Telkom has had a very rough time of it over the years. When the company first listed, it looked like a no-brainer cash cow, but some mismanagement and unwise investment led to the stock falling out of favour. Over the last two years or so, Telkom’s share price has started to march back up the hill, but the jury is still out on whether or not the company has truly turned around. It’s most recent results, released on Friday, don’t do much to ease the confusion. While earnings rose, and costs seemed under control, there was clear evidence that Telkom’s bread-and-butter, its fixed-line revenue, is trending downward. Although mobile revenue has ticked up, it’s not yet clear that the increase in mobile is enough to offset the fall in fixed and deliver net long-term growth. Basically, Telkom is a stock in search of a clear strategy and a decisive path to profitability and growth. Until we see that, its performance will be mixed at best. – FD
ALEC HOGG: Well, there are a lot of very happy investors today. Telkom posted a rise in its full-year earnings, but it continues to face shrinking revenue, so how do the two add up? You have a profit jump there of 35 percent in the headline earnings. You have a share price that’s up 160 percent in the past year, but the revenues are flat. Phillip Short, Investment Analyst at Old Mutual Investment Group Equities joins us now. Phillip, I suppose just to put that question to bed it is part of the fact that this was a turnaround. A year ago, when the share was trading at about R12.00 or R13.00 and its R42.00 today, it really was just too cheap.
PHILLIP SHORT: Yes, you hear a lot of commentary on its last 12-month performance and as you say, it’s 160 percent up, but if you look over the last five years, it’s pretty much flat where the market, the JSE, or the All Share Index has been up almost double. It depends where you’re taking your starting point but yes, it does seem that they have started to turn things around.
ALEC HOGG: It’s a very good point that you make there Phillip, because I have a three-year graph in front of me here and the share price three years ago today, was R35.00 per share. It went all the way down to R12.00 and then it’s been climbing up the mountain thereafter. What caused it to decline so sharply in that first year-and-a-half period and why has it been reversed in the past 12 months?
PHILLIP SHORT: What started happening with the decline was a couple of investments that didn’t work out. For example, if we look at Multi Links that which was a R10bn investment in Nigeria, which they had to write off. There were some other things. Management weren’t completing on their strategy, so things started disappointing and they were just burning cash on bad investments. Telkom Mobile, with 8ta when that first started that was loss making, so there were a couple of investments, which didn’t work out too well. I think management didn’t run the ship properly and new management has now started to take things into their own hands, and that’s causing the upward trend.
ALEC HOGG: So clearly, the market is saying ‘we are confident in these new guys, we’ll forget about what happened in the last three years, and we’ll look ahead’. This set of financial results: do they justify that confidence?
PHILLIP SHORT: It’s quite a polarised view in the market. There’s still a lot of people who are not buying into the stock at the moment. I think a lot of people have been burnt in the past when that stock dropped, as we mentioned earlier. I think a lot of people are still waiting on the sidelines. Looking at the results today, it’s not trading at a very demanding multiple. In fact, if you look at the EBITDA, it’s trading at three times. When you look at global peers or integrated Telco’s, they trading at about five times. Its PE is about 11 times and they’re now talking about actually giving quite positive guidance on FY15, 16, and 17 of stabilise into increased revenues and actually expanding on their EBITDA margin. If they can fulfil on that, we should expect to see the stock run further.
ALEC HOGG: There are some things in these results that you can get quite excited about, for example, the 30 percent plus growth at the headline earnings level and the reduction in debt by about one-third. Was there anything in here, outside of the revenue, that didn’t seem to grow, that was worrying?
PHILLIP SHORT: That’s a good point. For me, the most important thing was costs. Because you’re with fixed line, which [inaudible 0:04] to the business is fixed line, that is declining industry, so structurally, that part is not attractive. What they can do and where they can make the difference – when they can grow earnings – is by taking out a lot of fat that is sitting in their costs. They haven’t been able to do that very well in the past. Management has committed themselves to doing that going forward, and they’ve actually started doing that in these results. I think that’s the key focus area for an investor when looking at Telkom. They must be looking at whether they can continue pulling out the costs.
ALEC HOGG: What about the mobile side? As you mentioned a little while ago, 8ta was haemorrhaged very badly. They brought in a new Head of the Mobile Division, who seems to have gotten their act together. Your view on that…
PHILLIP SHORT: It’s an interesting point. The most interesting thing for me, with them and mobile and for them to turn it around is this type they’ve mentioned they’ll be doing with MTN South Africa. For me, to really get that business profitable they’re going to need someone like MTN to partner with. They need MTN’s large network and they need MTN’s expertise in mobile. For me, they key would be to have that contract tied up as soon as possible.
ALEC HOGG: That’s an interesting point. If you have Cell C, who are piggy-backing off the Vodacom network at times, and now Telkom mobile getting closer to MTN, would that not reduce competition then?
PHILLIP SHORT: It would, but they’re both forced to do something because with Vodacom that’s now gone to Neotel – and we are seeing worldwide that you are seeing mobile players trying to get in onto the fixed line. They need to do it. It’s for a converse solution of having fixed and mobile, so if they can share each other’s networks – MTN and Telkom – it might make market less competitive. It will leave Cell C out by itself, but I think that’s how it’s going to end up.
ALEC HOGG: Phillip, there are all kinds of rumours and speculation about Netflix coming into South Africa as a partner with Telkom. We are seeing the convergence of those markets. They did try once before to go into the media area, through Telkom media. That was a disaster. Are you expecting that Telkom might put a toe in the water there again?
PHILLIP SHORT: They have said that they will be doing that. They have opened up to those types of players – the Netflix and Bertelsmann etcetera – and said ‘please come up with an offer/idea of how you can put your concept through our fibre’. Listening to the other call and the Telkom results, they actually highlighted in the next financial year, all the areas where they can add fibre to the home. It was interesting to see that it’s happening a little bit quicker than I initially expected – the amount of fibre to the amount of area that they’re covering. They need to do that first – get the fibre to the home – before they can start negotiating with Netflix and others who can provide that content over their fibre.
ALEC HOGG: You’ll recall that a year ago, there was great concern when the Korean deal fell apart: with hindsight, was that a good thing?
PHILLIP SHORT: I don’t know. Since the development with MTN, that any positive that investors may feel was lost by not doing that KT deal, could now possibly be regained with the MTN deal.
ALEC HOGG: Finally, the company has said it’s looking to pay dividends again from next year. Is that something that will hearten investors?
PHILLIP SHORT: That’s an extremely positive tone for them to set. People who usually look at Telco’s as a sector to invest in, because they’re cash-generating companies (high cash-generating companies) usually with low top-line growth, investors expect a dividend – it’s one of the reasons why they invest in Telco’s. I think that would be a very positive underpin for the stock – having a dividend – and just for sentiment, showing that they have the cash to pay it as well, is very positive.
ALEC HOGG: That was Phillip Short, Investment Analyst at Old Mutual Investment Group Equities.
