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Edited Transcript of TKG.J earnings conference call or presentation 22-Jun-20 2:00pm GMT

Pretoria Jun 23, 2020 (Thomson StreetEvents) — Edited Transcript of Telkom SA SOC Ltd earnings conference call or presentation Monday, June 22, 2020 at 2:00:00pm GMT

* Tsholofelo B. L. Molefe

* Preshendran M. Odayar

Good afternoon, ladies and gentlemen, and welcome to the Telkom Annual Results Conference. (Operator Instructions) Please also note that this call is being recorded.

I would now like to turn the conference over to Sipho Maseko. Please go ahead, sir.

Sipho Nkosinathi Maseko, Telkom SA SOC Limited – Group CEO & Executive Director [2]

Thank you very much, Chris. And good morning to everyone in the U.S., and good afternoon to everybody else. With me, I have our group CFO, Tsholo Molefe; and our Head of IR, Babalwa George. I will dive straight in and unpack — make an attempt to unpack our annual results performance as follows.

I will speak a little bit about the strategic themes that are underlying in the annual results performance. Tsholo will then unpack the financial performance a bit more. I will then come back addressing the regulatory environment as the country prepares for the release of spectrum on a permanent basis. And I will also share how we are thinking about unlocking the value trapped in our portfolio of businesses. I will also conclude by sharing the impact of COVID-19 on our business, and how we responded to it in relation to our employees, our customers, managing the demand within our existing infrastructure as well as how we have supported government in the overall response to COVID-19.

I must start by saying that today, we announced the delivery of an encouraging annual set of results that actually demonstrated trends that are encouraging in a very, very difficult economic environment. The country, if you recall, slipped into a technical recession. And secondly, we were not spared the global pandemic of COVID-19. This also — this year, in particular, also concludes a very challenging decade of a very, very depressed economic growth, currency volatility, massive technology changes, increasing competition in the market and a regulatory environment that was uncertain. And all of these, at Telkom, we were not spared from. However, I must say that despite these challenges relating to the operating environment, the results are pretty solid, notwithstanding the decline in the fixed voice revenues which impacted the group EBITDA earnings negatively.

And maybe just to mention a couple of highlights. Our mobile business remains the fastest-growing mobile business in South Africa with service revenue growth of 54% supported by a net customer addition of about 1.9 million, which takes us to a 12 million number of subscribers at a blended ARPU of about ZAR 91, which is actually the highest in the industry. We continue to gain customers and revenue share from our peers.

The second highlight is in relation to our connectivity rate with fiber to the home. It remains the highest in the market at about 48% of homes connected relative to homes passed. Our free cash flow of ZAR 2 billion is 3x higher than the previous year and the swing of ZAR 3 billion from the first half of the year where we reported a negative free cash of about ZAR 1.2 billion. And Tsholo will spend a bit of time really unpacking all the initiatives that we put in place to ensure this structural change in our free cash flow generation. One of the highlights is that our balance sheet was strengthened with a net debt-to-EBITDA of less than 1x. Tsholo will also unpack the balance sheet later on.

There were 4 strategic themes that underpinned our annual results: number one, our infrastructure investment is yielding positive results; number two, broadband leadership being attained across the broadband ecosystem; number three, the evolution of the fixed voice business; and last, but not least, the mobile business growth.

And maybe let me start with the infrastructure investments and how these are yielding the results that we are looking for. Over the past few years, we’ve been investing a lot in our broad infrastructure. Now this includes having an all-IP fixed and mobile network, data centers, Mast & Tower. In the current year, our capital investment of about ZAR 7.8 billion with a CapEx to revenue intensity of 18% in the period was to increase coverage and the capacity of our mobile and fixed business: fiber backhaul, 5G small cells, automating data centers. And as we speak today, we have 3 out of 4 Tier 4 data centers in Africa, and you would have seen some of our references in terms of data center services as well beginning to make a positive contribution underpinned by hybrid cloud.

Whilst we invest in our infrastructure, we also focused on commercializing our assets to monetize our capital investment. COVID-19 pandemic is also having the effect of fast-tracking digital transformation in companies. And we see this in a sense, also partly as an opportunity, for Telkom to commercialize all of its asset classes. Our ongoing investment in new revenue streams has enabled the group to grow operating revenue in evolving technology where our traditional revenues are shrinking. I’m truly pleased that our operating revenue grew 3% to ZAR 43 billion despite the fact that 22% of revenues that we saw declining in our fixed voice business. Our ability, therefore, to grow operating revenue in the face of these challenges, best testimony to the success, as I indicated, of our infrastructure investment beginning to bear the right outcomes.

And then you might ask, this investment in infrastructure, is to what end. And this takes me to the second theme, which is broadband leadership being attained across the entire ecosystem. So to execute — we continue to execute on our overall strategy with regards to data, both fixed and mobile. We remain the leader in the fiber industry with a national fiber network of about 164,000 kilometers.

Maybe talking about traffic. Fixed traffic went up about 11.5% supported by roughly about 724,000 fixed customers. I mean, in fact, there’s a statistic which one of my colleagues gave me today. Ordinarily, we would get roughly about 5,000 fixed orders a month, and actually, on Friday, they had 1,000 orders just for Friday. So we’re beginning to see the uptick in the demand around fixed services beginning to come through.

Now with this fixed data traffic up, it was also augmented by traffic for fiber to the home and fiber to the base station. I’ve already mentioned fiber to the home connectivity rate improvement. Last year, same period, it was 38%. This year, it’s 48%. It’s the highest in the market, and we continue to really focus on that so that we can have as much of our capital deployed in that area beginning to remunerate the investment that is being made. Fiber to the business, it’s up about 25 — about 26%. And fiber to the base station, up about 9%. So that’s on the fiber bit.

When it comes to mobile, our broadband propositions continue to resonate with customers. Mobile data revenue grew about 46% to ZAR 8.7 billion, and this is supported by roughly a 28% increase in mobile broadband customers. Now 80% — approximately 70% to 80% of our active mobile customers are using data. And that’s informed by the all-IP network that we’ve built, fixed and mobile, and also the data-led propositions that we continued to launch in the last couple of years.

We have also refarmed a significant portion of our 1,800 megahertz spectrum, and also started refarming portions of our 2,100 for both LTE and LTE Advanced to cater for the data traffic. Mobile traffic, as I indicated in the presentation in the morning, the traffic grew by about 69%. So thus, we will continue to drive aggressive broadband growth, accessing all the untapped segments, leading with high-speed mobile with an option to switch over to fiber. So that’s the second theme really, how do we continue to attain a leadership across the broadband ecosystem.

The third theme that is underlying in our results is around the evolution of the fixed business. We operate in a — yes, in a business environment that’s constantly evolving. Advances in technology and changing customer needs, obviously, would impact traditional revenue streams. And thus, we need to transform the business with a view for long-term growth. However, one of the things that we have seen is that our traditional fixed voice business has continued to decline. And this is impacted, obviously, by these technology changes, and it’s in line with global trend. And these fixed voice business revenues are high margin traditionally. I mean although our multiyear transformation program has reduced our legacy fixed voice revenue contribution to the group from roughly about 56% in 2013 to about 20% this year, the impact on group EBITDA is still high and could not be offset by new revenue streams for now.

And if you were to kind of think back actually, if we never — if we did not have a mobile business and, actually, if we did not have an IT business, this picture would look even more depressing because we would have no alternative revenues that would be offsetting the decline in legacy fixed voice contribution. We, therefore, expect fixed voice revenue to continue to decline driven by usage as people work from home, but we also believe that data is expected to partially offset the impact as this environment presents an upside to be offset by data, fixed or mobile. The contribution of fixed voice will decline from a lower base, while the contribution of the mobile business is expected to increase from a higher base, offsetting this decline.

In the last 2 months of April and May, we continue to see our mobile business holding on the trends that we saw. In fact, actually, when the lockdown started, we, all of a sudden, began to get quite an increased number of enterprises who were looking for either LTV solutions or fiber solutions for their employees that they were moving to work from home. And we see this actually as a potential gap for us to be able to access what we call enterprise revenue, leading with data, therefore, employees as [web persons and fund persons] begin to change. However, until that inflection point at EBITDA level is reached, we will continue to focus on ongoing sustainable cost management to close the EBITDA gap.

We initiated the first phase of a two-phased process around staff optimization. Last year, therefore, we took a charge of approximately ZAR 1.2 billion insofar as that is concerned. We also announced, obviously, the beginning of the second phase, which we will execute on in the second half of the year. So that has been the third theme, the evolution of the fixed business driven by technology changes and, in particular, as it relates to copper.

The fourth theme is around mobile business, which has been driving growth and continues to drive the growth. Sales revenue on the mobile business was up by about 54% to about ZAR 12.5 billion, which is an increase of about ZAR 4 billion. What has defined this? What supports it? Customer growth of about 34%, ARPU growth of about ZAR 91 as our affordable data-led products continue to resonate with our customers.

Prepaid subscribers grew about 21% with a net addition of about 1.6 million subscribers to about 9.4 million. Though prepaid ARPU declined by 8.2% to ZAR 66 compared to the year before, this is a slight improvement compared to the first half of the year as we address some of the distributors that we had who were acquiring very, very low-value customers and also driving spend in our customer base.

We also saw good growth in postpaid segment as well, increasing by about 36%, with a stable ARPU of about ZAR 188. Postpaid ARPU trends have improved following a 7% decline in the first half of the year, and we still believe these will continue to hold. Yes, we noted changes in pricing by our peers. We have not seen any impact in our business. We believe that our broadband proposition remains best in the market despite these changes. We have a data-led network. We have the right broadband proposition. We’ve used the spectrum that we have, I think, very, very smartly. We’ve installed as much fiber to the base station for backhaul as much as possible because most of our customers from the very beginning was skewed towards data, and we believe that this recipe will enable us to withstand the intense competitive landscape going forward.

We’ve made significant strides as well in enhancing the mobile profitability. Three years ago or so, I think their margins were roughly about 1%, now it’s at about 15%. And if you use IFRS, this would be at about 18.5%. We are comfortable that our mobile business will be operating in the sort of 20% to 25% EBITDA margin corridor in the foreseeable future, offsetting the decline in fixed voice.

The team continues to really drive hard every opportunity of efficiency. And actually, with COVID, we are starting to rethink a lot of things 100%. If, for instance, we are stuck in this COVID environment for the next 18 to 24 months, actually, do we need stores? And how do we use this as an opportunity to change customer behavior so that we drive them to digital channels as hard as we can? So based on our revenue market share estimates, Telkom Mobile will be the #3 player in South Africa in the next 12 to 18 months.

I will now let our group CFO unpack the financial numbers for you. And then I will come back and conclude post that. Over to you, Tsholo.

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Tsholofelo B. L. Molefe, Telkom SA SOC Limited – Group CFO & Executive Director [3]

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Thank you, Sipho. Thank you, ladies and gentlemen. I will unpack the key financial messages. I think what is important, before I go into the detail, is to really just highlight some of the exceptional items that impacted on our financial performance this year.

Firstly, the adoption of the new accounting statement on leases. IFRS 16 boosted our EBITDA by about ZAR 1.1 billion, but the impact on earnings overall was immaterial. Secondly, the charge that we took relating to the restructuring of about ZAR 1.2 billion had a negative impact on EBITDA. We also had to account for additional impairment of trade receivables, really taking a prudent approach to take account of the COVID-19 impact, and we raised an additional provision for bad debt of ZAR 626 million, and this was in addition to the normal provision for bad debt of about ZAR 514 million.

If I then just unpack our underlying performance, which excludes the impact of these one-off and exceptional items, I think, firstly, on our revenue, we can see that we grew revenue by 3% to ZAR 43 billion, largely driven by mobile which continues to be the driver of growth. However, this was offset by the decline in our fixed voice revenue of about 22%, as alluded earlier. The mobile business growth was really underpinned by our ongoing capital investments and the mobile broadband propositions that we continue to see resonating with customers in that area. It is also pleasing to see that all the new revenue streams grew, contributing positively to overall group revenue.

Despite the challenges that we are seeing in the economy where BCX, mainly our ICT business, operates, with the countries leading into technical recession in the second and in the fourth quarter of the year, the external business revenue — the external IT business revenue grew by about 1.8%. Gyro also showed good growth from the Mast & Tower portfolio, with external revenues increasing by about 7% as the demand for external leases increased. So the challenges that we faced really was the impact of the fixed voice decline on our group EBITDA. The decline in this fixed air voice revenue of approximately 22%, as I indicated, was offset by the significant growth that we saw in mobile.

From a cost perspective, management continued to really focus on cost containment, and we saw our group operating expenses really growing below inflation at about 2.5% growth year-on-year. We are also able to optimize on our direct cost, particularly relating to the mobile business where we saw an improvement, firstly, from the first half of the year from a mobile direct cost to revenue ratio of 52% — 52.6% to now about 44% in the second half of the year, and we will continue with the initiatives that we embarked on to make sure — to ensure the sustainability of our mobile business. However, the extent of this decline in our fixed voice on group EBITDA was really not offset yet as our fixed voice is high margin, therefore, resulting in margin pressure from an EBITDA perspective, with absolute EBITDA declining by 8.7% from the previous financial year.

If we then look at our group earnings, which were really impacted as well by these one-off items that I referred to earlier, we saw that our reported headline earnings per share and the basic earnings per share were down 66% and about 78%, respectively. And these were due to the restructuring charge that we took, that I referred to earlier on, of about ZAR 1.2 billion; the additional impairment on receivables of about ZAR 626 million. These one-offs are really not deductible as well from a tax perspective, and we saw the group profit before tax as well increasing from an effective tax rate perspective from a statutory 28% to 37.6%. Underlying performance, therefore, which excludes the one-off costs relating to the restructuring program and this additional provision for bad debt impacted earnings by about ZAR 2.62. So your underlying headline earnings per share, as well as your basic earnings per share, actually declined by 30% and 37%, respectively.

If we now move on to the free cash flow. As we indicated, we’ve seen strong improvement in our free cash flow compared to the previous financial year. If you recall, at the interims, we did announce that we would be seeking to put in place some cash release initiatives, really focusing on our working capital improvement. We said that we would focus on supply chain financing, which is in relation to our trade payables. We said that we would look at some opportunistic disposal of noncore assets in areas where we could. We also said that given that our postpaid book will recover the cash from the customers over 24 months, we would also be seeking to look at handsets receivable financing. So we are pleased to announce that with the efforts that we actually made in the second half of the year, we were able to actually put in a lot of measures in place.

And if I can take you through some of the achievements, firstly, that we’ve made. Firstly, we were able to collect close to about ZAR 800 million more than we expected from our customers, but this was slightly offset by some of the real provisions that we saw in the BCX environment as customers — some of the enterprise customers are in distress. So overall, our cash collection on a net basis were about ZAR 667 million as an improvement.

So in line with best practice as well, we also reviewed some of our standard supplier payment terms in the current financial year, and these are indicated as part of our cash release initiatives. So we were very — if we look at — and we did a lot of work actually when we were reporting at the interims, just looking at how to improve our trade payables. We have actually been lagging behind the curve relative to some of our peer groups. So this is really a permanent change. It is a structural change. The payment terms are now 90 days. And really, we make it available for suppliers that require it. And those that want to require immediate cash, we then establish a supply chain financing tool for them.

So we did not actually defer the creditor’s payment to reflect positive free cash flow, but this is really rather a real improvement in working capital, in looking at how we pay our suppliers. And also if you take into account what I said earlier on that your customer collections, particularly from a postpaid perspective, takes about 24 months with regards to customers that have devices, you, therefore, have to make sure that you can protect your liquidity and cash by making sure that, structurally, you make those changes to be able to free up your cash. So overall, we are quite comfortable that these payment terms — obviously, we’ve changed the payment term, and we’ve been able to improve on our payments with suppliers.

And it’s really a rigorous process that we actually go into with our main suppliers that have long-term contracts with us. And as a result, those trade payables improved by about ZAR 1 billion and ZAR 1.9 billion year-on-year. And we will continue where we see opportunities into the future with these efforts that we are making. We are still to do the handsets receivable financing with some of the potential financial services companies, and we’ll be able to see, obviously, particularly under the COVID environment, what can be done. There’s still also opportunities from an inventory management as we move forward into the new financial year.

So as a result of the strong free cash flow improvement, we saw that our balance sheet also strengthened during the year. We were able to pay down debt of about ZAR 1.2 billion after increasing our borrowings in the first half of the year by about ZAR 1.8 billion. So as a result of that, our gearing improved since the first half of the year, with our net debt to EBITDA, now excluding the impact of IFRS 16, reducing to 0.7x from about 0.8x last year and about 1.3x, including IFRS 16 as an improvement. And this is within our guided 1.5x, including the impact of IFRS.

We have also extended the maturity profile of our debt book to reduce the refinancing risk that we are seeing, and we’re comfortable as well that we have sufficient balances and sufficient facilities going forward to be able to weather the storm going forward. So we have facilities to the value of about ZAR 5.7 billion in terms of committed facilities with various banks.

So the Board declared also a final dividend in line with the current dividend policy of about ZAR 0.50, so 50% to headline earnings, which is a payout of about ZAR 0.50 for the final dividend. As Telkom indicated in the first half of the year as well that we would be seeking to review the dividend policy, and that in considering the new dividend policy, we would prioritize our capital investment program where we are seeing good returns and good growth into the future while, at the same time, being able to maintain a healthy balance sheet and consider the cash position, particularly within the current environment of COVID. The spectrum auction that is imminent as well will require substantial amount of capital, and it is of strategic importance to us to be able to participate and ensure the sustainability of our mobile business. At the same time, preserving cash and maintaining a flexible balance sheet, as I indicated, has become quite critical under these conditions as the economy is under strain.

So given all these factors and also the fact that we would be making payments for the restructuring program, as Sipho indicated, we are doing Phase 1 and Phase 2, Phase 2 of which we expect to start rolling out in the second half of the year, and that would also require some capital. So given all these factors, that are expected to, obviously, have an impact on our numbers, we found it prudent to suspend the dividend policy from the new financial year over the next 3 years. Obviously, if things change and we see that we have surplus cash, we would obviously review the decision that we have made on the dividend policy.

We also had issued a medium-term guidance commencing in 2019, with the financial year 2018 being the base year of that 3-year guidance. So the financial year 2020 was the second year of the guidance where we experienced a challenge in terms of meeting the EBITDA target, largely due to the fixed voice decline which has a high margin. However, we see that we have performed well in line with the guidance except for the EBITDA. So top line growth overall were within guidance on a compound average growth rate. When you look at the 2 years, we’re able to meet the net debt to EBITDA. We’ve been able to keep our CapEx intensity as well within the 16% to 20%, really having seen a reduction as well since 2018 from about 20% to now 18%.

In addition, I think the lockdown response to COVID-19, as well, pandemic is expected to impact the South African economy significantly and, therefore, quantifying the — but quantifying the likely magnitude of this crisis also is quite challenging at this point in time. So different sectors within the economy, obviously, are suited differently to continue operating under different lockdown phases. So based on all those factors that we take into account, we felt it prudent to suspend the guidance for the financial year 2021. And obviously, once we know what the impact of COVID would be, and also some of the new products that we are introducing in the market to take advantage of the COVID, obviously, we need to see how those materialize. And therefore, we’d probably be able to give a better guidance to the market at the end of the year. Should we, obviously, see it much later, we will then lift the suspension of the guidance.

I will then now hand over to Sipho to conclude.

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Sipho Nkosinathi Maseko, Telkom SA SOC Limited – Group CEO & Executive Director [4]

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Yes. Thank you very much, Tsholo, for the update. And in particular, we’re, as appropriate, really making sure that we are very clear as to our net working capital story. We were inefficient, so lagging behind our peers. And this move is in line with industry terms, which is having the right supply chain management terms, having the right payment terms, improving collection and, going forward, we will continue with handset receivables, financing, continue with supply chain management, further optimization of debt. As we are achieving scale in our mobile business, it gives us the ability to renegotiate quite a lot of services and terms that when we were a start-up in mobile, it was very, very difficult for us to be able to renegotiate those. And I think we’re beginning to see our ability to reset some of those terms in some of our businesses.

So perhaps maybe just to find a way in which we can wrap it up. So clearly, around the regulatory environment, we’ve been engaging the regulators and the department around — and policymakers to motivate for regulatory and policy certainty, which supports fairness and encourages competition with long-term benefits for consumers and the growth for South Africa. And it’s a very, very important point for us that we will take down to the wire to make sure that spectrum gets released almost once every 20, 25 years. And we do know that once spectrum is released, then the game is set for the next 25 years. And we really want to make sure that during this window of spectrum allocation, it is not done in a way that entrenches a duopoly for the next 25 years. It is not done in a way in which competition is not encouraged for the next 25 years.

So it’s a big area of focus for us. The competition commission’s inquiry into the cost of data affirmed that the South African market has no effective competition, and the recommendations resulted in a decrease in data pricing to benefit consumers and enable greater access. So much as we welcome the ruling that was made, but actually, it needs much more than just reducing data prices. We actually think that the next frontier is to make sure that how spectrum, therefore, is allocated is not allocated in a way that entrenches the lack of effective competition. So we are absolutely convinced that we want to push for that and make sure that we continue to be well positioned to offer the right data — the right value for broadband propositions in the market.

The policy on high demand spectrum was published in the first half of full year 2020. It helped with bringing some clarity. We will obviously wait for ICASA to give effect to the policy. We’ve seen as well announced spectrum sharing agreements, which, in our view, have changed spectrum access. And it’s one of the things which we would implore the regulator to take into account in terms of how do they divi up spectrum. They need to start reading some of the spectrum arrangements almost as one. The spectrum arrangement between Cell C and MTN should be read essentially as MTN having access to all of the spectrum, and the spectrum arrangements between Vodacom and Liquid and Rain should be led as Vodacom having access to all of the spectrum, in terms of how they use it. And it’s a very, very important point for us.

In April 2020, we were all granted temporary spectrum to ease network concentration during the lockdown. We did benefit from that in terms of making sure that our areas of congestion are addressed, especially sub-1 gig. Obviously, this is temporary. And after the lockdown, or in November, this will be returned, unless, obviously, ICASA extends it.

We’ve also been very encouraged by the speed and the deliberateness of government’s decision-making during this time. Decisions have been made fast. We are hopeful that going forward as well, this will be a new cadence. And it has shown that decisions can be made. As long as there’s clarity in policy and very, very clear outcomes that seek to be achieved, decisions get made. And for us, actually, it’s been very, very encouraging to look at that.

So I’ll then proceed to value unlock. So when we began the process of making sure that in our operating model, we set up these businesses as standalone businesses with a very, very clear profit accountability responsibility. It actually began to deal with some of the issues we had in the past of cost subsidization, some of the businesses relying on being supported by other businesses. I mean we had a lot of these Mast & Towers, but actually, there was no fair value that was put in them because other businesses were subsidizing others using the same infrastructure. And we think that we have largely achieved the journey that we began back in 2014.

Gyro and BCX are essentially structurally separated. Openserve and consumer are functionally separated. We are in the process, led by Tsholo and her team, of completing the balance sheet split between Openserve and consumer, which will then naturally lead to a structural separation of Openserve so that we then have the right level of flexibility for value unlock opportunity and complete the operating model. And in essence, what you will end up with is a very, very small corporate center, extremely small. You will end up with 4 or so businesses, or 5, whatever number they are, that needs to be able to demonstrate relative to their peer group that they have strategic clarity, the trifecta of scale, growth and capabilities is met. And then we begin to look at how we are able to then commence with the process of value extraction.

We — obviously, in some instances, the issue of scale and capabilities has hindered growth. We saw it in mobile. We are now beginning to achieve a reasonably sound scale that enables us to do other things in the market. We acquired BCX. And Jonas and his team are beginning to grow the cloud business and the IT Solutions business. But it is our considered view that as things stand, the market cap is not a true reflection of the intrinsic value of the company. There’s a massive valuation gap at the sort of EBITDA multiples of full year 2020, which is, on an underlying basis, based on the sum of the parts, we believe that there’s a valuation gap of around ZAR 40 billion. And we will explore ways to unlock this trapped value in this conglomerate sort of structure, starting most likely with Gyro, Mast & Tower going forward.

COVID-19 response and impact. In the fourth quarter of the year, obviously, there was the pandemic spread, which disrupted every aspect of our lives and business operations. Then a national state of disaster was declared in March. Our sector was deemed to be an essential service, and we have been doing quite a lot to provide support and keep connectivity. When the National Command Council meets and the cabinet ministers are having their own virtual meetings, we deployed fiber to many of their houses in a record amount of time. And we’ve seen this nascent demand growing. We’ve obviously focused on our employees. At the end of March, we had approximately 80% of our employees already working from home. By the time, as Level 5 was declared, that increased to about 90% to 94%, there or thereabouts.

We’ve seen a huge surge in fixed and mobile traffic during this time, people working from home and they’re learning for home. And we have sufficient network and redundancy to manage the increase in demand. All of the investments we’ve made in modernizing the network: fiber backhaul, strengthening the core network, packet optical transport network, that has been absolutely worthwhile and provided the resilient system to support this growing demand. The mobile footprint was also improved with new sites and increased radio capacity on existing sites. And where we had congestion, the temporary aspects have helped us achieve that.

For the lockdown, we also scaled up a lot of our digital platforms. I mean there’ll be some announcements made around Yapp, which is an e-commerce platform. We scaled up our ability to use digital channels and online 24/7. And we’ve been able to do quite a lot with our logistics partners and our very own Openserve in relation to fiber-based products. We also took advantage of our existing copper network. We launched broadband on copper services, or Naked DSL, using the spare capacity ports and essentially the spare capacity on the network altogether because, as people are looking for a stable Internet connection, whether it’s 4 or 8 or 10 megabits per second on copper, if they’re able to get that, that is better than wireless. And we’ve seen some stabilization, and we expect to see upside on fixed data revenue going forward.

We’ve also been helping government a lot on a number of things, I mean, really on a number of things. We’re working with the Red Cross to support all of the, yes, unsung heroes or frontline health care workers. That was our contribution. We developed the track-and-trace platform that we were — we work with the NICD and aggregating all of the steps that we see the minister announcing every day. We do that. And we help them indicate where most of the infections are coming from, what the movement looks like, what the spread looks like. And this particular pandemic is quite real. But also our own employees have really come forward, contributing within the company as well. And we’ve also given the public the opportunity to contribute as well through donations made by SMS.

So as we conclude — I mean at Telkom, we embrace our new normal. We’ve come to terms with the fact that the pandemic has not just disrupted our lives temporarily, but we also have the view that this is the beginning of a change in the way the world operates. We continue to do the best that we can, first and foremost, to continue to service our customers and help them navigate this particular issue. Some of them never had sufficient redundancy, some of the print media companies just did not have any online presence and they didn’t know how they will enable their employees to work from home. We had to process orders in the thousands just when the lockdown started as different companies were looking for solutions for their staff to be able to work from home, and we think we’re beginning to see a change in how broadband will become an even more permanent feature and digital services and online, everything.

And therefore, we prepare ourselves for that. We embrace it. We also see there’s an opportunity to reset our cost base even more. We ask ourselves, will we go back to the office? Do we need all of the people that we had? Do we need all of the stores that we had if, actually, we are still able to see enough sales coming through digital channels? So we continue to ask the uncomfortable questions so that we continue to push the business for it to stabilize at the right point where we think it potentially can get.

So it’s been a very, very long presentation. So I’ll pause there, and hand back to Chris, the operator, and apologies for being cut out earlier on.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Preshendran Odayar of Nedbank.

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Preshendran M. Odayar, Nedbank Corporate and Investment Bank, Research Division – Analyst [2]

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Firstly, congratulations on the good results. I’ve got 3 questions, if I may. I’ll start with the first one on the balance sheet. So I don’t know if you can share with us some color on what the impact will be on the handset financing, how that will affect your net debt. And if you can give us some color, post paying the voluntary severance and all the other matters that you’ve done post year-end, where is net debt sitting at now? And what are you expecting it to be at the interim?

And then 2 other questions I’ve got is on the Phase 2 of the headcount restructuring, I mean, can you share with us any potential figures of what that may run into? And then the third thing is on the Multi-Links issue, you mentioned that you’ve made a partial payment already to SARS, and I think it was ZAR 300 million. I just want to know if you can give us some color on what is still — I know you’ve provided for it in prior periods, but what could be the potential cash outlay for that for the rest of the year?

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Tsholofelo B. L. Molefe, Telkom SA SOC Limited – Group CFO & Executive Director [3]

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Presh, thank you. I think I’ll take probably all the questions. So the handset receivables, we haven’t been able to implement yet. We have, however, made some good progress with one of the banks. I think when we went into lockdown, obviously, some of the banks wanted to see what does it mean from a customer behavior perspective because, obviously, they price in a credit risk premium in there. However, what we do is we actually assess it against our own average cost of borrowings. It is an off-balance sheet. It improves your working capital, but it’s not yet in the numbers. Your other initiatives, however, that we were able to deliver on at year-end, they were factored in. And hence, there’s improvement in our balance sheet. That’s why we were able to actually pay down debt of ZAR 1.2 billion instead of refinancing.

So that enabled us to, therefore, improve our net debt-to-EBITDA. Our net debt-to-EBITDA ended at — if we exclude the impact of IFRS, ended at 0.7x from 0.8x last year. If you recall, we had actually increased it at interim. And I think we reported 1.2x, excluding the impact of IFRS. With IFRS impact, it was at around 1.4x. And we had revised the market guidance to 1.5x. Going forward, obviously, we are continuing with these initiatives. If we exclude the impact of all these payments that we need to make, particularly the restructuring, we’re quite comfortable that we should be able to contain it within the 1x mark.

In terms of the Phase 2 of the restructuring, we, obviously, still have to do a lot of work. We have not consulted with labor in detail, although we have announced it. So we’re doing the work currently, and we are seeking to implement in the second half of the year. So we’re not able to give numbers at this point. However, it will be really focused on BCX and Telkom head office as well as all the support functions across the group. It will impact the FY 2021 financial year at both the charge as well as the impact, as well as the payments relating to that. And I think, as we indicated, Phase 1, we already paid for it in April, which forms part of the new financial year.

In terms of Multi-Links, if you recall, over the last couple of years, we had indicated that we had fully provided it — for it on our financials, and it was around ZAR 1.5 billion. While we were going to cut with SARS, obviously, we have been able to apply for a suspension of payment. And from time-to-time, SARS would request us to make some payments. So we have been able to service the payments. And at this point in time, and it is in our booklet, we have an outstanding amount of about — roughly about ZAR 800 million, just over ZAR 800 million. This is after making the payment of about ZAR 300 million in the last quarter of the financial year 2020.

I think it’s important also to highlight that the court matter still continues. We have engaged quite extensively with our legal counsel, and the matter has been put through the constitutional court for review as well on our side. So we do await that outcome. And at this point in time, obviously, SARS has asked us to pay now and ID later, and we’re in the process of finalizing payment terms with them.

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Preshendran M. Odayar, Nedbank Corporate and Investment Bank, Research Division – Analyst [4]

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Comforting to know that the net debt number going into interim is still going to be contained within that 1x range. Cheers.

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Operator [5]

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The next question is from John Kim of UBS.

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John Kim, UBS Investment Bank, Research Division – Research Analyst [6]

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I just wanted to get a little bit more color in detail on the CapEx plan for the next 2 to 3 years. I understand the next — the core network build-out is, call it, 2 years further. But how do you think about where you are versus your targets on fiberization to the base station and how mobile CapEx might progress next 2 or 3 years? Should we be thinking about these in either dollar-rand quantums or percentage of sales? Any color you could provide there would be helpful.

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Tsholofelo B. L. Molefe, Telkom SA SOC Limited – Group CFO & Executive Director [7]

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So yes, so I’ll start, and maybe Sipho can add. I think if we look at — we’ve always said that it was important for us to modernize our network. So the investments that we are making in our packet optical transport network, we are almost complete with that investment phase. We’re probably around 80% there. And I think in terms of what we had initially set out to do from a fiber to the home perspective, we’re also quite advanced in terms of that. I think what we’re seeing actually now is that with the increased demand for broadband, particularly post-COVID, it really presents itself in terms of looking at additional fiber deployments. However, we are thoughtful about that because we, obviously, wanted to make sure that we increase the connectivity rate. So if you think about historically, the original plan was really to do as much land grab as possible. So we’re now at 455,000, just over 455,000 homes passed. And therefore, we actually slowed down to make sure that we increase the connectivity rate.

I think, as well, because we’ve been able to improve our productivity, so from a capital productivity perspective, as I indicated in my presentation, we have seen a 40% reduction in cost as a result of that. And I think that enables us as well to be able to take up a lot more than what we have with those productivity improvements that we’ve done. So overall, just from a CapEx perspective, I think what’s important to highlight as well is that we’ll be quite thoughtful about CapEx. Obviously, we want to make sure that we can still invest for growth to ensure sustainability over long term. So from a mobile business, from a fixed broadband perspective as well, we’ll continue with those investments. But we will be flexible, informed by how we see our revenue forecast coming through, particularly under these challenging times. And should we see that the revenues are probably not coming through as a result of the impact of COVID, we’ll then be flexible enough to cut back CapEx where we can.

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Sipho Nkosinathi Maseko, Telkom SA SOC Limited – Group CEO & Executive Director [8]

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Yes, very little to add to Tsholo’s point. Our CapEx spend and the project execution thereof is pretty modularized. Depending on the sort of revenue trends that we see, we can be able to dial it up or down. Insofar as the big lumps of CapEx, the packet optical transport network, 80% of that is broadly done. And we actually have seen, as we speak, the value and the benefit of that, both in terms of the capacity that we are using but also our customers, the MNOs themselves, the increased capacity that they are asking for during this time. And then post that, it will then be driven by largely fiber to the home, fiber to the base station. I mean in terms of the coverage that we have of our sites, it’s still in the sort of 70%. So even as we are adding sites, we pull as much fiber to the base station as we can. And on the fiber to the home side, we want to manage delicately, the fiber homes passed and the homes connection ratio very, very delicately.

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John Kim, UBS Investment Bank, Research Division – Research Analyst [9]

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Okay. Helpful. Longer term, where do you — what do you think is a fair estimate for EBITDA margin in the mobile business longer term? Where should that stabilize?

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Sipho Nkosinathi Maseko, Telkom SA SOC Limited – Group CEO & Executive Director [10]

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Yes. We’re targeting between 20% to 25% in that area. I mean if you kind of think about it, all right, when we started off as mobile, we’ll go through a big retailer who would be distributing and helping you gain market share. The cost that they would put on us at the time, we just did not have the ability to negotiate as — and so one of the things that we are finding now is that we are able to renegotiate some of those. And so as we achieve scale, we are able actually to bring further our cost down across the different lines that we have. We’re starting to have clout with device providers. So what they used to charge us before, we are able to get — negotiate better discounts. And even the component providers for the network, we’re starting to have an ability to really get the right price points. So 20% to 25% is the corridor that we are aiming for in the next 12 to 18 months, and we’ll see how that goes.

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John Kim, UBS Investment Bank, Research Division – Research Analyst [11]

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And on the call this morning, you talked quite a bit about the need for spectrum. What sort of headroom do you have on your mobile network capacity today? And is it the optimization of the backhaul that you’re looking for with the further allocation in December? Or what is the primary use of the lots that you want?

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Sipho Nkosinathi Maseko, Telkom SA SOC Limited – Group CEO & Executive Director [12]

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So for us, the first and foremost is the sub-1 gig spectrum, all right, because that gives us a lot more coverage, and that helps reduce the CapEx intensity. So today, we are having to densify the network a lot because we don’t have the low-frequency spectrum. Sub-1 gig will help us with that coverage capability. And then in terms of 2600 and 3500, that helps us with the capacity, 2 or 3 carrier aggregation capacity, to be able to deliver speeds for customers as well. So that’s the dual use of the spectrum that we are looking to use it for.

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John Kim, UBS Investment Bank, Research Division – Research Analyst [13]

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Great. And headroom on network currently?

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Sipho Nkosinathi Maseko, Telkom SA SOC Limited – Group CEO & Executive Director [14]

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So headroom on network?

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John Kim, UBS Investment Bank, Research Division – Research Analyst [15]

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Yes. So if you were — if the emergency spectrum goes back and the auction in December is delayed, how much more traffic could you carry right now without congestion?

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Sipho Nkosinathi Maseko, Telkom SA SOC Limited – Group CEO & Executive Director [16]

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No, we still — I mean — so we — so I mean we’ve switched off 2G everywhere else in this country, except Gauteng. Hopefully, by the end of July, we would have switched off 2G in Gauteng. We are refarming 1800 and 2100 to be able to just use it for LTE and LTE Advanced. So we still have that headroom. And remember that we are using 2300 essentially as well as broadband as a fixed look-alike. We are not using it for mobile. And actually, one of the things that COVID showed is that during the lockdown, mobile doesn’t help you much in the sense that you are not mobile. So you can’t do a Teams’ call driving around or you can’t do a Zoom call driving around. Actually, fixed becomes absolutely paramount to be able to do that. Whether you are using wireless broadband, which is fixed look-alike or you are using copper or you are using fiber, but in essence, you need to be stationary, in a house or at home, wherever you are, to be able to use the service. And we actually even think that might appear a very, very small and negligible issue. But in itself, it’s beginning to transform how people — even if people are using their mobile devices, they’re using an iPad or a laptop or a smartphone, but they are accessing that broadband service essentially using a fixed technology whether it’s fiber, with WiFi in the home or they use LTE, which enable multiple connections and multiple services that can be consumed in the home.

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Operator [17]

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(Operator Instructions) The next question is from Ziyad Joosub of Nedbank.

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Ziyad Joosub, Nedbank Corporate and Investment Bank, Research Division – Analyst [18]

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Just one question, please, on BCX. In your booklet, you mentioned that there were marginal improvements in the public sector. If you could just give a bit more color on that and how you see those evolving? And then also to the lockdown, on the private sector side in BCX, if you could possibly give us an indication of how is demand evolving in the private sector for BCX over the past 2 months.

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Sipho Nkosinathi Maseko, Telkom SA SOC Limited – Group CEO & Executive Director [19]

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Yes, sure, Ziyad. So a couple of things, let me start with the private sector. Actually, I mean, BCX demand on the voice side, they would have been under a bit of pressure, fixed voice. However, many of their customers were asking them, I mean large banks and then media houses, right, can you connect 3,000 of our staff either with LTE or fiber? And can you do that in 2 weeks’ time? So that was the first thrust of the demand that was coming from most of their clients. I probably was one of their biggest sales benefit. They owe me a commission, yes, the BCX guys, during the time. So many of their enterprises were looking for, firstly, the ability to set up their employees to be able to work from home. The second bit that their customers were looking for is do they have sufficient infrastructure resilience to be able to move their services online. And hence, you see some of the IT solutions and also hybrid cloud services beginning to be quite important to a lot of entities. So that’s on the public — private sector side.

On the public sector side, actually, it is largely not different. I mean so we do this for the National Department of Health, track and trace. I personally have been on calls with probably about — of the 8 or 9 provinces, with more than half of them, with regards to what it is that we can do for them, not just insofar as health is concerned, because they are looking to manage the health dimension, but also some of the issues around transport as they, themselves, are looking to digitize their services. I mean just last week, I think they signed — the Department of Health Western Cape signed with BCX 2 weeks ago; and a week after that, Eastern Cape. And we’ve never been quite strong with the Western Cape department. So we see COVID almost changing the ability to be able to deliver different types of solutions over and above connectivity.

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Operator [20]

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The next question is from Dilya Ibragimova of Citi.

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Dilya Ibragimova, Citigroup Inc, Research Division – VP & Analyst [21]

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I had a couple of questions. The first is on data centers in which you mentioned, I think, you have 3 out of 4 Tier 4 data centers in the country. Could you give us a bit more color in terms of capacity that you have in total? And maybe how much of the capacity is there, either in terms of number of racks or in other terms? And also where those data centers are sitting within the business, is it part of Openserve? Or is it a separate business unit? Or maybe it’s somewhere between Openserve and BCX, just to get some understanding in whether you have separate plans to separate them out to drive maybe take-up of the services.

And the second question is on — sorry, a number of questions on data centers. And the second question is on mobile. How important is the customer growth for you going forward? I understand that some of the slowdown in the customer growth in the second half was due to some of the renegotiation of the terms with the — or commission-related terms, which you mentioned now you have better scale, and that’s why you can reduce the scale. Yes, maybe just a color how — whether that is still an important KPI for you and where you see that going forward. If you have any comment there, that would be great.

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Sipho Nkosinathi Maseko, Telkom SA SOC Limited – Group CEO & Executive Director [22]

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Sure. No, no, that’s fine. I mean I’ll start with data centers. We have roughly about — just of the — we have about 3 Tier 4 data centers, as I’ve indicated. About 12,000-plus square meters of data center capacity. One is in Bellville, one is at [Hartbeespoort], one is in Pretoria. And then I don’t have the actual detail with me in terms of racks, but they are able to do hybrid cloud, which means that we work with Azure, AWS, Cisco. So we have cloud agreements with different cloud service providers. We have analytics-driven operations, and we are able to manage and host quite a lot of these as our customers are moving to utility-based business models where applications and services are consumed on digital platforms. We have sufficient capacity to be able to acquire them. And remember that cloud consumption can also be on-premise or on our own cloud, public cloud versus private cloud, and different customers begin to ask for different solutions and a software-defined architecture — and yes, the demand for cloud services and even just pure data center services. Remember that we’re offering more a service rather than just a rental.

One of the existing — is that we are moving the data — the infrastructure. So the asset class, we are moving it to one of the business units, which is Gyro. So Gyro essentially will have 3 asset classes. And because they’re essentially an infrastructure business, Mast & Towers properties and data centers, which they will then open them up not just to BCX but also begin to open them up to other service providers who would want to have access to the premises which then, in essence, really positions it very well. Firstly, Gyro would have BCX as an anchor tenant in those data centers to provide different kinds of services but also have the flexibility to actually attract other potential tenants, exactly as we’re doing in Mast & Towers. So that’s on Mast & Towers.

In terms of mobile, I mean, it’s profitable growth that we are after rather than just numbers of subscribers for the sake of it. So I look at a couple of things with Tsholo. We obviously look at new subscribers. We look at churn, why we’re losing these customers, and we look at whether is it a distribution chain-induced churn. As well, we are migrating quite a lot of our acquisition to our own digital platforms. Instead of using intermediaries, we are renegotiating things like the incentive schemes when new customers are being acquired. We really also seek strategic alignment between ourselves and the distributor in terms of where we’re going. I mean it’s a very, very important metric for us and for mobile as we are looking for how do we enhance the value from existing customers, number one; but number two, how do we make sure that we use, in boxing language, a combination of your left hand and your right hand to acquire the customer relative to the competition, using either LTE or mobile or fiber, which we have in our arsenal.

So growth is important, but margins are becoming even more important. And we’re quite thoughtful in terms of the cost that which we make. And that is why we’ve actually walked away from some of the deals, actually. I mean some of these deals with some of the universities where they want you to provide them with data at ridiculous cost, we sort of say, “No, no, no. Good luck.” So if somebody else will sell you at ZAR 0.03 a meg, we’re not going to do that. So we are in a position where we can walk away from unprofitable arrangement on the mobile side because we’re quite conscious of the cost that you load onto the network if you have unprofitable traffic that you bring on and the consequence, potentially, of losing your profitable customers because you then begin to deteriorate their customer experience.

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Operator [23]

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Sir, we have no further questions in the queue. Do you have any closing comments?

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Sipho Nkosinathi Maseko, Telkom SA SOC Limited – Group CEO & Executive Director [24]

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No, no. Thank you very much. I mean thanks to everyone for their time. And hopefully, we will engage in one form or another going forward. And yes, we continue to be pretty focused on the task at hand, and we’ll certainly, hopefully, speak to you again in this form when we present our media results. Thank you.

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Operator [25]

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Ladies and gentlemen, that concludes this conference call, and you may now disconnect your lines.

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