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darkest before the dawn?

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David Lerche

Chief Investment Officer

MTN is emerging from a tough two-year period during which an adverse macro environment exposed the failings of poor management. Over the next three years, however, we expect new management to drive a revival at the MTN group from an operational perspective while the macro headwinds gradually subside.

Lower commodity prices over the past few years have squeezed both African governments and consumers, a situation exacerbated by deteriorating exchange rates. The MTN group’s poor business performance in these difficult conditions was magnified by an over-optimistic share price in mid-2015, as the market reassessed its view on the risks associated with doing business in frontier markets.

In announcing the group’s annual results earlier this month, MTN reported a loss for 2016. If we adjust for the Nigerian regulatory fine in June 2016, however, the group would have made 423 cents per share of profit. If other once-offs are excluded, this figure increases to 787 cents per share.

The past 18 months have seen major changes at MTN, the most important of which has been a complete overhaul of top management. The group has embarked on a deep and fundamental strategic review of its operations. New CEO Rob Shuter – who demonstrated his abilities at Vodacom and Vodafone – should not only drive MTN forward, but ease many of the market’s concerns.

MTN is implementing a new strategy, IGNITE, which appears likely to drive new revenue streams and improve operational efficiencies. However, in our view the greater challenge is to transform the group’s culture. As management consultant Peter Drucker famously said, ‘Culture eats strategy for breakfast’. Through the complete refresh of the group’s top management, MTN now has the opportunity to dramatically alter its organisational culture.

At its core, MTN has a set of top-class assets – it is the leading telecoms operator in 14 of its 22 markets. In an industry with clear and enduring scale advantages, MTN not only has a sustainable business, but it should be able to generate long-term super-profits in the markets in which it leads.

Fighting against this view are the governments in MTN’s countries of operation. In the time-honoured tradition of frontier-market governments, the tallest tree is at the greatest risk of being cut down. Governments in many of MTN’s markets see the company as an easy route to tax collection, adding specific duties to airtime while at the same time advocating for lower retail prices. These countries generally have highly variable (if any) electricity supply and poor infrastructure, yet governments expect MTN to deliver developed-world call quality.

While MTN’s markets have experienced a tough couple of years, the group does remain exposed to one of the few predictions one can make with certainty: each year, there will be more and more people living in Africa. Exposure to the world’s fastest-growing populations, and economies that generally have wide scope for improvement off low bases, creates an attractive long-term picture.

Such opportunities don’t come without risk, however. The greatest unknown for investors is the future of the Nigerian naira, which remains pegged to the US dollar at an artificial rate. This means there is limited currency liquidity to import capital items, and effectively none for the externalisation of dividends. MTN’s largest operation reports accounting earnings based on the official exchange rate of NGN315/US$, but should be valued based on a best estimate of the exchange rate at which MTN will eventually be able to send dividends upstream to group level, probably NGN400/US$.

Supporting the valuation is management’s commitment to a dividend of at least R7 per share, which means the share trades at a 5.6% dividend yield, despite its forward price earnings ratio of 18.3 times. In our view, MTN’s share price of R124 per share fairly reflects a balance between the future prospects and the risks the group faces.

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