What's too cheap?

HOW can a company with total assets of R63.6bn and operating margins of 37.5% be worth absolutely nothing?

That's exactly what the market is saying about Telkom.

Although the market's not always right, it is seldom wrong. The gap is where value investors make their money; by looking for those golden opportunities where assets are being mispriced because of something which the herd that makes up the market is missing.

Last year, shortly after the negotiations between Telkom, MTN and Vodafone ended, some fund managers whom I spoke to expressed a view that Telkom's share price had just fallen way too far to justify.

The 50% stake in Vodacom has long been seen as the jewel in Telkom's crown. Although valuations for Vodacom differ, an average of between R140bn and R150bn is probably not far off the mark, implying Telkom's stake at around R70bn to R75bn.

Telkom's share price, since the cautionaries fell apart, has been a virtually one-way bet downwards and the company's market value is now around R72bn. Which means that the market values the fixed line operations at essentially nothing.

Most comprehensive telecoms infrastructure

As one portfolio manager expressed to me (to paraphrase roughly - but he was tearing his hair out to try pinpointing what he was missing, in case you're wondering about the tone of our conversation) last year: "How can such a vast network of physical infrastructure be worth absolutely nothing?"

Among other things, Telkom's network consists of copper wires into almost every home and office (baring rural areas with little demand), roughly 170 000km of fibre in the ground, a network of exchanges for switching traffic locally and internationally, a sophisticated National Network Operations centre in Centurion, a national transmission network, satellite earth stations, numerous WiFi hotspots and WiMAX base stations, stakes in undersea cable systems including SAT-2, SAT-3/WASC and SAFE and soon also in EASSy.

At the end of September last year, Telkom had total assets of $63.6bn and net debt of R17.7bn.

Although the network is in need of an upgrade - which is under way - it is still the best and most comprehensive telecoms infrastructure that the country has.

Corporate action

Companies, although some are adding Neotel as a provider, are not dumping Telkom. Instead, they are increasingly adopting a dual-provider strategy for their telecoms needs. So Telkom will lose some market share, but not all of it. And in fact, a rejuvenated Telkom under new management could start 2008 with new impetus.

One must also not count out potential corporate action. Some still believe that Vodacom could be listed separately, as Vodafone had said it could do if it bought the majority stake.

But any potential for corporate action aside - investors should never buy shares on the prospect of a deal, that's the realm of the traders and speculators - Telkom's performance metrics are still hardly looking shabby, despite having suffered. For a fixed line telco to boast EBITDA (earnings before interest, tax, depreciation and amortisation) margins of 37.5% remains admirable.

And Telkom is on a price: earnings multiple of below 10, and generates lots of cash.

MTN better bet

For anyone that thinks I'm singing Telkom's praises, or ignoring the threat that competition poses to its business, this is hardly the case. My colleagues and I have spent numerous column and online centimetres in the past pointing these out.

And, despite the seemingly glaring value trap, if it came down to a choice between putting MTN or Telkom shares in my pension fund; I'd pick MTN for sure. It's just a sentiment thing for me, as is probably the case for many others.

The question is whether Telkom can prove the market wrong on the extent of the potentially negative impact that competition will have on its revenues. Or if not, whether Telkom will do something to unlock the value.

belindaa@finweek.co.za

- Fin24