Telkom: number 3 in a race I don’t want my money to run

• South Africa
• ICASA, MTN, Spectrum, Telkom, Vodacom
• November 10, 2020

So, Telkom has managed to overtake Cell C as the third largest mobile operator in South Africa, although that’s a bit like beating your granny at the 100m sprint. Cell C has never turned a profit and has shed over 4.5 million subscribers in the last year alone.

Cell C says that it would rather focus on profitable customers than growth for the sake of growth, measured by Average Revenue Per User (ARPU). Cell C has a debt balance of nearly R10bn and continues to post eye-watering losses, so hopefully this turnaround strategy turns out to be the right one. The silver lining is that Cell C’s spectrum is supposedly worth over R10bn, valued using a similar approach to the pending spectrum auction in SA. At least that covers the debt, then.

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Telkom now has 13.7 million subscribers in total. It’s still tiny compared to the likes of Vodacom with around 40 million subscribers in South Africa. Vodacom has twice as many lucrative “post-paid” subscribers i.e. contract customers, compared to MTN’s natural strength in prepaid subscribers.

This goes some way towards explaining why Vodacom is worth nearly R238bn and trades on a Price / Earnings (P/E) ratio of around 13x. MTN is only worth R125bn and trades on a P/E of nearly 9x.

Over 5 years, MTN is down nearly 57% while Vodacom is down nearly 13%. That’s not pretty.

Neither telecoms company has offered a pleasant few years for shareholders, but MTN has been worse off as it dealt with the fallout of the enormous $5.2bn fine from Nigerian authorities (which was eventually reduced to $1.5bn).

It’s ironic that during a time in the world when smartphone usage has exploded and Big Tech companies have created incredible shareholder value, the leading South African telecoms companies haven’t proven to be successful investments for shareholders.

The real value has been in the hardware, software and apps, not the telecoms infrastructure itself.

Things might have been very different

It’s impossible to predict what today’s position could be, had things happened differently in 2009. As the world reeled from the Global Financial Crisis, both firms were locked in negotiations for major corporate actions.

Vodacom listed on the JSE in May 2009. Just before the listing, it was held 50% by Telkom and 50% by Vodafone Plc. As part of the deal, Telkom sold a 15% stake to Vodafone (taking it to 65%) and unbundled the other 35% in Vodacom to Telkom shareholders.

Trade unions and ICASA tried their best to derail the transaction, hoping to prevent control of Vodacom falling into foreign hands. They were unsuccessful and Vodacom rebranded from blue to red a couple of years later, completing its transformation into a Vodafone group company.

At around the same time, India’s Bharti Airtel was having a serious look at merging with MTN, which would’ve created a telecoms giant across Africa, Asia and the Middle East with 120 million customers. The deal eventually fell over as the parties couldn’t agree on who would control the merged entity (surprise surprise).

MTN is under new management

MTN is on a digital and FinTech journey, with new CEO Ralph Mupita aspiring to bring these revenues lines up to 25% of total revenue by 2025. They currently contribute 10%.

MTN boasts nearly 275 million subscribers and posted 13.9% growth in Earnings Before Interest, Taxation, Depreciation and Amortisation (EBITDA) for the 9 months to end September.

Investors in MTN will hope for some resolution to the repatriation challenges in Nigeria, where MTN struggles to take cash out the country due to a lack of availability of US Dollars. MTN operates in several markets, so constant-currency growth is also important. This measures the underlying revenue growth in each country, ignoring the impact of changes in exchange rates.

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Telkom must keep pushing the mobile strategy

Telkom’s results for the six months to end-September reveal that mobile revenue grew nearly 48%. Group revenue was down 0.4%, so mobile is carrying the entire team right now. If you’ve ever watched cricket in your life, Telkom Mobile is Chris Gayle and the rest of the company is the West Indian middle-order.

EBITDA at least grew 6.3% so that’s something, but free cash flow remains a major concern among analysts. A telecoms company is a cash-hungry beast and the industry exhibits all the signs of a winner-takes-all industry, particularly for players who own their own infrastructure.

Is there really space for a third major infrastructure owner? Cell C has given up on that journey.

Telkom jumped 17.5% on the day of its trading update release on November 3^rd but cooled off today with a nasty -7.6% drop as the market digested the full results.

There’s a Competition Commission storm brewing over spectrum

Spectrum is the lifeblood of the telecoms companies. Spectrum has not been allocated in South Africa for over a decade, so it’s a major step that ICASA now plans to auction R8bn worth of broadband spectrum.

Telkom has appealed to the Competition Commission to consider the impact of agreements that Vodacom and MTN have with smaller players, including Cell C and Rain. The argument is that this gives them further reach than would otherwise be possible.

It’s a weak argument in my view. I’m certainly no telecoms expert, but doesn’t an agreement to share infrastructure encourage competition, rather than diminish it?

Telkom isn’t in much of a position to cry about not having enough infrastructure. It has the largest fibre deployment in the country and could conclude deals with the likes of Rain, albeit for fibre products rather than mobile data.

It smells a little bit of desperation. Telkom has lost nearly half its value over the past decade and it’s not clear to me why the next few years will be different. The mobile growth is great at the moment, but it’s coming off a small base and will require incredible capex to continue at this rate into the future.

This isn’t an industry I would want to own shares in, so I especially don’t want to own shares in the number 3 player.

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