Saturday, June 04, 2011

Jamaica’s telecommunications industry

THIS week CNN reported on an article titled "WHO: Cellphone use can increase possible cancer risk". I think that this is something that many persons suspected, before but coming from the World Health Organisation this cements the belief in people's minds. I wonder how this will affect cellphone usage going forward.

This got me thinking about Jamaica's telecommunication sector, which has made a valiant attempt to keep pace with what is happening in a developed market such as the US, but with the coming merger between Claro and Digicel and the consistent losses being shown by Cable and Wireless (trading as LIME), it seems as if this sector could fall back into one where competition is all but absent.

I had long thought that this day was coming, and remember advising someone a few years ago that C&W shares at J$1.60 at the time was a bad buy, even though that price was a 52-week low, because I felt that the share price would fall considerably. It is now trading at approximately 20 cents. I also expect that the share price will fall further as when I look at the way the company is presently structured I don't see how it will emerge from the black hole it finds itself in. There are a few reasons for my thinking this way, which I will briefly outline. Before I do so, I think that given this situation it is important for the regulators to look at the situation and see how best the consumer can be protected going forward.

The truth is that given the nature of the business and the market, I wouldn't be surprised if Digicel is having a difficult time also, which cannot be assessed because of the lack of financial information.

The industry itself is one where significant capital infrastructure investment is consistently required, and with the decline in disposable income across Jamaica, it should be extremely difficult to recover. So like the airline industry, the greatest amounts of money are not made by the service providers, by the agents, or those that do business with the service provider. The main issue of course is the capital investment cost. The Jamaican market is just too poor for maintaining a sustainable competitive environment in telecommunications development.

As a result the regulators will have to be proactive in protecting the consumer.

C&W financials

The recently published audited statements for C&W show a company that has significant challenges, and I think the mistake that management has consistently made in that company is not recognising the need for a paradigm shift. Maybe the current management will make that change given their ability.

The group continued to show significant losses, and losses attributable to stockholders increased from J$3.3 billion to a whopping J$6.1 billion in fiscal year ended 2011. Further analysis on the Group Income Statement showed that the gross margin declined year over year (YoY) from 65 per cent to 57.6 per cent, reflecting the deteriorating market conditions and competition from Digicel. Although the group managed to reduce operating expenses by over $2 billion, a careful look showed that the reduction was due to a non-cash item, depreciation and amortisation, which does not add cash flow and also suggests that the equipment is ageing and will need to be replaced soon, especially if it is to keep up with Digicel, which already has over 70 per cent of the market. The group shows an improvement in the operating loss before net finance cost line, from $3.0 billion to $2.6 billion, but when one removes the depreciation consideration, it shows that the cash-generating activities worsened, as is reflected in the cash flow statement, which shows that net cash provided by operating activities declined YoY from $4.9 billion to $1.2 billion. This suggests that the group is facing a tighter liquidity situation and is supported by a cash injection from group companies of $5.6 billion.

It is important to note, though, that the group is still very liquid and is still generating cash from operations. The main concern is that going forward it will need cash resources to upgrade infrastructure.

LIME at the crossroads

One of the things that the group may have to look at in restructuring the operations is the charge of the interest to C&W from advances from other group companies. If this debt is taken into consideration ($19.9 billion), the group has a debt to equity ratio of 3.7, but if the internal debt is removed the debt to equity is 0.12. The majority of the interest paid is also within the group. The suggestion is that one way the group could significantly turn around the fortunes of the company is to capitalise the debt. This would significantly reduce the burden on the company and improve the operating position.

The challenge they will continue to face, however, is capital replacement going forward and competition from Digicel. As I had stated in an article a few weeks ago, this big bother about the Digicel-Claro merger is really a red herring. Even if the merger does not take place C&W is in danger of extinction without any significant restructuring, or unless the regulators introduce portability of numbers.

This operating challenge is also evident in the current ratio, which stood at 0.72 on March 31, 2011, and where the Trade and accounts payable is twice the Accounts receivable balance.

The numbers do tell a lot more about the group, but lack of of space and time does not permit a much more comprehensive report. Suffice it to say that C&W is at the crossroads and must make a fundamental shift in order to preserve the competition in the local marketplace. There is of course a logical action I think either Digicel or C&W can take to increase profitability, which I am sure they have thought about already. The group still has significant liquidity, despite the decline, and I am hopeful that with the management team that is there it will overcome this obstacle for the benefit of Jamaica's telecommunication industry.


Leahcim Semaj said...

Good work Dennis. I agree with you that the portability of numbers is critical and the Digicel may also be in pain (but masking it much better).

The biggest problem that LIME has is internal. They no longer believe in their product and service. I believe that most of their staff are just waiting for there redundancy payments.

How can you save someone who no longer has the will to live?

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