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

Good day, ladies and gentlemen, and welcome to the Telkom Q3 FY 2023 Trading Update Conference Call. [Operator Instructions] Please note that this call is being recorded. I'd now like to turn the conference over to Mr. Dirk Reyneke. Please go ahead, sir.

Thank you, Claudia, and good afternoon, all, and good morning to those in the U.S. I think upfront, just apologies on behalf of Serame Taukobong, our CEO. He will be joining shortly. He is still on a flight that was slightly delayed, but he will join in shortly, but he asked that we proceed. So I'm going to continue on that basis, and Serame will join us as soon as he's available. So earlier today, we published our third quarter trading update for the current financial year. I assume you've all gone through it in detail, and we'll touch on the key aspects of it to allow for more time to questions. You'll only might have noted a further update around 2:00 on some restructuring progress that was published on since. In terms of unpacking the trading update for the third quarter, we will begin by taking the business performance for the quarter under review. Thereafter, I'll touch on the key financial messages and the cost savings program, and we will then return to give you an update on value unlock and conclude with an outlook. We navigated challenging trading and economic conditions in the quarter, but grew group revenue driven by continued growth in new generation technologies and increased data consumption. Our mobile and broadband strategies continued bearing fruit, and we saw good growth in broadband as our data-led and connected strategies continued to drive growth in mobile and fiber subscriptions along with the data usage. Despite this top line growth and the ongoing optimization of roaming costs, the migration of legacy projects to NGN continued. Our investment in postpaid to drive a higher annuity revenue from this space and the impact of sustainable nationwide load shedding with pressure on our costs, therefore, our EBITDA and our cash flows. If we look at the different business units, I'll start with Openserve. Openserve sustained the new generation network growth to direct trajectory. It grew fixed data revenue by 12.5%, driven by broadband, which was up 23.9%; carrier services, up 9.4%; and enterprise services up 1.4%, contributing to Openserve's leadership in providing open access connectivity across South Africa. Overall revenue declined by 3.8% as Openserve continued to experience the pressure of legacy-based products across all 3 segments of enterprise, consumer and small to medium business, which resulted in a 27.9% decline in fixed voice revenue. As demand for connectivity and consumption increased, Openserve saw a sustained increase in its overall broadband base over the last 4 quarters, which now grew to more than 567,000 connections, while fixed data traffic increased by 15% to 492 petabytes. Our homes past grew by 27.6% year-on-year with more than 1 million homes passed now. We continue to focus on execution, coupled with a connect-led strategy, enabled the business unit to increase the number of homes connected with fiber by 33% to almost 470,000 maintaining its leading connectivity rate of 45.9%. Despite the increased challenge of load shedding, Openserve continued providing the best customer experience by maintaining its core aggregation network availability at 99.9% and connected its fiber broadband customers within an average of less than 3 days. If we look at revenue in mobile, value compelling propositions advance revenue for mobile, Telkom Consumer revenue increased by 1.7% in the quarter, with traditional copper-based voice revenue continued the downward trajectory and declined by 27.5%. These legacy services that now only account for 5.3% of total operating revenue will continue to decrease. Mobile revenue increased by 7%, spurred by the continued provision of its value compelling propositions, which continue to drive data consumption. Mobile traffic grew by 25.6% to 309 petabytes, while fiber subscribers and revenue improved by 22.1% and 34.3%, respectively. Service revenue increased by 4.5%, strengthened by 12.9% year-on-year growth in active subscribers to now 18.6 million at a blended ARPU of ZAR 87. Our prepaid ARPU was ZAR 204 having declined 5.5% year-on-year, and we are now leveling towards our preCOVID-19 levels with subscribers for this space growing by 13.1%. The prepaid ARPU at ZAR 64 is holding within our target range, and this space saw subscriber growth of 12.9%. Feeding from the strategy of growing data supported by a 9.9% growth in mobile broadband subscribers to 11.5 million. If you look at BCX, BCX maintained top line supported by hardware and software sales. The revenue was flat for the quarter, mainly due to an increase in hardware and software sales, slightly offset by the decline in the converged communication business. The IT business grew by 7.4%, largely attributable to growth in the hardware and software business of 30.2%. The IT hardware and software business leveraged of its partner ecosystem and a more reliable global supply chain to improve the fulfillment of backlog and new orders. Performance was, however, negatively impacted by a 2.5% decline in the total IT service revenue due to a once-off project in the prior year. The converged communication business revenue declined by 7.4%. The business continued to see a decline in fixed voice revenue with ongoing migrations to more cost-effective next-generation solutions. It also experienced lower-than-expected uptake of the next-generation technologies due to customers still seeing value in the legacy services, especially in the public sector. That brings us to Swiftnet, the masts and tower business. We continued to commercialize the portfolio with healthy margins. Swiftnet focused on commercializing the mast and tower portfolio that amounted to 396 towers. These are productive towers at the end of the quarter and included 14 towers and 3 indoor solutions at newbuilds. Revenue was flat for the quarter. New site applications received from various tenants as their 5G rollout plans are implemented will further augment growth. That concludes on the different business operating unit results. I will take you through the key financial messages and the cost-saving programs. We will be implementing to improve the medium-term group profitability. As mentioned above, the group revenue grew by 2.3% to ZAR 11 billion, largely driven by growth in active subscribers, both in mobile and fiber, increased data traffic, higher handset and equipment sales to retail as well as increased IT solutions to enterprise customers. Group EBITDA, however, declined by 13.5% with contracting the EBITDA margin by 4.1 percentage points to 22.6%, largely affected by the decline in legacy revenues, higher direct cost and higher operating costs exacerbated by load shedding. If we unpack the detail of the group revenue, the growth of 27%, largely driven by growth in active subscribers, increased IT solutions. Group top line performance was resilient, considering ongoing load-shedding, pressure on consumers due to ongoing interest rate hikes, high energy and fuel prices and other inflationary pressures on the cost of living. If you look at the business performance, revenue drivers, revenue in Openserve declined by 3.8% to ZAR 3.2 billion. Openserve grew fixed data revenue by 12.5%, driven by broadband, which was up 23.9%; carrier services, up 9.4%; and enterprise services up 14%. Revenue from external channels increased by 5%, contributing to Openserve's total revenue, and the above was still offset by as a result of the legacy decline across the 3 segments, as mentioned earlier on. The Telkom Consumer revenue increased by 1.7% to ZAR 6.7 billion despite trading in an adverse economic climate and accelerated…

Mr. Reyneke, apologies to interrupt, but we have been joined by Mr. Taukobong.

Thank you, Claudia, and welcome Serame. Serame, I'm just going through the financial results, and then I'll hand back to you for the value unlock and the outlook statement.

Dirk, please proceed. I'm in the car, I'll listen, and I'll be available for Q&A.

Thanks. So Telkom Consumer revenue increased almost 7% despite trading in an adverse economic climate and the accelerated migration of legacy to next-generation technologies. The mobile revenue increased by 7% to ZAR 5.7 billion. And as mentioned earlier on, this was spurred by the continued provision of value compelling propositions, which drove data consumption. Mobile service revenue increased 4.5% quarter-on-quarter, strengthened by a 12.9% year-on-year growth in active subscribers. The growth in mobile data traffic supported by growth in broadband subscribers led to mobile data revenue growing by 5.8%. BCX, when we look at BCX, the revenue was flat at ZAR 3.5 billion for the quarter. The IT business grew revenue by 7.4% to ZAR 1.9 billion, but conversely converged communications revenue declined by 7.6% to ZAR 1.6 billion. Revenue for Swiftnet amounted to ZAR 318 million, which was flat as indicated before, the revenue growth was underpinned by escalations, new tenancies, and existing tenant installation upgrades, which was, however, offset by terminations from 1 of the mobile network operator customers as well as the continued Openserve consolidation and optimization of legacy-based sites. The legacy revenue declines, which is typical -- topical, higher direct and operating costs plus accelerated load shedding impacted EBITDA. So the group EBITDA declined by 13.5% to ZAR 2.5 billion for the quarter as a result, contracting the EBITDA margin by 4.1 percentage points to 22.6%. And largely affected, as I said, by legacy revenues, higher direct cost due to the commitment to sustainably evolve and position our mobile subscriber base to a bigger postpaid representation and then load shedding exacerbated the cost pressure. Just in terms of load shedding, this resulted in a year-on-year increase of more than ZAR 150 million additional costs for the quarter. Similarly to revenue, let me now take you through the performance of the EBITDA of the business units. Openserve EBITDA declined by 13.4% to circa ZAR 950 million with a margin of 29.4%. The ongoing economic pressures and load shedding negatively impacted cost with a significant year-on-year increase of ZAR 108 million in diesel costs, which resulted in a lower EBITDA margin. Telkom Consumer EBITDA declined by 28.1% to ZAR 840 million with approximately 28.3% of this decline, circa ZAR 92 million attributable to load shedding impact, while the balance is due to growth in the net footprint and increased investment in postpaid base. The EBITDA for BCX declined by 19.1% to ZAR 441 million due to limited revenue growth as well as the impact of product mix. The BCX EBITDA margin shrunk by 2.9 percentage points in the quarter, resulting in a margin of 12.6%. Swiftnet EBITDA at ZAR 221 million at a healthy 69.5% margin, the margin declined by 9 percentage point year-on-year due to the implementation of the refined property operating costs towards the last quarter in the prior financial year. I think given the above, if you look at revenue and cost, you'll all agree with me that the cost initiatives are of ultimate importance. So cost savings program to uplift the medium-term profitability are top of the agenda. The impact of ongoing load shedding for the quarter and the increased mobile network footprint resulted in a higher cost base for the group. This, coupled with the required investment in working capital to optimize the mobile subscriber base mix negatively impacted Telkom's profitability for the current financial year-to-date. In response to this, we've embarked on various cost-cutting initiatives, targeting a reduction of costs over the next 6 to 18 months to reduce and optimize the group cost structure on a sustainable basis and return to a blended group EBITDA margin of more than 25%. A number of initiatives are already in progress to address the group cost base and include, amongst others, the alignment of operating cost to be in line with evolving technology capabilities. As we manage the delicate balance of revenue from old and new technologies, we are challenged to manage the cost associated with the different technologies as newer technologies comes at lower margins. For Telkom to navigate the migration to new technologies as well as economic headwinds effectively, we have decided to start the consultative process aimed at restructuring the organization to meet future demands. The section 189 notice was issued earlier today, advising organized labor of contemplated retrenchments and inviting organized labor to attend consultation meetings as required by South African labor law. This process impacts all business units as well as subsidiaries and is intended to materially contribute towards rebasing our costs. Up to 15% of our total workforce across the group may be impacted as a result of this initiative. In addition to this, the management teams of all the business units are also working on other initiatives, and these include renegotiating key contracts to reduce direct and operating costs and close management of the working capital associated with growing the postpaid base, et cetera. I think the result of this, the benefits of all initiatives are expected to be visible in the medium term from '24 onwards. We will be required to invest in exiting and reducing certain direct and operating costs in the coming 6 to 18 months, but a substantial portion of these costs will be accrued for in the full year 2023, which is in 6 weeks' time. In addition, to mitigate the impact of the front-loaded investment and cost in working capital, we plan to raise a further circa ZAR 1 billion through the sale of qualifying device receivables to external financial institutions before the March '23 year-end. Serame, are you comfortable or in a position where you can talk to value unlock?

Dirk, I'm happy for you to proceed. I think the feedback from me might be quite disturbing, unless my line is clear.

Okay. I'll proceed on that basis. And Serame will come in on the question a -- Q&A session.

Thank you, Dirk.

So the value unlock strategy adopted to realize the intrinsic value of the underlying business remains underway. Following the broad in-principle approval to affirm and realize the value of Swiftnet, the mast and tower business through a full or partial disposal of the mast and towers, a multiparty sales process commenced in late '22, and offers are expected to be received during the course of March '23. Telkom will then evaluate the office received, and a further update will be provided in due course. Following the legal separation of Openserve on 1 September '22, various initiatives are underway within the goal of realizing value through the sale of a minority stake. We have today received a number of unsolicited approaches for Openserve and are currently undertaking a market standing exercise to test the breadth of interest in this team to be core business of Telkom. With adequate interest, a formal process will be launched by the end of the '23 financial year. To complement the partnership with Alibaba, which gives BCX exclusivity to sell cloud service in South Africa and the rest of the continent, Bcx acquired DotCom, a cloud consulting service company to further facilitate the growth of its cloud capabilities. And then BCX will continue to pursue partnerships to drive scale and capabilities to grow amongst others, its cybersecurity segment. If we look at what we expect for full year, while the group saw an uplift in quarter 3 of the full year '23 revenue, the trend of declining profitability is expected to continue into the fourth quarter, driven by ongoing upfront investment in working capital, inflationary cost pressures and continuing accelerated load shedding. The upfront costs relating to cost-cutting initiatives will further put pressure on the group profitability and free cash flow for quarter 4 and in turn, for the full year 2023. I will conclude with that and will now hand over to the operator for questions and answers. Thanks, Claudia.

[Operator Instructions] The first question comes from Preshendran Odayar from Nedbank.

I've got just 2 from my side. Can you tell us what is the network uptime on your towers? I know you mentioned on the call, it's about 99.99%, but what's the uptime on your towers on the various stages of load shedding, so say, Stage 2, Stage 4 and Stage 6? And then the second question is, you mentioned that you're expecting to generate ZAR 1 billion of cash flow in the last quarter -- quarter 4 that probably is from the sale of your handset receivable book. Just want to know what your progress was year-to-date so far because we have seen an acceleration in handset or should I say, contract sales, so that affects the handset receivable book. I just want to know what you've done so far in the last 3 quarters, so we can judge against the ZAR 1 billion that you're projecting for the last quarter?

Let me deal with the upside of the mobile network first. In stages 1 and 2, the network availability ranges between 90% and 95%; in stage 3 to 4, it ranges between 85% and 89%; and at Stage 5 to 6, it's between 70% and 85%. And I think that must be seen as a -- on top of the accelerated costs both in terms of emergency power and then the flow-through to the roaming cost as our customers then start running on the networks of MTN and Vodacom. I think in terms of the free cash flow at half year, we have concluded, if I recall, just around ZAR 700 million -- the number was ZAR 750 million of contract sales to date at half year. And as I say, I'm very confident that I'll conclude another ZAR 1 billion before year-end. Hope that helps.

The next question comes from Nadim Mohamed from SBG Securities.