BLUE LABEL TELECOMS- DEEP DIVE AND ANALYSIS

An insight into one of the most undervalued company's on the JSE!

• Overview

• Business Model and Operating Structure

• The Financials

• Valuation

• Additional Thoughts

• Our Position

Overview

BLT is a virtual distributor of digital products, that was founded in 2001 by brothers Mark and Brett Levy. The company first started out by selling electronics such as TVs and Radios, which allowed them to build a large distribution network. They were then awarded a license to distribute phone cards on behalf of Telkom, the third largest telecommunications network operator in South Africa. These phone cards contained a pin that users would type into the olden day phone boxes, which then allowed them to make calls. Once demand for mobile products grew in South Africa, BLT started distributing prepaid products on behalf of the larger network operators, MTN and Vodacom. In those days, these products were all physical, such as scratch cards for airtime. It became inefficient and uneconomical for the business to physically go and distribute these products to some retailers who were thousands of kilometres away and only wanted to buy a small batch, such as 5 x R75 airtime scratch cards. This led to the company investing in technology that allowed them to distribute these products virtually to all retailers, so physical distribution costs were cut, inventory management became easier for both the business and the retailers, and these retailers could now also replenish stock as they needed. Fast forward to today, and the company has built up a proprietary technology system that allows them to distribute any kind of digital product, from airtime and data, to electricity and entertainment tickets. This has allowed them to continuously deliver on the core foundation of the business: distributing products on behalf of suppliers that don’t want to invest into distribution channels and technological infrastructure and at the same time providing retailers the opportunity to sell various different types of products without worrying about inventory management or any additional issues.

Now that we have a foundational understanding of the business, lets take a deeper look at their business model and operating structure.

---

Business Model and Operating Structure

BLT has increased their product and service offering overtime, by entering into industries that are aligned with the businesses core capabilities. This has led to the business owning more than 25 companies, which have been grouped into 8 divisions. Most of these subsidiaries are wholly/majority owned by BLT but there are a few exceptions where the business is a minority shareholder. In the current operating structure, the 2 founders, Mark and Brett sit as Co-CEOS of BLT. They both oversee 4 divisions within the group, as you can see below:

It would be too time consuming to go into every division and company within the BLT Group, so let’s just take a look at those that contribute significantly to revenue and that we feel will be important for the business moving forward.

1. AFRICA DISTRIBUTION

Blue Label Distribution (BLD)

BLD specialises in electronically distributing prepaid products through their proprietary technology systems and extensive distribution channel (+150 000 distribution points), which includes all major supermarkets, retailers and banking institutions. They distribute products on behalf of companies within the group as well as other third parties. For example, they distribute airtime, data, tickets and prepaid electricity for companies within the group. They also provide additional services such as bill payments, meaning that you can pay certain bills like utilities or traffic fines at any one of their distribution points. Another important product that they offer is an internally developed one called Blu Voucher. Basically, you go to any one of the retailers and buy a Blu Voucher for the value that you want. You then go online to any business or service that accepts Blu Voucher and input your voucher pin to make use of the service or buy the product that you need. This is a valuable product for the business as it allows those without bank accounts and cash to access services that they previously couldn’t access without a debit/credit card. As it stands, almost 25% of the South African population is unbanked, so there clearly is demand for this type of product.

Ticketpro

Ticketpro provides a distribution and sales platform for third party companies to sell tickets for services such as travel, sports events or entertainment. Ticketpro earns a commission on all tickets that are sold and makes use of BLT’s distribution channel to get these products to consumers.

Comm Equipment Company (CEC)

CEC primarily specialised in providing financing to network operators for the handset component of their postpaid contracts (cellphone contracts where customers pay monthly for a device and airtime/data). Simply put, if you go to Cell C and buy an iPhone on contract, you don’t pay the full price upfront, but usually over a 24 month period. However, Cell C still has to pay their supplier for that phone, but they can’t because you have not yet paid for it in full. This is where CEC company steps in and provides Cell C with financing (a loan) for that phone.

In 2021, CEC evolved from a specialist lender to a fully operational business unit, as it began to manage Cell C’s postpaid base (all the customers that are on a post paid contract at Cell C). In return for managing Cell Cs postpaid base, CEC and Cell C entered into a subscription income sharing agreement. CEC receives a share of the income earned from Cell Cs postpaid customers. In addition to this, CEC bears the operating costs of Cell Cs post paid business for the duration of the agreement. The agreement comes to an end in 2025 but BLT has the right to renew it for another 4 years.

2. WHOLESALE

The Prepaid Company (TPC)

TPC is the largest distributor of prepaid products for all major network operators in South Africa. They are essentially wholesalers of these prepaid products as they buy them from the network operators and sell them to retailers and other businesses. Some of these products include airtime, data and starter packs. The prepaid airtime and data that they sell is BLTs largest contributor to revenue.

These products are always going to be in demand irrespective of market conditions. Consumers are always going to need airtime and data to communicate, especially as we transition to a more digitally dependent economy.

3. ELECTRICITY/MUNICIPALITIES

Cigicell

Cigicell provides revenue collection and assurance services for municipalities in South Africa. So they basically collect utility (water and electricity) payments on behalf of the municipalities. They have also deployed an in-house technology system that allows customers to make their utility payments at almost any retailer of their choice. This is another example of BLT using their distribution channel to provide Value Add Services to companies. They currently provide these services to almost 100 municipalities in South Africa, as well as Eskom, and collect more than R20 Billion. Although this number sounds lucrative, its important to note that the commissions earned by BLT on these type of transactions are low, usually around 1-2%.

Network Operator

CELL C

Cell C is a mobile network operator that was founded in 2001 by 3C Telecommunications, a subsidiary of Saudi Arabian company Saudi Oger.

In 2017, Blue Label acquired 45% of Cell C for a purchase consideration of R5.5 billion, through their wholly owned subsidiary TPC, in an attempt to recapitalise (inject more money into) the debt burdened company. Cell Cs strategy at the time was to invest in the expansion of its network and compete with MTN and Vodacom. However, that was an extremely capital intensive strategy which was unsuccessful, resulting in BLT impairing its Cell C stake to nil in 2019. This led to a second recapitalisation in 2022, where BLT lent Cell C R1.03 billion to settle their renegotiated debts with lenders for 20c on the rand. They also provided liquidity support to Cell C through deferring payments that were owed to CEC and by making prepaid airtime purchases (as part of ordinary business activities). The strategy this time was different though. Instead of building a network that would compete with the larger players, they would make use of the larger players networks through roaming. So they entered into roaming agreements with both Vodacom and MTN. Cell C postpaid customers now roam on Vodacoms network and prepaid customers on MTN. This allows them to access the best networks and infrastructure that South Africa has to offer, without any investing any additional capex (capital expenditure).

Post the second recap, Blue Label now owns 49.54% of Cell C. However, due to loans made to certain SPVs (Special Purpose Vehicles) involved in the recap, Blue Label has an additional economic interest of 13.66 % of Cell C, resulting in a total economic interest of 63.2%. They also receive cash flows from CECs subscription sharing agreement mentioned earlier. We estimate that their total interest in Cell Cs profits are just over 70%. This means that although they directly own 49.54% of Cell C, they receive 70% of Cell Cs profits. They cannot take complete ownership of the additional 13.66% of shares though, as they need approval from the Competitions Commision and ICASA (Independent Communications Authority of SA). In Dec 2023, BLT did submit an application to both regulatory bodies to obtain an additional 4.04% stake in Cell C, which would then give them complete control.

When Cell C entered into roaming agreements with MTN and Vodacom, their was a lot of controversy among telecom experts surrounding their status as a Mobile Network Operator (MNO). Many argued that due to them not having their own network and roaming on other networks, they were now a Mobile Virtual Network Operator (MVNO). A MNO owns and controls its own infrastructure and spectrum (explained later), whereas an MVNO essentially pays to use an MNOs network and spectrum and resells it as their own. Although Cell C does not have their own network, they do own their own spectrum. Spectrum can be thought of as invisible radio frequencies that allow signals to travel. Spectrum is a finite natural resource that is highly valuable and therefore controlled by regulatory authorities within each country. These authorities auction off spectrum licenses to network providers. According to independent evaluators, Cell Cs spectrum is arguably worth close to R10 Billion.

Another noticeable part of Cell Cs business is their MVNO base. They are currently the leading enabler of MVNO services in South Africa, with over 20 MVNOs. These include FNB, Capitec, Shoprite and Mr Price. These MVNOs roam on MTNs network as part of Cell Cs roaming agreement. The partnership that we are most excited about is Capitec, through their Capitec Connect offering. The Capitec customer base currently exceeds over 20 million people, about a third of the South African population. Of these 20 million customers, 1.3 million sim cards have already been activated on Capitec Connect, as of Capitec’s latest financial reporting date on 31 August 2023. This number should be much higher now as they saw strong monthly growth in new users. Capitec Connect currently offers the lowest prepaid data rates on the market, so it would only make sense for Capitec customers to switch from their current network providers to Capitec Connect. They get access to a great network in the form of MTN, the best rates on the market and a full service package from Capitec (banking and mobile). As MVNOs attract more customers, there is a corresponding increase in mobile services usage. This results in higher fees and revenue earned by Cell C.

Another possible catalyst that could play out is if Capitec Connect entered the postpaid and handset contracts market, which FNB Connect already offers. The most obvious solution for the handset financing would be Comm Equipment Company. There has not been any talks of this yet, but we do feel it is something that will be introduced in the future.

---

The Financials

The latest set of financials that we have for BLT are the interim results for the 6 months ended 30 November 2023.

*Any percentage increases/decreases mentioned are in relation to the comparative period, which is for the 6 months ended 30 November 2022.

Revenue

Revenue for the 6 months was R7.6 Billion, a 23% decline. However, the group only recognises gross profit as part of revenue for some products, as they act as the agent and not the principal of these products. Although they sell the products, they don’t record the full value of the sale in line with certain accounting standards criteria. If you have to impute the revenue (adjust it for the full value), the total revenue increased by 12% to R43.8 Billion. Although this sounds great, it might not be, if imputed revenue is up but reported revenue is down. It could mean that the company’s profit margins are coming under pressure or they are selling less higher margin products. However, they reported an increase in the Gross Profit Margin from 15.67% to 21.8% and Gross Profit also increased by 4% to R1.6 Billion. The increase in the Gross Profit margin could be attributed to lower operating costs in proportion to the comparative period. In the comparative period, operating costs (expenses directly attributable to the production of goods and services sold by the Group) made up 86% of revenue, whereas it only makes up 80% for this period. Another positive to note also is the R4.8 Billion (311%) revenue increase in Gross Universal Vouchers, which is due to an increase in Blu Voucher sales as well as a new financial institution. This shows that there is still strong continued demand for the groups core products.

Earnings

At first glance, if you took a quick look at the Earnings Per Share (EPS) for the period, you would’ve been pleased to see that it increased from -8.4c per share in the comparative period to 45.67c per share in this period. However, you can’t take these numbers at face value as they are severely distorted as a result of the complexity of transactions that were involved in the second recapitalisation of Cell C. To get a clearer picture, the best metric to look at would be the Core Headline EPS (Core HEPS), after adjusting for the extraneous numbers that were mainly related to Cell C. This then gives us a 23% decrease in Core HEPS to 39.9c per share. This decrease is largely attributable to a R119 million decline in CEC, mainly due to increased expenditure as a result of the subscription agreement which is most likely a once off transaction. The decline also includes an increase in Expected Credit Losses (ECL) and this is just standard conservative procedure to reflect the deteriorating macroeconomic conditions. One thing that we did pick up on CECs side also was a R203 million revenue increase in handset sales, which is extremely positive.

Cell C

In a recent Investec Telecom conference, Jorge Mendes (Cell C CEO) gave the market an idea on what to expect from Cell Cs Full Year Results:

• Revenue= R14.8 Billion

• EBITDA= R2.3 Billion

• Average Revenue Per User (ARPU)= R89

• Total Customer Base= 9.4 million

The ARPU and Customer base are showing robust growth. More customers and more money per customer can only lead to good things going forward.

Valuation

Prior to buying Cell C, BLT traded between a 12-17 P/E (Price / Earnings ) multiple. Obviously, you have now have to adjust that for the difference in the number of shares outstanding then vs now. If you have more shares outstanding, your earnings are divided by a larger base and are therefore lower. The number of shares outstanding now are almost 37% higher than they were previously. You also have to factor in the macroeconomic environment that we are in today. So lets take a conservative view and use a P/E of 10. The interim Core HEPS adjusted for the extraneous figures are 39.90c. Annualised thats about 80c. On a P/E ratio of 10, that puts BLT at a share price of R8. This is just the core business without factoring in Cell C.

Lets take Cell C into account now. The only other privately owned telecom company of Cell C’s size is Rain, which you can gain exposure to through the JSE listed African Rainbow Capital (ARC). ARC owns 21% of Rain and values the business at R23 Billion on their statements. Rains EBITDA is exactly the same as Cell Cs- R2.3 Billion. That puts Rain at an EBITDA multiple of 10. However, the market does believe that their valuation is questionable. So we’ll adjust it to an extremely conservative EBITDA multiple of 6:

• R2.3 Billion x 6= R13.8 Billion

• R13.8 Billion/2 (reflect BLTs “official” 50 % stake in Cell C)=R6.9 Billion

• R6.9 Billion/889 918 000 (BLTs Outstanding Shares)= R7.75 per share

• Total BLT share price = R8 + R7.75 = R15.75

• Current BLT share price= R4.50

This is obviously just an estimated figure, but it gives us a good guideline as to where the share should possibly be trading at.

Additional Thoughts

• The market has discounted BLT due to its investment in Cell C and the failure of the first recap

• The complexity surrounding the reporting of Cell C in the Financial Statements has put off many retail investors. Once BLT become majority shareholders, things will be a lot clearer.

• Mark and Brett (Co-CEOs) currently own close to 20% of BLT. Thats always a positive because they have skin in the game as well and their goals are aligned with us as shareholders.

• The telecom industry can be a complex one to navigate and it does take a certain level of specialised skill. Cell C has continued to appoint executives with strong industry experience from both Vodacom and MTN. This speaks volumes about their belief in the businesses potential.

Our Position

Blue Label Telecoms makes up 100% of our portfolio:

• Number of shares- 121 350

• Average purchase price- R3.66

If you enjoyed this article, make sure to let us know in the comments! If you would like to add anything or feel like we missed out on something, we would be more than happy to hear to it.

Thank you for joining us on this journey,

MC CAPITAL