STOP screaming
SOUTH AFRICAN CONSUMERS are set for a bumpy ride over the next few years as a massive shake-out in the telecoms industry takes hold. But if the various players have the guts to follow through with what’s been set in motion, the impact should be overwhelmingly positive for investors and consumers alike.
If industry speculation is to be believed, Telkom is on the verge of selling off the family jewels – with Vodafone taking the 50% of Vodacom it doesn’t already own and MTN buying its fixed-line operations.
An additional complication is likely to be the strong union presence within Telkom, which could cause additional problems, as any attempt to reduce the head count at the provider would be met with strong resistance.
In a statement issued last week, the Communications Workers’ Union – which took its members at Telkom out on strike earlier this year – decried the proposed deal and cautioned against allowing foreign organisations to take over SA telecoms assets. Spokesman Mfanafuthi Sithebe commented that should Telkom be looking to dispose of Vodacom, it should be to an SA stakeholder rather than to Britain’s Vodafone.
Although speculation differs as to what the final outcome will be, there’s consensus that the deal would be huge and extremely complex. And Telkom would become a fundamentally different company to the one we know now. The only sticking point could be price.
Both MTN and Telkom released near simultaneous cautionary announcements – 20 seconds apart, to be exact – on 3 September, saying they’d entered into negotiations that, in each case, could affect the price of their shares. Telkom reiterated that it had been reviewing its mobile strategy and was talking to Vodacom’s joint parent, Vodafone, as well as MTN. But no decisions had yet been reached.
MTN provided only a little more clarity, saying it was talking to Telkom about a transaction involving certain of its assets but that discussions were at a preliminary stage.
Telkom shareholders cracked open the bubbly, adding R4,5bn to the company’s market value in a single day at the prospect that a significant dividend payout could be in the offing.
Meanwhile, MTN shareholders were a little more circumspect at the prospect that their company could pick up some of Telkom’s fixed line assets. MTN’s price fell around 3% (nearly R6bn shaved off the market cap, which is roughly double that of Telkom).
If the looming corporate action reaches what seems like its logical conclusion, then Vodafone would buy Telkom’s 50% stake in Vodacom and MTN would buy some – or all – of Telkom’s fixed-line assets.
However, we wonder why MTN – which has been diversifying away from SA – would want to put more eggs back in the same basket? And given that staff costs are among the highest faced by any telco, it seems unlikely that MTN would want to take on Telkom’s nearly 27 000, largely unionised, workforce (MTN has only 14 000 staff worldwide).
Views on the likelihood of an MTN/Telkom tie-up diverged significantly. But there was little divergence on just how significant an impact this looming corporate action would have on SA’s telecoms landscape.
Renaissance Specialist Fund Managers’ Khulekani Dlamini says: “This is very exciting for the sector.” He adds that while on paper such a transaction makes “absolute sense, in the execution it’s just mired in complexity”. But although complex, it could still be viable.
There’s been market speculation concerning corporate action in the sector for months, with permutations ranging from Telkom buying MTN to MTN buying Telkom and Telkom buying Cell C. It’s possible that many of those options have been explored in early-stage discussions.
However, the arguably seminal cautionary announcements seem to have been spurred on by a Sunday Times report suggesting that concrete offers had changed hands but that the Telkom board advised the parties to raise their price before coming back to the negotiating table.
Dlamini says he thought the parties would have preferred to be further down the line before making any announcements, but it seemed that for the first time negotiations had reached a material stage. He estimates it could take between nine and 12 months before a transaction of this order could be wrapped up in its entirety – taking into account issues such as working through tax matters, securing funding and sorting out the management issues. “It will be quite protracted.”
The biggest issue for Telkom shareholders during that time, says Dlamini, will be to decide at what price they’d be willing to sell or whether to hang on until the transaction’s conclusion. “Because you could wake up one day and the deal’s been called off.”
But warnings aside, Dlamini says the most likely course would be for Vodafone to do “another VenFin” – buying the whole of Telkom and selling off the parts it doesn’t want afterwards (everything but the Vodacom stake).
Vodafone bought VenFin’s 15% stake in Vodacom for R16bn in 2006, implying a value of around R104bn for the whole of Vodacom at that stage. But it structured the deal in such a way that it made an offer of R21bn for VenFin and then spun the surplus assets – valued at R5bn – into a separate company, which now trades over the counter.
The British mobile giant has shown no indication that it would be interested in buying fixed line assets in Africa.
However, Andrew Kingston, of Sanlam Investment Management, says Vodafone has indicated it wants to increase its exposure to mobile in emerging markets. He says the sale of Telkom’s 50% stake in Vodacom to Vodafone is “pretty likely”.
The more interesting permutation is around MTN’s interest in Telkom’s fixed-line assets. Kingston says MTN would be prepared to buy the entire fixed-line business “at a price” but adds it’s probably being a bit opportunistic. He doesn’t believe the Telkom board would be prepared to sell off only a part of the fixed-line assets; rather, it had indicated that it’s looking for a mobile partner.
Although Vodacom CEO Alan Knott-Craig told Finweek earlier this year that the company’s relationship with Telkom had probably never been better, both companies have never been able to realise the fixed/mobile synergies that they arguably should have been able to do (if Vodacom had had a single parent), through cross-selling and having a single billing system.
Kingston says a key issue is whether a transaction between MTN and Telkom would receive regulatory and competition authority approval. But he believes Government’s stated imperative of bringing down prices and enhancing telecoms access might give the deal impetus if MTN were forced to commit to pricing reductions.
Kingston also says President Thabo Mbeki liked a pan-African strategy, and an MTN/Telkom merger could create a significant fixed and mobile player on the continent. “A bigger picture will emerge from this; we’re just not yet sure what that will be.”
Coronation Fund Managers’ Pallavi Ambekar said on 702’s business radio show The World at Six that the possibility of MTN buying Telkom’s fixed-line assets was backed up by a mention from MTN CEO Phuthuma Nhleko at the company’s interim results recently.
Ambekar says if that were the case Telkom shareholders would be likely to get paid out the Vodacom sale proceeds, plus any additional cash, if the company didn’t find anything large enough to invest in outside pay-TV, which Telkom has said would require a maximum investment of R7,5bn.
Regulator Icasa announced the successful pay-TV applicants on 12 September, earlier than the November deadline it had mentioned previously.
However, interestingly Nhleko’s comments at the results are being interpreted in a variety of ways: some say he definitely implied a deal with Telkom. Others disagree, saying he would rather have said a firm “no comment” if there was something on the cards.
Kaplan Equity Analysts’ MD Irnest Kaplan says he doesn’t believe there’s a compelling case for MTN to buy Telkom’s fixed-line assets. He says some parts of Telkom would make sense to MTN, such as the international gateway, the local loop (lines into homes and offices) and some of its wholesale access. But he doesn’t believe that Telkom would make itself available for sale on a piecemeal basis.
If MTN does decide to buy Telkom’s fixed-line assets, Kaplan says he believes the market would punish the company for that, as was evident by the fall in MTN’s share price on its cautionary announcements. Kaplan says while Telkom was a totally different, declining business that offered value mostly because it was a cash cow, MTN currently offered the most direct bet on emerging markets that investors could buy. “I think MTN’s efforts would be better served by focusing on Iran and its other operations. That would drag it down a bit,” Kaplan says.
Valuations touted for Vodacom range from R120bn to as much as R175bn, and from R45bn to as high as R90bn for Telkom’s fixed line assets. Although Vodafone is known to have deep pockets, negotiations are going to be tough if expectations really are so far apart.
The wild cards in this deal are Icasa, the Competition Commission and SA’s unions. Both State entities would have to sign off on any deal, given that it would represent a significant shift in the balance of power in the market. The unions, in turn, would rightly be concerned about any structural change inside Telkom.
The most difficult hurdle would be, says Africa Analysis’ André Wills, the Competition Commission. He says that given the already high levels of concentration in the telecoms market the commission would be looking very carefully at the level of market power a combined MTN/Telkom would have.
Richard Hurst, a telecoms analyst at BMI-T, adds that the lessons learned from the commission rejecting the Telkom/BCX deal indicates that there would need to be a compelling argument in favour of the deal to get it past the watchdog.
Icasa would be less of a concern, primarily because by the time any deal gets past the commission, the licensing regime would have changed, enabling MTN to provide the same service that Telkom currently offers. And given the large shareholding that Government has in Telkom, it’s unlikely the deal would happen without Government approval and any regulatory issues would probably be smoothed over by the Communications Department.
However, the unions are likely to resist. Wills says that Telkom’s workforce is heavily unionised with the Communication Workers’ Union and Solidarity both having strong presences inside the operator. While that wouldn’t affect the sale of Vodacom it would be a real consideration, as splitting the fixed-line operations would dilute the ability of the unions to operate in the sector. It would also remain to be seen how MTN would react to inheriting a highly unionised workforce should it acquire the fixed-line operations of Telkom.
That just adds to the considerable culture clash that would occur should an MTN/Telkom deal happen. Hurst says the corporate cultures of the two organisations couldn’t be more different, with MTN pursuing an aggressive expansionist strategy while Telkom has been fighting a rearguard action to protect its existing business.
Who wants what
WHILE THE DETAIL concerning the latter part of the transaction remains highly speculative, what we do know is the following:
MTN
MTN wants to reduce the cost of its transmission infrastructure and penetrate the corporate market in South Africa more deeply. It’s spent between R8m and R10m on a fibre optic trial between Sandton and Rosebank, north of Johannesburg.
Members of MTN’s management are considered smooth operators and known to not unnecessarily pay over the top for assets. The group continues to be on the lookout for further acquisition opportunities.
MTN has been diversifying its revenue base away from SA, aiming for a third/third split between each of its three key regions: South and East Africa, West and Central Africa and the Middle East and North Africa (the latter should grow as its Iran penetration deepens).
Telkom
TELKOM has spoken for some time about a possible wholesale/retail split, although it’s been unclear what form that would take. The group has yet to appoint a new permanent CEO, despite the position being filled by Reuben September in an acting capacity for months. Could that be in acknowledgement that Telkom could soon look very different from now?
The Competition Tribunal’s blocking of Telkom’s buying Business Connexion signalled a crackdown on monopolistic practices in SA’s ICT sector. It would likely only support competition-enhancing transactions from here on.
Government has no intention of divesting its investment in telecoms infrastructure. But would it be willing to exchange its Telkom stake for something that spurred on price cuts and unlocked value?
What finweek would like to see:
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Telkom sells its Vodacom stake to Vodafone, pocketing roughly R75bn – average valuation. That’s paid out to shareholders (amounting to around R13/share, but probably less after tax leakage, according to Renaissance Specialist Fund Managers’ Khulekani Dlamini).
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It sells all its transmission and corporate clients to MTN. That wouldn’t only give MTN the lion’s share of the corporate market but also preferential access to the SAT-3 undersea cable. Considering that MTN has operations in a number of countries where the SAT-3 cable lands, preferential access to it could have a positive spin-off for more than just the SA operations.
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Telkom is left with Telkom Internet, Telkom Media and the retail business, as well as the local loop infrastructure.
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It then spins off all the local loop assets into a new company and repositions itself as a super media and connectivity company, providing bundled voice (fixed and wireless), broadband and television over various platforms, including satellite, broadband and mobile.
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Telkom keeps the cash it needs to grow and pays the rest out in the form of an additional dividend to shareholders.
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The local loop capacity is sold by a newly formed company (owned by the private or public sector, but heavily regulated by Icasa) at more market-related rates and the entire country benefits. President Thabo Mbeki identified the local loop at the recent presidential IT advisory council meeting as an area of telecoms that needed to be freed as quickly as possible.
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While some analysts are predicting that the local loop will only be partially unbundled – with only Telkom and Neotel given access to the infrastructure – in our model that infrastructure would be opened up for any licensed service providers to use. (The local loop includes the entire telecoms infrastructure from the local exchange to the client, including the exchange itself.)
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British Telecom spun off its local loop infrastructure into a separate subsidiary, which is heavily regulated to ensure that all players have equitable access. The benefit is that the new company would also absorb a significant number of Telkom staff – all those responsible for the installation and maintenance of the infrastructure.
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Government swaps its stake in Telkom for a smaller share in MTN or, more optimally, agrees to concentrate its efforts in the infrastructure space, on Infraco, and accepts a dividend windfall that goes down well with Trevor Manuel.
Finweek
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