Talktalk hits new low as analysts clash, institutions 'revolt'

Talktalk's profit warning and proposed placing elicited a mixed reaction among City analysts and institutional investors, with Goldman Sachs unimpressed and reiterating its 'sell' recommendation, while RBC Capital Markets hoped this was the beginning of a new era.

TalkTalk shares tumbled for a second day on Friday, the day after the telecoms group cut its dividend, reduced earnings guidance and asked shareholders for £200m to strengthen its balance sheet and invest in a big new fibre-to-the-home (FTTH) broadband project.

Talktalk shares were down another 3% on Friday to 105p, making it around a 14% fall for the week and almost 30% in 2018 so far and 70% from 2015's high above 400p. Stories of a shareholder "revolt" over its fundraising were not helping, with the Times reporting that at least one heavyweight shareholder had called for the telecoms company not to go ahead with the fundraising as a row apparently erupted over whether existing investors were being unfairly treated.

Talktalk boss Charles Dunstone and corporate advisers Barclays and Deutsche Bank were "flouting one of the sacred tenets of City behaviour", the newspaper said, by failing to give existing shareholders first option of buying new shares on offer, known in the Square Mile as pre-emption rights.

The FTSE 250 telecoms group also said it would cut the annual dividend “temporarily” to 2.5p a share after previously steering investors towards a 7.5p payout. TalkTalk also cut its guidance for 2018 adjusted earnings to £230-245m, down from November's guidance for at least £270m.

"The natural question is – is this the end of the profit warning series?" wondered RBC. "We believe it is."

Seeing the main drivers of falling profitability over the last couple of years as being higher subscribers and therefore acquisition costs, lower average revenue per user and higher fibre costs due to higher take-up than anticipated, RBC sees these issues as melting away. "The subs trajectory is clearer, ARPU stabilising and fibre take-up known, profitability should be more stable."

Analysts added that, while it may be "tempting to give up" on Talktalk following the succession of profit warnings, "we feel this would be the wrong course of action. We believe profitability should start to inflect with the higher sub base and stabilised ARPU."

Having upgraded TALK to 'outperform' at the start of the month, RBC said price regulation of 40Mbps fibre should save the company up to £50m per year by 2021, while there are "margin incentives" to offer Openreach wholesale G.Fast services and invest in FTTH.

Valuing the company's business-to-business unit at circa £500m and the consumer business at £1.3bn, or just £330 per subscriber, RBC added that with three mobile-only networks in a rapidly converging UK market, independent Talktalk's 15% market share "may look tempting to a strategic bidder".

But for Goldman, while TALK has returned to subscriber growth the negative of continued downgrades in profits comes as the company "has not shown evidence of lower subscriber acquisition costs as it drives more scale".

The placing of new equity does bring some near-term balance sheet relief, but Goldman's analysts estimated that given continued cash outflows n 2018 and 2019, debt will only fall to circa 2.8 times earnings before interest, tax and exceptionals by the end of the 2019 financial year versus its prior estimate of 3.2x before the placing was announced.

EBITDA growth guidance for FY19 continues to be reliant on FTTC wholesale price cuts by Ofcom and cost cutting, Goldman said, "with limited evidence to date".

The analysts reiterated the 'sell' and, given that the valuation remains "relatively expensive in our view", cut its 12-month target price to 100p from 130p.