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Telkom: Out of growth, out of options, and still burning cash

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Telkom has a big problem. In the last six months (to end September) it burned through nearly R2 billion in cash (it reported negative free cash flow of R1.89 billion). In the last financial year (ended March), it had negative free cash flow of R2.08 billion, meaning the total cash burn in the last 18 months is R4 billion.

A year ago, it blamed the timing of capex payments for the cash flow ‘challenges’. Then it spent R1.1 billion in the spectrum auction which added a further knock.

Now it says that free cash flow is “under pressure mainly due to the impact of handset sales on working capital”. It is selling handsets on 24- and 36-month contracts and only getting that cash over the contract term, while it pays for device immediately.

It says this meant cash collections deteriorated by R860 million. Lower profitability also impacted cash generated.

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In the last six months, Telkom generated R2.8 billion in cash from operations, versus R4.5 billion a year ago. It has been using handset financing to improve cash flow and says R730 million of this is included in the R2.8 billion figure. In the first six months last year, a similar transaction boosted cash by R305 million.

One can see the issue here … last year, handset financing was 7% of cash generated. Now, it’s a full quarter.

Simply put, Telkom is not generating anything close to the cash it used to because it is not nearly as profitable as it once was.

These warning signs have been piling up for some time …

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Ex-growth?

When comparing halves, the top line has been flat since the second half of 2019. It is down 1% on the same period last year. Revenue in the fixed line business is declining at 10% a year and has been for some time – the average annual decline since 2019 is 13%. Fixed line revenue is down 42% over the last four years.

Until fiscal 2021, mobile revenue had been making up for this drop, but mobile revenue has been largely flat for the last 24 months (ranging between R8.6 billion and R8.8 billion). Over that two-year period, it is up 1% … a far cry from the growth rates of years past where service revenue was increasing at 50%-plus.

BCX is not making up the slack – growth in IT services sales (+14%) was offset by declines in voice and connectivity (-11%).

Swiftnet – the tower business which was to be listed separately to help unlock value until “market conditions” forced its postponement – saw revenue reduce by 2% to R660 million.

Telkom chose to highlight that revenue from “continuing customers” was up 7.6% to R467 million.

It says overall, the group is “replacing high margin business with lower margin business”.

And costs are rising. This is the fundamental conundrum being faced by Telkom executives.

MTN sale?

MTN has walked away from a potential transaction to buy Telkom, or at least the parts it really wants (read: needs). Openserve remains the most attractive piece of Telkom’s business. Rain knows this too, which is why it has also approached the operator about a deal.

Telkom says two-thirds of revenue now comes from next-generation services – fibre, not voice or copper. Its fibre-to-the-home connectivity rate of 46.2% is the best in the industry and it wants to get this to 50%.

It says now that Openserve is a legally separate subsidiary, “this presents the group with opportunities to unlock value through aligned partnerships”.

Might it attempt a transaction similar to Remgro with its fibre assets – Dark Fibre Africa (DFA) and Vumatel – where a new minority shareholder, Vodacom, has been brought on board to (effectively) fund growth in the medium-term?

Openserve is easily worth more than DFA and Vumatel, and a deal where Telkom sells, say, 40% to an operator like, say, MTN would provide it with a large amount of cash to solve its debt problem.

Such a transaction would also be significantly more politically palatable, versus an outright sale which government has already informally kiboshed. (Rain is a non-starter for this kind of deal – its proposal relies on its rich valuation to essentially effect a merger of the two companies).

Debt and dividend

Telkom’s net debt is now R16.3 billion, 16% higher than the R14 billion a year ago.

Its net debt to Ebitda (earnings before interest, tax, depreciation and amortisation) ratio is at 1.7 times, far above the target range of below 1.2 times.

Some of this can be blamed on the billion rand spent on spectrum and the group also justifies the elevated level due to “investments in this working capital cycle”. It says it has a further R2.3 billion in “unutilised facilities” which provide it with “adequate headroom to fund future growth”.

That’s only half true. With a deteriorating free cash flow picture, this debt will become a bigger and bigger problem to service.

Still, the group somehow sees a path to resuming its dividend: “Returning cash to shareholders remains a key element of our capital allocation framework,” it says.

“Telkom is in the final year of the three-year dividend policy suspension period. The Board remains committed to reinstating the dividend policy at the end of FY2023 and is reviewing the policy.”

There is no way the group can afford a dividend without reducing its debt pile. Perhaps selling a part of its most important asset is that key, but would shareholders really be enamoured with this plan? It wouldn’t solve the issue of unlocking the value trapped inside Telkom. Although Telkom may yet be forced into this kind of transaction …

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