And then there were three! Which telecoms play should you back?

From Gareth Stokes, MoneyWeek editor, SA

Dear Money Morning reader,

After the unbundling and separate listing of Vodacom, South African investors suddenly have three major listed telecommunications companies to choose from. You can stick with the tried and tested MTN Group (JSE: MTN) – turn your attentions to an unfettered Vodacom (JSE: VOD) – or stick with the dinosaur of African fixed-line infrastructure, Telkom. But before you splash your spare cash on a share in this sector you need to answer two questions. First – is telecommunications the place to be given the appalling 6.4% contraction in South Africa’s Q1 2009 GDP? “Is this numbers bad enough for ex-finance minister Trevor Manuel to admit to a recession,” we wonder. And the second is which of the listed telecommunications opportunities offer the best prospects for capital growth over the medium-term, say three to five years?

To answer the first question we must consider the business environment in which the telecoms companies ply their trade. StanLib economist Kevin Lings provides some guidance in his recent analysis of the aforementioned Q1 GDP number. He notes the decline is broad-based across a range of economic sectors. Manufacturing, finance, retail and mining were on the back foot while construction and government expenditure kept the economy from total collapse. But the slump doesn’t come as a total surprise. We’ve seen dismal statistics from most domestic sectors going back six to eight months already. Lings says retail is in trouble “due to weak consumer confidence and slumping disposable income growth.” And the outlook for the remainder of 2009 isn’t great. “The SA leading indicator has been pointing to a meaningful slowdown in domestic economic activity for some time and continues to suggest further declines in the quarter ahead,” says Lings. Since this indicator shows a strong correlation with growth, StanLib expects full-year 2009 GDP to come in at -2.2% (after 5.1% in 2007 and 3.1% in 2008). What about individual telecoms companies?

On paper, MTN Group is a step ahead of the game. Its turnover topped R102bn to 31 December 2008. And profit attributable to ordinary shareholders surged 44.6% to R15.315bn! Add these stellar numbers to the company’s aggressive growth strategy in Africa and the Middle East and it’s difficult to resist. That’s why an array of international suitors has made grabs for the company in recent times. As we pen this newsletter there’s talk of a merger between Bharti Airtel (of India) and MTN. The cash and equity swap would result in Bharti owning 49% of MTN, with MTN receiving $4bn plus 36% of Bharti. Provided the groups agree on management structures we expect the deal to go ahead. In that case MTN and Bharti would gain a dominant – perhaps unassailable – foothold in three of the world’s most promising cellular markets – Africa, Asia and the Middle East. You won’t find many analysts to dispute the cash-generating potential of 200m subscribers in those regions.

It’s more difficult to asses Vodacom’s prospects. The group squeezed its 39.6m subscribers for R55.2bn in revenue and an operating profit of R12bn in the year to 31 March 2009. We know the group is well managed despite nestling within Telkom Limited for the past decade. We also know that the group’s parent company, Vodafone, is a giant in Europe. But we’re not so sure where Vodacom will focus in the coming years. Will they try and win a larger share of the domestic market? Or will they try and claw back lost ground in Africa through their recent Gateway Communication acquisition? At 5550c per share Vodacom is trading on a price-to-earnings of around 13.66, making it a tad more expensive than MTN. But growth prospects are solid and we’d certainly be buyers of Vodacom on a three to five year view. Besides, you can never discount the possibility of new suitors pairing with Vodacom in a bid to gain a cellular presence on the southern tip of Africa.

In our book Telkom is the ugly duckling of the three. With Vodacom off its books, Telkom is going to have to do some fancy footwork to regain momentum. Given the group’s track record and its rather poor understanding of competition we rate Telkom as the least promising of the counters on offer. We’d choose MTN (first) and Vodacom (second) and expect similar capital growth over the next three years. Both will weather the current consumer malaise with flying colours. You should steer clear of Telkom until a clearer picture emerges of management’s plan for the company.

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Turning to the markets...

The JSE all share index closed up 0.36% yesterday. The gold mining index lost 1.69%. Resources added 0.6%. Banks and financials rallied 1.08% and 1.35% respectively. Industrials fell 0.67% and the platinum mining index rocketed 4.26%.

London’s FTSE100 closed up 0.10%. The Dow Jones lost 2.05% and the Nasdaq shed 0.95%.

Tokyo’s Nikkei closed 0.29% up. Hong Kong’s Hang Seng is closed for the dragon boat festival.

Brent crude is currently trading at $61.90 per barrel.

Spot gold’s trading at $946.65 and platinum was last quoted at $1,130.

And here’s how the rand is performing against the major currencies:
R/$ 8.19
R/£ 13.05
R/€ 11.33