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**This report was written on the 28th of March 2023

Airtel Africa PLC (AAF) is the second-largest provider of telecommunications services in Africa, operating in 14 countries (Figure 2), with its biggest market in Nigeria. The firm aims to provide ‘a simple and intuitive customer experience through streamlined customer journeys.’ Airtel Africa generates revenue from three sources; mobile voice; data services; and mobile money services. All three segments operate both nationally and internationally for its 128m customers.

The company is a subsidiary of The Bharti Group (56% ownership of Airtel Africa), a multinational conglomerate headquartered in New Delhi, India. This group has a range of financial services and telecommunication businesses with over 400 million mobile customers worldwide. With this enterprise behind it, Airtel Africa has significant financial backing and is primed for expansion in one of the world’s fastest-growing markets.

Business Model and Performance

Airtel’s primary source of revenue comes from mobile telecommunications services. This includes pre/post-paid call services, texts, international roaming, and its mobile data services, offering 2-4G data to mobile subscribers. Its second and most exciting source of revenue comes in the form of ‘Airtel Money’, its mobile money services, which generate 13% of revenue. Working alongside financial institutions, this service offers all the benefits of a bank account to its customers; for example, sending and receiving money, paying for goods, and depositing or withdrawing funds, similar to Fintech companies like PayPal. This is a key value driver for Airtel. The company’s latest quarterly results (Q3 2023) showed the 20th quarter of double-digit revenue growth and EBITDA expansion (Figure 3), conveying the strength of Airtel’s brand and products, being the first or second largest operator in 13 of its 14 markets.

Airtel’s business model is built around a “more for more” service, where it adds customers to its basic plans and encourages them to upgrade, adding new services over time. This creates a fly-wheel effect. All of its mobile and data revenues are subscription-based, providing the business with the benefit of assured recurring revenues each month. Some may question Airtel’s ability to grow sustainably, given the underperformance of Telecom’s giants in the UK Market. However, with revenue growing at 9% CAGR alongside a 13.6% increase in its data customer base and a 22% for Airtel Money in the latest quarter (Q3 2023), the company’s ability to successfully cross-sell its products is evident. Airtel also provides data bundles and ‘Pay-as-you-go tariffs’.

Within its ‘Airtel Money’ segment, revenue is generated through transfers (% of total value), merchant payments, and withdrawals. Its Average Revenue Per User (ARPU) has risen 7% on a constant currency basis with transaction values up 37% for the nine months to December 2022 when compared to the same period last year. This comes as mobile sales have fallen significantly, and global growth is faltering. Airtel Money only accounts for 31m of its 138.5m customers, so the company has a great opportunity to cross-sell its mobile money services to its customers, which is clearly working, as evident by its consumer base growth. The company’s operational performance is clearly strong.

In regard to its financial performance, Airtel is also operating efficiently. The company produced a Return on Capital Employed (ROCE) of 17% during 2020, an outstanding feat while navigating through the COVID-19 pandemic and showing its ability to use capital efficiently to increase business value. Its ROCE has grown since then (Table 2). Airtel also offers a dividend yield of 3%, an attractive level for a growing company trading at 7x earnings, a discount to its peers (Table 2). However, due to the capital-intensive nature of the telecom industry, it is prudent to take a closer look at its debt structure. Its debt-to-equity ratio is 108%. Some Analysts are concerned by this, however, compared to its peers is reasonable and covered well by operating cash flows at 42% of revenue. Its interest payments are covered 4.7x by EBIT, and therefore these higher debt levels aren’t a major concern. In the last twelve months, Airtel Africa paid down $1.7bn of debt, to a leverage ratio of 1.4x, while simultaneously spending $490m to upgrade all its markets to 4G and 5G and continuing to pay dividends. Recent investments into its Airtel Money segment will also be used to reduce Group debt further. There has also been no share issuance since the company was listed. This confirms the company has both conservative and shareholder-friendly management.

Airtel has a clear business model with strong operating and financial performance. However, for this company to be a viable investment, the long-term trends in Airtel’s markets of operation must be assessed.

Secular Trends

On closer inspection of the regions Airtel Africa operates in, it’s evident that there are several secular trends favouring these regions for more sustained growth, compared to developed nations. As a whole, the continent of Africa is ranked second by population and has a median age of 19.7 years, according to World Population Review. Six of Airtel Africa’s markets are in the top eight countries for the lowest median age. This comes alongside higher population growth rates, as seen in Figure 4. In contrast, western nations have ageing populations, meaning declining labour growth.

Alongside this, with an average annual GDP Growth rate of 4.5% in Sub-Saharan Africa (double that of the USA), and a predicted increase in middle-class Africans from 23% in 2020 to 42% by 2060 (fastest growing middle class in the world), these countries are becoming increasingly wealthy, with better standards of living, lower infant mortality rates and longer life expectancies (Table 3). Evidently, there is vast scope for growth in many industries as African people become better educated and wealthier. This places Airtel Africa in a prime market position for the huge demand for its services as more people can both afford and need to communicate on a regular basis for work and leisure.

Alongside population growth, the huge technological shift witnessed during the COVID-19 pandemic should accelerate in the coming years. This will trickle through to Africa as companies are attracted to the higher growth prospects in the continent. The rollout of 5G around the world will encourage African nations to increase infrastructure spending to stay in touch globally. We are only at the early stages of this 5G revolution, but with Airtel implementing 4G into all of its markets during 2022, 5G is the next step. This technological advancement will undoubtedly boost productivity in Africa, leading to further demand for Airtel’s services. I am confident that African nations are eager to spend on new technology as Nigeria has become one of the first countries to release a Central Bank Digital Currency (CBDC) in 2022, for example. This move towards a cashless society will generate more demand for Airtel’s Money services too. Although there have been protests in Nigeria due to the introduction of this CBDC, in the medium/long term it seems likely this will come to fruition globally, as in the Western world only 3% of capital is currently held in cash.

Long-term growth for a nation come from a mix of higher labour productivity and population (labour) growth. It’s clear that Africa has both and Airtel Africa stands to benefit. However, there is a third method to boost growth in a nation, debt.

Since the Great Financial Crisis of 2008 (exacerbated during COVID-19), the scale of spending in the Western world, through increases in debt levels, means the US and Europe are set to experience poorer growth in the coming years, as this unproductive debt becomes a significant drag on economic development. Figure 5 (right chart) depicts this, showing that as US debt levels have risen, US GDP growth has fallen. This has occurred because as GDP growth has slowed governments have used debt to fuel demand and attempt to continue growing. However, this has been a short-term fix to a long-term problem, with Figure 5 (left chart) showing that the velocity of money (impact of a $1 rise in debt on economic activity) has also fallen over time as debt levels have risen, conveying this increase in unproductive debt loads. With inflation now rampant in many Western nations, the period of easy money (more debt) and low interest rates seems to have passed. As a result, investors must look beyond developed markets and into emerging nations to find sustainable growth. Airtel Africa fits this mould.

The Macro Landscape

With a positive outlook for Airtel Africa from a long-term standpoint, it’s also important to drill down into the macroeconomic landscape on a shorter-term basis to assess how near-term drivers of economic growth and the business cycle will impact the company over the coming quarters.

From a geopolitical standpoint, emerging markets have largely avoided the turmoil of the Russia-Ukraine war and the US-China tensions. This makes these markets a more attractive place for investors in the medium term. In addition, with the China reopening underway (Figure 6), economic activity (especially oil usage) should pick up. This comes alongside structural undersupply of energy, reduction in supply from Russia, and support of higher oil prices by the OPEC+ cartel. This will benefit net exporters of oil, such as Nigeria (Airtel’s biggest market), bringing more revenue into the government which can be spent on upgrading infrastructure and improving the overall standard of living further, benefitting Airtel Africa.

**Figure 6**: China’s air travel is rising, Source: Bloomberg

Alongside this, the UK equities market (FTSE), where Airtel Africa’s stock is listed, has been outperforming other major developed markets. It is priced cheaply on a relative basis, especially the US, and has a significant ‘Value’ bias. This outperformance and relative valuation will become attractive to money managers as we continue through a period of higher inflation and interest rates, as such an environment tends to lead to value stocks outperforming growth stocks. Once again, Airtel Africa fits this mould, as is discussed later (refer to Return Analysis).

**Figure 7**: FTSE 100 performance versus other major assets, Source: Yahoo Finance

Airtel’s operations within the telecoms industry mean its cashflows are more stable and reliable as the UK economy enters a slowdown/recession, which could again be favoured by investors. Looking back to the COVID-19 pandemic, Airtel’s revenue only declined 5% Quarter-over-Quarter (QoQ) for the June 2020 quarter but was still 13% higher YoY versus June 2019. EBITDA only fell 6% for the same quarter but was still 7.8% higher than in June 2019. This shows the resilience of Airtel’s business in the face of one of the largest exogenous shocks of the last century. I believe this business has both the strength and stability to survive any environment we may face in the coming years, and this will be appreciated by equity investors.

Industry

As a whole, Africa’s telecommunications industry is predicted to grow rapidly in the future. The market is projected to have an 11.2% CAGR until 2026, according to Mordor Intelligence, and this comes alongside rising smartphone affordability, leading to an increased total addressable market for Airtel. This suggests a strong long-term runway for the company. Taking Africa’s most populated country, Nigeria, as an example, around 90% of the population now owns a mobile phone, with 50% of the population using the internet (DataReportal). As internet user growth continues to expand, the need for and reliance upon telecom companies like Airtel Africa will increase. In Sub-Saharan Africa, the most impoverished region in the continent and one of Airtel’s biggest coverage points, 46% of the population subscribed to mobile services at the end of 2021 and this is predicted to grow a further 20% by 2025. There is clear scope for huge growth here.

Alongside this, the fintech arm of Airtel’s business (Airtel Money) is set to continue its exponential growth trend in the coming years. Roughly half of all Africans don’t have a bank account, which presents an opportunity for fintech companies to digitise payments. Airtel Money’s services eliminate the need for a bank account, providing a huge catalyst for further earnings growth. The African electronic payments market is predicted to grow by 20% every year to $40bn by 2025, according to Mastercard. In contrast, the industry is only expected to grow by 7% globally in the same period. There were 2398 fintech start-ups in Africa during 2021 (Figure 8) and Sub-Saharan Africa dominated the space, with the value of funding at $1.56bn. If Airtel Money was to be spun off, I have no doubt it would demand a high valuation, with over $100bn in transaction volume recorded this year (annualised).

**Figure 8**: Number/value of fintech deals in Africa is growing rapidly, Source: McKinsey

Although the economic slowdown and geopolitical crises during 2022 impacted smartphone sales, down 18% YoY, African startups attracted $5.6bn in funding, the highest ever recorded. Evidently, investors are eager to commit capital to Africa regardless of the wider economic environment, in the hope of strong growth in the long-term. The future is bright for Airtel’s industry.

Competitive Positioning

Airtel Africa is either the top or second most prominent mobile provider in each country it operates in, with its main competitor being the MTN Group. In relation to market share, Airtel and Globacom control 27% of the mobile carrier market each and MTN is ahead with 37% (as of February 2022 – Figure 9). MTN competes with Airtel Africa for market share in four of the same countries: Uganda, Democratic Rep. of Congo, Rwanda, and Nigeria. Airtel differentiates itself by aiming to stay close to its customers with over 2.5 million retail points (kiosks and branches), and 286,000 SIM distribution outlets. It also employs freelance sales agents, making it easy for new customers to gain access to its services. Airtel is the only listed African telecoms business on the UK stock market, making it the obvious choice for many investors (both institutional and retail), another factor contributing to its competitive advantage from a shareholder’s point of view.

Furthermore, Airtel has partnerships with Standard Chartered and Samsung, aiming to continue to generate new innovative products for its customers. In April 2021 Mastercard also invested $100 million into its Airtel Money segment. The backing by such prominent names further conveys Airtel’s prime position in distributing both fintech and telecom services across Africa. Airtel Money is a high-margin, low-capital expenditure side to the business, helping to boost free cash flow and improve EBITDA and Net Income margins. This is attractive as the cash flows can be returned to shareholders directly via share buybacks or dividends, or indirectly through further investments and debt reduction,.

The extensive capital needed to build cellular towers and operate in the Telecoms market also places significant barriers to entry for any potential competitors. This explains Samsung, Standard Chartered, and Mastercard’s investments in Airtel. With margins continuing to rise year-over-year, this shows the company's pricing power and advantageous positioning, an essential trait in an inflationary environment.

Return Analysis

Having analysed the medium to long-term growth opportunities for Airtel Africa from a Secular, Macro, and Industry perspective, it’s important to analyse Airtel’s market returns to gain a full grasp of what drives the stock. This will play an essential role in valuing the company. The R-squared of Airtel’s stock returns regressed against major equity factors, sectors and indices is shown in Table 2 below.

Through this analysis, it was uncovered that most of Airtel’s stock returns come from the performance of the FTSE 100, as well as UK Telecoms and the UK Value Factor. This makes intuitive sense given Airtel’s operations, so this cyclicality will be factored into my Discounted Cash Flow (DCF) analysis. I found no significant correlation between Airtel’s returns and commodities or currencies and a low correlation to African equities. A regression of Airtel’s returns versus the returns of the UK Telecom Index can be seen in Figure 10, which shows that Airtel has a beta of 0.7 to the index.

Valuation

From the analysis completed so far, there is no doubt that Airtel is in the growth stage of its company/product life cycle, but its stock moves in line with the ‘Value’ factor. This will be accounted for in my assumptions when projecting the company’s revenue growth over the coming years.

When considering the model used to value Airtel, I have chosen Discounted Cash Flow (DCF) and sum-of-the-parts Relative Multiple models. Airtel has been aggressively paying down debt in recent years to reduce its leverage ratio, so a Dividend Discount Model would not accurately reflect the cash flow and investment returns of the business. A sum-of-the-parts model is applicable for Airtel as one segment is a pure telecoms business and the other is closely tied to fintech. For each of these models, I have run grey-sky (recession), base-case, and blue-sky (economic expansion) scenarios, with assigned probabilities of 30%, 50%, and 20% respectively. I have assigned a higher probability to a recession than an expansion scenario as I believe the aggressive rise in interest rates will take a significant toll on the economy in the coming year.

Relative Multiple Valuation

The revenue streams identified have proven extremely robust thus far for the company, with a fall of just 6% during the COVID-19 bear market. Although Airtel Africa is an increasingly profitable company, it trades at 7.2x next twelve months (NTM) earning’s, compared to an industry median of 11.7x. When comparing Airtel against its competitors on liquidity, profitability and valuation metrics, there seems to be no apparent reason for this valuation discrepancy (Table 5 below – All figures NTM).

Airtel’s Return on Capital Employed (ROCE) is well above my estimate of the Weighted Average Cost of Capital (8%), giving me confidence in the long-term sustainability of Airtel’s current growth. Breaking the business down into its two main components, Airtel Telecoms and Airtel Money, I have built a multiple model in order to assess the company’s valuation.

For the Telecoms side of Airtel’s business, I have assumed multiples of 3.5x, 4x and 5x EBITDA under the three scenarios, which I believe is reasonable given the quality of this business and strength compared to its peer group. For Airtel Money, in 2021 management stated that it’s estimated to be worth around $2.65bn on a cash and debt-free basis, and they would be interested in selling off this segment in the future. If it were to be bought over by a large fintech company, such as PayPal, there would be huge upside for the share price. For Airtel Money (FinTech side of the business), I have assumed a higher multiple of 7x, 10x, and 12x EBITDA, as this segment is a higher-growth, lower-capex side to Airtel’s operations. Looking at other transactions in the Fintech space, Nuvei’s recent acquisition of Paya for 13x EBITDA gives me confidence that my forecasted multiples are reasonable and conservative. With investments by Mastercard and Standard Chartered, it seems likely that this segment will be acquired or spun off in the coming years. With these valuation multiples and implied probabilities, I have come to an estimated share price of £1.70, a 57% increase from its current price.

Discounted Cash Flow - Free Cash Flow to Equity Model

Despite Airtel Africa’s countries of operation being in emerging markets, the stock has a beta of 1.1 (5yr monthly), just above that of the market. However, regressing Airtel’s returns versus the FTSE 100 on a reduced sample from February to May 2020 (following the COVID-19 related market sell-off), the beta increases significantly to 1.8. Although this is a telecommunications company with more assured and less volatile profits, due to its emerging markets exposure it can become increasingly volatile in market drawdowns as correlations tend to 1. Given the macroeconomic environment we currently face in the UK, I believe it’s prudent to use a higher beta of 1.5 for my DCF model. Other key assumptions for the model can be seen in Table 6 below.

When projecting the cash flows of Airtel over the next 10 years, my blue-sky scenario forecasts current analysts estimated growth rates of revenue and EBIT for the company, according to Bloomberg. This leads to an implied share price of £1.94, slightly above the median analyst forecast of £1.65. I believe this is a blue-sky case as analysts are often slow to adjust earnings estimates as the economic environment changes, as is evident by the many earnings downgrades witnessed over the last year.

For my base case, I assumed a 2% miss on revenue growth in 2023 due to the current economic slowdown, and 0% growth in 2024 along with margin compression of 3% to an EBIT margin of 30%, before returning to the estimated revenue growth of 8% in 2026. This aligns with my base case view that the UK and global economy will enter a recession in the next year as the aggressive rise in interest rates is reflected in the economy. This gives an implied share price of £1.26, 15% above the current share price.

I have projected continued EBIT growth and margin stability long-term as I believe continued technological advancement and higher standards of living in Africa, will lead to a continued expansion of Airtel’s customer base. I have been conservative with my EBIT margin increase (to 35%), as there could be significant upside in margins if Airtel continues to cross-sell its Airtel Money segment, which experiences higher margins at a lower capex.

Finally, my grey-sky scenario projects a large miss on revenue estimates for 2023 of 6% versus consensus 12%, and 0% growth in 2024 and 2025, alongside margin compression from 33% in 2023, to 27% in 2024 and 30% in 2025. Airtel won’t return to trend growth until 2027. I also assumed a higher beta of 1.7 given Airtel’s beta during the COVID-19 sell-off was at this level. I made these assumptions based on a continued deterioration of economic conditions, and a further bout of contagion selling in the market if continued bad news surfaces following the collapse of several banks in the US. This gives me an implied share price of £0.86, or 22% below the current market price.

Ensemble Method

Bringing both the relative multiple method and the DCF together, I created a triangulated approach for my final valuation. Using the assumed subjective probabilities of 30%, 50%, and 20% for the grey-sky, base case, and blue-sky scenarios, I have arrived at a final price target for the company of £1.48, using a 50/50 split between the two modelling approaches. Modelling each scenario separately I arrive at an implied price range of £1.01 - £2.34 for Airtel Africa. I believe that given my assumptions are more conservative than current Wall Street estimates and more accurately reflect the potential for a larger than currently priced drawdown in markets and recession in the economy, my base case.

Environment, Social and Governance (ESG)

Airtel Africa is very conscious of both its environmental and social impact. It aims to make an impact in rural and poorer areas in the countries in which it operates, opening a free-to-use ICT centre in West Nigeria, for example. Also, 300,000 students have benefitted from Airtel Africa’s free internet services which have been rolled out across African nations. Furthermore, there are many indirect benefits of the company’s operations. For example, its 4G voice and data technology is used by the Kenya Wildlife Service to better monitor and protect the poaching of black rhinos.

On a governance level, the average management tenure is five years. The only institutional owner which holds above 8% of shares is Bharti Airtel with a 56% stake, aligning Airtel Africa's values with overall enterprise aims. This can only be good for shareholders. Executives’ pay is also linked to broader employee pay, so any increase should not far exceed the overall employee base increases. One issue, however, is government corruption in some countries Airtel operates in. Countries such as Chad also have relatively high levels of crime. This cannot be mitigated against but should be monitored as this may affect operations for Airtel. As with many emerging markets, these are the risks investors assume when investing in such markets.

Risk Factors

The most prominent risk factor through 2023 and beyond is the potential for a global recession as inflation remains significantly above the central bank’s target of 2% and interest rates rise aggressively. Due to higher inflation expectations, the correlation between equities and bonds has turned positive, and both asset classes have experienced significant drawdowns over the last year. The stickiness of inflation is a major concern going forward. If inflation does not continue to fall towards the target of 2% in Western nations, then interest rates may have to stay higher for longer, to the detriment of the economy. Traditionally, such ‘risk-off’ environments have led to significant underperformance for emerging markets. If a global recession does begin, Nigeria (being Airtel’s largest market) could be impacted significantly as oil exports account for about 10% of GDP. Although we may only be at the beginning of this bear market, emerging markets have not performed as poorly as in previous cycles. Also, due to the limited geopolitical risk and benefits from the China reopening (previously mentioned), emerging markets may not be as hard hit.

It must also be understood that the countries in which Airtel Africa operates are historically at high risk of default which could have a serious impact on the currencies in which earnings are received. Furthermore, rises in the US Dollar will cause short-term pain or local macroeconomic issues. Note also that while many of these countries have historically suffered from poor economic management their debt-to-GDP ratios are now far lower than in the West, for example, Nigeria with 38% and Chad with 45%. Even the highest, DRC on 77% is far lower than the average western nation.

Of course, none of this is a guarantee against default (being unable to pay back debts), which African nations have been adept at doing in the past. However, with the current conditions across Western nations, if interest rates are not held higher for longer, financial repression is the only other option. This means Western countries will be devaluing their currencies at a higher level than in the past. This will hurt people who save money in bank accounts and will encourage investors to move money into emerging markets.

From an infrastructure standpoint, there is a lack of access to electricity in rural areas of Africa. However, as the population becomes increasingly wealthy and educated, and as governments increase spending in line with GDP growth, this should change. Also, innovative companies such as Orange SA are tackling this problem by offering solar kits. This should help overcome such hurdles.

Alongside this, personal identification documents have been an issue across African nations. 45% of the population of Sub-Saharan Africa does not have an official identity document, and the Nigerian government had prevented any new customers from obtaining a SIM card from Telecoms companies like Airtel until they had a National Identity Number (NiN). The identity issue will continue to be a roadblock that Airtel will have to overcome, but it is not an idiosyncratic risk and is something that must be dealt with by all companies in the industry. Continued insider buying of Airtel Africa’s stock by management and Bharti Airtel gives me further confidence that they can overcome these issues. There has been no insider selling since the stock was listed in 2019.

Finally, exacerbated moves in currency markets are also a cause for concern for Airtel Africa. For the nine months to 31st of December 2022, adverse FX moves led to a $184 million loss (inc. Derivatives). However, taking a wider view $184 million is not a huge impact on overall EBITDA of $1.9 billion. The company hedges foreign currency-denominated payables and loans through derivatives to reduce this risk which should mitigate against significant losses.

Conclusion

The remarkable events that have transpired since the COVID-19 pandemic have fundamentally changed the investment landscape. The rapid global adoption of technology will have lasting effects on our lives and given the enormous technological advances made in the West, it’s only a matter of time before emerging markets catch up. Urbanisation is increasing as more educated individuals move to bigger towns and cities in search of work. This will increase the need for telecommunications companies to facilitate the activities of an increasingly prosperous continent. These exciting prospects for this continent have been confirmed further by companies in other industries such as Diageo which now operate there.

The boom of global fiscal spending over the past decade in Western nations is a double-edged sword. Because of the pandemic, there has been a huge shift toward technology adoption, which will have huge benefits for companies like Airtel Africa which operate in this market. However, this spending has led to an inflationary environment. In this ‘new normal’, companies with real assets and reliable cash flows (people need to use phones/bank accounts) are favoured over technology companies with high prospects and no profit. Therefore, I believe Airtel Africa PLC is a lower-risk alternative to profit from the future of technology and 5G.

Action:

Selling BioNTech at a 36% loss

Adding a 5.2% position in The Biotech Growth Trust (BIOG.L) at £8.43

Adding a 5% position in Airtel Africa PLC (AAF.L) at £1.23

***Portfolio Return Year-to-date: -4.6% vs S&P500: 11%***
***Total Return since inception (20/09/2021): -1.8% vs S&P500: -2.8%***

Let me know your thoughts by emailing me at thesparknewsletter@gmail.com

See you next time,

Peter

Disclaimer

This communication is for informational and educational purposes only and should not be taken nor used as investment advice, as a personal recommendation, or solicitation to buy or sell any financial instrument. This material has been prepared without considering any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or structured product are not, and should not be taken as, a reliable indicator of future performance. I assume no liability as to the accuracy or completeness of the content of this publication.