JSE-listed Blue Label Telecoms seems like a great business on paper: it has few infrastructure costs and is the leading supplier in South Africa of prepaid airtime, prepaid electricity, gaming and content services to the public.

The company partners with retailers, credit providers, cellular dealers and large corporate customers to offer a complete virtual mobile retail solution.

Its digital sales component includes a variety of transaction channels and payment mechanisms, increasing customer reach and allowing it to move beyond physical stores to receive payments from traditional and emerging payment methods.

So, why are its shares in the toilet, having collapsed even further in the past week following publication of its full-year results, which, according to analysts polled by TechCentral, were reasonably good given the economic environment in which the company is operating?

Blue Label, founded by brothers Brett and Mark Levy in 2001, listed on the JSE six years later and over the next decade grew quickly, with its market cap exceeding R19-billion in 2016. At one point, it even counted US software giant Microsoft among its shareholders.

In August 2017, it signed its biggest deal yet – the acquisition of 45% of Cell C for R5.5-billlion in a large recapitalisation and turnaround plan.

The extent of Blue Label’s financial support is known. But what is the future burden on Blue if Cell C continues to lose money, and will there come a time when the company is no longer willing to carry that burden? Many market players seem to think it’s already beyond that point, given that the shares are trading at a massive discount to the value of Blue Label’s operations.

‘Pretty good’ results

Global equity analyst at Flagship Asset Management Philip Short told TechCentral: “I thought the results were pretty good, with gross profit up 19% and underlying earnings per share up 9%. Especially considering the current macro backdrop, this was a good result.

“Cash flow was weaker in this period due to increased airtime inventory build-up, but that should unwind in the current year as Blue Label sells that airtime. I think the required IFRS accounting standards, due to the recap, did not help in that they had to report a convoluted set of line items.”

Short said he would like to see more disclosure on Cell C. “Blue Label and Cell C management mentioned in the recent Blue Label results call that they would have a separate investor call to disclose and discuss Cell C’s numbers in full. As I understand it, Cell C is finalising its most recent audited financial statements, post recap, and they will be released to the market.”

Read: Cell C a big drag on Blue Label earnings

From a strategic and economic point of view, Short believes it makes sense for Blue Label to seek control of Cell C, and it has stated it intends to do just that. “If you believe that Cell C is worth something, Blue should buy as much of Cell C as possible, as its current implied price is zero, looking at Blue’s share price.”

Short said Cell C’s spectrum assets are worth about R15-billion alone. “It’s a scarce asset in South Africa with an indefinite life. Cell C also has a deferred tax asset of R8-billion and a subscriber base of 12 million that you could sell to MTN or Vodacom. And most importantly, it’s an operationally viable business with a recapitalised balance sheet (debt now reduced from R10-billion to R4-billion),” said Short.

“A singular example of why I say an ‘operationally viable business’ is the recent tie-up with Capitec Connect as an MVNO (mobile virtual network operator) partner. Capitec rightly envisions the convergence of telcos and banks and is aiming to disrupt the telco sector before the telcos do the same to the banks. Capitec has 20 million banking clients, with the Capitec CEO recently saying they can ‘easily get 10-12 million subscribers onto Capitec Connect’, and these subscribers will be Capitec Connect primary Sim subscribers in time.”

Cell C currently has 12-million subscribers.

“If the Capitec CEO is correct, and he and his team have a stellar track record, then Cell C will double its subscriber base (with very little cannibalisation of the existing Cell C subscribers), and importantly, these MVNO subscribers will be very profitable to Cell C; it’s a high margin type of subscriber in the banking MVNO,” Short said.

He pointed out that pre-launch of Capitec Connect, 40% of all prepaid airtime in South Africa, or R25-billion, was sold via Capitec channels. “A Capitec client was buying their MTN/Vodacom prepaid airtime via a Capitec ATM or the Capitec app. And guess who was facilitating the backend of this transaction? Blue’s The Prepaid Company.

“So, imagine if Capitec channels this 40% prepaid airtime onto Capitec Connect? The numbers are staggering. The Ebitda that Capitec Connect will generate for Cell C is multiples of what Blue currently generates on its own. For this reason alone, Blue should’ve recapitalised Cell C and increased its shareholding. Blue has had this prepaid airtime and electricity partnership with Capitec for years so they’ve known what a recapped Cell C and a joint MVNO can achieve this time round.”

Another view of the Blue Label/Cell C collaboration is that it has become an accounting monster that even the Levys can no longer control

Short said that although Cell C has been through a recap before, it failed because the strategy was wrong. “Building your own network is expensive, the debt levels were too high, and the right partnerships weren’t in place. That’s different now. I don’t blame investors for not wanting to give Blue the benefit of the doubt but I appreciate the fact that because of this apathy, the market may give you an entry point.

“Cell C has R4-billion of debt but R3-billion of that is owed to Blue Label. And that same R3-billion sits on Blue’s balance sheet as debt owed to banks. On taking control of Cell C, Blue Label would consolidate Cell C into its financials, and they’d report as one.

“That means the R3-billion which was reported twice separately, now reports as R3-billion just once, and thus R3-billion falls off the combined balance sheet. I’m not saying there is a magic R3-billion value creation; it’s the optics of valuing the business as one, as more favourable than the sum of its parts,” said Short.

Another view of the Blue Label/Cell C collaboration is that it has become an accounting monster that even the Levys can no longer control. There are other serious problems to address, the first of these being that their debt is not covered by operating cash flow, with a profit margin of only 1.4%., down from 5.9% last year. Also, the business has a high level of non-cash earnings.

In the Blue Label audited results for the year ended May 2023, published last week, there were no financial results reported for Cell C – only a cryptic statement that “significant milestones were reached” and that expenses were reduced by 20%, along with a graph showing a decline in average revenue per user, a closely watched industry metric.

Blue Label said it is finalising an application to the Competition Commission seeking control of Cell C.

One well-known analyst and investor, who declined to be named given the sensitivities and his ongoing need to engagement with management, said the new leadership team at Cell C – led by former Vodacom Group executive Jorge Mendes – is unproven but “seems promising”.

Read: Cell C to become a subsidiary of Blue Label Telecoms

The company, the investor said, should maybe be “given the benefit of the doubt, given its recap and the new executive team”. There does not seem to be an immediate solution, however, and he wondered how long a turnaround would take, suggesting anything between three and five years.

Blue Label said Cell C will have its own engagement with the market soon, during which it will talk through its finances and operations – and it reiterated its belief that the recapitalisation, aimed at deleveraging the mobile operator’s balance sheet and providing it with the needed liquidity to operate, was the right one.