The revolution sweeping SA telecoms
After a decade of little change in which Telkom held sway over the industry and consumers, everything is changing. Everything. Within a year, SA telecoms will have been recast, thanks to some of the biggest corporate deals in the country’s history.
The big boys are ready to reveal their cards. Mega-deals, triggered by Telkom’s review of its mobile strategy, are set to reshape the sector and usher in a new, more competitive era in which communications costs, especially for broadband services, will plummet. Doing business in SA will become cheaper, and SA’s economy, which for years has been hostage to Telkom’s high prices, is set to reap the rewards.
Analysts say consolidation has already begun and will quickly gather pace as the big players seek to provide services across the telecom value chain — from mobile telephony to fixed-line broadband, and from corporate IT services to media.
The past six months alone have been the most exciting in SA telecoms, with the bigger players locally and foreign companies setting the markets alight with talk of buyouts.
For the first time, SA telecom companies have become hot takeover targets, and the number of possibilities that have emerged could cause a tectonic shift in the industry. The sector’s biggest players, keenly focused on opportunities that an industry wide restructuring would bring, are getting ready to play their cards.
A merger between MTN and Telkom, discussed earlier this year, is now off the table, but potential multibillion-rand deals involving the sector’s biggest network operators — Vodacom, MTN, Telkom — have investors salivating.
The words of outgoing Vodacom CEO Alan Knott-Craig set the tone for just how high the stakes have become, and who will leave the table empty-handed: “Everything you’ve seen until now will look like kids’ stuff. We might think we’ve seen it all. But we ain’t seen nothing yet.”
The genesis of this high-stakes industry restructuring can be traced back two years, to the promulgation of the Electronic Communications Act (ECA). The law, introduced in 2006, provides for a far more level playing field in which new competitors can emerge to challenge incumbent operators. It also supports the eventual liberalisation of the industry.
The technology-neutral legislation — unlike the much-maligned, Telkom-friendly Telecommunications Act of 1996, which it replaced — gives licensed infrastructure operators a chance to build any type of network. This opens the way for mobile players MTN and Vodacom, for example, to compete directly with Telkom for the first time.
And it provides for value-added network service operators — these are traditionally Internet service providers — to apply for licences that allow them to become fully fledged network operators that can compete with the bigger players.
The benefits of the ECA are already being felt across the industry, though the full scale of its impact, especially on consumers, is still to come.
It’s evident, though, that big changes are already afoot. Telkom and its new rival, the Tata Communications-controlled Neotel, as well as Vodacom and MTN, are all laying high-capacity fibre-optic cables in metropolitan areas in expectation of an explosion in demand for broadband. Some, such as the state-owned company Broadband Infraco and private-sector player Dark Fibre Africa, are also doing this between the country’s cities and towns.
International connectivity, which for the longest time has been overpriced and in short supply, is also about to be thrown wide open. Three new submarine cables, which will ultimately deliver 50 times the design capacity of the Sat-3 system controlled by Telkom, will drive down international bandwidth costs between 70% and 90% and, for the first time, give more SA consumers access to media-rich online content and applications.
Operators are already dropping their prices. Neotel, licensed in 2006 to take on Telkom in fixed lines, recently unveiled its first retail consumer offerings. Despite the company saying initially that it would not start a price war with Telkom, its prices have significantly undercut the incumbent’s. Telkom is expected to respond on June 20, when it files its annual tariffs for approval by the industry regulator.
Analysts feel the industry has underestimated Neotel’s potential and the damage it could inflict on Telkom.
“If Neotel continues in the way it is, it may get 10% or 15% market share, and a growing share at that. For a second network operator, that is damn good,” says Denis Smit, MD of local market research and consulting firm BMI-TechKnowledge.
Kristoff Puelinckx, managing partner at Dubai-based emerging markets telecom advisory and investment firm Delta Partners, says Neotel’s fortunes are closely tied to Telkom’s. “If Telkom turns the business around, it will not be easy for Neotel. The uncertainty around Telkom creates an opportunity for Neotel to push aggressively into the market.”
But Neotel MD Ajay Pandey is adamant his company will not be influenced by Telkom. “Neotel is charting its own flight plan and in the short and medium term we don’t see our plans being affected by what the incumbent is or is not doing.”
Still, price competition has entered the market and is here to stay. Says Smit: “We predict that broadband prices will fall to sub-US$20, all-inclusive, even on serious packages. SA is a couple of years late to the party, but in two years we won’t recognise this industry.”
It’s good news for consumers but potentially bad for the incumbent industry players, especially Telkom. The fixed-line operator finds itself in a bind. With the exception of broadband, its fixed-line business is in decline.
Most SA consumers prefer the convenience of mobility and have switched to cellular operators for their voice telephony needs. Telkom retains technological advantages in fixed-line broadband but with new, high-speed wireless technologies emerging — WiMax and 3G HSPA — even that advantage is rapidly being eroded.
Years ago, Telkom identified the need to work more closely with Vodacom, in which it holds a noncontrolling 50% equity stake — the UK’s Vodafone holds the other 50%. But it was never to be. Cultural differences and other factors meant the fractious relationship never amounted to anything. Frustrated, Telkom began a review of its mobile strategy last year, with CEO Reuben September (pictured above) promising that no options would be left off the table.
It now seems inevitable that Telkom will sell Vodacom and look for a new mobile partner. Talk is that it could knock on the door of Cell C. Vodafone has offered Telkom $2,5bn (R19,7bn) for 12,5% of its equity in Vodacom on condition that it unbundles the rest of the stake to Telkom shareholders. Some will be sold to a black partner; the rest listed on the JSE.
The sale would give Vodafone management control of Vodacom, a company outgoing Vodafone CEO Arun Sarin has long coveted. The UK group, the world’s largest cellular operator by revenues, wants to step up its investments into faster-growing emerging markets to offset flat and declining performances in developed economies.
But without Vodacom, is Telkom still an attractive investment? To defend its market share, the company has to invest billions of rand into its fixed-line network and must do so in an environment where competitive pressures are rapidly mounting. The operator will have to continue reducing its prices, which will put its margins under pressure.
Margins have already fallen sharply. Net profit fell 7,7% between 2007 and 2008. Operating expenses rose 12,8%, chiefly because of investment in the company’s core network infrastructure.
Now Telkom is considering outsourcing many operations, including core functions such IT and network management. The plan, which could lead to job losses, is unlikely to be welcomed by the trade unions. September says Telkom management has begun to engage the unions and government. “We are not looking at reducing head count per se,” he says. “This is not about putting people out on the street.”
Despite the challenges that Telkom is facing, suitors, including the Saudi-backed Oger Telecom and a consortium led by Tokyo Sexwale’s Mvelaphanda Group, are keen to snap up Telkom’s fixed-line assets — provided they can get the company for a good price.
It looks very likely that Telkom will seek to sell its fixed-line business, though government, which holds 39% of the company (54% if the Public Investment Corp’s stake is included), would have to approve the sale — and that’s not guaranteed. Communications department director-general Lyndall Shope-Mafole could not be reached for comment but has indicated in the past that government is not prepared to relinquish its stake in Telkom.
The PIC declined to comment.
BMI-T’s Smit feels the offer from Mvela is counterintuitive as it does not gel with government policy, which is set to lurch to the left after the next election. “Government wants to get more involved in telecoms, not less,” he says.
He points to the example of state-owned Infraco, the new national and international infrastructure company conceived by public enterprises minister Alec Erwin, and efforts by municipalities to build their own networks at a cumulative cost of billions of rand. “We are facing a sea change in political ideology in SA,” Smit says. “There is talk again of nationalisation. Why would government put money into Infraco and then sell the stake in Telkom? It’s not coherent with the new economic agenda.”
But one high-placed source who is close to the process says government may be prepared to facilitate a deal by reducing its stake in Telkom if it means keeping the company in SA hands. Government realises it needs to unlock value in Telkom’s fixed-line business and may be prepared to reduce its stake to achieve that, says the source.
Knott-Craig says a deal will be good for all the companies involved, and for consumers. “This is not a constructive shareholding arrangement, not for the shareholders, and not for us,” he says. “There are hundreds of things that Telkom, Vodacom and Vodafone could do, but first this gridlock has to be addressed. It has to happen. It just puzzles me why it has taken so long.”
Politics could help facilitate the sale of Telkom. In fact, political considerations could have spurred Mvela’s approach to the company.
On May 30, the Mvela consortium, which includes US private equity company Och-Ziff Capital Management, made an offer to acquire the entire issued share capital of Telkom on condition that the board agreed to unbundle Telkom’s entire 50% stake in Vodacom.
Sexwale (pictured above) is closely aligned with the new leadership of the ANC, and with its president, Jacob Zuma. It’s difficult to establish to what extent Sexwale’s support for Zuma leading up to the ANC leadership election in Polokwane would help grease the wheels of a deal.
Mvela chief investment officer Mark Willcox declines to comment, but says that having a “locally controlled” Telkom is important to the sector.
Yet a Telkom without Vodacom does not necessarily look like a good investment. Delta Partners’ Puelinckx says Telkom is set to go through the same pain that its European counterparts endured around the turn of the century.
Telkom, he says, must reinvent itself as a provider of data and broadband services as its fixed-line voice business is in decline. But the pressures are enormous — different stakeholders are pulling the company in different directions. Shareholders want to see short-term financial gain, while consumers and government are demanding lower prices. Shareholders are likely to be the losers, at least for now.
When Telkom was 30%-owned and run by strategic foreign partner Thintana — comprising SBC Communications (now AT&T) and Telekom Malaysia — it did not invest sufficiently in its network. Thintana cuts costs to maximise dividends. At the first sign of competition, it bailed and ran. This short-termism has left Telkom with a big headache — it now has to spend billions of rand more than it should have to keep itself relevant and fend off new rivals. Though it isn’t good for profits in the near term, some analysts believe it is imperative for the company’s survival in the longer term.
Growing the top line, rather than simply cutting costs in an effort to maintain margins, is key. “Telkom is in a unique position to drive broadband in SA,” says Puelinckx. “But that requires investment and vision. Management has to transform the company.”
That’s easier said than done. Telkom management’s team, under CEO September, has come under fire from investment analysts and fund managers for failing to unlock value in the company sooner. And consumers continue to lament its high prices and shoddy service.
The investment community widely believes that September, who has worked at Telkom all his life, is not the best man to lead the company. Though well-liked by employees, he is regarded as a technocrat, not the visionary and charismatic leader that Telkom needs if it is to adapt to a fast-changing telecom environment.
“Telkom needs visionary shareholders and visionary management,” Puelinckx says. “Government hasn’t stimulated its transformation so far. If government were to remain a shareholder, which is not necessarily a bad thing, it needs to ensure that the management has the freedom to really develop the company.”
Some of the decisions management needs to take won’t be popular in government. Though it has shed more than half its workforce in the past decade, the company is still not nearly as efficient and streamlined as it could be. Yet retrenchments could prove politically unpalatable so close to the next election.
Mvela and Och-Ziff would do well to seek upfront guarantees from government that there would be no interference in their management of the company, including in the execution of retrenchments. Sources say the subject of layoffs featured centrally in MTN’s decision earlier this year when it walked away from a deal to buy Telkom’s fixed-line business. Since then, MTN has moved on to talks with Indian mobile operators, first Bharti Airtel, and now Reliance Communications.
Puelinckx thinks Telkom’s management is doing the right things. Its decision to exit its pay-TV venture, Telkom Media, was the correct one, however unpopular it might have been with the new venture’s staff. He says the company needs to get its core business right before venturing into new business areas, especially into areas where it has no operational experience.
“Telkom needs to invest in its infrastructure, develop a clear plan for protecting its voice business, and grow its data business. That’s a very big job. If it can become a reference player in the data market, it may then be well-positioned to move into new areas. But it is not equipped to do that right now.”
Puelinckx is not convinced that Telkom needs a mobile arm in the short term, despite opportunities to leverage the core network and share distribution channels and do co-branding. “BT Group (formerly British Telecom) got out of the mobile business years ago and focused on developing the corporate market,” he says. BT has since launched a mobile virtual network operator (MVNO) off the back of O2’s network.
September says one option for Telkom is to create an MVNO, possibly with Vodacom. Another option is to form a strategic partnership or even merge its operations with mobile operator Cell C. Oger Telecom, which holds an effective 75% controlling stake in Cell C — 60% directly and 15% through Lanun Securities — is rumoured to be involved, or may become involved, in the Mvela/Och-Ziff bid for Telkom. Earlier this year, Telkom rejected a separate proposal from Oger (no specific offer was made), saying it was not in shareholders’ best interests.
A source close to Oger says the company is still interested in Telkom, but that interest has cooled somewhat since its initial approach. Another source says Telkom and Oger have not engaged in any serious way.
It is still possible that Oger — or another telecom operator aligned with the Mvela consortium — could be brought in to help run Telkom. The Saudi-backed Oger has experience running foreign wireless and fixed-line operators — it owns 55% of Türk Telekom, which in turn owns Avea, Turkey’s third-largest mobile operator.
Cell C CEO Jeffrey Hedberg says he relishes the idea of Cell C and Telkom working closely together. The American-born Hedberg, who is credited with turning around SA’s smallest cellular operator, says Mvela does not have much experience in telecoms and would need an operator as a strategic partner.
Mvela’s case to government would be stronger if it had a strategic operator on board with experience in integrating fixed and wireless businesses and a proven track record with managing a restructuring (including retrenchments), he says.
A merger or partnership between Telkom and Cell C would “provide scale and help us reduce our costs and provide us with a better seat at the table with the regulator and the department of communications. Of course, the cultures are different, but that’s business.”
But Puelinckx says merging the two companies right now would be a big mistake. “You could create a strong combined player but both of them have significant issues to deal with,” he says. “You’re not putting the two stars of the industry together. I’d rather fix them separately first.”
The option of creating an MVNO, similar to Cell C’s relationship with Virgin Mobile, could be difficult. The other operators may be reluctant to allow Telkom onto their networks.
And Puelinckx says the SA market is not yet mature enough for the MVNO model.
It’s a difficult situation for Telkom. The company said earlier this year that any sale of its stake in Vodacom was contingent on the sale of its fixed-line business. Smit says the divorce of the two companies, though potentially traumatic for Telkom, would be good for Vodacom and for the industry. It would allow Vodacom to mimic MTN and grow aggressively into new markets in Africa.
Vodacom’s Knott-Craig says the shareholding change is at least two years overdue. “Finally, the volcano has cracked its top.”
Vodacom will be freed up to do things it couldn’t before. “We’re not confined to a coffin anymore,” he says. “We can expand horizontally and geographically.”
Knott-Craig says splitting Vodacom and Telkom would unleash new competitive forces, allowing the industry to grow strongly again.
Indeed, the restructuring of the sector has only just begun. Industry watchers are waiting eagerly to see the sector players’ next moves. The game is on and the stakes high.
South African telecoms discussion
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