Conversation with Joint Chief Executive Officers

The momentum in Group earnings continues

Mark Levy and Brett Levy   We continue to implement our strategic objective of distributing electronic tokens of value in emerging markets.
Mark Levy and Brett Levy
Joint Chief Executive Officers

Blue Label is a distributor of digital merchandise

We continue to implement our strategic objective of distributing electronic tokens of value in emerging markets. We have strategically expanded our range of products and services, while simultaneously increasing our distribution footprint. The speed of creating, launching and delivering new products is one of our key strengths*.

* To reach one billion users, telephones took 110 years, TV took 49 years, mobile phones took 22 years. The internet took 14 years and smartphones took eight years. With every new technology introduced, reaching one billion users takes half as long as the previous one. Source: Oxigen Services India/Wikipedia

The importance of distribution is that the operator of the last mile of the channel determines merchandising techniques and pricing, as the point-of-sale (POS) terminal is located in the last mile of the channel and in most instances is placed there by Blue Label.

The distribution of physical and virtual tokens is achieved through the roll out of various technologies, including POS devices, and is akin to a virtual delivery system, with our proprietary technology as the enabling carrier for transactions. Incremental costs are minimal, because the heavy lifting to establish the distribution network is already in place, which results in profit margins filtering straight through to the bottom line.

In South Africa, we distribute a variety of categories of products and services: prepaid airtime, starter packs, data, prepaid electricity and water, ticketing for events, sports and transport, financial services, such as debit and debit card acquiring, bill payments, Lotto and money transfers to name a few. In a replication of the South African business model, we operate in India and Mexico.

Technology is our cornerstone

Our strong distribution capability is underpinned by sophisticated proprietary technology platforms. Technology is our competitive advantage and its success and strength can be attributed to its adaptability to cater for ever-changing demands, which is complemented by our thorough methodology in deploying technology. Our technology platform is product and hardware agnostic, a neutral aggregator, capable of plug ’n play, proven, scalable and owes no fees to others.

The level of sophistication has enabled the introduction of modern products and services, such as prepaid electricity and its proprietary, UniPIN, the offline solution to an online problem. The success and rapid uptake of the product with consumers, municipalities and utilities alike, holds us in good stead as and when the distribution of prepaid water e-tokens are enabled, as in the case of electricity.

Acquisitive and organic growth over many years has enabled us to consolidate and optimise various technology landscapes, as well as share technology skills, know-how and resources, both locally and across our international operations.

During the year, we commenced accumulating “big data” in-house, recognising the benefits from accruing and channelling our vast data resources. Ultimately, a “big database” will aggregate, process, analyse and prioritise the huge sets of customer and transactional data sourced from Group subsidiaries and their partners. “Big data” records are being normalised and harmonised into a single usable profile per customer. Initial output reveals patterns and trends enabling us to improve customer engagement and spend, while results help identify vertical integration as well as cross and upselling opportunities around the Group.

How we operate

The distribution model is based on strategic partnerships, underpinned by long-term contracts, which inevitably develop into firm relationships where customers become partners. The model continues to evolve, enabling us to drive opportunities in both the vertical and forward integration planes.

Income is derived from three main pillars: the sales of commodities (such as airtime, electricity and ticketing), annuity transactions (from our SIM card base, location-based services, content and other subscription services) and interest earned on surplus cash generated.

The commission structure is based on long-term contracts with not only the network operators, but also other product and service providers, covering payment terms, annuity and commissions receivable. Commissions received are shared with merchants in the distribution channel as an added incentive to sell our merchandise. In turn, the Group channels merchants’ R&D feedback and manages all their field support requirements, in addition to supplying merchandise and marketing materials.

Field support is differentiated into three tier groupings: Gold, Silver and Bronze. Merchants are encouraged to upgrade to a higher level, while their value proposition in selling our merchandise is enhanced. This allows for price differentiation and response times via service level agreements with us.

We run our businesses sustainably and ensure cost containment on all levels. The Board oversees these commitments, ensuring that a rigorous risk assessment process is driven through the IRCC, which in turn reports to the ARCC, a committee of the Board.

Operations are grouped into four main segments: South African Distribution, International Distribution, Mobile and Solutions. The South African segment remains the predominant contributor to the Group’s profitability, derived mainly from the sale of prepaid airtime, starter packs, data and the electricity businesses. The Technology division is housed in this segment, as the bulk of its functions and services are interdependent with the distribution of airtime, starter packs, electricity and ticketing. The strategy of the International segment is to pursue growth opportunities across our global footprint, presently though our operations in India and Mexico.

South Africa’s core business is solid

South African Distribution segment is the predominant contributor to Group profitability. This year, revenue grew 19% to R26.2 billion, primarily attributable to organic growth, underpinned by an expanding multitude of distribution channels, ultimately resulting in growth in market share. Revenue generated on “PINless top-ups” increased by R1.4 billion to R4.1 billion, equating to effective growth in the segment’s revenue of 23%, as only the commissions earned thereon are recognised.

International segment is evolving

Since inception of the Group’s investment in Oxigen Services India in 2004, our focus has been on expanding its offline network of retail outlets, now reaching in excess of 200 000 touch points. This part of the business generated profitability of which the Group’s share equated to R24 million, in comparison to R2.6 million in the previous financial year.

In line with a dynamic shift in demand for online wallets, a strategic decision was made to enter this field of business. Although offline retail-based wallets continue to increase, creation of wallets through online channels has the potential to compound transactional growth, as consumers transact on web-based and/or mobile applications.

Creating additional wallets not only increases transactional revenue, but also the wallets have an intrinsic value based on worldwide trends.

Developing brand awareness and visual identity are keys to acquiring both online and offline wallets. Accordingly, during the second half of the financial year, significant expenditure was incurred in marketing the brand and the acquiring of wallets. This resulted in the online part of the business incurring losses, with the effect that the Group’s net share of losses in Oxigen Services India amounted to R28 million.

At the end of the previous financial year, the total wallet subscribers amounted to 5.4 million. At the end of the current year, this subscriber base has increased to 22.6 million, the bulk of which was congruent with the expenditure incurred in the second half of the financial year.

The Group’s share of losses in Blue Label Mexico was R63.3 million, a decrease of 28% from the previous year. Although the telco sector is highly competitive, declining losses were attributable to increases in revenue by 14% and gross profit by R67 million, underpinned by higher gross profit margins and a focus on cost efficiencies. Further declines in losses are expected.

Measuring Group performance

This year, Group earnings gained momentum, resulting in headline earnings increasing by 22% to R668 million. Revenue increased by 19% to R26.2 billion. We do not measure an increase in revenue as indicative of the Group’s growth. Rather, we believe growth should be measured by gross profit achieved, as there is an increasing trend for us to act as agent on products. This means that only the gross profit or commission earned, not the face value of the sale, is included in the revenue line.

As an illustration, growth continues to escalate in “PINless top-ups” distributed as an alternative mechanism for vending prepaid airtime.

An example of our reliance on the gross profit metric is our accounting treatment of prepaid electricity and water sales, where we act as the agent on behalf of utilities. Only the commission earned on these sales is included in revenue, not the product’s face value.

Gross profit increased by 11% to R1.8 billion. The contraction in gross profit margin from 7.46% to 6.98% was directly attributable to additional margin incentives afforded to large and long-term distributors, which in part boosted our revenue.

We pride ourselves in working smart in order to perform exceptionally. We often deploy funds for financing bulk inventory purchases or for making early settlement payments, where favourable discount rates are obtainable.

We think of our culture as a “can-do company”. This ethos speaks to our tenacious entrepreneurial and creative spirit complemented by robust internal controls and due processes. We believe we are unique – our achievements in building the Group, our proprietary AEON technology, the UniPIN prepaid electricity voucher, and various unique selling points such as our ticketing engine and online wallets, to name a few.

Our values were selected and ranked by the staff. We celebrate achievements by embodying our values in a charter that ensures their longevity in our working culture.

Forward integration – retail strategy

The retail strategy complements our existing distribution channels. By extending reach in the formal retail sector, we can amplify our footprint and capitalise on opportunities in “managing the last mile” of the distribution chain.

The Group has a strong track record on importing hardware, such as POS devices, tablets, phablets and phones, gained through varying economic cycles. A derisked model is pursued, with the bulk of stock (by value) pre-ordered and the remainder held on consignment in store. Certain products, for example, cellphones, sell better in retail outlets, with customers preferring to purchase and activate them in a personalised, hands-on, expert and online environment. The trend is in customers demanding low-cost smartphones, fully enabled with social media and data consumption apps. There is also a requirement for certified pre-owned and refurbished handsets and screens.

Owing to the high cost of branded smartphones, we believe that customers in the postpaid world will soon benefit by being able to finance the mobile device element of their contract. We are well aligned with this opportunity as it integrates with our importation and distribution of both branded and unbranded handsets.

In terms of our route to market, we are entrenched in the Edcon Group. Its excellent back-end approved customer credit facilities and systems, complements our unequalled experience and management of starter packs/SIM cards throughout South Africa. In addition, our diverse range of merchandise is available at retail outlets branded Blue Label Connect and Edgars Connect.

Vertical integration plan is progressing

On 10 December 2015, we announced our proposed participation in the recapitalisation of Cell C, followed on 5 October 2016 by the finalised terms for the acquisition of a 45% stake in Cell C for R5.5 billion.

The process to finalisation and implementation continues steadily. Our rationale for this bold vertical integration plan embraces three main pillars:

  1. Valuation and ROI in the medium term: Cell C houses good and attractively valued assets, which can serve as the cornerstone to a positive turnaround in Cell C’s financial and operational performance. A restructured Cell C offers compelling growth prospects, including a liquidity event such as a stock exchange listing.
  2. Margin defence in protecting our existing trading relationship with Cell C: Our participation in a recapitalised Cell C aligns with our vertical integration plan, will neutralise any theoretic disintermediation and enable us to manage more of the “last mile”. It is important to emphasise that our existing contracts with the main networks continue in “business as usual” mode, with long-term contracts in place.
  3. Synergies as Blue Label becomes a virtual service provider to Cell C across a multitude of shared services: We foresee a number of opportunities for Blue Label in a tie-up with Cell C, arising from vertical integration and other synergies in the procurement chain, distribution network and in products and services.

Marketing and brand awareness campaigns

Our marketing approach focuses on delivering technology, products and services which are required by merchants and consumers. Extensive research and perception studies help to identify opportunities in order to entrench our distribution footprint in formal retail, independent, petroleum forecourts, corporate or low-cost device channels.

Our visual identity and brand awareness campaign, accelerated just after the financial year-end, with Blue Label’s partnership with SA Rugby in sponsoring the Springboks for the remainder of 2016. With jersey branding rights, on and off-field prominence, and concomitant media exposure around each game, both domestically and abroad, stakeholders are assured to see the name Blue Label Telecoms prominently.

Brett Levy   Mark Levy
Joint Chief Executive Officers

9 November 2016