Safaricom: Evaluating downside risks
Aikya has a twin purpose: to generate healthy long-term returns for our clients with strong downside protection and make a significant impact when it comes to addressing the sustainable development challenges facing Emerging Markets. We aim to achieve both of these purposes by investing in high-quality companies that are responsibly managed. We believe that companies not aligned with a social purpose will eventually be exposed to regulatory and other downside risks. In our view, such companies are unlikely to generate healthy long-term returns.
Before accepting a company onto the Aikya Quality List, we conduct a thorough evaluation of the quality of stewardship, franchise, and financials – stress-testing for downside risks that might not be immediately obvious.
Most investors looking to invest in high-quality and sustainable businesses in Emerging Markets start their assessment by analysing the franchise and the financial statements – but often miss the risks associated with questionable stewardship. For example:
Alibaba was widely understood to be a high-quality and sustainable company, with the appearance of a business that empowered SME merchants while generally contributing to technology and financial infrastructure in China. Its dominant e-commerce franchise delivered healthy ROEs for several years, to the contentment of investors. We believe that the competitive advantage was explained mostly by the management’s early links to the Shanghai faction of the CCP. As the political winds have changed, the business has proven to be less resilient than first perceived.
Chinese Education companies were understood to be high return, high growth businesses that help educate the Chinese youth. They were held by many Emerging Market investors who claimed to favour high quality and sustainable investments. However, these companies failed the social purpose test: there was scant evidence that these businesses were improving education outcomes, and there was plenty of evidence that they were instead contributing to higher costs and anxiety levels for parents. This exposed the education companies to a regulatory risk that eventually materialised, wiping out the many years of high returns and growth for shareholders.
Downside risks are not always obvious and often lay dormant. They may be masked by marketing and greenwashing, a seemingly dominant franchise, or healthy-looking financials. In this quarterly, we will demonstrate how our process attempts to uncover these dormant risks using the case-study of Kenyan telecommunications and mobile-money player, Safaricom.
Safaricom is one of the most profitable companies in Africa. It is a Kenyan mobile operator best known for being the owner of m-Pesa, the country’s leading mobile-banking service. The shares are held by the Government of Kenya (35%), Vodafone’s African subsidiary, Vodacom (35%), and UK-listed Vodafone (5%), with the remainder being free-float (25%).
m-Pesa has played a significant role in improving financial inclusion within Kenya and is often cited as a best-practice example for other micro-lending institutions globally. It is no wonder that this seemingly powerful combination of doing social good in a highly profitable manner should attract the attention of “ESG” minded investors. Safaricom has returned 16% annualised returns (US$) since its listing, reflecting its spectacular success over the years.
On first impressions, Safaricom appears to have the hallmarks of a high quality and sustainable business. Our comprehensive evaluation, however, might suggest otherwise.
Quality of Stewardship
There are two basic questions we would recommend Emerging Markets investors keep in their toolkit when evaluating stewardship.
First, can a business’ competitive advantages and high returns be explained innocently, i.e. without strong political connections? Second, does the company truly solve a social problem, and can we tangibly measure the positive contributions made?
Failure to get satisfactory answers to these questions should alert us that a business may not be as sustainable as it first appears. In our experience, it then becomes a matter of time before a seemingly strong franchise loses its lustre.
Safaricom was established in 1997 as a wholly-owned subsidiary of state-owned Telkom Kenya and was fully privatised in 1998 after President Moi received pressure to do so from international donors.
In May 2000, UK-based Vodafone was allowed to acquire a 40% stake in Safaricom (official foreign investments ceiling was 30%). It was later revealed that 12.5% of Vodafone Kenya was given to an obscure Guernsey-registered company called Mobitelea Ventures in exchange for “advice and assistance on securing the investment”. Mobitelea’s owners are widely understood to include Moi’s son, Gideon and several heavyweights from the ruling political party (KANU).
Moi’s successor, Uhuru Kenyatta, lost the 2002 elections to Opposition Leader Mwai Kibaki’s Rainbow Alliance, which included several senior KANU members who had defected from Moi. It was therefore under the Kibaki administration that the Safaricom IPO took place in 2008. The IPO was conducted outside the privatisation protocol, and several irregularities were reported. Shares were distributed to “faceless nominee accounts” across the entire political spectrum represented by the Rainbow Coalition. This ensured that Safaricom would enjoy widespread support in the highest echelons of Kenyan politics; the Moi faction, as well as the Kibaki and Rainbow Alliance political elites were onside. Sadly, keeping the politicians happy came at the expense of 860K retail investors who received a fraction of their subscribed shares.
In a further twist to the political backdrop, the 2008 elections were a violent and messy affair, and although Kibaki was re-elected, Kofi Annan had to broker a power-sharing agreement. The Opposition Leader, Odinga, was appointed to the newly created role of Prime Minister, and he did enough to delay the IPO until his appointment, to ensure that his faction was also accommodated into the IPO process. The other opposition candidate, Musyoka, was appointed as Vice President whose key ally became the Telecom regulator (ICT Minister), with oversight responsibility of Safaricom.
Later in 2008, Kibaki appointed Kenyatta as his successor, and in order to keep him within the patronage network of Safaricom, the banking partner for m-Pesa was chosen to be Commercial Bank of Africa (CBA), which was owned by Kenyatta’s family. Through the partnership with m-Pesa, CBA has catapulted from a mid-tier bank to one of the most profitable banks in the country, with its accounts growing from 35 thousand to over 10 million. This guaranteed that the otherwise powerful banking lobby would not hinder the adoption of m-Pesa. Kenyatta’s Jubilee coalition won the 2013 elections – which was conducted using a Safaricom-developed VPN and Safaricom sim cards at polling stations. The close ties of Kenyatta and Safaricom became an inconvenient truth when accusations of voter fraud arose. In this context, it is unsurprising that Safaricom has continued to enjoy support from Kenyatta’s administration, who awarded the company a generous national surveillance contract.
In short, Safaricom appears entrenched within the mechanisms of Kenyan politics. Viewing Safaricom through this lens, it is easier to understand some of the regulatory advantages that the business experienced.
For example, on monetary policy grounds, why was Safaricom not regulated by the central bank, as is the practice with most other countries? Instead, Safaricom is regulated by the Communication Authority. This meant that Safaricom was able to establish its agent network without being subject to regulatory burdens such as KYC requirements – making their agency network expansion cheaper and easier, when compared to traditional banks.
Also, why was Zain, the second-largest mobile-network operator, blocked from launching a rival service to m-Pesa for two years despite applying for a license just a month after Safaricom and arguably having a comparable product with more features and a strong banking partner (Standard Chartered)? It seems the Kibaki administration was more committed to Safaricom’s success than pursuing mobile money.
One might expect that the presence of Vodafone as a major shareholder should bring some Western-style checks and balances and ensure that such political connections and kickbacks are not tolerated. Unfortunately, Vodafone’s track record in Africa does not provide comfort. Vodafone has been accused in the past of lending money to locally connected individuals to fund their purchase of shares in the locally listed Vodafone entities in exchange for political favours. An investigation into this topic detailed arrangements made by Vodafone in Tanzania and Mozambique similar to those made between Vodafone and the Moi administration in Kenya.
From our perspective, we consider Safaricom to be a politically influential company which has used its patronage network to resist competition and forge a dominant position in mobile money and mobile telephony. Underpinning Safaricom’s seemingly stable position is the diversity and breadth of political involvement.
When thinking through the question of what is the true purpose of a business, it is not sufficient to look at part of the picture nor take the purpose statement at face value. There is no question that m-Pesa has been a remarkable success story for financial inclusion: financial participation has gone from 27% of the population in 2006 to over 80% since the launch of m-Pesa.
We have already established that Safaricom’s success is largely the result of favourable treatment by politicians and regulators (or rather the lack of appropriate financial regulation). Judging from Safaricom’s corporate actions, we believe that the true purpose of Safaricom as a corporate entity is to maintain its dominance at all costs in order to continue greasing its patronage network. This has meant that management teams have engaged in business activities that go against the stated purpose of contributing to sustainable living so long as these activities ensure handsome dividends for shareholders (including special dividends during election years!).
m-Pesa’s dominant position and anti-competitive actions – specifically its agent exclusivity, high fees on its infrastructure to other payment providers and limited interoperability (Safaricom charges 4x the standard fees to transfer cash to a user of a rival network) – suggests to us that management is not focused on financial inclusion outcomes but instead preoccupied maintaining m-Pesa’s dominance.
Further, having provided access to previously unbanked and remote populations, m-Pesa now has the responsibility to ensure that this vulnerable group is not exploited. This is where the overdraft facility, Fuliza, which was launched in 2019, raises some concerns. Fuliza targets the especially vulnerable who have run out of digital credit and charges them >300% interest per annum (cleverly advertised as just 1% per day). Even m-Shwari, the product in partnership with Kenyatta’s CBA, offers micro-loans with >100% annualised interest rates (disguised partly as facilitation fees). The regulatory protection offered to Safaricom has paved the way for other even more usurious loan apps with misleading labelling, which has created a spike in indebtedness amongst the Kenyan population. In addition, most of these apps have not catered to data privacy concerns. Safaricom was sued in 2019 for leaking the information of more than 11 million customers to the black market. In the absence of appropriate regulatory oversight, Google stepped in and started preventing the most aggressive lenders from accessing their platform. Such unchecked unsecured lending has come with aggressive and unethical debt collectors and has caused social anxiety for those trapped in debt.
The proliferation of mobile phones and wide adoption of m-Pesa has also promoted the growth of the online gambling industry in Kenya. Between 2013 and 2018, Kenyans increased their gambling spending from $20m to $2B – a 100-fold increase. 96% of gamblers in Kenya are using their mobile phones to do so. By 2019, 7% of m-Pesa’s revenue was linked to gambling and it prompted tighter regulations.
Even within telecom services, Kenya has one of the most concentrated market structures in the world and Safaricom’s dominance has meant that the average rates paid for by the Kenyan consumer (ARPU) are much higher than countries at a similar stage of development.
How did a development-world darling and case-study for financial inclusion stumble into becoming a micro-lender with usurious practices and an enabler of the gambling industry? In our opinion, the management’s actions and choices are not consistent with an organisation whose purpose is to improve sustainable living for Kenyans. Rather, it seems to be a classic rent-extraction construct and such companies usually lose the social goodwill within the community they operate in.
Quality of Franchise and Financials
Safaricom’s business is considered to be a high quality one because of its dominant market share in both telecommunications and mobile money. The dominance in each business is mutually reinforcing, which has made for an enduring competitive advantage. However, looking at this dominance through the lens of political patronage and questionable social goodwill brings up the lingering question of a potential break-up of Safaricom.
Kenya’s Competition Act states that a company with greater than 50% market share should be declared as dominant. Airtel has recently dialled up their concerns to the parliament on this point. In 2017, the regulator had engaged an independent consultant to answer the dominance question and their leaked report had recommended that Safaricom be broken up as the two businesses were mutually reinforcing each other’s dominance and preventing smaller players from competing. Regulators have previously looked into whether Safaricom should provide roaming on its network to its competitors in a regulated tower sharing arrangement.
Even if we could get comfortable with how Safaricom got here, the Kenyan economy is much too reliant on one company: Safaricom controls 87% of telecom revenue and 99% of mobile money deposits. More than half of Kenya’s GDP is transacted on Safaricom-owned services and so when there are outages at m-Pesa, it is very costly to the economy.
Safaricom management has also previously argued that a break-up will do nothing to the underlying business. But this claim is rather dubious as their market share in the telecom segment is heavily supported by the ubiquity of m-Pesa and the imposed limits on interoperability. We can see this evidenced by a steady market share in the telecom segment despite rapidly falling customer satisfaction scores (as measured by NPS).
Safaricom has so far managed to dodge the break-up and avoided being labelled as dominant. But what if the political winds change and the ruling party stops supporting Safaricom? This is not an outlandish thought and Safaricom has had its share of opposition backlash. As noted earlier, it was important to have Kenyatta onside, as he had vested interests in the banking lobby and could have put a spanner in the works for m-Pesa. After the 2017 Presidential elections, the opposition leader, Odinga, had called for a boycott of Safaricom. So far, Safaricom has come out unscathed as the patronage network has managed to accommodate all the politicians that have made noise against the company. But is it reasonable to believe that competing interests will not arise at some point? What if a politician who gains control of the parliament has a vested interest in one of the competitors? For example, Equity Bank partnered with Airtel to launch Equitel. Safaricom tried to block Equitel by raising legal and security challenges. However, Equity Bank is also backed by powerful Jubilee coalition members and so not only did they manage to launch Equitel, they also got the regulator to ban the practice of exclusivity in agency network contracts. M-Pesa has been forced to respond with price-cuts. While Equitel has not managed to dislodge Safaricom’s dominance, it is not difficult to see how a disruptive competitor could emerge under the right political circumstances.
Safaricom generates high returns and has grown well over the past several years and m-Pesa’s contribution to financial inclusion is well understood. Hence, it is no surprise that many fund managers who market their funds as either “high quality” or “sustainable” hold a position in Safaricom.
A more holistic assessment suggests that Safaricom’s strong position results from a political patronage network and is hence vulnerable to political change. Furthermore, Safaricom’s purpose today appears to be aligned with defending its dominant position and contributing cashflows to its patronage network at all cost, rather than their stated purpose to contribute towards sustainable living. Several choices that Safaricom management teams have made over recent years indicate a willingness to set aside social obligations in exchange for shorter-term profiteering. Such actions risk losing their social license to operate.
All of this means that there are dormant risks to owning Safaricom, which have the potential to impair the franchise and financials. For these reasons, we do not consider Safaricom to be a high quality or sustainable company and exclude it from the Aikya Quality List.
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