kestrel capital september 2014 · september 2014 safaricom ltd ... duced higher loan bands of kes...

KESTREL CAPITAL Member of the Nairobi Securities Exchange

September 2014

SAFARICOM LTD

Recommendation: ACCUMULATE We maintain our ACCUMULATE recommendation on Safaricom with a Fair Value of KES 14.20, 8.1% above the

current price. We estimate total return of 12.7% including our forecasted dividend of KES 0.60 for FY15F (a for-

ward dividend yield of 4.6%). For FY15F, we forecast earnings to grow 31.7% y/y largely driven by growth in reve-

nue on the back of additional subscribers and increased usage as costs remain stable. Safaricom’s revenue growth

over the last 3 years has largely been driven by growing subscriber numbers. However, as subscriber growth be-

gins to taper off and the quality and variety of products continue to rise, we believe that growth in the long term

will be driven by increased usage. Safaricom trades at a forward P/E of 17.4x, EV/EBITDA of 7.2 and dividend yield

of 4.6%. While this is compares unfavourably to the regional median P/E of 11.8x and EV/EBITDA of 6.3x, Sa-

faricom’s M-PESA advantage and the expected growth in earnings and dividends justify the premium. Notably,

Safaricom’s forward dividend yield of 4.6% is higher than the regional median of 3.3%.

Positives

Growth in voice revenues (3 year forward CAGR of 10.5%) will be driven by increased minutes of use

Non-voice revenue will contribute more to service revenue (41.8% in FY17 compared to 37.6% in FY14) due

to faster growth (3 year forward CAGR of 17.1% )

Growth in M-PESA revenues (3 year forward CAGR of 15.8% ) will be supported by increased transactions per

user and a rise in the average value of each transaction of M-PESA and its associated products

SMS revenue growth (3 year forward CAGR of 16.0% ) will be driven by increased usage per subscriber as a

result of lower pricing and promotions

Increased data usage and subscribers on the back of faster internet and increased data coverage will be the

drivers of mobile data revenue growth (3 year forward CAGR 22.3%)

Fixed data revenue growth (3 year forward CAGR of 16.2%) will be driven by additional subscribers and

increased usage

Safaricom’s strong distribution network (of 270,000 retailers, 43 shops, 3,000 dealer outlets and 81,025 M-

PESA agents) will support airtime sales

Contribution margins and EBITDA margins will continue to increase (+204bps and 251bps respectively over

the next 3 years) as costs rise slower than revenue

Increased finance income as a result of negative net debt will drive up earnings

Capital expenditure (including the acquisition of Yu’s infrastructure) will be focused on improving the net-

work

Dividends are likely to increase as capital expenditure remains relatively stable and debt declines

Negatives

Increased competition from MVNOs is expected slow growth in subscriber numbers and prevent any signifi-

cant rise in prices of products and services

Data-supported text applications are likely to subdue growth in SMS revenues in the long term

Equity Bank’s mobile banking system running on its MVNO license will be a strong competitor to M-PESA

The interoperability of M-PESA agents will reduce some of Safaricom’s competitive advantage

FY10 FY11 FY12 FY13 FY14 FY15F FY16F FY17F

Revenue (KES bn) 83.96 94.84 107.00 124.29 144.67 167.20 192.46 206.76

y/y % ch 13.0 12.8 16.2 16.4 15.6 15.1 7.4

EBITDA (KES bn) 36.61 35.73 37.50 49.24 60.94 70.56 80.75 86.56

y/y % ch (2.4) 5.0 31.3 23.8 15.8 14.4 7.2

EPS (KES) 0.38 0.33 0.32 0.44 0.57 0.76 0.92 0.99

y/y % ch (13.2) (4.0) 38.9 31.2 31.7 21.8 6.8

DPS (KES) 0.20 0.20 0.22 0.31 0.47 0.60 0.80 0.85

y/y % ch - 10.0 40.9 51.7 27.7 33.3 6.3

EV/EBITDA (x) 14.5 15.0 14.3 10.8 8.5 7.2 6.1 5.4

P/E (x) 34.7 40.0 41.7 30.0 22.9 17.4 14.3 13.3

Div yield (%) 1.5 1.5 1.7 2.4 3.6 4.6 6.1 6.5

Tickers

Bloomberg: SAFCOM KN Reuters: SCOM NR Share Statistics Fair Value (KES) 14.20

Price (KES) 13.15

Issued shares (m) 40,044.6

Market cap (USD m) 5,988.35

Year end March

Free Float % 25.0

Foreign ownership (%) 13.1

Av daily trading vol (USD) 1,847,836

Price Return Absolute Excess 3m 3.1% (3.7%)

6m 12.8% (0.6%)

12m 64.6% 34.4%

Price Graph

Source: NSE

Analyst

Kuria Kamau [email protected] +254 20 2251 758 +254 20 2217 049 www.kestrelcapital.com

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Safaricom Update September 2014 KESTREL CAPITAL

2

Positives

Growth in voice revenues will be driven by increased minutes of use: In FY14, voice revenues

grew 11.6% y/y largely driven by an 11.1% y/y increase in subscribers. The company was able to

regain some of the subscribers that were lost in FY13 due to the switching off of counterfeit

phones and unregistered lines. Voice ARPU, meanwhile, increased 0.5% y/y largely on the back

of higher effective minutes yield (+2.2% y/y) as minutes of use declined (-1.6% y/y). The effec-

tive minutes yield increased on the back of more on-net outgoing calls and more emergency

top-ups. The increase in subscriber market share (from 65.1% to 67.8% in FY14) and reduction

in churn (from 30.5% in FY13 to 19.3% in FY14), helped raise the effective minutes yield as evi-

denced by the 2.6% y/y increase in outbound calls minutes by subscriber. The company intro-

duced higher loan bands of KES 250, KES 500 and KES 1,000, for its emergency top-up service,

Okoa Jahazi. This helped grow revenues on emergency top ups by 37.0% y/y. Also, in FY14, Sa-

faricom entered into partnerships with MTN and UTL in Uganda, Vodacom in Tanzania and MTN

in Rwanda to provide roaming bundles within the East Africa region. This helped encourage

subscribers to make better use of their Safaricom airtime. The increase in effective minutes

yield was despite a decline in mobile termination rates (MTRs). The Kenya telecommunications’

regulator, Communications Commission of Kenya (now Communications Authority of Kenya)

announced a glide path for MTRs in 2012. MTRs declined 20.1% y/y on 1 July 2013 and were

due to decline by a further 13.9% y/y on 1 July 2014. Minutes of use disappointed despite pro-

motions including the top-up promotion, Tetemesha na Safaricom. The promotion was able to

increase voice traffic by 6.0% y/y in 1Q14 but the higher minutes of use were not maintained

for the rest of the year. In 1Q15, the company carried out a repeat of the promotion, increasing

the number and amount of prizes. Safaricom’s minutes of usage are at 92; much lower than

Vodafone South Africa’s minutes of usage of 122. This is despite the fact that Kenya’s call rates

are USD 0.10 cents per minute cheaper than South Africa’s. We expect minutes of use to keep

growing as real disposable income rises. On call quality, Safaricom’s next phase of the Best Net-

work in Kenya programme will focus on customer quality of experience and sustainability and

increase population coverage to 93.5%. To reduce dropped calls, the company invested in new

technology (pooling and Wavelength Switched Optical Networks) in FY14 that ensures that any

failure of a network element is supported by other network capabilities, without the customer

experiencing any service loss. Improved call quality and organic growth in minutes of use will be

the drivers of voice revenue in the future. We forecast 3 year forward CAGR of 10.5%.

Non-voice revenue will contribute more to service revenue: In FY14, non-voice revenue grew

27.8% y/y compared to the 11.6% y/y growth recorded by voice revenue. As a result, non-voice

revenue accounted for 37.6% of total service revenue in FY14 up from 34.5% in FY13. We fore-

cast 3 year CAGR on non-voice revenue of 17.1% against 3 year CAGR on voice revenue of

10.1%. By FY17F, we expect non-voice revenue to account for 41.8% of total service revenue.

(Source: Safaricom)

(Source: Safaricom)

(Source: Safaricom)

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1H10 2H10 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14

Voice Revenue versus Voice Subscribers

Voice Revenue (KES bn) Voice Subscribers (m)

Voice Revenue56%

SMS Revenue

10%

Mobile Data Revenue

8%

Fixed Service Revenue

2%

M-PESA Revenue20%

Handset Revenue3%

Acquisition and other revenue

1%

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100.00

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Voice Revenue versus Non-voice Revenue

Voice Revenue Non-voice Revenue


3

Growth in M-PESA revenues will be supported by increased number of transactions per user

and a rise in the average value of each transaction of M-PESA and its associated products: M-

PESA revenues accounted for 19.2% of total service revenues in FY14. Subscriber growth was

the major contributor of the growth. M-PESA revenue grew 21.6% y/y while M-PESA subscrib-

ers grew 13.0% y/y. M-PESA ARPUs also grew after Safaricom increased M-PESA tariffs at the

start of FY14 to factor in the new excise duty on mobile money transactions. For transactions

below KES 100, it held the tariff stable but increased the tariff for transactions above KES 100.

The number of transactions per subscriber remained relatively stable in FY14. This was in spite

of a 23.6% y/y increase in the number of agents to 81,025. Safaricom has launched several

products to help grow M-PESA revenue. The products include M-Shwari, Lipa Kodi, M-PESA IMT

and Mymarket. As at the end of FY14, M-Shwari had 3.6 million active customers and Commer-

cial Bank of Africa (Safaricom’s partner on M-Shwari) had managed to attract deposits worth

KES 4.0bn and issue KES 1.2bn in loans per month while maintaining a Non-Performing Loans

ratio of 2.7%. Lipa Kodi has enabled 88 landlords/housing agents and tenants in 60,000 housing

units monitor and access statements of rental payments for record keeping purposes. M-PESA

International Money Transfer (M-PESA IMT) allows M-PESA subscribers to receive funds from

over 100 countries worldwide via a Safaricom IMT partner at no fee. Safaricom Mymarket is an

online merchandising platform introduced in December 2013, which offers free auction services

through mobile phones. The service, which can be accessed via USSD, currently includes jobs,

classifieds, automobiles, property, mobile phones and electronics. All payments are made

through M-PESA. Furthermore, Safaricom has increased its cashless distributors to 158 with a

total of 1,271 distribution points. Among the companies that have signed up are Coca Cola, Uni-

lever, East African Breweries Ltd, British American Tobacco, Nation Media and Standard Group.

With growth in subscriber numbers expected to taper off in the medium term due to saturation

and increased competition, increasing the number of transactions per subscriber and the aver-

age value of each transaction are the only sustainable ways to grow M-PESA revenues in the

long term. Safaricom has already been positioning itself for this. Safaricom launched a new mer-

chant service, LIPA na M-PESA in FY14 which allows M-PESA subscribers to pay for goods and

services from merchants with M-PESA till numbers. As at the end of FY14, Safaricom had signed

on 122,000 merchants with 24,137 active on a 30-day period. To encourage the growth of the

product, Safaricom reduced the transaction fee from 1.5% to 1.0% of the transaction value.

Furthermore, Safaricom announced new M-PESA tariffs on 20 August 2014 to encourage in-

creased usage, pass on cost savings from moving the M-PESA system to Kenya and also posi-

tioned itself ahead of expected competition from Equity Bank. The tariffs for transaction sizes

below KES 1,500 were reduced by an average of 48.9% to an average tariff of KES 11.00. The

tariffs for transaction sizes of KES 1,500 and above (to the maximum transaction size of KES

70,000) increased by an average of 41.8% to an average tariff of KES 91.42. M-PESA is an

EBITDA dilutive product (it has an EBITDA margin of approximately 17.0% before the tariff

change compared to the company EBITDA margin of 42.1%) and therefore it requires large vol-

umes to generate good return. We forecast 3 year forward CAGR of 15.9% on M-PESA reve-

nues.

(Source: Safaricom)

(Source: Safaricom, Central Bank of Kenya)

- 500.00 1,000.00 1,500.00 2,000.00 2,500.00

FY10

FY11

FY12

FY13

FY14

Number of transactions versus Value of Transactions

Value of Transactions (KES bn) Number of Transactions (m)

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M-PESA Revenue versus M-PESA Subscribers

M-PESA Revenues (KES bn) M-PESA Subscribers (m)


4

Investment in the M-PESA system will help improve processing time, capability and reliability:

In 4Q14, a system upgrade to the M-PESA and M-Shwari platforms resulted in a significant in-

crease in the processing capabilities and speeds to near real-time processing. Following the up-

grade, the system can handle 440 airtime top-up transactions per second from 320. It has also

increased speeds at which M-PESA subscribers can withdraw funds directly from their bank

accounts in 30 different banks to M-PESA. The system upgrade also streamlined operations for

the 160 business partners that disburse staff salaries through M-PESA, as well as those that re-

ceive payments through M-PESA and need to move cash to their bank accounts on a regular

basis. Service availability of MPESA was 99.6% in FY14 with a peak average of 260 transactions

per second. Safaricom’s 2 year programme of transferring the M-PESA system to Kenya will be

complete at the end of FY15. This will result in increased functionality, reliability and faster pro-

cessing time of the system. This will help improve the customer experience ahead of the com-

petition from Equity Bank.

SMS revenue growth will be driven by increased usage per subscriber as a result of lower pric-

ing and promotions: In FY14, SMS revenues accounted for 9.8% of service revenues. Growth

in SMS revenue was 34.2% y/y on the back of increased usage. The SMS usage per customer

increased 129.0% y/y despite a 64.0% y/y decline in the average price per SMS. The increased

usage was driven by the Bonyeza Ushinde promotion. Safaricom, through the Bonyeza Ushinde

promotion, offered subscribers a free SMS for 3 questions answered, 2 free SMSes for 4 ques-

tions answered and 3 free SMSes for 5 questions answered. All questions were answered using

SMSes charged at KES 5.00 compared to the normal SMS charge of KES 1.00. The promotion has

a sticky effect on SMS volumes as evidenced by the fact that the higher SMS volumes recorded

during the quarter in which the promotion took place (7 August to 5 October) continued onto

the following quarters. SMS volumes for the promotion quarter stood at 4.8bn and increased to

6.0bn in each of the following quarters. The sustained SMS volumes was also on the back of

increased uptake of SMS bundles. The SMS bundles revenue grew 66% y/y to KES 2.5bn. Going

forward, we expect Safaricom to grow its SMS revenues largely on the back of increased vol-

umes by running promotions and maintaining prices low. Safaricom introduced, Chatitude, a

product whereby subscribers access 10MB of data and 10 on-net SMS at a cost of KES 10. It

combines data and SMS in bundles and helps customers with smartphones to make the best of

both of these services. We forecast SMS revenue to grow at a 3 year CAGR of 16.0% y/y.

Increased data usage and subscribers on the back of faster internet and increased data cover-

age will be the drivers of mobile data revenue growth (3 year forward CAGR 22.3%): Like

most other business segments, mobile data revenue grew on the back of subscriber growth.

Mobile data revenue grew 40.6% y/y while mobile data subscribers grew 34.1%. The growth in

subscribers was supported by the Jisort na Smartphone promotion which involved selling entry

level smartphones at affordable prices. The loyalty points system (Bonga Points) was revamped

to enable subscribers to use part cash and points to purchase internet enabled devices. Sa-

faricom is able to purchase a variety of smartphones at relatively low prices through its pro-

curement partnership with Vodafone. The company then passes on the lower costs to subscrib-

(Source: Communications Authority of Kenya)

(Source: Communications Authority of Kenya)

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3Q13 4Q13 1Q14 2Q14 3Q14 4Q14

SMS numbers per operator (in millions)

Safaricom Airtel Essar Yu Orange

Safaricom

Airtel Kenya

OrangeYu

Number of mobile data/internet subscriptions

Safaricom Airtel Kenya Orange Yu


5

ers through promotions. As a result of the promotions, Safaricom had 9.5m subscribers with

data enabled phones of which 3.1m customers use 3G enabled devices and 1.9m use

smartphones as at the end of FY14. Internet penetration in Kenya was at 53.3%, of which 73.6%

of subscribers accessed the internet (mostly mobile data) via the Safaricom network. In order to

increase mobile data interest from new potential subscribers, Safaricom launched a WiFi ser-

vice on more than 3,000 public service vehicles called Vuma Online. The Wifi service has al-

lowed subscribers to sample 3G internet for free on public service vehicles. Every day approxi-

mately 24.5 GB worth of data is consumed in the public service vehicles. In addition to this, the

company hopes to introduce a Dynamic Discounting System (DDS) located in high youth density

areas that will offer affordable options to young people. Mobile data usage was up 16.1% y/y

while average price per MB declined 14.4% y/y. Safaricom has been encouraging its subscribers

to convert from the more expensive Pay As You Go (PAYG) internet to the cheaper in-bundle

browsing to drive increased usage. In FY14, the company expanded data 2G coverage to 91.0%

of population coverage and 3G coverage to 61.0% of population coverage. The increased cover-

age will result in increased usage. Safaricom will have significant first mover advantage when it

rolls out 4G. It would be able to attract new subscribers and drive increased usage. In exchange

for building the government a security monitoring system, Safaricom will be handed USD 75.0m

worth of spectrum on which it will set up 4G. In addition to this, the acquisition of Yu’s assets

will allow for more spectrum. 4G will be supported by the fibre network that Safaricom has

been investing in. The company has already tested 4G at 10 sites and managed to record down-

load speeds of 70 Mbps. We forecast 3 year CAGR of 22.3% on mobile data revenue.

Fixed data revenue growth will be driven by additional subscribers and increased usage: In

FY14, fixed data revenue grew 21.8% y/y on the back of increased fixed data ARPU (+16.8% y/y)

as fixed data subscribers rose 4.3% y/y. To support fixed data growth the company is building a

backbone fibre network in major towns and cities in Kenya. Safaricom has completed 770 km of

fibre and is ready for service with 70% of the targeted 385 sites connected as at 31 March 2014.

Another 640 km of fibre is under construction in Nairobi, Nakuru, Mombasa and Kisumu. Fol-

lowing the completion of the additional 640km, Safaricom intends to deploy fibre buildings in

four large towns in Kenya. The company had already connected 119 buildings out of a target of

623 buildings in Nairobi and hopes to connect 934 buildings in Kenya by the end of March 2015.

With connections to major buildings in Nairobi, Safaricom will be able to grow its fixed data

subscriber numbers at a relatively low additional cost. The faster internet speeds will encourage

increased usage. The company has migrated its services to its own fibre from leased lines giving

it more power on pricing. Moreover, the fibre network will allow the company to have in-

creased capacity for larger product offerings for both consumer and enterprise services. By hav-

ing its own fibre network, Safaricom will be able to respond quickly to any damages on the line

to avoid loss of revenue. We forecast 3 year CAGR of 16.2% for fixed data revenue.

Innovative new products, M-PESA and increased coverage will help grow revenues from large

enterprises and SME: Safaricom is the largest seller of bundled telecommunications services

to business customers in Kenya. The company leverages on its subscriber numbers, network

(Source: Communications Commission of Kenya)

(Source: Communications Commission of Kenya)

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

0.0

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10.0

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20.0

25.0

3Q13 4Q13 1Q14 2Q14 3Q14 4Q14

Internet Penetration in Kenya

Internet Users in Kenya (in millions) Internet Penetration

Wananchi Telecom

Liquid Telecom

Access Kenya

Telkom Kenya

Safaricom

Others

FIXED DATA MARKET SHARE


6

coverage and extensive M-PESA ecosystem to provide these services to corporates in Kenya.

Safaricom Enterprise Business Unit’s market share grew from 37% in FY13 to 42% in FY14, large-

ly driven by 35.0% y/y growth in total business unit revenue to KES 10.2bn. The increase in rev-

enues was supported by 28.0% y/y growth in enterprise data to KES 4.2bn, 70.0% y/y growth in

business related M-PESA revenue to KES 1.5bn and 32.0% y/y increase in voice to KES 3.7bn.

The growth in business related M-PESA revenue was driven by cashless distribution for corpo-

rates. Other enterprise services added KES 0.8bn to revenues. The company hopes to extend its

product offering outside just enterprise telecommunications to managed services; and a host of

advanced IP, data, voice, video collaboration and security solutions. Small and medium sized

enterprises are the next corporates and Safaricom is leveraging on its Zidisha Biashara product

to attract SMEs. The Zidisha Biashara product provides an integrated bundled offering of voice,

data, cloud SAAS services for SMEs (payroll, accounting, domain and webhosting), Lipa na M-

PESA and Unified Communications for SMEs. In FY14 the product helped bring an additional

11,500 SMEs raising the number of SMES using products and services to 30,500. The company’s

focus in FY15 is to grow the number of customers to 64,000 and Average Revenue Per Account.

The acquisition of Yu’s telecommunications infrastructure will result in improved call quality

and faster internet speeds: Despite the fact that Safaricom has more than 2.0x the number of

base stations as Airtel and an equal amount of spectrum, it has 4.0x as many subscribers. As a

result, Safaricom’s network infrastructure is stretched resulting in dropped calls and network

downtime which lead to lost sales. The acquisition of Yu’s network infrastructure

(approximately 400 base stations) will help alleviate the pressure on Safaricom’s infrastructure.

The Communications Authority of Kenya received a joint bid from Safaricom and Airtel Kenya to

acquire the assets of the third largest telecommunications company in Kenya by subscriber

numbers, Essar Yu mobile. In the joint bid, Airtel will take Yu’s subscribers and Safaricom will

take its network infrastructure including staff. Yu’s network infrastructure includes 7.5MHz

paired of 900MHz spectrum and 10MHz paired of 1800MHz spectrum. It’s not clear if Safaricom

will also acquire Yu’s option to purchase an additional 10MHz of 2100MHz spectrum for USD

10.0m. The acquisition of the spectrum (still under review by CAK) as well as approximately 400

base stations will allow Safaricom to improve its call quality and internet speeds. The 900MHz

will allow Safaricom increase its reach while the 1800MHz will allow the company increase data

speeds. The company will, however, need to spend more to modernize and optimize the base

stations that it will acquire from Yu.

The renewal of Safaricom’s operating license will eliminate any uncertainty relating to non-

compliance of meeting the minimum quality standards: The regulator had threatened not to

renew Safaricom’s licence until it had meet its minimum Quality of Service (QoS) standards.

However, the regulator renewed Safaricom’s license but increased the penalties for non-

compliance from KES 500,000 to 0.2% of gross turnover of the offending licensee. Safaricom

commissioned independent drive tests in October 2013 to measure key quality metrics such as

dropped calls, voice quality and data speeds. The results of the tests showed that its network

delivers the best data services and comparative voice services.


7

Safaricom’s strong distribution network will support airtime sales: In FY14, the company rec-

orded a 17.0% y/y growth in airtime sales on the back of the company’s large distribution net-

work. Safaricom’s retail reach increased to 270,000 retailers, 43 retail shops and a dealership

network of 3,000 outlets. The company ran several dealer promotions to encourage more sales

and better distribution. The M-PESA agent network has also expanded to 81,025 agents coun-

trywide ensuring that M-PESA services and M-PESA top-ups in particular are available through-

out the country. Safaricom supported M-PESA agents by arranging agent loan bank facilities to

assist them purchase float for their outlets on a daily basis. The amount given to agents as part

of this scheme, was over KES 600.0m in FY14. The large airtime distribution network ensures

98.0% availability in the market. Going forward the company intends to refurbish its shops

which provide customer care and products including headsets and tablets. It also plans on roll-

ing out 73 Safaricom care desks at selected dealers, which will be manned by Safaricom staff

and provide the same level of service as the retail shops. The company introduced an online self

-service platform to reduce traffic at its shops.

Contribution and EBITDA margins will continue increase as costs rise slower than revenue: In

FY14, direct costs and operating costs grew 10.2% y/y and 14.0% y/y respectively, compared to

the 16.4% y/y increase in total revenue. This resulted in a 204bps y/y and 251bps y/y rise in the

contribution margin and EBITDA margin respectively. In FY14, 34.0% of all top-up were carried

out on M-PESA resulting in savings on scratch card production costs, airtime commissions and

logistics costs. Network operating costs (including fuel) declined after the company adopted

energy saving batteries in 11% of their sites resulting in a 15% y/y decline in unit power utiliza-

tion. IT operational costs fell after the company upgraded its information systems. Going for-

ward, we expect savings from more M-PESA top ups, reductions in network operation costs and

the implementation of the new ERM system.

Increased finance income due to negative net debt will drive up earnings: As at the end of

FY14, Safaricom had long term borrowings worth KES 5.1bn after it reclassified part of its corpo-

rate bond (worth KES 7.5bn) from non-current liabilities to current liabilities ahead of the repay-

ment in November 2014. This debt cost the company 12.25% per annum. Once this portion of

the corporate bond is paid, the effective interest on borrowing will decrease significantly. The

remaining borrowings include the 2nd tranche of the corporate bond which is worth KES 4.5bn

at 7.75% per annum and a 2 year bank loan worth KES 615.4m at 91-day T-Bill minus 1.0%. The

2nd tranche of the corporate bond is due for payment in December 2015. Safaricom has cash

worth KES 17.6bn and according to our forecasts will generate an additional KES 34.5bn in

EBITDA in 1H15. Of this KES 52.1bn of cash, KES 18.8bn will be used to pay dividends and ap-

proximately KES 10.5bn will be used to acquire Yu’s assets. The rest will be maintained for capi-

tal expenditure and supporting the construction of the government’s security system. After the

repayment of the corporate bond and the 2 year bank loan, we see no immediate need to take

up additional borrowings. Therefore, we believe that the company will earn net finance income

from FY15 as opposed to paying net finance costs as it has done in the past.

(Source: Safaricom, Kestrel Capital Research)


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Contribution and EBITDA margins

Contribution Margin EBITDA Margin

(60.00)

(50.00)

(40.00)

(30.00)

(20.00)

(10.00)

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20.00


Net Debt/(Cash)


8

Capital expenditure including the acquisition of Yu’s infrastructure will be focused on improv-

ing the network: Safaricom spent 90.0% of its KES 27.8bn capital expenditure on network

quality, capacity and coverage. The company invested in an additional 235 base stations as well

as the modernisation and optimisation of 267 existing base stations and 500 microwave links

for the transmission platform. The company has upgraded core elements on its 3G network to

technology that will allow for internet speeds of 21 and 42 Mbps. As a result, over 95% of Sa-

faricom sites are able to achieve data speeds of 21 Mbps. It has 1,847 3G-enabled base stations

mostly in the major cities. Furthermore, it upgraded 78% of its transmission network to Internet

Protocol (IP). This will improve the quality of the network, activate certain features and capabili-

ties that would otherwise be unavailable and increase capacity to handle the customer growth.

Following investments over the last 2 years, Safaricom has now modernized 85% of its radio

network. It has also increased the bandwidth of its existing network. By doing this, the company

has expanded data 2G coverage to 91.0% of population coverage and 3G coverage to 61.0% of

population coverage. The company has also invested in back-up power solutions to avoid any

loss of service during grid power interruptions. It also installed 70 hybrid energy systems, solar

and wind energy solutions in areas where grid power is not accessible. Furthermore, the com-

pany invested in new technology (pooling and Wavelength Switched Optical Networks) in FY14

that ensures that any failure of a network element is supported by other network capabilities,

without the customer experiencing any service loss. During the year, the company completed

770km of fibre and began construction of 640km of fibre in Nairobi, Nakuru, Mombasa and Ki-

sumu. Going forward, Safaricom will spend approximately KES 10.5bn to acquire Yu’s infrastruc-

ture and employees. It will spend additional money to modernize and optimise the base sta-

tions. The acquisition will give the company more spectrum to improve voice quality as well as

the ability to roll out faster internet. Despite the fact that Safaricom has modernized and opti-

mized most of its network, we expect similar amounts of capital expenditure over the next 3

years as the company acquires and modernizes Yu’s network.

Dividends are likely to increase as capital expenditure remains flat and debt declines: Capital

expenditure is likely to remain stable over the next couple of years as the company continues to

build network infrastructure organically and through acquisitions. With debt declining to KES

0.6bn after December 2015 and no immediate need for significant amounts of capital, we be-

lieve that the company will be able to pay higher dividends. We forecast that DPS will increase

27.7% y/y to KES 0.60 in FY15, 33.3% y/y in FY16 and 6.3% y/y to KES 0.85 in FY17.

Safaricom will be a major beneficiary of the consolidation of existing industry players: Sa-

faricom and Airtel announced that they would put in a joint bid to acquire Yu’s assets. Sa-

faricom is to acquire Yu’s infrastructure and staff while Airtel was acquire Yu’s subscribers. Fur-

thermore, media reports suggested that Orange could pull out of Kenya. This would likely be

through sale to another multinational which will leave the industry with 3 players. Safaricom’s

independent drive test showed that it had the best data network in Kenya and similar voice

quality as other payers in the market. On quality, it appears that Safaricom is better than its

competitors. Service delivery and customer support are likely to be the key differentiators. The


-

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90


DPS (KES)

DPS (KES)


9

loyalty points system (“Bonga Points”) was revamped allowing customers to use part cash and

points to purchase internet enabled devices. Also, Safaricom has partnered with third party

service providers (like DSTV and Kenya Airways) which allow subscribers with a small cash

amount to redeem loyalty points for services and Safaricom headsets and tablets. These factors

contributed to a reduction in churn rate from 30.5% in FY13 to 19.3% in FY14. Therefore, apart

from the competition on M-PESA from new players using MVNO licences, we believe that Sa-

faricom could be a beneficiary of the industry consolidation.


10

Negatives

Increased competition from MVNOs is expected to slow growth in subscriber numbers and

prevent any significant rise in prices of products and services: In FY14, voice revenue grew

11.6% y/y largely on the back of an 11.1% y/y growth in the number of subscribers. In FY13,

Safaricom lost subscribers after the regulator switched off counterfeit phones and unregistered

SIMs. The return of these lost subscribers helped drive the increase in subscriber numbers. In

FY14, a change in regulation allowed for the formation of Mobile Virtual Network Operators

(MVNOs). Following the change, several companies announced that they would apply to be-

come MVNOs. While these companies are not expected to outperform Safaricom in the tradi-

tional telecommunications products, they are likely to have an upper hand in mobile money

linked services. Companies with existing spare IT capacity may consider setting up MVNOs as

non-core activity to support their existing operations and bring down costs. Equity Bank is

mostly focused on the mobile money aspect of telecommunications. It sees it as a channel to

access its banking products and bring down its operating expenses. Equity Bank’s MVNO will be

supported by the bank’s existing IT infrastructure and will leverage off of the distribution net-

work through its branches and agents. The bank has also negotiated a variable rate with Airtel,

Equity Bank’s host for the MVNO. As a result, Equity Bank’s initial cost of investment and oper-

ating costs will be lower than the conventional telecommunications company. Therefore, as a

non-core business that leverages off of existing infrastructure, Equity Bank will be able to offer

similar services as a telecommunications company at the same rates. Kenya already has the

lowest call rates and mobile termination rates in Africa and any further cut could be detri-

mental to the industry as whole. Increased competition could prevent significant rises in the

prices of telecommunications services.

Data-supported text applications subdue growth in SMS revenues in the long term: As at the

end of FY14, there were 9.5m mobile data subscribers most of whom have access to data-

supported text applications. These applications are downloadable for free and allow subscribers

to send text messages and media files to each other using an internet connection. The text mes-

sages sent using these applications are not limited by the number of characters as SMSes are.

Each SMS costs KES 1.00 while a subscriber with KES 5.00 can access 4.0MB of data which gives

the subscribers an almost an unlimited number of texts on the application. As a result, data

could cannibalise SMS. In order to reduce this cannibalization, Safaricom introduced data bun-

dles which significantly reduce the price per SMS. For KES 5.00 a subscriber can send 20 SMSes.

Furthermore, Safaricom introduced, ‘Chatitude’, a product whereby subscribers access 10MB of

data and 10 on-net SMS at a cost of KES 10. It combines data and SMS in bundles and helps cus-

tomers with smartphones to make the best of both of these services. In the longer term, we

expect data to cannibalise SMS. Also, there could be additional cannibalization on voice from

data applications like Viber, Skype and Wifi calling)


11

Equity Bank’s mobile banking system running on its MVNO license is expected to be a strong

competitor to M-PESA: On 26 May 2014, Equity Bank gave details on its rationale for acquir-

ing MVNO licences. Equity Bank is essentially looking at the mobile phone as a channel to dis-

tribute all of its banking products. There will be no need for a virtual M-PESA account as cus-

tomers will be connected directly to their bank accounts. Using credit pre-scoring, customer will

be able to borrow pre-approved amounts at a maximum of 2.0% per month for 30 days or more

compared to the M-Shwari’s interest rate of 7.5% and credit period of 30 days. Using Equity

Bank, subscribers will be able to make payments from their phones to bank accounts, mer-

chants with POS terminals, PayPal, Google wallet and directly to cardholders of the major card

companies. The charges to access the mobile system will be the lower of 1.0% of the value of

the transaction and KES 25.00; the same using the bank’s agents. This is significantly cheaper

than M-PESA. On the face of it, Equity Bank proposition seems to be attractive compared to M-

PESA and other M-PESA linked products (including M-Shwari) both in terms of product offering

and price. The company had moved to court to block the slim SIMs which Equity Bank custom-

ers will attach to their Safaricom SIM cards. The slim SIMs will automatically convert single SIM

phones into dual SIM. Equity Bank were granted a trial period of 1 year during which the regula-

tor would monitor whether the slim SIM interfered with the working of the normal SIM. As

mentioned above, Safaricom announced new M-PESA tariffs on 20 August 2014. This was likely

to pass on some of the savings generated from the migration of the M-PESA system and bring

pricing to a more sustainable level given the level of competition that is expected and also to

encourage more transactions per user. M-PESA’s EBITDA margin (at 17.0%) is already lower

than the company EBITDA of 42.1%. The price cut will further lower the group’s EBITDA margins

unless the company had been able to generate the requisite cost savings.

The interoperability of M-PESA agents will reduce some of Safaricom’s competitive edge in M

-PESA: Safaricom has 81,025 M-PESA agents across the country as of 31 March 2014. The fact

that M-PESA is available virtually everywhere is part of the reason for its success. Subscribers

can be sure that they will be able to carry out M-PESA deposits and withdrawals virtually any-

where in the country. One of the conditions for acquiring Yu assets was to open up the M-PESA

system to its competitors. By doing this, Safaricom will lose part of its competitive advantage on

M-PESA. The same accessibility of its M-PESA agents will be available to competitor mobile

money transfer systems. While Safaricom still has a competitive advantage in that fact that it

has more innovative products that ride on M-PESA (like M-Shwari, Lipa na M-PESA, M-Benki,

Paybill etc), we feel that in the longer term this advantage will continue to narrow unless inno-

vation on M-PESA continues.


12

Annual Financials

KES bn FY10 FY11 FY12 FY13 FY14 FY15F FY16F FY17F

Income Statement

Voice revenue 64.58 63.50 68.96 77.33 86.30 97.17 109.58 116.37

Messaging revenue 5.19 7.54 7.77 10.15 13.62 16.51 19.54 21.26

Mobile Data revenue 2.89 4.54 5.22 6.62 9.31 12.00 15.15 17.03

Fixed Data revenue 0.08 0.84 1.37 2.11 2.57 3.09 3.69 4.03

M-PESA revenue 7.56 11.78 16.87 21.84 26.56 31.96 37.87 41.22

Service revenue 80.30 88.20 100.19 118.05 138.36 160.74 185.83 199.90

Handset revenue 3.66 6.64 5.94 4.93 4.95 4.95 4.95 5.00

Acquisition and other - - 0.87 1.31 1.36 1.51 1.68 1.86

Total Revenue 83.96 94.84 107.00 124.29 144.67 167.20 192.46 206.76

Direct costs (28.50) (37.24) (43.47) (47.17) (51.96) (60.39) (69.81) (75.12)

Contribution 55.46 57.60 63.53 77.12 92.71 106.80 122.64 131.64

Operating Costs (18.85) (21.87) (26.03) (27.88) (31.77) (36.25) (41.90) (45.08)

EBITDA 36.61 35.73 37.50 49.24 60.94 70.56 80.75 86.56

Depreciation & amortization (13.99) (16.33) (17.35) (22.14) (25.79) (27.11) (27.70) (28.03)

Net financing (costs) (1.64) (1.04) (2.78) (1.65) (0.16) 0.25 0.53 0.69

Taxation (5.82) (5.20) (4.74) (7.91) (11.97) (13.39) (16.64) (18.79)

Net Income 15.16 13.16 12.63 17.54 23.02 30.31 36.93 40.43

EPS (KES) 0.38 0.33 0.32 0.44 0.57 0.76 0.92 0.99

DPS (KES) 0.20 0.20 0.22 0.31 0.47 0.60 0.80 0.85

Balance Sheet

Equity & Minority Interest 62.30 67.45 72.08 80.27 91.24 103.66 118.46 140.67

Borrowings 7.61 12.11 12.10 12.00 5.10 0.62 (0.00) (0.00)

Other liabilities 0.40 0.18 0.10 - - - - -

Net assets 70.30 79.74 84.28 92.27 96.34 104.28 118.46 140.67

Non-current assets 81.55 92.15 100.71 103.50 106.28 108.68 111.21 109.99

Current assets 22.57 21.70 21.19 25.36 28.32 32.88 45.18 71.50

Current liabilities (33.82) (34.12) (37.62) (36.59) (38.26) (37.29) (37.94) (40.83)

Net assets 70.30 79.74 84.28 92.27 96.34 104.27 118.45 140.66

Cash flow statement

Net operating cash flows 24.05 31.00 33.24 39.13 51.13 57.83 67.83 70.26

Net investing cash flows (18.97) (26.85) (25.68) (25.36) (28.85) (29.51) (30.23) (30.13)

Free cash flows 5.07 4.15 7.55 13.77 22.28 28.32 37.60 40.13

Net financing cash flows 1.34 (9.62) (4.01) (7.58) (19.66) (26.33) (29.12) (28.51)

Change in cash 6.41 (5.46) 3.55 6.19 2.62 1.99 8.48 11.62

Cash at the start 4.31 10.72 5.26 8.81 15.00 17.62 19.60 28.08

Cash at the end 10.72 5.26 8.81 15.00 17.62 19.60 28.08 39.70

(Source: Company, Kestrel Capital Research)


13

Semi Annual Financials

1H14 2H14 1H15F 2H15F 1H16F 2H16F 1H17F 2H17F

Income Statement

Voice revenue 41.92 44.38 47.13 50.05 53.15 56.44 59.93 63.64

Messaging revenue 6.35 7.27 7.91 8.6 9.36 10.18 11.07 12.05

Mobile Data revenue 4.25 5.06 5.65 6.35 7.14 8.02 9.01 10.12

Fixed Data revenue 1.22 1.35 1.48 1.61 1.76 1.93 2.11 2.3

M-PESA revenue 12.5 14.06 15.3 16.66 18.13 19.74 21.48 23.38

Service revenue 66.24 72.12 77.47 83.27 89.53 96.3 103.6 111.5

Handset revenue 2.22 2.73 2.83 2.93 3.04 3.15 3.26 3.38

Acquisition and other 0.74 0.62 0.74 0.89 1.06 1.27 1.54 1.87

Total Revenue 69.2 75.47 81.04 87.09 93.63 100.72 108.4 116.74

Direct costs (24.85) (27.11) (29.11) (31.28) (33.63) (36.18) (38.94) (41.94)

Contribution 44.35 48.36 51.93 55.81 60 64.54 69.46 74.81

Operating Costs (15.5) (16.27) (17.47) (18.78) (20.19) (21.71) (23.37) (25.17)

EBITDA 28.85 32.09 34.46 37.03 39.81 42.82 46.09 49.64

Depreciation & amortization (12.7) (13.09) (13.6) (13.51) (13.9) (13.8) (14.23) (14.07)

Net financing (costs) (0.24) 0.08 0.05 0.2 0.16 0.37 0.32 0.57

Taxation (4.65) (7.32) (6.27) (7.11) (7.82) (8.82) (9.98) (11.57)

Net Income 11.26 11.76 14.64 16.6 18.25 20.57 22.21 24.58

EPS 0.28 0.29 0.37 0.41 0.46 0.51 0.55 0.61

DPS - 0.47 - 0.6 - 0.8 - -

Balance Sheet

Equity & Minority Interest 79.25 91.24 105.88 103.66 121.91 118.46 140.67 133.22

Borrowings 12 5.1 5.1 0.62 0 0 0 0

Other liabilities - - - - - - - -

Net assets 91.25 96.34 110.98 104.28 121.91 118.46 140.67 133.22

Non-current assets 102.33 106.28 105.65 108.68 107.89 111.21 109.99 113.43

Current assets 33.81 28.32 43.36 32.88 53.77 45.18 71.5 63.75

Current liabilities (44.89) (38.26) (38.04) (37.29) (39.76) (37.94) (40.83) (43.97)

Net assets 91.25 96.34 110.97 104.27 121.9 118.45 140.66 133.21

Cash flow statement

Net operating cash flows 24.25 26.88 27.22 31.53 33.69 36.04 38.23 40.61

Net investing cash flows (10.51) (18.34) (12.97) (16.55) (13.11) (17.12) (13.01) (17.51)

Free cash flows 13.74 8.54 14.26 14.99 20.58 18.92 25.23 23.09

Net financing cash flows (8.23) (11.43) 0 (26.33) (0.62) (28.51) - (32.03)

Change in cash 5.51 -2.89 14.25 -11.34 19.96 -9.59 25.23 -8.93

Cash at the start 15 20.51 17.62 31.87 20.53 40.49 30.9 56.13

Cash at the end 20.51 17.62 31.87 20.53 40.49 30.9 56.13 47.2



14

Financial Ratios

FY10 FY11 FY12 FY13 FY14 FY15E FY16F FY17F

Profitability Ratios

Contribution margin 66.1 60.7 59.4 62.0 64.1 63.9 63.7 63.7

EBITDA margin 43.6 37.7 35.0 39.6 42.1 42.2 42.0 41.9

Operating margin 26.9 20.5 18.8 21.8 24.3 26.0 27.6 28.3

Pre-tax margin 25.0 19.4 16.2 20.5 24.2 26.1 27.8 28.6

PAT margin 18.1 13.9 11.8 14.1 15.9 18.1 19.2 19.6

Return on investment

Operating ROA 17.8 17.1 21.6 26.7 31.5 35.6 34.6

ROaA 12.1 10.7 14.0 17.5 22.0 24.8 23.9

ROCE 25.9 24.6 30.7 37.3 43.3 47.6 45.2

ROaE 20.3 18.1 23.0 26.8 31.1 33.3 31.2

Activity Ratios

Inventory Turnover 8.5 10.2 19.3 20.1 19.0 19.0 18.4

Receivables Turnover 9.7 10.5 13.9 18.2 20.0 20.0 19.3

Payables Turnover 1.4 1.3 1.6 1.8 1.9 2.0 1.9

Working capital turnover (8.0) (7.4) (9.0) (13.7) (23.3) 136.0 10.9

Fixed asset Turnover 1.1 1.1 1.2 1.4 1.6 1.8 1.9

Total asset Turnover 0.9 0.9 1.0 1.1 1.2 1.3 1.2

Liquidity Ratios

Current Ratio 0.7 0.6 0.6 0.7 0.7 0.9 1.2 1.8

Quick Ratio 0.6 0.5 0.5 0.6 0.7 0.8 1.1 1.6

Cash Ratio 0.3 0.2 0.2 0.4 0.5 0.6 0.8 1.4

Solvency Ratio

Net Debt/Assets 5.7 8.7 8.4 4.1 (3.7) (10.9) (19.8) (30.9)

Net Debt/Capital 8.5 12.4 12.2 5.7 (5.2) (14.8) (26.1) (39.9)

Net Debt/Equity 9.6 14.6 14.3 6.5 (5.5) (14.9) (26.1) (39.9)

Financial Leverage 1.7 1.7 1.7 1.6 1.5 1.4 1.3 1.3

Interest coverage 13.8 18.7 7.2 16.4 219.7 (174.8) (100.7) (85.4)

Net Debt/EBITDA 0.2 0.3 0.3 0.1 (0.1) (0.2) (0.4) (0.6)



15

Valuation

EV/EBITDA Method FY15

EBITDA 70.56

EV/EBITDA 8.00

EV 564.47

less net debt 5.00

Equity 569.48

No of shares 40.04

Price 14.22

P/E Method FY15

EPS 0.76

P/E 19.0

Price 14.38

FCFE Method

Risk free rate 11%

Beta 1.0

Risk premium 6%

Cost of equity 17%

Exit P/FCFE 9.0

FY15 FY16 FY17F Post FY17F

Free cash flows 28.32 37.60 40.13

plus Net borrowings 10.42 15.47 25.23

FCFE 38.74 53.08 65.35 588.18

Time - 1.00 2.00 2.00

Discounted FCFE 38.74 45.36 47.74 429.68

Total Discounted FCFE 561.52

No of shares 40.04

Price 14.03

Blended Value

EV/EBITDA Method 14.22

P/E Method 14.38

FCFE Method 14.03

Fair Value Price 14.21

Current Price 13.15

Upside 8.07


16

Peer Comparison

Country P/E P/B Dividend Yield EV/EBITDA

SAFARICOM Kenya 17.4 5.1 4.6 7.2

AIRTEL ZAMBIA Zambia 11.2 2.9 2.9 n/a

ECONET WIRELESS Zimbabwe 9.9 2.1 0.0 3.9

MTN GROUP South Africa 16.9 3.9 4.5 6.9

VODACOM GROUP South Africa 14.5 8.3 6.4 7.3

STARCOMMS Nigeria n/a 0.6 0 n/a

(Source: Bloomberg)

Safaricom Global Median Global Mean Regional Median Regional Mean

P/E 17.40 20.00 31.30 11.80 14.00

P/B 5.10 3.00 6.50 2.80 3.30

Dividend Yield 4.60 1.90 12.70 3.30 2.90

EV/EBITDA 7.20 6.80 2.40 6.30 11.10



17

FY14 Results

Safaricom released its FY14 results recording growth in EPS of 30.1% y/y to KES 0.57. The rise in profits was driven by strong growth in both voice (+11.6% y/y) and non-voice revenue (+27.8% y/y) as well as improvements in cost efficiency (EBITDA margin: +255bps to 42.1%). The growth in non-voice revenue was driven by mobile data (+40.6% y/y) and SMS (34.2% y/y). As a result of higher revenues and better cost efficiency, EBITDA grew 23.8% y/y. The higher EBITDA, a rel-atively subdued increase in capital expenditure and less debt meant more cash was available to pay dividends. DPS increased 51.7% y/y to KES 0.47. The results were largely in line with our expectations. Below are key highlights of the results:

KES bn FY14 FY13 FY14E y/y % ch % var

Income Statement

Voice revenue 86.30 77.33 87.10 11.6 (0.9)

Messaging revenue 13.62 10.15 15.06 34.2 (9.6)

Mobile Data revenue 9.31 6.62 9.00 40.6 3.4

Fixed Data revenue 2.57 2.11 2.55 21.8 0.7

M-PESA revenue 26.56 21.84 26.36 21.6 0.7

Service revenue 138.36 118.05 140.08 17.2 (1.2)

Handset revenue 4.95 4.93 4.93 0.4 0.4

Acquisition and other 1.36 1.31 1.47 3.8 (7.7)

Total Revenue 144.67 124.29 146.48 16.4 (1.2)

Direct costs (51.96) (47.17) (52.22) 10.2 (0.5)

Contribution 92.71 77.12 94.26 20.2 (1.6)

Operating Costs (31.77) (27.88) (32.76) 14.0 (3.0)

EBITDA 60.94 49.24 61.50 23.8 (0.9)

Depreciation & amortisation (25.79) (22.14) (27.03) 16.5 (4.6)

Net financing income/ (costs) (0.16) (1.65) 0.61 (90.3) (126.2)

Taxation (11.97) (7.91) (10.34) 51.3 15.8

Net Income 23.02 17.54 24.74 31.2 (7.0)

EPS 0.57 0.44 0.62 30.1 (7.8)

DPS 0.47 0.31 0.45 51.7 4.4

Balance Sheet

Equity & Minority Interest 91.24 80.27 80.13 13.9 13.9

Borrowings 5.10 12.00 4.50 13.3 13.3

Net assets 96.34 92.27 84.63 13.8 13.8

Non-current assets 106.28 103.50 104.96 1.3 1.3

Current assets 28.32 25.36 15.94 77.7 77.7

Current liabilities (38.26) (36.59) (36.27) 5.5 5.5

Net assets 96.34 92.27 84.63 13.8 13.8


18

Cash flow statement

Net operating cash flows 50.47 39.39 47.95 28.1 5.3

Net investing cash flows (27.78) (24.88) (27.47) 11.7 1.1

Free cash flows 22.69 14.51 20.48 56.4 10.8

Net financing cash flows (20.07) (8.32) (20.63) 141.2 (2.7)

Change in cash 2.62 6.19 (0.15) (57.6) (1,862.2)

Cash at the start 15.00 8.81 15.00

Cash at the end 17.62 15.00 14.85

Total Customers 21.57 19.42 22.07 11.1 (2.3)

M-PESA Customers 19.34 17.11 19.44 13.0 (0.5)

Mobile Data Customers 9.56 7.13 9.03 34.1 5.9

Fixed Data Customers 0.01 0.01 0.01 4.3 (4.4)

Voice ARPUs 333 333 329 0.0 1.4

SMS ARPUs 53 43 57 21.1 (7.5)

M-PESA ARPUs 114 106 113 7.6 1.3

Mobile Data ARPUs 81 74 83 10.0 (2.3)

Fixed Data ARPUs 30,508 26,123 28,947 16.8 5.4

Service ARPU 535 507 529 5.5 1.1

Contribution margin 64.08 62.05 64.35 2.04 (0.27)

EBITDA margin 42.12 39.62 41.98 2.51 0.14

Net profit margins 15.91 14.11 16.89 1.80 (0.98)

ROE 25.23 21.85 30.88 3.38 (5.65)


Key Highlights:

The growth in voice revenue (11.6% y/y) was driven by 11.1% y/y growth in subscrib-

ers: The 11.6% y/y growth in voice revenue was largely driven by an 11.1% y/y increase in

subscribers. While the number of industry subscriptions increased 1.9% y/y and mobile

penetration remained unchanged at 76.9%, Safaricom was able to increase its subscriber

market share from 66.7% to 67.9% due to a decline in the churn rate and acquisition of

subscribers from some of its competitors. The subscriber churn rate declined from 30.5% to

19.3%. Even more importantly, Safaricom currently has 78.2% of the industry voice minutes

and its higher prices relative to its competitors (KES 4.00 while most of competitors are at

around KES 3.60) mean that its revenue market share is even higher. Also impressive was

the fact that Safaricom managed to keep its voice ARPUs stable at KES 333 despite the

13.9% decline in mobile termination rates (MTRs) to KES 0.99 which took effect on 1 July

2013. The slight decline in effective yield was made up for by a 3.0% increase in usage.


19

With no further cuts in MTRs expected going forward, we believe organic growth in

minutes of use will drive growth in voice ARPUs. Following the news that both Essar Yu and

Telkom Kenya could exit the margin (probably replaced by one new player), we believe

there’s room for more subscriber growth for Safaricom.

SMS revenues increased 34.2% y/y driven by a 129% rise in usage due to the Bonyeza

Ushinde promotion and a cut in SMS prices (-64%): Safaricom cut prices on its SMS by

64.0% and as a result managed to record a 66% increase in revenues from SMS bundles.

This along with the successful Bonyeza Ushinde helped drive SMS usage up 129 % y/y. The

11.1% y/y increase in subscriber numbers also contributed to some of the growth. As a

result of the increase in SMS usage, Safaircom’s SMS market share increased to 95.8%. The

Bonyeza Ushinde promotion appears to have a sticky effect on volumes which remain high

even after the promotion period comes to an end. We expect the company to keep running

the promotion to drive SMS volumes. As long as mobile data applications continue to can-

nibalize SMS, there will continue to be room to cut SMS prices to encourage use.

The increase in mobile data customers (+34.1% y/y) and usage (+16.1% y/y) drove the

40.6% y/y growth in mobile data revenues: As at the start of FY14, Safaricom was the

largest mobile data provider with 74.4% of all mobile data subscriptions. Despite this, it

was able to grow its active mobile data subscriptions in FY14 by 34.1% y/y. Mobile data

usage also managed to grow 16.1%. The growth in subscribers and increase in usage was

supported by 14.4% cut in the average price per MB. Country wide, internet penetration is

still relatively low at 52.3%. Safaricom has 44% of its customer base connected onto its mo-

bile data network, there is still room to keep growing subscribers. With improved coverage

(91.0% of the population is covered by 2G and 61.0% of the population is covered by 3G)

and increased data infrastructure (an 8.1% y/y increase in 2G sites of which 59.0% are 3G

enabled), it makes sense to take advantage of operating leverage by cutting prices to grow

revenues.

M-PESA revenues rose 21.6% y/y on increased active subscribers (15.4% y/y) and higher

average transaction value: The rise in M-PESA revenues (+21.6% y/y) was largely due to

increased subscribers. Total M-PESA subscribers grew 13.0% y/y while the number of 30-

day active subscribers was up 15.4%. To support this increase in subscribers the number of

M-PESA agents increased 23.6% to 81,025. The number of transactions per user, however,

remained relatively unchanged. Safaricom’s M-PESA tariffs differ by the value of transac-

tions. During the period, the monthly value of person-to-business and business-to -person

transactions grew 73% and 70% respectively while person-to-person transactions grew

16.0%. The effect may have been higher fees generated per transaction per user. During

the year, Safaricom acquired 122,000 merchants for its M-PESA linked payment processing

system, Lipa Na M-PESA, but only 24,137 were active as at the end of the year. Lipa Na M-

PESA continues to have a lot of potential and promotions should help encourage usage.


20

EBITDA margin rises 251bps to 42.1%: Direct costs increased 10.2% y/y while operating

costs were up 14.0% y/y. These increases were much slower than the 16.4% y/y growth in

total revenue. The result was a 204bps improvement in contribution margin to 64.1% and

251bps increase in EBITDA margin to 42.1%. The slow rise in direct costs was due to lower

interconnect costs following the cut in MTRs and also due to savings generated from in-

creasing the number of airtime top-ups that are carried out on M-PESA to 34.0% of total

top-ups. This saves dealer fees, card manufacture costs and the logistics of their distribu-

tion. On operating costs, the company realized savings in transmission costs , network and

IT operating costs. Going forward, we expect margins to keep increasing due to operating

leverage as revenue grows faster than costs.

Free cash flows rise 56.4% y/y on higher EBITDA (+23.4% y/y) and comparatively slower

increase in capital expenditure (11.7% y/y) : Following the 23.4% y/y increase in EBITDA

and comparatively slower rise in capital expenditure (+11.7% y/y), free cash flows rose

56.4% y/y to KES 22.7bn. The company expects to keep capital expenditure stable at ap-

proximately KES 27bn – KES 28 bn. With EBITDA continuing to grow fast, we expect free

cash flow to continue rising strongly. The company has provided guidance of free cash

flows of 25.0bn to 26.5bn.

Dividends rise 51.7% y/y due to higher free cash flows (+56.4% y/y) and less debt: With

the cash generated from operations and working capital savings, the company paid back

the first tranche of its corporate bond which amounted to KES 6.9bn. The next tranche is

due for payment in 2H15. With cash balances of KES 17.6bn and total debt of KES 12.6bn,

the company now has negative net debt. It paid net finance costs of KES 160 million in FY14

and we expect it earn net finance income in FY15. As a result, we believe dividends will

continue to grow faster that net income.


21

Recommendation guide

STRONG BUY: Highly undervalued/ strong fundamentals

BUY: Good value/ strong fundamentals

ACCUMULATE: Buy on price dips

HOLD: Correctly valued with little pricing upside or downside

LIGHTEN: Overvalued by the market/ Reduce exposure/Declining fundamentals/

industry concerns

SELL: Weak fundamentals and challenging operating environment/Highly

overpriced

Disclaimer Note: Readers should be aware that Kestrel Capital (EA) Ltd does and seeks to do business with companies covered in its research

reports. Consequently, a conflict of interest may arise that could affect the objectivity of this report. This document should only be

considered a single factor used by investors in making their investment decisions. The reader should independently evaluate the

investment risks and is solely responsible for their investment decisions.

The opinions and information portrayed in this report may change without prior notice to investors. This publication may not be distrib-

uted to the public media or quoted or used by the public media without prior and express written consent of Kestrel Capital (EA) Ltd.

Directors, staff of Kestrel Capital (EA) Ltd and their family members, may from time to time hold shares in the company it recommends

to either buy or sell and as such the investor should determine for themselves the applicability of this recommendation.

This document does not constitute an offer, or the solicitation of an offer, for the sale or purchase of any security. Whilst every care

has been taken in preparing this document, no representation, warranty or undertaking (express or implied) is given and no responsi-

bility or liability is accepted by Kestrel Capital or any employee of Kestrel Capital as to the accuracy of the information contained and

opinions expressed herein.

kestrel capital september 2014 · september 2014 safaricom ltd ... duced higher loan bands of kes...

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