Telkom South Africa

Telkom South Africa remains focused on ensuring its competitiveness in terms of pricing, product and service mix. The competitive environment demands price decreases together with higher speed and service level increases. This places pressure on both revenue and investment in the network. In response Telkom South Africa continues to defend revenue through highlighting the value and quality offered by the fixed-line, developing innovative new products, growing annuity voice and data products and moving up the ICT value chain through Cybernest.

Following the launch of 8ta our focus into the future will be on offering fully converged products that marry mobile voice and data services with the quality and resilience of the fixed-line to both the enterprise and residential markets.

Voice revenue

Voice revenues declined 19.1% to R6.9 billion as a result of lower minutes of use and lower tariffs. Telkom elected to pass 100% of the benefit of the drop in mobile termination rates from 125 cents per minute to 89 cents per minute to its customers. Local voice revenue declined 10.8% to R1.5 billion, long distance voice revenue was down by 12.4% to R809 million, fixed-to-mobile revenue was down 24.0% to R2.5 billion and international outgoing revenue declined 19.9% to R378 million. Our continued drive to convert customers to annuity revenue streams saw revenue from subscription based calling plans grow 10.2% to R807 million. Voice annuity revenue, which includes line rental, calling plans, customer premise equipment rental and value added services grew 1.5% to R3.9 billion. Telkom Closer subscribers grew 16.1% to 738,396 and Supreme Call subscribers grew 54.2% to 23,674. Traffic revenue is also continuing to be converted to data revenue through our drive to grow Virtual Private Networks and managed network services.

We continue to focus on reducing customer churn, increasing customer loyalty and promoting the value offered by fixed-line converged services through many initiatives such as continued enhancement to the Closer packages, free line installation to all of Telkom's former customers returning, telemarketing and direct marketing.

Interconnection revenue

Interconnection revenue decreased 37.4% to R912 million reflecting the 41.1% decrease in mobile domestic interconnection revenue to R356 million, which includes mobile-to-fixed revenue (down 5.3% to R252 million) and international mobile outgoing revenue (down 69.2% to R104 million). The decline in mobile interconnection revenue is as a result of continuing mobile substitution and the sharp decline in international mobile outgoing revenue is as a result of lower volumes, especially on switched hubbing, due to operators using alternate international gateway providers. Fixed domestic interconnection revenue grew 118.8% to R210 million as Neotel gained further traction. International interconnection revenue declined 54.4% to R346 million as we are more selective with our switched hubbing revenue, which is impacted by exchange rates and decreased 76.2% to R116 million. International incoming revenue dropped 15.1% to R230 million.

Mobile and fixed-line termination rate developments

On 29 October 2010, ICASA published its final Call Termination Rate regulations for both fixed and mobile networks.

Vodacom and MTN are obliged to reduce call termination on their networks as follows:

As from 1 March 2013 there will be no distinction between peak and off-peak rates in respect of call termination services.

Smaller market players - both 8ta and Cell C - may charge up to 20% more for call terminating on their networks between 1 March 2011 and 28 February 2012. Thereafter the maximum premium they may charge falls to 15% on 1 March 2012 and finally to 10% on 1 March 2013.

The regulation also reduces Telkom's fixed termination rates and removes the differentiation between peak and offpeak rates in respect of call termination services by 1 March 2013.

Telkom is pleased to have secured asymmetric mobile termination rates. Asymmetry is positive for 8ta and may or may not be positive for Telkom's fixed-line service depending on the level of pass through and traffic patterns.

The mobile termination rate cut from 125 cents per minute to 89 cents per minute effective from March 2010 resulted in Telkom's fixed-to-mobile voice revenue falling R640 million. Telkom elected to pass through 100% of the benefit of the reduction to its customers. Payments to other operators decreased R616 million resulting in a net loss for Telkom of R24 million.

Broadband and data revenue

Total data revenue increased 14.9% to R5,550 million despite significant price reductions with effect from 1 August 2009. Data connectivity services revenue increased 9.3% to R2,707 million which includes the 23.4% increase in ADSL revenue to R790 million. Leased line revenue increased 13.5% to R1,116 million. Mobile leased line revenue continues to grow healthily, despite self-provisioning, reflecting the growing demand for bandwidth. Internet access and related services revenue increased 13.5% to R986 million and managed data network services revenue increased 37.3% to R641 million. Managed network sites grew 10.7% to 33,023.

ADSL subscribers increased 16.0% to 699,368 when compared to the 30 September 2009 reporting period. Broadband remains a growth area for Telkom and more capital is being allocated to this revenue stream. 10 Mbps services and new PC broadband bundles have been launched. Telkom Simple, a campaign offering fast internet, free landline calls and free installation for R369 per month will run from 12 September 2010 to 15 December 2010. Telkom continues to aggressively promote its broadband packages through focusing our marketing efforts on particular customer groupings and the up-selling of the higher end broadband packages which offer substantial value. We have also put in maximum effort to promote entry-level ADSL packages with extremely competitive pricing. We continue to make every effort to increase the bandwidth available to our customers.

Telkom is facing stiff competition on price for traditional data services. We continue to maximise the benefit of our capacity and ability to provide quality and security. We are also offering innovative products and services using the intelligence of our next generation network. We are focusing on differentiating our service. Our differentiators include the reliability of our comprehensive service level agreements that are flexible and can be designed to match customer requirements. Other differentiators that we are working towards include: providing full communication and converged solutions, including mobility and data centre services that offer value and are clean and simple to understand.

Cost management

Operating expenditure decreased 6.3% to R15.1 billion. This was largely as a result of the reduction in payment to other operators of 28.6% to R3,057 million. Employee expenses increased 10.0% to R4,853 million as a result of the 7.5% annual salary increase and R144 million workforce reduction expenses. Selling, general and administrative expenses decreased 10.5% to R2,848 million due to lower inventory write-offs, service fees increased 5.3% to R1,411 million mainly due to electricity increases and operating leases grew 11.0% to R526 million due to higher cell site leases in Multi-Links. Also included in operating expenditure is R205 million relating to 8ta operational expenditure.

Telkom is firmly committed to reducing its costs. This must be done in a manner to ensure sustainable, long term benefits. All elements of our operating model - network and IT, marketing, channel and customer, corporate services - have been examined and cost saving projects have been initiated. Excluding payments to other operators, depreciation, amortisation, impairments and write-offs, mobile operating expenditure of R205 million and the R144 million workforce reduction expenses, operating expenses decreased by 1.3%. We are continuing to explore and execute on all cost efficiency opportunities.

We have continued optimising staff vacancies through natural attrition and have been actively managing overtime and contractor spending in order to manage costs as far as possible. We launched voluntary separation packages for management employees with 186 employees approved to take advantage of the packages at a cost of R144 million. The benefits of the reduction in employee expenses are expected in the second half of the 2011 financial year.

8ta - Telkom's mobile service

8ta was successfully launched on 18 October 2010. On 18 November 2010 8ta had signed up 186,033 new customers, all of whom comply with RICA.

8ta's approach is one of simplicity, quality, value and authenticity. We intend to be innovative and aggressive but rational. We provide differentiated products and pricing, which are difficult to replicate, and importantly, encourage primary SIM usage.

As promised, Telkom launched post paid products on 8 November 2010 and intends to launch fully converged products to corporate and consumers in the first half of the 2011 calendar year. Competitors have yet to replicate our offer at a rate of 65c for calls terminating on Telkom's fixed-line network. This will provide an attractive incentive to corporate customers in future.

Telkom has existing distribution channels and points of presence that are used for the distribution of Telkom WorldCall and pre-paid cards. We have simply added another product - 8ta - to this existing distribution channel and gone further to secure additional national distribution partners. 8ta is working with 51 dealers with 3,000 points of presence around South Africa. We have also ensured that we are able to reach deeply into semi-urban and rural areas through the use of independent micro distributors.

8ta has constructed 800 base stations. As previously announced, we are working through an order to build a further 2,000 base stations. In addition, we are using the avenues of co-location and infrastructure sharing as much as possible to reduce the extent of our capital outlay.

Telkom is at an inflection point with growth in traditional fixed-line voice revenues declining. We believe that there is a market opportunity in South Africa as mobile voice and especially mobile data are still experiencing growth. Telkom has a competitive advantage by virtue of its existing business and customer base. This is particularly so as wireless voice growth slows and converged data becomes more prevalent. A product range spanning both mobile and fixed value pools will assist Telkom to defend itself more effectively against competitors and to grow revenues. The mobile business is designed to also assist Telkom in addressing fixed-line cost challenges and to position Telkom more competitively in the market. To this end Telkom will undertake best endeavours to attain the market share required to achieve its required IRR.

Telkom also plans to use mobile technology to offer fixed-line services in areas where Telkom is experiencing operational challenges such as copper theft, breakages, slow copper roll-out to new greenfield areas, etc. This will assist the company in being more responsive to its customers' needs.

We estimate that the capital expenditure required to implement mobility will be a maximum of R6 billion over five years.Back to Top

Cybernest

Cybernest has been in operation for a year and has gained considerable traction in the market. While the majority of the R614 million revenue achieved in the six months to 30 September 2010 is generated from Telkom, non-Telkom revenue has increased 94.7% from a low base to R37 million.

There has been pleasing interest from businesses wishing to outsource part or all of their IT infrastructure and services. Various industry verticals, particularly mining and retail, have displayed a keen interest to focus on their core business and this has afforded Cybernest the opportunity to secure a number of notable deals ranging from hosting, storage, security, disaster recovery and messaging. In addition, Cybernest has managed to secure two total outsource deals, a considerable achievement given that total outsourcing was planned to commence towards the end of this financial year. The average size of deal won is increasing as our credibility grows with customers moving towards Cybernest fully owning their infrastructure on either a shared or dedicated basis, and providing managed services out of our facilities.

Cybernest has afforded the Telkom Group the opportunity of decreasing non-standard and non-useful infrastructure through the promotion of industrialised infrastructures and technologies and increased automation. The sharing of resources and merging of operating teams has also allowed headcount to grow more slowly than activities. Cybernest continues to focus on key partnerships with various industry leaders in order to offer tailor made solutions to the market that are cost effective, efficient and reliable.

Trudon

Trudon's revenue increased by 1.4% to R647 million while EBITDA declined 8.1% to R305 million. Operating profit decreased 8.9% to R287 million.

The core printed directories business has reached maturity in South Africa as evidenced by the reduction in Trudon's revenue growth. In the European and United States markets, directory businesses are in decline. To combat this decline, directory businesses are growing their presence in the online search arena. In this arena Google is the dominant player and is a formidable competitor.

In addition, directory companies are trying to build or access content via multi-platforms including mobile and online. Directory companies have moved away from their traditional core focus into areas where they are not the dominant players, for example online search and advertising.

To keep pace with the changes in the marketplace, Trudon is busy evolving from being a publisher of traditional print products to being a local search solutions provider. Print usage by subscribers has reduced and younger users access information primarily through internet and mobile channels, rather than printed white or yellow pages. Trudon has no choice but to follow this migration and build up its capabilities and capacity to offer these products. The online expansion will require capital investment and we anticipate capital investment of approximately R110 million over the following two financial years.

Multi-Links

Operating revenue decreased 9.0% to R744 million and operating expenses decreased 15.4% to R1,008 million. The loss from operating activities improved by 29.4% to a loss of R262 million.

Multi-Links incurred R158 million of capital expenditure for the six months ended 30 September 2010. The expenditure mainly relates to the completion of assets under construction. The net asset value has been impaired by a further R201 million.

The Telkom Group board has mandated management to review options for the exit of the CDMA business. We have received a number of expressions of interest which will be evaluated and quantified over the next quarter.

The backbone network which includes 4,639 km of Multi-Links owned fibre and a further 2,034 km of fibre through swap arrangements, has performed well in the six months under review with data leased lines growing 61.2% to 732 lines.

Guidance

Capital expenditure for the Group is expected to range between 20% and 25% of revenue over the current financial year including the impact of our mobile investment. Given the current run rate, the Telkom Group may deliver a capital expenditure to revenue ratio at the lower end of the stated guidance.

The targeted ceiling net debt to EBITDA is aimed at a maximum of 1.4 times. In the short term we will operate at lower levels pending the cash outflows associated with the mobile related capital expenditure.