Flash Equity Report /
Kenya

Safaricom: Ruling on Airtel-Telkom merger poses short-term competition risk

  • Airtel and Telkom win appeal overturning key conditions set by the competition authority on their impending merger

  • The merged entity retains its entire spectrum, bringing competition risk for Safaricom in mobile data in the short term

  • We retain our Safaricom target price but downgrade our recommendation to Hold due to recent price movement

Tracy Kivunyu
Tracy Kivunyu

Equity Research Analyst, Telecoms

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Tellimer Research
6 May 2020
Published byTellimer Research

Mobile service providers Airtel and Telkom Kenya this week won their appeal against conditions imposed on their merger by the Competition Authority of Kenya (CAK) in December 2019. We show the initial conditions given by CAK below, highlighting changes made by the tribunal in bold, and reflect on the impact on market leader Safaricom:

  1. Upon expiry of the term of the merged entities' operating license, the spectrum in the 900MHz and  1800MHz  acquired from Telkom will revert back to the Government of Kenya.
    Update: Airtel and Telkom have now been allowed to keep their existing network licenses in accordance with conditions imposed by the CAK, including the 900MHz and 1,800MHz spectrum owned by Telkom.
  2. The merged entity, or part of it, is restricted from entering into any form of sale agreement within the next five years. However, in the event of any indication the firm is failing within the period, the CAK will conduct a forensic audit at the cost of the merged entity. Update: The tribunal has lifted the prohibition barring the merged entity from entering into commercial agreements within the first five years (including sale agreements) but limits the entity from being taken over or floating more than 40% of its stake.
  3. The merged entity must honour all the existing contractual terms with government entities.
  4. The merged entity can only access the 4,204km of fibre managed by Telkom on behalf of the government at current market rates and no preferential rates will be given to them (unless as provided for in existing contracts).
  5. The merged entity will not enjoy any preferential access to use capacity on the 4,204km of fibre managed by Telkom on behalf of the government. Update: Airtel and Telkom have been allowed to negotiate terms of access relating to the 4,204km of fibre managed by Telkom on behalf of the government of Kenya.
  6. The merged entity must ensure that at least 349 of the 674 employees of the target are retained as follows: (a)  120 employees by the merged entity for a period of two years from the date of the implementation of the merger; (b)  114 employees by Telkom Kenya Ltd for a period of two years from the date of the implementation of the merger; and (c)  115 employees to be absorbed by the network partners of the merged entity; and
  7. The merged entity must annually furnish the CAK with a detailed report on compliance with the above conditions. Update: The tribunal has revised the compliance rules by allowing the merged entity to furnish the CAK with an annual compliance report on merger conditions for up to two years. 

Competition risk for Safaricom to increase in the short term due to merged entity's spectrum share

The combined entity will have similar spectrum capacity to Safaricom, despite having a combined subscriber market share of just 32% (compared with Safaricom's 65%) in December 2019.

Table 1: Spectrum distribution in Kenya 

800MHz900MHz1800MHz2100MHz
Safaricom
17.5 MHz20 MHz10 MHz
Airtel
10 MHz10 MHz10 MHz
Telkom5MHz7.5 MHz10 MHz10 MHz
Source: CAK

Airtel and Telkom network licences will be due for renewal in 2025. We  expect the merged entity to be aggressive over the next four years (assuming the merger is concluded this year), especially in mobile data pricing, to attract customers. Looking at the proportion of spectrum compared with number of subscribers, the merged entity should be able to sustain a strong data offering without worrying about the impact on its network quality.

In addition, Airtel and Telkom are both loss making in Kenya. Ramping up subscription market share will be a priority if they are to attract investors. 

However, we note that the two telcos are still lagging in access to the burgeoning mobile transfers and payments market, with Safaricom dominating on revenue share. Given that Safaricom has strong cashflows and steadily invests in network quality, it is likely that Airtel and Telkom will only be able to be aggressive in the short term due to cash flow constraints.

Merger not out of the woods yet

The Ethics and Anti-Corruption Commission (EACC) in November 2019 stated that it had not approved the merger between Airtel and Telkom, and was still investigating the sale of the latter's shares to France Telkom.

We also await feedback from the CAK regarding these developments.

Maintain target price, downgrade to Hold on price moves

Safaricom today closed at KES30.45, compared with our TP of KES31.24. This is 16% up from a low of KES26.20 on 8 April. We thus downgrade our recommendation to Hold.