EDITORIAL: Sipho Maseko makes a tough call on Cell C
Telkom’s bid is good news for consumers but perhaps not for shareholders
Telkom CEO Sipho Maseko is walking a tightrope. Maseko, at the helm since 2013, is aggressively pushing Telkom’s mobile phone business deeper into a market dominated by established rivals MTN and Vodacom. But its hefty capital expenditure has jacked up debt to dangerously high levels and wiped out its cash flows.
News on Friday that Telkom has put in a buyout bid for his long-term target, Cell C, underlines Maseko’s unassailable strategic logic of building a stronger mobile phone business but also raises questions about its effect on Telkom’s capital structure.
From a consumer point of view his dogged determination to increase competition and break the Vodacom and MTN stranglehold on the market is welcomed. For shareholders, it is crucial for the long-term survival of Africa’s biggest fixed-line phone operator in a country where cellphone SIM cards outnumber the population nearly 2 to 1.
Maseko’s pitch might be tripped up by his valuation of Cell C.
So far, so good for Maseko.
In last week’s half-year results announcement, Telkom reported almost a 70% jump to R772m in underlying core earnings, or earnings before interest, tax, depreciation and amortisation (ebitda), after spending more than half of its roughly R4bn capital expenditure rolling out high-speed 4G networks and boosting its subscriber base by more than three-quarters to 11.5-million.
The mobile division, written off as doomed to fail when it launched in 2010, is slowly becoming a gem, contributing more than a quarter to Telkom’s annual revenue.
That said, Vodacom and MTN are still miles more profitable. Their ebitda margins, or the percentage of revenue converted into income, of 35% and 40%, respectively, put that of Telkom’s mobile business in the shade: its margin was 11% at the end of September.
To help close the gap, Maseko is pursuing Cell C, SA’s third-largest mobile phone company boasting 16-million subscribers and an ebitda margin that would double the margin at Telkom’s mobile division.
It is not hard to imagine that shareholders will not dispute the industrial merits of the deal, which is sold as vital for Telkom to compete with Vodacom and MTN and will boost the company’s annual ebitda by almost a third to R15bn.
But Maseko’s pitch might be tripped up by his valuation of Cell C. Shareholders might resist forgoing a portion or all their dividend payouts to help fund the deal, and they will also have to weigh up the merits of the deal with a weakened capital structure.
It’s anyone’s guess how much Maseko has offered Cell C, which is valued at zero in the books of its biggest shareholder, Blue Label Telecoms, which coughed up R5.5bn for a 45% stake in 2017. Either way, Maseko should respond to legitimate expectations of a lowball offer.
Telkom will inherit a company labouring under R8.2bn debt, which is almost double Telkom’s own borrowings. That will put pressure on Telkom’s capital structure and possibly breach its own stated target of a net debt to ebitda ratio of 1.5 times.
Assuming that Telkom can snatch Cell C for a trifling sum, the combined entity’s net debt would be roughly R24bn and have an annual ebitda of nearly R15bn, pushing Telkom’s net debt to ebitda ratio to 1.6 times.
Maseko has already signalled that shareholders might have to share the pain, saying its dividend payout policy could come under review because the company needs cash to fund the rollout of high-speed mobile phone networks. Should he close the dividend taps, he would boost the company’s cash flow by about R2bn, the amount it paid in dividends in the 2018 financial year and slightly below investments made in the mobile business.
Given that both MTN and Vodacom keep dividends flowing even as they pivot away from basic telecom services, tightening the dividend taps will annoy Telkom shareholders.
Yet, faced with the alternative of letting their company fall behind in a fast-changing telecom industry that is preparing for the ultra-fast 5G network, shareholders, the biggest of whom is the government with a 40% stake, may have little choice.
And SA’s consumers could do with a bigger, financially stable third player in the industry as the government prepares to auction off the long-delayed radio frequency spectrum.