Telkom Mounting Risks Trough Multiples

EQUITY RESEARCH Telecommunications | CEEMEA Telecom Services | 11 June 2012

TELKOM Mounting risks, trough multiples

Telkom’s reinvestment strategy is ambitious, but visibility on returns is poor. We see high execution risk in its mobile venture, and see it absorbing R10bn of value from here. Also the absence of credible cost cutting will likely impair fixed returns. We see limited value at current levels, and remain 3-UW, and cut our price target to R19 from R27.

Mounting risks = trough multiple warranted. Telkom is extending its network transformation plan, started in 2007. We see challenges to the updated growth/investment plan, and detail these in the body of the note. In short, we are incrementally cautious on mobile, and remain sceptical on the upsell to its corporate customers. This, coupled with cost inflexibility (c70% of employees are unionized), implies high execution risk for future returns.

Dividend cut needed as KT talks fail. The company believes that legacy fixed line cash flows and the dividend cut (saves R0.8bn) provides sufficient funding for its reinvestment programme (R18-21bn over three years). Also, it ruled out a near-term need to tap debt/equity markets. Based on our EFCF forecasts, we see limited scope for dividend resumption over the next three years.

Valuation reflects execution risk. We estimate Telkom trades on 6.2xFY13 P/E and 2.2x EV/EBITDA vs. CEEMEA peers on 8.1x and 4.2x respectively. We cut our forecasts, largely due to higher mobile losses over the next three years, but also accelerated depreciation in fixed line. Our downside and upside valuation boundaries are R17-27/share.

TKGJ.J: Financial and Valuation Metrics ZAR

FY Mar 2011 2012 2013 2014 2015

EPS 4.85A 3.25A 3.35E 3.23E 3.87E

Previous EPS 4.81A 3.38E 4.17E 4.57E N/A

EV/EBITDA N/A N/A 2.2x 2.2x 2.1x

Dividend yield N/A N/A 0.0% 0.0% 18.7%

P/E 4.3 6.4 6.2 6.4 5.3

Source: Barclays Research.

Barclays Capital Inc. and/or one of its affiliates does and seeks to do business with companies coveredin its research reports. As a result, investors should be aware that the firm may have a conflict of interestthat could affect the objectivity of this report.

Investors should consider this report as only a single factor in making their investment decision.

This research report has been prepared in whole or in part by equity research analysts based outside theUS who are not registered/qualified as research analysts with FINRA.

PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 20.

Stock Rating 3-UNDERWEIGHTUnchanged

Sector View 2-NEUTRALUnchanged

Price Target ZAR 19.00lowered -30% from ZAR 27.00

Price (07-Jun-2012) ZAR 20.68Potential Upside/Downside -8%Tickers TKG SJ / TKGJ.J

Market Cap (ZAR mn) 10770Shares Outstanding (mn) 520.78Free Float (%) 55.3152 Wk Avg Daily Volume (mn) 1.5Dividend Yield (%) 7.0Return on Equity TTM (%) 5.21Current BVPS (ZAR) 56.96Source: FactSet Fundamentals

Price Performance Exchange-ZAR52 Week range ZAR 37.80-19.80

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Link to Barclays Live for interactive charting

CEEMEA Telecom Services JP Davids, CFA +44 (0)20 3134 3437 [email protected] Barclays, London Sara Mather +27 1189 56943 [email protected] Absa Capital, Johannesburg Jonathan Dann +44 (0)20 3134 3525 [email protected] Barclays, London San Dhillon +44 (0)20 3134 3484 [email protected] Barclays, London

Barclays | Telkom

11 June 2012 2

COMPANY SNAPSHOT

Telkom SA Limited CEEMEA Telecom Services

Income statement (ZARmn) 2012A 2013E 2014E 2015E CAGRRevenue 33,079 33,625 33,810 33,837 0.8%EBITDA 8,546 8,511 8,640 9,001 1.7%EBIT 2,408 3,025 2,939 3,364 11.8%Finance costs - net -527 -550 -554 -505 N/APre-tax income 774 2,475 2,385 2,859 54.6%Tax rate (%) 0.0 28.0 28.0 28.0 N/ANet income -216 1,711 1,648 1,976 N/AEPS (reported) (ZAR) 3.25 3.35 3.23 3.87 6.0%Diluted shares (mn) 511 511 511 511 0.0%DPS (ZAR) 0.00 0.00 0.00 3.87 N/A

Margin and return data AverageEBITDA margin (%) 25.8 25.3 25.6 26.6 25.8EBIT margin (%) 8.5 9.0 8.7 9.9 9.0Pre-tax margin (%) 2.3 7.4 7.0 8.4 6.3Net margin (%) -0.6 5.1 4.9 5.8 3.8Operating CF margin (%) 11.7 3.3 4.9 7.4 6.8ROIC (%) 5.3 4.0 3.8 8.3 5.4RONTA (%) 7.5 6.0 5.6 6.2 6.3ROA (%) 5.3 4.0 3.8 8.3 5.4ROE (%) -0.7 5.5 5.0 10.8 5.1

Balance sheet and cash flow (ZARmn) CAGRTangible fixed assets 36,155 38,023 39,287 40,134 3.5%Intangible fixed assets 3,555 3,594 3,620 3,622 0.6%Cash and equivalents 1,168 1,498 2,218 2,462 28.2%Total assets 52,568 55,179 57,205 58,133 3.4%Short and long-term debt 7,344 7,844 8,344 7,344 0.0%Other long-term liabilities 26 26 26 26 0.0%Total liabilities 22,427 22,955 23,015 21,634 -1.2%Net debt/(funds) 3,933 4,103 3,883 2,639 -12.5%Shareholders' equity 30,141 32,223 34,190 36,499 6.6%Cash flow from operations 6,704 7,424 7,411 7,929 5.8%Capex and acquisitions -4,675 -7,394 -6,991 -6,485 N/AFree cash flow 2,029 30 420 1,444 -10.7%NOPAT 2,810 2,178 2,116 2,422 -4.8%

Valuation and leverage metrics AverageP/E (reported) (x) 6.4 6.2 6.4 5.3 6.1EV/EBITDA (x) 2.2 2.2 2.2 2.1 2.2Equity FCF yield (%) 19.2 0.3 4.0 13.7 9.3EV/sales (x) 0.6 0.6 0.6 0.6 0.6Price/BV (x) 0.4 0.3 0.3 0.3 0.3Dividend yield (%) 0.0 0.0 0.0 18.7 4.7Total debt/capital (%) 14.0 14.2 14.6 12.6 13.8Net debt/EBITDA (x) 0.5 0.5 0.4 0.3 0.4

Stock Rating 3-UNDERWEIGHTSector View 2-NEUTRALPrice (07-Jun-2012) ZAR 20.7Price Target ZAR 19.0Ticker TKGJ.J

Investment case Why a 3-Underweight? High exposure to legacy telecommunications services, limited cost flexibility and mobile EBITDA losses pose risks to EBITDA margins.

Upside case ZAR 29.6We expect Telkom’s mobile business to destory value. In the upside case where EBITDA breaks even (ie no value destruction) we see upside to almost R30/share

Downside case ZAR 16.8Based on a trough PE multiple of 5x earnings, we see valuation near R17/share.

Upside/downside scenarios

71420273441

08- Jun- 11 07- Jun- 12

16.8( - 19% )

DownsideCase

19.0

PriceTarget

( - 8.1% )

29.6

UpsideCase

( 43.1% )

Source: Barclays Research

Line loss (% and 000s)

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Source: Company Data, Barclays Research

Source: Company data, Barclays Research Note: FY End Mar

Barclays | Telkom

11 June 2012 3

Trough multiples warranted, execution

BT Group share price collapsed in 2008/09 as it slashed its dividend (FY08: 15.8p, FY10: 6.9p) and warned on the profitability of its global expansion (BT Global Services). In mid 2009, the company’s forward PE multiple troughed at 4.7x. Since then, both earnings and the multiple have recovered, as the company has delivered ahead of expectations on cost cutting (see “Telkom: Limited power to cut costs”).

Figure 1: BT Group – Forward PE

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Source: DataStream

For Telkom, as it embarks on its investment and growth lead turn-around we see material execution risk. Our concerns include:

Its will get worse, before it gets better – Telkom, by its own admission (Results presentation), has a history of poor execution. Ahead of its replacement of its network, the run-off of legacy (and higher profitable) revenues will remain pervasive. Indeed fixed traffic revenues interconnect, which are in structural decline, make up a third of group revenues.

Execution on investment, extending 2007 NGN plan – At its NGN investor day in March 20071, the company said it planned a multi-year overhaul of its Operational Support Systems (OSS) and create an IP Network infrastructure. The company confirmed on its FY12 call that the core network has been upgraded, but it is unclear what progress if any was made on OSS. We believe the management team needs to present a clear plan on how its network investment/deployment can be measured, to rebuild credibility. The company concedes, that it the KT deal does not complete it will need to make “senior hires” to address its strategic aims.

Need to win in mobile, limited reason to believe this will be the case – The company targets revenue share of 12-15% by FY16. As we set out in our initiation piece, we see major challenges this being achieved. We forecast revenue share of <5% by this point. We remain sceptical on the “easy-win” from an upsell to fixed corporate customers. Indeed, we note that Turk Telekom, a best-in-class fixed operator (>80% share in

1 https://secure1.telkom.co.za/apps_static/ir/pdf/financial/docs/NGN%20for%20analyst%20day%20draft6.pdf

Barclays | Telkom

11 June 2012 4

corporate fixed line) has had limited success with its mobile operation Avea (established 2004). In the consumer space, we expect Vodacom and MTN to remain dominant.

No clear plan to address low penetration. Fixed line penetration is just 7.9% in South Africa, limiting the addressable broadband market. This compares unfavourably with markets like Egypt and Turkey, as we highlight below.

Figure 2: Telecoms – Fixed line penetration of households

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Focus on growth rather than costs – high levels of unionisation (c70%) limit scope for wholesale changes to employee costs. These make up 35% of fixed segment opex. The company remains inefficient by global standards with 191 employees per fixed line versus peers like Turk Telekom at just over 600. Also we continue to see electricity price rises presenting an R255m headwind by FY13. The company believes it has a 15 months window before it needs to take radical intervention on costs.

Price target cut We update our mobile forecasts and take a more cautious view on future cash profitability. Our revised DCF based price target is now R19/share (was R27/share). Indeed we now see a breakeven valuation for the mobile business as a blue sky scenario. Further, in the absence of a meaningful cost programme to de-risk the company’s reinvestment programme, we near term downside risk to ZAR16.8/share (trough multiple earnings multiple of 5x).

Barclays | Telkom

11 June 2012 5

Figure 3: SOTP, ZARm

Method EV Stake, % Value (ZARm) WACC (%) Growth (%)

Fixed line DCF 33,351 100.0 33,351 12.8 -1%

Mobile -5,519 100.0 -5,519 Other OpFCF multiple -9,407 100.0 -9,407 Total EV 18,425

Net debt, 2013E -4,103

Post retirement medical benefits -4,309

Equity Value 10,013

Number of shares (m) 521

Price target (ZAR) 19.0

Source: Barclays Research

Figure 4: Telkom Mobile valuation

2014E 2015E 2016E 2017E 2018E 2019E 2020E Terminal year Total

Avg subscribers 2,532 2,983 3,444 3,973 4,373 4,673 4,873

ARPU 118 120 123 125 126 128 130.0

Revenues 3,590 4,313 5,079 5,953 6,636 7,164 7,602

EBITDA -1,436 -863 -102 595 830 1,075 1,368

Margin -40.0 -20.0 -2.0 10.0 12.5 15.0 18.0

Depreciation -782 -935 -1,093 -1,091 -1,152 -1,118 -1,197

Other

EBIT -2,218 -1,797 -1,195 -496 -323 -44 171

Tax 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Capex -1,974 -1,725 -1,270 -893 -929 -967 -1,017

Working Capital movements -120 -100 -152 -119 -133 -107 -100

FCF -3,530 -2,688 -1,524 -417 -232 0 252 596

PV FCF -2,740 -1,838 -918 -221 -109 0 91 216 -5,519

Source: Barclays Research

Barclays | Telkom

11 June 2012 6

SA fixed market – ABC revenue trends deteriorate, KPIs mixed

Global fixed-line operators generate ABC (access, broadband and call) revenues from access lines, broadband and IPTV. We term these Revenue Generating Units (“RGUs”). For Telkom, ABC revenue growth deteriorated 4.5pp to -5.7% in 2H12. This as call revenue growth deteriorated -11% yoy (1H12: -5%, 2H11: -11.1%, 1H11: -15.4%) while we estimate broadband revenue growth eased to 6.2% (1H12: 9.1%, 2H11: 13.5%, 1H11: 23.4%). RGU growth was +0.7%, as access line losses eased. Specifically we note:

Line losses ease, calling plan subscribers adds stable. Telkom reported line losses of -14k in 2H12, an improvement on recent trends (1H12: -39k, 2H11: -40k, 1H11: -33k). The drive to convert customers to calling rate/annuity revenue streams saw calling plan subscribers net adds stable yoy at +21k in 1H12 (1H12: +15k, 2H11: +21k, 1H11: +47k). However, calling plan revenue declined 8.6% yoy in 2H12 reflecting increased penetration and as customers shifted to lower priced products (1H12: +1.5%, 2H11: +10.4%. 1H11: +10.2%).

RGU’s growth stable. RGU growth including broadband improved 20bps to 0.7% in 2H12 as broadband net adds offset line losses (1H12: +0.5%, 2H12: +1%, 1H11: - 0.2%). However, broadband net adds eased in 2H12 to +32k (1H12: +44k, 2H11: +52k, 1H11: +52k). We note that Vodacom added 72k mobile broadband subscribers over the same period.

Figure 5: ABC, ARPU and revenue growth per RGU (%)

Figure 6: Telkom PSTN line loss and growth (000s/%)

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Barclays | Telkom

11 June 2012 7

Telkom’s ABC revenue decline deteriorated to -5.7% in 2H12 (1H12: -1.2%, 2H11: -6.0%, 1H11: -8.9%). This as call (traffic) revenue growth declines offset access and broadband revenue growth. Call revenue pressure (2H12: -11%, 1H12:-5%, 2H11: -11.1%, 1H11: -15.4%) was a function of lower minutes of use due to fixed to mobile substitution.

Figure 7: Calling plan subs and revenue growth (000s/%)

Figure 8: Telkom fixed RGU’s (000s)

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Source: Company data, Barclays Research Source: Company data, Barclays Research

Figure 9: Telkom fixed – Price per minute (ZARc)

Figure 10: Telkom fixed – ABC revenues (ZARm)

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Barclays | Telkom

11 June 2012 8

Figure 11: Telkom broadband net adds and growth (000s/%)

Figure 12: Broadband market composition (000s)

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Barclays | Telkom

11 June 2012 9

South African mobile market – 8ta flailing

Telkom’s mobile unit continues to struggle, with net adds easing during 2H12. Management expects to reduce mobile EBITDA losses by approximately 20% in FY13 (FY12: R2.2bn), while investing between R2bn and R2.5bn in capital expenditure. Meanwhile, Vodacom posted lighter underlying service revenue growth in the quarter, as a result of the higher prevalence of low end usage prepaid customers. Additionally, lower out of bundle spend in the contract segment saw contract ARPU decline 10% in FY4Q12. Its service revenue growth on an underlying basis was +5.6% during the quarter, a 2.3pp deterioration on 3Q12. MTN underlying service revenue trends remained robust during the quarter, as contract subscriber growth remains impressive.

Telkom mobile net adds ease – Telkom’s 8ta reported net adds of +343k in 2H12 (1H12: +667k, 474k between its launch in October 2010 and the end of March 2011). Within the mix, Telkom added +157k prepaid and +187k postpaid subscribers (1H12: +442k and +225k respectively). Vodacom reported net adds of 2.58m in 4Q12 (calendar 1Q12), driven by low cost handset deals and refocused distribution channels (3Q12: 2.82m, 2Q12: +1.18m, 1Q12: +1.2m, 4Q11: +1.2m). Subscriber growth continued to be driven by the prepaid segment, with net adds of 2.49m (3Q12: +2.72m, 2Q12: +1.06m, 1Q12: +1m, 4Q:11: +1.1m). Postpaid subscriber growth continued to ease in the quarter, with slower net adds of 91k (3Q12: +99k, 2Q12: +119k, 1Q12: +194k, 4Q11: +134k). MTN reported net adds of 702k in 1Q12 (4Q11: +1.1m, 3Q11: +1.2m). Within the mix, postpaid net adds were improved at +170k (4Q11: +146k, 3Q11: +133k) supported by hybrid package and telemetry SIM sales, while prepaid nets adds were sequentially weaker at 532k (4Q11: +919k, 3Q11: +1.04m).

Reduced consumer spend impacts voice market. Vodacom posted underlying service revenue growth of +5.6% on our estimates in FY4Q12, a 2.3pp slow down on the prior quarter (3Q12: +7.9%, 2Q12: +6.6%, 1Q12+7.4%, 4Q11: +7.5%). This on the back of softer spend in both the prepaid and contract segments. MTN’s reported subscriber and APRU data implied service revenue growth of 3.6% in 4Q (underlying c7%), broadly in line with 3Q11 (+4.0%). For additional colour on the market, and the potential for competition to disrupt, see our recent report “SA Connect: Iliad contagion risk” (2 March).

Barclays | Telkom

11 June 2012 10

Usage trends a mixed bag. Vodacom’s outbound usage was stable at 6.8% yoy in FY4Q12 or 6.47bn minutes (3Q12: +6.9%, 2Q12: +31.8%, 1Q12: +36.8%). We estimate that Vodacom’s blended outbound price per minute fell 5%, with prices near 114c. MTN’s 2H11 outbound usage increased 8.9pp to 18.8%. We estimate that effective price per minute fell 14.8% to 115c.

Figure 13: South Africa mobile – subscriber share, % Figure 14: South Africa mobile – Cumulative net adds, 000’s

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Figure 15: South Africa mobile – Service revenues, ZARbn Figure 16: South Africa mobile – Service revenue growth, %

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Source: Company data, Barclays Research. Due to the timing difference in Y/E reporting we capture Vodacom’s FY1H 2011 as calendar 1H10.

Barclays | Telkom

11 June 2012 11

Data growth trends mixed. Vodacom reported total data revenue growth of 14.7% in 4Q12 (3Q12: +15.1%, 2Q12: +18.2%, 1Q12: +24.7%, 4Q11: +21%). Non-SMS data revenues were 16.4% of service revenues in 4Q12 (3Q12: 15.1%, 2Q12: 15.6%, 1Q12: 16.1%, 4Q11: 14.2%). Non-sms data growth was 17.8% from 19.3% in 3Q12. At MTN, data revenues, including SMS, made up 22.8% of service revenues in 4Q11(1H11: 21%, 2H10: 19.2%). MTN reported total data growth of 23.3% in 2H11 (1H11: +14.1%).

Figure 17: South Africa mobile – Voice prices, ZARc

Figure 18: South Africa mobile – Outbound min growth, %

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Barclays | Telkom

11 June 2012 12

Conference Call Feedback

Telkom hosted a conference call on 8 June. Below we highlight the key points:

Staff costs – Management would not give explicit guidance as to whether there is scope for staff costs to be reduced through retrenchments. Efficiency will be a focus of management.

Competition in the mobile environment – Management believe that they cannot compete with the mobile incumbents on price. They acknowledge the need to remain competitive on pricing but maintain that the focus will be on rolling out their own network (reduce roaming costs by bringing more traffic on net).

Dividend – Management acknowledged that should the KT deal have materialised, the dividend would not have been suspended. Management believe it was a prudent measure (given the ongoing Competition Commission Case and the capital commitments). The decision will be reviewed annually.

Mobile losses – Management do not expect the FY14 EBITDA loss to be significantly lower than the FY13 guidance (20% lower than FY12 loss of R2.2bn). Management have identified the need to reduce SAC and marketing costs in the mobile business.

Potential for a rights issue – Management’s message was that, having suspended the dividend, they don’t believe it will be necessary to ask shareholders for more cash. However they highlighted that the success of the mobile business poses a risk to this.

Executive pa incentives – Are based on a scorecard of metrics. The path to mobile breakeven is very important where applicable.

Strategic partner – Management highlighted that they will pursue a different plan to obtain the benefits of having a strategic partner that the KT deal would have afforded them.

Customer service – Some of the problems with customer service is structural according to management (cable theft, ageing network) which will be addressed as far as capital will allow.

Hurdle rate for investments – The company’s WACC of 13% is the hurdle rate for investments. Investments are rolled out on a pilot basis.

Barclays | Telkom

11 June 2012 13

COMPS Figure 19: COMPS Ccy Share Price Mkt Cap P/E EV/EBITDA EV/OpFCF EFCF Yield (Normalized) Dividend Yield Now (EUR b) 2011E 2012E 2013E 2011E 2012E 2013E 2011E 2012E 2013E 2011E 2012E 2013E 2011E 2012E 2013EIncumbent - EU Belgacom EUR 21.11 6.7 9.0x 9.4x 10.3x 4.6x 4.8x 4.9x 7.8x 8.6x 8.7x 11.7% 9.3% 9.4% 10.3% 10.3% 9.4%BT Group GBP 2.05 19.7 8.7x 7.9x 7.5x 4.6x 4.5x 4.4x 7.9x 7.7x 7.6x 0.7% 15.5% 13.3% 4.0% 4.6% 5.3%Deutsche Telekom EUR 7.80 34.0 11.9x 13.3x 12.6x 4.0x 4.2x 4.2x 7.3x 8.2x 8.2x 19.8% 14.1% 15.5% 9.0% 9.0% 9.0%Elisa EUR 15.13 2.4 11.7x 11.2x 10.7x 6.1x 6.1x 6.0x 9.8x 9.8x 9.1x 7.9% 7.6% 8.5% 8.6% 9.5% 9.4%France Telecom EUR 10.30 27.4 6.5x 7.9x 8.1x 4.0x 4.3x 4.3x 6.4x 7.5x 7.6x 19.4% 15.7% 12.7% 13.6% 11.7% 9.7%KPN EUR 7.66 10.9 7.3x 10.4x 9.8x 4.2x 4.7x 4.5x 7.0x 9.4x 7.6x 19.3% 12.2% 18.7% 11.1% 11.8% 11.8%OTE EUR 1.28 0.6 - 1.9x 2.0x 2.7x 2.7x 2.8x 4.5x 4.0x 4.5x 272.3% 245.2% 253.0% - - -Portugal Telecom EUR 3.19 2.8 6.0x 6.6x 6.4x 4.4x 4.1x 4.2x 10.1x 9.1x 9.0x 8.8% 15.0% 16.7% 40.8% 14.9% 14.9%Swisscom CHF 350.80 15.1 26.6x 10.1x 10.1x 6.2x 6.4x 6.3x 11.4x 12.8x 12.7x 8.8% 6.4% 9.2% 6.3% 6.3% 6.6%TDC DKK 37.35 4.1 10.9x 9.0x 9.6x 4.8x 4.8x 4.9x 7.3x 6.4x 7.3x 14.4% 13.5% 15.2% 11.6% 12.3% 12.5%Telecom Italia (blend) EUR 0.67 13.0 - 5.1x 4.9x 4.0x 4.0x 4.1x 7.3x 7.1x 6.9x 39.7% 23.6% 20.0% 6.9% 6.5% 6.4%Telecom Italia (ordinary) EUR 0.71 - - 5.4x 5.2x 4.0x 4.1x 4.1x 7.4x 7.2x 7.0x 37.5% 22.3% 18.9% 6.1% 6.1% 6.1%Telecom Italia (saver) EUR 0.58 - - 4.5x 4.2x 3.8x 3.9x 3.9x 7.0x 6.8x 6.7x 45.8% 27.2% 23.1% 9.3% 9.3% 9.3%Telefonica EUR 9.44 42.5 7.9x 9.4x 7.8x 4.7x 4.5x 4.4x 7.9x 8.4x 8.2x 21.3% 18.4% 14.5% 13.8% 10.6% 10.6%Telekom Austria EUR 7.62 3.4 27.2x 14.1x 12.6x 5.0x 5.2x 5.3x 9.7x 16.5x 10.8x 14.1% 8.3% 11.0% 5.0% 5.0% 6.3%Telenor NOK 89.85 18.7 25.5x 9.5x 8.2x 5.9x 5.2x 4.9x 9.6x 7.9x 7.0x 10.5% 10.7% 11.0% 5.6% 7.4% 8.5%TeliaSonera SEK 43.14 20.8 10.5x 9.9x 9.3x 5.7x 5.6x 5.4x 10.7x 9.1x 8.5x 3.9% 11.2% 7.9% 6.6% 7.4% 8.1%Altnets/Other - EU C&W Communications GBP 0.29 0.9 7.0x 6.5x 6.2x 4.7x 4.7x 4.6x 8.1x 7.6x 7.5x 3.6% 5.9% 11.5% 17.8% 8.9% 8.9%Colt GBP 1.16 1.3 3.2x 3.1x 3.0x 20.5x - - 3.4% - - - - -Daisy GBP 0.94 0.3 7.0x 6.7x 6.2x 5.8x 5.4x 5.2x 6.1x 5.6x 5.4x 7.0% 11.9% 15.7% - - -Iliad EUR 104.55 5.7 22.6x 35.7x 30.7x 8.3x 9.0x 8.0x 15.8x nm 27.8x 6.7% - - 0.4% 0.3% 0.4%Inmarsat GBP 4.62 2.8 13.1x 12.0x 13.0x 6.1x 7.5x 7.6x 14.3x nm 23.2x 9.5% - 1.3% 5.6% 6.2% 6.5%Jazztel EUR 4.67 1.1 22.6x 18.7x 13.2x 8.3x 6.3x 5.2x 25.1x 13.6x 15.9x 3.4% 3.4% 1.5% - - -Kabel Deutschland EUR 44.52 3.9 27.3x 17.1x 13.8x 9.2x 8.4x 7.1x 18.3x 15.9x 13.5x 1.0% 4.1% 7.3% 3.4% 6.7% 11.2%KCOM GBP 0.69 0.4 9.4x 8.6x 8.2x 5.3x 5.2x 5.0x 6.7x 7.9x 7.5x 11.2% 10.1% 11.8% 5.8% 6.4% 7.5%Mobistar EUR 24.73 1.5 6.7x 8.6x 7.8x 3.6x 4.0x 4.0x 5.8x 6.0x 6.0x 16.4% 12.7% 14.7% 15.0% 11.7% 12.9%Sonaecom EUR 1.17 0.4 6.9x 9.2x 12.0x 2.8x 2.8x 2.9x - 5.7x 6.5x 11.3% 3.9% 19.4% 6.0% 6.0% 6.0%TalkTalk Group GBP 1.56 1.8 9.1x 7.9x 7.1x 5.2x 4.8x 4.6x 7.6x 6.7x 6.3x 8.9% 14.1% 17.6% 5.8% 6.6% 7.6%Telenet EUR 31.77 3.5 - 29.1x 20.4x 8.8x 8.2x 7.6x 36.3x 14.7x 12.4x 7.9% 6.3% 6.5% 13.4% 14.2% 12.6%Tele2 SEK 103.60 5.1 9.7x 9.8x 8.2x 5.2x 5.0x 4.6x 10.3x 9.0x 7.8x 7.7% 7.7% 10.3% 12.5% 12.5% 12.5%Virgin Media GBP 14.65 5.3 nm 13.9x 9.8x 5.4x 5.1x 4.9x 10.3x 11.3x 9.1x 8.2% 5.0% 10.3% 1.1% 1.1% 1.1%Ziggo EUR 23.03 4.6 22.0x 23.9x 13.7x 9.3x 9.2x 8.4x 13.3x 13.8x 12.9x - 6.5% 6.5% - 4.8% 4.3%ZON Multimedia EUR 2.08 0.6 18.9x 20.6x 15.7x 4.7x 4.6x 4.5x 15.6x 9.5x 8.6x 7.4% 15.4% 18.0% 7.7% 7.7% 9.6%Datacentres Equinix USD 161.69 6.3 - nm 41.8x 13.6x 12.6x 9.9x nm nm nm nm - 1.0% nm nm nmInterXion USD 16.79 0.9 31.7x 30.1x 26.2x 10.7x 9.2x 7.0x nm - nm nm nm nm nm nm nmTelecity GBP 8.03 2.0 32.5x 26.6x 20.8x 16.4x 13.2x 11.0x nm nm 22.3x nm - 0.8% nm 0.8% 1.4%

Barclays | Telkom

11 June 2012 14

EMEA Median 9.6 12.2x 8.1x 8.3x 4.4x 4.2x 4.1x 9.6x 8.2x 7.4x 8.9% 9.6% 11.1% 7.2% 8.3% 10.1%Mobinil EGP 136.38 1.8 - - 35.6x 6.3x 6.1x 5.8x 13.7x 12.7x 11.7x 7.0% 4.4% 4.8% - 2.2% 2.1%MTN ZAR 134.30 23.6 12.6x 10.3x 9.4x 5.0x 4.8x 4.4x 6.7x 6.9x 7.6x 8.9% 9.6% 11.1% 5.6% 7.3% 9.1%MTS USD 17.94 14.2 12.2x 10.8x 10.3x 4.8x 4.6x 4.4x 9.6x 9.3x 7.7x 7.6% 9.6% 11.3% 5.6% 6.1% 7.8%Orascom USD 2.43 2.0 3.8x 6.5x 5.3x 3.2x 3.0x 2.8x 5.0x 3.9x 4.3x 23.1% 22.5% 11.1% - - -Telecom Egypt EGP 12.33 2.8 8.3x 7.8x 8.0x 3.7x 3.6x 3.7x 4.3x 4.6x 5.0x 9.0% 12.1% 11.2% 11.4% 11.4% 11.4%Telkom ZAR 20.68 1.0 6.4x 6.2x 6.4x 2.2x 2.2x 2.2x 4.9x 17.0x 11.5x 25.8% - 3.5% - - -Turkcell TRY 8.24 7.9 15.4x 8.5x 8.5x 4.4x 4.1x 3.9x 10.1x 8.2x 7.4x 5.7% 2.8% 7.4% - - -Turk Telekom TRY 6.30 9.6 10.7x 8.1x 8.3x 5.5x 5.3x 5.2x 9.9x 9.3x 8.6x 8.3% 8.2% 10.7% 8.6% 11.3% 11.1%VIP USD 7.93 10.2 24.5x 8.0x 6.7x 4.3x 4.2x 4.1x 11.7x 8.0x 7.4x 12.8% 20.7% 19.5% 10.1% 10.1% 10.1%Vodacom ZAR 98.80 13.9 14.0x 12.1x 11.5x 6.8x 6.3x 6.1x 10.1x 9.5x 9.0x 8.2% 7.3% 7.9% 7.2% 8.3% 8.7%

Source: Barclays Research, Reuters; prices as of close 7th of June.

Barclays | Telkom

11 June 2012 15

Changes to estimates Following the release of the 2H12 results we have cut FY13E – FY15E EBITDA forecasts by c3.7%-1.8% , as we reflect our incrementally cautious stance on mobile, and due to higher depreciation in fixed line .

Figure 20: Changes to estimates (2013E – 2016E)

Year to March 2013E 2014E 2015E 2016E

New

Normalised Operating Revenue 33,625 33,810 33,837 34,124 Total revenue 34,225 34,310 34,337 34,624 Clean EBITDA 8,511 8,640 9,001 9,441 Headline EPS from cont operations (c) - diluted 335 323 387 461

Dividend per share (c) - - 387 461

Capex 7,394 6,991 6,485 5,644 Net debt/(cash) at end of the period 4,103 3,883 2,639 2,018

EFCF 30 420 1,444 2,797

Old Normalised Operating Revenue 32,905 32,970 32,913 33,112 Total revenue 33,205 33,270 33,213 33,412 EBITDA 8,838 9,090 9,169 9,346 Clean EBITDA 8,838 9,090 9,169 9,346 Headline EPS from cont operations (c) - diluted 417 457 472 495 Dividend per share (c) 167 229 472 495 Capex 6,726 6,292 5,803 5,126 Net debt/(cash) at end of the period 4,300 4,129 3,659 3,576 EFCF 616 1,223 1,838 2,693 % Change Reported Operating revenue 2.2 2.5 2.8 3.1Total revenue 3.1 3.1 3.4 3.6Clean EBITDA -3.7 -4.9 -1.8 1.0Headline EPS from cont operations (c) - diluted -19.7 -29.4 -18.0 -6.8Dividend per share (c) -100.0 -100.0 -18.0 -6.8Capex 9.9 11.1 11.8 10.1Net debt/(cash) at end of the period -4.6 -6.0 -27.9 -43.6EFCF -95.1 -65.7 -21.4 3.9

Source: Barclays Research

Barclays | Telkom

11 June 2012 16

Forecasts

Figure 21: Forecast profit and loss account

ZARm 2012A 2013E 2014E 2015E 2016E 2017E

Reported Operating revenue 33,079 33,625 33,810 33,837 34,124 34,444 Other income 579 600 500 500 500 500 Total revenue 33,658 34,225 34,310 34,337 34,624 34,944 EBITDA 8,546 8,511 8,640 9,001 9,441 9,890 Non-recurring items 167 - - - - -Clean EBITDA 8,546 8,511 8,640 9,001 9,441 9,890 EBITDA margin (%) 25.8 25.3 25.6 26.6 27.7 28.7 Depreciation 4,608 4,786 5,028 4,990 5,057 4,944 Amortisation 701 700 673 647 633 619 Impairments 569 - - - - -Write offs 260 - - - - -Reported EBIT 2,408 3,025 2,939 3,364 3,751 4,327 Non-recurring items 402 0 - - - -Clean EBIT 2,810 3,025 2,939 3,364 3,751 4,327 EBIT margin 8.5 9.0 8.7 9.9 11.0 12.6 Investment income 238 160 180 180 180 180 Gain on distribution of assets - - - - - -Interest 765 710 734 685 523 442 Foreign exchange and fair value movement 1,107 - - - - -Profit before taxation 774 2,475 2,385 2,859 3,408 4,065 Taxation 595 693 668 801 954 1,138 Profit from continuing operations 179 1,782 1,717 2,059 2,454 2,927 Profit/(loss) from discontinued operation (269) - - - - -Profit for the year (90) 1,782 1,717 2,059 2,454 2,927 Profit attributable to:

Owners of Telkom (216) 1,711 1,648 1,976 2,356 2,810 Non-controlling interest 126 71 69 82 98 117

Capex 4,783 7,394 6,991 6,485 5,644 5,182 Capex to Sales (%) 14.5 22.0 20.7 19.2 16.5 15.0 OpFCF 3,763 1,117 1,649 2,516 3,797 4,708 OpFCF Margin (%) 11.4 3.3 4.9 7.4 11.1 13.7

Source: Company data, Barclays Research

Barclays | Telkom

11 June 2012 17

Figure 22: Forecast Revenue

ZARm 2012A 2013E 2014E 2015E 2016E 2017E

Telkom South Africa 30,638 29,803 28,880 28,160 27,652 27,066 Mobile 1,200 2,518 3,590 4,313 5,079 5,953 Other International

iWay Africa 368 339 315 293 272 253 Other South African

Trudon (yellow pages) 1,180 1,156 1,133 1,111 1,088 1,067 Swiftnet 128 138 148 157 165 173 Data Centre Operations 1,406 1,518 1,594 1,658 1,725 1,793 Corporate centre 78 72 68 65 62 58

Eliminations (1,919) (1,919) (1,919) (1,919) (1,919) (1,919)Total 33,079 33,625 33,810 33,837 34,124 34,444 Source: Company data, Barclays Research

Figure 23: Forecast EBITDA

ZARm 2012A 2013E 2014E 2015E 2016E 2017E

Telkom South Africa 11,813 11,461 10,990 10,491 10,164 9,907 Mobile (2,425) (2,050) (1,436) (863) (102) 595Other International (45) (34) (31) (29) (14) 5Other South African (917) (865) (883) (598) (608) (618)Eliminations 120 0 0 0 0 0Total 8,546 8,511 8,640 9,001 9,441 9,890 Source: Company data, Barclays Research

Barclays | Telkom

11 June 2012 18

Figure 24: Forecast Cash Flow Statements

ZARm 2012A 2013E 2014E 2015E 2016E 2017E

EBITDA 8,546 8,511 8,640 9,001 9,441 8,546Income tax paid (920) (693) (668) (801) (954) (920)Net Interest paid (80) (250) (304) (255) (93) (80)Other (842) (145) (257) (17) 48 (842)Cashflow from operating activities 6,704 7,424 7,411 7,929 8,441 6,704

Capex (4,675) (7,394) (6,991) (6,485) (5,644) (4,675)Other investments 0 - - - - 0Assets disposals (acquisitions) 105 - - - - 105Cashflow from investing activities (4,570) (7,394) (6,991) (6,485) (5,644) (4,570)

Net change in loans (1,253) 500 500 (1,000) (500) (1,253)Dividends paid (812) 0 0 0 (1,976) (812)Finance lease capital repaid (177) (200) (200) (200) (200) (177)Share buy back/purchase of treasury shares 0 - - - - 0Acquisition of non-controlling interest 0 - - - - 0(Increase)/decrease in net financial assets (493) - - - - (493)Cashflow from financing activities (2,735) 300 300 (1,200) (2,676) (2,735)

Net cashflow (601) 330 720 244 121 (601)

Cash at beginning of year 1,773 1,165 1,495 2,215 2,459 1,773Net foreign currency/other effect -7 0 0 0 0 -7Net cash and cash equivalent at end of period 1,165 1,495 2,215 2,459 2,580 1,165

Net debt Net debt at start of the period 4,907 3,933 4,103 3,883 2,639 4,907Changes in debt and shareholder's contribution -652 170 -220 -1,244 -621 -652Net foreign currency/other effects (322) - - - - (322)Net debt/(cash) at end of the period 3,933 4,103 3,883 2,639 2,018 3,933Source: Company data, Barclays Research

Barclays | Telkom

11 June 2012 19

Figure 25: Forecast Balance Sheets

ZARmn 2012A 2013E 2014E 2015E 2016E 2017E

Property, plant and equipment 36,155 38,023 39,287 40,134 40,157 39,876 Intangible assets 3,555 3,594 3,620 3,622 3,553 3,453 Investments 2,260 2,260 2,260 2,260 2,260 2,260 Deferred expenses 47 47 47 47 47 47 Other financial assets 48 48 48 48 48 48 Finance lease receivables 244 244 244 244 244 244 Deferred taxation 53 53 53 53 53 53 Non-current assets 42,362 44,270 45,560 46,407 46,362 45,981 Inventories 993 993 993 993 993 993 Income tax receivable 26 26 26 26 26 26 Current portion of deferred expenses - - - - - -Current portion of finance lease revceivables 128 128 128 128 128 128 Trade and other receivables 5,696 6,069 6,086 5,921 5,972 6,028 Other financial assets 2,195 2,195 2,195 2,195 2,195 2,195Cash and cash equivalents 1,168 1,498 2,218 2,462 2,583 3,007 Current assets 10,206 10,909 11,646 11,726 11,897 12,377 Total assets 52,568 55,179 57,205 58,133 58,259 58,358

Share capital 5,208 5,208 5,208 5,208 5,208 5,208 Treasury shares (771) (771) (771) (771) (771) (771)Share based compensation reserve - - - - - -Non-distributable reserves 1,887 1,887 1,887 1,887 1,887 1,887 Retained earnings 23,383 25,394 27,293 29,519 30,148 30,852 Reserves of disposal groups classified as held for sale 0 - - - - -Non-controlling interests 434 505 574 656 754 872 Equity and liabilities 30,141 32,223 34,190 36,499 37,227 38,048 Interest-bearing debt 5,897 6,397 6,897 5,897 5,397 4,897 Other financial liabilities 26 26 26 26 26 26 Provisions 4,916 4,716 4,516 4,316 4,116 3,916 Deferred revenue 1,132 1,132 1,132 1,132 1,132 1,132 Deferred taxation 747 747 747 747 747 747 Non-current liabilities 12,718 13,018 13,318 12,118 11,418 10,718 Trade and other payables 4,291 4,519 4,279 4,098 4,196 4,174 Shareholders for dividend 23 23 23 23 23 23 Current portion of interest-bearing debt 1,289 1,289 1,289 1,289 1,289 1,289 Current portion of provisions 1,892 1,892 1,892 1,892 1,892 1,892 Current portion of deferred revenue 1,995 1,995 1,995 1,995 1,995 1,995 Income tax payable 87 87 87 87 87 87 Other financial liabilities 129 129 129 129 129 129 Credit facilities used 3 3 3 3 3 3 Current liabilities 9,709 9,937 9,697 9,516 9,614 9,592 Total equity and liabilities 52,568 55,179 57,205 58,133 58,259 58,358 Source: Company data, Barclays Research

Barclays | Telkom

11 June 2012 20

ANALYST(S) CERTIFICATION(S)

We, JP Davids, CFA, Sara Mather, Jonathan Dann and Maurice Patrick, hereby certify (1) that the views expressed in this research reportaccurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report.

IMPORTANT DISCLOSURES CONTINUED

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Primary Stocks (Ticker, Date, Price)

Telkom (TKGJ.J, 07-Jun-2012, ZAR 20.68), 3-Underweight/2-Neutral

Guide to the Barclays Fundamental Equity Research Rating System:

Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2-Equal Weight or 3-Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry sector (the "sector coverage universe").

In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investorsshould carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone.

Stock Rating

1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.

2-Equal Weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.

3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.

RS-Rating Suspended - The rating and target price have been suspended temporarily due to market events that made coverage impracticable orto comply with applicable regulations and/or firm policies in certain circumstances including where the Corporate and Investment BankingDivision of Barclays is acting in an advisory capacity in a merger or strategic transaction involving the company.

Sector View

1-Positive - sector coverage universe fundamentals/valuations are improving.

2-Neutral - sector coverage universe fundamentals/valuations are steady, neither improving nor deteriorating.

3-Negative - sector coverage universe fundamentals/valuations are deteriorating.

Below is the list of companies that constitute the "sector coverage universe":

CEEMEA Telecom Services

Mobile TeleSystems (MBT) Mobinil - Egyptian Company for Mobile Services (EMOB.CA) MTN Group Limited (MTNJ.J)

Orascom Telecom Holding (ORTEq.L) Telecom Egypt (ETEL.CA) Telkom (TKGJ.J)

Turk Telekom (TTKOM.IS) Turkcell (TCELL.IS) VimpelCom (VIP)

Vodacom Group Ltd. (VODJ.J)

Barclays | Telkom

11 June 2012 21

IMPORTANT DISCLOSURES CONTINUED

Distribution of Ratings:

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43% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Buy rating; 55% ofcompanies with this rating are investment banking clients of the Firm.

42% have been assigned a 2-Equal Weight rating which, for purposes of mandatory regulatory disclosures, is classified as a Hold rating; 48% ofcompanies with this rating are investment banking clients of the Firm.

13% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Sell rating; 41% ofcompanies with this rating are investment banking clients of the Firm.

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Barclays | Telkom

11 June 2012 22

IMPORTANT DISCLOSURES CONTINUED

Telkom (TKG SJ / TKGJ.J) Stock Rating Sector View

ZAR 20.68 (07-Jun-2012) 3-UNDERWEIGHT 2-NEUTRAL

Rating and Price Target Chart - ZAR (as of 07-Jun-2012) Currency=ZAR

Date Closing Price Rating Price Target

18-Apr-2012 23.17 27.00

22-Nov-2011 29.06 32.00

30-Sep-2011 32.03 36.00

Closing PriceTarget PriceRating Change

Jul- 09 Jan- 10 Jul- 10 Jan- 11 Jul- 11 Jan- 1215

20

25

30

35

40

45

50

14-Sep-2011 33.60 3-Underweight 37.00

Link to Barclays Live for interactive charting

Barclays Bank PLC and/or an affiliate has received compensation for investment banking services from Telkom in the past 12 months.

Barclays Bank PLC and/or an affiliate beneficially owned 1% or more of a class of equity securities of Telkom as of the end of the month prior tothe research report's issuance.

Barclays Bank PLC and/or an affiliate trades regularly in the securities of Telkom.

Barclays Bank PLC and/or an affiliate has received non-investment banking related compensation from Telkom within the past 12 months.

Telkom is, or during the past 12 months has been, an investment banking client of Barclays Bank PLC and/or an affiliate.

Telkom is, or during the past 12 months has been, a non-investment banking client (securities related services) of Barclays Bank PLC and/or anaffiliate.

Valuation Methodology: We use a DCF and multiples-based SOTP to derive our price target. Our South African WACC is consistent with thoseused for Vodacom and MTN. We apply a perpetual growth rate of -1% in the terminal year.

Risks which May Impede the Achievement of the Barclays Research Price Target: Telkom is encumbered with high exposure to legacy telecommunications services. The Group earns more than 60% of group revenues from fixed access and calls. The company is addressing thisstructural challenge by investing in corporate data services and mobile. Both of these markets present challenges. As such, we believe that costflexibility is key to de-risking the investment case.

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CEEMEA Telecom Services (Cont'd) Maurice Patrick Michael Bishop Roman Arbuzov +44 (0)20 3134 3622 +44 (0)20 3134 5626 +44 (0)20 7773 1320 [email protected] [email protected] [email protected] Barclays, London Barclays, London Barclays, London

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