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Digging into MTN’s R408m Afrihost deal

More questions than answers.

It’s fair to say that MTN’s purchase of internet service provider Afrihost in late 2014 caught most of the industry by surprise. Not because MTN paid over R400 million for half of the business (which no one knew at the time), but because this meant MTN suddenly owned a consumer ISP.

Now, ISPs – especially consumer-facing ones – are tough businesses. Sure, there’s annuity income and (very) predictable cash flow, but margins on many broadband products aren’t exactly large. This is a volume game.

It’s worth noting that larger rival Vodacom exited the consumer ISP space in 2004 (it owned World Online for a period). After the disposal of the unit to Tiscali, the Italian firm then disposed of the base to MWEB. Even Internet Solutions’ purchase of most of MWEB last year excluded the consumer ISP unit. Consumer ISPs are tough businesses, remember.

So, what did MTN buy?

While the purchase price of R408 million for 50% plus one share (valuing Afrihost at ±R800 million) was disclosed in March 2015, additional data related to the transaction has been revealed in a subsequent presentation by MTN to investors.

The R408 million purchase price included R319 million of goodwill. That’s an awfully large amount of goodwill, but how many assets could an ISP really have besides the implied value of its customer base?

 

 

Screen Shot 2015-08-27 at 3.21.34 PM

 

Source: MTN

The presentation also discloses that Afrihost has 200 000 customers. This is the first time this number has been made public. By way of context, Telkom has 574 761 ‘internet all access subscribers’. These are not lines, but customers who use Telkom as their ISP (i.e. they buy bandwidth from Telkom)1. MWEB does not publish numbers, but the most recently available (reliable) figure for subscribers (from 2010) was 320 000. Well-placed sources in the market suggest that number is lower nowadays.

So, MTN now owns half of the country’s third- or second-largest (mainly consumer) ISP.

In the first six months of 2015, MTN reported revenue from Afrihost of R272 million. Double that for the full year and you get to a revenue run-rate of R550 million. That’s a big number for an ISP which started in CEO Gian Visser’s house. Even at low, single-digit margins, its a tidy business.

Using the number above, it’s easy to calculate that average revenue per user (ARPU) at Afrihost is R226 per month. Mobile operators love looking at the world through the lens of ARPU. By comparison, in the first quarter of 2015, ARPU of postpaid (contract) MTN customers in SA was R159.52 (per month). While the Afrihost numbers are skewed, likely significantly, by DSL line rental revenue that is effectively paid straight through to Telkom, it’s still an interesting comparison.

In the greater scheme of things at MTN, however, Afrihost is tiny. It’s 4.8% of the South African business’s data revenue (R272 million of R5.677 billion). But, that comparison is skewed by the nearly R4 billion in H1 mobile data revenue. When you consider Afrihost within the context of MTN’s ISP revenue (primarily from its enterprise business unit which services corporates and SMEs), the R272 million number becomes meaningful.

Its (existing) ISP revenue has been on the decline for a while now. In H1 2013, revenue was R604 million, last year’s H1 number was R586 million (but nearly two months of Afrihost revenue was included in this number). This year, ISP revenue was R462 million for the first-half. That’s a drop of practically a quarter inside two years (Afrihost excluded, of course).

In fact, without Afrihost, the 26.6% increase in data revenue across its South African business (mobile data included) in the first six months would’ve been closer to 20%. Was the deal (partly?) to buy growth?

At the time, MTN said the “transaction is aligned to the group’s strategy of optimising its operating model” (whatever that means).

It also waxed lyrically about how the “acquisition will add scale to MTN South Africa’s online ICT service offering, which is focused on the consumer and SME market. MTN South Africa expects to leverage off Afrihost’s strong customer service, value proposition and agility, thereby boosting MTN South Africa’s presence in the SME, Corporate/Consumer and Connected Home segments. MTN South Africa will in addition be able to supply Afrihost with products for its existing customer base and vice versa.”

Standard, MBA textbook stuff.

To date, there hasn’t been much noticeable cross-selling at all.

There are two other bits to this puzzle. Afrihost is a very large customer of MTN’s. It pioneered the reselling of MTN mobile data at prices that had simply never before been seen in this country. Very simply, it purchased a gateway on the mobile network through which it would route traffic, and then resold this to customers. Enterprises do these kinds of deals with mobile operators all the time (where dedicated APNs (access point names) ensure that employees are connected via that operator’s network to a secure private network. I’m not going to get into any more detail here, lest you all close your browser tab).

Afrihost was clever enough to figure out that it could resell this data very cheaply and still make a profit at large volume (also known as the traditional ISP business model).

And given the instant popularity of Afrihost’s mobile products2, it would’ve quickly accounted for a noticeable portion of MTN’s overall data traffic. And, it would’ve likely been a contributor to the data network congestion seen on MTN over the last few years (especially in Gauteng).

Prior to the mobile deal, in 2012, Afrihost switched its backhaul network to MTN from Internet Solutions. At the time, MTN Business executives were chuffed it managed to win this deal. It hasn’t been plain-sailing since, however. While network issues during the change-over were to be expected, these haven’t disappeared completely.

Was the deal for half of Afrihost a defensive one, then?

Perhaps not. New MTN South Africa CEO Mteto Nyati (who is also chairman at Afrihost) made some rather interesting comments earlier this month on the sidelines of the operator’s first-half financial results presentation. In an interview with TechCentral, he said that the operator had “given them wholesale prices that were subsidised by MTN”, and that it “cannot afford to do that going forward”.

“It’s important that that business … must deliver the profits we expect. When we assessed [Afrihost], we felt if they could get similar pricing from us from outside, it’s a good thing. We will still get the profits. We will not consider to [continue to] subsidise the prices they’ve been getting [until now].”

Afrihost’s Visser contends this. He told MyBroadband that Afrihost has always paid MTN’s full price for wholesale DSL services: “We have no idea what MTN’s exact input costs are to provide this service to us or their other clients. We have never received a discount on these prices and any ISP could have got these same prices from MTN”.

So the deal wasn’t about the volume of Afrihost traffic across MTN’s networks?

In an effort to resolve the DSL network problems, which have gotten worse in recent months, Afrihost is currently running a proof of concept (POC) network, ‘Afrigreen’. If the POC is successful, it will in all likelihood switch providers from MTN. In an open letter on MyBroadband, Visser calls it “the next giant leap forward for Afrihost”.

It’s an open secret that the ‘Afrigreen’ POC network is being run on a Neotel backbone.

Now, if Vodacom’s R7 billion deal for Neotel is concluded (and after the Mail & Guardian’s recent ‘kickback’ exposé, there’s no certainty that it will be), we could have a situation where an ISP majority-owned by MTN is using a backhaul network operated by (effectively) its main competitor. You can’t make this up.

For all Nyati’s talk, one wonders if Afrihost will really be allowed to switch upstream providers?

Afrihost customers are frustrated and are leaving. And in the commodity consumer ISP space, there are only three vectors on which to compete: network, service, price (in that order). Afrihost built a commanding lead based on all three, but all have slipped (to varying degrees) in recent years.

Perhaps MTN has some grand plan for Afrihost. Nyati, who would’ve had sight of this deal (if not rubber-stamped it) in his previous role as group chief enterprise officer, knows the business well. Perhaps there are some great ‘synergies’. Maybe the boost to revenue and profits is enough to justify the investment. I’m not convinced owning 50% of Afrihost is the endgame though.

1 Telkom stopped disclosing dial-up subscribers separately in 2008, but in that year it had 242 732 dial-up subscribers on a total base of 358 066 internet customers. I’d hazard a guess that there are around 100 000 Telkom internet customers still on dial-up.

2 I was lucky enough to test Afrihost’s mobile offering prior to launch in mid-2013, and it really did live up to all the hype.

* I am a (legitimate, paying) Afrihost DSL user, however, the ISP will have no record of me as a customer. It’s complicated.

* Hilton Tarrant works at immedia. He can still be contacted at hilton@moneyweb.co.za.

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Thanks for the great article Hilton.

I joined Afrihost a few years ago – about 5 years or so. They were great. Well priced, good service, good speeds on their network. I and many of their subscribers will say the same thing: MTN was the very worst thing to happen to Afrihost.

Gian Visser got into bed with MTN for the reason of money. That has caused them to suffer. Look, my personal opinion is that Afrihost got too big and did not have the adequate capitalisation to grow their network. Simple as that.

Afrihost grew significantly, but since then they are on the decline, and I believe that the R300 million goodwill is craziness on MTN’s part. Goodwill is intangible and worth so much until the goodwill dries up. Afrihost has lost its goodwill: bad service, poor network speeds and constant network problems. They are in terminal decline. And will be for so for some time.

I can relate this to my personal experience of a company being listed on the JSE, with major investment from outside: The Video Lab Group and the Sasani deal. In 1998, the board of the Video Lab Group made a deal with investors and they then listed on the JSE. At the time, the Video Lab Group was the dominant player in the post production television market. They had 90% of the market. They owned just about everything in terms of facilities. A new player emerged called the Refinery. After 21 years or so, the Video Lab does not exist. Gone. Confined to history. The Refinery and the combination of smaller players, and Final Cut Pro killed the Video Lab. The Refinery actually bought the Video Lab – the Refinery was owned by MFP Holdings.

End of comments.

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