Rain’s valuation analysed – with a big risk to its revenue

The successful spectrum auction in March 2022 means Vodacom will rely less on Rain for its 4G network capacity, which can significantly impact Rain’s roaming revenue and valuation.

African Rainbow Capital Investments (ARC Investments) holds a 20.2% stake in Rain, which it values at R3.372 billion.

Rain accounts for 24% of ARC Investments’ total portfolio, meaning its valuation is crucial to assess the investment firm’s prospects.

The challenge for investors is that neither Rain nor ARC Investments has released financial or operational data, making a proper analysis impossible.

It is because ARC Investments is not required to report these figures as they are classified as an investment entity, not a consolidated group.

Over the last four years, Rain’s valuation increased from R9.460 billion to R16.643 billion, raising eyebrows among investors.

This valuation is based on a multistage discounted free cash flow method with a weighted average cost of capital (WACC) of 15.58%.

It further uses undisclosed supernormal growth rates – based on Rain’s subscriber growth – with a terminal value calculated at a terminal growth rate of 3%.

Discounted cash flow valuations are notoriously sensitive to terminal growth rate forecasts as the greatest weighting of the valuation is determined by this metric.

ARCs indicated that a 1% increase and decrease in the terminal growth rate would cause a R210 million increase and R179 million reduction to the fair value, respectively.

It means that Rain is valued at a premium because of its expected future growth.

Should the growth slow or its revenue take a knock because of a sudden change in the market, it can significantly impact Rain’s valuation.

Rain has enjoyed rapid growth as demand for broadband access and mobile data spiked during the lockdown.

Over the last two years, the mobile operator recorded a rapid increase in 5G subscribers and roaming revenue from Vodacom – which uses Rain’s network to serve its 4G data customers.

The increased demand for data had helped Rain to exceed R1 billion in earnings before interest, taxes, depreciation, and amortisation (EBITDA) for the year ended February 2022.

Threat to Rain’s roaming revenue

Rain continues to meet targets with strong demand for its 4G and 5G services, while its 5G rollouts across the country are progressing well.

However, South Africa’s successful spectrum auction in March has changed the mobile data landscape.

Rain derives a large part of its R1 billion EBITDA from roaming revenue from Vodacom.

The reason Vodacom partnered with Rain to roam on its network is that it lacked spectrum.

Rain had valuable broadband spectrum – 34MHz in the 1,800MHz band and 20MHz in the 2,600MHz band – and capitalised on this valuable resource to sign a favourable deal with Vodacom.

The deal helped Rain to roll out a new 4G network with very little capital expenditure (Capex) and at a rapid rate.

Rain also benefitted tremendously financially from its Vodacom partnership. ARC co-CEO Johan van Zyl said roaming revenue from Vodacom contributed around 80% of Rain’s valuation in 2019.

In March 2021, Van Zyl said a big part of the existing value which “you can put a price-to-earnings ratio (PE) on”, came from Vodacom.

In June 2022, Rain CEO Brandon Leigh said their 5G revenue contributes a much larger part to their EBITDA (earnings before interest, taxes, depreciation, and amortization) than previously.

He said Rain’s risk profile, where it was largely dependent on wholesale revenue from Vodacom for its EBITDA, changed significantly over the last three years.

Although a larger portion of Rain’s business comes from its 5G broadband and 4G today, roaming payments from Vodacom remains a core part of Rain’s revenue.

It brings us to the potential impact of the spectrum auction.

Vodacom acquired 80Mhz spectrum in the 2,600MHz band, 10MHz in the 3,500Mhz band, and 20MHz in the 700MHz band.

Vodacom is no longer in the same spectrum-starved situation when it signed a deal with Rain. In fact, it now has far more spectrum than Rain in the valuable 2,600Mhz band.

It means Vodacom can move all its Rain roaming traffic to its own network without any deterioration in performance.

Should this happen, Rain would be in trouble. It will lose a large part of its revenue and struggle to maintain its 4G network growth.

Industry speculation suggests that Vodacom and Rain signed a new agreement which is more balanced and puts Rain at more risk.

As the agreement remains secret, it is not clear if Vodacom has financial obligations and whether it is allowed to significantly cut its roaming on Rain.

What is clear is that Rain faces a significant threat after the spectrum auction and that the tables have turned. Rain is now more reliant on Vodacom than the other way around.

Daily Investor asked Vodacom and Rain for comment about the impact of the spectrum auction on their roaming agreement, but they are tight-lipped about the issue.

Vodacom would not comment on whether it will reduce its roaming on Rain because it now has its own 2,600MHz spectrum. It only said its agreement with Rain is long-term in nature.

“We will use a combination of our own spectrum, roaming arrangements, and capital investment to reach the most efficient capital allocation and best customer experience,” Vodacom said.

Rain would also not comment on the impact of the spectrum auction on its roaming revenue from Vodacom.

It said it has a long-term agreement with Vodacom and has always planned for the auction.

“We have successfully acquired 20MHz in the 700MHz band and an additional 20MHz in the 2600MHz band, taking us to 40MHz in the 2600MHz band,” Rain added.

Rain’s valuation

The lack of financial and operational data about Rain makes it difficult to challenge or confirm its R16.6 billion valuation.

However, a few calculations are possible to better understand how the valuation compares to what we know about ARC.

At the beginning of July, ARC Investments was trading at a price-to-earnings (P/E) ratio of 5.05.

It raises the question – what earnings (net profit) should be expected from Rain to maintain this ARC Investments’ P/E ratio?

Based on the valuation of R16.36 billion, Rain should generate net profits of R3.27 billion to be in line with ARCs P/E multiple of 5.05. Rain’s EBITDA wasn’t even a third of this amount.

Based on a price multiple valuation method, Rain appears to be overvalued.

However, ARC Investments does not use a P/E multiple valuation as they have additional information at their disposal to forecast Rain’s future growth.

Without financial data, it is impossible to assess the spectrum auction’s impact on roaming revenue from Vodacom or the company’s growth over the last few years.