AFRICAN LAKES IN THE PROFIT SPOTLIGHT AFTER COLLAPSE OF IFC DEAL

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African Lakes in its new technology incarnation is one of those businesses that could become emblematic of the whole African internet sector. If its dream of being a continent-wide service provider fails, then Africa’s internet sector may be destined to become a series of marginalised, local markets that will struggle to find future international investors. The collapse of its deal with IFC for further financing has meant it has had to turn a sharp spotlight on profits. Russell Southwood talked to its Executive Deputy Chair last week on where the company is headed.

African Lakes is primarily an internet business: 90% of its companies fit that core definition. According to Wilkinson:"The largest business is the ISP business. That’s our main business and will increasingly be so. The others are being disposed of or are small".

Its companies include Africa Online (operating in eight countries), Menanet (Egypt) and a satellite company, GDBC. The latter is a joint venture with the Egyptian Government the majority shareholder that provides bandwidth to all but the most southern of its operations. Outside of the internet, it has a online financial transactions company, African Lakes Technologies that operates in Zimbabwe and Kenya. Beyond this group of technology businesses, it has two "legacy" businesses that it is in the process of selling.

Its vision of being a continent-wide provider at all levels - from cyber-cafes to satellites - has taken a battering from a number of directions. The dot.com downturn has knocked the stuffing out of its share price. It has suffered a number of management setbacks. There have been some "wrong turnings" in its business strategy. All this has meant that it either had to find additional external funding or make a more fundamental assessment of the scope of its ambition.

Africa Online is only in one of the three "super-scale" markets, with a successful company in Egypt but has no significant presence in either Nigeria or South Africa. Nevertheless it is well placed in most of the middle-markets across the continent:"The ISP business is a volume business. Unless you get scale, you can’t deliver profits. Luckily we’re number one or two in our markets. All our ISP businesses are now profitable and all are companies are cash-positive". However its portfolio of ISPs contains countries like the relatively tiny Swaziland operation that Wilkinson concedes would probably not be feature if you were to start all over again:"There are legacy countries in our portfolio. We’d probably be in different countries if we were to start from scratch again".

The most convincing argument for a continent-wide operation of this kind must be economies of scale in key areas like bandwidth purchasing. It also has the ability to purchase and move equipment around. It can development a cadre of skilled managers who can also be mobile, increasing their skills by operating outside home markets. It can also cross-market to the all-important corporate market.

The ISP sector has effectively two markets: dial-up and corporate customers. The latter is a much more fruitful area to make money in as customers are not quite as strapped for cash as the individual African dial-up customer. According to Wilkinson:"People have tended to muddle the two businesses up, using the corporate to subsidise the dial-up. Without the growth of a genuine middle class in Africa, there will not be the volume that you find in markets elsewhere. Therefore the ISPs will have to remain a premium product".

In order for Africa Online to be successful financially it will have to entrench itself in the premium niche. A looming danger is the new expansion plans of the only other continental contender, MWeb, owned by the South African Naspers group. In Zimbabwe and Namibia where the two come face-to-face, it competes heavily on price and looks for maximum market share. How will Africa Online react to its apparent plans to resume its continental expansion?"It will be interesting to see. I don’t yet know yet. We currently compete in Namibia and Zimbabwe. They are competing on price".

In many markets, the number of dial-up customers is now fairly static, whilst corporate markets continue to grow. It is this tricky two-track path that Africa Online must seek to keep astride. It will prove difficult to grow the businesses where its markets are static or maturing. So is it still interested in buying others?: "We’re not in the acquisition business. The days of "land grabbing" are gone. However we are open to consolidation as volume will remain important". The attempt to buy Zimbabwe Online is testimony to the latter.

The past two years have been a sharp learning curve for what does and does not work. Its joint venture with UUNet to chase corporate customers was eventually only launched in two countries (Kenya and Zambia) but there matters will rest:"We’re not expanding the relationship beyond those two countries. In Kenya, UUNet is our partner for corporate business. In other countries we do it ourselves. We felt that it was important to gain this expertise and see what the dynamics of the two businesses were. However we now feel that keeping control of our corporate business is important for delivering value to shareholders. We’ve both learnt a lot. The business in Kenya is very successful but we’ve got what we like out of the relationship".

It has not been able to make financial sense out of cybercafes despite having run at it several different ways. The relaunched e-Touch is likely to remain in place but "we’re withdrawing steadily from cyber-cafes. These businesses don’t generate enough money to make a profit". Its cybercafe partnership with Barclays also hit the same rock:"Both Barclays and ourselves felt that the prospects were fairly bleak. They were asking "was it core to Barclays business"? The offer was too expensive for the market". The deal with South Africa’s CAN has put three cybercafes into their stores - two in Johannesburg and one in Durban- and has been more successful. However things are uncertain after the recent ownership change:"We’ll wait and see what happens".

The development of content and e-commerce is now off the agenda:"We’ll maintain the portal but we’re not in the content business. We view it as a marketing cost to the group. If we can justify it as a marketing cost we’ll retain it, if not then we won’t. We run slightly different portals in Egypt and sub-Sahara. And we’re not doing e-commerce."

Outside of its core internet business African Lakes Technologies is financially self-sustaining but the Kenyan operation "will take some time to seed the market. There’s not yet much market acceptance. We’re almost the only players. If there were others, it would at least raise awareness. As a product, it’s a fantastic product and it should be successful because it was made in Africa and is supported in Africa".

The nub of its financial problem is that it is still losing money, despite having cut the "burn rate" by 60%. Individual businesses may be making profits or going "cash positive" but they do not cover the overheads of running an international company with a London Stock Exchange listing:"We need to deliver enough cash and profits to cover the central costs (including the London Stock Exchange listing) of the group".

Once it disposes of its "legacy" businesses it will have £7 million to cover recurring costs and then...Well, and then in a positive sense it can do one of three things: raise more money to fund further expansion to build future profits (unlikely in the current climate), get profitable on the current base of the business or sell out at the best price going.

The deal with IFC was the first route. It wanted to put capital into the business to sustain the continent-wide ambition and keep the London office (and listing) in place. It went through a six month process after which the IFC signed off on the deal in August last year. The deal involved a total investment of £4 million from IFC and AIG and £1 million from existing investors."

The "fly-in-the-ointment" was that of the money going in, 50% was to come from the AIG Infrastructure Fund run by the Emerging Market Fund:"It didn’t go ahead because AIG didn’t want to invest. This was a huge surprise to us and the IFC. We had to take a quick review after that".

So what about selling the company?:"The bland reply is that if the right offer came along we’d take it. Part of setting it up was to create a regional business. The exit for the shareholders is likely to come from a trade sale. Whether now or when the cycle swings will depend on a number of things. If the operating companies can create cash and profit, then a company with an existing head office buys cash and profit". Would there be a fit with Mweb? :"Yes, I’d have thought so".

Without a sale the company has to get into profit as quickly as it can manage it: "We have two issues as a company: cash and profits". The underlying financial picture is not easy to read. At the end of financial year 2001 the "continuing operations" made a loss of £3.54 million. At the end of the quarter to June 2002, the same businesses were losing £1.4 million, up from £0.8 million in the same quarter the previous year. If these losses have been cut by 60% and the cuts are sustainable, then perhaps we can guess that the business has enough cash to last a couple of years. Time enough one hopes to get it to the stage where it makes enough profit to keep its investors happy.

And might this affect where the company was based:"In the longer term, I’m not sure we’d have this office in London. It would be in several different places and not necessarily Nairobi".

When will profits come?"I’m not going to give you a forecast on profit. The first thing is to get the business cash positive. We have to complete the disposal programme. I can understand why there’s (shareholder) frustration".

No-one - except its competitors - wants to see African Lakes fail. If you cannot invest in the internet profitably in Africa, then what hope is their the wider transformation of the continent.

Background note:
The primary shareholders in the company are:
Blakeney Management +20%
Aberdeen Asset Management 14%
RAB Capital 10%
Marwan family 10%

The shareholding in Nairobi is very small. The largest shareholder in Africa is Old Mutual with 1 million shares. To put that into context, there is a total of 160 million shares issued.