UPDATE TalkTalk shares surge after dividend hike

Updated 1100 GMT, Wednesday 11th November 2015

Dividend undefeated

TalkTalk stock’s surge of more than 10% early on Wednesday came as a surprise to some in The City, if not all.

Our preview article below outlined why we thought it was time for a strong bounce, despite the deep mess the company undoubtedly remains in.

TalkTalk trumped quite a few dire expectations with first-half results.

A widely feared dividend cut (again, not our base case, see below) failed to materialise.

In fact the interim dividend was raised 15% to 5.29p, in line with guidance.

Revenues of £912m also edged ahead of the £908m most analysts were expecting, on average, according to Thomson Reuters.

TalkTalk was also keen to point out that sales accelerated even faster in its second quarter, rising 5.9% compared with 4.7% in H1.

Disconnect

Perhaps predictably though, the company’s assessment of the “one-off financial impact” from its most recent cyber-attack was less credible.

It forecasts a hit of just £30m-£35m.

This is very likely to be net of legal costs and damages or even official penalties.

A conference call with CEO Dido Harding later confirmed the estimate excluded potential long-term impact from weaker customer additions.

Or even net customer attritions: TalkTalk’s broadband base fell 80,000 in H1.

However the cause for that decline was blurred by the company stating it had changed its disconnection policy for non-payers to terminating their services after 90 days instead of 180 days before.

Still, “underlying on-net adds” fell 8,000 in the half, said the 12-year old company, even if mobile, fibre and TV-only additions were 132,000, 99,000 and 25,000 respectively.

“We obviously saw an immediate bounce in customers wishing to cancel their direct debits and to churn, but we saw those leading indicators come back down quite quickly,” Harding said in an interview on Wednesday.

A survey of customers in the wake of the cyber-attack revealed that 54% would continue subscribing, she noted.

Obviously, it would be interesting to know the results of a similar survey taken before the cyber-attacks emerged.

Also, the tally of subscribers that would leave TalkTalk was still an uncomfortable 46%.

‘Step-Up’

The CEO, who is under considerable public pressure, was also optimistic on the earnings outlook.

She saw a “material step-up in EBITDA” in the second half, as TalkTalk’s efforts to scale its enterprise business (19% of total revenue) gain traction, introductory mobile offers expire and cost savings take effect.

TalkTalk remained on track to deliver FY’16 results in line with pre-cyber-attack market expectations, the company said.

Core earnings, however, fell 18% to £90m.

And there was a pre-tax loss of £8m for the six months to 30th September, compared with profit of £20m the year before.

Without one-off factors, there would have been a pre-tax profit of £14m, though that would be sharply lower than £34m in H1 2014.

Overall, notwithstanding, pre-existing challenges, it looks doubtful its prospects for the full-year and beyond have materially improved.

The cyber-attack impact is of course the big unknown.

We stick with the medium-term outlook for the stock outlined in the article below.

On an intraday technical basis, after an early sharp jump of more than 12%, the stock remained strong as this update was about to go online.

However the pull of the powerful 61.8% retracement of 3rd November-10th November slide, combined with the 100-hourly trend were at risk of triggering the relapse we forecasted below.

An 18 pence gap between 216p-234p from Tuesday is another risk.

Topside, in view of precarious news flow, and continued shorting pressure on the shares, recent highs (including last week’s at 258p) should cap the stock for the medium term.

HOURLY CHART

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Published on Tuesday 10th November 2015

• Stalked by two well-known hedge funds since October
• TalkTalk has refused to accept liability for hacking that goes back years
• Customer problem
• No signs of ‘distress’
• Shares should bounce

Notorious hedgers

TalkTalk said last week far fewer customer details were accessed by hackers in a recent cyber attack than initially thought.

But any hopes the news might put a floor under the mid-cap telecom’s shares—ahead of interim results on 11th November— were dashed after it emerged two notorious City short sellers had taken massive bets against a rebound.

Hedge funds Odey Asset Management and Eminence Capital LP have been selling borrowed TT stock at least since the week beginning 12th October.

This means Odey and Eminence ought to have profited from the near 34% drop by the stock since then.

FCA data shows Odey gradually increased its short, with a position that was 1.3% of TalkTalk’s total outstanding stock by the end of that week, rising to 1.7% in the week ending 23rd October.

The latest information (from 5th November) shows Odey trimmed its position by the equivalent of 0.06% of the float to 1.65%, whilst Eminence dialled its short about 10 basis points higher to 1.9%.

For reference, 1% of the company’s outstanding stock equals 5,113,200 shares.

The pair remained responsible for the total 3.55% disclosed aggregate short in the name at last tally.

TalkTalk shares were not the most ‘borrowed’ on the London Stock Exchange.

However,  that Odey and Eminence recently judged risks/rewards still justified staying short despite the stock’s deep loss in recent weeks, should worry its execs and investors.

It’s not difficult to see why shorters have scented blood.

Poor choices

Talktalk has now gone beyond accusations that it offers among the worst standards of customer service in the telecom world and a USP which rests largely on being relatively inexpensive.

The broadband provider should now be deemed a poorer choice for consumers because it has repeatedly placed their data at risk.

In recent days, evidence has emerged that data breaches probably brought about by TalkTalk negligence or incompetence go back to at least 2013.

Despite repeated instances of proven or suspected fraud against customers whose data was breached, TalkTalk has established a pattern of refusing to accept liability—something which has stirred sufficient ire among some victims to bring a ‘class action’ against the firm.

Unfortunately going to law might be the only remedy which works against the firm: some customers who lost thousands of pounds after a cyber-attack in November 2014 are still fighting for compensation.

The UK Information Commissioner’s Office continues to investigate the November 2014 breach—which the company only warned customers about by email—and others.

The ICO could eventually rule that TalkTalk breached the Data Protection Act by negligence, potentially triggering millions in penalties.

Additionally, the government’s Culture, Media and Sport Committee last week announced an inquiry into the circumstances surrounding the latest cyber-attack.

It aims to investigate the robustness of systems telecoms have in place to prevent infiltration.

Experts have said the TalkTalk hacks were not particularly sophisticated, raising questions about how strong the firm’s security was, especially as the latest attack was the third such incident to hit the firm this year.

Senior TalkTalk executives like Chairman Charles Dunstone and CEO Dido Harding could be called to give evidence at committee hearings that could take place this month.

Parliamentary committee hearings have a gained a reputation of embarrassing senior business figures in recent years.

Shame and The Law

Near-term opprobrium and medium-to-long-term risk of legal action will be the main weights on TalkTalk stock for the foreseeable future.

How has the firm stumbled into these ‘schoolboy errors’?

There’s no lack of corporate heavyweights on TalkTalk’s board, not least Carphone Warehouse founder Charles Dunstone, former Sony boss Sir Howard Stringer, and Non-Executive Vice Chairman John Gildersleeve.

The board is also well-resourced with experience in direct customer facing-rough and tumble: Dunstone again, CEO Diana Harding, and former Carphone Warehouse exec Tristia Harrison, now TalkTalk’s consumer MD.

However, there are no names on the doors of the ‘C-Suite’ with particular instincts or experience that may be sensitised to 21st Century security concerns.

The lack of a Chief Operating Officer might also be relevant.

By default or design, TalkTalk has opted to rely instead on first-time CEO Dido Harding to both run the show, and take complete responsibility for backstage too.

Despite undoubtedly highly refined retailing experience gained from senior roles at several high street names, Harding’s most senior managerial position before her current job was as Sainsbury’s Convenience Director.

It would be foolish to suggest Harding were not capable—in the last quarter of 2014, she led the firm to its fastest quarterly revenue growth (+6%) and slowest annual churn.

True, reining in churn risk resulted in highly-prized net new TV additions slumping to 82,000 in Q4 vs. 115,000 in Q3, but the benefits of ‘stickier’ customers are obvious and the strategy remains sound for the longer term.

However, that someone or something that might have forestalled recent consumer protection failures and the public relations disasters that followed, is clearly missing from TalkTalk.

Lightweight, heavy attitude

Whilst the perception of ‘light weight’ management exposed by the company’s debacle can be fixed fairly easily by executive additions, TalkTalk’s deeply damaged reputation will take far longer.

The company has insisted that only customers who can demonstrate they’ve lost money “as a direct result of the cyber-attack” can break their 12-18 month contracts without paying a fee.

TalkTalk’s fear of a mass exodus is probably well-founded, but potential new customers now have another reason to think twice about choosing its services.

That will place further pressure on its crucial customer additions.

At the same time, much larger rivals, BT and Sky, reported 82,000 and 133,000 new broadband subscribers respectively in their most recent quarters.

They’ve also cut broadband prices, just as TalkTalk raised its own by as much as 50%.

TalkTalk is forecast to have lost as many as 60,000 customers in the first half of the year.

Continuing its strategy of reducing churn combined with selective offers could, eventually, stem the customer decline, but what about net customer additions?

Unfortunately, there is an air of inevitability about potential consequences from TalkTalk’s serious mis-steps for its CEO.

However, Harding has so far shown little inclination to go quickly.

That is probably the principal point which short sellers have focused on.

Still, shorting the stock into TalkTalk’s results on Wednesday is not without risk, particularly after its fall so far this year.

Also, whilst the press and City have speculated that TalkTalk might scrap its dividend, we see the prospect of that as balanced.

TalkTalk’s finances are sound.

It is nowhere near as leveraged as most of its closest rivals, albeit they are all larger and more diversified.

Its current net debt is about 22% of its total financial assets, compared to 15% at BT and 25% at Vodafone.

TalkTalk’s borrowing is also under control: its principal active loan at the moment is about £560m.

Finally the balance sheet is also healthy: there was no material ‘unrealised’ issue of any kind as of its last full-year results.

Given moderate use of debt compared to peers, and a net interest expense coverage ratio that was a fraction of income in the last full-year, TalkTalk has potential scope to increase borrowing.

Its financing costs are unlikely to be onerous, equating to a synthetic credit ratio of A-, according to Thomson Reuters data.

That would be comfortably within the range of an ‘investment grade’ rating from the biggest agencies.

We therefore see a fair chance TalkTalk can maintain its dividend for 2015.

The payout has latterly been expected at 4.6p for the half-year, with a final one of 9.2p.

Future payments, of course, are far more likely to be at risk.

And the rest of Wednesday’s earnings will also tell a tale of woe.

Key H1 Forecasts

• H1 EBIT: £36.71m, down 23% from £48m in H1 2014
• H1 EBIT margin: 4%, from 5.5% in H1 2014
• H1 Revenue: £908.17m, up 4.3% from £871m in H1 2014
• H1 Underlying Pre-tax Profit:  £24.7m, down 18.5% from £43m in H1 2014

A short rally

Even so, the probable figures by no means show a company falling off a cliff, yet.

For that reason and others, there appears to be more than moderate chance that TalkTalk’s battered shares could bounce in the near-term.

This is especially so given that the shares have recently been trading at a record discount to intrinsic value.

On a technical basis, four-hourly intervals show TalkTalk stock has consolidated over the last few sessions.

This is happening close to the equivalent of 50%, by extension, of the down-leg between 25th September and 26th October.

Descending trends in place since May continue, but have not been broken to the downside.

All this suggests some support at current prices, whilst short-term momentum (see stochastic sub-chart) is rallying sharply after having been oversold.

Divergence of momentum from the underlying price may be less significant in shorter-term time frames, though can still signal that price could soon follow.

Daily and weekly interval chart momentum (not pictured) is still lagging, but close to being oversold, increasing chances of a strong stock price bounce.

The higher-than-average shorting activity in TalkTalk could give a rebound an additional charge.

The first watch on the upside would be above the consolidation zone and a 38.2% marker around 220p.

In the absence of any corporate signal from the firm of the kind outlined above, getting above 227p could still be a stretch.

And if the stock fails to revive—note there’s a sharper descending trend overhead—fresh all-time lows are likely.

FOUR-HOURLY CHART

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