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					   AN INTERNATIONAL COMPARISON OF SOUTH AFRICAN
TELECOMMUNICATION CO STS AND THE POSSIBLE EFFECT OF
  TELECOMMUNICATIONS O N ECONOMIC PERFORMANCE

                                                  AND

  A REPORT ON TELKOM’S FINANCIAL STATEMENTS AND
COMPARISONS WITH SELECTED LOCAL AND INTERNATIONAL
                    COMPANIES



Prepared by Efficient Research Pty (Ltd)
September 2004


    Efficient Research Pty (Ltd), an independent economic and financial research company, has
    been approached by Solidarity to prepare a concise report regarding Telkom and
    telecommunications in South Africa


                                    Directors: Dawie Roodt, Charles Snyman
                                             Reg no: 2004/001978/07
                        8 Blinkblaar street, Zwartkop x4; P O Box 11713, Zwartkop 0051
                           Tel: 012 663 8106, Fax: 012 643 1928 www.efgroup.co.za
Executive summary.......................................................................................................................................i

An international comparison of South African telecommunication costs and the possible effect of

telecommunications on economic performance ......................................................................................1

   South African’s telecommunication costs: A comparison.......................................................................1

       Telecommunication costs.....................................................................................................................3

       Telephone connection charges (business and residential) ...................................................................4

       Telephone monthly subscription charges (business and residential) .................................................11

       Cost of local 3 minute call at peak rate ..............................................................................................16

       Telephone connection charges versus the cost of local 3 minute call at peak rate ............................21

       Telephone monthly subscription charges versus the cost of local 3 minute call at peak rate............24

       Comparative costs per basket of calls per year..................................................................................28

   Selected telecommunication cost comparisons between South Africa and other countries ..................31

   Comparisons of demographics related to telecommunication between South Africa and other

   countries.................................................................................................................................................35

       International outgoing telephone traffic (minutes) per capita............................................................35

       Coverage of population (%)...............................................................................................................37

       DSL Internet subscriptions per 1 000 ................................................................................................38

       Internet users per 100 inhabitants ......................................................................................................39

       Main telephone lin es in operation per 100 inhabitants ......................................................................41

       Number of local telephone (minutes) per capita................................................................................42

       Number of national long distance telephone (minutes) per capita ....................................................43

       Telephone faults per 100 main lines ..................................................................................................45

       Summary of demographic comparisons .............................................................................................46
  Case studiesregarding past telecommunication charges and regulatory developments on economic

  performance – past and present ..............................................................................................................48

     Scenario One ......................................................................................................................................48

     Scenario Two .....................................................................................................................................52

     Scenario Three ...................................................................................................................................53

     CONCLUSION..................................................................................................................................54

A report on and comparison of Telkom’s financial statements wit a typical local company and a

report on and comparison of Telkom’s financial statements with selected international peers ......55

  Telkom SA Limited - Group Annual Results for the 12 months ending 31 March 2004 ......................55

     Human Capital Management .............................................................................................................58

     Current Share Price and Price/Earnings Ratio ...................................................................................59

     Directors Emoluments........................................................................................................................61

     Tariff Adjustments for 2004 ..............................................................................................................62

     The Regulatory Environment.............................................................................................................62

     Conclusion .........................................................................................................................................64

  A Financial Comparison of Telkom with its peers in New Zealand and Australia ...............................65

     Conclusion .........................................................................................................................................69

  Comparison of Telkom with the Standard Bank Group ........................................................................72

     Conclusion .........................................................................................................................................75
                                  EXECUTIVE SUMMARY


Efficient Research is a research company that offers independent and unbiased economic and
financial research.


Solidarity contracted Efficient Research to provide a condensed report on telecommunication
charges in South Africa as well as an analysis and comparison of Telkom’s financial
statements.


We conducted our research and concluded the report within a period of two weeks which is
totally insufficient to come to well researched conclusions. Furthermore, a general lack of
information as well as difficulties in comparability also hampered a clearer result.
Nevertheless, with our best efforts and with realistic assumptions we were able to come to a
preliminary conclusion regarding telecommunication costs in South Africa.


This report simulates three possible historic variables and discuss their outcomes. These
historic cases are typical “what if” analyses that explores the possible economic results that
different policies or decisions may have had on a number of economic aggregates.


Telkom’s financial analysis and the comparisons to other telecommunication companies, and
to a typical and comparable South African listed company, are more comprehensive (due to
the nature of the subjects) than the economic analysis. However, the financial analysis do
collaborate the economic findings.


Comparing South Africa’s telecommunication charges or costs to that of other countries,
South Africa is generally more expensive and price increases in recent years were also
generally higher than in most countries. In some cases telecommunication costs in South
Africa is extraordinarily high.


A certain telephony pricing strategy by Telkom was also identified and which corresponds to
countries like the UK and Australia. This strategy entails relatively low initial and recurring
costs but high operational costs. In general the populations of countries that follow such a
                                               i
strategy falls behinds their peers on demographic data related to telecommunications.
Generally, telecommunication companies following this price strategy are also less profitable.


Conversely countries like New Zealand and the USA, follow a strategy where the initial or
connection charges are high combined with relatively high recurring cost, but with relatively
low or even no operational costs. In these cases telecommunication demographics appear to
be superior to the demographic of countries utilizing a different price strategy.


The high cost of telecommunications in South Africa is further mirrored in demographic data.
Naturally the high cost of telecommunication has a large impact on demand. The inevitable
effect is that in South Africa, telecommunication connections and access is limited and that
the people in South Africa are increasingly finding themselves on the wrong side of the
digital divide.


We also ran three “what if” analyses which suggests that inflation and interest rates would
have been much lower today had telecommunication price increases been limited to the
average increase of selected countries. Approximately 67 000 new job opportunities would
have been created and economic growth would have been 0.06 % per annum higher.


In another “what if” analysis it was assumed that Telkom was 100% privatized in 2000. As a
result an additional approximately R50 billion would have been available to the authorities.
Assuming this amount was utilized exclusively to reduce state debt it would have resulted in
an interest expense saving of more than R6bn per year since 2000, apart from all the other
advantages of a liberalized telecommunications market.


Our analysis and comparisons of Telkom’s financial statements suggest a dramatically
improved expense curtailment over the past few years. Despite the obvious improvement
introduced by Telkom’s management, total expenses still compare unfavourably with other
telecommunication companies and with a comparable South Africa company. Telkom’s
profitability improved markedly mainly due to improved management.




                                               ii
To summarize, it must be concluded that          telecommunication costs in South Africa is
excessively high and that it is a major obstacle to economic growth, wealth creation and the
creation of employment opportunities. The management of Telkom is simply doing what
should be expected from a superior management team, namely to create wealth for the
shareholders. Much still needs to be done but much has been achieved.


The authorities missed out on many golden opportunities to liberalise telecommunications.
Today South Africa probably has the worst of all worlds regarding telecommunications. A
state owned monopoly was replaced by a privately owned monopoly. Furthermore, the part
privatization of Telkom was (correctly) used as an opportunity to empower thousands of
previously disadvantaged. This was a wonderful success, perhaps too successful. Allowing
competition now will inevitably affect Telkom’s profitability and may even result in a lower
price for Telkom shares.

The conclusions are:
   • Telecommunications in South Africa are expensive
   • and that the industry effects economic aggregates like inflation, interest rates and the
       GDP growth rate.
   • Telkom is not as efficient regarding Net Income as a percentage of Revenue as some
       of its international peers.

In order to determine fully the effect of telecommunications on the South African economy
and her people, and to assist in policy formulation, a comprehensive study covering the
following is suggested:
   • An international telecommunication costs comparisons,
   • The effect of telecommunications on economic performance,
   • Alternative pricing strategies and its effect on the social environment, economic
       aggregates and company profitability.
   • Accessibility of telecommunications to the people,
   • Levels of telecommunications empowerment and
   • Development of a benchmark to measure South Africa’s success in closing the digital
       divide.

                                               iii
AN       INTERNATIONAL               COMPARISON             OF        SOUTH         AFRICAN
TELECOMMUNICATION                COSTS       AND      THE      POSSIBLE        EFFECT    OF
TELECOMMUNICATIONS ON ECONOMIC PERFORMAN CE


Due to time constraints and a general lack of data the information presented in this first
section must be considered as approximates and as a general background to the rest of this
report. Note should be taken that the expected effect of telecommunications charges/costs on
economic aggregates are based on Efficient Research’s economic models and concomitant
assumptions regarding economic aggregates. Different assumptions may result in different
conclusions.


     SOUTH AFRICAN’S TELECOMMUNICATION COSTS: A COMPARISON


In this section selected telecommunication costs or charges in South Africa are compared to
similar charges abroad. The most recent available, and fairly complete, comparable
information is for the year 2002. In a number of instances we have updated South African
information to 2004, but basic comparisons are made with the 2002 data of a number of other
countries.


Conventionally, economic comparisons are most often in US dollars. However, large
fluctuations in the exchange rates of some currencies often render such comparisons
inadequate. In certain instances we provide information in local currencies.


To address the possibility of data distortions due to the effect of, amongst others, currency
fluctuations, we also include price comparisons based on purchasing power parity (PPP)
based on a standard basket.


It is important to realise that the telecommunication charges, structures, supply and demand
factors and official policies all differ from country to country. Comparing telecommunication
costs across borders are therefore flawed by all kinds of regulatory and other issues.




                                               1
Instead of aiming to prove that South Africa’s telecommunication costs differs markedly
from other countries, this section has as its singular objective the aim of putting South
African communications charges, compared to other countries, in perspective.


The graphical comparisons that follow are for the 2002 calendar year and for countries that
do have available data – in general they aim to:
   • Illustrate and rank the per capita GDP of different countries in US$ terms.
   • Illustrate and rank adjusted per capita GDP (adjusted for a purchasing power parity
       basis) on the horizontal axis. This is probably a better GDP comparison.
   • On the vertical (or Y axis), plot in US$ or in local currency the actual or percentage
       change in certain costs or charges.
   • Indicate how developed (rich) countries compare in terms of absolute, and changes in,
       telecommunication charges.
   • Provide data to show the South African position after taking the 2004’s currency value
       into consideration – even if such a comparison is not completely fair.
   • Provide a comparison of country size and development level. Both richer and
       countries in our sub-region are included.
   • Adjusted illustrative data for PPP in the different countries. For example, in PPP
       terms, South Africa’s cost of living in 2002 was 31.8 (US 100). Therefore, all product
       prices should be 31.8% of their dollar counterparts. As a simple consequence, prices
       above 31.8% of the US equivalent, in PPP terms, are expensive. During mid 2004 the
       PPP and the stronger ZAR currency resulted in a cost of living factor of 64.1 (US
       100).




                                              2
   Telecommunication costs


All telecommunication charges differ from country to country and a comparison may be open
to some measure of criticism. We will endeavour to fairly compare telecommunication
charges in South Africa with that of other countries. We relied heavily on the ITU 2004 data
but used other sources of information where possible. The text will indicate when and where
adjustments and/or refinements were made to raw data.


In this section, three telecommunication charges/costs items were compared. In general a
differentiation between business and residential (individual) charges were drawn on three
levels, initial charges, monthly recurring and operating charges.




                                               3
       Telephone connection charges (business and residential)


Definition:
Installation refers to the one time charge involved in applying for basic telephone service for
business/residential purposes. Where there are different charges for different exchange
areas, the charge is generally for the largest urban area unless otherwise noted.


                                                                                    Business telephone connection charge (US$) '02
                                                           600
                                                                                                                                                  Japan

                                                           540


                                                           480
              Business telephone connection charge (US$)




                                                           420


                                                           360
                                                                     Russia

                                                           300


                                                                                                    Kuwait
                                                           240


                                                           180                                                                       United Kingdom


                                                           120                                                   Australia

                                                                                                                                                              United States
                                                           60
                                                                                                   New Zealand                Germany
                                                                     South Africa
                                                            0                                                                                                  Switzerland
                                                                 0      5000           10000    15000      20000             25000        30000       35000          40000
                                                                                                        GDP per capita




The above scatter graph illustrates the per capita GDP in dollar terms of a number of
countries on the horizontal axis and compares relative wealth at prevailing exchange rates.
The vertical axis displays a business telephone connection charge in US$. South Africa is
grouped together with countries like Botswana, Namibia and Tunisia with similar per capita
GDP’s and business telephone connection costs in the bottom left hand corner.




                                                                                                             4
                                                                                     Residential telephone connection charge (US$)
                                                            600
                                                                                                                                                   Japan



                                                            500
            Residential telephone connection charge (US$)




                                                            400




                                                            300




                                                            200
                                                                      Russia



                                                                                                                  Australia           United Kingdom
                                                            100


                                                                                                                               Germany
                                                                                                                               France                              United States
                                                                      South Africa                  New Zealand
                                                              0                                                                                                     Switzerland
                                                                  0      5000         10000      15000      20000             25000        30000           35000          40000
                                                                                                         GDP per capita
           Source: ITU 2004




For residential connection charges a similar pattern emerges. South Africa is grouped
together with countries like Botswana, Namibia and Tunisia with similar per capita GDP’s
(and residential telephone connection costs – that is what the comparison shows) in the
bottom left hand corner.


Japan and Russia were significantly more expensive for both business and residential
connections while Kuwait and the UK were also significantly more expensive regarding
business connection costs. When these countries are excluded from the averages (because of
their high costs) a clearer picture emerges.




                                                                                                             5
                                                                     Business telephone connection charge (US$) adjusted for '02 PPP
                                                  1800



                                                  1600
                                                                                                            Zambia
     Business telephone connection charge (US$)


                                                  1400


                                                  1200


                                                                                                      Kenya
                                                  1000



                                                   800
                                                                                                                                                                              Japan


                                                   600



                                                   400                Russia                                                   Kuwait


                                                                                                                                                                 United Kingdom
                                                   200
                                                                                                                                           Australia
                                                                                                                                          Spain
                                                          Pakistan                   South Africa                                                             United States
                                                                                                                                                          France
                                                   South Africa '04
                                                    0                                                                                                                    Switzerland
                                                            0             5000         10000        15000        20000     25000           30000        35000      40000         45000
                                                                                                                  GDP per capita
Source: ITU 2004



                                                                      Business telephone connection charge (US$) adjusted for '02 PPP
                                                  260
                                                                                                             Czech Republic
                                                                                                                                                                United Kingdom
                                                  240

                                                  220
Business telephone connection charge (US$)




                                                  200

                                                  180

                                                  160                                                                                     Australia

                                                  140

                                                                                      Average
                                                  120

                                                                          Tunisia
                                                  100                                                                                   Israel
                                                                Nigeria

                                                  80
                                                                                    South Africa                                         New Zealand          United States
                                                        South Africa '04                                                                                  France
                                                  60                                                                                                   Germany
                                                                                                                              Greece
                                                  40

                                                  20

                                                   0                                                                                                                       Switzerland
                                                        0             5000            10000         15000        20000      25000         30000         35000      40000         45000
                                                                                                                  GDP per capita
Source: ITU 2004




                                                                                                                     6
                                                                      Residential telephone connection charge (US$) adjusted for '02 PPP
                                                            200

                                                                                                                        Kuwait
                                                            180


                                                            160
            Residential telephone connection charge (US$)

                                                                                                                                 Australia             United Kingdom
                                                                                                                                                            Ireland

                                                            140


                                                            120


                                                            100
                                                                                                  Average


                                                            80
                                                                               South Africa

                                                            60                                                                                France
                                                                               South Africa '04                                            Germany
                                                                                                                                 New Zealand

                                                                                                                                                     United States
                                                            40


                                                            20


                                                             0                                                                                                   Japan
                                                                                                                                                              Switzerland
                                                                  0     5000      10000       15000         20000      25000     30000       35000       40000      45000
                                                                                                             GDP per capita
           Source: ITU 2004




After adjusting the average, South Africa compares favourably with the average and peers in
terms of the connection charges for residential and business telephones in 2002. We are
cheaper than the average cost in US$ terms. When adjusted for the current exchange rate,
current costs are nearly double that of 2002 - but remains below the 2002 average.


Comparing costs of different countries are quite often distorted by exchange rate volatilities
and other structural differences. To adjust for such differences and to provide for a better
comparison, data can be adjusted to reflect purchasing power parity. When the connection
costs are so adjusted, the comparisons can be illustrated as follows:




                                                                                                               7
                                                                                                                   Business telephone connection charge (US$) adjusted for '02 PPP
                                                                                       1800



                                                                                       1600
                                                                                                                                                 Zambia
            Business telephone connection charge (US$)


                                                                                       1400



                                                                                       1200


                                                                                                                                              Kenya
                                                                                       1000


                                                                                                     800
                                                                                                                                                                                                                  Japan


                                                                                                     600


                                                                                                     400            Russia                                             Kuwait


                                                                                                                                                                                                     United Kingdom
                                                                                                     200
                                                                                                                                                                                 Australia
                                                                                                                                                                                Spain
                                                                                                            Pakistan
                                                                                                     South Africa '04        South Africa                                                          United States
                                                                                                                                                                                               France
                                                                                                      0                                                                                                      Switzerland
                                                                                                           0         5000      10000         15000        20000     25000        30000       35000     40000        45000
                                                                                                                                                           GDP per capita
            Source: ITU 2004



                                                                                                                   Residential telephone connection charge (US$) adjusted for '02 PPP
                                                                                                     1200



                                                                                                                                               Kenya
                                                                                                     1000
                                                     Residential telephone connection charge (US$)




                                                                                                      800




                                                                                                      600

                                                                                                                                                     Zambia


                                                                                                      400



                                                                                                                                                      Czech Republic
                                                                                                      200
                                                                                                                                                                                 Australia           United Kingdom
                                                                                                                                                                                                          Ireland

                                                                                                                              South Africa
                                                                                                                                                                                New Zealand France
                                                                                                                                                                                          Germany
                                                                                                                                                                                                United States
                                                                                                           0                                                                                                     Japan
                                                                                                                                                                                                               Switzerland
                                                                                                               0      5000      10000         15000       20000      25000       30000       35000     40000         45000
                                                                                                                                                           GDP per capita
            Source: ITU 2004




If the illustrated charges data of different countries are adjusted for PPP, both South Africa’s
(and many other countries’) per capita GDP and business connection charges “increases”
strongly.




                                                                                                                                                              8
South Africa seems to compare fairly well with most countries in terms of connection
charges. However, as illustrated, the connection charges of a few countries, in PPP terms, are
exceptionally expensive. When the countries on the extremes (in the case of business
connection charges Japan, Kenya, Russia, Kuwait and Zambia; in the case of residential
connection charges Kenya, Zambia and the Czech Republic) are excluded, South Africa’s
costs remain below the adjusted average.


                                                                        Business telephone connection charge (US$) adjusted for '02 PPP
                                                        260
                                                                                                             Czech Republic
                                                                                                                                                              United Kingdom
                                                        240

                                                        220
           Business telephone connection charge (US$)




                                                        200

                                                        180

                                                        160                                                                              Australia

                                                        140

                                                                                        Average
                                                        120

                                                                            Tunisia
                                                        100                                                                            Israel
                                                                  Nigeria

                                                        80
                                                                                      South Africa                                      New Zealand         United States
                                                              South Africa '04                                                                          France
                                                        60                                                                                           Germany
                                                                                                                              Greece
                                                        40

                                                        20

                                                         0                                                                                                               Switzerland
                                                              0         5000            10000        15000       20000      25000        30000        35000      40000         45000
                                                                                                                  GDP per capita
           Source: ITU 2004




                                                                                                                     9
                                                                       Residential telephone connection charge (US$) adjusted for '02 PPP
                                                             200

                                                                                                                        Kuwait
                                                             180


                                                             160
             Residential telephone connection charge (US$)

                                                                                                                                 Australia             United Kingdom
                                                                                                                                                            Ireland

                                                             140


                                                             120


                                                             100
                                                                                                   Average


                                                             80
                                                                                South Africa

                                                             60                                                                               France
                                                                                South Africa '04                                           Germany
                                                                                                                                 New Zealand

                                                                                                                                                     United States
                                                             40


                                                             20


                                                              0                                                                                                 Japan
                                                                                                                                                              Switzerland
                                                                   0     5000      10000       15000         20000     25000     30000       35000       40000      45000
                                                                                                              GDP per capita
            Source: ITU 2004




If the South African data is further adjusted for the actual 2004 costs and PPP, South Africa’s
business connection charges drop further. Clearly, South Africa’s business and residential
telephone connection charges were (and probably still are) lower than most countries. Since
this is a once-off charge it is unlikely to have a significant impact on total telecommunication
charges and does not present a significant access barrier to telecommunication services.




                                                                                                              10
       Telephone monthly subscription charges (business and residential)


Definition:
Telephone mo nthly subscription refers to the recurring fixed charge for business/residential
subscribers to the PSTN. The charge should cover the rental of the line but not the rental of
the terminal (e.g., telephone set) where the terminal equipment market is liberalized. In some
cases, the rental charge includes an allowance for free or reduced rate call units. If there are
different charges for different exchange areas, the largest urban area is used.


                                                                                         Business telephone monthly subscription (US$)
                                                               45
                                                                                                                                                           United States

                                                               40
               Business telephone monthly subscription (US$)




                                                               35



                                                               30
                                                                                                        New Zealand

                                                               25
                                                                                                                                       United Kingdom

                                                                                                                                                   Japan
                                                               20
                                                                                                                      Australia
                                                                               South Africa '04                                                             Switzerland
                                                               15
                                                                                                                                  France

                                                                        Average                                                   Germany
                                                               10
                                                                          South Africa

                                                                5



                                                                0
                                                                    0                                          20000                                              40000
                                                                                                            GDP per capita
              Source: ITU 2004




                                                                                                                11
                                                                                   Residential monthly telephone subscription (US$)
                                                               25

                                                                                                                                                           United States

            Residential monthly telephone subscription (US$)

                                                               20


                                                                                                     New Zealand
                                                                                                                                                            Switzerland
                                                               15
                                                                                                                                   United Kingdom
                                                                                                                                               Japan

                                                                             South Africa '04
                                                                                                                   Australia France
                                                                                                                             Germany
                                                               10


                                                                                       Average

                                                                        South Africa

                                                               5




                                                               0
                                                                    0      5000           10000   15000      20000         25000        30000      35000          40000
                                                                                                          GDP per capita
           Source: ITU 2004




The above scatter graphs illustrate the per capita GDP in dollar terms of a number of
countries on the horizontal axis. On the vertical axis the telephone monthly subscription
charge is measured in US$.


As indicated by the definition, some rental charges include an allowance for free or reduced-
rate call units. It should therefore be more useful to compare this cost with call rates (see
below).


South Africa is grouped with countries with similar sized GDP’s and per capita GDP’s like
Botswana, Namibia and Tunisia. The scatter graph shows that South Africa’s business and
residential telephone subscription charges are generally higher than its peers.


In general, South African charges in 2002 compared well with the average, but appear to be
more expensive when measured against its GDP peers. Plotting South Africa’s subscription
charges for 2004 at the current exchange rate indicates a value significantly higher than the
2002 charge and higher than the average. South African telephone subscription charges are
clearly more expensive than comparable sized countries but compares well with the charges
of developed countries.

                                                                                                            12
                                                                                              Business telephone monthly subscription (US$) Adjusted for '02 PPP
                                                                                  240
                                                                                                                          Kenya



                                                                                  200
            Business telephone monthly subscription (US$)




                                                                                  160




                                                                                  120

                                                                                                                             Zambia


                                                                                   80




                                                                                                                                                                              United States
                                                                                   40
                                                                                                                                                  Kuwait                         United Kingdom
                                                                                                          South Africa           Czech Republic                                       Ireland
                                                                                                                                                           Australia
                                                                                                                                                                          France          Switzerland
                                                                                                                                                                       Germany
                                                                                                 Russia
                                                                                            Nigeria
                                                                                    0
                                                                                        0         5000      10000        15000       20000     25000       30000        35000       40000      45000
                                                                                                                                      GDP per capita
          Source: ITU 2004



                                                                                             Residential monthly telephone subscription (US$) Adjusted for '02 PPP
                                                                                  250


                                                                                                                           Kenya
                               Residential monthly telephone subscription (US$)




                                                                                  200




                                                                                  150




                                                                                  100




                                                                                   50                                        Zambia

                                                                                                                                                           New Zealand
                                                                                                                                                                                      Ireland
                                                                                                                                                                              United States
                                                                                                          South Africa                                     Australia      France United Kingdom
                                                                                                                                                                                              Japan
                                                                                                                                                                                          Switzerland
                                                                                                                                                                       Germany

                                                                                    0
                                                                                        0         5000       10000       15000        20000      25000     30000         35000      40000       45000
                                                                                                                                       GDP per capita
           Source: ITU 2004




When adjusted for PPP, both South Africa’s (and many other countries’) per capita GDP and
telephone monthly subscription charges increased very strongly.




                                                                                                                                        13
                                                                               Business telephone monthly subscription (US$) Adjusted for '02 PPP
                                                                  55
                                                                                                                                         New Zealand
                                                                  50


                                                                  45
                  Business telephone monthly subscription (US$)

                                                                                                                                                            United States

                                                                  40


                                                                  35
                                                                                                                                                                United Kingdom
                                                                                                                                Kuwait
                                                                  30
                                                                                                              Czech Republic
                                                                                        South Africa                                                                Ireland
                                                                    South Africa '04                                                      Australia
                                                                  25
                                                                                                    Average

                                                                  20                                                                                     France
                                                                                                                                                                       Switzerland
                                                                  15                                                                                  Germany


                                                                  10
                                                                               Russia
                                                                   5       Nigeria


                                                                   0
                                                                       0                                                    25000                                                        50000
                                                                                                                         GDP per capita
           Source: ITU 2004



                                                                             Residential monthly telephone subscription (US$) Adjusted for '02 PPP
                                                                  35
                                                                                                                                                New Zealand


                                                                  30
            Residential monthly telephone subscription (US$)




                                                                                                                                                                               Ireland
                                                                  25
                                                                                                                                                                      United States


                                                                  20                     South Africa                                                                      United Kingdom
                                                                                                                                                                                      Japan
                                                                                                                                                                                   Switzerland
                                                                                                              Average                                             France
                                                                                                                                                Australia
                                                                                        South Africa '04
                                                                  15                                                                                        Germany




                                                                  10




                                                                   5




                                                                   0
                                                                       0         5000       10000        15000          20000     25000          30000        35000           40000      45000
                                                                                                                         GDP per capita
           Source: ITU 2004




If countries with extreme charges (e.g. the business and residential charges of Kenya and
Zambia) are excluded, and after PPP adjustment, costs in South Africa’s are higher than the
adjusted average. If the South African charges data is further adjusted for the actual 2004
costs and PPP, our subscription charges drops to just below the adjusted average.



                                                                                                                           14
In PPP terms South Africa’s subscription charges are marginally higher than most, vis-à-vis
South Africa’s initial connection charges which are relatively low compared to other
countries.


Connection, subscription and non-operating charges are important revenue items for
telecommunication companies. However, the relative importance of these items can differ
markedly between companies. In the case of Telkom it contributes approximately 16.5% of
total fixed line revenue.




                                            15
       Cost of local 3 minute call at peak rate


Definition:
Local call refers to the cost of a peak rate 3-minute call within the same exchange area using
the subscriber's own terminal (i.e., not from a public telephone).


                                                                                            Cost of a local 3 minute call (peak rate $)
                                                             0.21       Uganda



                                                             0.18                                                                       United Kingdom
               Cost of a local 3 minute call (peak rate $)




                                                                                  South Africa '04                                                                  Switzerland
                                                             0.15
                                                                                                                                                     Ireland


                                                                                                                                   France
                                                             0.12                                                      Australia



                                                                            South Africa                                           Germany
                                                             0.09

                                                                                                           Average
                                                                                                                                                     Japan
                                                             0.06




                                                             0.03




                                                               0                                          New Zealand                                              United States
                                                                    0            5000        10000     15000       20000       25000         30000         35000          40000
                                                                                                              GDP per capita
              Source: ITU 2004




On the vertical axis the cost of a local 3 minute call at peak rate is measured in US$. South
Africa is grouped together with countries like Kenya and Zambia with similar per capita
GDP’s but South Africa’s cost of a local 3 minute call at peak rate is clearly more expensive
with a few exceptions, most notably Uganda which is exceptionally expensive.


South Africa compared poorly with the average and its GDP peers in terms of the cost of a
local 3 minute call in 2002. If the current cost (2004) and exchange rate is taken into account
the cost (of a local 3 minute call) increases significantly to well above the 2002 average. The
cost of a South African telephone call is more comparable to that of richer countries. In fact,
bar Uganda, the UK and Switzerland, South Africa’s local 3 minute call rates appear to be the
most expensive in the world in 2004 US$ terms.


                                                                                                               16
                                                                                                           Cost of a local 3 minute call (peak rate $) adjusted for '02 PPP
                                                                                        4.5

                                                                                                                                             Zambia
                                                                                         4


                                                                                        3.5
            Cost of a local 3 minute call (peak rate $)



                                                                                                                                          Kenya


                                                                                         3


                                                                                        2.5



                                                                                         2



                                                                                        1.5



                                                                                         1



                                                                                        0.5
                                                                                                                     South Africa                Czech Republic                                 United Kingdom
                                                                                                                                                                                       Germany           Switzerland
                                                                                                                                                                                                            Japan
                                                                                         0                                                                                                    United States
                                                                                              0            5000            10000         15000       20000      25000      30000        35000      40000       45000
                                                                                                                                                      GDP per capita
           Source: ITU 2004




Adjusted for PPP, the SA comparison deteriorates considerably. However, both Kenya and
Zambia are significantly more expensive than even South Africa.


                                                                                                            Cost of a local 3 minute call (peak rate $) adjusted for '02 PPP
                                                                                         0.32
                                                                                                                                                  Czech Republic
                                                                                                                          South Africa
                                                                                         0.28


                                                                                                                                                                                                  UK
                                          Cost of a local 3 minute call (peak rate $)




                                                                                         0.24
                                                                                                                      South Africa '04



                                                                                          0.2

                                                                                                                             Average                                                     France        Ireland
                                                                                                                                                                                                            Switzerland
                                                                                                                                                                           Australia
                                                                                         0.16

                                                                                                      Nigeria
                                                                                                                                                                                       Germany
                                                                                         0.12


                                                                                                                                                                    Taiwan, China                             Japan
                                                                                         0.08



                                                                                         0.04                   Tunisia



                                                                                              0            Russia                                                                             United States
                                                                                                  0                                                   20000                                        40000
                                                                                                                                                       GDP per capita
           Source: ITU 2004




                                                                                                                                                        17
If averages are adjusted (sans Kenya and Zambia), South African charges are significantly
higher than that of the adjusted average. In fact, in 2002 South Africa was the most expensive
country, bar the Czech Republic (and Kenya and Zambia). When adjusted to 2004 the cost of
a 3 minute call remains excessively expensive in South Africa albeit slightly lower than in
2002.




                                             18
Telephony pricing strategies


Two basic pricing strategies by telecommunication companies have already become clear
after only a few comparisons. The first pricing strategy is to grow their client base by offering
low initial or connection charges and low recurring subscription charges. The sting in the tail
is relatively high operating (call) charges. The second pricing strategy is to charge relatively
high initial (or connection) and subscription charges followed by low (or no) operating
charges.


The first strategy will encourage the general public and enterprises to acquire access to
telephony, but will discourage frequent use because of the relative high call cost. Units of
consumption will not decrease in average price over time, but will be closely correlated with
call charges. Strategy one has an unintended disadvantage – higher levels of bad debt and
collection expenses.


Telephone companies following this pricing strategy will endeavour to maximise revenue
(and therefore profit) over the longer term by the high unit cost of consumption. In contrast,
consumers will limit consumption. This policy is probably more harmful to the economy as a
whole compared to strategy two.


The second pricing strategy will encourage both actions, to acquire access to, and utilize the
facility as frequently as possible or necessary. The underlying principle is that the higher
initial and subscription charge will be spread over a large number of inexpensive calls over a
long time period. Units of consumption will decrease in average price over time. Because of
the price structure of the product it is unlikely that higher connection and subscription
charges will influence the volume consumed. In fact, the higher the consumption the better,
since marginal cost to the consumer decreases as consumption increases. Strategy number
                                                         e
two has an unintended advantage. Because the initial and r curring charges are high and
operating costs are low, consumers will be loath to loose their facility through non-payment
of bills. In fact, because call cost are low, bad debts and collection expenses are probably also
low.


                                               19
Telephone companies following this pricing strategy will endeavour to maximise revenue
(and therefore profit) over the longer term by high entry charges and high volumes of
connections. In contrast to the price strategy one, consumers will not limit consumption, but
will seek to maximise current consumption.


The two strategies are direct derivatives of what individual telecommunication companies
expect will make them profitable - given the size of their market.


By inspection the two strategies are clearly visible in the attendant scatter graphs. Certain
countries have a higher (than the norm) initial charge (connection and subscription) while
operating costs (calls) may be lower than the norm. Developed nations are mostly of the
strategy two pricing type, while poorer or developing nations are more often of the strategy
one type. From an economic growth point of view, the second pricing strategy is probably
more conducive to economic growth and is indeed associated with developed economies.


Moreover, it seems to be a common pricing strategy to discriminate between commercial and
residential business in favour of residents in terms of connection and subscription charges.


A comparison of initial and subscription (e.g. monthly) fixed charges and operating costs
(cost of a 3 minute call) may provide a better indication of South Africa’s pricing policy and
comparative competitive position.




                                              20
       Telephone connection charges versus the cost of local 3 minute call at peak rate


                                                                                                           Business telephone connection charge (US$) '02
                                                          180
                                                                                                                                                                                           United Kingdom

                                                          160
            Business telephone connection charge (US$)




                                                          140



                                                          120
                                                                                                                                                                        Australia

                                                          100



                                                                              80



                                                                              60


                                                                              40                                                                      Germany                                  South Africa '04


                                                                                                                                                     South Africa
                                                                              20



                                                                               0                                                                                                                Switzerland
                                                                                    0           0.02         0.04           0.06        0.08           0.1           0.12           0.14        0.16        0.18
                                                                                                                                    Cost of a local 3 minute call
            Source: ITU 2004



                                                                                                                Residential telephone connection charge (US$)
                                                                              160


                                                                                            Iran (Islamic Rep. of)
                                                                              140
                              Residential telephone connection charge (US$)




                                                                              120
                                                                                                                                                         Australia                         United Kingdom

                                                                              100



                                                                               80



                                                                               60


                                                                                        United States                                   Germany          France             South Africa '04
                                                                               40

                                                                                        New Zealand
                                                                                                                                        South Africa
                                                                               20



                                                                                0                                             Japan                                         Switzerland
                                                                                    0         0.02       0.04        0.06       0.08       0.1        0.12       0.14        0.16       0.18        0.2       0.22
                                                                                                                                    Cost of a local 3 minute call
                          Source: ITU 2004




By inspection, South Africa’s telephony service provider probably follows pricing strategy
one - connection charges for business and residential use are relatively low while call charges
are relatively high.

                                                                                                                                            21
It is interesting to note that both Australia and the United Kingdom score high on business
and residential connection charges as well as the cost of a 3 minute call.


Even when these costs are adjusted for purchasing power, South Africa’s position in relation
to other countries hardly changes. Se e the two scatter graphs below. Our calls are, by
comparison, expensive, in fact, bar the Czech Republic, the most expensive on a PPP basis.


                                                                      Business telephone connection charge (US$) adjusted for '02 PPP
                                                          260
                                                                                                                                                         Czech Republic
                                                                                                                                          United Kingdom
                                                          240

                                                          220
             Business telephone connection charge (US$)




                                                          200

                                                          180
                                                                                      Taiwan, China
                                                          160                                               Australia

                                                          140
                                                                                                                               Portugal
                                                          120

                                                          100

                                                           80
                                                                United States                                                                          South Africa
                                                                                                                France             South Africa '04
                                                           60

                                                           40

                                                           20

                                                            0                                                Switzerland
                                                            0.00            0.05     0.10         0.15              0.20             0.25             0.30            0.35
                                                                                                Cost of a local 3minute call
            Source: ITU 2004




                                                                                                       22
                                                                   Residential telephone connection charge (US$) adjusted for '02 PPP
                                                200

                                                          Kuwait
                                                180


                                                160
Residential telephone connection charge (US$)


                                                                                                   Australia              United Kingdom


                                                140


                                                120


                                                100


                                                 80
                                                                                                                                           South Africa

                                                 60                                                  France
                                                                                        Germany                       South Africa '04
                                                          New Zealand

                                                          United States
                                                 40


                                                 20


                                                  0       Russia                Japan             Switzerland
                                                      0              0.05       0.1       0.15           0.2           0.25          0.3             0.35   0.4
                                                                                            Cost of a local 3 minute call
Source: ITU 2004




                                                                                                     23
Telephone monthly subscription charges vers us the cost of local 3 minute call at peak
rate


Subscription charges are probably a better gauge to determine the pricing policies and
strategies of telephony service providers. Subscription is a recurring charge, usually monthly,
and as a rule contribut es significantly to the total revenue of most telephony companies.


In the scatter graphs below subscription cost is compared to the cost of a local peak hour call
in a number of countries. Intuitively, and in line with the basic pricing strategies identified,
countries with a high cost per call will have a low subscription cost.


                                                                                        Business telephone monthly subscription (US$)
                                                             45
                                                                      United States

                                                             40
             Business telephone monthly subscription (US$)




                                                             35



                                                             30
                                                                                      New Zealand

                                                             25
                                                                                                                                            United Kingdom

                                                                             Japan
                                                             20
                                                                                                                             Australia
                                                                                                                                               South Africa '04
                                                             15
                                                                                                                                France

                                                                                         Average                Germany
                                                             10
                                                                                                                          South Africa

                                                             5                                                                                                    Uganda



                                                             0
                                                                  0         0.02       0.04    0.06   0.08      0.1        0.12      0.14        0.16     0.18      0.2    0.22
                                                                                                         Cost of a local 3 minute call
            Source: ITU 2004




                                                                                                                 24
                                                                                          Residential monthly telephone subscription (US$)
                                                                25

                                                                         United States


             Residential monthly telephone subscription (US$)
                                                                20


                                                                         New Zealand

                                                                                                                                                   Switzerland
                                                                15
                                                                                                           Japan                                                    United Kingdom

                                                                                                                                                   South Africa '04
                                                                                                                                    Australia
                                                                                                                                    France
                                                                                                                    Germany
                                                                10

                                                                         Kuwait
                                                                                            Average

                                                                                                                    South Africa
                                                                                                                                                                        Uganda
                                                                 5




                                                                 0           Iran (Islamic Rep. of)
                                                                     0         0.02       0.04      0.06    0.08       0.1        0.12      0.14    0.16         0.18     0.2        0.22
                                                                                                                Cost of a local 3 minute call
           Source: ITU 2004




Intuition seems to have been correct. The US, Japan and New Zealand seem to have a pricing
strategy whereby business subscription charges are high but call costs (operating costs) are
low. The UK, South Africa and Australia follow a pricing strategy of lower subscription
charges coupled with higher call charges. These different pricing strategies will probably lead
to a higher consumption in countries like the US and New Zealand than in countries like SA
en the UK (see below). It also appears as if the pricing strategy two, contributes to a better
return on equity than pricing strategy one. (See our comparison of the financial statements of
a New Zealand and an Australian company below.)


Nevertheless, countries that are the furthest away from the origin on both axes are those
countries which are the most expensive in terms of subscription and call costs. The UK,
South Africa, Ireland and Australia are generally the most expensive in terms of this
measurement.


Countries like the USA, Japan and New Zealand rate high on the subscription scale but very
low on the call cost scale – very typical of the pricing strategy two approach. For example,
the cost of maintaining a telephone connection in the USA without making any telephone
calls will be much more expensive than in a country like Uganda or South Africa.

                                                                                                                        25
The difference lies in the pricing strategies of countries close to the vertical axes (like the
USA) compared to countries close to the horizontal axis (like Uganda). The pricing strategy
in the USA is clearly focused on increasing the number of connections while other countries
like Tunisia focuses on increasing the number of calls. The probable result is a large number
of connections in one country (USA) and fewer connections in other (SA). See the relevant
demographic comparison below.


                                                                      Business telephone monthly subscription (US$) Adjusted for '02 PPP
                                                            55
                                                                 New Zealand
                                                            50


                                                            45
            Business telephone monthly subscription (US$)




                                                                 United States

                                                            40


                                                            35
                                                                                                                                                 United Kingdom

                                                            30
                                                                                                                                                 Czech Republic
                                                                                                                                                 South Africa
                                                            25                                     South Africa '04       Australia
                                                                                  Average

                                                            20                                                                France


                                                            15                                               Germany


                                                            10
                                                                 Russia
                                                            5


                                                            0
                                                             0.00          0.04             0.08       0.12          0.16          0.20   0.24         0.28       0.32
                                                                                                         Cost of a local 3 minute call
           Source: ITU 2004




                                                                                                                 26
                                                                       Residential monthly telephone subscription (US$) Adjusted for '02 PPP
                                                               35
                                                                    New Zealand

            Residential monthly telephone subscription (US$)   30


                                                                                                                                      Ireland
                                                               25
                                                                    United States


                                                               20                                                                           United Kingdom                South Africa
                                                                                                     Japan
                                                                                                                                   Switzerland
                                                                                                                                      France
                                                                                                                                   Australia
                                                                                                                                                       South Africa '04
                                                               15                                                   Germany


                                                                                                             Average

                                                               10




                                                               5
                                                                                    Tunisia


                                                               0
                                                                0.00          0.04            0.08           0.12           0.16           0.20       0.24         0.28           0.32
                                                                                                                Cost of a local 3 minute call
           Source: ITU 2004




If adjusted for PPP South Africa shifts further away from the origin and illustrates that calls
in SA are more expensive than most on a PPP basis. However, when adjusted for 2004 PPP
values, South Africa’s business telephone subscription charges fall in relative terms and
become more competitive. In the case of residential subscription charges South Africa
remains rather expensive, in fact the most expensive in the world in 2002 and, bar the UK,
also in 2004 terms!




                                                                                                                        27
Comparative costs per basket of calls per year


                                                                                 Total cost for the year US$
                                        0.7



                                        0.6
                                                                                                                                        6000 '04


                                                          1500 '04            2700 '02
                                        0.5
                                                                                    3000 '04                           5100 '02     Average South
                                                                                                                                    Africa usage 2004
              Total cost for the year




                                                                                                                                    6800
                                        0.4




                                        0.3



                                        0.2




                                        0.1



                                         0
                                         1000         1500      2000   2500      3000        3500    4000   4500    5000     5500    6000     6500      7000
                                                                                                  Minutes
                                              Australia      New Zealand      South Africa      United Kingdom     United States    South Africa '04
            Source: ITU 2004




The above illustration continues to labour on the different price strategies that have been
identified. The diagram represents a “basket” of costs comprising connection-, subscription-
and operational costs. The data is for 2002, while the cost in South Africa for 2004 is also
included.


The “basket” consist of, on the vertical axes, a once of initial connection costs, a monthly
subscription cost annualised and the call charge per minute. Put differently, on the vertical
axe s the total average cost per minute is illustrated in US$ terms. The number of minutes
called is illustrated on the horizontal axes.


The graph illustrates that the fixed costs per call minute (connection and subscription costs)
fall as call minutes increase. However, the cost per minute remains unchanged irrespective of
the number of call minutes. The result is a falling marginal cost per minute. Countries with
higher fixed costs (connection and subscription) will start “highest” on the vertical axes while
the graphs of countries with the lowest call costs will “fall” fastest.


                                                                                                    28
Note: South Africa's average annual minutes consumed per line is approximately 6800
minutes per annum.


In the graph the marginal cost of a one minute call in South Africa equals that of New
Zealand at 2 700 minutes and the US at 5100 minutes in terms of 2002’s data. Compared to
the UK and Australia, South Africa was cheaper irrespective of the number of calls.


In terms of 2004’s data, South Africa’s cost per minute increased and surpassed the US
(3 000 minutes) and New Zealand (1 500 minutes) and equalled Australia (6 000 minutes).
However, when South Africa’s 2004 data is compared with the UK’s 2002 data, South Africa
remains cheaper per call than in the UK.


                                                                                              Total cost for the year adjusted for '02 PPP
                                                             1.6



                                                             1.4
                                                                         600 '02                                        3500 '04
              Total cost for the year adjusted for '02 PPP




                                                             1.2
                                                                          700 '02         1600 '04

                                                                                   1100 '02      2000 '04                                                         6000 '02
                                                              1
                                                                                                                                                            Average South
                                                                                                                                                            Africa usage 2004
                                                                                                                                                            6800
                                                             0.8



                                                             0.6



                                                             0.4



                                                             0.2



                                                              0
                                                                   500      1000      1500    2000    2500   3000     3500   4000   4500    5000     5500     6000    6500       7000
                                                                                                                        Minutes
                                                                    Australia          New Zealand     South Africa    United Kingdom      United States      South Africa '04
            Source: ITU 2004




Adjusted for PPP, the situation worsens for South Africa. At the average annual consumption
of just less than 7 000 minutes only the UK is more expensive than South Africa in PPP
terms. On this measure, the UK remains more expensive than South Africa seeing that their
cost per 3 minute call is higher than in South Africa.




                                                                                                                      29
In conclusion it can be summarised that South Africa’s telephony charges per minute exceed
that of most countries in US$ terms and in PPP terms. The only other country that is more
expensive is the UK.




                                           30
Selected telecommunication cost comparisons between South Africa and other countries


The previous section provided a general comparison between the telecommunication costs of
countries. In general the conclusion can be made that South Africa is relatively expensive,
especially if adjusted for PPP.


This section examines another approach to the comparison of international telephony costs.
                                                                                   all
The histogram below compares the average increase in connection, subscriptions and c
costs of selected countries, all in US$ terms.



                                               Average increases since 1995 - 2002
                        16

                        14

                        12

                        10

                         8

                         6
            Average %




                         4

                         2

                         0

                        -2

                        -4

                        -6

                        -8
                             Aus   Bot   Fra     Ger   India   Ken   Moz   NZ    SA   UK   US   Avg
           Source: ITU 2004




Over the period 1995-2002, high increases in costs were reported for Mozambique, Kenya
and South Africa. Certain countries, particularly developed countries, actually reported
declines in such costs. Currency fluctuations obviously do affect the data. Some countries,
like South Africa, experienced sharp depreciations in the value of their currencies over the
period. If charges are adjusted for the currency depreciation, South Africa is a good example,
such charges will be higher.




                                                                31
The charge items in the basket were, for the sake of simplicity, assigned equal weights for
this calculation. On this basis, equal weights of charges, the cost increases of South African
telephony are generally higher than in most countries over the review period. This higher
than average increase in charges is also reflected in South Africa’s inflation data.


A better comparison of actual cost is probably represented in the histogram below which
illustrates a basket of telephony products for a business consumer in Australia, Mexico, New
Zealand, South Africa, the UK and the USA. It consists of the initial connection cost,
monthly subscription cost for a year and calls totalling 6 800 minutes calls per year (the
average usage during 2004 in South Africa). The data is presented in US$ and currency
fluctuations can obviously affect the comparisons.



                                                                            Cost of a basket of goods
                                            7500

                                            7000
                                            6500

                                            6000
                                            5500
            Cost of a basket of goods US$




                                            5000
                                            4500

                                            4000

                                            3500
                                            3000

                                            2500

                                            2000
                                            1500

                                            1000
                                             500

                                               0
                                                   1994       1995    1996    1997      1998       1999    2000      2001      2002   02 PPP
                                                      Australia Mexico   New Zealand   South Africa United Kingdom    United States
           Source: ITU 2004




The data suggests that South Africa compares well with Australia, Mexico and the UK but
seems to be more expensive than New Zealand and the US. On a PPP basis the basket is
marginally more expensive in South Africa than in the UK while it is considerably more
expensive than in Australia, New Zealand, UK and USA. Only Mexico was more expensive
than South Africa on a PPP basis.


                                                                                         32
The above comparison is further elucidated if the same data is presented as an annual
percentage change. Not only were South Africa’s annual percentage increases larger than that
of the other countries which on average experienced a decrease in charges over the period.


                                                                                      Cost of a basket of goods
                                                    35
                                                    30
                                                    25
                                                    20
           Cost of a basket of goods US$ % change




                                                    15
                                                    10
                                                     5
                                                     0
                                                     -5
                                                    -10
                                                    -15
                                                    -20
                                                    -25
                                                    -30
                                                    -35
                                                    -40
                                                    -45
                                                    -50
                                                    -55
                                                          1995     1996        1997       1998       1999          2000      2001       2002         Average

                                                                 Australia   Mexico   New Zealand   South Africa    United Kingdom   United States
           Source: ITU 2004




The illustrations suggest that telecommunication costs in South Africa are relatively high and
rising while costs in other countries are mostly lower than in South Africa and falling!


Information regarding data services and the cost thereof is hard to come by and in most cases
not fully comparable. However, data transfer is becoming ever more important as economies
develop. Revenue from data services are also becoming a more important revenue source for
telecommunication companies in general.




                                                                                                    33
                                                                          Cost of 24 month 3 GB ADSL contract
                                               12000
                                                        2 GB limit


                                               10000
                                                                                                                Unlimited
            Cost of 24 month ADSL contract R




                                                8000

                                                                                                                                           Unlimited

                                                6000                                                                           Unlimited


                                                                                                   15 GB
                                                4000                                               limit




                                                2000




                                                   0
                                                       Australia     New Zeeland   South Africa    UK British    US NY         Singapore     Mexico
                                                        Telstra       Telecom        Telkom        telecom      Bellatlantic     Singtel     Telmex




The histogram illustrates the annual subscription cost of a 3 GB ADSL contract in different
countries. This data is for 2004 and was compiled from web page data of the different
companies. The data is in South African rands. South Africa’s data service costs are
significantly more expensive than all the countries with the possible exception of Australia
which is less expensive but is limited to 2GB. Most of t he other countries are cheaper with an
unlimited bandwidth. The only conclusion is that South Africa’s data service charge is
significantly more expensive than most (if not all) other countries.




                                                                                                  34
Comparisons of demographics related to telecommunication be tween South Africa and
other countries


From the analysis above it is quite clear that South Africa’s telecommunication costs in
general exceed that of most developed and developing countries. Obviously cost is an
important factor in the consumption of telecommunication services. Intuitively, since South
Africa’s telecommunication costs are relatively expensive one would expect demographic
data to suggest that South Africa’s use of telecommunication services compare unsatisfactory
with most countries. The following illustrations will shed some light.


       International outgoing telephone traffic (minutes) per capita


Definition:
This covers the effective (completed) traffic originating in a given country to destinations
outside that country. Expressed in number of minutes of traffic.


                                                                                 International outgoing telephone traffic (minutes) per capita
                                                                    360                                                                           Ireland


                                                                    320
               International outgoing telephone traffic (minutes)




                                                                    280


                                                                                                        New Zealand
                                                                    240



                                                                    200

                                                                                                          Israel
                                                                    160
                                                                                                                                      United Kingdom
                                                                                                                                                                United States

                                                                    120                                                        Germany



                                                                    80                                                         France


                                                                    40
                                                                                                                                                  Japan
                                                                              South Africa
                                                                     0
                                                                          0      5000        10000   15000       20000        25000       30000         35000          40000
                                                                                                             GDP per capita
              Source: ITU 2004




                                                                                                               35
Adjusted for extreme data points, the following results.


                                                                              International outgoing telephone traffic (minutes) per capita
                                                                 160
                                                                                                                                        United Kingdom

                                                                 140                                                                                             United States
            International outgoing telephone traffic (minutes)




                                                                                                                                 Germany
                                                                 120



                                                                 100



                                                                 80                                                              France



                                                                 60



                                                                 40



                                                                 20        Tunisia                                                                  Japan
                                                                                     Mexico
                                                                           South Africa           Argentina
                                                                           Russia
                                                                  0
                                                                       0      5000        10000        15000       20000        25000       30000        35000          40000
                                                                                                               GDP per capita
           Source: ITU 2004




                                                                                                                 36
       Coverage of population (%)


Definition:
Mobile cellular coverage of population in percent. Note that this is not the same as the
mobile subscription density or penetration. The mobile population coverage measures the
percentage of inhabitants that are within range of a mobile cellular signal whether or not
they are subscribers. This is calculated by dividing the number of inhabitants within range of
a mobile cellular signal by the total population.


                                                                             Coverage of population (%)
                                            100                                                            Germany           Japan        Switzerland
                                                                                   New Zealand Australia
                                                      South Africa                                                                       United States

                                            90




                                            80
               Coverage of population (%)




                                            70




                                            60




                                            50




                                            40




                                            30
                                                  0      5000        10000      15000       20000        25000       30000       35000          40000
                                                                                        GDP per capita
              Source: ITU 2004




                                                                                          37
       DSL Internet subscriptions per 1 000


Definition:
Internet subscribers using Digital Subscriber Line (DSL) technology. Speed should be
greater than 128kbps in at least one direction. Internet subscribers using Digital Subscriber
Line (DSL) technology. Speed should be greater than 128kbps in any direction.


                                                                               DSL Internet subscribers per 1000
                                                   1000




                                                                                Korea (Rep. of)
                                                   100
                                                                                      Taiwan, China
                                                                                                                                         Japan
               DSL Internet subscribers per 1000




                                                                                                                       Germany
                                                                                                  Spain                                                Switzerland
                                                                                                                       France                         United States
                                                                                                                             United Kingdom
                                                     10                                     New Zealand
                                                                                                           Australia




                                                      1




                                                    0.1
                                                              South Africa




                                                   0.01
                                                          0      5000        10000       15000        20000         25000        30000        35000          40000
                                                                                                   GDP per capita
              Source: ITU 2004




                                                                                                    38
       Internet users per 100 inhabitants


Definition:
Number of internet users divided by the population multiplied by 100.


                                                                               Internet users per 100 inhabitants
                                                    60

                                                                               Korea (Rep. of)                                                   United States


                                                    50
                                                                                            New Zealand Australia

                                                                                                                                     Japan
                                                                                                                     Germany
               Internet users per 100 inhabitants




                                                                                                                         United Kingdom
                                                    40


                                                                                                                                                  Switzerland

                                                                                                                     France
                                                    30




                                                    20




                                                    10
                                                             South Africa



                                                    0
                                                         0      5000        10000       15000       20000           25000     30000      35000          40000
                                                                                                 GDP per capita
              Source: ITU 2004




                                                                                                   39
Excluding countries with a per capita GDP greater than US$15 000 annually, results in the
following comparison:


                                                                        Internet users per 100 inhabitants
                                                60

                                                                                                                Korea (Rep. of)


                                                50
                                                                                                                                    New Zealand
           Internet users per 100 inhabitants




                                                40
                                                                                                                                  Taiwan, China




                                                30

                                                                                            Czech Republic
                                                                              Poland
                                                20




                                                                                                                        Argentina
                                                10                                      Mexico
                                                             South Africa

                                                         Namibia      Libya
                                                0
                                                     0         3000              6000                    9000             12000                   15000
                                                                                        GDP per capita
          Source: ITU 2004




                                                                                          40
       Main telephone lines in operation per 100 inhabitants


Definition:
Calculated by dividing the number of main lines by the population and multiplying by 100.


                                                                                    Main telephone lines in operation per 100
                                                           100
                                                                                                                                                        Switzerland
                                                                                                                          Germany                      United States
                                                                                                                               United Kingdom
                                                                                                                Australia France           Japan
                                                                                                  New Zealand
               Main telephone lines in operation per 100




                                                           10        South Africa




                                                            1




                                                           0.1
                                                                 0      5000        10000      15000       20000        25000      30000       35000          40000
                                                                                                       GDP per capita
              Source: ITU 2004




                                                                                                         41
       Number of local telephone (minutes) per capita


Definition:
Local traffic consists of effective (completed) traffic exchanged within the local charging
area in which the calling station is situated. This is the area within which one subscriber can
call another on payment of the local charge (if applicable). The indicator is expressed as the
number of minutes of traffic.


                                                                            Number of local telephone (minutes) per capita
                                                      5000


                                                      4500                                                Israel


                                                      4000
                Number of local telephone (minutes)




                                                      3500


                                                      3000


                                                      2500
                                                                                                Taiwan, China
                                                      2000


                                                      1500                                     Greece
                                                                                              Portugal         Average
                                                                                                                                United Kingdom
                                                                                Czech Republic                           France               Japan
                                                      1000
                                                                                        Korea (Rep. of)                  Germany


                                                       500       South Africa


                                                         0
                                                             0       5000            10000         15000         20000   25000       30000            35000
                                                                                                      GDP per capita
              Source: ITU 2004




                                                                                                          42
       Number of national long distance telephone (minutes) per capita


Definition:
National trunk (toll) traffic consists of effective (completed) nat ional traffic exchanged with a
station outside the local charging area of the calling station. The indicator is expressed as
the number of minutes of traffic.


                                                                             Number of national telephone (minutes) per capita
                                                        1500
                                                                                                                      Germany
                                                        1400

                                                        1300

                                                        1200
               Number of national telephone (minutes)




                                                        1100

                                                        1000

                                                        900
                                                                                                                             United Kingdom
                                                        800

                                                        700
                                                                                                                                         Japan
                                                        600
                                                                                                                                         Ireland
                                                        500
                                                                                                                      France
                                                        400

                                                        300

                                                        200                   Mexico

                                                        100        South Africa

                                                           0
                                                               0      5000         10000    15000      20000         25000       30000         35000   40000
                                                                                                    GDP per capita
              Source: ITU 2004




                                                                                                     43
       Total telephone subscribers per 100


Definition:
Total telephone subscribers divided by population multiplied by 100.


                                                                                Total telephone subscribers per 100
                                                     180


                                                                                      Taiwan, China
                                                     160
                                                                                                                                                    Switzerland

                                                                                                                          United Kingdom
                                                     140
                                                                                                                     Germany
               Total telephone subscribers per 100




                                                     120                                                             France
                                                                                                         Australia                     Japan
                                                                                                                                                   United States
                                                                                           New Zealand
                                                     100



                                                     80



                                                     60


                                                     40        South Africa



                                                     20



                                                      0
                                                           0      5000        10000     15000       20000        25000         30000       35000          40000
                                                                                                GDP per capita
              Source: ITU 2004




                                                                                                  44
       Telephone faults per 100 main lines


Definition:
This is calculated by dividing the total number of reported faults for the year by the total
number of main lines in operation and multiplying by 100. The definition of fault can vary.
Some countries include faulty customer equipment. Others distinguish between reported and
actual found faults. There is also sometimes a distinction between residential and business
lines. Another consideration is the time period concerned, as some countries report this
indicator on a monthly basis; in these cases data are converted to yearly estimates.


                                                                                    Telephone faults per 100 main lines
                                                     160

                                                               Kenya
                                                     140



                                                     120
               Telephone faults per 100 main lines




                                                     100



                                                     80



                                                     60

                                                                   South Africa
                                                     40



                                                     20

                                                                                                                             United Kingdom           US
                                                                                                            Australia
                                                      0
                                                           0           5000       10000     15000       20000        25000       30000        35000        40000
                                                                                                    GDP per capita
              Source: ITU 2004




                                                                                                      45
Summary of demographic comparisons


Generally, most of the illustrations above offer the same message. Most are self explanatory
and the outcome in most cases is unsurprising. What is illustrated is that the average South
African’s telecommunication expenditure is higher and usage is lower is lower than most of
the richer countries but compares rather well with peers.


Obviously the high cost of telecommunication could partly be to blame. South Africa is a
developing country with fewer resources available per person to spend on “luxuries” like
telecommunications.


South Africa’s access to telecommunication networks compare well with developed countries
- mobile coverage per capita is a good example.


The technological revolution and globalisation are issues that are extremely important to
developing countries and internet subscriptions are probably an excellent proxy to measure
the level of the technological development of any country. This single measure is probably
also an excellent leading indicator of future economic development and the data suggest that
South Africa compares dismally to developed countries. Although telecommunication costs
are probably a contributing reason, other factors associated with a developing country
probably also come into play.


It should be a priority of the South African authorities to make technology as affordable and
accessible as possible. Accessibility does not seem to be a typical South African
telecommunication problem, perhaps the “roll out” of fixed lines by Telkom in recent years
improved our relative position. Affordability, however, certainly seems to hinder the use of
the existing infrastructure.




                                              46
Faults per number of lines are probably a fair measurement of the relative effectiveness of the
quality of service, and the quality of telecommunication capital (physical and human) in
different countries. On this measure South Africa measures relative better than most
developing countries but unsatisfactory compared to developed countries. The conclusion
could be made that despite the relative high costs of telecommunications in South Africa the
relative quality does not compare well with other countries.


In South Africa access to telecommunication services does not seem to be a hurdle, but the
utilisation of technology and quality of services appear sub-standard. Apart from the already
mentioned reasons, general technological education is probably partially to blame.




                                              47
CASE STUDIES REGADING PAST TELECOMMUNICATION CHARGES AND
REGULATORY DEVELOPMENTS ON ECONOMIC PERFORMANCE – PAST
AND PRESENT


This section considers a number of analyses regarding telecommunications charges in South
Africa and the probable impact it may have had on past economic performance. Calculations
were made using the utmost care, prudence and circumspect. Due to the variability of the
interactions amongst economic aggregates, no economic modelling will ever be able to
duplicate real life fully. The best an economist can do is to estimate, based on economic
modelling, what the future may have looked like had other, for example regulatory, decisions
been made in the past. This section will explore three such “what if” scenarios.


All scenarios only consider the initial impact on economic aggregates and ignore secondary
impacts. Therefore all results are generally conservative.


Scenario One


In this scenario the base assumption is that the average US$ increase in telephony charges in
South Africa from 1995 to 2002, equalled that of the average increase in eleven other
countries (Australia, Botswana, France, Germany, India, Kenya, Mozambique, New Zealand,
South Africa, UK, and the US). The second assumption is that peak local calls account for
85% of total local minutes and the third is that peak national calls account for 90% of total
national minutes.




                                              48
The following table provides a summary of the different charge increases implemented by the
mentioned countries over the past seven years and which is used in this scenario:


                   Charge                          Average annual % change 1995 - 2002
Business telephone connection charge                                 0.4%
Business telephone monthly subscription                              5.4%
Residential telephone monthly subscription                           4.7%
Residential telephone connection charge                             -0.5%
Cost of a local call (peak)                                          3.4%
Cost of a local call (off-peak)                                      4.9%


These assumptions attempt to reconstruct a historic situation where price increases were
limited. This may have occurred under full competition or limitations on price increases in
South Africa since 1994. The assumptions attempt to reconstruct an environment wherein
telephony price increases were equal to the average of the eleven countries.


Under these assumptions Telkom’s revenue items will be affected as follows:


                   Charge                          Actual charge          Assumed charge
Business telephone connection charge                  R268.98                  R251.52
Business telephone monthly subscription               R101.23                  R65.58
Residential telephone monthly subscription             R76.20                  R61.36
Residential telephone connection charge               R268.98                  R229.86
Cost of a local call (peak)                             R1.11                   R0.33
Cost of a local call (off-peak)                         R0.55                   R0.27


With these assumptions in place, Telkom’s revenue from calls, national and local for 2004
will decline from R10.0bn to R3.6bn. The additional revenue of approximately R6bn
represents monopoly profits or “excess” revenue, purely due to Telkom’s statutory
monopoly. Monopoly profits are academically defined as the revenue that a monopoly
receives above the revenue it would have received if it operated in a competitive market.

                                              49
Given the above assumptions and outcomes, the possible direct effects that a liberalised
telecommunications regime may have had on the current level of inflation and interest rates
are explored. The potential effects on other aggregates are ignored.



                                            Consumer Inflation
                13


                12

                11


                10


                9

                8
            %




                7


                6

                5


                4

                3


                2

                1
                 Jan-96   Jan-97   Jan-98     Jan-99          Jan-00   Jan-01   Jan-02
                                                  CPI       CPI Adj




Inflation in 2002 would most probably have been 1% lower than the actual 12.4% reported
for December 2002. Is it fair to assume that inflation would have been at least 1% lower in
2004? – Probably yes. Over the period the lack of competition probably “added” 1% to the
South African inflation rate.


Since South Africa’s monetary authority targets inflation, it is fair to assume that the historic
spread or gap between inflation and interest rates would have been maintained. Taking this
assumption one logic step further the level of interest rates can be inferred. The following
histogram illustrates the actual and the most likely levels of interest rates (prime in this case)
under our assumption of limited price increases. This is a likely scenario had we had full
telephony competition since 1996. Interest rates may have been a full one percent lower than
the current level!




                                                       50
                                Prime Interest Rates
    26

    25

    24

    23

    22

    21

    20
%




    19

    18

    17

    16

    15

    14

    13
     Jan-96   Jan-97   Jan-98      Jan-99          Jan-00    Jan-01   Jan-02
                                     Prime       Prime Adj




                                            51
Scenario Two


This scenario examines the consequence of Telkom’s monopoly profit on economic
performance. Theoretically, monopolies allocate their resources (and their profits) in a
suboptimal fashion. This scenario assumes that merely 10% of the approximate R6bn
monopoly profit of Telkom is allocated inefficiently annually – over a period of ten years .


If this same 10% is allocated efficiently in this scenario, the corresponding effect on GDP,
applied to actual South African GDP growth rates, the comparative results are shown below.
Over a period of nine years the economic growth rate should be, on average, 0.06 percentage
points per annum higher. In rand terms the effect on the economy in today’s terms may
represent a loss of approximately R6bn.


                                                 GDP
               4.5


               4.0


               3.5



               3.0


               2.5
           %




               2.0


               1.5



               1.0


               0.5


               0.0
                     1995   1996   1997   1998     1999      2000   2001   2002   2003
                                                 GDP   Adj GDP




Continuing this train of thought and applying this outcome to employment data, and further
assuming no increase in employment, the average South African worker’s productivity would
have increased to R104 308 per annum in 2004. Conversely, if current productivity levels
were maintained nearly 70 000 new jobs would have created over a period of 10 years. The
table provides a summary of the 2004 results of this scenario.

                                                 52
Current GDP                                        R1.210 trillion
Adjusted GDP                                       R1.216 trillion
Current production per worker                      R103 714
Adjusted production per worker                     R104 308


Additional    workers   over    10   years   if 66 846
production per worker is unaltered
Current unemployment                               28.20%
Adjusted unemployment                              27.56%


In scenario one lower inflation and interest rates were concluded. Combining scenario one
and two, the effect would have been a further acceleration of potential economic growth and
subsequent attendant job creation.


Scenario Three

In this scenario it is assumed (unrealistically) that Telkom was fully privatised during the
peak of the NASDAQ in February/March 2000. At the time of the telecommunications boom,
a market capitalisation of as much as R100bn was mooted as a realistic price for Telkom. In
addition it is fair to assume that a price/earnings ratio of at least double the current ratio
would have been possible at the height of the TMT (Technology, Media and
Telecommunications) boom.

This scenario assumes a full privatisation of Telkom in 2000 and the realisation of R100bn by
the state. The state would have realised R50bn more than the current value of Telkom.

Assuming that this “extra” R50bn was only utilised to reduce state debt, and assuming all
other factors remained unaltered, a saving of approximately R6bn per annum in interest on
state debt would have been realised. State debt would have fallen to less than 34.5% of GDP
compared to the current 38.6%. The magnitude of such a saving may be equal to building 320
000 low cost houses of R20 000 each per annum, or a 1 percentage point reduction in Value
Added Tax (VAT).
                                              53
This scenario may also have resulted in lower telecommunication charges with all the
concomitant benefits.


The obvious conclusion is that the authorities missed a golden opportunity to fully privatise
Telkom and liberalise the telecommunication market in 2000. Hindsight is twenty-twenty
sight! Unfortunately the South African economy is worse off due to this lack of vision and
action.


CONCLUSION


This section examines telecommunication costs in South Africa and compares certain costs to
selected countries. In general South Africa’s telecommunication costs exceed that of its peers
and are in most cases even more expensive than developed countries. The rates of increases in
telecommunication costs also exceed that of most countries over the past five years.


We reconstructed three possible scenarios. In scenario one it was assumed that certain
telecommunication costs were increased at the same rate as the average increase in selected
countries. According to our simulation the resultant lower telecommunication cost may have
resulted in significantly lower inflation and interest rates while economic growth may have
been much enhanced.


In scenario two the effect of Telkom’s monopoly profits on economic performance is
analysed and it was found that economic growth is hampered with a factor of 0.06 percentage
points per annum. In addition our simulation suggests that South Africa missed out on the
creation of at least 67 000 job opportunities over ten years due to the fact that
telecommunications services is not liberalised.


Scenario three examines the impact on state finance has Telkom been privatised at the peak
of the NASDAQ. This would have increased the available resources to the state
tremendously.


                                              54
 A REPORT ON AND COMPARISON OF TELKOM’S FINANCIAL STATEMENTS
                         WITH A TYPICAL LOCAL COMPANY


                                           AND


 A REPORT ON AND COMPARISON OF TELKOM’S FINANCIAL STATEMENTS
                       WITH SELECTED INTERNATIONAL PEERS


   • Part I - the financial results of Telkom SA Limited for the 12 months ending 31
         March 2004,
   • Part II - a comparison of Telkom with peers in New Zealand and Australia
   • Part III - and a comparison with the financial results of the Standard Bank
         Group.


It is not the intension or objective of Efficient Research to create certain standards or
benchmarks for Telkom or any other company. We have merely examined the financial
statements of the companies mentioned and have drawn attention to and made comments on a
number of important differences. All the information used is from company statements and
from the JSE Securities Exchange and are therefore in the public domain.


Part I


Telkom SA Limited - Group Annual Results for the 12 months ending 31 March 2004


We have studied the group annual results and the operationa l overview of Telkom SA
Limited for the 12 months to 31 March 2004. The annual report and financial results of any
listed entity may be both voluminous and complicated. We have endeavoured, for this
purpose, to demystify numbers and comments found in the annual report. As a result this
document serves as an understandable executive summary of the elements of the financial
results and of the operational and competitive environment that we regard as important and
that we wish to draw attention to.


                                            55
The opening paragraph of the official financial results document describes the activities of
the year ending March 2004 accurately:


“In our fixed line business, we expanded operating margins by aggressively defending
revenues and systematic streamlining of our operations, while our mobile business continued
to deliver robust growth by winning customers in the local markets and in other countries.
These achievements underpinned the generation of strong cash flows, allowing the Group to
repay debt and invest capital in driving growth and supporting ongoing cost savings”


According to the annual report, good financial progress was made within the Group, driven
by a focused strategy to create shareholder value comprising three key imperatives:
   • An intense focus on customer growth and retention
   • Driving operational efficiencies and innovation, and
   • Sustained marketplace development


The salient features of the financial Results may be summarized as follows:


   • Headline earnings per share increased by 175% to R8.64
   • Basic earnings per share increased by 178% to R8.12
   • Revenue increased 8.8% to R40 795m
   • Expenses increased by only 1.9%
   • Operating profit increased by 40%
   • Net debt decreased by 34% to R13.4bn


This strong earnings growth was created by a combination of the following factors:


   • Relatively buoyant economic environment
   • Increased margin on fixed line business by aggressively managing expenses
   • The mobile business most certainly grew and revenue increased by 23%
   • A 22% reduction in finance charges



                                             56
Included in the finance charges is a revaluation loss of R780m due to the market value
adjustment of derivatives and currency exposure. Such valuation gains or losses are quite
normal for longer term borrowers and should be included in finance charges.


The result was that cash from operating activities increased by 43% to R13.9bn. This amount
was large enough to cover capital expenditure of around R5bn and to repay debt amounting
to approximately R6.4bn.


The Income Statement ’s most important features are summarised below.


An inspection of the Income Statement confirms the aggressive cost management program.
Operating expenses only increased by 1.9%. In this category employee expenses increased by
only 2.8% and general sales and administrative expenses by only 3.8%. Other expense items
were lower (decreased) but depreciation and amortization increased by almost 12%. A very
good time to write things down!


The total of the finance charge items decreased by almost R1bn or 21.5%. This is a wonderful
bonus for any company that relies heavily on borrowings to supply long term capital.
Obviously debt levels should depend on interest rates and the willingness of shareholders to
attract risk.


The aggressive management of expenses allowed the increase in revenue to “go straight to
the bottom line”


The Balance Sheet’s most important features are summarised below.


Although total capital and liabilities did not change much, two very important changes did
occur. Retained earnings increased by 38% while long-term debt decreased by 27%. This
strengthens the balance sheet considerably.


Although current liabilities exceed current assets, this should not be a problem and will be
financed from operating cash flows, credit facilities and new borrowings.
                                              57
As a borrower, Telkom enjoys an investment rating grade by both Moody’s and Standard &
Poor’s. During May, Moody’s stated that it may possibly upgrade the credit rating. In view of
the strengthening of the balance sheet, Moody’s indeed announced the upgrade on 21 July
2004. Such upgrade will reduce the borrowing costs over the longer period.


No statement was made about the borrowing strategy during the next 12 to 24 months – a
very important operational activity for any long-term borrower like Telkom.


Human Capital Management


During the period fixed-line employees were reduced by 8.5% to 32 358. The annual report
states that Telkom has a socially responsible retrenchment program and aims to reduce
employee numbers by 7% to 10%, inclusive of natural attrition, annually.


During the 12 months under review the reduction in employees amounted to 3 106. Of this
number only 112 were involuntary reductions. Total reductions are made up as follows:


Voluntary early retirement                                224
Voluntary severance                                       985
Involuntary severance                                     112
Natural Attrition                                        1 785
Total                                                    3 106


The increase in per capita productivity of employees was impressive. Fixed line productivity
increased from 137 lines per employee to 149 lines per employee – an 8.8% improvement.
Mobile services employee productivity increased by 25% to 2 527 customers per employee.
For the period under review the Employee Expenses item in the income statement includes
R302 million retrenchment costs.




                                             58
Current Share Price and Price/Earnings Ratio


On 12 August 2004 the share price closed at R80.30. The Price/Earnings (P/E) ratio was 9
times, well priced compared to the Alsi 40 P/E ratio of 14.3. The daily closing Telkom share
price compared to the Alsi 40 is illustrated in the graph below.




Compared to the FTSE-JSE Information Technology Index Telkom’s share price did
exceptionally well – note that Telkom is not included in this index and that the P/E ratio of
this index is negative. The share price performance (and by implication the financial
performance) of Telkom has done much better than that of the Information Technology
industry.




                                              59
However, Telkom is included in the JSE Telecommunication Services index which is
included in the index is known as the Non Cyclical Services index. The sectors that fall under
this index are Food and Drug Retailers and Telecommunication Services. The large
constituents here are Pick 'n Pay, Shoprite, Johnnic, MTN and Telkom.


The P/E ratio of the JSE Telecommunication Services index is 9.8 times, slightly higher than
that of Telkom. The Telkom share price also performed better than this index.


In fact, comparing the price/earnings ratio of Telkom to other similar international players,
Telkom remains the least expensive entry into such investments.




                                             60
Directors Emoluments


Aggregate consolidated compensation of Telkom directors (executive and non-executive)
amounted to R48m for the year. Fees for management services rendered paid to SBC
Communications amounted to R5.7m and to Telekom Malaysia amounted to R29.9m
(included in the above remuneration amounts).


Compared to Standard Bank, a similar sized listed South African company (see comparisons
below), total emoluments to directors (executive and non-executive) amounts to R21m.


If compared to Telstra, an Australian peer (see below), the aggregate consolidated
compensation to directors and members of senior management amounted to A$21m.
Remuneration for executive directors amounted to A$6.2m (ZAR 30m). Telecom (see below)
New Zealand’s directors earned NZ$2.6m (or ZAR 12m).




                                            61
Tariff Adjustments for 2004


On November 14, 2003, Telkom filed its Fixed-line average tariff adjustments of 2.7%
effective from January 2004 with the Independent Communications Authority of South
Africa, ICASA.


On December 10, 2003, a revised filing was submitted to ICASA with an average tariff
adjustment of 2.2% to take account of Vodacom’s reduction of their fixed-to-mobile tariff.

The Regulatory Environment

On July 15, 2003, the Department of Communications announced their plans to introduce a
Convergence Bill that will provide a licensing and regulatory framework for a converged
telecommunications, broadcasting and information technology industry. This will supplement
or replace current sector-specific legislation. No formal timeline for the tabling in Parliament
of the new legislation has been communicated, but Government will continue to interact with
the industry in its development.

On November 4, 2003, the Minister of Communications announced her intention to licence
the Second National Operator (SNO). However, the process is still under way and no SNO
licence has been awarded. In June, 2004 the Minister approved four licence applicants for
under-serviced areas.

In terms of the competitive enabling regulations surrounding carrier selection, a two -phased
approach has been adopted. This will initially entail a call-by-call carrier selection, which has
already been built into Telkom’s exchanges, followed by full carrier pre-selection.

The regulator is expected to review price tariffs in terms of the composition of the basket of
services and the application of the price control formula, which currently caps overall price
increases on a basket of services at CPI minus 1.5%. The regulations on interconnection are fairly
stable and little new developments are expected over the next year. However, the refinement of
interconnection   guidelines   will   evolve   as   Telkom   negotiates   with   new    licensees.




                                               62
Competition Commission



The South African Value Added Network Services Association (“SAVA”), an association of
value added network service (“VANS”) providers, filed complaints against Telkom at the
Competition Commission regarding alleged anti-competitive practices on the part of Telkom.
Certain of the complaints have been referred to the Competition Tribunal by the Competition
Commission for adjudication.


The general nature of the complaints deal with Telkom’s alleged:
   • Refusal to provide telecommunications facilities to certain VANS providers to
       construct their networks,
   • Refusal to lease access facilities to VANS providers,
   • Discriminatory pricing with regard to leased line services and alleged refusal to peer
       with certain VANS providers.


A maximum administrative penalty (of up to 10% of Telkom’s annual turnover, excluding
the turnover of subsidiaries and joint ventures, for the financial year prior to the complaint
date) may be imposed it if is found that Telkom has committed a prohibited practice as set
out in the Competition Act, 1998 (as amended). The Competition Commission has to date not
imposed the maximum penalty.


Telkom has brought an application in the High Court in respect of the Competition Tribunal’s
jurisdiction to adjudicate this matter, on the basis that:
   • The Competition Tribunal should not decide on the nature of Telkom’s rights as
       contained in the Telecommunication’s Act, 1996 (as amended) as well as Telkom’s
       various licences; and
   • Several of the complaints are already the subject of matters still pending at the
       Independent Communications Authority of South Africa (“ICASA”).


Telkom argues that it is for the sectoral regulator, ICASA, to decide on the rights and
obligations given to Telkom in terms of the Telecommunication’s Act and its PSTS license.

                                                63
Telkom is confident that it has not committed a prohibited practice as set out in the provisions
of the Competition Act as authorized by its PSTS license.


It is not expected that the Competition Tribunal to adjudicate this matter within the next two
years – which may be the reason for the fact that the pricing of the share in the equity market
does not indicate a high probability of a pending substantial fine.


Conclusion


The 12 months to March 2004 was Telkom’s first year as a listed company. As such it has
been open to public scrutiny of its financial results and all matters pertaining to compliance
requirements. The maiden financial results of any listed company are always of very special
significance, even more so for international players. Equity investors scrutinise their new
acquisitions with much verve in year one. In this very crucial period, Telkom not only lived
up to the challenge but passed with distinction.




                                               64
PART II


A Financial Comparison of Telkom with its peers in New Zealand and Australia


Efficient Research compared the financial results of Telkom SA Limited with Telecom New
Zealand and Te lstra Corporation Limited (Australia). The objective is to compare
organizations, in different parts of the world, all with similar business objectives.


These two companies follow different price strategies as identified in this report. In addition
the economic, social political environments are not too different. All three countries are not
typical European in terms of culture and attitude, yet originate from a European background.
All three are following a similar developmental path and either is already, or is on the
threshold of developed status. They enjoy comparable similar corporative ethics and
legislation.


The comparison divides the income statement of each into six easy to understand parts and
compares each as a percentage of revenue (a comparison technique known as
standardization):


   1. Revenue
   2. Operating Expenses
   3. Earnings before interest, tax, depreciation and amortization (EBITDA)
   4. Depreciation and Amortization
   5. Earnings before interest and tax (EBIT)
   6. Net Income (NI)


The standardized items are comp ared and are intuitively easy to understand. However, it is
not the intension or objective of this report to prescribe or create certain standards or
benchmarks for Telkom or any other company.




                                               65
We have examined the standardized financial statements of the companies mentioned and
have drawn attention to and made comments on certain differences. Information is from
company statements and the JSE Securities Exchange.


Major state and other shareholding in Telkom as at 31 May 2004
SA Government                      38% of Telkom SA
Thintana                           15% of Telkom SA


Major state shareholding in Telkom’s peers as at 31 May 2004
Australian Government              50% of Telstra Australia
New Zealand Government             Nil of Telecom New Zealand


In South Africa, Telkom is a fixed line monopoly albeit a regulated one. In New Zealand,
Telecom is in theory not a monopoly. The market/environment is also regulated and there are
mobile (Vodafone) and land line (Telstra) competitors. However, these companies have to
use the infrastructure of Telecom. In future the competitive environment in South Africa may
look very similar.


In Australia there are three telephony service providers. Two are mobile services and one is a
fixed line facility.


Relative Size – Assets in US Dollars as per balance sheet


South Africa                       $8.3bn at R6.5 to 1 UD$ (ZAR 54bn)
Australia                          $25bn at 1.4 A$ to 1 US$ (A$ 35bn)
New Zealand                        $5.2bn at 1.5 NZ $ to 1 US$ (NZ$ 7.755bn)


The Telstra Corporation is by far the largest followed by Telkom SA Limited. The smallest is
Telecom New Zealand.




                                             66
Relative Size - Revenue in US Dollars as per income statement


South Africa                      $6.3bn at R6.5 to 1 UD$ (ZAR 41bn)
Australia                         $15.3bn at 1.4 A$ to 1 US$ (A$ 21bn)
New Zealand                       $3.5bn at 1.5 NZ $ to 1 US$ (NZ$ 5bn)


Operational Expenses as % of Revenue (Cost to Revenue & Cost to Income)


South Africa                      60%
Australia                         52%
New Zealand                       55%

Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA) as % of Revenue

South Africa                      40%
Australia                         48%
New Zealand                       45%

Depreciation and Amortization as % of Revenue

South Africa                      18%
Australia                         17%
New Zealand                       16%

Labour Expenses as % of Revenue

South Africa                      18%
Australia                         15%
New Zealand                       11%

Telkom’s labour expenses compares unfavourably with both Australia and New Zealand. To
compare with Australia, Telkom’s labour expenses should be reduced by a further 3% of
Revenue; or R1 227m. Compared to New Zealand, Telkom’s labour expenses should
decrease by approximately 7% of Revenue or R2 862m.

                                            67
Net Income as % of Revenue


South Africa                        11%
Australia                           19%
New Zealand                         14%


Net Debt as % of Revenue


South Africa                        33%
Australia                           53%
New Zealand                         90%


Fixed Line Revenue as % of Revenue


South Africa                        74%
Australia                           75%
New Zealand                         54%


Mobile Revenue as % of Revenue


South Africa                        25%
Australia                           23%
New Zealand                         15%


Unit of Asset Used to Create a Unit of Sales


South Africa                 1 asset unit creates 0.76 units of sales
Australia                    1 asset unit creates 0.61 units of sales
New Zealand                  1 asset unit creates 0.67 units of sales


Telkom’s total assets as percentage of revenue are less than its peers and indicate that assets
are probably employed more efficiently.
                                               68
Return on Total Assets


South Africa                       8.4%
Australia                          11.8%
New Zealand                        9.1%


Return on Equity


South Africa                       21%
Australia                          27%
New Zealand                        40%


Assets per staff member


South Africa                       R1 460 or UD$225 at R6.5 to 1 US$
Australia                          A$834 or US$595 at 1.4 to 1 UD$
New Zealand                        NZ$704 or US$469 at 1.5 to 1 US$


Revenue per staff memb er


South Africa                       R1 106 or US$170 at 6.5 to 1 US$
Australia                          A$507 or US$360 at 1.4 to 1 UD$
New Zealand                        NZ$471 or US$314 at 1.5 to 1 US$


Conclusion


   1. In terms of operating expenses (all expenses bar interest, tax, amortization and
       depreciation) as percentage of revenue, Telkom seems to be less efficient than its
       peers by quiet a margin. In rand terms such expenses must be reduced by around
       R2.6bn to achieve the same efficiencies as that of New Zealand and Australia.


                                             69
2. In terms of labour expenses as percentage of revenue, Telkom seems to be slightly
   less efficient than its peers. In rand terms labour expenses must be reduced by R1.2bn
   to achieve the level of efficiency enjoyed by Australia.


3. In terms of Net Income retained as percentage of revenue, Telkom is much behind
   Australia and such retention will have to increase to R7.9bn (an increase of R3.4
   billion) to attain the 19.35% level the Australians enjoy.


4. Telecom New Zealand was able to retain 14% of revenue as net income. Telkom
   would have to increase net income by R1.2bn to achieve the same standard of
   profitability. To increase profitability by 20% or more is hard work. See notes number
   10 to 12.


5. Fixed Line and Mobile Revenue is in exactly the same proportions as Telstra
   Corporation.


6. Assets and revenue per staff member for Telkom in US$ terms are less than its peers.


7. Generally, our examination of the numbers indicates that Telkom SA is less efficient
   than its neighbours and must be able to increase efficiencies, as is their stated
   intention. This should be clear from the unit of asset used to create a unit of sales
   ratio and the net income as percentage of revenue ratio.


8. In all three the company statements (Australia, New Zealand and South Africa) there
   is a strong emphasis on cost control and productivity improvements. The most recent
   annual report of British Telecom contains the same emphasis.


9. Although employee expenses contribute to the relatively high total expenses of
   Telkom, it is most certainly not the only errant entry in the income statement.
   Compared to Telstra, employee expenses are only about R1.2bn “too high”. If the
   Telstra employee expense proportion is correct, or is aimed at to achieve, a 16%
   reduction in this expense must be made. On the other hand, the Standard Bank
                                          70
   employee expense is much larger than that of Telkom (33% versus 18% of revenue,
   see below).


10. The staff expense saving that will be achieved by 4 000 (about 11% of the current
   staff complement) less staff members at an average expense of R200 000 per member
   per annum, will amount to a saving of about R800m per year – sans the once off cost.
   Restructuring cost associated with reducing the staff complement amounted to R302
   million in the financial year to March 2004. It will be fairly safe to assume that
   another restructure program will cost a similar amount.


11. Saving an annual amount of R800 million in expenses will make a small positive
   difference. The real problem, proportion wise, is that total expenses are too high by an
   amount of approximately R3bn. The worrying expense numbers are probably spread
   throughout the numbers that make up EBITDA, rather than one particular entry. In
   our view the employee expenses is not the (only) problem. The real challenge is to
   reduce expenses throughout the entire organization.




                                          71
PART III


Comparison of Telkom with the Standard Bank Group


In addition, Efficient Research compared the financial results of Standard Bank Group and
Telkom SA. The objective was to compare two similarly sized (in terms of numbers
employed) South African listed companies. The comparison divides the income statement of
each into six easy to understand segments and compares each as a percentage of revenue
(standardization):


   1. Revenue
   2. Operating Expenses
   3. Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA)
   4. Depreciation and Amortization
   5. Earnings Before Interest and Tax (EBIT)
   6. Net Income (NI)


The standardized items are compared and are intuitively easy to understand. We reiterate that
it is not the intension or objective of this report to prescribe or create certain standards or
benchmarks for Telkom or any other company.


We examined the standardized financial statements of the companies mentioned and have
drawn attention to and made comments on certain differences. All the information used are
from company statements and the JSE Securities Exchange. The result of the comparison
renders the following information and ratios:


Relative Size - Number of employees


Standard Bank                       35 000 average employee expense R216 400
Telkom                              37 000 average employee expense R200 400




                                                72
Relative Size - Revenue in Rand


Standard Bank                     R22.4bn
Telkom                            R40.9bn


Operating Expenses as % of Revenue (Cost to Revenue ratio)


Standard Bank                     61%
Telkom                            60%


Labour Expenses as % of Revenue


Standard Bank                     34%
Telkom                            18%


Operating Margin - Earnings Before Interest and Tax (EBIT) as % of Revenue


Standard Bank                     39%
Telkom                            22%


Net Profit Margin - Net Income as % of Revenue


Standard Bank                     27%
Telkom                            11%


Return on Equity


Standard Bank                     22.8%
Telkom                            20.5%




                                            73
Revenue per staff member


Standard Bank                      R640
Telkom                             R1 100


Net Income per staff member


Standard Bank                      R170
Telkom                             R122


Price/Earnings Ratio


Standard Bank                      9 Times
Telkom                             9 Times


The price movements for Telkom and Standard Bank over the past approximately 18 months
are shown in the graph below. The following notes are interesting.


Telkom Share Price
1 April 2003                                                   R29.55
18 Augustus 2004                                               R76.80
Increase over the period                                       260%
JSE Non-Cyclical Ser vices index 1 April 2003                  7 538
JSE Non-Cyclical Services index 18 Augustus 2004               16 764
Increase over the period                                       222%
JSE Telecommunication Services index 1 April 2003              263
JSE Telecommunication Services index 18 Augustus 2004          639
Increase over the period                                       243%




                                             74
Standard Bank Share Price
1 April 2003                                                  R27.32
18 April 2004                                                 R42.90
Increase over the period                                      157%
JSE Bank index on 1 April 2003                                10 794
JSE Bank index on 18 Augustus 2004                            15 686
Increase over the period                                      145%




Conclusion


Both companies have produced excellent financial results and both share prices have done
better than the indices that they are included in. In terms of Price/Earnings ratios the
companies are rated almost identically. The essence of the differences between the income
statements of Telkom and Standard Bank are found in two important ratios:




                                            75
Operating Margin


Standard Bank                      39%
Telkom                             22%


Net Profit Margin


Standard Bank                      27%
Telkom                             11%


Generally the cost structures of Telkom are much higher than that of Standard Bank. This is
borne by the fact that the remaining proportion of revenue before interest, depreciation,
amortization and tax (Operating Margin) for Standard Bank is almost twice as large as that of
Telkom (39% versus 22%).


The second part of the income statement treats Telkom second best again. After interest and
taxes (Net Profit Margin) Telkom only retains 11% of revenue, versus 27% for Standard
Bank.


Although employee expenses is a part of the problem (of total expenses being too high), it is
most certainly not the only errant entry in the income statement. Compared to Telstra,
employee expenses are only about R1.2bn “too high”. If the Telstra employee expense
proportion is correct, or used as a benchmark, a 16% reduction in this expense must be made.
On the other hand, the Standard Bank employee expense is much larger than that of Telkom
(33% versus 18% of revenue).


The staff expense saving that will be achieved by 4 000 (about 11% of the current staff
complement) less staff members at an average expense of R200 000 per member per year will
amount to a saving of about R800m per year – sans the once off cost. Restructuring cost
                                                                                 ear
associated with reducing the staff complement amounted to R302m in the financial y to
March 2004. It will be fairly safe to assume that another restructure program will cost a
similar amount.
                                             76
Saving an annual amount of R800m in expenses will make a small positive difference. The
real problem, proportion wise, is that total expenses are too high by an amount of
approximately R7 000m. Reducing expenses by this amount will restore Operating Profit to
the same proportional levels of that of Standard Bank.


The worrying expense numbers are probably spread throughout the numbers that make up
EBIT, rather than one particular entry. Employee expenses are not the only productivity
hurdle – the real solution would be to reduce expenses throughout the entire organization
(and income statement).




                                             77

				
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