Telkom is not a spent force – yet

Former telecommunications monopoly Telkom, which until about 15 years ago had a stranglehold over the sector in South Africa, faces huge challenges if it hopes to remain a significant market player.

Rapidly growing demand for data services such as video streaming and cloud-based business applications is making further significant investment essential for telecoms companies, including Telkom.

The problem is that although the company has an extensive fibre network, most South Africans rely on wireless rather than fixed lines to connect to the internet. Telkom Mobile has grown into a sizeable operation (placed third in the market behind Vodacom and MTN, but ahead of Cell C), but is going up against rivals with deeper pockets (Vodacom and MTN) in rolling out 5G.

Also, Telkom must deal with handicaps it inherited by starting life as 100% state owned – one of these being that it has many more employees than MTN or Vodacom relative to the revenue it generates.

As a result, Telkom announced in February that it would let go up to 15% of its employees to cut costs, blaming tough market conditions. It also announced a cost-saving drive to increase profits impacted by rolling power cuts and high working capital requirements.

It said it aims to cut costs “over the next six to 18 months and return to a blended group Ebitda margin of more than 25%”. (Ebitda, a measure of operating profit, is an acronym for earnings before interest, tax, depreciation and amortisation.)

A top-rated telecoms analyst, who is precluded from being quoted in the media due to company policy, believes a key indicator to watch when Telkom publishes its annual results for the 12 months ended 31 March 2023 next Tuesday is the operating outlook and the company’s plans to conserve or generate cash flow after the planned job cuts have been completed.

Impairment shock

Last month, Telkom warned shareholders that its board was considering an impairment in respect of the group’s cash-generating units – Openserve, Telkom Consumer, Gyro and BCX – of about R13-billion (excluding tax effects).

Telkom will also take a big hit to earnings due to the impairment charge. Reported Heps will be as much as 105% lower, Telkom warned. Basic earnings per share, or Beps, will fall by as much as 485% to a loss of around R20/share.

“The asset impairment is non-cash, so while somewhat negative, it is not really that relevant to the outlook,” the telecoms analyst said. “Tied to the cash-flow outlook would be plans to reduce net debt to below the company’s guidance of 1.5 times net debt to Ebitda – in other words, balance sheet stability is key.”

Though Telkom’s annual results will disappoint – the recent profit warning sent the shares tumbling – they should be seen in the context of the company having to reinvent itself from being a fixed-line monopoly that could dictate prices to the market, to a full-service telecoms operator trying to hold its own in a competitive market.

Its mobile operation, for instance, has well over 18 million subscribers, despite being launched 16 years after MTN and Vodacom’s 1994 debut. It has even overtaken the previously third-placed Cell C. Telkom at one stage had entertained buying Cell C, but those talks went nowhere.

Cell C’s largest shareholder, Blue Label Telecoms, has since led a recapitalisation of the mobile operator’s balance sheet. Cell C also exited the wireless infrastructure business after realising it didn’t have the scale or capital resources to compete in network spending with its bigger rivals.

Could Telkom soon find itself in the same boat?

The weakness of its balance sheet compared to its rivals leaves it at a disadvantage in a difficult economy and given the expensive complications that come with dealing with South Africa’s rolling blackouts.

The concern is that Telkom could easily become a minor player in a market it once dominated. Africa Analysis business development director Dobek Pater told TechCentral that one of the major problems is that for several years there has been little strategic consistency.

“Telkom’s struggles have resulted from both internal and external factors. A lack of consecutive and clear strategy means it has been oscillating between different strategies over the past several years, particularly under [former CEO] Sipho Maseko; focusing one year on fibre (and Openserve), another year on Telkom Mobile, then back to fibre, etc. The lack of clear focus and persistent pursuit of defined goals has resulted in Telkom not gaining much of an advantage in any specific area of the telecoms market,” he said.

Changing mobile market dynamics also played a part, he said. “Telkom Mobile used to focus on price competition and the offer of good packages to attract customers and grow its subscriber base. It still does that, but the market has changed, with prices of mobile services (both voice and data) continuously declining. It has become more difficult for Telkom to compete on price, particularly given that it also roams on the larger mobile networks (MTN and Vodacom) in parts of the country.”

The wholesale infrastructure environment has also become more competitive. Newer operators have been building infrastructure, providing downstream retail service providers with greater choice of wholesale products. This makes it more difficult for Telkom to compete.

Pater said growth in the IT market, including cloud services, means business customers have a greater choice available to them from both domestic and foreign providers. This has made life more difficult for BCX, Telkom’s IT services subsidiary, which it acquired in 2015 for R2.7-billion in cash.

Under pressure

Asked whether there is much left to salvage at Telkom, Pater said there are elements of Telkom that continue to present good value:

• Its Openserve and telecoms network infrastructure (mainly fibre) – the most extensive in the country;
• Telkom Mobile – here the value lies mainly with the spectrum Telkom holds;
• Swiftnet – the passive infrastructure (towers, excluding radio masts) may be of value as mobile/wireless infrastructure must be densified, especially with the deployment of high-frequency 5G networks;
• Telkom property management company Gyro’s telephone exchanges and data centres may be valuable as the demand for cloud server space grows. This would depend on the state of these facilities and how much upgrading needs to be done; and
• BCX still has an excellent corporate customer portfolio, with extensive relationships in this segment of the market.

Telkom warned recently that its free cash flow is under severe pressure due to the impact of “front-loaded investment in working capital”. The subsidisation of smartphones and other devices, designed to grow Telkom’s contract user base, is putting huge pressure on company margins and cash generation as it fights to retain and grow market share in mobile.

“The working capital investment in mobile handsets and the post-paid cost of sales are immediate costs, with corresponding revenues recognised over 24-36 months and therefore do not immediately offset the upfront costs associated with growing our post-paid subscriber base,” Telkom said in February.

Equities analyst Irnest Kaplan said although Telkom is facing challenging circumstances, the company – which is still 40.5% directly held by the South African government – is “not going to disappear” because “lots of big businesses still rely on it and it has lots of good things going for it”.

Its assets are also valuable, Kaplan said: its extensive fibre network can’t be replicated easily, which is highly attractive.

“But fixed-line operators are slowly in decline; they’re having to defend what they have. Its mobile business is doing well, but Telkom’s small and it’s competing against big spenders like MTN, which is all over Africa, and Vodacom, which is spending huge amounts on capex,” he said.

In their most recent full-year results, South Africa’s top three telecoms operators spent the following sums on network investments and other capital expenditure:

• Vodacom spent R11.2-billion, a record amount in one year (to end-March 2023);
• MTN spent R8.8-billion (to end-December 2022); and
• Telkom spent R6.5-billion (excluding BCX, Gyro and Trudon), but only R2.8-billion was spent on its mobile network, with much of the rest (R2.1-billion) going to fibre.

“It’s not the end of Telkom. What will be interesting is to chart its path from here,” said Kaplan.

One person who is clearly bullish about the company’s prospect is former CEO Maseko, who is backing a possible bid to buy 35% of its equity. Maseko’s consortium includes his investment fund, Afrifund, and Mauritius-based Axian Telecom.  – © 2023 NewsCentral Media

• TechCentral will provide full coverage of Telkom’s annual results next Tuesday, including an interview with group CEO Serame Taukobong