Industry trends justify Telkom’s re-positioning

Describing Telkom’s 2010 financial year as being ‚tough with muted revenue growth‚ , Group CEO Reuben September, emphasised that the impact of competition and the weaker economic environment were evident in the Telkom Group’s financial results for the year ended 31 March 2010.

He added that restructuring Telkom into three business units and the start-up of Telkom Mobile had increased expenditure but that Telkom had identified specific cost-saving opportunities.

‚Our strategy seeking to re-position the Telkom Group is imperative given the tough operating environment. Similar to the strategies of other leading operators in the world, we are focusing on growing other revenue streams ‚ data centre operation, mobile and Africa – to compensate for the decline in fixed voice revenues. We are improving our execution in current growth markets, such as broadband and wholesale, and are taking actions to defend our consumer and enterprise markets,‚ said September.

The 50% share of Vodacom’s results in the 2009 financial year and Telkom Media’s results are disclosed as discontinued operations in the Telkom Group’s consolidated financial statements.

Group salient features for the six months ended 31 March 2010 include:

Vodacom transaction accounts for profit of R40.5 billion.

Impairment of Multi-Links goodwill of R2,148 million and assets of R3,012 million.

Normalised operating revenue up 0.7% to R37.0 billion.

Capital expenditure reduced by 44.2% to R5.4 billion.

Normalised free cash flow of R5.5 billion.

Normalised net financing costs decreased 44.3% to R1.4 billion.

Net debt reduced by R10.8 billion decreasing normalised net debt to EBITDA from 1.3 times to 0.5 times.

Normalised headline earnings per share from continuing operations decreased by 11.2% to 473.0 cents.

Normalised basic earnings per share decreased 12.0% to 425.2 cents per share.

Normal dividend declared increased 8.7% to 125 cents per share from 115 cents per share.

Special dividend declared from Vodacom proceeds of 175 cents per share.

ADSL subscribers increase 18.1% to 647,462.

Alluding to the Telkom Group results, September added that high operating expense growth as a result of inventory write-offs in both Telkom SA and Multi-Links and employee expense growth in excess of inflation also impacted Telkom’s results. ‚Our EDITDA margin declined to 26.5% from 31.5% recorded at 31 March 2009. Lower taxation, lower finance charges and increased investment income resulted in a more modest normalised headline earnings per share decline of 11.2% to 473.0 cents per share,‚ September explained.

In addition, the negative effect of intensifying competition and fixed-to-mobile substitution also accounted for a 9.3% decrease in Telkom SA’s traffic revenue. ‚This continuing trend justifies the imperative for the Group to enter the mobile market, particularly the mobile data market,‚ stated September.

He added that the launch of Telkom’s data centre operation, Cybernest, in November last year further denotes Telkom’s drive to ‚diversify and grow our revenue streams and take costs out of our current operations‚ .

September emphasised that the Group exhibited strong management of the capital expenditure programme, spending R5.4 billion for the year ended 31 March 2010. This was down 44.2% from the R9.6 billion spent in the 2009 financial year. As a result, normalised free cash flow improved significantly to R5.5 billion.

‚Every effort will be made to continuously improve the cash flow position. We still have an extremely healthy net debt position with annualised net debt to EBITDA of 0.5 times,‚ emphasised September.

He added: ‚Although our Group operating expenditure grew 8.4% to R32.7 billion, we are confident that the pace of reduction will increase and we remain committed to reducing costs,‚ stated September, adding that improved efficiencies and cost management are ongoing business imperatives. He emphasised that during the period under review, Telkom had:

· Examined ways of working more efficiently to improve the quality of the customer experience through, for example, specific interventions to improve the effectiveness of our field force and contact centres.

· Looked at ways of improving the efficiency of marginal businesses such as payphones and directory services.

· Continued optimising vacancies created through natural attrition and actively managed overtime and contractors spend.

· Launched voluntary separation packages for management.

He emphasised that the commitment of Telkom’s executive leadership to position Telkom to aggressively compete in the South African and African markets was gaining momentum. ‚I am confident that the strength inherent in the fixed-line network and the business leadership and operations skills of our employees will allow us to offer our markets simple, quality, cost effective services that will be competitive in our markets,‚ stated September.

September also explained the calculation of the ordinary and special dividends that were declared, stating that the ordinary dividend was calculated with reference to Telkom’s current and future debt and cash flow levels. Telkom’s commitment to return to shareholders any proceeds from the Vodacom transaction not utilised within 24 months enabled the Company to pay a further special dividend of 175 cents per share (2009:260 cents).

‚In this regard, ordinary dividend number 15 of [125] cents per share (2009:115 cents) and special dividend of [175] cents per share (2009:260 cents) in respect of the financial year ended 31 March 2010 have been declared payable on 19 July 2010 to shareholders recorded in the Company register at close of business on 16 July 2010,‚ announced September.

In operationally reviewing the Group’s reporting segments, September stated that the restructuring of Telkom SA into ‚leaner, more flexible business units is complete allowing for focussed attention on revenue growth opportunities‚ .

Continued competitive pressures in the voice market, the effects of fixed-to-mobile substitution and least cost routing have resulted in declines in traffic revenue streams. ‚This,‚ explained September, ‚is also the result of our drive to offer significant value through annuity products, managed network services and virtual private networks which shifts traffic revenue into other revenue streams.‚

The development of a mobile service is one way of winning back traffic onto the Telkom network. Annuity revenue streams were, nevertheless, encouraging as voice annuity grew 3.7% while data annuity showed a 7.1% growth. Telkom Closer subscribers increased 20.6% while Supreme Call subscribers have increased 41.2%. The current line penetration rate for Closer packages is 53.5% (up from 41.7% last year).

Interconnection revenue during the reporting period also increased 25.1% to R2,608 million. From February 2010, there was a reduction in the peak mobile interconnect rate from 125 cents to 89 cents, with off-peak mobile rates remaining unchanged at 77 cents. With regard to broadband and data revenue, ADSL subscribers increased by 18.1% (compared to 31 March 2009) and Do Broadband subscribers have increased 25.4%. Broadband penetration as a percentage of post-paid lines equals 19%.

In addition, total data revenue increased 7.1%, data connectivity services increased by 3.7%, leased line revenue increased 8.1% and Internet access and related services revenue increased 12.9%. Furthermore, managed data network services revenue increased 15.9% – this includes an increase of 16.3% in satellite services revenue and a 15.9% increase in VPN services revenue.

‚Telkom is aggressively promoting its broadband packages and is currently negotiating a triple-play partnership in order to provide our customers with enhanced content, while speeds of up to 10 mbps have been installed in selected exchanges,‚ stated September.

With traditional fixed-line voice revenues declining, the majority of global fixed-line incumbents have discovered that a successful operation requires an integrated mobile business. With mobile voice and, especially, mobile data still experiencing growth, there are tremendous market opportunities in South Africa.

‚In fact, Telkom has a competitive advantage by virtue of its existing business and customer base. This is particularly so as wireless growth slows down and converged data becomes more prevalent,‚ said September, adding that both mobile and fixed value pools will assist Telkom to defend itself more effectively against competitors and to grow revenues.

‚Simplicity, quality and value‚ will be the three main guiding principles to Telkom’s entry into the mobile market. Telkom also plans to use mobile technology to offer fixed-line services where Telkom is experiencing operational challenges such as recurring cable theft.

Telkom’s roaming agreement with MTN covers services such as voice, 2G and 3G data, MMS and USSD on a national basis. Telkom will also offer a full international roaming agreement at launch.

Initially, prepaid, post-paid and hybrid voice and data services will be offered and these will be provided by a unified 2G and 3G voice and data network.

Telkom has already ordered 2,000 base stations which are in the process of being constructed in the first year. We plan to have 40% of our own population coverage at launch which will be grown as required over five years. Full national coverage will be provided through the roaming agreement with MTN. We estimate that the capital expenditure required to implement mobility will be a maximum of R6 billion over five years,‚ stated September, adding that as at 31 March 2010, Telkom’s W-CDMA subscribers showed an increase of 210.3% compared to the same period last year.

In reviewing Telkom’s Data Centre Operation ‚ called Cybernest ‚ that was launched in November last year, September said that the transfer of certain IT staff from Telkom has been concluded to add critical mass and experience to Cybernest. Our Bellville Data Centre in Cape Town is already recognised as a unique industry-leading facility in South Africa for its eco-friendly design which assists in reducing carbon emissions in terms of power and cooling,‚ said September.

He added that key partnerships with various industry leaders enabled the tailoring of solutions to fit customer-specific requirements. ‚A new shared virtual hosting offering has been launched with early client success, as the trend towards Cloud Computing gains momentum,‚ stated September.

With reference to Telkom International, September stated that the Nigerian Multi-Links operation remains a major concern as EBITDA losses of R659 million were reported, a 191.6% increase from the loss of R226 million reported at the corresponding period last year. This was largely attributable to trading conditions in Nigeria, tough local economic conditions, pricing pressures and the short-term strategy previously in place to reduce inventories and acquire subscribers.

Despite these challenges, interconnection revenue increased by 315.3%, active voice subscribers increased 18.7%, data revenues increased 81.8%, fixed data customers increased 55.7% and data (EVDO) subscribers increased to 45 340 (from 2699 as at 31 March 2009).

During the 2009/10 financial year, Multi-Links’ build and expansion programme achieved the following:

· Deployed additional packet based mobile switching centres increasing the available capacity from 2 800,000 to 4,000,000 subscribers.

· Rolled out an additional 373 base transceiver stations to 878, increasing total radio capacity (Rf) from 1,800,000 to 3,100,000 subscribers on 706 tower sites, 340 of which are Multi-Links owned and the remaining are co-located.

· Successfully launched its broadband service offering by rolling out an EVDO 3G network to a capacity of 199,000 subscribers.

· Added 2,962 kilometres of optic fibre (1,822 MLTL owned and 1,140 Swop) resulting in a total to 6,673 km (4,639 Multi-Links owned and 2,034 swop).

· Successfully completed the roll-out of the DWDM transmission network to 39 cities. The implementation of the DWDM network provides additional 4 x STM64 capacity in protected rings.

· Successfully launched four new Customer Service Branches to support the network growth.

· Increased international capacity by the addition of 2 x 155Mb services on the SAT-3 submarine cable system.

· Extended coverage to 22 states.

September explained that it was necessary to continue investing in the Multi-Links network and operations in order to complete capital projects and ensure that the asset is properly structured for future viability.

He added that the balance sheet of Multi-Links was over-geared and undercapitalised.

‚Accordingly, Multi-Links was recapitalised with preference share capital in order to enable the company to repay existing debt and negotiate third party financing,‚ stated September.

September added that the integration of Africa Online and MWEB Africa is expected to be complete by end September 2010 and is to be rebranded iWay Africa. ‚The goal of the integration is to drive the ISP business in Africa up the ICT value chain by developing Pan African major city-to-city backbone infrastructure as well as Sub-Sahara hub-to-international cable access infrastructure,‚ said September.

Telkom Management Services (TMS) was created to provide consultancy services to telecommunications operators in Africa in order to improve their performance by providing network, IT, vendor and funding strategies, hands-on management and technical expertise best suited to meet their challenges.

TMS is currently exploring opportunities in Malawi, Zimbabwe, the Democratic Republic of Congo, Liberia, Angola, Ghana, Uganda, Botswana, Namibia, Lesotho and Swaziland. Services offered range from training services to human capital solutions, networks, systems, data services planning and landing station management.

‚The major obstacle to ramping up this business is securing funding on behalf of operators in Africa. We are currently working on innovative solutions with a number of financial institutions,‚ explained September.

Looking ahead, September projected that capital expenditure for the Group is expected to range between 20% and 25% of revenue over the next financial year, including the impact of Telkom’s mobile investment.

The targeted ceiling net debt to EBITDA is aimed at a maximum of 1.4 times.

Referring to Telkom’s de-listing from the New York Stock Exchange in August 2009, September explained that the US listing had been expensive and took ‚considerable management time‚ . ‚The discipline gained from compliance with the Sarbanes-Oxley reporting requirements are retained, where appropriate, to ensure strict corporate governance compliance and transparent financial reporting,‚ said September, adding that Telkom maintains a level 1 American Depository Receipt programme to facilitate over-the-counter trading in America.

‚Finally, as a result of the 2010 FIFA World Cup‚Ñ¢ and competitive sensitivities, Telkom will be delaying the investor road show until the latter half of September 2010,‚ he concluded.

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