Mergers, Acquisitions and Financial Results

Ever since it listed in 2003, telecoms group Telkom has been the darling of the markets. A former state-owned company with a de facto monopoly over SA's fixed line market, Telkom could seemingly do no wrong.

Reacting, perhaps, to management's efforts to use the group's protected status to streamline its operations, reduce costs and grow revenue, Telkom's share price had an almost unfettered three-year run. From a listing price of R28 in March 2003, Telkom was trading at around the R170 mark in February -- and showed few signs of abating.

The market's confidence in Telkom remained firm despite clear indications from government that it planned to introduce far more competition into the telecoms market in the coming months; and that would put pressure on Telkom to reduce its prices. International trends showing that revenues from both voice and mobile calls were falling, and gloomy warnings from management that the local fixed-line market (from which the group garners 80% of its revenue) was becoming saturated, had little impact.

But a R30bn investment and acquisition strategy, unveiled by Telkom's new management team last week, certainly caught the market's attention. More than R6bn of value was wiped off Telkom in one day as investors worried about the impact of the strategy on dividends, and railed against a guidance which saw Telkom cutting its forecast for earnings before interest, tax, depreciation and amortisation (ebitda).

The chances are that the share price will level out this week as analysts digest Telkom's strategy. Management makes the point that Telkom could sit tight and not accelerate its investments in a new broadband network and in boosting its appalling customer-service levels. Dividends would be steady and ebitda margins would remain at the 44% level. But it's not only a short-term strategy, it's short-sighted.

While it's always going to be difficult to unseat an incumbent operator in any industry, in a fast-moving one such as telecoms, there is no case for sitting tight. It's imperative that Telkom not only continues with its current investment plans, but speeds them up. Communications are a critical factor in the growth of any economy and Telkom is well placed to deliver the broadband and other applications needed to help drive up growth. SA is already behind the game -- global cable operators and traditional telecoms firms are gearing up their networks to provide a so-called "quadruple play" package of fixed-line phone services, broadband internet, television and cellphones. SA has yet to have the ability to offer the "triple play" of phones, broadband and TV.

The real challenge for Telkom lies in its ability to overcome its "monopoly-type" thinking of the past. Telkom does not need to be all things to all people, particularly with competition coming. While it is critical for the organisation to make use of the opportunities presented by the convergence of technologies, it needs to think very carefully about how large its footprint should be.

This applies to the type of services it provides and the strategies it employs to get those services to the market -- does it buy an entire company or simply create its own skills base, for example. But more importantly, it needs to do its homework before moving into foreign markets. Many companies have become unstuck when venturing into unknown territory -- with Eskom Enterprises being just one example.

Chasing revenue in foreign markets is always a delicate balancing act. Telkom seems well aware of the need to be prudent, particularly given the expected squeeze on revenues in its back yard.

Last week's share hiccup shows Telkom will be severely punished if management makes any missteps. But there are also big future benefits for consumers and the economy if Telkom manages to become a truly competitive organisation.

Business Day