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Rating Action:

Moody's downgrades Telkom's rating to Baa2 from Baa1; outlook is stable

16 Dec 2011

London, 16 December 2011 -- Moody's Investors Service has today downgraded the senior unsecured issuer rating of Telkom SA Ltd. ("Telkom") to Baa2 from Baa1 and the national scale long-term issuer rating to A2.za from A1.za. The outlook on these ratings is stable. This action concludes Moody's review for downgrade initiated on 30 June 2011.

RATINGS RATIONALE

"The one-notch downgrade reflects Telkom's difficulties and delays experienced so far in stabilising its business as part of its focus towards expanding as an integrated telecommunications service provider, as evidenced by its weaker operating performance over the past 12-18 months, leading to a declining operating margin trend," explained Moody's Vice-President Senior Analyst, Soummo Mukherjee. "The downgrade also considers the significant execution challenges ahead to improve customer service and successfully grow its mobile and broadband operations while stemming the losses from its traditional fixed-line business while facing intensifying competition in a four player mobile market," added Mukherjee.

Telkom's operating margins as adjusted by Moody's have steadily declined from 28.2% in FY07, when it still had its stake in Vodacom, to its current 8.2% for the last twelve months ended on 30 September, 2011. The company, however, has cut total adjusted debt significantly from ZAR 22.5 billion in FY09 to ZAR 11.6 billion at the end of September 2011. Consequently, credit metrics have improved and remained strong for Baa rating category with leverage, as measured by Debt to EBITDA, at 1.4x, Retained Cash Flow to Total Debt of 54% and Free Cash Flow to Net Debt of 31% for the last twelve months ended in 30 September, 2011. The company's relatively strong credit metrics combined with its solid liquidity profile were critical to avoid a downgrade by more than one notch or for the outlook to remain stable. Free cash flow, however, is likely to be weaker going forward due to the company's planned investment programme and mobile roll out.

As of 31st of March, 2011, Telkom was 39.8% owned by the South African Government, 10.9% by PIC, 2% in treasury shares and the remaining 47.3% free float. Given Telkom's 39.8% ownership by the South African government (rated A3 with a negative outlook), Moody's Global Scale Rating of Baa2 and National Scale Rating of A2.za for Telkom reflect the application of Moody's rating methodology for government-related issuers ("GRIs") that take into account Telkom's strategic importance to the South African economy, resulting in Moody's assessment of high dependence and strong support from the South African government, which still award the company a one-notch uplift from its baseline credit assessment ("BCA") of Baa3.

Telkom's BCA of Baa3 factors Moody's expectation that Telkom will remain a leading telecommunications operator, with a leading market position in South Africa's fixed-line business and a growing presence in broadband and mobile offerings. However, the rating also incorporates Telkom's significant execution challenges to deploy its 8ta offering and stabilise its operating margins through the successful of its strategies towards information communication technology (ICT) growth for its business customers, customer service improvement and network upgrade for its improved bundled offerings. The current rating is based on the company's low leverage and overall strong credit metrics for the rating category which offsets to some degree the company's operating and competitive challenges and higher capital investment requirements to deliver on its key strategies for the upcoming years.

On 12 December, 2011, Telkom announced that it has entered into a memorandum of understanding (MOU) with South Korea-based, KT Corporation ("KT", rated A3/stable), to hold exclusive talks on a strategic partnership. The MOU provides for an exclusive period of engagement and information exchange to enable the companies to confirm the areas of mutual strategic and business cooperation and envisaged benefits of the venture. The companies announced in October that they were in talks for KT to acquire a 20 percent stake in the post-issue ordinary share capital of Telkom, equivalent to an approximate amount of ZAR 4.6 billion. Telkom advised shareholders that it will provide an update of the review with KT in six weeks time. Other pre-conditions for the transaction include: 1) conclusion of the requisite transaction agreements to the satisfaction of both Telkom and KT; 2) endorsement by Telkom's major shareholders; 3) prior consultation with the financial surveillance department of the South African Reserve Bank.

"If concluded, we view this transaction as credit supportive for Telkom due not only to the proceeds received that can be used to accelerate Telkom's key strategic project, but also due to the expected transfer of technologies given KT's experience as a successful integrated operator in South Korea," explained Mukherjee.

The stable outlook assumes that Telkom will not face significant delays or challenges to execute on its key strategies to stabilise its business and gain steady market share in its mobile offering. The stable outlook further assumes that leverage will not increase materially from current levels and liquidity will remain strong at all times.

Upward pressure on Telkom's BCA is not likely in the short-term as it will require successful stabilisation of its operating margins, which is only likely after it has demonstrated that its mobile business has reached break-even and the company's consolidated EBITDA margin is on an improving trajectory towards 30% on an adjusted basis.

Negative pressure on Telkom's rating or outlook will be prompted by higher than expected competitive threats or execution challenges in its mobile offering or bundled services that leads towards further operating margin declines. Quantitatatively negative pressure is likely if EBITDA margin falls and is sustained below 20% and/or if leverage, as measured by Debt to EBITDA increases towards 2.5 times. Negative pressure would also arise if the company sustained Retained Cash Flow to Total Debt below 25% (currently above 50%) due to higher debt levels or dividend distribution.

The principal methodology used in rating Telkom SA Ltd was the Global Telecommunications Industry Methodology published in December 2010 and Government-Related Issuers: Methodology Update published in July 2010. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

Moody's National Scale Ratings (NSRs) are intended as relative measures of creditworthiness among debt issues and issuers within a country, enabling market participants to better differentiate relative risks. NSRs differ from Moody's global scale ratings in that they are not globally comparable with the full universe of Moody's rated entities, but only with NSRs for other rated debt issues and issuers within the same country. NSRs are designated by a ".nn" country modifier signifying the relevant country, as in ".mx" for Mexico. For further information on Moody's approach to national scale ratings, please refer to Moody's Rating Implementation Guidance published in March 2011 entitled "Mapping Moody's National Scale Ratings to Global Scale Ratings".

Telkom SA Limited is a JSE-listed, dominant South African integrated telecommunications operator with consolidated operating revenue of ZAR32.2 billion (approx. USD 4.2 billion) for the last twelve months ended 30 September 2011.

The Local Market analyst for this rating is Dion Bate, 27-11-217-5472.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides relevant regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides relevant regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides relevant regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

The rating has been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

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Moody's adopts all necessary measures so that the information it uses in assigning a rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Moody's Investors Service may have provided Ancillary or Other Permissible Service(s) to the rated entity or its related third parties within the two years preceding the credit rating action. Please see the special report "Ancillary or other permissible services provided to entities rated by MIS's EU credit rating agencies" on the ratings disclosure page on our website www.moodys.com for further information.

Please see the ratings disclosure page on www.moodys.com for general disclosure on potential conflicts of interests.

Please see the ratings disclosure page on www.moodys.com for information on (A) MCO's major shareholders (above 5%) and for (B) further information regarding certain affiliations that may exist between directors of MCO and rated entities as well as (C) the names of entities that hold ratings from MIS that have also publicly reported to the SEC an ownership interest in MCO of more than 5%. A member of the board of directors of this rated entity may also be a member of the board of directors of a shareholder of Moody's Corporation; however, Moody's has not independently verified this matter.

Please see Moody's Rating Symbols and Definitions on the Rating Process page on www.moodys.com for further information on the meaning of each rating category and the definition of default and recovery.

Please see ratings tab on the issuer/entity page on www.moodys.com for the last rating action and the rating history.

The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Soummo Mukherjee
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Services Limited, Dubai Branch
Gate Precinct 3, Level 3
P.O. Box 506845
DIFC - Dubai
UAE
Telephone: 00971 4237 9536

David G. Staples
MD - Corporate Finance
Corporate Finance Group
Telephone: 00971 4237 9536

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Moody's downgrades Telkom's rating to Baa2 from Baa1; outlook is stable
No Related Data.
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