‘Telkom is not for sale’

Telkom is not for sale. That’s the crisp message from CEO Serame Taukobong, even as his predecessor, Sipho Maseko, is mounting a bid to buy the listless telecoms operator.

The clouds seem to be gathering for the one-time fixed-line telephone monopoly derided as “Hellkom” by frustrated customers: its shares plunged 15% on May 17, when it warned that its profit for the year to March would be at least 85% worse than that of the previous year.

It illustrates how times have changed for a company that has been around forever: the first telephone exchange was opened in Port Elizabeth in 1882, six years after Alexander Graham Bell filed his patent for an “apparatus for transmitting vocal or other sounds telegraphically”.

The modern Telkom was birthed in 1991, when it was split from the South African Post Office. At the time it was a corporate powerhouse, providing 3.5-million landlines, and employing 67,667 people. Its services, said then CEO Danie du Toit, “affect the lives of all South Africans”.

But as the global economy digitised and fixed-line phones were surpassed by cellphones, Telkom had to face its mortality. The company, worth R14.3bn, is now miles behind South Africa’s telecoms titans MTN and Vodacom. It has never seemed more irrelevant.

And yet, in a wide-ranging interview with the FM, Taukobong is adamant that Telkom has a future as a stand-alone company — and that it most certainly doesn’t need a white knight.

“I think the biggest misconception is that there is a big ‘for sale’ sign outside Telkom ... that we’re on a fire-sale journey [with] the sentiment that Telkom needs a saviour, a knight in shining armour to come and save it,” Taukobong says.

If so, the profit warning two weeks ago illustrates just why that misconception is there. The company said it would have to write off R13bn in assets — a quarter of its assets — as it “accelerates its migration to newer technologies”.

This is a serious chunk out of its rump, given that the company’s market capitalisation is just R14.3bn. That in itself is an indictment of the way in which Telkom has lost value. In 2003, when it listed on the JSE, it was valued at R15.6bn. Today, its shares have slumped to R26.02 — less than a third of the R96.70 it hit just three years ago.

More worryingly, the profit warning suggests Taukobong’s team hasn’t  reversed the trajectory that was evident in the financials for the three months to December, which showed revenueinching up just 2.3% to R11.03bn,  with pretax earnings dropping 13.5% to R2.49bn.

Brokerage JPMorgan, which has a “sell” recommendation on the company, says this seems to be part of a structural shift in Telkom’s business, “which is exacerbated by continued weak South African macro conditions and deteriorating power supply”.

It adds: “Telkom’s fixed-line and IT services business remains under pressure, while mobile revenue growth has slowed significantly ... we expect slowing fixed-line, BCX [IT services subsidiary Business Connexion] and other revenue decay, with limited future cost rationalisation and weaker mobile growth.”

It sounds dismal. And yet some see green shoots — not least of them Maseko.

This week, Bloomberg reported that the former CEO’s investment company Afrifund and Mauritius-based Axian Telecom were in talks with the state-owned Public Investment Corp (PIC) to back a deal to secure 35% of Telkom.

The speculation caused the company’s shares to bounce 10.5%, despite the lack of detail.

As it is, the PIC already speaks for about 15% of Telkom, while the government owns 40.1% — ensuring the state has effective control. If the government were to sell its stake  entirely, it would bring R5.6bn into the National Treasury’s coffers.

Insiders close to the deal tell the FM that Maseko is actually looking to wrest control of Telkom, with his consortium hoping to secure more than 50% of the company’s shares.

The plan, according to these sources, is “advanced” and would see Maseko’s company and Axian buy 35% partly from the government (which would sell a third of its stake to him) and partly from some smaller minority shareholders he has already negotiated with. The PIC’s 15% would then push that group over the 50% mark.

However, takeover rules stipulate that if any party buys more than 35% of a company’s shares, this triggers a mandatory offer to all the other shareholders. This would imply that Maseko’s group would then have to launch a public offer to all Telkom’s remaining shareholders.

It is just as well, then, that the sources say he already has secured funding of R12bn.

The sources say that if Telkom were to team up with Axian, which has a presence in nine African countries, it would allow it to expand beyond South Africa’s borders and combine their fibre and tower assets. Telkom will be wary, however: it got burned badly in Nigeria a decade ago.

Africa Analysis’s Dobek Pater, a telecoms veteran, told Bruce Whitfield’s Money Show on 702 that Telkom is “undervalued quite significantly”, given the breadth of its network in the cities.

“Perhaps Sipho Maseko sees an opportunity here, where [he] expects Telkom, in a more privatised role, would be able to perform a lot more efficiently and to a better degree than when it’s got a significant government shareholding,” he said.

Patek said that if Maseko’s consortium buys the shares from the government, the state would “become a very minor shareholder with probably a lot less to say at board level”.

Maseko isn’t the only one who believes that, with the right strategy, Telkom could be revived.

Last July, South Africa’s second-largest cellular company, MTN, said it had “entered into discussions” to buy “the entire issued share capital of Telkom”. This sparked a flurry of interest: Rain, backed by Patrice Motsepe, tabled a “nonbinding” merger proposal, while another group, the Toto Consortium, then made an offer too.

By September, however, everyone had walked away. Telkom was left standing alone at the altar.

Chasing data revenue, not customers

As much as Taukobong, who joined Telkom during Maseko’s tenure in 2018, talks big about going it alone, the market seems to believe a benefactor with deep pockets is the better option.

But Taukobong has always been a contrarian. He believes, for example, that the company’s heavy asset base — which seems more in line with a 1990s telecoms firm than a lithe modern tech firm — is precisely why it will thrive in the next decade.

Taukobong is no greenhorn. As one of South Africa’s most respected telecoms executives, his experience in the sector extends over two decades. He’s spent 10 years at MTN, where he was CEO of its third-largest business, in Ghana, and chief marketing officer at MTN South Africa. Before that he held senior positions at Unilever, South African Breweries and M-Net.

Prior to taking over as Telkom CEO in mid-2022, he led its mobile business. Under his leadership, it became the fastest-growing mobile provider: the customer base more than tripled (it now stands at 18-million), and it surpassed Cell C to become the third-largest mobile provider in South Africa.

Now, however, mobile growth has slowed sharply. This appears a consequence of Telkom’s strategy to focus on growth in mobile data (which makes up 75% of the service revenue for Telkom Mobile), rather than simply chase subscribers. More profit, less growth at any cost.

But Telkom’s greatest prize isn’t its mobile arm or its fixed-line business. According to Fitch Solutions — a unit of global financial services company Fitch Group — Telkom’s main attraction is its extensive wholesale fibreoptic network, housed in Openserve.

“Telkom operates by far the longest network in South Africa with more than 170,000km of fibreoptic cables and this network is growing,” it says.

Data traffic driven by fibre is the new gold, which makes Telkom hot property again.

Besides Openserve, Telkom’s assets include IT services business BCX, property division Gyro and towers operation Swiftnet. But all those divisions have been struggling: Telkom has cited “significant market changes and current economic conditions, including accelerated load-shedding, low anticipated economic growth rates and a high interest rate environment” for the need to write down its assets.

Moreover, while Taukobong says Telkom as a whole isn’t for sale, some parts of it definitely are.

The company’s strategy seems to be to hold on to the best parts, bring in outside investment to scale other parts, and sell those that no longer fit the strategy.

Swiftnet falls into the latter category. Telkom wants to ditch the subsidiary, as evidenced by its failed effort to list Swiftnet on the JSE last year.

With BCX, bought for R2.7bn in 2015, Taukobong says Telkom will consider bringing in outside investors. “Depending on the type of partner, we’d be prepared to go to a minority stake if the partner is bringing significant scale and capability,” he says.

While BCX produces about a third of Telkom’s revenue, it has struggled to produce consistent profits. Though Telkom tried, and failed, to sell BCX a few years ago, Taukobong believes an investor can still be found.

“It’s really about getting the right scale and the right partner,” he says. Ideally, Telkom wants a global partner, which can help it boost its cybersecurity capacity — a growing niche worldwide.

BCX, in fact, has been increasingly looking for global partners. Take, for example, its partnership with German software firm SAP, which aims to be 100% on cloud computing by 2027.

“BCX is rapidly building the capacity to make sure it is the leader and provider of SAP services cloud,” says Taukobong.

I think the biggest misconception is that there is a big ‘for sale’ sign outside Telkom ... that we’re on a fire sale journey [with] the sentiment that Telkom needs a saviour, a knight in shining armour

—  Serame Taukobong

In the same vein, BCX last year signed a deal to supply cloud computing services on behalf of Jack Ma’s Alibaba, the 31st-biggest corporation in the world, according to the Forbes list, which clocked up  $129bn in revenue last year. Telkom expects to begin making money from this Alibaba deal from 2024.

One asset it won’t be selling is Openserve. Says Taukobong: “With Openserve, we will always have a majority [stake]. That is fundamental and key to us.”

You can see why, as the fibre industry is one of the few growing industries in South Africa.

In November 2021, Vodacom joined forces with Remgro’s telecom infrastructure unit CIVH in a deal worth R13bn. That gave the company, already the largest mobile operator in South Africa, control over Dark Fibre Africa and Vuma, the country’s largest fibre-to-the-home network operator, with 1.4-million homes passed.

“We are seeing lots of activity around consolidation, and we feel that — particularly in the fibre space — we’re quite strong,” he says. Even when it comes to fibre-to-the-home, where Telkom is a laggard, the backhaul connectivity is still being done by Openserve.

It’s no surprise that Telkom says it has received “a number of unsolicited approaches” to sell part of Openserve, and is “undertaking a market-sounding exercise to test the breadth of interest” in the fibre operator. But even if it sells a stake, it won’t give up control.

Breaking up, or slimming down

The bigger picture is that there’s plenty of value at Telkom — it’s just trapped in an unwieldy and anachronistic structure. Finding a way to unlock this is Taukobong’s main concern.

It was Maseko who first mooted a break-up of Telkom back in 2020, when he said the company had been “looking at how we can unlock value”. If you took into account Telkom’s valuation, he said, the value of its properties and other assets weren’t reflected in its share price.

Maseko argued that the sum-of-the-parts for Telkom could add up to R53bn, with Swiftnet accounting for R13bn. At the time, Telkom was worth more than R20bn, though it has since plunged to R14.3bn — nearly a quarter  of Maseko’s calculation of fair value.

Independent analyst Philip Short believes “the value lies in breaking it up or having other companies buying and running parts of the underlying businesses”.

Even as Taukobong touts Telkom’s bright future, the profit warning reveals that, when it comes to cash in the bank, the company is in a financial rut. And, to stem this bleeding, it has resorted to cutting jobs.

In a conference call in February, Telkom CFO Dirk Reyneke told investors: “Cost-savings programmes to uplift the medium-term profitability are top of the agenda.”

Reyneke said Telkom’s profitability had been whacked by “the impact of ongoing load-shedding”, as well as the “required investment in working capital to optimise the mobile subscriber base”.

It’s somewhat ironic that Eskom, which began life as the state-owned electricity counterpart to the state-owned telecoms company, is partly to blame for the red ink in Telkom’s accounts.

Like other operators, Telkom has had to shoulder the costs for keeping its base stations powered during blackouts — paying out R150m for diesel in the three months to December.

Already, Vodacom and MTN have sounded the alarm about the cost of the blackouts: MTN is using more than 400,000l of fuel a month to keep generators operating at 9,000 of its sites, while Vodacom spent upwards of R4bn since 2020, and R300m just this year, trying to insulate itself from the blackouts.

Paul Colmer, from the Wireless Access Providers Association, says things are even worse for Telkom, as it operates internet exchanges through which fibre networks are routed. Given the size of the company’s fibre system and its role as the backbone connecting networks, its costs quickly ramp up.

So, with growth sluggish and costs rising, Telkom’s cash-saving plan consisted of slashing up to 15% of its workforce. Consultations with staff on this front began in February.

Given the last staff number of 11,788, this suggests 1,770 jobs may be on the line — even though the Communication Workers Union (CWU) estimates the impact at more than 2,000 jobs.

The trade unions have vowed to fight the job cuts all the way.

The CWU’s Aubrey Tshabalala, for one, has accused Telkom of creating “artificial profits” that benefit its executive and shareholders, saying its reasons for cutting jobs are “lousy”.

“Telkom has been [cutting jobs] every two years [from 2014], and the rationale behind these jobs bloodbaths is the same, with a few senseless additions such as the release of spectrum, load-shedding and the Covid lockdown,” says Tshabalala.

The National Union of Metalworkers of South Africa (Numsa) says it is the government — as the largest shareholder in Telkom and as Eskom’s parent — that is responsible for creating an unfavourable operating environment. 

“The contemplated retrenchments are as a result of load-shedding, which is another reminder of the dire impact that rolling blackouts are having on the economy and on all aspects of business ... job losses and high unemployment are synonymous with the ANC,” it says.

For years, however, Telkom’s workforce was considered bloated — a legacy, some argued, of the fact that it was considered a “strategic asset” by government, and was meant to help create jobs.

But the speed of jobs culling has been notable. From a company with 67,667 employees in 1991, when the landline business was still booming, it has shed four-fifths of that.

If affiliation with government is any yardstick, the state’s other communications venture, the Post Office, has been equally brutal when it comes to slashing jobs. That company, which this week argued in the North Gauteng High Court why it shouldn’t be finally liquidated, employed 14,440 staff at last count, and announced plans earlier this year to cut 3,000 employees.

This is why Numsa is so furious that the government “has no vision to create jobs, and it has no plan to retain the few jobs that exist”.

Telkom may desperately need to cut its costs, but it can expect a fierce fight from the trade unions.

SBG Securities estimated in February that the staff cuts would save Telkom between R900m and R1bn a year. But it warned: “The organisational restructure is likely to also face opposition from unions and political parties — both are key sources of risk.”

A toxic cocktail

None of this changes the essential reality of Telkom in 2023: growth has stalled in some of the critical parts of the business, its profit margins are down, and it has to make its money in a grim — and fiercely competitive — economic environment characterised by rising unemployment.

“It’s a toxic cocktail of a very poor macroeconomic background and intense competition,” says Peter Takaendesa, head of equities at Mergence Investment Managers.

“Unfortunately for the management team, there’s no quick fix here. It’s almost like Eskom: whatever strategy they come up with, no matter how clever, will take years to turn things around sustainably, especially now that the growth engines — mobile and fibre — have slowed a lot.”

Telkom may have a rich heritage, but that hasn’t exactly helped as people ditch legacy voice businesses in favour of new technologies. And as Telkom doesn’t have a monopoly in those markets (as it used to have in fixed-line telephones), it makes less money.

As Reyneke put it in February: “Newer technologies come at lower margins.”

SBG Securities analysts agree, arguing in a research note that the transition from a legacy to a next-generation business “continues to result in revenue leakage and lower margins”.

It’s no surprise, in this context, that investors who’ve borne the brunt of the value destruction are questioning what the point is of holding Telkom shares any more.

Says Short: “One should hold Telkom if you’re, first, an event-driven manager [or] investor due to corporate action, and, second, if you believe an event [or] corporate action [such as a merger or asset sale] will indeed play out.”

Still, on any number of metrics, he says Telkom’s shares are cheap. Its p:e is now about six — far below rivals such as MTN (9.9) or Vodacom (11.2). But this probably reflects the lack of faith that it’ll be able to maintain its profit levels.

Short points out that Telkom’s discount to its net asset value remains large too, which means the sum-of-its-parts is still worth a lot more than its shares. “And we know they’re willing to talk to Rain, MTN and others,” he explains.

On this front, Maseko’s bid looms as the largest factor, though if this doesn’t happen for one reason or another, there’s always a chance that MTN could step back into the fray.

Taukobong says Telkom “isn’t opposed” to reopening talks with MTN. And you can imagine MTN CEO Ralph Mupita would probably also welcome the leg-up such a deal would give his operator in the burgeoning fibre sector.

Says Short: “Consolidation is inevitable. Yes, regulators don’t want big players, but there is so much cost duplication right now.”

Taukobong is clear that Telkom has a future as a stand-alone company, but even if that’s proved true, it is guaranteed to look vastly different a decade from now. Right now, it’s an even bet whether the company will be broken up entirely.  And if Maseko can swing his deal through the goalposts, and a new Africa strategy is rolled out, the company’s direction will change radically too. 

But today, with cash scarce and growth prospects dim, Telkom probably wishes it hadn’t let go of its 50% stake in Vodacom back in 2008. That would be worth R131bn today — nearly ten times Telkom’s value right now. That’s the sort of buffer investors can only dream of.