Industry Overview

Telkom is an integrated communications service provider offering bundled voice, data, broadband and internet services with its service offerings expanded to business and residential customers.

Competition in the South African fixed-line communications market is intense and is increasing as a result of the Electronic Communications Act and determinations issued by the Minister of Communications.

The new licensing framework included in the Act has resulted in the market becoming more horizontally layered with a large number of separate licences being issued for electronic communications network services, electronic communications services, broadcasting services and radio frequency spectrum and, as a result, this will substantially increase competition in Telkom's fixed-line business.

In the areas where we currently face competition, and expect to compete for public switched telecommunications services, Telkom competes primarily on the basis of customer service, quality, dependability and price. In addition, we intend to introduce new products, services and tariff structures to enable us to maintain and grow revenue.

Fixed-line voice competition

In September 2004, South Africa's Minister of Communications granted an additional licence to provide switched telecommunications services to Neotel, a company that was 30% owned by Transtel Telecoms, a division of Transnet Limited, and Esitel, which is beneficially owned by the South African government and other strategic equity investors, including a 26% shareholding owned by TATA Africa Holdings (Pty) Ltd, a member of the TATA Group, a large Indian conglomerate with information and communications operations. On March 19, 2008, Neotel announced that the Competition Tribunal of South Africa had approved its acquisition of Transtel without any conditions. Subsequently, TATA Africa Holdings (Pty) Ltd acquired the government's 30% equity, extending its equity in Neotel to 56%.

Neotel started providing services to large corporations and other licensees at the start of the 2007 calendar year and on April 25, 2008, announced that the first of its consumer products were available to limited parts of Johannesburg and Pretoria.

As a result of an amendment to the Electronic Communications Act to enable state investment and licensing in the sector, the government created an infrastructure company, Broadband Infraco (Pty) Ltd, in 2007, to provide inter-city bandwidth at cost based prices to Neotel and, later, to the rest of the industry, which added further competition to Telkom's communications network. Broadband Infraco will also be involved in some of the undersea cable projects.

Licences

On October 29, 2008, the Minister of Communications published for public comment, a draft policy direction which would direct ICASA to grant Broadband Infraco individual Electronic Communications Services (ECS) and Electronic Communications Network Services (ECNS) licences.

On March 13, 2009, ICASA published an invitation for a public entity to apply for individual ECNS and individual ECS licences for a public entity', inviting Broadband Infraco to submit applications for these licences.

The process to issue additional licences to small business operators for the purpose of providing telecommunications services in underserviced areas with a teledensity of less than 5% started in 2005. To date, the Minister of Communications has identified 27 underserviced areas and ICASA has issued licences to seven successful bidders with the Minister issuing invitations to apply for licences in an additional 14 areas.

All existing USAL licences, including Telkom's, have been converted into ECS and ECNS licences, and all future licences for this category will be issued as ECS and ECNS licences.

These licences provide the authorisation to construct, maintain and operate an electronic communications network and provide ECNS and ECS. All the obligations contained in Telkom's public switched telecommunications service licence, including licence fees to be paid, minimum services to be provided to customers and other service obligations, will be contained in regulations, some of which have been promulgated and some of which are in the process of being promulgated.

Telkom's licence fee under the public switched telecommunications service licence amounted to 0.1% of its annual revenue generated from the provision of the licensed public switched telecommunications services. This provision was retained following the conversion to the ECS and ECNS licences. However, in terms of a regulation published on April 1, 2009, Telkom's annual licence fees for ECS and ECNS were set at 1.5% of gross profit from licensed activities, defined as total revenue obtained from the provision of licensed services, less total costs directly incurred in the provision of such services. As a result, there may be a material increase in Telkom's annual licence fee.

On March 25, 2009, the telecommunications industry put forward proposals to ICASA regarding a Service Charter regulation that stipulated standard levels of service. The standards stipulated in the regulation are extremely demanding and, the communications industry has made representation to ICASA. On July 24, 2009, ICASA has repeated the previous Service Charter regulation and published a new regulation that implements many of the recommendations made by the industry.

Other licences

In August 1995, Telkom's subsidiary, Swiftnet, was granted a telecommunications licence and a radio frequency spectrum licence for the provision of:

• The construction, maintenance and operation of a national wireless data network and the provision of wireless data telecommunications services; and
• Interconnection with Telkom's network.

In terms of the licence agreement, Swiftnet was required to have at least a 30% black economic empowerment (BEE) shareholding. In spite of Telkom entering into an agreement in 2007 to sell 30% of Swiftnet to the Radio Surveillance Consortium, a group of empowerment investors, an agreement that received Competition Commission approval, ICASA did not approve the transaction. As a result, Swiftnet was in breach of its licence.

Swiftnet, assisted by Telkom, has subsequently had two meetings with ICASA on this matter and ICASA has indicated that currently there is no agreement within the industry as to acceptable BEE shareholding percentages for all licensees. ICASA also indicated that the shareholding issue for the Swiftnet licence would have to be in line with the BEE values applicable to other similar licensees.

Swiftnet received a new licence from ICASA on January 16, 2009 which stipulated that the company still needed to secure a 30% BEE shareholding. However, ICASA has said that in the 2010 financial year it will be reviewing the equity shareholdings of all licensees, after which it is anticipated that all licensees will be given sufficient time to meet their equity shareholding requirements. Telkom's Board of directors has decided to dispose of Swiftnet, and Telkom is currently seeking potential purchasers that would comply with Swiftnet's BEE requirements.

Carrier pre-selection

The now repealed Telecommunications Act mandated that fixed-line operators were required to implement carrier pre-selection to enable customers to choose and vary their fixed-line telecommunications carrier for long distance and international calls. These provisions were retained in the Electronic Communications Act and on June 24, 2005, regulations were published for the implementation of carrier pre-selection in two phases (the implementation of call-by-call pre-selection and fully automatic pre-selection, to be implemented and provided within two months and 10 months, respectively, of them being requested by another operator). Telkom had already conditioned its exchanges to handle call-by-call carrier pre-selection by December 31, 2003. Telkom has met with Neotel to discuss its request for implementing carrier pre-selection.

Until Neotel's interconnection systems and its inter-operator process and systems to support carrier pre-selection become available, Telkom cannot fully implement carrier pre-selection. However, Telkom does not believe it can meet the 10 months deadline for automatic carrier preselection.

Number portability

The Telecommunications Act mandated that number portability, to enable customers to retain their fixed-line and mobile telephone numbers if they switch between fixed-line operators or between mobile operators, be introduced. These provisions were retained in the Electronic Communications Act. A framework number portability regulation was published at the end of 2004 that generically provides for the introduction of fixed-to-fixed and mobile-to-mobile number portability. Telkom is required to implement number portability in blocks of 10,000 numbers within two months after Neotel launches such retail services and individual number portability within 12 months of receiving a request from Neotel. Telkom has received a request from Neotel to implement both block and individual number portability and Telkom and Neotel implemented number portability in blocks of 10,000 and 1,000 numbers in May 2009. After several delays mobile number portability phase one was launched on November 11, 2006. Phase 2, which was implemented during April 2007, includes multi-line porting, secure file transfer protocol access to third parties and operational software upgrades on the central reference data base.

The set-up and per-operator costs are typically the largest cost components of implementing number portability. Similar to carrier pre-selection, there is a risk of not fully recovering system set-up costs. The implementation of these requirements in a timely manner, could result in Telkom's business being disrupted and cause its net profit to decline and the implementation of these requirements will likely further increase competition and cause churn rates to increase.

Fees and tariffs

Telkom has made significant progress in rebalancing its fixed-line tariffs with a view to focusing more on the relationship between the actual costs and tariffs of subscriptions and connections and traffic in order to more accurately reflect underlying costs and to be more competitive.

Regulations made under the repealed Telecommunications Act, but which are still in effect, imposed a price cap (3.5% below inflation, effectively implying a continuous real decrease in prices) on a basket of Telkom's specified services. These include installations; pre-paid and postpaid line rentals; local, long distance and international calls; fixed-to-mobile calls; public payphone calls; ISDN services; its Diginet product and its Megaline product. A similar cap applies to a sub-basket of those services provided to residential customers, including leased lines up to and including lines of 2 Mbps of capacity and the rental and installation of business exchange lines.

Approximately 57% of Telkom's operating revenue in the year ended March 31, 2008 was included in this basket, compared to approximately 54% in the year ended March 31, 2009.