"Abuse or not?"

[JSE:VOD] Vodacom

Sector: Mobile Telecommunications

Share price: R154,30 

Net shares in issue: 1,7 billion

Market cap: R263,3 billion

Forward EPS: 970 cents

Forward PE: 15,9x

Forward DPS: 873 cents

Dividend yield: 5,6%

EV/EBITDA: 8,0x 

Fair value: R152,00 

Target price: R160,00

Trading Buy and Portfolio Buy  

Mark Ingham's Fundamental analysis 

What you need to know:

TWEET THIS ANALYSIS

The Competition Commission is investigating Vodacom for alleged abuse of market dominance in securing a mobile services contract with government. Is this sufficient reason to avoid the stock? The short answer is probably not, as I explain. In fact, the stock has retreated quite nicely from recent levels around R180 and offers opportunity for fresh money.

This contract is worth R5 billion and lasts for four years and was awarded last year, essentially an extension of an existing contract. What is odd is that the Competition Commission was involved with the eighteen-month tender process. Vodacom just so happened to offer a good deal.

Telkom put up a fuss, indicating they were going to sue Treasury on procedural, substantive, and moral grounds – the latter to do with the fact that Vodacom is majority owned by the UK parent and thus a chunk of cash flows offshore.

On the procedural issue, which is more to do with government than Vodacom, there may be something to answer. The procurement officer would likely need to reach out to the twenty government departments that the officer was contracting for. But this is not what the Competition Commission is targeting and it is does not have application to the Competition Act.

Whether there is an incentive for the contract is something else and the Commission says that the exclusive contract may constitute an exclusionary abuse of dominance, referring to section 8 (d) of the Act.

This section of the Act says that there is a breach of the Act if a company required or induced a customer to exclude a rival; refused to supply goods to a rival when it would be feasible to do so; sold goods or services conditional on the purchaser separate goods or services not related to the contract; required a buyer to accept a condition not related to the contract; sold goods or services under marginal or variable cost; secured a sole supply of intermediate goods needed by a competitor.

To suggest that Vodacom would have been complicit in any or all of the above is stretching things a bit.

The Competition Commission is required to get evidence and decide if there is a basis for complaint.

Should there be some basis, then they refer it to the Competition Tribunal. The Competition Tribunal can either throw it out or levy a penalty. If it gets that far a company is able to appeal to the Competition Appeals Court.

There appears no evidence that Vodacom is in breach of the Competition Act. Competitors may be cheesed off but that is another matter.

Also, there does not appear to be any particular incentive that benefits all government departments equally unless there is an extension clause that prohibits rivals like MTN and Telkom from competing on a level playing field.

Saying that this four-year contract, which if invoiced annually at R1,25 billion would equate to 1,5% of annual revenue for Vodacom, is entrenching a dominant position, distorting of competition, putting up a barrier to entry, and making others lose market share is also a bit of a stretch.

If, let’s say, Vodacom is a better competitor and others lose market share, that is not against the Act. The Competition Act is in place to police underhand actions not prevent a good business getting ahead. You can’t fall back on the Act to get a competitor penalised for being a stronger competitor.

We’ll see what the Competition Commission unearths but on the face of things Vodacom does appear to have good grounds to be surprised by the investigation. The company has said it’ll cooperate.

Recommendation:

TWEET THIS ANALYSIS

Vodacom should meantime be regarded on its fundamental commercial merits. The company does have an edge on its three main rivals. Telecommunications companies are not high earnings growth investments, at best Vodacom will grow earnings per share at a compound rate of 5% over the coming three years. But the company does have a policy to pay out 90% of earnings and so there is yield attraction at a reasonable price with the forward gross yield 5,6%.  

Trading Buy and Portfolio Buy maintained.    

Vodacom share price in ZA cents

Vodacom and MTN based to 100 over three years

Wishing you profitable investing, until next time.

Mark N Ingham     

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