In late 2015, when pre paid technology specialist Blue Label Telecoms proposed a strategic re capitalisation of SA’s third-largest cellular services provider, Cell C, the market’s initial reaction was to place an investment call on hold.
Some initial trepidation in the market was probably justified. The proposed recapitalisation — first mooted as a R4bn capital injection in exchange for a 35% stake in Cell C — was a big step for Blue Label, which has over the years built a compelling cash-generative business model by successfully managing a high volume-low margin operation in the prepaid services niche.
Cell C, by all accounts, was straining under an excessive debt load. Though financial information has not been readily available, anecdotal evidence (which has not been disputed) suggested Cell C was dangerously debt laden and that its Saudi-based controlling shareholder Oger Telecom had little enthusiasm to pump more capital into the business.
But the scoreboard will show that Blue Label’s share price has more than doubled since the December 10 2015 cautionary on negotiations with Cell C was issued. Though the transaction seemed to have been put on hold for a prolonged period, Blue Label’s share price has surged 40% in the past three months as the Cell C transaction started looking like a done deal.
Cynics might question the froth of sentiment for Blue Label, and there have already been questions about whether sufficient operational leverage can be extracted from what is essentially a mobile services provider that is dwarfed by market leaders Vodacom and MTN.
Certainly Blue Label has put its money where its mouth is by pitching for a markedly larger 45% stake in Cell C at a cost of R5.5bn. Blue Label’s appetite for more of Cell C will spur speculation that the cellular services provider — carrying an implied value of around R12.5bn — is finding profitable traction.
Over and above that hefty commitment is the unexpected participation of payment solutions technology company Net1 UEPS in the Cell C transaction. Net1 will garner a roughly 15% stake in Blue Label by subscribing for shares worth about R2.5bn.
Some context is needed. Blue Label, which carries a market value of just over R14bn, is making an investment that is nearly 40% of its market capitalisation. Net1 — which, broadly speaking, might be construed a competitor to Blue Label — is making an investment that represents more than a third of its market capitalisation.
To put it bluntly, it’s safe to presume there is a high level of conviction from two of the JSE’s most successful technology companies that Cell C is going to ring up resounding returns.
Cell C’s exact financial status will become clear only around October 20, when the deal circular is published.
Blue Label joint CEO Brett Levy confirms there will be a comprehensive financial review of Cell C’s financial position in the circular. But he argues that the financial history of Cell C is less critical to assess than the effort to emancipate the company from its legacy debt.
Levy tells the Financial Mail that Cell C is "very profitable" on an Ebitda (earnings before interest, tax, depreciation and amortisation) basis — which is perhaps not entirely surprising, since the company’s new management team has claimed growth in the subscriber base from 9m to over 25m in the past four years.
Levy also dropped an intriguing throwaway line at last week’s investor conference call when he suggested investors might be "pleasantly surprised" when perusing Cell C’s latest financial statements. At the conference Levy also addressed overriding worries that Blue Label’s influential stake in Cell C could rub MTN and Vodacom up the wrong way.
AlphaWealth portfolio manager Keith McLachlan, a shareholder in Blue Label, is not overly concerned. "It’s binary ... either MTN and Vodacom are skittish or they are not."
The sense, though, is that existing arrangements between Blue Label and the two largest mobile operators won’t be disrupted. Levy is adamant that it’s business as usual with Vodacom and MTN. "Blue Label remains a neutral aggregator of all cellular services products, but we have an anchor tenant in Cell C."
Cell C, it seems, will continue to operate in its niche and not challenge the broad offering of Vodacom and MTN head-on. Levy says: "It’s good for Cell C not to be everything to everyone. Cell C will remain a specific offering to a niche market. There is definitely room for the company in SA."
Levy says the Cell C deal is essentially a defensive transaction, allowing Blue Label to acquire a revenue stream for the future. Just how compelling that revenue stream is will become more apparent when the circular’s financial details of Cell C can be unpacked.
Meanwhile, the Net1 transaction — naturally somewhat overshadowed by the Cell C transaction — is worth delving into.
Levy stresses that Net1 never came into the larger Cell C deal frame as the "money man", and that negotiations were taking place separately. "Net1 is a strategic investor, a great value-add partner with whom we can add synergies."
Levy points out that though there is some services and product crossover between Blue Label and Cell C there are many more synergies that can be unlocked from the companies’ services offerings. "This is a powerful tie-up that we think will be fruitful in the future."
The companies’ respective offshore points of presence share some commonality too, with India perhaps the most intriguing.
The big question is whether the "powerful tie-up" will ultimately materialise more concretely as a full-blown merger between Blue Label and Net1.
This seems unlikely in the short term, as potential synergies between the two companies are sifted through. But an engaging financial performance from Cell C in the next few years certainly won’t mute mutual enthusiasm for a merger.