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Can TalkTalk turn things around?

By Gary Newman | Monday 12 February 2018

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

TalkTalk Telecom Group (TALK) has been having a torrid time recently and has pretty much seen its share price halved since the start of November. It has posted some disappointing results, and given that the slide in share price started just prior to the release of the interims around three months ago, it would seem that such figures weren’t entirely unexpected.

Currently the company doesn’t look in great shape, but I don’t think that is terminal and can see it turning things around long term - and the directors of the company would seem to agree, given the amounts of money that they have just invested, and in particular executive chairman Charles Dunstone who has taken an additional 32.7 million shares at a price of 107p in the recent placing – although that did still see his holding diluted from 30.77% to 28.51%, it was a significant amount to have contributed.

Unfortunately though the placing has come about as a result of the amount of debt that the company had on its balance sheet and the proceeds are being used to strengthen that, rather than to invest in the growth of the business. Part of the reason for the problems that TalkTalk now finds itself in would seem to be its dividend payments and the fact that they have exceeded the profitability of the company. For instance, during 2014, 2015 and 2016, dividend cover stood at just 0.57, 0.59 and 0.53 respectively, and for the year ending March 2017 it only just about covered it from its net profit with a ratio of 1.02.

This situation was unsustainable, and the dividend has now been temporarily slashed to 2.5p per annum, from 7.5p previously, and will only return to the historical level once leverage is reduced to 2x EBITDA – although I would argue that unless the profitability of the business has improved dramatically by then, that may not be the wisest move. I am all for returning profits to shareholders, but not at the expense of having access to the capital needed in order to provide further growth.

The company has actually been rapidly adding to its customer base, with at least 150,000 new ones being expected by the end of its current financial year (up until March 31 2018), and although that may sound great news, it all comes at a cost.

Adding those extra customers and giving them the incentive to switch, over and above what the company had been expecting, may have helped to contribute to a 1% rise in revenue for Q3, but it also means that EBITDA guidance for the year has been slashed to just £230 to £245 million, from the previous forecast of £270 to £300 million. Given this cost, it now needs to show that churn rates can be kept low, otherwise this customer acquisition cost won’t be worthwhile – latest figures show that churn for Q3 2018 did reduce by a fair bit to 1.3% though, as compared to the same quarter the previous year.

On a positive note though, the company showed just how serious it is in taking on the big players like BT Openreach, when it signed an agreement with M&G’s Infracapital arm to form a new company, which will be 80% funded by Infracapital and 20% by TalkTalk, to provide full fibre broadband to more than 3 million homes and businesses across the UK.

It is planned that there will be a £500 million equity investment in the new company - £100 million coming from TalkTalk – and this will enable it to secure around £1.5 billion in total investment, via debt. The move, which would see TalkTalk as the founding wholesale customer of the new fibre network, has been widely welcomed, including by Culture secretary Matt Hancock.

So whilst results have been disappointing of late, and although the dividend yield still isn’t bad at a little over 2% you wouldn’t be investing in it as an income stock, I can see light at the end of the tunnel. It certainly isn’t without risk if it remains unable to control its balance sheet leverage in a highly competitive market – even though the ridiculously high dividend payments played a big part – but I can see value in this share as a recovery play from the current share price of around 108p, pretty much what the institutions and directors were happy to pay in the placing.

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