Telkom’s turnaround shows potential for privatising tax-guzzling SOEs

As President Cyril Ramaphosa puts the final touches to his soon-to-be announced Cabinet that will be tasked with restructuring bankrupt Eskom and South African Airways (SAA), Telkom continues to prove that privatising and depoliticising an entity could drastically turn its fortunes around.

Telkom’s latest financial results show that the telecoms group, which was once wholly owned by the state but is now partially owned, has a lucid strategy for growth in a highly competitive industry. And more importantly, it’s profitable.

Telkom grew its earnings before interest, tax, depreciation and amortisation (ebitda) by a better-than-expected 8.5% to R11.3-billion for the year to March 2019. Analysts surveyed by Bloomberg expected ebitda of R10.9-billion.

Profit after tax rose 11.5% to R3.3-billion and headline earnings per share (another measure of profit because it excludes certain once-off items that might boost profits) grew 22.6% to R7.22 over the same period.

Telkom is so profitable that it will contribute to the fiscus and the SA Revenue Service bank account.  It paid R1.2-billion in taxes and about R750-million in dividends to the government for its 40.5% direct shareholding in the company.

This pales into comparison with state-owned entities, mainly Eskom and SAA, which have been draining billions of rands from taxpayers.  In the next two-to-three years alone, SAA needs an additional R22-billion to mount a turnaround strategy and Eskom requires a financial rescue package of at least R69-billion.  

Ramaphosa has already hinted a quasi-privatisation model at Eskom, which will be unbundled into three separate units (generation, transmission, and distribution). Meanwhile, SAA has ruled out the possibility of privatisation.

Whoever is appointed as Public Enterprises minister will have in Telkom a successful case study for partial or outright privatisation, which has paved the way for business decisions and appointments of senior management to be made without any political influence at the company.

However, the turnaround of Telkom didn’t happen overnight.  

After its first privatisation phase – through the US$1.3-billion purchase of a 30% shareholding in Telkom by SBC Communications and Telekom Malaysia in 1997 – it went into a 15-year cycle of recording losses.

The losses worsened after Telkom listed on the JSE in 2003 because the government still controlled management and board appointments for eight years after the listing, resulting in a revolving door of executives.  During this period, Telkom had five CEOs in seven years.

Turnaround

The appointment of Jabu Mabuza as chairman (now outgoing) and Sipho Maseko as CEO in 2012 was a game-changer.  Maseko repositioned Telkom away from its core fixed-line business, which is in structural decline as customers rely more on mobile data to message and make calls.

In doing so, he unleashed more than R6-billion worth of investment into its network infrastructure to support its mobile services business. It introduced flexible mobile bundles, which include free calls and messaging on WhatsApp and similar applications.

This has paid off. Telkom’s mobile service revenue jumped by 58.3% for the 2018 financial year on the back of an 85.9% leap in active subscribers to 9.7-million. Prepaid subscribers increased by 109.3% to 7.8-million compared with 3.7-million in the previous year.

Mobile service revenue of R3.7-billion was the largest contributor to group revenue of R39.6-billion. Underscoring the concerted effort by management to transform the business is that its fixed-line business contributed 50% to group revenue in 2013 vs 27% today, while mobile accounted for 3% of revenue in 2013 vs 26% today.

“For me, more important than the Telkom results in this regard is the impact of this on Vodacom and MTN. In a tightly contested market, one has to ask who Telkom is taking market share from?” said Reuben Beelders, chief investment officer at Gryphon Asset Management.

If Telkom maintains this growth, it might pip Cell C, which had 12.1 million active data subscribers in 2018, as SA’s third-largest mobile operator behind Vodacom and MTN.

Ron Klipin, a senior analyst at Cratos Capital, says Telkom’s profitability might prompt it to make a bid for its vulnerable and struggling rival Cell C, whose debt profile was recently downgraded by S&P Global Ratings over its deteriorating liquidity position. About R8.8-billion of Cell C’s R9-billion reported debt matures within the next 18 months while it still has negative free cash flow.

“It might be the right time for Telkom to rescue Cell C to build critical mass. Telkom is growing nicely in the mobile market in the short term, but not quickly enough for the long term,” says Klipin.

Expansion

Telkom plans to accelerate investments in its 4G network, with the aim of building 2,000 new towers over the next three years. The group’s overall capital expenditure (capex) to revenue ratio will be about 16% to 20% in the next three years.

Beelders is concerned about the capex in Telkom’s mobile division, which amounted to R3-billion for the year to March 2019. “The extensive capex in the mobile division will have to produce returns into the future,” he says.

Market watchers agree that Telkom’s shares have created shareholder value. Early backers of Telkom bought its share at around R13 in 2013. On Monday, its shares rose as much as R98,20, commanding a lofty price/earnings ratio of 17x. “The share at current prices… is a little overdone for a company still only producing a return on equity of around 10%.”

Telkom shares were usually buoyant when the market believed that the government was about to sell its shares in the company to raise money to bailout Eskom or SAA (again).

“Perhaps with Telkom’s return to profitability, it might be beneficial for the government to be selling at higher level say via a bookbuild,” says Klipin. DM