Fixed line operator caught with its pants down

From Gareth Stokes, MoneyWeek editor, SA

Dear Money Morning reader,

There was probably a disconcerting silence when Telkom Limited pulled the wraps from its full-year results recently. At first glance the numbers suggest resilience under the much-publicised recessionary trading conditions. But when you look past the moderate improvement in total revenue (from R34.1bn to R36.4bn) to the R2.7bn decline in operating profit you become painfully aware of the income statement ‘black hole’ the Vodacom disposal will leave in future periods. Despite the strong Vodacom contribution in the 2009 year, net profit attributable to ordinary shareholders almost halved (from R8bn to R4.2bn) and Telkom’s management had to placate shareholders by dipping into the group’s cash reserves. They announced a special dividend of 260c/share in addition to the 115c/share final payment.

The group’s fixed-line division hit the skids with a 46.5% decrease in operating profit, to R4.334bn, on the back of a disappointing 12.9% (down from 24.9% in 2008) operating profit margin. Given this performance shareholders will want to know how Telkom will reward them in FY2010 and beyond. The group has thus far failed to create profitable businesses to compensate for its exit from the domestic cellular service provider space. Writing in the Mail & Guardian Online, Kevin Davie provided the ammunition for today’s headline. He reminded us of Warren Buffett’s insightful comment on market trends: “Only when the tide goes out do you discover who’s been swimming naked.” In this case shareholders (and management) will be hard pressed to cover their embarrassment when the R27.594bn in Vodacom revenue (Telkom used to benefit from 50% of this lolly) is stripped away.

Management’s attempts to plug the revenue gap have failed dismally. The group’s foray into Africa is burning cash rather than generating it. Case in point is the Multi-Links operation in Nigeria weighing in with a net loss of R1.763bn over the period. Telkom also had to walk away from its Telkom Media venture when it couldn’t work out how to convert its media licences into a revenue generating opportunity.

The ultimate irony is that Telkom’s management did what many a corporate raider has done in the past. They stripped their own company of its best assets. The bits and pieces that remain could just as easily be sold to the waiting vultures as used to create a truly viable fixed-line operator. Would we invest in Telkom today? Our gut response is: “No!” We simply don’t want to be caught in a compromising position when the tide goes out. Until management shows it has the tools to successfully acquire and integrate a profitable business, or demonstrate their ability to right-size the disastrous African operations, we’ll stay away. At the very least the group needs to streamline its product offering to compete with an array of new telecommunications entrants.

As things stand, Telkom evokes too many love/hate emotions. We love the 124.9% surge in revenue and the 209.3% jump in subscriber numbers at Multi-Links, but we hate the debt burden and interest charge overhang. We love the decision to part ways with Vodacom, but hate that nothing was done to plug the earnings gap etc. If you’re the patient type you should add a few Telkom shares every month over the next couple of years. Then sit back and wait for the boom times that go hand-in-hand with the inevitable payoff from Telkom’s African expansion. Analysts reckon you will wait until mid-2011 for this to occur. The less patient among you should give the company a wide berth. As Davie concludes, Telkom is a bit like “a tragedy masquerading as a telecommunications company” at the moment.

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Turning to the markets...

The JSE all share index shot up 2.51% yesterday. The gold mining index rocketed 4.07%. Resources closed up 3.8%. Banks and financials climbed 1.95% and 1.6% respectively. Industrials grew 1.53% and the platinum mining index rose 3.46%.

London's FTSE100 climbed 1.18%. The Dow Jones slipped 0.28% and the Nasdaq added 1.55%.

Tokyo's Nikkei grew 2.12%. Hong Kong's Hang Seng closed up 2.17%.

Brent crude is currently trading at $68.62 per barrel.

Spot gold's trading at $934.55 and platinum was last quoted at $1181.00.

And here's how the rand is performing against the major currencies:
R/$ 8.07
R/₤ 13.25
R/€ 11.27