WhatsApp to offer free voice calls – how will that affect MTN, Vodacom?

Facebook's decision to purchase text messaging service WhatsApp for $19bn has attracted a great deal of attention. While some have hailed it as a masterstroke, many are asking themselves what makes WhatsApp so valuable. As First Avenue's Nadim Mohamed points out, the price of the deal puts the value of each WhatsApp user at $42, which is a lot considering that WhatsApp costs just $1 a year in subscription fees. It's hard to imagine how Facebook will extract value from these users, given the premium it's paying. But, as Mohamed points out, WhatsApp is a cutting edge service, particularly as it plans to start offering voice-over-internet calls. Given the connectivity it offers users, it makes sense as a part of the world's biggest social network – adding WhatsApp gives Facebook yet more way to keep you in touch with your friends and family. But no one can deny it's a gamble at the price. And don't miss the update at the bottom of the transcript. There's an interesting South African connection in the mega deal. – FD

GUGULETHU MFUPHI: The world's biggest messaging service WhatsApp plans to add voice calls to its product this year after just being purchased by Facebook for $19 billion. Joining us now is Nadim Mohamed. He is from First Avenue. How you can justify WhatsApp being worth nineteen billion dollars.

NADIM MOHAMED: It's very hard to justify. If you look at 19 billion dollars, it means 42 dollars per active user on WhatsApp and right now, at most they make one dollar, which is the subscription fee they charge every year to users. That subscription fee is charged after the user has had 12 months' of use, so when you go from one dollar to 42 dollars, it's very hard to justify. I can understand from Facebook's context because the Internet is all about disruptive technology, so the next big thing, which disrupts an industry… From Facebook's perspective, they've been looking at WhatsApp, and looking at the kind of engagement the user has with WhatsApp. If you think about it, there are about 450 million users globally. Over 300 million of those use the application every day – so very high levels of engagement. I think Facebook was thinking 'do I need to defend against this? Do I become irrelevant if I don't get into this industry?'

ALEC HOGG: So they can plug WhatsApp now – presumably – into Facebook. It was interesting to see Mark Zuckerberg this morning, saying they're going to offer free calls on WhatsApp and secondly, that they're killing off the Facebook email service. You therefore have almost a double indication to us of why they did this deal. Those free calls…would that hurt Telco's?

NADIM MOHAMED: I think in the longer term it will so already, WhatsApp service, which is text based is already taking share away – especially from SMS's – but also voice, because it's a very convenient and low-cost way of communicating. Right now, the Smartphone penetration is not high enough and I think historically, the quality of your data was not good enough to give you a good call – using VOIP – so that's been addressed. If you look at LTE in South Africa, it has been very successful. Their speeds are very good. If you try to make a call with your iPad or iPhone and Skype, it's very good quality.

ALEC HOGG: I'm sorry, Gugu. LTE doesn't work on my iPhone.

NADIM MOHAMED: Doesn't it?

ALEC HOGG: I have to switch it off otherwise my iPhone doesn't work. What is this LTE, what does it mean, and why is it not working on my phone?

NADIM MOHAMED: Okay, the long-term evolution is the next step in terms of mobile data technology. Admittedly, I think most of the users in South Africa are still on 3G, which is also very good. The speeds are good enough for a VOIP call. LTE will be your next generation. The new generations of iPads are supposed to be compliant, but I have noticed the same kinds of issues. I don't personally use it, so I can't tell you how good or bad it is at this point, but they are supposed to be compliant.

ALEC HOGG: Gugu, do you have LTE switched on, on your phone?

GUGULETHU MFUPHI: Not at all…unfortunately, I'm still on 3G but I have tried LTE out, when some of the mobile operators had it on a trial basis for some individuals. It works amazingly, Alec – no buffering for your YouTube videos. It's quite a nice product I think, and probably should be rolled out in many more other places…maybe even corporates.

ALEC HOGG: Okay, well let's get back to those free calls on WhatsApp and how they're going to affect the South African mobile operators – particularly the listed ones.

NADIM MOHAMED: In the past, you couldn't make a very good quality call because of GPRS, which was the technology at the time and it was very expensive. It used to cost you up to R3.00/meg for your data. Now it's come down, you can get ten cents or 20 cents/meg. By my rough calculations, I think a minute of VOIP uses about half a meg of data, so you're talking about somewhere in the region of five to 15 cents per minute, which is well below what tariffs are today. The trouble is, if you dial to a mobile phone from your Skype or WhatsApp, you will have to pay Interconnect, so as that Interconnect rate comes down it also becomes easier to call people who are not on VOIP, using your WhatsApp or other application.

GUGULETHU MFUPHI: You touched on Interconnect fees and we know what's unfolding regarding MTN taking ICASA – the Regulator – to court. What do you make of the legalities there?

NADIM MOHAMED: I think it's a very bold move by MTN. The Regulator does have the right to specify these regulations. In fact, this is a review of a previous dispensation, which was lost. I think it's going to be a very difficult legal case for them to argue, and it also shows a level of desperation. I think that this time the level of asymmetry is going to hurt for MTN.

GUGULETHU MFUPHI: How much will it hurt them?

NADIM MOHAMED: Well, the immediate effect they say is about one billion rand – that's Net Interconnect. They're currently the Net receiver of Interconnect from Cell C. They would become a Net player and in total, the Net Interconnect they would pay is roughly about one billion rand, so that's not huge. I think the bigger problem is when Cell C and Telkom mobiles reduce tariffs then MTN has to match those tariffs. You even saw a few days ago, they came out with a 90 cents rate although it's not exactly a 90 cents rate, because you only get it for three days after you recharge.

ALEC HOGG: That price war you've been talking about for some time…

NADIM MOHAMED: It's unfolding – it's slowly unfolding. Obviously, the bigger guys with deeper pockets are going to try their best to defend against it.

ALEC HOGG: Nadim, one thing has been puzzling me a little – these MTR's or the termination rates. What are they based on? It has gone from 40cents to 20cents to 15 cents to ten cents. Where do they get that number? Do they pull it out of a hat somewhere or is it actually scientific?

NADIM MOHAMED: The way it's usually done is based on a cost study. I think this is what MTN were arguing, that the full cost study was not done. The other way to do it is to benchmark and that is where this particular ten cents has come about, I think, from benchmarks with other countries with similar environments input costs to the mobile operators. They then use those benchmarks to guide them on where the tariff should be. Mind you, our Interconnect rates were actually 20 cents a long time ago when it was just MTN and Vodacom operating in South Africa. It then went up to R1.25 when the third operator came into operation. Then it actually just went back to the level it was at.

ALEC HOGG: So it should have just stayed at 20 cents?

NADIM MOHAMED: I think so.

ALEC HOGG: But it's interesting that you say there are two arguments. The one is what is the actual cost? That analysis has not been done, but the other one – the one they're arguing – is that it's a benchmark.

NADIM MOHAMED: It's actually the smaller guys who are Net payers – normally – unless there's asymmetry in the market. Normally, your smaller players like Cell C…80 percent of their calls goes to another network, whereas Vodacom and MTN typically have somewhere in the region of 60 or even 70 percent of their calls on the same network, so they don't pay…

ALEC HOGG: Given what's happening here and all of the noise that's going around, would you be concerned about owning Vodacom and MTN shares?

NADIM MOHAMED: Vodacom have done very well with their pricing strategy, to keep their customers and to keep their revenue per customer. In fact, they actually gained a few customers in the process. MTN has been the Net loser. If you look at Blue Label Telecoms recent results, MTN has lost about five percent share of the prepaid market, according to their stats and they're usually quite reliable. It looks as though Cell C has gained most of that share of prepaid MTN, so I would be worried from an asset perspective. Obviously, MTN's asset is about 29 to 30 percent of their global operations so overseas MTN still has some growth, but they've been more worried about currency movements. If you look at the MTN trading update – 25 to 30 percent growth – about 19 percent of that was just pure currency movement.

GUGULETHU MFUPHI: So in the long term, Cell C is better positioned to gain market share.

NADIM MOHAMED: I think they're well positioned if the asymmetry goes through. If it doesn't go through, it will be very hard for them to gain share from here.

* After the interview Nadim sent through this note: "Sequoia Capital is a venture capital investor that's been involved in several highly successful companies including Apple, Google, Yahoo, YouTube, Oracle, Instagram, PayPal and Zappos.   The founder is Donald Valentine who is a veteran in the industry and they are the only VC firm that has partnered with WhatsApp.  Sequoia invested $60 million in three separate funding rounds – the first was as low as $8million in 2011 which was all WhatsApp could command at the time.  Its not clear how much of WhatApp they own, but it is believed to be worth $3 – $4 billion after the Facebook deal.   This is of course an astounding return in a short space of time – the last round of funding was 2013. The interesting thing about Sequoia is that one of its partners is Roelof Botha who previous worked for PayPal with Elon Musk.  His grandfather is Pik Botha, the former SA Foreign Minister. I'm not sure exactly how involved he was with WhatsApp but he did post something about it on Twitter – https://twitter.com/roelofbotha. "