How Cell C got the blues

In June 2001, after winning a lengthy court tussle with disgruntled losers for SA’s third mobile licence, Cell C proclaimed itself ready to transform the local industry.

Huge banners outside the Sandton Convention Centre read: "It’s all systems go at Cell C." Inside the hall, it was standing room only as CEO Talaat Laham proclaimed: "We are ready with a dazzling marketing campaign which will present potential customers with a range of offerings to suit their needs."

Cell C director Zwelakhe Mankazana told the media the company was ready "for the real challenge of serving the SA market, which we believe we can do with success".

Cell C’s goal was to win 15%-20% of the SA market after seven years, which it estimated could amount to 3.6-million customers. It reckoned it could turn a cash profit by year four thanks to "better-quality service than that offered by MTN and Vodacom".

It was always a hard sell, since MTN and Vodacom had been in the game since 1994. Nonetheless, at first it went swimmingly. On its opening weekend, Cell C signed up 250,000 customers. Within a year, it had 1-million customers — more than 20% of the market at that stage. By year two, it had 2.5-million customers.

Each year, its number grew — but so did its debt. Sustainability always seemed inches away. In its 18 years, Cell C has only twice been able to record a net profit.

And those early vows to transform SA’s mobile sector have all but evaporated. The Cell C experiment, certainly as it was envisaged in 2001, is all but dead.

Last month Cell C revealed that for the year to May, it made an R8bn after-tax loss. Worse: the number of subscribers on its network fell by 2% to 15.9-million — exactly the wrong trajectory for a struggling company.

The real problem has been Cell C’s huge debt — R8.9bn at last count. Things reached a crisis point in July, when Cell C wasn’t even able to pay R194m in interest owed to its creditors.

In August, ratings agency S&P Global downgraded Cell C to "default", the lowest junk rating available. In corporate terms, it meant Cell C was about as reliable as Venezuela when it came to repaying debt.

As S&P put it: "We believe there is an increased likelihood that Cell C will be unable to repay all or substantially all of the obligations as they become due, unless it is able to restructure its debt and recapitalise its balance sheet."

Read together, it meant Cell C was running out of time.

It’s an indication of the company’s troubled life that Douglas Craigie Stevenson, who took up the CEO role in March, is the company’s sixth leader since its inception.

And he seems to realise that the original vision of competing with Vodacom and MTN is basically over.

"We cannot run our business in the same way as the large operators run theirs," he told the FM in an interview.

"Cell C as an organisation needed to understand, or needs to understand, that it can in no way compete with the incumbents. We have to cut our cloth to fit."

When the FM visited the sprawling Cell C headquarters, between Joburg and Pretoria, it didn’t carry the smell of imminent death you’d expect from a company staring destruction in the face. The corridors were a hive of activity, as the 2,000-odd staff bustled about as if nothing was wrong.

Perhaps it was because Cell C had faced the wall so many times before and come through it; perhaps it’s because Craigie Stevenson’s newfound zeal for communication is beginning to reap rewards.

The irony of Cell C’s predicament is that as far as customer numbers go, it has far exceeded its wildest expectations from back in 2001. However, while it has 15.9-million subscribers, Vodacom has 43.8-million and MTN 29.2-million. Cell C is well ahead of the fourth operator, Telkom Mobile, which at last count had 9.7-million subscribers.

But in a country where SIM cards outnumber the 58-million population, Cell C’s customers never spent the kind of dosh its larger rivals got. And what money it did get was swallowed in a bid to pay off debt.

Says Craigie Stevenson: "Telkom and Cell C have a limitation to the type of customer we can bring on, due to not having an adequate network footprint and service offering. So the two incumbent networks are still maintaining their own revenue-generating customers. Moving the high-end clients [over to us] is very hard to do."

By earlier this year, Cell C had the lowest average revenue per user (ARPU) of the four networks, at R72. This trailed Vodacom (R95), Telkom Mobile (R100), and MTN (R101).

Craigie Stevenson is no financial amateur. He cut his teeth at Vodacom, heading finance for several of its group’s businesses, including those in Tanzania and Mozambique. He was then picked as CEO of Telekom Networks Malawi.

But the harsh reality has hit home. It’s a realisation that has led Cell C to change course entirely. Until now, it has sought to act as a conventional mobile network: spending billions on building and maintaining cellphone towers, and carrying its customer traffic on that infrastructure.

Now Craigie Stevenson says that as part of a planned new "recapitalisation" bid, Cell C is negotiating a "roaming deal" with MTN that will result in that operator carrying all Cell C’s traffic. In return, Cell C is likely to hand over its towers to MTN.

In other words, Cell C will become more like a mobile virtual network operator (MVNO), which essentially "rents" space on other networks and on sells it to customers. Virgin Mobile and FNB Connect use this model.

Craigie Stevenson says the deal with MTN is expected to be finalised by the end of this month. It’s a radical shift, but Cell C didn’t really have a choice, especially after it was recapitalised just two years ago, when JSE-listed Blue Label and Net1 ploughed R7.5bn into the company in exchange for a combined 60% stake.

"We can’t carry on with a capital-intensive model. It’s as simple as that," says Craigie Stevenson. "The deal would entail substituting capital expenditure for operational expenditure and allowing us to compete on the basis of having the same geographical footprint and quality of service."

In monetary terms, the swap will probably entail MTN taking over Cell C’s towers and in return, Cell C will pay a lower tariff to use MTN’s network.

Craigie Stevenson’s company will get nationwide roaming on a 4G network without any quality issues. And it won’t have to spend money on maintaining the towers.

Analysts believe it’s a deal that would be fantastic for MTN — which is something it needs, after a torrid five years in which its share price has tumbled 60%, thanks mainly to clashes with Nigerian regulators.

Philip Short, an investment analyst at Old Mutual Equities, says this high-margin revenue would drop straight to MTN’s bottom line. "MTN has already invested in its network over the past few years to match Vodacom’s network, but it has fewer subscribers, so the return on capital for MTN is lower than Vodacom’s. Hence, adding Cell C subscribers to its network at no extra cost increases MTN’s return on capital," he says.

Short believes it will allow Cell C to increase the average spend of its users. "We think Cell C will turn cash-flow positive after the deal," he says.

Cell C still hasn’t put numbers to it, but it says the recapitalisation will "dramatically change the structure of the balance sheet".

The problem is, Cell C’s long-suffering shareholders, including the empowerment consortium CellSaf (which has been diluted to 7.5%), and its customers, have heard this "recapitalisation" story before.

Why should they believe it now?

Just two years ago, Blue Label Telecoms waded into the fray as a white knight. The company, fronted by brothers Brett and Mark Levy, is SA’s largest distributor of prepaid airtime and starter packs for mobile operators like Cell C.

In 2017, Mark Levy told the FM: "We want the asset to grow and have some form of liquidity. And, somewhere down the road, there is a listing of Cell C, which will also unlock value for shareholders."

The brothers put their money where their mouths were, ploughing in R5.5bn for a 45% stake. Soon after, Net1 UEPS pitched in R2bn for 15% of Cell C.

This bailout helped Cell C cut its debt from an impossible R23bn to a merely overwhelming R6bn. But, as many suspected, even that has proved too much to handle.

And Cell C’s travails have nearly sucked the life out of Blue Label too.

Since the 2017 deal, Blue Label’s share price has tumbled 85%, from R19 in 2017, to just R2.79. Today, the Levy company is worth less than it paid for its Cell C stake.

Remarkably, Brett Levy seems unfazed. "We went into it eyes wide open. We had good advice in buying Cell C … hopefully in the end we deliver a Cell C that does deliver on what we had promised the market," he said last month.

There’s little chance Levy would have suspected it would get as bad as it has. For the year to May, Blue turned in a R6.6bn net loss — a grim reversal from the R1.1bn profit the year before. And, as final evidence that it was a poor deal, Blue Label also wrote down its entire Cell C purchase to zero.

Levy admits some investors have communicated how unhappy they are with the destruction in value. "They’ve seen destruction in the share price over the past 12 months and it’s important for us, as management at Blue Label, to really gain the respect of the market again and gain trust," he says.

But how do you do that?

Says Levy: "You put it all on the table, which we have now, and you slowly make promises you deliver on. If you deliver on your promises, and deliver on what you say, then slowly you get back the respect and trust of the market and you repair the damage that’s been done."

Net1 also took a hammering and wrote its investment in Cell C down to zero by June.

Old Mutual’s Short says that in hindsight, it doesn’t seem Blue Label did a proper due diligence. "The Cell C management team was probably not where it needed to be and I think the cost of the debt was higher than they initially expected," he says.

While Blue Label billed the deal as a "fixer-upper", market watchers weren’t convinced from the start.

If anything, says Short, it seemed like a deal done by Blue Label to protect its own market position.

"Though Cell C subscribers, in the event of Cell C going bust, would have been recycled into the airtime ecosystem via the other operators, Blue Label earns a bit more in commission from Cell C than it does from MTN and Vodacom," says Short.

Today, the sorry saga stands as a cautionary tale of the dangers of trying to salvage a company you directly transact with.

So why didn’t that recapitalisation work?

Craigie Stevenson says the main reason is that the Blue Label deal didn’t properly fix the balance sheet — and the weak SA consumer, battling in a wider environment of less than 1% GDP growth, didn’t help.

"No-one puts a business plan on the table they don’t believe in. But subsequent to the recapitalisation, a few things came out. The biggest was that the recap didn’t really address the level of debt adequately at the time. Second, the cost of the debt, with a portion of it incurring hedging costs as it was dollar-denominated, meant we were carrying debt with an average interest rate of 13.6% per annum."

Still, it takes some going to burn through R7.5bn in less than two years.

S&P Global Ratings director Omega Collocott tells the FM that the Blue Label restructuring was simply suboptimal.

"It’s quite a complicated story — not all of these factors are internal to the company. The weak economy, the swift pace of technological advancement, and the competitive environment all spoke to not being able to handle the capital structure that was put in place," she says.

To make matters worse, Cell C had a long institutional history of aggressively chasing growth, whatever the cost.

When Alan Knott-Craig took over in 2012, he launched a price war with rivals by slashing calling costs to 99c a minute. It was a gamble to aggressively get revenue. But while Cell C won market share, the problem was that it didn’t bring the cash flow needed to reduce the debt.

S&P analyst Rishav Singh says: "I think they underestimated how much they needed to invest in the network to deliver on their strategy. We think their cash flows after capital expenditure are negative."

At the same time, Telkom Mobile was getting in on the action, competing head-to-head (but with a bigger balance sheet behind it) for the same pool of price-sensitive customers. It was a recipe for disaster.

The good news for Cell C is that there are still people who believe in its future — even if the company assumes a new guise. In particular, there’s a new white knight on the horizon, with deep pockets.

This time, it’s one of SA’s most reclusive investors, Jonathan Beare, who signed a "pre-agreement" to recapitalise Cell C in February. Details are sketchy, but Beare’s Buffet Investments would seek to reduce Cell C’s monstrous debt at a lower interest rate, while he’d take an equity stake too.

But one of the conditions for Beare’s buy-in, apparently, is that the MTN roaming agreement is signed on fair terms.

Beare is perhaps the wealthiest SA billionaire you’ve never heard of. The FM has previously reported how the KwaZulu-Natal businessman made a fortune in the Dutch property market in the 1980s, and has since linked up with Patrice Motsepe and the Balwin Property Group.

There is also speculation about others riding to the rescue.

As the FM was going to print, ITWeb reported that the world’s largest mobile company, China Mobile, was in "negotiations" with Cell C and a takeover was "imminent". If true, it would be a big deal, considering China Mobile is owned by the Chinese government, has 1.1-billion customers and makes annual revenues exceeding $103bn.

But quite how true this is has yet to be confirmed. One Cell C insider tells the FM: "We’ve had no discussions with China Mobile at this point." But, officially, Cell C says it will "keep the door open to any conversations that will assist the company’s future viability".

Clearly, Beare believes Cell C can be saved. But then so did the Levy brothers. And Knott-Craig. And Jeffrey Hedberg, the CEO before him.

So how can this time be different?

S&P’s Collocott says the question should rather be framed like this: "What level of capital expenditure, operational cash flows and capital structure is required to create a picture of sustainability?"

Once it resembles an MVNO, using MTN’s network to woo customers, Cell C will also have fewer capital demands.

Craigie Stevenson says there are big opportunities for MVNOs.

"I think there will be many more MVNOs as you liberalise this whole telecommunications industry," he says. "Offering converged products and services is the way the industry is going. You look at a device, it does so many things now. All the applications being developed are part of the convergence story."

The company is likely to do many more collaborative deals, pushing avenues like fibre to the home. "[Fibre] is the real way to unlock data, particularly with 5G coming," says Craigie Stevenson. "It doesn’t become about one subscriber, it becomes about a multitude of devices."

But at the same time, Cell C needs to keep the confidence of its customers, and regain the trust of the market — not exactly an easy task, once you’ve defaulted on your bond repayments.

Creditors, however, have been understanding. They realise that demanding any repayment now could tip the company into business rescue.

Collocott says: "We don’t really expect the bondholders to request early repayment, it just wouldn’t make sense. They realise the company is in distress, so they need to decide how they are going to get the maximum value on their investment."

As it stands, Cell C has bought itself time until the end of the year to put in place the deal with MTN, and organise the later recapitalisation. Funders have agreed to wait for any repayments.

And to perform the open-heart surgery that the business requires, Cell C has hired UK law firm Clifford Chance to advise on improving its governance, and Deloitte UK to work on the restructuring.

Cell C CEO says the way forward will be to become more like a mobile virtual network operator (MVNO)

—  What it means

So will Blue Label one day consider the Cell C deal as a blessing, despite the trauma the past two years have inflicted?

Short says if you strip out Cell C’s performance from Blue Label’s earnings, it would have posted R1 of profit a share from continuing operations. Which, at a share price of R2.78, would put Blue Label on a very cheap p:e of three.

"Cell C might be worth zero in its current format, but I don’t think it’s a negative R7 a share as is implied in the current Blue Label share price," says Short. "What the market is worried about is if Cell C goes bust, then Blue Label will have to do a rights issue to throw good money after bad."

It’s a risk. If Cell C survives, and can do what Craigie Stevenson promises, the Levys might not end up ruing the day they forked out billions for the third mobile operator.

But if Cell C’s history has taught us anything, it’s that it’s a big "if".