Description

Blu Label Telecoms (BLU.SJ) trades on a 1.4 times EV/EBITDA ratio despite sailing through the Covid19 havoc. The core “prepaid” operation is an asset light cash cow which we feel should conservatively trade on a 4 times EV/EBITDA multiple offering investors a return in excess of 250%.

In addition to its “prepaid” operation, BLU owns 45% of CellC which it bought for ZAR5.5bil in 2017. BLU has written this investment down to zero. CellC is currently in the final stages of a restructure and there is a strong possibility that BLU could recover some of it's investment. This could add significantly to the 250% upside.

Revenue Streams

BLU operates a point-of-sale network with over 150 000 points of presence. The wide distribution network is used to sell virtual prepaid products such as pre-paid airtime/data for cell phones and prepaid electricity. Most (70%) of BLU’s income is generated by merchants operating in the informal market. Formal retailers and banks also sell Blu’s products.

The table below shows the gross sales from these devices for the 6 months ended November 2019.

Airtime

BLU started selling airtime in 2001. BLU buys airtime in bulk from the four mobile networks (Vodacom, MTN, CellC, Telkom). It sells the airtime to merchants who then sell it to the end customer.

Typically, the merchant will deposit money into a BLU bank account on a daily basis. Following the receipt of the deposit the merchants terminal is credited with airtime which he sells down during the day.

The margin between the bulk price and selling price is shared between the merchant and BLU. BLU’s airtime is also sold by banking apps. BLU earns a commission on these sales.

In South Africa, airtime is sold on a prepaid (ZAR54bil pa) and postpaid (ZAR37bil) basis. Prepaid airtime is generally used by people who do not have the means or desire to commit to long term contracts with the mobile operators. Essentially customers prepay for airtime which they use until it runs out.

The table above shows that BLU sold airtime valued at ZAR17bil over six months. This represents 60% of the total prepaid market illustrating the vast power of BLU’s network. It is important to note that many of the purchases are for micro amounts which would be too costly to collect without BLU’s network. Not only is it useful to the Mobile operators, it also benefits the merchant as it drives traffic to the store.

Electricity

Due to problems collecting electric bills, South African households are increasingly being sold electricity on a prepaid basis. This involves buying a virtual voucher from a merchant and punching the code into an electric meter installed in the home.

Annualizing the electricity sales in the table above indicates that electricity sales are currently running at ZAR23bil per annum. Electricity sales have doubled since 2015 and commissions earned by BLU have increased from ZAR165mil to ZAR278mil.

Adding electricity sales to the terminal allowed BLU to diversify it’s product range and to reduce it’s dependence on the mobile operators.

Other Revenue Streams

I am not going to discuss these as they are small. Obviously, the business plan is to sell more and more tokens over the network. The sale of tickets and sports betting are two new initiatives.

Covid19

The main reason I find BLU attractive is that I get to buy these defensive income streams for very little. Indications are that the main revenue streams have been very resilient despite Covid. In fact, BLU may have benefited from Covid as airtime/data traffic spiked during the lock-down as more people worked remotely.

Income Statement

In this section I will project a sustainable income statement following the restructuring of BLU.

BLU is being restructured following the hard lessons learnt from wasting ZAR5.5bil buying 45% of CellC in 2017. CellC is the third largest mobile operator in South Africa with roughly 12% market share.

Incredibly, the investment in CellC was written down to zero by May 2019. Asset sales were triggered by nervous bankers and a stretched balance sheet. The summarized income statement below is representative of a trimmed down BLU as the humbled management team return BLU to it’s core operations.

The current share price is ZAR2.50 which implies a PE of 3.3.

While I think the EBITDA of ZAR1 500mil is sustainable it probably needs a ZAR150mil haircut for Covid.

·         A large clothing retailer (Edgars) has gone into business rescue. Edgars owes BLU ZAR100mil for cellphones and airtime. While some of this is recoverable, I will be prudent and write-off the entire amount.

·         BLU’s financial year ends in May2020. South Africa has been in lock-down since March during which no ticket or gaming revenue was earned. I take this into account by knocking ZAR50mil off EBITDA.

Valuation

The enterprise value is ZAR1 926mil on a sustainable EBITDA ZAR1 500mil and a trimmed EBITDA of ZAR1 350mil.

Notes

·         The proceeds on disposals have been collected and will be reflected in the full year results ended May 2020.

·         The book of ZAR1 775mil is in run-down model. The expectation is to collect R600mil by May2020, R600mil by Nov2020 and R500mil by May2021. The book represents cell phones sold by CellC to it’s postpaid customers. The book will run-down as CellC collects the monthly installments from it’s postpaid customers. Collecting the book has historically been easy as customers are incentivized to pay in order to avoid the suspension of their mobile service.

Asset Light Cash Generative Business Model

I thought I it would be worthwhile spending time on the cash flows as they highlight important characteristics of the business. (The cash flow below is for the 6 months ended Nov2019 and is representative of the trimmed down operations).

The business generates lots of cash and does not have a large capex bill. The only area that needs to be managed is the working capital. Money has been flowing into working capital as BLU has bought ZAR1 000mil airtime from CellC in an attempt to support the distressed mobile operator. Under normal circumstances this airtime stock is very liquid as CellC sell ZAR600mil airtime per month. However, there are risks that the balance could be lost if CellC had to file for bankruptcy.

As I discuss further down, CellC is in the final stages of a restructure which should see the injection of fresh capital. If this goes to plan, then the drain on BLU’s cash flow will be eliminated.

Without the need to prop-up CellC, BLU becomes an asset light business capable of paying a substantial dividend. Before CellC, BLU was a good dividend payer and based on today’s cash flows a dividend between ZAR200mil to ZAR300mil per annum is certainly possible.

CellC Restructure and Upside

BLU bought 45% of CellC for ZAR5.5bil in 2017. By May 2019, the investment had been written down to zero.

CellC is the third largest mobile operator in South Africa with 12mil customers (Vodacom = 41mil, MTN = 30mil). It was a late entrant who struggled to compete given it’s debt and the endless capex demands of a mobile network.

The CellC restructuring involved two stages

·         Stage1: The sale of its network to MTN in return for an agreement to roam on the MTN network. This stage has been completed, transforming CellC into an asset light operator with no need to spend on capex.

·         Stage2: CellC has ZAR8bil of expensive debt which it can’t support. An announcement is expected by the end of June on the injection of new capital partners and the restructuring of the balance sheet.

Details of the restructuring have been kept incredibly quiet and one can only speculate on the final outcome. The bull’s expect BLU to be diluted to 15% on equity valued at ZAR20bil. If this holds BLU will have to write up its investment by ZAR3 000mil.

A more conservative view notes that CellC was valued at ZAR12 200mil when BLU bought 45% for ZAR5 500mil. Assuming a dilution to 15%, then BLU’s will recover ZAR1 800mil of it’s original investment.

I don’t want to waste too much time speculating on the value of CellC as no information has been given to the market. Negotiations have continued for a year and encouragingly were not terminated following Covid. Last week the competition commission approved elements of the restructuring and a final announcement with all the details is expected next month.

It is worth mentioning that BLU traded at ZAR20 before the CellC acquisition and at ZAR12 in May 2019 when BLU wrote-off the investment in CellC. The move from ZAR12 to ZAR2 was driven by concerns that CellC would go bankrupt. The airtime balance discussed above was at risk as well as the book which is now in run down. Also, CellC makes up 25% of BLU’s profit which may have been lost.

Hopefully, these concerns are in the past opening up a path for BLU's share price to recover. There are early signs that CellC's switch to an asset light roaming operator is working and the injection of new capital appears to be imminent.

Target Price and Conclusion

BLU is expected to make ZAR1 500mil in EBITDA on a sustainable basis. Even though BLU is asset light, I initially assume a multiple of 4 until the management are forgiven for the CellC misstep. This implies an EV and equity value of ZAR6 000mil (no debt) or ZAR6.60 a share versus the current share price of ZAR2.50.

If the bull case plays out for a restructured CellC, the valuation jumps by ZAR3 to ZAR9.60 a share.

Catalyst

- The restructuring of CellC. Announcement expected in June 2020

- Return to the core operations, restored confidence and multiple expansion