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Ring, ring...

18 June 2004 Angelo Coppola

Telkom released results last week, which were higher than the market's expectations.

Neels van Schaik at PSG Fund Managers says that although the results were received positively by the market, the news of the Thintana share sale (book building) was perceived as negative due to a potential share overhang.

Remember that these share placements are noise factors that influence share prices in the short term. It is however the real, underlying fundamentals of the company and industry that counts in the long run.

Vodacom is obviously playing a crucial role in Telkom's performance with a big chunk of the capex in 2005 being funded from Vodacom's cash flow. The growth of Vodacom is therefore very important in Telkom's life.

Having lost out on the Nigerian bandwagon, we perceive as a huge mistake on management's part as South Africastill contributes more than 90% of Vodacom's revenue.

The cost structures of the mobile networks are much higher in South Africa, and both MTN and Vodacom are feeling a margin squeeze due to increased competition and higher distribution and connection costs in South Africa. These are all signs of a maturing market.

Telkom reported 864 cps HEPS for the full year to March 2004. Earnings for 2005 have been upgraded to 1000 cps, which puts the company on a forward p/e of 7.4.

This compares favourably to a forward market p/e of around 11, one year out. We believe that this rating does not reflect the monopoly status of the company and the cash flow generating ability.

Capital expenditure in the form of infrastructure upgrades will largely be funded from existing cash flow. Earnings during the next few years will be driven by further efficiency gains and cost cutting initiatives.

The main goal would be to make the company as efficient as possible when the SNO finally enters the market. This could still be 12 to 18 months away, if not longer.

Revenue growth for the fixed line business will be under pressure during the next 12 months, but lack of revenue growth will be offset by falling interest costs due to the rollover of fixed debt into floating rate debt. Any share buybacks at current levels will also be earnings enhancing.

We believe that R74.00 is an attractive level to get exposure to this company.

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