Telkom Turmoil
Imagine getting one account at the end of each month that consolidates what you owe for your cellphone calls, your landline calls, your broadband connection and your pay-TV service.
It’s the Holy Grail of telecommunications, one that has already been forced on operators in developed markets because of rising competitive pressure, and it’s a vision that will drive a radical restructuring of SA’s telecom industry.
As voice telephony becomes little more than a low-margin, even a zero-margin, commodity, telecom companies need to expand into new business areas to stay profitable. Voice will become little more than an application in a broad range of multimedia services offered to you by telephone companies.
The more services they are able to sell to you, the more profitable you become to them. In turn, they’re able to offer you discounts to entice you to buy more services from them. Interested in their pay-TV offering? Sign up for it and they might give you a discount on that broadband connection, or free call minutes to use on your cellphone to keep you sweet.
That is a scenario that SA consumers can expect within the next five years. But to do it, much corporate action and change has to take place across the industry. What looks set to accelerate developments is the unravelling of Telkom and the rapid growth in the number of operators able to supply telecom services. Telkom is set to become just another player among many — if it’s not snapped up by MTN to become the cellular operator’s local fixed-line arm — rather than the industry bully it has been until now.
Telkom’s decline was in full evidence at this week’s interim results announcement. It reported a 15,1% decrease in headline earnings per share. The fall came in spite of another robust performance by 50%-held associate company, cellular network operator Vodacom.
The poor performance was all in its fixed-line business. Net profit from fixed lines plunged a precipitous 46,6% to R2,6bn and fixed-line operating profit fell 19,4% to R4,3bn. Fixed-line call volumes also fell sharply, down 9,6%, with local call volumes tumbling 22,3%, reflecting a move away from dial-up Internet access to broadband.
Management blames the poor performance on an increase in capital expenditure and the bundling of voice and data services — at discounted rates — through its Closer calling plans. Financial performance was adversely affected by new regulations, increased competition from mobile operators and Internet service providers, as well as a sharp rise in copper cable theft.
But is there more to the problems than the telecom group is letting on?
It has been without a full-time CEO since April, when Papi Molotsane, who lacked telecom industry experience, was forced out after only 18 months in the job. And reports this week suggest that President Thabo Mbeki has intervened to prevent acting CEO Reuben September from being appointed to the position permanently, fuelling uncertainty in the business. The group lacks a number of other full-time executive staff, including a chief financial officer.
Analysts say they are not surprised by the numbers, especially after the company issued a profit warning this month. They say the decline in profitability in the fixed-line business is inevitable and think Telkom will see more pain as competition intensifies in the next few years. They say the company is simply starting to go through the same pressures its peers in developed markets have been enduring for the past decade.
But others express concern that at least some of the poor performance may be attributable to management taking its eye off the ball at a crucial time.
September denies that Telkom management has lost focus. He says the company is making the necessary investments in areas such as customer service and the expansion of its network to ensure that it can prosper into the future. It has to endure pain in the short term so it can reap long-term rewards. “We have not taken our eye off the ball. But can we improve? Absolutely.”
Acting chief financial officer Deon Fredericks says it’s important to note that when SBC (now AT&T) of the US was an 18% shareholder in Telkom, the group neglected important areas of its business, such as customer service and investment in infrastructure. This enabled it to increase the margin on its earnings before tax, interest, depreciation and amortisation (Ebitda) to almost 45%, a level that management now says is unsustainable. Telkom expects Ebitda margin to be slightly above 37% for the 2008 financial year, which, arguably, is still a respectable level for a fixed-line operator.
To be sure, Telkom is not having the jolly time it had a few years ago, when it was able to slash costs and hike prices indiscriminately and watch the profits flow. “The low-hanging fruit doesn’t grow back,” September says.
Telkom is already starting to feel the effects of a competitive market, even though its new rivals are barely out of the starting blocks. It has lost several big contracts in recent months that previously it would have won by default thanks to its protected monopoly status. In May, Neotel, its new rival in fixed telecoms, secured a five-year, R700m contract from the State IT Agency (Sita) to provide telecom services to government departments. And, more recently, Neotel and Dimension Data division Internet Solutions (IS) jointly secured a two-year, R192m contract to supply bandwidth and network services to SA universities and research institutions.
But this loss of business may be just the start of bigger problems to come. Telkom may be headed into a perfect storm of bad news — with no option of changing course. A new regulatory and policy environment, which will result in a radical liberalisation of the telecom sector, is going to make it much more difficult for it to retain the kind of earnings it has enjoyed. It may be many years before the group is again able to rake in the more than R20bn in Ebitda it did in its 2006 financial year — if, indeed, this ever happens.
The root of Telkom’s problems lies in a two-year-old piece of legislation known as the Electronic Communications Act (ECA). Whereas this law’s predecessor, the Telecommunications Act, was written with the protection of Telkom’s monopoly in mind, the ECA provides for the introduction of competition at all levels of the industry and the convergence of broadcasting and telecoms. Under the ECA, no-one enjoys special protection.
Industry executives polled by the FM agree that the law, gazetted in 2005, is going to turn the industry on its head in the next few years.
As one senior company official put it to the FM this week: “By 2010, this industry will have changed completely.”
The seeds of revolution have already been sown. Telkom is reviewing its mobile interests and is widely expected to dispose of its 50% stake in Vodacom to the UK’s Vodafone and sell a portion (and maybe all) of its fixed-line assets to MTN.
Vodafone CEO Arun Sarin is already talking bullishly about taking a controlling stake in Vodacom, with the balance listed on the JSE. The listing would be the biggest in the history of the bourse — Vodacom is conservatively believed to be worth about R150bn.
Any sale by Telkom of its stake in Vodacom would probably be born out of frustration at the fact that it has been unable to gain management control of the cellular operator. In a converging telecom environment, where the distinction between mobile and fixed-line operators is blurring, Telkom needs a mobile partner it can work with closely.
Relations between Telkom and Vodacom have never been good – they reached their low point when SBC was a shareholder in Telkom and when SBC’s Tom Barry was chief operating officer. Vodacom Group CEO Alan Knott-Craig says the relationship has since improved — “Reuben comes to my house a lot,” he jokes. But the fact that the two companies never attempted to build a unified billing system — delivering consumers one phone bill for their fixed-line and mobile accounts – speaks volumes about their frosty relations.
Of course, an acquisition by MTN of Telkom’s fixed-line assets is likely to take time to happen, especially given the need for scrutiny by the competition authorities. But such a deal appears likely to win government backing. The biggest potential sticking point is how much control government, which directly holds 39% of Telkom (it owns a further 17% through the Public Investment Corp), would have in the merged group.
Not everyone is convinced the deal will happen, though. Knott-Craig says it is likely that Telkom will sell its stake in Vodacom – it’s in the interests of Telkom shareholders to do so, he says — but the fixed-line operator may not be able to conclude a deal with MTN because of competition concerns.
He says Telkom could be left without a mobile arm which, he believes, is not necessarily a bad thing. He says a merger of MTN and Telkom could make it difficult for the new entity to expand into new business areas through acquisition. But a smaller Telkom, without a cellular operator in tow, could be more successful in convincing the competition authorities that it ought to be allowed to buy its way into new areas, such as IT services.
If all the mooted transactions happen, they will precipitate further consolidation in the sector. Vodacom, which has ambitions to become a big player in media and fixed-line telecoms, is likely to buy one or more of the emerging alternative telecom operators.
Sources say Vodacom is in talks with four potential acquisition targets with the hope of concluding at least two of them by early next year. It has held talks with a number of companies, including Vox Telecom and Verizon Business, but a deal might not happen until there is clarity on Telkom’s mobile strategy.
MTN and Vodacom are proving to be formidable competitors to Telkom in data services. The two companies have already stolen voice customers from Telkom — the number of Telkom fixed lines in service continues to fall through fixed-mobile substitution. Now they’re making strong in roads into its market share in consumer broadband.
The two major cellular operators also have the right, under the ECA, to build their own fixed-line networks, and want to take the fight to Telkom by competing with it in the lucrative corporate data market.
Until last year, MTN and Vodacom had been reliant on Telkom to supply them with the cable links that connect their base stations. Now both are rolling out fibre-optic cables across the country to cater for the rapidly growing bandwidth demands on their cellular networks — from people using their networks to access 3G data — and to provide high-speed data services, including broadband Internet access, to businesses.
MTN is already running a pilot fibre network in Johannesburg’s northern suburbs and plans to expand this to serve other business centres countrywide if it proves successful. Vodacom is laying fibre in parts of central Johannesburg and will soon build a similar network to MTN’s in the Sandton area.
Then there are the traditional Internet service providers. The larger of these soon hope to receive licences, in terms of the ECA, that will allow them to build their own networks independently of Telkom. Until now, they’ve had to rely on Telkom’s last-mile of copper cables and on the company’s backhaul network to provide services. This has added enormously to their costs. Now they’ll be able to use wireless technologies, such as the promising WiMax standard, to bypass Telkom altogether.
The Independent Communications Authority of SA (Icasa), which is charged with giving effect to the ECA, was expected to have issued these licences this month but it now seems this will happen only in the first half of 2008. Nevertheless, when the licences are issued, they will help transform the industry further.
Companies likely to receive these licences include IS, Verizon Business, Altech, MWeb and Vox Telecom. Not all of them will build extensive networks — if they build networks at all — but the fact that they will have the right to provide their own links will give them the upper hand in price negotiations with infrastructure operators such as Telkom and Neotel. This will drive down prices dramatically, further eroding Telkom’s margins.
Of course, some of the newly licensed operators will build networks, especially as a replacement for Telkom’s last-mile of copper cables that connect consumers and businesses to its telephone exchanges. Altech, IS and MWeb are all running test WiMax networks. MWeb CEO Rudi Jansen won’t disclose the extent of his company’s plans but says the scale of its pilot network- – it has nearly 1 000 people testing the technology — is indicative of how aggressive it will be in rolling out WiMax commercially.
It also seems likely that bigger players, such as IS, will use not only wireless technologies to bypass Telkom but will lay fibre to some of their bigger corporate clients, where it makes sense to do so.
Consolidation, though, seems inevitable. Smaller players, unable to fund infrastructure roll-out, are likely to be bought out by the bigger players. Companies such as Neotel and Cell C could potentially find themselves in play. And services players – those that don’t build their own networks — are also likely to merge to create scale. There is already evidence of this in Vox Telecom’s aggressive acquisition spree.
Vox and other emerging alternative telecom operators are coming up with innovative ways of taking voice revenue from Telkom and the other incumbent operators, using voice-over-Internet Protocol and least-cost routing systems. Vox has come up with an audacious plan to pay consumers for receiving phone calls.
To compensate for the growing competition in its fixed-line business, the incumbent operator is engaged in a desperate scramble to broaden its business.
But it isn’t proving easy. Telkom’s attempt to buy Business Connexion, in a R2,4bn cash deal, was thwarted by the competition authorities. Now, according to September, it is looking to form a wide-ranging partnership with either a local or a multinational IT group.
Operators are also hungrily eyeing the media and entertainment industries. Telkom has launched head-first into the pay-TV business with Telkom Media. It plans to take on MultiChoice by delivering pay-TV bouquets to the middle- and upper-income segments delivered over satellite and over its telephone lines.
Vodacom is also keen on media and has launched its own radio station, Yebo Radio, which will be streamed over its network to its 25m customers. It already resells a DStv bouquet for MultiChoice in competition with products being developed by Telkom Media.
The cellular operator also recently inked a deal with the UK’s Omnifone to offer its subscribers access to 1m songs from the world’s big four record labels. The service costs R25/week for unlimited downloads. For Vodacom, the deal helps it drive up the average revenue it derives from each subscriber.
Vodacom recently launched its own advertising agency, On-The-Line, to deliver advertising to mobile handsets. “It is a huge new market and we estimate mobile media adspend in SA could reach R1,5bn by 2011,” says Vodacom SA commercial director Romeo Kumalo.
As telecom operators charge head-first into media and entertainment, IT services, and other areas they haven’t competed in before, they have the real potential of reshaping not only their own industry but also forcing a radical makeover of others.
Their objective will be to get you to buy as many services from them as possible. And, in the highly competitive telecom landscape that is emerging in SA, they’ll have to fight hard for your money. Within 24 months, the telecom industry will have been transformed. And, for once, SA consumers will be the big winners.
Loading ...