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By Dylan Bradfield*
Telkom released a trading statement that can only be described as shocking, but in the same breath, a wake-up call for South Africa!
Normalised headline earnings per share (HEPS) of R1.70 was way below consensus of R2.85. The significant deceleration in the 2nd half was mainly driven by loadshedding, inflationary cost pressures and “front-loading” of one-off provisions related to voluntary severance packages which will negatively impact this year but will come through as savings for FY24’s numbers.
Here’s where it gets ugly.
Telkom is guiding for R13bn in impairments for Openserve, Consumer, Gyro and BCX. Whilst this seems crazy and absurd, we previously mentioned that these assets have been terribly run and need to be placed in more professional hands. Our entire thesis was hinging on the company committing to accelerated asset sales, and not turning their lagging performance around in a crowded market space.
Now for the good news (taken with a pinch of salt).
An Impairment of this quantum must be viewed as a positive move by Telkom. Prioritising earmarked asset sales illustrates management’s commitment towards migrating to new technologies. Effectively, what we are seeing is a reset of the asset base (which does not impact cash flow) but brings inline the woeful operational performance for the past period. So, a big Impairment, as suggested, would ultimately lower depreciation charges and lead to a boost in earnings going forward. Historically, Telkom has had many impairments, so this isn’t a new story but perhaps the quantum is something that’s creating absolute panic selling.
Our base case suggested Telkom could sell their assets for 42bn, leaving Telkom Mobile. With a R13bn haircut that value moves to R29bn. If you take away the Debt of R16bn you are left with R13bn in cash which is exactly Telkom’s current market cap. This adjustment again needs to be seen as a progressive step towards finding suitable buyers, willing to pay the new adjusted value or a premium above the adjusted potential value.
There’s no doubt that Telkom’s management team have dropped the ball. We had hoped that by strengthening their board with ex-MTN/Samsung executives that would have resulted in a deal of sorts being brought to the table. Our belief now, is that relevant buyers looking in, will believe that now could be the “bargain opportunity” that they were holding out for. Of course, this isn’t the ideal outcome for shareholders, or our original thesis to “Unlock Value through Asset sales”, but it should once again under-pin the share price and again create a possibility of a future deal.
At this juncture, we think the SA Government really needs to extract some funds from their 40% shareholding in Telkom as funding for the National Health Insurance (NHI) is required and these funds have likely been targeted for roll-out of NHI. Therefore, we think Government would likely move along any potential deal from a regulatory perspective.
Moving back to our longer-term thesis of “consolidation” within the telco sector.
We briefly highlighted a theory that once Telkom moves ahead with earmarked asset sales, it would be left with “Telkom Mobile” and roughly R10-15bn in cash (after settling debt). We think the next smart move for Telkom would be to merge with a smaller listed or unlisted telco operator in South Africa. The telco sector locally is under considerable pressure, and the high probability of a SARB rate hike next week is likely to further impact consumers and telco operators alike.
So, while we recognise the overall constraints in the telco sector and South Africa, we think there are various possible scenarios which could play out over time and create significant shareholder value for investors in the telco sector.
Join me again next time when I play out possible corporate action scenarios for the local telco sector.
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