One of the predominant issues in telco service stocks right now is the weak growth environment – penetration rates in most developed markets are quite high, and competition makes it difficult to sustain any sort of real edge. That's not nearly as much of a problem for Africa's MTN Group (Nasdaq:MTNOY), given the low penetration rates and per-capita incomes in much of its territory, but the company has its own set of challenges ranging from regulatory, political, and economic uncertainties to the potential deployment of capital towards M&A. Regulation Never Helps The LeaderWhether it's France Telecom (NYSE:FTE), China Mobile (NYSE:CHL), SK Telecom (NYSE:SKM), or even AT&T (NYSE:T), regulation is a fact of life in the telco services world, and it seldom ever makes life better for the market leader. To that end, increasing regulatory activity in the key markets of South Africa and Nigeria (about two-thirds of company EBITDA) are not going to help matters. Regulators in South Africa have come to the conclusion that, despite the presence of four service providers, there isn't enough competition in the country and that high prices are hurting the economy. Given all of the screw ups of the South African government that have harmed the economy, it's a somewhat humorous conclusion, but there will be nothing humorous about attempts to reduce the revenue or profits that MTN earns from its large South African subscriber base. So too in Nigeria, where despite the lifting of a promotional ban on MTN, the government has declared the company a “dominant operator” and therefore subject to a different set of rules and regulations. A tariff cut is all but certain, but the good news is that even a 50% cut would only impact earnings about 5% (and most analysts seem to have already factored this in to estimates). The good news is that regulatory pricing pressure is not insurmountable or unknown to MTN Group. MTN, and its rivals like France Telecom, Vodafone (NYSE:VOD), and Millicom, have long dealt with this pressure and MTN can take advantage of increased penetration of post-paid subscribers and more consumption of higher-value data and ancillary services, as well as migration to 3G service. Expansion Seems Probable, But Where And At What Cost?Although MTN Group already operates in 21 countries, management is looking to potentially grow that number. The question for investors is how they go about it, and what sort of returns on investment management is willing to accept. SEE: How To Pick The Best Telecom StocksMTN Group is one of 11 companies to bid on the two licenses coming available in Myanmar (Burma), and a decision will be announced on June 27th. Management doesn't sound optimistic, though, citing an expectation that the average bid will be at or above $1 billion. As a reminder, Vodafone and China Mobile abandoned a joint bid on the basis of seeing too little potential return in winning a license. From with management's commentary, it doesn't sound like they were willing to overpay, so a win here would be unexpected. Even as MTN is showing price/return discipline in Myanmar, the markets are buzzing with the fear that the company is going to pursue an acquisition in India. While the company has previously been tied to India's market leader Bharti in M&A speculation, this rumor has MTN Group going after the #3 player Reliance. Call me skeptical – India may have long-term growth potential on par with MTN's core African markets, but competition is fierce, regulation is extreme, and returns on investment look low. Unless management makes a very convincing case for why India's long-term growth outweighs low near-term returns, I have a hard time reconciling a prudent bid for a Myanmar license with an imprudent bid for Reliance. Assuming that MTN does neither, the most probable use of the capital on the balance sheet would be dividends or buybacks, as the company could definitely support leverage (it currently has net cash). Perhaps management would be willing to be creative on M&A, though, as I believe buying a few select operations from France Telecom or TeliaSonera could be both viable and worthwhile. The Bottom LineIt's an unfortunate reality that the turbulence of emerging market currency markets can alter the fair value of MTN by as much as 20% in just a few months. Consequently, the fair value as expressed in U.S. dollars can swing quite a bit. For more long-term oriented investors, though, I believe the prospects of high single-digit revenue growth and mid-teens free cash flow growth make MTN Group a name to consider as a long-term holding. Regulation and competition are certainly threats, but MTN Group remains one of the better (and very scarce) ways to play growth across Africa and the long-term potential remains worthwhile relative to the risks and inconveniences. Disclosure – As of this writing, the author owns shares of MTN Group.
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