Telkom is selling the wrong pieces of itself

Telkom has a problem. Its four major businesses – Openserve, Gyro, Business Connexion Group (BCX) and Telkom Consumer – are together worth north of R50 billion.

But investors are simply not valuing its parts ‘correctly’, with its market capitalisation only exceeding this amount when it confirmed it was in talks with MTN about a potential sale.

Since this “significant discount” to the sum of the parts was described in detail by then CEO Sipho Maseko in mid 2020, it hasn’t been able to address the problem. At that point, its market cap was R14 billion.

Because of market conditions – global pandemic/Russia’s invasion of Ukraine/take your pick – it has since shelved its planned listing of its Swiftnet towers business.

Today, its market cap is R18 billion.

Rising debt woes

Compounding this trapped value is the fact that the group’s debt continues to rise. At the end of September, net debt was R16.3 billion, a 16% increase over the prior year.

With the group now effectively ex-growth – it reported 2% growth in revenue and a 13.5% decline in earnings before interest, tax, depreciation and amortisation (Ebitda) in its peak quarter (to December) – it has been forced to reduce costs and has implemented a restructuring programme that could see it cut up to 15% of its staff.

In the race to unlock value it commenced a sales process for the Swiftnet towers unit late last year, and it has engaged Bank of America to manage the sale of a stake in its Openserve fibre business. Updates on both transactions are planned for June, when it releases annual results.

Presuming it achieves an outright sale of Swiftnet, it could raise around R10 billion. Maseko valued the business at an estimated R13 billion in 2020. This neatly solves the group’s debt problem.

Why then, is it doggedly pursuing the sale of a portion of its most valuable asset Openserve?

Of course, by definition its fibre unit has commanded the most investor interest and will continue to do so.

What would the point be of unlocking value by selling 30% of Openserve now? One needs to consider what would be left in Telkom following these two transactions.

Unlocking value

Lumbering BCX, where revenue has effectively been flat for years, would be the largest remaining asset by value.

Then would come a hypothetical 60% or 70% of Openserve.

A property portfolio (Gyro) where some value remains to be unlocked would also be left behind.

Oh, and Telkom Consumer – which is not exactly a growth business any longer. Revenue in this unit has started to decline as growth in the mobile business stalls. In the first six months of 2023, it says “the mobile business continues to drive growth in Telkom Consumer”. Mobile revenue was up 0.5%. Revenue in the consumer unit declined 1.9%.

The problem is clear. The days of Telkom’s mobile business chugging along at 40% growth every year are long gone. Cell C has stabilised and shed unprofitable subscribers, while Vodacom and MTN are more formidable competitors than ever – especially following the 5G spectrum auction.

There’s an increasing pile of debt at the centre and free cash flow has been consistently negative.

Why would any investor want to own an ex-growth telecoms business, where its subscriber base means it’s in a distant third place in the market – 18.6 million versus 36.5 million/45.5 million? One could argue that ex-growth BCX being part of the group actually makes the proposition worse.

Swift changes 

What if the board looked at this a different way entirely? We can accept that Openserve is by far the most valuable asset within the group. Wouldn’t it make sense to position this as the rump of whatever is left? Add Swiftnet to it and turn it into a utility-style pure infrastructure play …

A useful comparison is the valuation Remgro affords to Community Investment Ventures Holdings (CIVH), the owner of Vumatel and Dark Fibre Africa (DFA). It raised funding in 2021 at a valuation of R27 billion. Nowadays, this is slightly lower at around R24 billion. However, post the transaction with Vodacom the resultant entity, Maziv – comprising DFA, Vumatel and Vodacom’s fibre assets – will be valued at around R40 billion.

Openserve should command a valuation of at least R25 billion – it has higher Ebitda on lower revenue than CIVH. Throw in Swiftnet and the valuation of this infrastructure business is probably R35 billion.

BCX – the ‘old’ BCX plus Telkom Business – could be unbundled, although this isn’t the sexiest enterprise, nor is it growing. Its Ebitda margin of 12% (lower than previous years) is a persistent drag on the group’s overall profitability.

That leaves the consumer (read: mobile) business. Of the roughly R25 billion in revenue this unit generates each year, more than half is from mobile, and given the decline in its fixed-line business, this contribution is growing.

Stronger together

The obvious endgame for Telkom, as has been the case for a decade now, is to merge this business with Cell C.

At least the combined business would then have the necessary scale, and Cell C’s valuable mobile virtual network operator (MVNO) wholesale base, to compete more effectively with Vodacom and MTN. Combined, this business would have more than 30 million subscribers with average revenue per user (Arpu) of ±R85. This is below the >R90 of Vodacom and MTN, but still healthy. Prior to its laboured recapitalisation, Cell C was simply not in a position to be acquired. Now, things are different.

An alternate path for Telkom would be to merge its consumer unit with Rain.

Rain proposed a tie-up with Telkom last year, but the parties abandoned talks in January.

This would leave the listing (to be renamed Openserve) comprising the country’s largest fibre network, a sizeable tower and masts portfolio, and some property assets. This is a far more compelling investment proposition than the current plan, which will leave behind Telkom Consumer, BCX, and a majority stake in Openserve.

There are no easy choices left for Telkom. It needs a plan for its consumer business. For shareholders, getting rid of it may be preferable to it being left behind …

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