South Africa - Institutional
Talking revolutions in Africa
01 February 2013 - Peter Leger
One of the hallmarks of living in the 21st century is just how many revolutions we get to witness. We’re not talking about political revolutions, which thankfully are becoming less and less fashionable. We’re talking everyday revolutions that impact how we live, how we relate and, mostly, how we communicate.
Take the ubiquitous ‘Like’ button that has become an icon of Facebook. Many high school English teachers tried to delete this drab word from our expressive vocabulary, yet in less than three years, this button articulates acknowledgement for over one billion Facebook users. And it’s not only in technology. Think of the joy of experiencing a Nespresso coffee, the fashion blight of Crocs footwear and many other examples of innovation where one would have thought not much new could be done. Yet it can.
Many economies in Africa provide a raw canvas for innovation, where the adoption rate of technologies that work can be simply eye-watering. The solutions are often relatively simple, and frequently result in the question being asked: Why don’t we do the same in developed economies? In poll position is the mobile money product M-Pesa in Kenya. Since its launch in 2007, just less than half the Kenyan population today have an M-Pesa account and the trans-actional value of transfers annually is larger than 30% of the country’s GDP. This is mostly consumer-to-consumer and only now we are seeing business-to-consumer transactional volumes picking up. In South Africa, we have quickly become used to our world of internet banking and credit cards. Few of us remember having to physically enter a bank for transfers and deposits; we now reluctantly handle cash and cheques. And we think we’re cutting edge. Yet, should I transfer cash to you electronically, it only appears the next day, or the day thereafter. My credit card transactions mysteriously ferment in the ether before reflecting on my statement. Not so for the average Kenyan using M-Pesa. Payments reflect immediately, and the $10 transferred a minute ago, can be winged on to the next person, and the next. Money velocity is fast and available.
Allow me to share the story of a Zimbabwean fisherman who uses mobile cash. During the day, he uses his mobile company-sponsored solar lamp to charge his cell phone (an uncharged phone won’t buy airtime). At night, he is on his boat, fishing, using his lamp to guide his way. As he lands his catch, he sends text messages to his potential customers notifying them of what is available. While he is still on the boat, they electronically pay him for what he has caught and allocated. When the orders and catch are matched, he returns to shore having been paid in full. He hands the fish over for delivery and returns home having wrapped up the fishing. When he awakes, the proceeds from his night’s fishing are fully available. An interesting story, you might think, but how relevant is this to making investment returns on the continent? We think it is very relevant as we explain below.
New ways of doing things can be devastatingly disruptive. Perhaps not in one or two years, but as momentum builds, change accelerates. We often ask ourselves, which are the legacy businesses that have grown lazy and comfortable that are most exposed? Which businesses are making super profits purely from where they have come from, and not from the value they are adding. In poll position are the banks across the continent.On the whole, we think these are poor to below-average businesses. The generic model for most banks is as follows:
- Build a large branch network that can be used to collect deposits that, as the bank, you pay nothing for.
- Take a large amount of the free depositors’ money and invest it in government bonds at a high yield. Government bond yields generally are very high across the continent.
- Take some of the deposits and do actual bank lending to corporates.
- Take some of the deposits and provide unsecured lending to consumers at very high interest rates, and deduct the repayment from the borrower’s employers where the risk of non-payment is virtually zero.
So while the branch network results in a very high fixed cost base, the difference in the interest rate earned (on the government bonds and unsecured lending), against the price paid for the deposits that allow for this lending, is high. In fact, it’s amongst the highest in the world at over 10%. To put it into simple terms, it’s like offering to look after a friend’s R1 000 for no interest to be paid, and then depositing that money into a secure bank account and earning 10%, which you pocket completely. We think this situation cannot last and bank profitability will continue to erode.
Returning to Kenya and talking to some simple metrics. The top five banks fund their business through taking very cheap deposits of $10 billion. On these deposits they earn an average 10% net interest return by lending the money to government, corporates and unsecured consumers. Very easy money of $1 billion. Up until recently, M-Pesa was only a transactional tool, akin to a wallet. Users only transfer enough for day-to-day needs as it was not backed by a bank. Think of what you carry in your wallet – only enough for your day-to-day needs. Recently, M-Pesa has added a fully fledged bank account. They can now target the $10 billion in cheap deposits, and chase after the easy 10% earned – all this without the cost of a branch network, which means they can pay a higher interest rate for deposits and still make much more money than the banks. Making modest assumptions that M-Pesa can win 10% of the cheap deposit base, and cause the margin earned by the banks to weaken (due to having to compete for deposits), the easy money profit pool available to banks would drop by 20% – 30% while the cost base would still be there. Consequently, bank profits would decline significantly more than 20% – 30%.
At Coronation, we put a lot of time and thought into what the quality of earnings of a business looks like when investing. Yes, the business might make a lot of money off very little equity, but just how defendable and value-adding is the earnings stream? In respect of the above example, we think for many of the banks the earnings stream is of low quality. Therefore, in doing our valuations, we have to be appropriately cautious regarding the rating used. Currently, a fascinating banking experiment is under way in Kenya. It might take years to play out, but as far as a financial revolution goes, it’s happening at warp speed.
PETER LEGER joined Coronation in April 2005 as a portfolio manager. He has 14 years’ experience in the financial markets in Africa as both a portfolio manager and research analyst. Peter currently heads up the Africa ex-SA unit for Coronation, which includes the Coronation All Africa and Coronation Africa Frontiers funds.
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