Why Cell C?

Blue Label Telecoms (BLU) has just fully implemented the recapitalisation of Cell C and now owns 45% of the third-tier mobile telecos.

Why Cell C?

There are a lot of misperceptions about what Blue Label’s Cell C investment is, so allow me to briefly unpack the logic for you here:

Defensive reasons for BLU to invest into Cell C:

Blue Label Telecoms’ core distribution business sells far more prepaid vouchers for MTN and Vodacom than its sells of Cell C’s. That said, given the size of MTN and Vodacom, the sales are done on a much lower margin. Tertiary networks tend to give better margin to distributors, and Cell C is no exception here.

Hence, Cell C’s share of bottom-line in Blue Label is much more material.

By ensuring the survival of Cell C with its recapitalisation, Blue Label Telecoms has ensured that one of its more profitable customers can keep profiting it. Likewise, given its shareholding, it is unlikely that Cell C will disintermediate Blue Label from its route-to-market now.

Hence, the defensive nature of Blue Label’s decision to invest into Cell C.

Commercial reasons for BLU to invest into Cell C:

Telecos are dumb-pipes that offer a great platform and eco-system to build product around, through and for. Hence, Blue Label Telecoms’ investment into Cell C gives it a large foot in the door to offer services, products and other value-add into the Cell C ecosystem.

For example, Blue Label’s content division can push product to Cell C’s customer-base. Maybe Cell C phones come preinstalled with apps to buy Blue Label’s prepaid products, like electricity and water and bus tickets? All manner of commercial synergies can be exploited, many of which I am sure I have not even imagined yet.

Blue Label Telecoms also recently bought 3G Mobile that finances Cell C’s phones. Given that Blue Label’s working capital cycle is negative, it has a large cash balance that it currently earns relatively lower interest income on. 3G Mobile offers a higher yielding book for Blue Label to deploy cash into while further integrates the Group’s operations deeper into Cell C.

In my opinion, the commercial reasons will be the real long-term blue sky if they can exploit them cleverly. I will be watching this space closely.

Financial reasons for BLU to invest into Cell C:

Blue Label Telecoms paid R5.5bn for its 45% stake in Cell C. My personal fair value for Cell C is closer to R8.5bn to R10bn. As Cell C hockey-stick curves its profits up from the break-even it reported last year and heads towards a listing, I expect confirmation of this fair value to start to materialise, if not outperform.

Hence, the financial reasons for the investment: it was a great deployment of capital.

In defence of Cell C’s market position:

But isn’t Cell C a bad asset, I hear you ask? Aren’t tertiary networks always laggards?

Historically, you may be accurate, but the prospects for these players are changing as networks become commoditised.

Ignoring the potential value-unlock from having one of the strongest distributors in South Africa as a shareholder, Cell C also has the advantage of the changing telecos landscape. Twenty years ago, capex spend to build your own network was a massive competitive advantage. Without a network, you could not offer coverage, and this meant that you weren’t a telecos.

That is being changed by one of the most powerful forces in the world: economics.

The capex land-grab is over and mobile towers lie pretty much everywhere. MTN and Vodacom can keep building towers that cost plenty and are only ever partially used. They are fast getting marginal diminishing returns on each further R1 spent on capex, especially when a lot of the capacity is left unused.

Rather, like what Vodacom has done with Cell C, if each major network starts to share its network, they get incremental revenues off this capex, use up unused capacity and lower their own capex costs (i.e. lift their on ROICs).

Hence, network sharing (the antithesis of ‘capex spend’) is coming. View it as the ‘cloud computing’ of the telecos, and Cell C will benefit massively from it.

So, if every telecos has access to a network, what is the competitive advantage?

Well, it is not size anymore. Rather, it is price, service and distribution. The big guys can compete on price, anyone willing to pay can get distribution, and so a tertiary network starts to compete on service.

While Vodacom is going for country-wide coverage, Cell C is focussing on dense urban areas to ramp up its niche offering. Given Cell C’s roaming agreement with Vodacom (i.e. infrastructure sharing with Vodacom), Cell C’s customers can get coverage anywhere that Vodacom is. Hence, Cell C can focus its smaller, more efficient capex spend on only those areas that it wants to target.

Hence, this is no longer a capex game.

And, therefore, Cell C is not an inferior telecos asset just because it is smaller. Rather, Cell C has the advantage of no legacy and no need to convince internal structures about infrastructure sharing or reining in capex spend. Rather, Cell C can focus on capturing its niche market and delivering superior product and service.

That is a really long way to say that a tertiary network with agile, aggressive management, a well-capitalized balance sheet, and with a strong distribution business should be a force to be reckoned with.

Finally, in conclusion, I hope I’ve unpacked what may appear to be a strange investment decision by Blue Label Telecoms to invest into Cell C. Far from this perception, I believe that this was a particularly smart move and I am very excited about what the future holds here.

Watch this space closely…

Note: Read some background on BLU’s distribution business here (Part I) and over here (Part II)

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