Safaricom post IPO-

Egypt Mobile last year made a net profit of Sh20 billion on revenues of Sh76 billion and is today valued at Sh213 billion on the Cairo Stock Exchange.

Sudatel made a net profit of Sh14.2 billion on revenues of Sh40 billion and has a market value of Sh96 billion, which is almost double Safaricom's despite being 35 per cent smaller in size (revenue wise).

Looking deeper, investors are currently valuing the revenues of mobile phone companies at a multiple of 3.1 in the sector. On sales to value basis, investors are buying Safaricom at a fair value of Sh3.22, compared to the market rate of 3.1.

On valuation metric that is bound to cause a lot of excitement-but its effectiveness, other than that of illustration is equivalent to a crude weapon-is price-to-earnings multiple.

On this measure, frontier market investors are picking Safaricom for a song. Going by the earnings released last week, Safaricom will start trading at a trailing multiple of 3.6, which is way below the sector average of 15.09.

Safaricom CEO Michael Joseph

If we were to make a bold assumption with the expectation that smart investors will spot this gap and that Safaricom's management keeps the till cranking at the current pace or more, if the company valuation was to converge at the current sector average, the share price could hit Sh21. On a sales to revenue measure, the price would be in Sh15 range.

One thing that an investor is bound to ask is that beside currency outlook (which is currently outperforming), why should they pay more for Safaricom which will have a market cap of Sh200 billion, when Egypt Mobile which is slightly bigger than the Kenyan operator would valued at Sh213 billion?

It seems like only some little arbitrage opportunities exist here.

For an investor looking inside, when Safaricom's ability to make money is compared to its peer group of blue chip Kenyan companies, investors seem to be buying the mobile carrier on the cheap. The trailing p/e ratios of these firms are in the range of 17 to 42, compared to 3.6 for Safaricom.

Again, it is difficult to explain why investors are willing to pay a p/e multiple of 41 for Equity Bank, 19.67 for Barclays Bank and 17 for Standard Chartered compared to 3.6 for Safaricom, yet its potential for faster profit growth is bigger.

One reason why investors are willing to pay higher multiples for blue chip stocks in Safaricom's peer group is based on the fact that firms like Barclays, Bamburi, EABL and StanChart are rock solid firms that have delivered good profit growth and a big dividend pay out over nearly a decade now.

Safaricom on the other hand started paying out hefty dividends of Sh4 billion, which is 29 per cent pay out the previous year. But even with free cashflows of Sh10 billion annually, this is a business that can be cash hungry and very price sensitive. Investors are likely to punish Safaricom for this risk.

Then, even with a good dividend payout, the number of people sharing at the pot-840,000 of them is quite a multitude, which leaves everyone with a small chunk. This means that for retail investors, it will take a long time for Safaricom to make huge profits that will yield a big payout. This share is for big investors.

The only saving grace is capital appreciation, which some analysts doubt.

In an interview, Mwangi Kimani, an independent financial analyst in Nairobi said that he did not see why the price per share was as high as Sh5 as he sees little prospects for organic growth. He is convinced that the Kenyan cell phone services market is almost saturated while the entry by competitors like Econet Wireless and Telkom would continue to push margins down on mobile calls. As it is now, there is a raging price war between Celtel Kenya and Safaricom.

Buying a rival in a neighbouring country such as MTN Tanzania could improve Safaricom's future fortunes, but the anchor shareholder, Vodafone would not be interested in geographical expansion in markets it already has a presence. Mr Kimani recommended a price of Sh2.50 per share for the Safaricom IPO.

"Well 30 cents per Sh5 investment is a return of six per cent on capital. That seems a bit low for a country with a projected inflation rate of at least 16 per cent over the next few years," said Mr Kimani.

He added that even diversification to data services may provide only a little headroom. "Data services, unlike mobile telephony, are not governed by high capital entry licenses, so smaller players like Access Kenya can easily provide M-pesa like services in conjunction with banks, using [other] highly efficient technologies (Wimax etc.)"

Although he is generally positive about the future growth prospects of the company, Humphrey Gathungu, a manager at Stanbic Investment Management Services, said that he did not expect the dividend payment for the Safaricom shareholders to go beyond 40 per cent in the next one to three financial years but this could go up to 60-70 per cent in the next four to five years.

The reason the company has to retain so much in earnings has all to do with need to expand especially in view of the fact that there will be fierce competition in the industry. This factor alone could keep the price of the share subdued for several years

A factor that has always suspected in the stock market but never proved and could influence prices after trading begins is speculative attacks from well-financed institutions or individuals. Such attacks could have the share make wild swings as has occasionally been seen on some counters.

Mr Gathungu pointed out that though there are cases such as Telkom Egypt and Telkom South Africa where the price was at about 1.7 and 2.21 times the book value respectively, there were also a number of other cases in which the price of a firm far exceeded the book value per share of the firm noting for example that Orascom of Egypt, a telecommunications firm, was at 7.5 times the book value taking into account its 2006 earnings. He also pointed out that Stanbic Uganda had seen its price to book value rise by even ten times.

Another success story with regard to price-to-book value is MTN of South Africa, which has been known to trade at over six times the book value.