Much as Ulysses endured the enchanting music of sirens trying to lure him to shipwreck, South African carrier MTN has been threatening to succumb to the sirens of consolidation. As the chants mount –the latest from Reliance- and MTN itself stays on the prowl for opportunities, we remain somewhat skeptical of the promise of the proposed deals. We review some of the proposed combinations.

THE ORASCOM SIREN: an African born company like MTN, Orascom Telecom is the most attractive opportunity of the bunch. It operates in two of the largest North African Markets (Algeria and Egypt), has a presence in a few small but high growth sub-Saharan African markets and features EBITDA levels well above the African average. But an Orascom deal may also be the toughest to pull off, with uncertainty looming over key assets. First, the company is embroiled in a geo-political tussle in Algeria where the government has rejected a possible buyout of Orascom unit Djezzy by MTN. Further, Orascom’s second most profitable operation, Egypt’s Mobinil, is partly owned by one MTN’s main competitors, France Telecom, who has negotiated an option to purchase Orascom’s remaining share by 2013. As for the remaining Orascom Telecom assets, they accounted for 44% of group revenues in 2009 but only 30% of the EBITDA. In other words, an Orascom without Algeria and/or Egypt is only remotely attractive.

THE RELIANCE SIREN: The Reliance siren resumed its singing last week when the Ambani brothers announced a truce in their longstanding feud by agreeing to do away with their “non-competing” agreements. This allows Anil Ambani to sell Reliance Communications without prior consent from his brother Mukesh; it also means that MTN, who had looked to purchase Reliance Communication through a share swap mechanism, can now go back to the negotiations table. Nonetheless, the asset looks a little less attractive than it did a couple of years ago. Reliance is facing substantial pressure on profitability as a result of stiff competition at home. Its revenues and earnings have dropped significantly over the past year. In addition, MTN may have a rival in Etisalat, which is also said to be interested in the Indian carrier.

THE LITTLE MERMAIDS: We believe MTN should go for smaller and sweeter assets providing both consolidation at home and a beachhead outside its current geographic footprint. Millicom would be a compelling option. The Luxemburg based operator provides some consolidation opportunities in key African markets such as Ghana and Rwanda and fills key African gaps for MTN. In addition, it would open the doors to new markets in Central and South America where the operator holds a strong position.

 In an aggressive step, the South African parliament’s Portfolio Committee on Communications has announced its intention to push for a major cut in South African mobile termination rates. South African mobile networks currently pay each other ZAR1.25 ($0.17) per peak time minute for terminating calls on their networks. The Committee has indicated that it would like telcos to reduce this rate to ZAR 0.60 by November this year, and by a further ZAR0.15 annually over the next three years. [Click title to read full analysis]

 The net impact of a sharp MTR cut on operators will be materially negative in our view; from a consumer and regulatory standpoint, however, this move may be too little too late.

 - South African MTRs are among the highest in Africa. They are at the same level as rates in such markets as Gabon and Congo-Brazzaville (hardly examples of progressive economies) and 2x-3x higher than at least a dozen other African markets. Regulators in other countries have been more aggressive in cutting MTRs; to say that South African MTRs are due for a downward correction is a hard form of euphemism.

- From a regulatory standpoint, and welcome though this measure would be, there are reasons to be skeptical of its medium term impact on headline retail prices. For one, South Africa is a mature market, with mobile penetration rates around 110%. Competition has settled into a comfortable triopoly, while most other African markets now have four to six operators. The optimal time to make this move would have been prior to the licensing of a third operator in 2001. South Africa’s high prices are the direct result of its policy approximations over the past 15 years, which have created a Gordian knot that will not be easily undone.

- MTRs are merely the tip of the iceberg underneath South Africa’s mobile cost structure. Peak time on-net prepaid rates are 70% higher than the African median. The differential between peak on-net and off-net airtime prices is less than 20%; in other words, on-net calls (which do not include any form of termination fee) are nearly as high as off-net calls. A cut in termination fees would not in itself impact on-net calls, which account for more than half of all voice traffic for the main operators.

- There are other issues; according to the AfricaNext Research report The Future of African Mobile Profitability, South Africa’s network costs are high, at about $4,500-$5,000 per site per month, higher than at least a third of African markets, though increased self-provisioning should start alleviating the burden of this item. Average per employee costs are 2x-3x higher than in most other African markets.

- Strategically, we expect MTR cuts to impact the South African market in a number of ways:

      -Push operators to offer better on-net deals, so as to increase the amount of traffic they control

      -Increase the differentials in prices between on-net and off-net calls

      -Increase overall average usage

 Slashing termination rates may not make much of a difference on a stand-alone basis, but should provide enough of a threat that operators will move to cut on net calls without additional regulatory prodding; moderate on-net price cuts would provide some arguments against deep MTR cuts, with increased usage making up for the decline in revenue.

 -We expect the overall impact of an MTR cut to be a net positive for mobile operator Cell C and fixed operator Telkom, both net interconnect payers. For MTN and Vodacom, the proposed interconnect cut would have a material impact if implemented within the next three to six months. Net interconnect margins typically account for 15%-20% of EBITDA; a 50% cut in termination rates, for example, would slash 3-4 percentage points in EBITDA margin, assuming no change in prices and traffic patterns. As a result, the optimal approach for the operators would be three-pronged:

(1) slow the process somewhat until alternative sources of revenue and cost-savings processes make MTR cuts inconsequential

(2) move in front of the public relations issue, ideally by slashing on-net prices before MTRs are cut

(3) accelerate network self-provisioning.