with TNM positioned to benefit from such. We arrive at a DCF target price of MWK 5.34 per share, while a weighted average price, after incorporating the P/E(x) and P/BV(x), arrives at a target price of KES 4.59. We rate the share LT Buy.

Risks
Volatile exchange rate: Seasonal depreciation of the Malawi Kwacha poses downside risk to earnings maximization, as exchange losses downplay earnings margins. Competition a threat to maintenance of market share: Despite the industry being a duopoly in nature, the issuance of new GSM licenses to new entrants will exert pressure on TNMs market share, and could lead to price wars and hence reduced earnings margins. However, there is a minimum chance of a new entrant in the near term, though CELCOM was licensed in 2010 but is yet to roll out, due to pronounced barriers to entry in the industry.

36

Financial Summary
Valuation metrics PER EV / EBITDA P / Book Dividend Yield (%) FCF Yield (%) EV / Sales Key Statistics Subsc ribers Base (m) Blended ARPU (M wk) Income Statement Revenue Y-o-Y Growth EBITDA Y-o-Y Growth EBIT Y-o-Y Growth Net financ e c osts PBT Inc ome tax Effective tax rate PAT Y-o-Y Growth Basic EPS Y-o-Y Growth DPS Y-o-Y Growth Dividend payout ratio Ratio Analysis EBITDA margin EBIT margin ROaE RoAA Debt / Equity Net debt / EBITDA Interest c over Balance sheet Non-c urrent assets PPE Intangiable assets Current assets Cash balanc es Total assets Current liabilities Non-c urrent liabilities Shareholder funds M inority interest Net debt (c ash) 2010 A 18.3 6.9 2.88 2.8 (4.9) 2.3 2010 A 1.1 618 2010 A 11 012 NA 3 647 NA 2 035 NA (424) 1 611 (436) 27% 1 175 NA 0.12 NA 0.06 NA 51% 2010 A 33.1% 18.5% 15.7% 7.5% 1.10 1.45 na 2010 A 13 396 13 208 188 2 269 853 15 665 6 835 1 357 7 473 (853) 2011 A 12.5 5.0 2.61 2.8 (1.3) 1.9 2011 A 1.5 566 2011 A 12 953 18% 5 059 39% 2 890 42% (669) 2 221 (501) 23% 1 720 46% 0.17 46% 0.06 0% 35% 2011 A 39.1% 22.3% 20.9% 10.1% 1.06 1.42 4.3 2011 A 14 118 13 347 548 2 854 1 051 16 972 5 345 3 399 8 229 (1 051) 2012 A 31.0 4.7 2.61 3.3 (14.1) 1.4 2012 A 1.9 568 2012 A 18 300 41% 5 407 7% 3 211 11% (2 025) 1 186 (494) 42% 692 -60% 0.07 -60% 0.07 17% 102% 2012 A 29.5% 17.5% 8.4% 3.0% 1.80 1.54 1.6 2012 A 20 500 18 783 942 2 927 515 23 426 9 723 5 067 8 218 (515) 2013 E 7.9 2.7 2.15 4.4 (10.0) 0.9 2013 E 1.9 909 2013 E 27 579 51% 9 280 72% 6 362 98% (2 494) 3 867 (1 160) 30% 2 707 291% 0.27 291% 0.09 35% 35% 2013 E 33.6% 23.1% 27.1% 10.1% 1.67 1.36 2.6 2013 E 22 160 20 051 1 344 4 526 1 045 26 686 12 551 4 158 9 978 (1 045) 2014 E 5.0 2.2 1.65 6.1 5.3 0.7 2014 E 2.1 1 045 2014 E 34 297 24% 11 498 24% 8 305 31% (2 107) 6 198 (1 859) 30% 4 339 60% 0.43 60% 0.13 37% 30% 2014 E 33.5% 24.2% 33.3% 15.3% 1.18 0.89 3.9 2014 E 23 015 20 495 1 755 5 401 1 327 28 416 10 756 4 645 13 015 (1 327) 2015 E 2.9 1.6 1.16 8.5 19.5 0.6 2015 E 2.3 1 201 2015 E 42 769 25% 15 766 37% 12 400 49% (1 904) 10 496 (3 149) 30% 7 347 69% 0.73 69% 0.18 41% 25% 2015 E 36.9% 29.0% 39.7% 20.0% 0.99 0.60 6.5 2015 E 26 834 23 821 2 248 9 991 4 930 36 824 13 057 5 242 18 525 (4 930) 2016 E 1.8 1.1 0.77 10.8 46.7 0.5 2016 E 2.6 1 382 2016 E 53 931 26% 22 143 40% 18 078 46% (1 464) 16 614 (4 984) 30% 11 630 58% 1.16 58% 0.23 27% 20% 2016 E 41.1% 33.5% 41.8% 23.3% 0.79 0.35 12.3 2016 E 31 722 28 204 2 753 18 150 11 790 49 872 16 111 5 932 27 829 (11 790) 2017 E 1.3 0.9 0.52 11.3 87.2 0.4 2017 E 2.8 1 589 2017 E 67 743 26% 29 151 32% 24 481 35% (1 319) 23 162 (6 949) 30% 16 213 39% 1.61 39% 0.24 5% 15% 2017 E 43.0% 36.1% 39.0% 23.8% 0.64 0.12 18.6 2017 E 38 229 34 147 3 317 29 955 21 987 68 184 19 893 6 680 41 611 (21 987)

37

Equity Research South Africa February 2014 Telecoms

With declining MTR revenue and increased competition in the home market, which contributes 83% of the groups service revenue, Vodacoms (VODs) top line growth has slowed down to single digit rates. Buoying the growth is VODs international operations and data revenue and these will have a greater impact going forward.

Recommendation Bloomberg Code Current Price (ZAR) Current Price (Usc) Target Price (ZAR) Target Price (Usc) Upside (%) Liquidity Market Cap (ZAR m) Market Cap (USD m) Shares (m) Free Float (%) Ave. daily vol - 1 yr. ('000s) Price Performance Price, 12 months ago (ZAR) Change (%) Price, 6 months ago (ZAR) Change (%) Financials (ZAR m) 31 Mar Turnover EBITDA Net Finance Income Attributable Earnings Per share data (ZAR) EPS DPS NAV/Share Ratios RoaA (%) RoaE (%) EBITDA Margin (%) Valuation Ratios Earnings Yield (%)* Dividend Yield (%) PE (x)* PBV (x) EV/EBITDA (x)* EV/Subscribers (USD) * TTM F2013 69 917 25 275 (687) 12 991 2014F 75 429 27 836 (769) 14 432 HOLD VOD:SJ 118.81 1 051 122.00 1 080 2.7

Cut in MTRs and increased competition in South Africa slowing revenue growth further. Vodacom SAs voice and interconnection revenue declined 2.6% and 23.6%, respectively, over H1 14 after MTRs were cut by 23% to ZAR 0.40 and price competition ensued. A 50% cut in tariffs will be effected on 1 March 2014 and we expect interconnect revenue to decline accordingly whilst voice comes under pressure on price competition.

176 789 15 645 1 488 15.6 2 117

Data to benefit from higher disposable incomes in RSA; M-Pesa to excel in lesser developed markets. Vodacoms data penetration in RSA is 52% of its mobile subscriber base implying that there is significant growth upside for its data business. Growth in the customer base will essentially be driven by expansion of the network and the decline in the prices of devices. The international operations face low income challenges, however, the low banking penetration in these markets present a conducive environment for M-Pesa growth. Tanzania has already shown success, signing up c.55% of its mobile subscribers to the service. The introduction of M-Pesa to the DRC, Mozambique and Lesotho, which carry c.37% of the groups mobile subscribers, present significant growth prospects for the service. EPS CAGR of 6.1% to FY 18. Despite the muted SA contribution to growth, VOD is expected to grow revenue, EBITDA and EPS at a CAGR of 5.3%,7.5% and 6.1%, respectively, to FY 18. We arrive at a target price of ZAR 122.00 and recommend the stock as a HOLD.
Share price vs. S&P Africa Frontier Index
140

121.35 -2.1 119.00 -0.2 2015F 81 857 30 957 (474) 14 751

8.89 7.86 14.23

9.70 8.70 15.77

9.91 9.79 15.90

25.7 66.1 36.2 Current 7.7 6.6 13.0 8.4 7.0 305

25.3 64.7 36.9 2014F 8.2 7.3 12.2 7.5 6.7 283

26.6 62.6 37.8 2015F 8.3 8.2 12.0 7.5 6.0 257

120

100

STRENGTHS Majority market share in South Africa Diversified markets; A subsidiary of global giant, Vodafone Plc OPPORTUNITIES Strong growth prospects from the DRC Increased data usage in RSA Take off in data in other markets

WEAKNESSES More vulnerable to ZAR and RSA shocks than MTN Key market highly advanced and competitive THREATS Escalation of local competition Regulatory action

80

60 Jan-13

Mar-13

May-13

Jul-13

Sep-13

Nov-13

Jan-14

VOD SJ (USD)

S&P Africa Frontier Index

38

H1 14 Financial & Operational Review

Data and internationals offset RSA voice woes. VODs service revenue for H1 14 grew a marginal 1.7% to ZAR 30.3bn (USD 3.0bn) as competition and lower MTRs in RSA saw the flagships contribution remain flat at ZAR 23.7bn. Whilst mobile subscribers grew 1.4% to 30.1m, voice revenue was 2.6% lower to ZAR 14.1bn on account of the increased competition which saw customers switch to price competitive bundles. Interconnection fees also fared badly, declining 23.1% to ZAR 1.9bn as MTRs were cut by an average 23% over the period. Figure 1: RSA voice subs stagnate
Subscribers (m) Operation Voice Data Smartphones M-Pesa RSA Inter. RSA Inter. RSA Inter. H1 12 24.4 16.2 10.5 1.9 3.9 2.1 H1 13 29.7 19.3 13.3 4.3 5.3 4.2 H1 14 30.1 23.7 15.1 6.1 6.6 5.5 % Change 13/12 21.7% 19.2% 26.7% 126.3% 35.9% 100.0% 14/13 1.4% 22.4% 13.2% 41.0% 23.9% 31.0%
10.54
0.96

Interconnect fees and SMS revenue were each 37% higher at ZAR 693m and ZAR 262m, respectively. Data also performed well, growing subscribers by 41% to 6.1m and this saw revenue for the segment double to ZAR 985m. RSA still the driver of EBITDA growth. Group EBITDA margins expanded by 140bp to 36.1% and EBITDA grew 10.7% to ZAR 13.3bn in H1 14. Behind the expansion in margins was the 630bp improvement in margins at the international segment to 26.9%. This in turn was a result of a 19.2% decrease in direct expenses after the sale of loss-making subsidiary, Gateway. EBITDA from internationals grew 42.2% over the period. Figure 3: EBITDA (ZAR bn) growth by segment
0.53 0.63 0.57
12.06 13.22

Source: Company filings

Offsetting these declines was a 20.6% growth in data revenue to ZAR 5.1bn. Vodacom SA grew its data subscribers by 13% to 15.1m and added 1.3m smartphones (+24.0%) to 6.6m (21.8% of mobile subscribers). This helped revenue from the sale of devices to grow by 41.2% to ZAR 6.0bn, which in turn helped total revenue grow by 6.0% to ZAR 30.1bn. Figure 2: Data driving top-line growth
1 364 451 (831) (397) 30 253

H1 12

RSA

Inter.

H1 13

RSA

Inter.

H1 14

Source: Company filings

In RSA, EBITDA margins improved a marginal 30bp to 38.1% and EBITDA for the segment grew 6.9% to ZAR 11.5bn. Capex grew 14.2% to ZAR 4.8bn driven by internationals (+74.1% to ZAR 1.8bn), whilst RSA expenditure declined 4.9%. In RSA, capex was targeted at increasing data reach and improving customer service. Depreciation increased 5.7% to ZAR 3.3bn and EBIT grew 12.4% to ZAR 10.0bn. Net finance costs grew 27.9% to ZAR 454m underpinned by a 17.7% increase in total debt to ZAR 11.5bn. NPAT grows 8.4% in H1 14. PBT and income tax grew 8.0% and 7.0% to ZAR 9.5bn and ZAR 6.6bn, respectively, and NPAT for H1 14 was ZAR 6.6bn from ZAR 6.1bn in H1 13. EPS in turn grew 7.9% to ZAR 4.43.

29 744

(78)

SMS

Data

Inter-con

Other

H1 13

Voice

Source: Company filings

Internationals drive service revenue growth. The internationals continue to enjoy high growth in voice as penetration increased by c.30% to a still relatively low 42% across Vodacoms international markets. Underpinned by a 22.4% increase in subscribers to 23.7m, voice revenue grew 27.1% to ZAR 3.9bn, boosted notably by the 16.5% gain of the Tanzanian shilling against the rand.

39

H1 14

Outlook
Further cuts in MTRs and competition to intensify and threaten SA margins. MTRs will be cut from the current ZAR 0.40 level to ZAR 0.20 on 1 March 2014. As observed before, this will put further pressure on interconnect revenue even though an increase in inbound MOUs is expected. Furthermore, the new glide-path could encourage Cell-C and 8ta to lower their tariffs and become more competitive. This in turn could see Vodacom and MTN introduce more competitive packages and therefore lower their voice ARPUs. Investment in voice quality to counter competition. and data to increase value offerings. Networks will continue to invest in voice capacity but at a diminished rate. The focus will be on improving quality and efficiency, in order to protect or increase MOUs and ultimately combat churn. This will at least allow operators to maximise returns from voice. Continued investment in data a must. A reliable data offering will also ensure that the data hungry customer base is fully serviced. Figure 4: Outlook on smartphone penetration in RSA and Tanzania
50% 40%
30%

Nevertheless, capex intensity in RSA is expected to remain relatively low as capex in voice tails off. Growth in international markets and data to support bottom and top line growth for the group. Voice penetration currently sits at 138% in RSA and 42% across the international operations. Combined, mobile penetration across the group is 68%. This implies that Vodacom still has fairly attractive growth prospects in voice. The ratio of data to mobile subscriber in RSA is currently 52.3% compared with 25.6% in the Vodacoms international markets. Given that we anticipate high mobile voice growth in internationals to be accompanied by rising data penetration, we expect even higher growth in data usage. The issue, though, remains the relatively low per capita incomes and low urbanised population in Vodacoms growth markets. We generally look to high economic growth, the associate increase in urbanisation in the region and declining device prices to increase penetration and usage. M-Pesa on the other hand is conducive to lesser developed markets. The mobile money service was launched in DRC, Mozambique and Lesotho over H1 14 and is already gaining traction in these markets. We also expect the mobile money service to encourage coverage over the lower density, rural areas. Overall, we expect revenue from the segment to achieve a CAGR of 21.4% vs. 3.5% for RSA. EPS CAGR of 6.1% to FY 18 to ensure dividend quality is maintained. Group EBITDA margins are expected to improve to 36.9% in FY 14 and average 39% to FY 18 owing to the growing contribution from the international operations against narrowing margins in SA. We expect FY 14 revenue, EBITDA and NPAT to grow 7.9%, 10.1% and 11.3% to ZAR 75.4bn, ZAR 27.8bn and ZAR 14.7bn, respectively.

20% 10% 0%
2010 2011 2012 FY 14 RSA
Source: Company filings

FY 15

FY 16

FY 17

FY 18

Tanzania

In RSA, Vodacoms smartphone users are expected to reach 16.3m by FY 18 from the current 6.6m. Given that a combination of a 16% decrease in data prices and a 24.0% increase in smartphones on the Vodacom network led to a 78.9% increase in data usage to 220MB by the average data subscriber in RSA, a robust network is required to handle the anticipated growth. A big win will be the acquisition of the Neotel spectrum as this will increase wireless data transmission capacity significantly.

Valuation and Recommendation

We have a target price of ZAR 122.00, and forecast FY 14 EPS of ZAR 9.70 and annualised FY 14 DPS of 8.70. HOLD

40

Financial Summary
Valuation metrics PER EV / EBITDA P / Book Dividend Yield (%) FCF Yield (%) EV / Sales Key Statistics Subscribers (m) Blended ARPU (ZAR) Income Statement Revenue Y-o-Y Growth EBITDA Y-o-Y Growth EBIT Y-o-Y Growth Net finance costs PBT Income tax Effective tax rate NPAT Y-o-Y Growth Attr. NPAT Y-o-Y Growth Basic EPS Y-o-Y Growth DPS Y-o-Y Growth Dividend payout ratio Ratio Analysis EBITDA margin EBIT margin ROaE RoAA Debt / Equity Net debt / EBITDA Interest cover Capex intensity Balance sheet Non-current assets PPE Intangible assets Current assets Cash balances Total assets Current liabilities Non-current liabilities Shareholder funds Minority interest Net debt (cash) 76.0% 2008 A 34.0% 25.8% 68.5% 23.3% 0.52 0.31 38.8 13.5% 2008 A 24 468 19 120 4 224 9 707 978 34 175 17 582 4 788 11 402 404 5 165 3.99 5.25 7 812 (424) 12 067 (4 109) 34.1% 7 958 12 491 16 432 2008 A 22.6 11.3 15.51 3.4 2.8 3.8 2008 A 33.97 119 2008 A 48 334 2009 A 29.0 11.1 12.61 2.9 2.3 3.3 2009 A 39.61 126 2009 A 55 442 14.7% 16 800 2.2% 12 005 -3.9% (1 768) 10 237 (4 045) 39.5% 6 192 -22.2% 6 089 -22.1% 4.09 -22.1% 3.49 -12.5% 85.4% 2009 A 30.3% 21.7% 47.9% 15.2% 1.07 0.90 9.5 13.1% 2009 A 35 224 21 844 11 794 12 135 1 104 47 359 21 831 10 430 14 017 1 081 15 107 2010 A 42.1 9.4 12.87 0.9 5.0 3.2 2010 A 39.89 123 2010 A 58 535 5.6% 19 765 17.6% 11 238 -6.4% (2 293) 8 945 (4 745) 53.0% 4 200 -32.2% 4 196 -31.1% 2.82 -31.1% 1.10 -68.6% 38.9% 2010 A 33.8% 19.2% 30.2% 9.4% 0.90 0.61 8.6 10.8% 2010 A 29 131 21 383 6 673 12 560 1 061 41 691 15 465 11 590 13 738 898 12 074 2011 A 21.4 9.0 11.32 3.8 5.2 3.0 2011 A 43.49 122 2011 A 61 197 4.5% 20 559 4.0% 13 696 21.9% (1 058) 12 638 (4 659) 36.9% 7 979 90.0% 8 245 96.5% 5.54 96.5% 4.57 316.9% 82.5% 2011 A 33.6% 22.4% 56.2% 19.2% 0.64 0.46 19.4 10.9% 2011 A 27 982 21 577 5 215 13 638 870 41 620 16 512 8 743 15 622 558 9 524 2012 A 19.3 8.2 9.38 6.0 5.3 2.8 2012 A 48.99 121 2012 A 66 929 9.4% 22 698 10.4% 16 617 21.3% (684) 15 933 (6 106) 38.3% 9 827 23.2% 8 995 9.1% 6.15 11.0% 7.10 55.4% 115.5% 2012 A 33.9% 24.8% 53.1% 22.1% 0.60 0.38 33.2 12.9% 2012 A 30 678 24 367 5 123 16 620 2 849 47 298 18 368 10 932 18 530 400 8 576 2013 A 13.4 7.3 8.35 6.6 7.3 2.7 2013 A 53.58 114 2013 A 69 917 4.5% 25 275 11.4% 18 897 13.7% (687) 18 434 (5 210) 28.3% 13 224 34.6% 12 991 44.4% 8.89 44.5% 7.86 10.7% 88.4% 2013 A 36.2% 27.0% 66.1% 25.7% 0.68 0.31 36.8 13.5% 2013 A 34 434 27 741 5 332 21 207 6 578 55 641 24 755 9 620 20 800 416 7 933 2014 E 12.2 6.7 7.53 7.3 5.5 2.5 2014 E 58.13 113 2014 E 75 429 7.9% 27 836 10.1% 21 903 15.9% (769) 21 134 (6 414) 30.4% 14 720 11.3% 14 432 11.1% 9.70 9.2% 8.70 10.7% 89.7% 2014 E 36.9% 29.0% 64.7% 25.3% 0.62 0.39 36.2 12.3% 2014 E 37 200 31 071 5 317 23 360 3 997 60 561 24 631 14 554 23 469 704 10 916 2015 E 12.0 6.0 7.47 8.2 7.7 2.3 2015 E 64.04 112 2015 E 81 857 8.5% 30 957 11.2% 24 404 11.4% (474) 23 930 (7 263) 30.4% 16 667 13.2% 14 751 2.2% 9.91 2.2% 9.79 12.4% 98.7% 2015 E 37.8% 29.8% 62.6% 26.6% 0.57 0.33 65.3 12.0% 2015 E 40 441 34 327 5 302 24 185 4 810 64 626 27 865 14 554 23 658 2 620 10 103 2016 E 11.4 5.7 7.40 8.7 7.9 2.2 2016 E 70.25 105 2016 E 84 744 3.5% 32 379 4.6% 25 684 5.2% (258) 25 426 (7 717) 30.4% 17 709 6.3% 15 540 5.3% 10.44 5.3% 10.29 5.2% 98.5% 2016 E 38.2% 30.3% 65.4% 26.6% 0.52 0.32 125.6 12.0% 2016 E 43 954 37 854 5 287 24 549 4 597 68 502 29 343 14 554 23 886 4 790 10 316 2017 E 10.6 5.3 7.28 9.2 8.9 2.1 2017 E 76.72 100 2017 E 88 543 4.5% 34 983 8.0% 27 727 8.0% (279) 27 448 (8 331) 30.4% 19 118 8.0% 16 733 7.7% 11.25 7.7% 10.98 6.7% 97.6% 2017 E 39.5% 31.3% 69.5% 27.0% 0.47 0.27 125.3 11.8% 2017 E 47 114 41 030 5 273 26 152 5 441 73 267 31 329 14 554 24 280 7 174 9 472 2018 E 10.2 5.1 7.16 9.5 9.2 2.1 2018 E 83.45 94 2018 E 90 491 2.2% 36 292 3.7% 28 527 2.9% (195) 28 332 (8 599) 30.4% 19 733 3.2% 17 267 3.2% 11.60 3.2% 11.33 3.2% 97.6% 2018 E 40.1% 31.5% 70.5% 26.2% 0.43 0.24 186.4 11.8% 2018 E 49 990 43 920 5 258 27 163 6 061 77 152 32 341 14 554 24 687 9 640 8 852 2019 E 10.3 5.1 7.03 9.4 9.2 2.0 2019 E 90.26 88 2019 E 91 256 0.8% 36 537 0.7% 28 325 -0.7% (133) 28 192 (8 689) 30.8% 19 503 -1.2% 17 100 -1.0% 11.49 -1.0% 11.17 -1.4% 97.2% 2019 E 40.0% 31.0% 68.6% 24.8% 0.40 0.24 275.5 11.8% 2019 E 52 509 46 453 5 243 27 479 6 225 79 988 32 302 14 554 25 159 12 043 8 688

41

Imara Africa Securities (A division of Imara SP Reid) Imara House Block 3, 257 Oxford Road, Illovo Johannesburg 2146 South Africa Tel: +27 11 550 6200 Fax: +27 11 550 6295

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