Telkom investors are confused. When the telecommunications company issued its trading update at the end of last month, the surprise aspect was not the further R900m loss it incurred to get mobile operator 8ta on to its feet, nor the write-off on yet another ill-conceived African venture. It was the warning from that its data revenue had shrunk by about 6% over the six months to September.
The news could be the final straw to investors still toying with the view that Telkom is a misunderstood and neglected deep-value stock.
SA consumers’ growing preference for mobile telephony over fixed-line services is an established trend and the reason for Telkom’s belated move into the mobile space. But now there’s proof that the company is losing its grip on the data market, too, as consumers opt out of its fixed-line broadband service towards cheaper mobile broadband offerings from competitors.
“The expectation had been that the steep cuts in the price of mobile broadband would increase competition between the mobile operators. From Telkom’s announcement, it seems that the biggest shift has been mobile broadband gaining significant market share at the expense of Telkom,” said Jean Pierre Verster, an analyst at 36ONE Asset Management.
The trouble is that this trend is likely to continue, unless Telkom can reverse its track record of squandered opportunities.
Steve Minnaar, portfolio manager at Abax Investments, argues that Telkom, instead of having made the best of its dominance in the fixed-line market — ensured initially by regulation, but also by high barriers to entry — diluted the advantage by trying its hand at all sorts of other ventures.
“The decision to buy the Nigerian business Multi-Links, based on CDMA technology rather than the widely used GSM, has cost shareholders more than R10bn and was a disastrous decision from the get-go,” said Minnaar. “Then there was Telkom Media. That created about R500m in write-offs, while iWayAfrica has just added R450m to the list.”
He points out that with mobile operators putting in their own links and about 400 other players offering telecoms networks, it will be difficult for Telkom to claw back its market share, be it in data or voice. “Other companies are picking up critical mass. If Telkom doesn’t act fast to correct its lack of growth in data volume, the business is headed for a tipping point,” Minnaar says.
This could be an overreaction, though. Nombulelo Moholi, appointed CEO in April this year, has the vision and credentials to lead Telkom into growth. She also has the support of new financial chief Jacques Schindehütte.
And, as is often the case with a newly appointed management team, the dramatic nature of the recent profit warning could be an effort to clean house before the rebuilding begins.
Delphine Govender, the portfolio manager at fund manager Allan Gray, described the “newly installed, focused and capable management team” as an important plus within the “overwhelming negativity” of the Telkom story.
“The management uncertainty and rapid turnover that has prevailed in Telkom over the past few years has only served to exacerbate significantly the challenges faced by the business. Therefore, the power of an accountable and energised management team for this business cannot be understated.”
Besides, Telkom has a track record of rewarding its shareholders with generous dividends. The tally of dividends and special dividends paid since the 2003 listing, which includes the R19 windfall from the sale of its Vodacom stake and the R1,45 dividend declared in June this year, is R122,80. Not bad, given the listing price of R28.
“Even as an organisation under pressure on many fronts, Telkom remains considerably cash-generative,” says Govender.
But, Verster argues, it will be difficult for Telkom to deliver the operational cash flow needed to sustain its dividend performance. Without such cash generation, the dividend will need to be cut in future. Given its low return on equity, the company is likely to witness an increase in the gap between its share price and its tangible net asset value — its net worth excluding non-monetary assets such as goodwill or intellectual property rights.
“Telkom stock looks very cheap if one compares the prevailing price of around R32 (6 October) with the tangible net asset value of R40,22 measured at the end of April,” says Verster.
“However, given the loss-making nature of 8ta’s roll-out and the diminishing returns from Telkom’s voice business, it could be some time still before Telkom generates a respectable return on equity to narrow the discount.”
Another possible avenue for pushing cash generation and shareholder returns higher is convergence.
“The so-called triple play of voice, data and video may well be the direction in which Telkom is moving. Even though it abandoned Telkom Media in the past, the recent uncapped broadband offering could be the first step to start competing on video content,” Verster says.
“The risk is that this is too late, given the increased competition posed by satellite and digital terrestrial television.”
Minnaar’s view is that Telkom’s future hinges on a much more fundamental consideration. “Government needs to decide whether this is a listed company or not. Telkom’s seeming inability to make good commercial decisions in its allocation of capital, which in many ways is intertwined with government’s attempts to use the business to reach some of its own social objectives, makes it difficult for it to participate in an increasingly competitive landscape.”
Government’s shareholding in Telkom is just shy of 40%, more or less steady at the proportion that it kept upon listing. The Public Investment Corp, which runs government pension money, holds a hefty 10,9%.
Arguably, the concentrated shareholding in favour of government influence makes for a weak board. Moholi and Schindehütte are the only members of the executive team in a board of eleven members.
Govender, who says Telkom is asset-rich and strategically fundamental to the operation of the South African economy, concedes that Telkom’s management team “must be given the necessary autonomy to make what they believe are the best decisions for the future of the company, especially in the context of being able to rightsize the business”.
Loyal shareholders will be hoping that these two new brooms will have both the verve and the nerve to get the business on track.
Govender is one of those, although she warns that the investment case for Telkom is not without risk. “But, for contrarian investors who have an investment horizon that is greater than a year or two and who are able to include Telkom as a share in a wider portfolio of investments, the return opportunity from the stock is skewed towards the upside from these price levels.” — Erika van der Merwe, Mail & Guardian
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