Telkom faces huge loss

Pending legal action against Telkom could see the company's recent profit turn into a loss of more than R1 billion.

This will place even more pressure on the company, which is battling to keep its head above water.

Telkom is being sued by Phuthuma Networks for damages of R3.7 billion, or an alternative claim of R5.5 billion and another alternate claim of R1.8 billion, over a tender that was not awarded. The companies are set to square off next February, when the matter will be heard by the North Gauteng High Court in Pretoria.

Analysts say if Telkom loses in court, or has to restate its financials to allow for a contingent liability which it had not done in the year to March, its net profit could be wiped out and replaced with a loss.

The lawsuit is the latest issue to hit the operator, which recently lost both its CEO and CFO weeks after several top managers elected to take a retrenchment package. In addition, Telkom has to pay out R605.5 million after a nine-year-old breach of contract dispute with US-based Telcordia was finally settled.

Phuthuma initially claimed damages of R1.5 billion, or alternatively R3.8 billion and another alternative amount of R496 million and interest at 15.5% a year dating back to April 2008, Telkom notes. However, on Friday, the fixed-line operator told the market that the claim was increased by Phuthuma during November last year.

In a Stock Exchange News Service announcement, Telkom says, after publication of its results in June, “it has come to Telkom's attention that there was an inaccurate reflection of the amounts being disclosed with regards to Phuthuma's claim”.

As a result, the company needed to withdraw and correct its financials to reflect the correct situation. Auditor firm Ernst & Young has issued an emphasis of matter “due to the fact that [it] believed the inaccurate reflection to be material,” says Telkom in its announcement.

Phuthuma Networks is suing Telkom over a tender published in November 2007 for the outsourcing of Telkom's Telex and Gentex Services, and to provide a solution to support its maritime industry requirements, the fixed-line operator says.

Telkom cancelled the tender last June without awarding it, as the validity period of 180 days had lapsed. The company says it is defending the action, which is set to go to court on 17 February.

However, Phuthuma has also lodged a claim with the Independent Communications Authority of SA over an alleged contravention of the Preferential Procurement Framework Act and the Broad-Based Black Economic Empowerment Act, Telkom says.

In addition, Phuthuma has filed a complaint against Telkom at the Competition Commission around a contravention of the Competition Act and the JSE. Telkom told the market that the commission had decided not to refer the complaint to the Competition Tribunal, which is the higher body.

Telkom's most recent results for the year to March showed all but flat revenue growth, as turnover increased 0.7% to R37 billion, and reported headline earnings fell from R3 billion last year to R236 million this year after cash-generative Vodacom was spun out of the group.

In addition, Telkom's operations are not generating cash. The company reported negative cash from operations of R3.3 billion, although it had R3.793 billion in the bank at the end of the year.

Chris Gilmour, Absa Investments analyst, says the potential award against Telkom needs to be viewed against the company's reported headline earnings line, as its profits were inflated by a once-off gain on the sale of Vodacom.

If Phuthuma were successful in its claim, it would add insult to injury considering Telkom's already bad financial results, says Gilmour.

“The fact that the previous report has been withdrawn indicates that the auditors are saying there is something here. While we cannot speculate on the outcome of proceedings, the hefty increase in the claim will have a great impact on the fixed-line operator's financial standing,” he notes.

Frost & Sullivan ICT industry analyst Spiwe Chireka says a successful claim has the potential to put Telkom's profit into the red. Chireka believes Telkom would not be able to pay the full amount once-off, and would have to negotiate that the claim be paid off over time or defer the settlement to the next financial year. Either way, it would spell disaster for Telkom, she notes.

Denis Smit, MD of BMI-TechKnowledge, says if Telkom has no allowed for an award against it, its profit could turn into a loss.

He says the fact that Telkom has not made a provision indicates it believes the claim is spurious. However, the court could rule against Telkom, which may result in a huge bottom line loss.

Smit says while Telkom is a large company and can carry a loss, shareholders would be “very upset”.

Telkom refused to comment on the impact a loss in court could have on its financials, and did not clarify why it had not made a provision for an award in Phuthuma's favour. Phuthuma was not contactable as it has neither a Web site, nor a directory listing.