Cell C is set to use the proposed drop in interconnect rates to grow its base; causing a shakeup in the sector as MTN and Vodacom will be forced to reinvent their offerings.
The Independent Communications Authority of SA (ICASA) on Friday proposed that mobile termination rates drop to 10c by 2016. While the drop will cut into operators' termination revenue, the biggest shift for cellular companies will come from the benefit Cell C will receive.
ICASA's proposed rates cut the current charge by 50% - to 20c - next year before falling to 10c in 2016. However, as it has included asymmetry, the proposal is skewed in favour of the smaller players with less than 20% of the market - Telkom Mobile and Cell C.
Asymmetrical rates will drop in yearly increments to eventually get to 10c in 2019. Asymmetry means Vodacom and MTN will pay more to connect calls to Telkom Mobile and Cell C than the smaller networks pay to connect to the duopoly.
As a result, Cell C and Telkom Mobile will see a cash flow benefit.
Competitive advantage
Cell C was behind the most recent price war after it slashed costs to 99c a minute on per second billing. CEO Alan Knott-Craig says it will pass on savings from the cut to grow its base, which will be done in conjunction with improving network coverage.
The third mobile operator's target is to build an additional 319 sites nationally by the end of 2013. The step-up in coverage came after its parent company, Ogar Telecom, pumped $350 million into the operator, most of which will go into its network.
The proposed cuts are the first step in "normalising" the local telecoms space, says Knott-Craig. "There is much more to come, and the competition is going to be fierce. Cell C needs more market share, and we will only gain that through aggressive pricing and good network quality."
Knott-Craig says trimming mobile termination rates will bring down its biggest input cost. It will directly affect pricing, he adds. "Asymmetry gives smaller players the ability to compete on a financially-sustainable basis."
Cell C has long pushed for asymmetrical rates, and future funding from its parent company is dependent on the regulatory environment becoming more competitive and investor-friendly.
Knott-Craig says it is encouraging that ICASA was working quickly, "favouring neither friend nor foe". He notes that in cent terms, the cut is less than what he had hoped for, but ICASA has been "smart" in providing asymmetry over a longer period with a relatively gentle glide path.
"While my first instinct is to challenge ICASA, they have had to tread a fine line between under-reacting and over-reacting, and they have cleverly done what they needed to do to make it possible for the telecommunications market in South Africa to gain a semblance of normality."
Yet, not all the players are happy about the win that could be handed to Cell C. Vodacom CEO Shameel Joosub argues against asymmetry, saying the proposal effectively means Vodacom - and its customers - will be subsidising its competitors.
Take the gap
Irnest Kaplan, MD of Equity Analysts, says the proposed cuts are almost like ICASA is saying: "Here's your chance, take it and go for it."
Kaplan explains the mooted rates give Cell C a gap to grow its subscriber base as it can pass the benefit along to consumers in the form of lower call charges. Cell C sparked the most recent price war when it launched a 99c a minute tariff.
MTN and Vodacom will have to react, either by cutting their charges, or reinventing offerings to add more value, says Kaplan. While the lower rates will put pressure on margins and eat into revenue, the leg-up ICASA is proposing to give Cell C will have the biggest impact, he says.
Telecoms and market analyst at Africa Analysis, Dobek Pater, says the proposed glide path will assist Cell C and Telkom Mobile with cash flow, but he is not sure it will help Cell C in terms of either net or operating profitability.
"Asymmetry is designed to protect, to a degree, new (small) mobile operators from the larger operators in terms of outflow of cash, and allow them to use that time to become competitive and stand on their own two feet."
Pater says Cell C's success will hinge on its strategy and approach to the market. Cell C has around 17% of the local market and is targeting 20% of the total market.
As ICASA has proposed a five-year tie-up even if the 20% stake is breached - which provides for certainty - Cell C has been given a hand up, explains Kaplan. He expects the "cheeky and aggressive" operator to use the proposed changes to come out with fantastic deals.
As a result, MTN and Vodacom will be forced to react, and if they cut costs, this will affect their top line to the tune of billions, says Kaplan. He adds the big two may have to reinvent their offerings and offer more value-add to end-users, leading to a shakeup in the sector.
The market has already moved on the news, with stock in both MTN and Vodacom closing lower the day after the announcement. Vodacom, expected to be hardest hit, lost 6.26%, while MTN lost 3.06%.
Margin pressure
Kaplan notes the mooted amendments would have a net negative effect on interconnect revenue for SA's two largest cellular operators in the short-term. Vodacom earns less than 10% of its local revenue from mobile termination and, although it is not stripped out, MTN's percentage would be similar, or a bit lower.
Pater explains Vodacom and MTN will see lower revenues from mobile termination rates and will have to replace that income from elsewhere. However, lower MTRs do not automatically mean profitability will be negatively impacted, he adds.
Sasha Naryshkine, an analyst with Vestact, says operators will seek to protect margins by cutting costs and giving away fewer freebees. He says the telcos will shuffle their strategy to compensate, and will carry on pulling costs out.
Interconnect initially came about as a way of helping out operators that were pumping billions into the ground in the form of infrastructure, says Naryshkine. He says it was a mechanism that allowed them to recoup some of their spend.
Naryshkine notes the growth in data will more than offset any interconnect losses. While data is at lower margins, it is growing fast, he adds. "The mobile companies are much more nimble and will continue to offer what the consumer wants."
MTN is still studying the proposals.
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