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EOH, The Most Prolific M&A Company in the SA ICT Sector

EOH Holdings Limited (EOH) is the most prolific M&A company in the SA ICT sector. Analysis of the revenue streams over the period 2011 to 2016 shows that by FY2016, EOH had earned 63% of its revenues from the cumulative acquisitions it had made over this period. The EOH challenge, however, is how to continue to deliver such impressive revenue growth over the coming years.

The Competition Commission Announcements in November 2016

The Competition Commission recommended to the Competition Tribunal that two proposed transactions by EOH, be approved without conditions. These transaction are the acquisitions by EOH of PIA Solar South Africa (Pty) Ltd (PIA) and Scan RF Projects (Pty) Ltd (Scan RF).

These announcements caught our attention as they highlighted EOH’s ongoing and relentless M&A strategy, a strategy that has been part of the EOH “DNA” going back to the year 2000.  This commentary provides an assessment of the EOH M&A activity over the period 2011 to 2016.

EOH Revenue Analysis

EOH reported revenues of R12.76 billion for its financial year ending July 2016. The 2015/2016 annual revenue growth was 31%, while the five-year compound annual growth (CAGR) was 39%. The following graph shows the EOH revenue reported from 2000 to 2016.

EOH Revenue 22.11.2016

Source: EOH Annual Reports 2004 to 2016

Revenue earned from M&A

A cautionary note –  EOH does not provide a detailed revenue breakdown of its individual subsidiaries, therefore we needed to make some assumptions. The value of this analysis serves to illustrate the revenue impact of the M&A strategy, as compared to accurately accounting for the different revenue streams.

We set-up the following revenue model to estimate the acquisition revenue contribution over the period 2011 to 2016:

  • We modelled the 2011 organic revenue per year from 2011 to 2016, this is defined as the “Core Revenue”;
  • We modelled the 2011 acquisition revenue per year from 2011 to 2016 + incremental acquisition revenue per year, with each year projected to 2016, this is defined as the “Cumulative Acquisition Revenue”; and
  • For simplicity, we assumed all revenue streams grew at the same annual growth rate per year.

Using this modelling approach, we calculated that in 2016, EOH had earned 63% of its revenue from cumulative acquisitions made over this period. The balance of 37% was earned from the growth of the 2011 organic revenue.

The following graph shows the two revenue streams.

EOH Revenue Analysis 22.11.2016

Source: Africa Analysis modelling of revenue streams

The CAGRs over the period 2011 to 2016 are as follows:

  • 2011 organic revenue          19%
  • 2011 acquisition revenue   77%

As shown, EOH’s revenue has enormously benefitted from its M&A strategy.

Two Year EOH M&A Track Record

The following diagram shows the M&A activity over the past 24 months. The M&A activity is shown in the quarter that the transaction was completed (as compared to the date when the transaction was announced). The M&A activity underlines EOH’s position as the most prolific M&A-driven ICT company operating in the SA market.

EOH Two Year M&A 22.11.2016

Source: Africa Analysis assessment of the M&A reported by EOH (2015 and 2016)

Shown in the M&A timeline are the transactions undertaken outside of South Africa. International M&A is to be expected as it is unlikely that EOH can continue to grow revenue, through M&A undertaken in the South African IT sector, at the rate that it has grown its revenue. There are just not enough companies that EOH can buy to continue to demonstrate the impressive annual revenue growth that it has shown.

The following figure shows a high-level application of the Africa Analysis M&A diagnostic model. This model determines the strategic intent of the acquisition regarding scale, customers, revenue and markets.

EOH M&A Analysis 22.11.2016

Source: ©Africa Analysis M&A Diagnostic Analysis 2016

Overall, EOH has driven the growth in finding new customers either in existing markets or new markets. EOH has also driven the acquisition of new capabilities that can be used to serve new and existing customers. The analysis also shows the drive to expand into adjacent markets.

Diversification Strategy

These acquisitions demonstrate the ongoing EOH diversification strategy. A review of some of the acquisitions made over the past 24 months shows the scope of diversification:

  • SCAN RF                          : Wireless infrastructure
  • PIA Solar                          : Alternative energy
  • JOAT Group                   : Civil engineering – water infrastructure
  • Mehleketo                       : Rail infrastructure
  • Paterson Candy           : Civil engineering – water infrastructure
  • Grid Control                  : Energy management services

EOH is building capacity in infrastructure technology – water, electricity and transportation.

Can EOH Sustain such revenue growth?

The key question is whether EOH can sustain such aggressive revenue growth? First, let’s explore possible revenue growth and M&A scenarios:

Scenario 1: If we assume the same CAGR of 39% for the next five years, and FY2016 core revenue grows at 19% per annum, then:

  • By 2021, EOH would reach R67 billion, or 5.3x its FY2016 revenue.
  • EOH will need to buy companies that contribute R27 billion in new revenue over this period
  • On average, EOH will need to add the equivalent of 15% in new revenues through M&A each year. EOH has shown an average of 15% new revenue growth per year over the five -year period. However, in 2016, the new revenue contribution from M&A was 10%.

Scenario 2: If we assume the average 2016 revenue growth of 31% for the next five years, and FY2016 core revenue grows at 19% per annum, then:

  • By 2021, EOH would reach R49 billion, or 3.9x its FY2016 revenue.
  • EOH will need to buy companies that contribute R14 billion in new revenue over this five-year period.
  • On average, EOH will need to add the equivalent of 9% in new revenues through M&A each year. EOH has shown an average of 15% new revenue growth per year over the five -year period. However, in 2016, the new revenue contribution from M&A was 10%.

Scenario 3: If we assume the FY2016 revenue growth of 10% for the next five years, and FY2016 core revenue grows at 10% per annum, then:

  • By 2021, EOH would reach R35 billion, or 2.7x its FY2016 revenue.
  • EOH will need to buy companies that contribute R12 billion in new revenue over this five-year period.
  • The assumption is that EOH adds the equivalent of 10% in new revenues through M&A each year. EOH has shown an average of 15% new revenue growth per year over the five -year period. However, in 2016, the new revenue contribution from M&A was 10%.

These scenarios show the outcome of revenue and M&A activity assumptions. Based on the scenarios, EOH will need to maintain an aggressive M&A strategy over the next five years to deliver similar revenue growth as it has shown over the past five years. Depending on how aggressive EOH sees its growth, it will need to add new revenue derived from M&A of between R12 and R27 billion of the next five years.

This is quite a challenge, and we expect that EOH will need to either seek international M&A targets and/or diversify into adjacent markets in the SA market.

Conclusion

The revenue analysis shows that EOH has successfully grown its revenue through an M&A strategy. Indexing revenues to FY2011, shows that by FY2016, EOH had earned 63% of its revenues from the cumulative acquisitions it had made over this period.

The EOH challenge, however, is how to continue to deliver such impressive revenue growth over the coming years.

 

Ruling imposed on the MTN / Smart Village acquisition

The MTN acquisition of Smart Village led to an interesting competition condition imposed by the Competition Commission – namely that MTN needed to introduce an open access model for Smart Village. The ruling does raise an interesting question about access to telecommunications infrastructure in gated communities. This note explores the Competition Commission ruling, looks at the issue of competition in gated communities, and considers possible future operator strategies.

The Challenge of Consumer Choice in Gated Communities

Consumer choice can be completely eliminated in gated communities through the establishment of a monopoly provider in these communities. These localised pockets of monopoly come into existence either through the home owners’ association providing an exclusive mandate to an infrastructure provider or by the behaviour of the telecommunications infrastructure provider. The creation of such monopolies results in the gated community consumers being denied choice. Furthermore, the MTN acquisition of Smart Village highlighted this competition issue.

What is the Competition Commission Ruling?

The following text is extracted from the Competition Commission news letter dated July 2016.

On 29 January 2016, the Competition Commission approved with conditions a merger whereby Mobile Telephone Networks (Pty) Ltd (“MTN”) acquired Smart Village (Pty) Ltd (“Smart Village”). MTN is a global communications partner and cellular network operator. Smart Village is mainly active in providing fixed line fibre broadband access to the residential market.

The merger presented a horizontal overlap in relation to the provision of fixed-line broadband fibre optic access network as both parties deploy fibre in gated residential estates. Both parties also operate as Internet Service Providers and offer internet connectivity services to residential estates where fibre is deployed. The Commission found that each gated residential estate constitutes a distinct separate geographic market as gated residential estates generally do not permit the duplication of fibre infrastructure in the respective gated estates. In that regard, there was no geographic overlap arising in the assessed markets. Smart Village holds 100% of the market in each of the gated residential estates wherein it has laid the fibre, thus the merged entity would have monopoly power over each of the gated residential estates.

The Commission found that the vertical relationships arising from the merger would result in a substantial lessening and prevention of competition. The merged entity would acquire a position that would allow it the ability to exercise market power. This could be exercised through foreclosure strategies over its fibre infrastructure in the gated residential estates. In addition, the Commission found that the merged entity would have the incentives to do so as MTN is also able and intends to expand its downstream services offerings in the gated residential estates. Such foreclosure conduct would ultimately harm consumers in those estates where such conduct would be perpetuated and prices are unlikely to decline when there are no viable competitive choices. MTN would also be in a prime position to leverage market power on its fibre into downstream services such as internet connectivity, TV on demand services and security services through bundling strategies.

The Commission found that the input foreclosure strategy could be remedied through the imposition of conditions relating to open access model to the fibre infrastructure on fair, reasonable and nondiscriminatory terms and having transparent and market related pricing. With an open access model, customers in gated residential estates would be afforded choice in terms of product and price offerings. The Commission was further of the view that as long as MTN’s ability to leverage its market power over fibre is curtailed by the adoption of an open access model on a non-discriminatory basis, other potential exclusionary strategies such as bundling are also unlikely to be achieved.

A Brief Global Review

The issue of access of telecommunications infrastructure within buildings or private estates has been dealt with in other jurisdictions. The key themes that run through the regulations are the protection of consumer choice and the encouragement of broadband growth.

Here are a few country examples:

  • Portugal
    • Decree-Law 123/2009 was published, setting out the legal regime applicable to the construction of infrastructures to lodge and install electronic communication networks and to the construction of telecommunications infrastructures in housing developments, urban settlements, concentrations of buildings and buildings. The essence of this law is that it obligates infrastructure sharing within the abovementioned settlements and buildings.
  • Qatar
    • In 2013 ictQATAR (the national regulatory authority) issued a set of instructions to service providers, developers and building owners that specially stated that exclusive telecoms infrastructure usage was prohibited. ictQATAR stated that end-users must have the possibility to choose between the offers of all and any service provider to the public licensed in Qatar and the arrangements which have a negative impact on competition, i.e. exclusionary or exploitative effects, between service providers and/or developers and/or building owners are forbidden.
  • Singapore
    • The telecom riser ducts (or simply risers) in buildings are administered by Infocomm Development Authority (IDA) under the provision of the Telecommunications Act, 1999. IDA’s policy is to reserve the risers for use by fixed-service facilities based operators (FBOs). Any other person or enterprise intending to use the risers shall seek permission from IDA.

In other jurisdictions, different methods of access to in-building or estate infrastructure exists. Where these regulations exist, they serve to promote fair competition.

Gated Communities in South Africa

A key characteristic of South Africa is the number and growth in gated communities.

These gates communities represent concentrated pockets of high-income households who are the prime target segment for the uptake of FTTH services. The challenge, however, is that the home owners’ associations typically sign exclusive contracts that give a single telecoms service provider or infrastructure provider exclusivity in the provision of services to that estate. Alternatively, the exclusivity relationship may arise when the telecommunications infrastructure provider deploys infrastructure and binds the gated community to an exclusive contract that excludes other competitors.

In either approach, the exclusivity behaviour serves to entrench a localised monopoly in a gated estate. Once such a monopoly exists, there exists the conditions for both horizontal and vertical closing out of other competitors. Consumers are thus deprived of freedom of choice.

In their ruling on the MTN/Smart Village acquisition, the Competition Commission ruling recognised this market behaviour and imposed open access conditions on the MTN acquisition.

Operator Strategies to Gain Access to Gated Community Infrastructure

As FTTH retail competition increases, these pockets of high-income households located in gated communities will become the focus of operators. Operators, however, will not gain access – given the monopoly that exists in these gated communities. We thus expect that there will be a rise in operators seeking mechanisms to break the monopoly in order to gain access.

The challenge is – how to gain access to infrastructure on a fair and equitable basis?

  • Given that there are very few open access networks operating in gated communities suggests that the owners of such infrastructure are employing practices to restrict access. Therefore, the likely route an operator will follow would be to approach a regulatory body to mandate such access.
  • It can be argued that these operators can make a case for being granted some form of access to the telecommunications infrastructure within gated communities. Furthermore, there are likely enough global case studies to illustrate how other national regulatory authorities have dealt with this challenge.
  • Approaching ICASA, to grant access to infrastructure, may not be the most expedient strategy to follow.
  • Rather, we would suggest that an approach to the Competition Commission would be the more economical route to follow. Based on the Competition Commission MTN/Smart Village ruling, we would expect that the operators, who challenge this monopoly situation, would receive a favourable ruling from the Commission.

Pre-emptive Strategies – Developing Wholesale Product Offerings

Operators who hold monopolies in gated communities for the provision of infrastructure should seek to develop open access or wholesale product offerings that offer access to other competing operators. This move can pre-empt the imposition of remedies that can end up being more onerous than what the operator would have developed.

The impact of 4G on new Subscriber Acquisitions

The deployment of 4G is having a significant positive impact on subscriber behaviour. This is according to the 2016 Acquisition and Retention Study, a report published by Nokia.

4G, the fastest growing network technology

The report covers key findings regarding the impact of 4G on subscribers, such as:

  • 4G customers are happier. Happier with their mobile data speed. More satisfied with the consistency of their mobile data and as a result, use more data.
  • Globally, 38% of new sign-ups in the last 12 months have been for 4G and the pace is accelerating.

Yet, the research shows there are still barriers to overcome:

  • Mature markets are 2x more likely to use 4G than transition markets
  • 17% of consumers globally are not aware of the network they use
  • Over 30% of consumers in both mature and transition markets stated device incompatibility as the top reason for not yet using 4G
  • Many consumers still perceive 4G to be more expensive.

In South Africa, 15% of the subscribers believe they use the 4G network, while 78% believe that they only use the 3G network. The remaining 7% don’t know what network they use (3G or 4G).

Overall, 4G has a significant beneficial impact on subscriber behaviour:

Source: 2016 Acquisition and Retention Study

Nokia 2016 Acquisition and Retention Study
The Nokia 2016 Acquisition and Retention Study has been designed to help mobile operators understand current trends in consumer behaviour, in order to make more informed decisions when developing acquisition and retention strategies. The focus of this extensive study is to uncover the core drivers of customer retention by providing detailed and granular insights around consumer perceptions, causes of dissatisfaction and the likelihood to churn across several scenarios.