Telkom SA SOC Ltd (TKG) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Telkom annual results international analyst call. [Operator Instructions] Please note that this call is being recorded. I would now like to hand the conference over to Serame Taukobong. Please go ahead, sir.

Thank you very much, ma'am. Good afternoon, everyone, and good morning to those in the U.S. With me, I have our Group CFO, Dirk Reyneke; and our Head of Investor Relations team, Babalwa George; and Kamohelo Selepe. I would like to unpack our annual results performance as follows. I will start by unpacking the business performance we witnessed in the year. Dirk will then unpack the group financial performance. I will come back and conclude with the strategy review and an update of the value unlock strategy. The results were delivered against a tough trading environment characterized by constrained economic environment and intense competitive landscape. The economy remains constrained and consumers are under pressure from rising interest rates, rising energy and fuel costs. Ongoing load-shedding is adding to the very constrained economy. We saw an increased competitive activity in the market, especially in the mobile space, and consolidation in the market. From a regulatory perspective, we are seeing a stabilizing environment. Spectrum was released in March 2022, where Telkom obtained 20 megahertz in the 800 band, 22 megahertz in the 3500 band for ZAR 2.1 billion. Telkom's total spectrum portfolio now stands at 170 megahertz across all bands. The newly acquired spectrum will enable us to offer credible 5G proposition. The sub-1 gig enables us to deploy network more efficiently and increase coverage. Subsequent to the release of spectrum, the forward-looking settlement we have agreed with ICASA is an opportunity to resolve the current market challenges. ICASA have agreed to license the spectrum that remained and assigned at the auction by no later than 30th June 2022, and finish the licensing process within the current financial year, F '23. In the spirit of our agreement with ICASA, Telkom has withdrawn its referral of the Vodacom Rain spectrum arrangement to the Competition Tribunal. This gives ICASA the opportunity to develop the appropriate regulatory framework for the secondary market for spectrum, including spectrum leasing or arrangements between larger and smaller licensees. Discussing the business performance, I will start with our infrastructure business. Openserve stabilization path continues, reporting flat revenue of ZAR 13.4 billion after several years of decline due to legacy business. Significant progress has been made to the transformation business -- to transform the business, my pardon. The business revenue mix has evolved. At the end of the year, more than half of its revenue is generated from next-generation business. Overall, Openserve's stable performance lays a good foundation for growth as Openserve returns to growth in the next financial year. Openserve performance is underpinned by increasing fiber demand for fiber services across the carrier and consumer segments. We continue to see growth correction in fiber business, fiber to the home, increasing homes passed by 52.7% to 840,000 homes passed and homes connected increasing by 38.4%. This represents a connectivity rate of 46.3%, demonstrating that our connect growth strategy of simultaneously expanding our FTTH footprint, whilst focusing on connecting premises, is bearing fruit. Our ongoing investment in our network, ZAR 3.5 billion in the current year, enabled us to carry a 16.6% increase in fixed broadband traffic to 1,665 petabytes. 79% of our fixed line broadband customers are using more than 10 megabits per second speed and higher -- supporting higher data consumption. In the current year, the fixed broadband connections evolved in favor of NGN. We now have a majority of our fixed line broadband customer on next-generation technologies and 65% attesting to successful migration strategy. In the second half of the year, we also saw overall fixed line base growing despite the ongoing decline in the ADS or subscriber base. Notwithstanding the strong demand in fiber, the impact of the pandemic in the small and medium business is evident in the challenging performance. From a profitability perspective, EBITDA was also flat at ZAR 4.2 billion, with EBITDA margin maintained at 31%. This was supported by efficiencies delivered by running a modernized network, decommissioning legacy infrastructure and optimizing costs and maintaining our network. I will now move to our Swiftnet business. Swiftnet continue to commercialize its portfolio, in line with its growth strategy, which entails increasing tenancy on the existing portfolio, acquiring sites and building new towers, as well as expanding the range of products and preparing for the implementation of 5G by our clients. In the current year, Swiftnet grew its new towers by 31% to 142, while it doubled the number of in-building solutions, albeit from a lower base. Overall, the productive portfolio size increased by 5.9% to just over 3,900 towers. The revenue increased by 4.4% to ZAR 1.3 billion. This performance includes the impact of terminations and continued focus on modernization of our mobile network operator customers. From a profitability perspective, Swiftnet EBITDA was impacted by a refined methodology of allocating property costs in the second half of the year, which was applied prospectively. As a result of this change, Swiftnet EBITDA declined by 8.6% to ZAR 909 million and EBITDA margin contracted to 70.4%. On a normalized basis, EBITDA increased by 2.7% to just over ZAR 1.21 billion at a margin of 79%. Moving on to our mobile revenue. Despite this competitive landscape, our subscriber base grew by 10.5% to 16.9 million subscribers with a blended ARPU of ZAR 90. The main contributor emanated from the prepaid base, which grew by 12% to 14.3 million subscribers, driven by LTE. Despite the challenging macro environment, our postpaid grew by 3.4% to 2.7 million subscribers with an ARPU holding steady at ZAR 212. Mobile broadband customers grew 3.8% to 10.7 million, supporting a 2.9% growth in mobile data revenue. Overall, mobile data traffic grew by 3.3% to 970 petabytes. We invested ZAR 2.8 billion in increasing mobile sites by 13.7% to 7,313, while the 4.5G sites grew 42.4% to 6,451 sites. We continue to target to maintain a further backhaul ratio between 70% and 80%. This paid off as well, allowing us to effect backhaul upgrades at sites where additional traffic was anticipated. At the end of F '22, 68% of our base stations had fiber backhaul. We will continue to invest in mobile owned network, while utilizing roaming agreements to supplement our network footprint, allowing our customers to access 3 networks: Telkom Mobile, Vodacom South Africa and MTN South Africa. The ongoing network investments in mobile delivered a revenue growth of 6.3% to ZAR 21.4 billion, while mobile EBITDA increased by 3.7% to ZAR 5.8 billion, resulting in an EBITDA margin of 27.2%, which is within our target EBITDA margin corridor of 27% to 30%. Moving to BCX. BCX remains under pressure due to the sluggish economy and the impact of the global supply chain. As a result, BCX revenue declined by 2.6% to ZAR 15.3 billion, with an EBITDA margin of 14.9%. The revenue performance fairs well compared to the first half of the year. We recorded a 6.1% decline in revenue. We saw an improvement with some clawback in revenue in the second half, though the revenue remains negative at 2.6% decline. This is because of the stabilized converged communication business with its revenue down 1.1% to ZAR 7.3 billion. We saw exceptional growth in cybersecurity, IoT solutions, innovation and technology, albeit off the lower base. We're encouraged by the improvement in the IT market with the investment in new capabilities, progress made with strategic programs and renewed activity in the market. I will now hand over to Dirk to unpack the group financial performance. Dirk?

Thank you, Serame, and good afternoon, everybody. I'll deal with the key financial messages, and then I'll come back to each one of them individually again. So overall, revenue under pressure, down 1.1% to ZAR 42,8 billion. Sustained underlying profitability underpinned by sustainable cost management with EBITDA flat, 0,5% decline at ZAR 11,9 billion and EBITDA margin expansion of 2 percentage points to 27,9%, despite a challenging top line. Growth in the underlying earnings, headline earnings as well as basic earnings per share up 2,5% and 1,4%, respectively. Disciplined capital allocation with CapEx down 11,4% to ZAR 7,5 billion, a stable balance sheet post spectrum acquisition with net debt-to-EBITDA ratio of 1.2x, excluding spectrum net debt-to-EBITDA is 1,1x. And then lastly, free cash flow significantly under pressure. Cash outflow of ZAR 2 billion due to spectrum investment, prior year CapEx overhang and the challenges in revenue. If we then unpack the revenue, group revenue down 1.1% to ZAR 42,8 billion, with our mobile stream continuing to be the driver of growth. This was offset by the decline in the fixed and IT businesses, which remain under pressure due to the challenging operating environment and a decline in the fixed business as customers migrate to modern technologies such as fiber and LTE. Mobile service revenue grew 3.3% to ZAR 17,5 billion, underpinned by double-digit growth in active customers. In addition, the Swiftnet Mast & Towers external revenue was up by 0,8% to ZAR 700 million. The slowdown in economic recovery and global supply chain constraints, which has resulted in computer chip shortages, has led to a further 6,4% decline in IT revenues. Fixed voice and fixed data declined 17,9% and 3,5%, respectively. This fares well compared to the decline of 21% and 8,6% in the prior year. The stability in the fixed business is attributable to a slowdown in the fixed voice churn and an increase in usage as there was improved economic activity in the year compared to the prior year. If you look at profitability, the group EBITDA was relatively flat, as I said, 0,5% down at ZAR 11,9 billion with an improved margin at 27,9%. This was mostly underpinned by our sustainable cost management initiatives from prior years, which seeks to contain OpEx below inflation and optimize cost to serve. OpEx declined 4% year-on-year despite an average group-wide salary increase of 6%. Direct cost increased by 4,3%, driven mostly by mobile handset revenue and partly offset by lower mobile roaming traffic. Despite the increase in costs associated with the postpaid market, such as distribution channel cost, mobile cost to serve was further optimized. Cost to serve improvement was enabled by optimized roaming cost as we maintain stringent roaming traffic threshold and migrate traffic to our network supported by the ongoing network investment. The reduction in OpEx and optimization of our cost to serve resulted in a reduction in our total cost to revenue ratio, which reduced by 0,7 percentage points. If you look at our earnings, I've referred to basic earnings per share increasing by 1,4% as well as headline earnings per share increasing by 2,5%. The ongoing settlement of the maturing debt in [ alone, ] relatively stable interest rate economic environment resulted in finance charges reducing by 17,7% to only ZAR 662 million. Fair value movement in foreign exchange losses reduced by 39,9% from ZAR 278 million to ZAR 167 million due to a favorable foreign exchange hedging position. In terms of CapEx, we continue to invest in our key growth areas of fiber, mobile and Mast & Towers. Capital investment decreased by 11,4% to ZAR 7,4 billion, representing a CapEx to revenue ratio of 17,5%. We continue to accelerate our fiber rollout and monetization. Fiber services now make up 44% of the total CapEx compared to 29% in the prior year. Homes passed increased by 52,7% year-on-year, while homes connected increased by 38,4%, which still gives us a connection ratio of 46%. I referred to free cash flow being under pressure. Negative free cash flow of ZAR 2 billion largely driven by the revenue decline in the current financial year; secondly, the increase in handset purchases and sales following the reopening of the economy because of the COVID-19 lockdowns which had an impact on working capital. The prior year CapEx overhang of ZAR 1,1 billion that I've communicated before relating to the quarter 4 ramp-up in the prior year where the cash was paid out in the current year and then the spectrum acquisition of ZAR 1,1 billion in the current year. We executed ZAR 1 billion of handset financing. Despite this, our handset debt has increased significantly because of the handset sales increase. Excluding the spectrum investment, our underlying negative free cash flow was ZAR 938 million for the year. If we look at our balance sheet post spectrum acquisition, we have an adequate balance sheet capacity to fund our strategy despite the acquisition of spectrum of ZAR 1,1 billion, which resulted in our net debt-to-EBITDA increasing to 1.2x. In the current year, we settled ZAR 193 million debt in line with our debt maturity profile. This is over and above the ZAR 1,4 billion matured debt repaid in the prior year. Excluding spectrum, our net debt to EBITDA is 1,1x, driven by 35,2% decrease in the cash balances at the end of the year and additional leases to support mobile that's increasing the IFRS 16 lease liabilities. We target to maintain annual debt redemptions at or below ZAR 2 billion per annum to manage the refinancing profile and thus reduce the refinancing risks. The floating rate debt versus fixed rate debt at 53-47 ratio. This marginal change in the fixed versus floating was largely because of the repayment of maturing debt. If you look at the outlook, a solid financial framework to support the group's strategy and deliver sustainable returns for shareholders is key as we go forward. We will certainly focus on enhancing our financial framework where the group returns to growth, both top line profitability and free cash flow, from the next financial year. Our mobile business has grown ahead of the market and secured a third market position. Going forward, we expect also mobile to grow in line with its industry peers, while we expect overall fixed data revenues to start growing from the next financial year. Given the slowdown in growth in the mobile business and continuous decline in the legacy business, group revenue will grow at mid-single digits over the medium term to full year '25. Underpinned by our sustainable cost management, we target to grow group EBITDA at mid-single digits over the medium term. We expect to continue to invest in the business with CapEx to revenue ratio of between 16% to 18% per annum, and we'll maintain a healthy balance sheet of net debt to EBITDA of 1.2x. I will now hand back to Serame for our strategy review, the value unlock and for him to conclude. Thanks, Serame.

Thank you, Dirk. It's been 6 months since I took over from my predecessor, Mr. Sipho Maseko. I'd like to thank Sipho, not just for the first 6 months in this year, but for his tenure in Telkom over the past 8 to 9 years and the solid path that he set us on. Given the changes in the operating environment, we have reviewed our PIVOT strategy and concluded that the strategy is sound, and there may be tweaking of tactics here and there. Broadband remains the backbone of our strategy. Victory in broadband is what has secured us the third position in the mobile market as a late entrant. Operational efficiencies were key to maintain our EBITDA margin in a tough environment where our legacy business with high margins was declining at a faster pace. Technical innovation. We have been investing in our network and fairly completed modernizing our core and transport network. We are now focusing on modernizing the access network. That is the last mark. We will set up our -- step up our effort significantly on portfolio diversification as we build a digital business in Telkom. Consumer will focus on greater solutions as we move to partner in these capabilities. Going forward, we will focus on strategic imperatives and strengthening our execution capabilities. To deliver sustainable growth, we will address scale and capabilities in some of our businesses. Scale enables market developments in our core businesses, and capabilities allow us to access adjacencies and new sources of growth. Our strategic goal is to establish a robust partnership model to drive partnership for scale and for capabilities. These partnerships will take different forms such as commercial, strategic and equity. We will assess on a case-by-case basis. In terms of the value unlock strategy, the Board remains committed to the value unlock strategy which is premised on Telkom's market capitalization, not representing its intrinsic value. Telkom has different classes of infrastructure assets such as data centers, fiber, Mast & Tower business which are globally valued at high multiples for separate individual businesses than telecommunications. During the year, the Board postponed the separate listing of Swiftnet due to the volatile capital markets. As our key focus is to maximize shareholder value, we also reviewed the strategic options presented to us. Strategic options will also unlock value for shareholders by affirming the valuation of Swiftnet and its contribution to the overall valuation of Telkom. They provide us with an opportunity to scale Swiftnet by being part of a bigger M&T portfolio and/or acquire more advanced expertise or capabilities and enhances Swiftnet's growth prospects through increasing Swiftnet tenancy and increase financial contribution to Telkom. At the appropriate time, the Board would advise the shareholders on the best route to unlock the value. In conclusion, we have made significant inroads in evolving our business from legacy to next generation business, which lays the foundation for future growth. Telkom is not excluded. We reported a negative growth in revenue in the mobile business, which has been the driver of the growth and a slow down to mid-single-digit growth, in line with its peers. We are confident that Openserve will return to growth in F 2023. Our confidence is underpinned by the evolution of this business. More than 50% of the revenue and fixed line broadband customer base, 65%, is on next generation and the overall fixed line broadband customer base started to grow in the second half of the year. Therefore, our key strategic themes moving forward will be to invest and commercialize our core businesses to drive growth. We will also look into adjacencies to support the growth. We will invest in our infrastructure business to drive 5G and commercialize the business. Broadband leadership, we will drive on fixed and mobile. We will accelerate migration from legacy to next generation. We'll drive converged IT solutions and fixed mobile conversions. Lastly, we will focus on implementing the value unlock strategy and rewarding our shareholders. This concludes the call. I will now hand over to the operator for Q&A. Thank you.

[Operator Instructions] We have a question from Madhvendra Singh of HSBC.

First question is on your CapEx plans, especially given that now you have received spectrum as well additional spectrum fund in the recent auction. So what does it mean for your CapEx as well as your roaming expenses? Whether there will be any reduction in your roaming expenses, which you incur on moving with Vodacom MTN? So that's the first question. And secondly, how -- what's the outlook on dividend, if you could comment on that a bit? What are the parameters which you need to see to do that?

So I think if we look at the CapEx spend, one has got to look at the 2 years past in tandem. On the mobile side, when we received the COVID temporary spectrum, we front-loaded our CapEx spend, spending about ZAR 4.8 billion in mobile CapEx. Obviously, in the next -- the year after that, given that we already had the temporary spectrum and had received the spectrum post the auction, the net effect is that, that spectrum over a period of 2 years has been running at a run rate of about ZAR 3 billion to ZAR 3.5 billion. We will maintain this on the lower end of the side, making sure that we balance between capacity and also managing our roaming. In regards to roaming as a percentage of revenue, the continued CapEx spend in mobile has allowed us to drop this from when we started at a high of 19%, and we target to aim it at single digits or high single digits. From a dividend outlook, I'll hand over to Dirk.

Yes. I think from a dividend outlook, we've suspended the dividend policy 2 years ago at the time we announced suspension of 3 years. The Board is still committed to reintroduce a new dividend policy by the end of the third year, which is the year ended March '23. We've deliberated and there's no -- I think it's premature to give any guidance on what such a dividend policy will consist of. Suffice to say that we are still within the 3-year suspension term and we will reinstate the dividend policy at the end of that 3 years.

So the dividend will not be paid for FY '23 either just to make it clear? It will be -- even if there is a policy, it will be for FY '24, right?

Yes. I don't think that's a given. One can reinstate the dividend policy and pay a dividend at the same time. But the dividend policy will probably be linked to free cash flow and it will then depend on the free cash flow picture whether there will be a dividend declaration.

Our next question is from Louise Pillay of Investec.

I have a question on mobile, please. It appears your pricing gap to peers have significantly narrowed. I mean, a key question is what is Telkom's customer value proposition now versus the peers? It used to be on pricing. But yes, I need a bit more conviction on what are you selling to your mobile customers. And further to that, it seems you've gained subscriber market share in prepaid, but it's not translating into service revenue market share gains. How are you going to change that, and I would say, the -- for this financial year? And then the second question is on -- just to unpack your guidance on revenue. Which divisions are those likely to come from if mobile is under so much pressure?

Thanks, Louise. I think the pricing gap to market can be read in a couple of ways. You're right that in your kind of higher-value LTE bundles, that's where we saw a significant drop in prices, particularly from MTN and Vodacom. What we do seem and remain competitive is in your lower value bundles, which typically carry a higher margin and which is where the highest usage is for customers. So we remain aggressive in those. We did respond to the market, and I think we saw it come through in how our postpaid numbers performed, growing by 3.7%, but most importantly, holding ARPU at the same level as even before COVID. You're absolutely right with the prepaid. And I think the key driver for us is how we are changing the type of acquisition and how we're rewarding our dealers. It's not about getting high volume, low ARPU subscribers, but rather acquiring more higher-value subscribers and rewarding them on tenure. The big focus on us is to make sure that how do we retain and migrate and move our active base to ensure that the prepaid customers we are bringing into the market are the right shape to drive the increased growth. In terms of the guidance, as we've said, even though the mobile is holding in at industry trends, we've seen good results in postpaid -- sorry, in Openserve, certainly the second half of last year, our continued focus on fiber to the home and fiber to the tower. And we see this as the shift where Openserve will also come to the party in contributing to that revenue growth.

Our next question is from Nadim Mohamed of SBG Securities.

Three questions from my side. Firstly, just would like to understand if you could just explain the dynamics around fixed mobile fixed data revenue. So it was down 3.5% just as it was also down quite a bit last year. But fixed broadband ARPU since we're going up over that period, I think in this current year from ZAR 248 to ZAR 274 if you could just unpack the dynamics behind that. I mean clearly is this just loss of subscribers that's driving the lower revenue growth or is it about some other trend there, if you could explain that to me? And then secondly, just, Serame, you mentioned that roaming as a percentage of revenue is likely to drop from the about 19%, I think you said to single digit. Over what time horizon do you see that happening?

I'll take the first one. I think in terms of fixed data revenue and fixed broadband ARPU, I think, again, we must unpack the fixed data market. I think there's 3 different components in that market. The first one is really the fiber to the base station, which is your top ARPU, where we're not seeing a decline in ARPUs and certainly not a decline in revenue. We see the backhaul links actually growing. I think in fixed broadband, to the curve or to the business, similarly, we've got a fair -- I don't want to call it dominance, but a fair chunk of that market share, and that talks to an ARPU of over ZAR 3,000 a month. And there, we haven't seen a decline. I think it's really in the last mile fiber and the fiber to the home, where we still experienced some moves away from copper fixed line into fiber. And that copper -- that fixed revenue from copper actually splits up into fiber, into LTE and also some churns away to competitors. So I think it's really the legacy fixed revenue decline that informs the fixed data revenue -- the sluggish fixed data revenue. Just repeat your second question for me. I know it was also...

Roaming.

Yes. I think Serame mentioned, if I'm referring correctly, that roaming as a percentage of revenue, you see for that to fall to single digits. I was just wondering over what kind of time period are you looking at that.

Yes. I think in terms of roaming traffic, currently, if you talk data traffic, roughly the roaming is about 2% to 3%. And I think if you talk voice traffic, it's about around 10%. I think it's just below 10%. So that's traffic that roams on either Vodacom, MTN. And then if you look at the split between Vodacom, MTN, it's probably -- not probably, it's the majority still MTN -- sorry, the majority is still Vodacom as the second roaming agreement with MTN is bidding down.

And I think as a percentage -- roaming as a percentage of cost, like I said, when we started, we were at 19%. We're currently sitting on about 9%. So that projection is moving in the right direction.

[Operator Instructions] We have a question from Vikhyat Sharma of RMB Morgan Stanley.

I just wanted to know the time lines with regards to legal separation of Openserve. I mean how that is progressing? And when can we expect that to be finished?

The process has started internally. We will be finalizing the final proposition with the Board in the next 2 months, and we'll announce the full proper timing and transaction after those sessions. So in terms of all the technical work and all the background work that needs to be done, we're almost like 85% there. We just need to have a final roundtable with the Board to agree on the final direction. I hope that answers your question.

It seems we have no further questions on the lines.

Thank you very much. Thank you all for attending and taking time off. We really appreciate your time. Have a good evening in South Africa, and a good morning to those in the U.S. Thank you.

Thank you. Goodbye.

Ladies and gentlemen, that concludes today's conference. Thank you for joining us. You may now disconnect your lines.