Why Telkom is our 2008 hot stock pick
The Financial Mail’s 2007 stock pick in the information & communication technology (ICT) sector, Bytes Technology Group, had a rip-roaring year, closing up more than 40%, making it one of the better performing shares not only in the sector but also on the JSE.
Luck played a role in our picking the stock: the FM could not have predicted in January that Bytes parent Altron would make an offer to the minority shareholders in the company. Shareholders narrowly approved the offer but rejected a similar Altron proposal to buy out the minorities in Bytes sister company Altech.
Bytes, which has a diverse portfolio of distribution and IT services businesses, will be delisted from the JSE this month. Shareholders will receive nonvoting preference shares in Altron
Finding a stock in the IT and telecom sectors that can repeat Bytes’ 2007 performance is no easy task. Firstly, there is evidence of a global slowdown in IT spending, led by the US. Secondly, rising interest rates and slowing economic growth in SA in 2008 are likely to put pressure on IT budgets. Rightly or wrongly, companies often slash their spending on tech before reducing costs in other areas.
That said, local IT services companies don’t look particularly overpriced. Most have trailing p:e multiples of under 12 — Dimension Data’s 20 is a notable exception. Some, such as EOH, Datacentrix and UCS Group, may even offer good value at current levels. But after years of solid growth in the sector, and given the economic uncertainties, I’m going to take a flier on a telecommunication company instead: incumbent fixed-line operator Telkom, whose share price has fallen sharply since it ended talks to sell some or all of its fixed-line assets to MTN.
While MTN will enjoy strong growth again in 2008, especially on the back of its successful network in Iran, it is Telkom that looks like the more attractive proposition right now, purely because of its depressed share price. Whereas MTN’s p:e is close to a record high, Telkom’s is not far off its low.
At current levels, Telkom, which is down nearly 40% since its peak on September 3, looks like a real steal. Consider this:
* Though Telkom faces vigorous competition for the first time in its core business, it still has formidable clout in the market. Despite efforts by second network operator Neotel and the mobile operators to compete in fixed lines, Telkom still owns SA’s largest national telecom network — by far. And it controls the broadband pipes into people’s homes and into businesses. It will be years before local-loop unbundling allows other operators to provide services using its so-called “last-mile” infrastructure.
* Its 50% stake in Vodacom is conservatively valued at R75bn (it may be worth much more). Yet, at R136/share, Telkom’s market capitalisation is a mere R72bn. That means its fixed-line business, under pressure but still highly profitable, is, at best, worth a negative R3bn. The market is pricing in disaster. Despite government and regulatory efforts to reduce telecom prices, this valuation simply does not make sense. On this basis alone, Telkom is a buy.
* The company has a dividend yield of 4,4 which is nearly five times the yield offered by MTN. And it has a forward p:e of only 8,6 (the trailing earnings multiple is 8,8, well below its average p:e since listing in March 2003).
* CEO Reuben September said last month that Telkom was open to mergers, acquisitions and joint ventures as it seeks to build a converged fixed-mobile business. Telkom has not worked well with Vodacom historically and, if it can find the right mobile partner, it may sell its stake in the cellular operator to the UK’s Vodafone. If that happens, shareholders can expect a huge special dividend. A portion of the proceeds could be used to buy Cell C, if Oger Telecom agrees to sell its stake in SA’s smallest cellular operator.
In short, unless management destroys the company, the sell-off in Telkom shares looks to be overdone. Look for a rebound in 2008.
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