COURSE: CORPORATE FINANCE

CELLULAR AFRICA

SUBMITTED TO:
MR. MUHAMMAD AKBAR

SUBMITTED BY:
MBA 4 MORN

SADAF FAYYAZ (01-122062-106)

AAMIR YAQOOB (01-122061-001)
SAQIB SATTI (01-122061-036)

SUBMITTED ON:

3RD JAN, 2007

FACULTY OF MANAGEMENT SCIENCES
BAHRIA INSTITUTE OF MANAGEMENT &
COMPUTER SCIENCES
ISLAMABAD

INTRODUCTION
This case is about a telecommunication organization, The Cellular, of South Africa.

Government of South Africa owns this organization. Government is selling 30%

percent stakes of it and few of the world’s best telecommunication service providers

are bidding for it.

South Africa faced a successful and peaceful revolution few years back in 1994.

South Africa demographic composition is dominated by blacks but in past whites

were ruling the country and creating problems for blacks. But after peaceful transition

of powers new government which is head by African National Congress (ANS), a

party with an approach to meet black community requirements. They presented an

agenda to develop black community persons and involve them in decision-making

process and put them into corporate world.

World realized that no country could achieve real growth and success without the

contribution of telecommunications industry. International governing bodies are also

putting stress on emerging markets to develop their telecommunications industry

because of its importance in economic development, safe investment and high returns

on growth.

New government of South Africa realized importance of telecommunication industry

in the economic growth. They analyzed that South Africa has better infrastructure

than other under developed countries but they are lacking in this industry. To achieve

better results they started commercialization process in Cellular few years back. It

faced few problems related to international accounting principles adaptability and as a

client-focused company.

Unmet demand in South Africa for high quality telecommunications services is also a

potential taking attention of international investors regarding Cellular.

As government is offering thirty percent stakes in Cellular, South African officials are

well aware of the situation that investors are taking keen interest in South Africa as a

gateway to whole Africa and growth inside South Africa. Government is offering this

package with few attractions. Officials are offering this opportunity with five years

monopoly in telecom sector and one year after this period if conditions are met.

There are concerns in mind of investors related to stability of new political system of

South Africa. Poor credit ratings, alarming exchange rates, poor economy and income

inequality, criminal activities racial tension and violence are the threats to the whole

economy and investors looking for any industry. But investors looking for the telecom

sector in South Africa also consider risks relating to the copper cable theft and

substitutes competition. But in case of the Cellular one also considers technical

disrepair, high cost of capital, post monopoly situation and debt to equity were the

concern related to this company.

Thintana (18% SBC, 12% Telekom Malaysia) was formed to bid for the stake of

Cellular. Telekom Malaysia has technical leadership and experienced of emerging

markets. SBC Communications Inc. is one of the world’s leading diversified

telecommunications companies. SBC has stakes in one of the cellular company,

MTN, in South Africa. Now there will be concerns for SBC related to dual leadership

of MTN and Cellular if they won bid of Cellular.

CHAPTER 1 COUNTRY HISTORY AND ANALYSIS

Over the past few years, the Republic of South Africa has been undergoing a series of

dramatic political and economic changes, aimed at repositioning the country among the top

emerging economies in the world. True, the country has a long history of economic and

political isolation, and its name remains invariably tied to the Apartheid, but this now belongs

to the past.

South Africa has been firmly moving toward liberalization and globalization. As it opens to

the rest of the world and the black majority gets a larger share of the country’s economic

resources, the country holds great potential in a number of markets. Such sectors as

information technologies, health care and wood products show great growth prospects, on

which Maine companies can capitalize.

Trade figures clearly show that South Africa is historically not a significant export destination

for Maine's products or services. This should gradually change as Maine companies realize

the synergies between their competencies and resources and South Africa's prospects.

South Africa is a developing country with an abundant supply of natural resources, well

developed financial, legal, communications, energy and transportation sectors and a stock

exchange that ranks among the 13 largest in the world. It has a “first world” infrastructure in

all aspects: good railways and roads, reasonably priced electric power, sufficient water

for industrial use, a well developed road transport industry including links with a

number of African countries and a general availability of land.

Internal airways are good and the country has established international air links with

most major foreign cities through its national carrier, South African Airways, and a

number of foreign airlines. This infrastructure supports an efficient distribution

system of goods to major urban centers throughout the country.

However, growth has not yet been strong enough to reduce the 30% unemployment

rate. Other problems affecting South Africa include crime, corruption, and rampant
HIV/AIDS.4 Further, the exclusionary nature of Apartheid and distortions caused by

the country’s international isolation through the early 1990s have left major

weaknesses. Today, the economy is undergoing a transition as the government seeks

to address the inequities of Apartheid, stimulate growth and create jobs. Although

business is now integrated into the international system and foreign investment has

increased, the economic disparities existing between population groups are expected

to persist for many years.

 Land mass: 1.219.912 sq km

 Estimated population in 2000: 43 million.

 GDP: $ 296.1 billion (1999 est.), GNP per capita (Atlas Method, 1999): $3,170

 GDP growth rate: 0.5%.

 Inflation rate: 5.2% in 1999, 5% in 2000 (est.).

 Approximately 90% of the population live in the industrial areas surrounding the

cities of

 Johannesburg, Pretoria, Durban, Cape Town and Port Elizabeth.

 Monetary unit: the South African Rand (International symbol: ZAR).

 Ethnic groups:

 black 75.2%

 white 13.6%

 colored 8.3%

 Indian 2.6%

The country faces two dramatic plagues: high crime levels and the spread of AIDS.
CRIME

Commercial crime is a real plague in South Africa. American companies must be

aware that the U.S. Embassy in Pretoria regards the Republic of South Africa as one

of the world’s most violent countries. First, the end of the Apartheid resulted in waves

of violence among the South African black population. Though political violence has

decreased in intensity in recent years, the country’s stability remains fragile,

especially considering the persistent existence of huge economic, social and

educational gaps between the Blacks and the Whites. The incidence levels of bank

robberies, car-theft and hijacking are very high and continue to rise, despite steps

taken by the South African authorities, including the creation of a FBI-type agency7.

Though such levels inevitably result in opportunities for security and safety-related

products and services, they clearly constitute a threat to any business in South Africa.

AIDS

In addition to crime, South Africa faces the AIDS plague. Its direct or indirect impact

is a disaster for the country. According to United Nations’ figures, an estimated 20%

of the South African adult population carried the HIV virus in 2008. Possible

economic, social and cultural impacts of such a plague include destruction of family

structures, increasing number of orphans who can be prone to violence and

psychological impact on the nation’s culture. In addition, the increased medical and

social

SECTOR ANALYSIS

Many opportunities for Maine companies exist in the IT sector. There is a growing

need for all kinds of IT equipment and services around the country as South Africa

opens its economy to the rest of the world. In their drive to become more competitive,
South African companies are turning to high-tech solutions in all areas of business.

This results in very promising growth prospects for both business-to-business and

business-to-consumer trade.13 Maine's exports of industrial machinery and computer

equipment to South Africa rose seven-fold between 1994 and 1999.

Despite the development gaps still existing in South Africa, Maine companies

considering entry into the South African market should regard this market as well

advanced and very competitive. Most of the large global players (Nortel, IBM,

Oracle, Microsoft, Novell, Cisco, and Compaq) already maintain operations in South

Africa.

E-COMMERCE

 E-commerce has been one of the fastest-growing sectors in South Africa over

the past two years and is expected to continue to grow significantly over the

next few years.

 Internet-based consumer transactions are expected to grow more than ten-fold

by 2005.

 South African Online sales during the 2000 Christmas holiday season were up

645% from the previous year.16

 Approximately $5 billion will be spent online by 2002, up from $580 million

in 1999.

 In 2000, 97% of large corporations, 89% of medium-sized companies and

80% of small companies were connected to the Internet.

 By 2003, an estimated 4.4% of the total population will have Internet access at

home (1.84 million people compared to 500,000 people in 1998).

INFORMATION TECHNOLOGY OUTSOURCING

IT outsourcing revenues in South Africa reached $300 million in 1999, up from $198

million in 1998. The stiff competition, the drive to cut costs and the need to focus on

core activities lead an increasing number of local businesses (from large to small

companies) to resort to outside specialized firms able to provide cost-efficient and

reliable IT solutions. Opportunities exist for both large and small American

companies, depending on what services or products they offer. Best prospects include

the services sector, E-commerce, health-care services, systems integration, web

hosting, software customization and security.

TELECOMMUNICATIONS EQUIPMENT AND SERVICES

 The size of the South African telecom equipment market reached an estimated

$5.1 billion in 2000.

 In 1999, Telkom, the South African monopolistic telecom company, planned to

spend $8.3 billion to $10.4 billion over the next five years to install 2.8 million

new lines and digitize 1.27 million analogue lines.

COMPUTER SOFTWARE AND SERVICES

 American IT companies dominate the South African software market, with a

market share of approximately 83 to 85 percent of all PC software.

 In 2000, South Africa's imports of computer software from the U.S. reached an

estimated $447.5 million, up from $302 million in 1998.25

The overall development of the IT sector in South Africa inevitably creates huge

demand for both professional and consumer-oriented software, with many niche

opportunities existing, notably in the field of marine software.

LUMBER AND OTHER WOOD PRODUCTS

 Many opportunities exist for the numerous Maine companies involved in the

wood products business.

 According to the U.S. Foreign Agricultural Service, demand for wood

products in South Africa is strong and should continue to grow significantly in

the near future.

 Maine's worldwide exports of lumber and wood products rose 8.9% between

1997 and 1999.

 Maine's total export of lumber and wood products in 1999 was $245

million.28

 In 1999, Maine export of wood products to South Africa totaled $35, 495 or

less than 1% of Maine’s total export of wood products.

 Forests and woodland account for 7% of South Africa’s geographic area.

SECURITY AND SAFETY EQUIPMENT AND SERVICES

 Rising crime levels in South Africa.

 A rising demand for security and self-defense-related products and services.

 The commercial and industrial security industry in South Africa is valued at

approximately $1.8 billion.

 Despite the efforts of local authorities, South Africa continues to face

increasing levels of crime. Bank robberies, car theft and hijacking, are all too

common. The upshot of this is a rising demand for security and self-defense-
 related products and services. Best prospects in this sector include vehicle

security products, perimeter security and access control (fence, wire, and

security gates), detection devices and building protections as well as internal

physical security and turnkey systems (security doors and computer-based

microprocessor systems).

AGRICULTURAL PRODUCTS

South Africa has a market-oriented agricultural economy, with significant volumes of

both agricultural imports and exports. South Africa profitably exports a wide range of

agricultural products and by-products (South Africa is the world’s third major

exporter for fruits and the eighth for wine) and is, in most respects, self-sufficient in

agriculture.

The decline in the value of Rand relative to the dollar over the last two years has

had a beneficial effect on the country's agricultural export earnings. Exports

rose from R12.3 billion in 1997 to R13.4 billion in 1998. Principal exports

included fresh and processed fruits, vegetables and sugar.

The United States plays a major role in the South African agricultural market,

supplying 11.5 percent of imports and taking 4.5 percent of the country's exports.

Although the country is mostly self sufficient in agriculture, some opportunities for

Maine companies still exist.

CHAPTER 2 TELECOM SECTOR ANALYSIS IN SOUTH

AFRICA
South Africa boasts the largest and most developed telecommunications network in

Africa, including the latest in fixed-line, wireless, satellite and cellular technology.

The country has over 14 million mobile phone and almost five million fixed line

subscribers. Telkom is the only licensed provider of public switched

telecommunications services. Cellular services are currently provided by three

licensed operators: Vodacom, MTN (Mobile Telephone Network) and Cell C. South

Africa runs on the GSM cellular system.

Parastatal’s Transtel (a division of Transnet) and Eskom are the only organizations in

South Africa that maintain private telecoms networks. Communications satellite users

include Telkom, Sentech and Transtel.

In 1997, Telkom was granted a further five-year exclusivity period as part of its

license conditions. In March of the same year, the government sold a 30% stake in

Telkom to the Thintana Communications consortium made up of SBC

Communications International and Telecom Malaysia. The agreement included a

commitment to install 2.8 million new lines (including 12 000 payphones) and replace

1.25 million analogue lines by March 2002.

Although Telkom's monopoly has expired its right to provide basic services has

simply been extended to include the second network operator and, in some cases,

signal carrier Sentech. But as the second operator has not yet been licensed, Telkom

remains the sole provider of services by default.

The South African cellular market has boomed since its inception in 1994, and is the

fourth fastest growing GSM market in the world. The cellular industry has been
accelerated by the successful introduction of pre-paid subscriber packages, with

contract subscribers showing slower growth.

It is expected that mobile data subscribers will experience growth over the next few

years as business users migrate to SMS (Short Message Service), WAP-enabled

(Wireless Application Protocol) and similar services due to increased mobile data

needs.

Access to telecoms services is still a major obstacle. One of the independent

Communications Authority of South Africa's (Icasa) key mandates is to promote

quality and affordable telecoms services to those previously denied them.

This includes the encouragement of service provision to previously neglected or

ignored areas, and promoting the involvement of new players in the industry.

The second issue is increasingly important in light of the fact that Telkom still

dominates the South African market. While the restructuring of Telkom, and the

eventual licensing of a second network operator, is expected to involve mostly black-

owned interests, it is a move that is eagerly awaited by South African businesses and

consumers who are weary of the parastatal's monopoly.

 CHAPTER 3 SOUTH AFRICA TELECOM INDUSTRY

HIGHLIGHTS

TELECOM SECTOR PROFILE

Year Milestones
1902 The first publics “call offices” (pay telephones) were introduced in South Africa.
1905 First exchange in Free State (Bloemfontein).
Underground cables were introduced in Johannesburg, Pretoria and other major cities.
1909
Farmers were allowed to erect own telephone lines at own costs.
The Department of Posts and Telegraphs was created. WT Hoal was the first Post Master General
(PMG) of the Union of SA.Radio communications was used for the first time in South Africa
when the Natal Administration established a coastal radiotelegraph station at the Bluff on 8 June
1910 to communicate with ships at sea. It could communicate with ships 400 km away. The first ship
to shore radio off Bluff in Durban message was received from the twin-screw steamer, Zealander
at 06:31. Four provinces united under one Department - pre-Union regions were autonomous -
with 13,650 services.
1911 The first Postal Act, No 10 was introduced.
The Creed high-speed telegraph system was put into operation. Uniform telephone rates were
1913
introduced.
The Telephone and Telegraph Association (a Labor Union) was formed in Johannesburg. It was
1918
dissolved and became part of ATU in 1997.
The multiplex telegraph system ("teletype") opened between Cape Town and Johannesburg. This
allowed 4 telegraphs to work in each direction simultaneously on a single line.
The first experimental automatic telephone exchanges were installed at Waterkloof in Pretoria in
1922 July and at Camps Bay in the Cape in September the same year.
The first outdoor telephone booths, made from concrete piping were introduced.
Telephone trunk line opened between Johannesburg and Cape Town. It was made possible by the
use of voice frequency repeaters.
 Five repeaters installed between Cape Town and Johannesburg to allow speech between two
1923
cities on telephone trunk lines.
First carrier system installed.
First two automatic telephone exchanges installed, one in Port Elizabeth the other in
Pietermaritzburg. First South Africa to United Kingdom radiotelegraph communications.
The first telegraph typewriter known as the tele printer were brought into use in South Africa
1924
between Pretoria and Johannesburg.
The first overseas radiotelegraph message was received from London on 3 December.
The first official radio broadcasting service of the Associated Scientific and Technical Societies
started in July 1924.
The African Broadcasting Company was founded in April, later to become the SABC.
1927 The first three-channel carrier system (3 and 12-channel) used in South Africa was instituted
between Johannesburg and Durban with two repeater stations along the route.
1928 The first landline for broadcasting is used between Johannesburg and Pretoria.
1929-49 Black bakelite phones used.
First automation program undertaken. The first direct telephone call (voice radio) to London
1932
from Cape Town took place on 1 February using radiotelephone - 1 channel.
1933 First discussion debating split between Post Office and Telecoms.
1934 Telex exchange (12 and 3 channel system) in Cape Town and Johannesburg installed.
The telex (telegraph) system was introduced to South Africa. This system allowed private
1935 subscribers to be inter-connected via a special manual telegraph exchange.
Every rural town in South Africa was connected to the trunk exchange system.
Short wave radio station for international traffic commissioned at Robert's Heights. Used by
1936
military during Second World War.
1937 First SOJ (Speech Open Wire - J System) 12-channel - USA system - introduced.
1938 40 Automatic exchanges operational.
1938 40 Automatic exchanges operational.
In December the SABC decided to broadcast "Nkosi Sikelela I Afrika" as concluding item of its
1940
Black station broadcasting.
1944 First 12 channel system between Durban and Pietermaritzburg.
Capex 1,098,624 pounds; 249,785 services; 50,000 waiters; 22,509 farms; 8,116 public. Bad
1944-45
debt: 315 pounds.
1945-46 Capex 2,179,518 pounds; Profit 2,903,340 pounds; Revenue 10,369,131 pounds; Opex 6,463,265
 pounds. 22,062 staff.
There are 264,037 services and 40,000 waiters. Huge training initiative started. Disabled
employed.
1946
First underground cable between Johannesburg and Vereeniging, Cape Town and Somerset West.
United Kingdom-United States of America radio service established.
1946-47 Cambridge exchange automated. 26,412 staff.
26,000 new services provided - rural priority - rental 7 pounds per year from Post Office, 5
pounds from railways. 23 telecommunication-training facilities established.
Cheese-dish black phone introduced. Exchanges classified into 3 classes coupled to promotion of
1947
staff: Class 1 - 750 services, class 2 between 50 and 750 services, class 3 less than 50 services.
First facsimile (photo-telegram) service introduced in South Africa between Johannesburg-Cape
Town-Durban-Port Elizabeth-Bloemfontein.
The Postal Administration purchased the external cable service of Cable & Wireless Ltd. on 1
January for 330,000 pounds - up until then this private company handled all foreign radio
telegraph and voice services. In March a direct radiotelephone and radiotelegraph service (South
Africa-United States of America and South Africa-Belgian) with the Congo (Leopoldville)
1948 opened.
Exchanges re-classified, Class 1 - 500 services and 2m units per year, class 2 between 51 and 500
services and 2m units per year, class 3 less than 50 services and less than 180,000 units per year.
78 United Kingdom staff recruited. Post Office staff 21.2% woman = 5,930.
First co-axe system and microwave.
Public Service Commission rejects equal treatment of people of different color. White / Non-
1949 White signs introduced. First South Africa-United States of America voice radio service
established.
1947-50 Exchanges at Bloemfontein, Rietfontein automated.
1950 Alternate language month policy introduced. South Africa develops local 12-channel system that
support 27 voice channels. World record established by operating 400 trunks lines over a single
carrier overhead route of 16 pairs. Rural local calls were free up to this time.
Between 1947 and 1950: 385,064 services; 95,995 installs; 30,638 staff; 109,639 waiters (in
United States of America: 31m to 52m telephones). First 24 channel system between Durban and
Pietermaritzburg.
South Africa-Rhodesia voice radio link established. Ship to Shore service commissioned along
east coast - Durban, Port Elizabeth, and Cape Town. Staff compliment: White 22,439; Colored
 635; Indian 40; and Black 5,012.
Automated Waterkloof, Vanderbijlpark, Bloemfontein, Port Elizabeth, Pietermaritzburg,
1950-51 Silverton, Vereeniging, 426,659 services; 105,890 waiters; 41,608 farms; 9,823 public. Bad debt
1,014 pounds.
25,600 staff - permanent only. 184 Dutch technicians employed. Workweek changed from 39 to
1951
42 hour week.
1951-52 46,983 farm lines, 5,375 new installs at a cost of 1,024,406 pounds.
479,823 services, 53,164 install, 99,180 waiters.
First co-axe system between Durban and Pietermaritzburg.
Cable theft becomes a problem.
South Africa-Australia voice radio link established.
1952
Radio link between Pretoria and Nairobi. Cost per port R80.
The co-axial cable system installed between Durban and Pietermaritzburg and Pretoria and
Johannesburg to Vereeniging. These allowed 1,920 speech channels over the cable.
Direct radiotelephone service between South Africa and Australia in September.
Automated New lands, Hilton Road, Paarl, Somerset West, Wellington, Bramley, Lyttelton,
1952-53
Queenstown, Three Rivers.
First radio link between South Africa and United Kingdom and America - 4 channel telex system
1953-54
- 423 telex services operational.
Only 8.3% Afrikaans speaking in top 24 jobs. Africans speaking given preference even with
1954 lower educational qualifications. South Africa-Argentina voice radio link established first radio
link to South America.
Split between Post Office and Telecom again raised. South Africa voice radio links with
Bahamas, Chile, Greece, and Germany. The first automatics telex (tele printer) exchange was
1955 installed in Johannesburg with facilities to reach all major centers in the country.
The first transistor radio receiver in South Africa was build by F Donkerbroek at the SAPT
laboratories.
36-channel voice system installed. 665,669 services; 71,602 waiters; 60,998 farms; 11,448
1955-56
public. Bad debt 12,563 pounds.
South African Federated Chamber of Industries calls for split between Post Office and Telecoms.
1956 Carrier route between Johannesburg and Cape Town via Kimberley commissioned.
Start of automation of trunk network. International Telecommunication Union (ITU) established.
1957 82 Auto exchanges exist. Russia launches Sputnik I.
 Modern radio transmitting and receiving stations at Olifantsfontein and Derdepoort were taken
into service. These stations made available 19 telephone and 98 telex and telegraph connections
1958 to about 100 countries possible. The Centenary telephone (grey color with maroon handset) was
the first plastic telephone used in South Africa. First private telex services between South Africa-
United Kingdom and South Africa-United States of America and South Africa-Belgian Congo.
1958-59 Capex 9,097,050 pous.
South Africa's network 19th largest in the world. Post Office dictionary introduced.
1959 The first license for a telephone answering service (a telephone connection for answering of the
telephone and recording a message) was issued.
First SOX 12 channel system between Bloemfontein and Klerksdorp. South Africa has the third
largest overhead carrier system in the world. First satellite connection in co-operation with
America.
1960 The first line-of-sight microwave tested in South Africa: Pretoria-Johannesburg route and first
commercial microwave system (838,000 services and 1,700 telex services) commissioned
between Johannesburg and Klerksdorp on 31 March. Sharpeville reversed a number of policies.
Staff compliment: White 32,005; Colored 1,897; Indian 75; and Black 7,351.
Automated trunk dialing. 91 auto exchanges. Uniselector becomes the standard.
1960-61
879,945 services; 14,615 waiters; 86,682 farms; 14,093 public. Bad debt R86,023.
PO salary R660 per year; Railways R1,160 per year; Municipality R1,350 per year.
1961 Whites to deliver in white areas introduced. Cut ties with commonwealth - isolation started.
12 Telex services to London, 1 to Leopoldville, 1 to USA Washington, 1 to USA Los Angeles.
National subscriber’s trunk dialing was introduced. Telex service to America.
1962 Gentex introduced. PCM introduced in South Africa. Also first year introduced in United States
of America.
1960-65 Trunk Lines between Durban-Johannesburg-Bloemfontein-Pretoria-Vereeniging.
1963 Rental changed from yearly to monthly. Mobile radio service demand increases.
1963-64 109 auto exchanges. First fully automated farm line system installed -Bethlehem and Virginia.
1964 The mobile public VHF radiotelephone service was introduced in Johannesburg, March 1964.
Capex R24, 700,000. Connected to 67 countries.
1964-65
Incoming calls: 23,838 - outgoing: 28,462.
1965 71 countries connected with Telex. First data transmission commissioned.
1965-66 SAT 1 cable laid between Cape Town and Europe - cost R50m. 1,119,878 services; 33,203
waiters; 91,939 farms; and 16,160 public. South African service increased by 72, 5%; Sweden
 61, 5% and America 68, 1%. And Debt R43, 420.
1965 The first data transmission in South Africa took place.
1966 Staff compliment: White 33,499; Colored 3,458; Indian 281; and Black 8,803.
1967 First fully electronic telephone in the world, transistor phone.
1967-68 1,704 PBX's incoming international calls: 42,306, outgoing: 47,517.
The Post Office attains autonomy, but still not split into two entities. The PO took control over its
staff, finances, buildings (minor works) vehicles, etc. (The Post Office Re-adjustment Act of
1968 1968 - Act No 67 of 1968). First 24 channel PCM systems introduced between Vereeniging and
Meyerton. 1,322,000 services. PO staff 35,7% woman = 12,331. Microwave services installed
between Pretoria and Johannesburg.
154 auto exchanges; 1,311,864 services; 79,545 waiters; 98,589 farms; 17,469 public. Bad Debt
1968-69
R34.467.
Staff housing subsidy introduced. Microwave route between Cape Town and Melkbosstrand
installed. Connected to 93 countries. Full auto links between Zimbabwe-South West and South
1969
Africa in addition to 95 countries - Telex. The private Durban Telephone Corporation was taken
over by the Department of P&T. Telephone accounts were fully computerized on 1 October.
Installation of the millionth telephone in South Africa on 29 April.
1970
South Africa ranked fifth country in terms of tele density.
1971 Opening of the Hillbrow (Johannesburg) microwave Tower on 17 April.
The international automatic telephone exchange opened in Cape Town.
1972 First 30 channel 2.048 Mbit/s Pulse Code Modulation system installed between Pretoria and
Johannesburg.
The name of the Department Posts and Telegraphs was changed to the Department of Posts and
1974
Telecommunications on 1 February.
South Africa's first satellite communication was provided by Intelsat (used the IV A series) on 2
December via the Hartebeesthoek satellite earth station that was also opened.
1975
The 2 millionth telephones, a golden Protea telephone, were presented to a Witwatersrand client
on 28 May.
South Africa' first television service, TV1, was established on 5 January and offered 37 hours of
1976
broadcast per week.
1977 The first non-white technicians trained by the Post Office qualified in May.
The SAPT was one of the first organizations in the world to changeover from analogue to digital
1978
switching.
 The first electronic telex exchange (Electronic Data Switching - EWSD) was opened in
1979 Johannesburg (Sunninghill Park) on 20 September. The electro-mechanical exchange it replaced
was the biggest in the world under one roof.
1980 The first E10 digital exchange commissioned in Pretoria (Proes Street).
First optic fiber cable commissioned between Roodepoort and Witpoortjie - 34Mbit/sec system.
The 140 Mb/s and 565 Mb/s fibre systems were also introduced.
Change from multi-mode to single mode fibre. Local production of fibre cable.
1981
The first electronic telephone exchange, a French SA 128, was opened in Pretoria on 23 October.
First push button phone (telephone dial was replaced by push-button switching) was introduced
with the introduction of the Lorea telephone.
1982 Saponet-P x.25 packet switching launched.
The first optic fibre cable system with a capacity of 1,920 circuits was put into operations in 1983
between New Doornfontein and Power Park. History was made when the Disa telephone was
1983
designed, developed and manufactured in South Africa and made its appearance as the first
locally produced electronic telephone.
1984 The first digital microwave system was introduced between Durban and Pietermaritzburg.
The toll-free telephone service was introduced in November. All calls to these numbers were
1985
debited to the account of the subscriber and no cost to the person making the call.
The first black staff association (POTWA) was constituted. Beltel the videotext service was
introduced.
1986
The introduction of Diginet, a digital point-to-point communication service to data users.
The Magnolia rural farm-line system was instigated to replace the existing magneto farm lines.
The first C450 analogue cellular radio mobile telephone system was commissioned.
1987
Frame Relay deployed.
TDM-CBR leased lines commissioned. South Africa's first card telephone was installed on 3
1988 March in Pretoria. With a prepaid call card direct dialing was possible worldwide from these
public telephones.
1989 Introduction of local call timing.
1990 On 10 April the 5 millionth telephones was issued in Pretoria.

Table 1: Source Telecom SA history

TELCOM FOUNDED
Telkom SA Ltd. was founded on 1 October.  On this date, the Dept. of Posts and

Telecommunications was divided to form three separate entities, namely the Dept. of

P & T, and the fully state-owned companies, Telkom SA Ltd. and the South African

Post Office Ltd. The number of employees was at that time 67, 667 of which 46% was

black - Africans were 30%, Colored, 13% and Indians 3%.  The large majority of

black personnel were employed in unskilled or semi-skilled work functions with less

than 0.25% in junior management positions. Telkom was incorporated with an

authorized share capital of R1 million divided into 1 million ordinary shares of R1

each. The first Board of Directors was appointed with two black directors - M.

Mahanyele and P. Malimela.  The rest were: Jack Clarke as Chairman, Neal

Chapman, Brian Clark, Rodney Craig, Marius Daling, Ritzema de la Bat, Johan de

Villiers, Jan Robbertze and Bill van der Merwe.

TELCOM 1996

AFFIRMATIVE ACTION

White recruits shrank to 32% and black staff accounting for 68% of appointments.

By March 1996 whites accounted for 53% of promotions and blacks for 47%.

By December 1996 the workforce composition was as follows: 46% were white and

54% were black.

HUMAN RESOURCES

The number of main service lines per employee rose by 11% from 63 to 70.

There were 55, 347 employees. 61% were whites leaving Telkom and 39% were

blacks by December 1996.

SHE (SAFETY HEALTH AND ENVIRONMENT)

AIDS education featured prominently during the year, with an industrial theatre

production reaching approximately 40, 000 employees. Revenue grew by 23% to

R13.32 billion due to a strong demand for international calls, the rapid growth in the

cellular industry, and the introduction of new products and services. The dividend per

share increased by 33% to 7.7 cents. Total payment to the Govt. comprising tax and

dividends amounted to R934. Net profit increased by 43% to R1, 208 million.

UNDERSEA CABLE

The proposed SAFE (South Africa Far East) cable (optic fibre) laid the foundation for

greatly enhanced international connectivity when Telkom and Telekom Malaysia

signed a memorandum of understanding to evaluate the project’s feasibility.

FRAUD

Cable theft escalated alarmingly during the year.  Some 4, 195 incidents were

reported.  Direct losses amounted to almost R29 million.  International fraud targeting

Telkom’s network resulted in losses of at least R200 million.  More than 160 persons

were arrested – 15 of them Telkom employees. New Telecommunications Act No

103 of 1996.  The new Telecommunication Act came into effect. The White Paper on

Telecoms. Policy was launched on 15 March 1996 – signaling a move towards a

regulatory environment in which Telkom will face rising levels of competition.

CHAPTER 4 CASE INTRODUCTION

TELCOM (CELLULAR AFRICA) FACTFILE

In October 1991, the South African Posts and Telecommunications separated into

three separate entities, one being Telkom South Africa (Telkom). Telkom was

“commercialized” in a public offering with the state as its sole shareholder. As a

commercial entity and public company, Telkom began to produce dividends, cut

costs, stimulate productivity, increase efficiency, and operate under full public

scrutiny. Along with the spin off, Telkom inherited a large and valuable

infrastructure as well as an outstanding debt bill of 10.2 billion Rand.

Telkom had a painful transition from a government bureaucracy to business enterprise

in 1991. Adoption of internationally acceptable commercial accounting practices and

controls was a mess. Additionally, the transformation into a “client-focused” service

company committed to practical and affordable solutions to telecom needs was

traumatic.

PRIVATIZATION AS A GOVT PROGRAM

The Telkom privatization was part of the South African government’s program to

partially privatize state enterprises (the National Framework Agreement, or NFA),

commenced in 1995. Before the program began, state-owed enterprises accounted for

one-quarter of the country’s total fixed capital assets. Telkom would be the largest

partial privatization in Sub-Saharan Africa to date and the single largest foreign fixed

investment in South Africa since the African National Congress (ANC) took power in

1994. The ANC chose to sell off only 30% of Telkom and keep the remaining 70% in

the state’s ownership.

RISING OPPORTUNITIES FOR TELCOM

Modern telecommunications is an indispensable aid in meeting basic needs.

Telecommunications lies at the very heart of progress. Not only is

telecommunications good for developing countries’ economic and social progress, it

is also a lucrative and comparatively safe investment in emerging markets (due to the

reliable stream of cash flows and high growth prospects). Telecom investment

(including openness to foreign direct investment, flexible financing requirements, tax

benefits, technology neutrality, and lack of purchasing bias) offer returns on equity in

the range of 20 to 30 percent

MONOPOLY

South Africa significantly lags behind the developed world in telecommunications

services. Measured by tele-density (the number of telephone lines per 100 people),

South Africa had one of the least developed telecommunications infrastructures in the

world in 1997 – which SBC considered a positive indication of unmet demand and

strong growth potential. On average, South Africa had one telephone line per 100

blacks and 60 lines per 100 whites.

FDI IN SOUTH AFRICA

South Africa emerged from its apartheid era as an engine of growth for Africa, a

continent historically plagued by economic hardship. In particular, South Africa’s

new openness to trade promised to have a positive impact on southern Africa, a

market of 120 million people.

The U.S. took a particularly strong interest in the potential of South Africa, both as a

source of investment capital and a gateway to the continent of Africa. The U.S.

government undertook numerous measures to encourage positive bilateral trade and

investment relations with South Africa. South Africa possessed a modern

infrastructure supporting an efficient distribution of goods to major urban centers

throughout the region and well-developed financial, legal, communications, energy

and transport sectors. Many economists described South Africa as a hybrid between

the third and first worlds because of its mixed economic indicators. South Africa

accounted for more than 40% of telephones in the entire African continent. Many

market analysts believed that Telkom’s privatization would raise the bar for

telecommunications all over Africa by introducing competition, foreign direct

investment, and leading-edge technology. SBCI, in addition to valuing Telkom

through a discounted cash flow model, considered valuing Telkom as a real option.

For example, if an investment in Telkom generated a negative NPV, that cost could be

seen as the price of an exercisable option to control telecommunications throughout

Africa. After the democratization of South African, and subsequent lifting of

sanctions, several U.S. telecommunications companies 1 moved in, including AT&T,

Lucent Technologies, Motorola, Sprint, Hughes Network Systems, Iridium, and

Teledesic.

1
RISKS PROFILE

COUNTRY SPECIFIC

As US removed sanctions South Africa has become attractive for investors. Now

Germany and US are investing lot of money in this country. After lot of years in

depression now investment in this country can yield high returns. Markets in this

economy are not matured so this could be a big advantage. Infrastructure is good as

compare to the other underdeveloped countries but there are some concerns relating to

the telecommunications industry. This is the big reason why government officials are

taking a chance.

Geographically South Africa is located on a location between South America, Middle

East and emerging South Asian markets. So this could be big point that is proving

crucial in investor’s minds. South Africa can become hub of the trading activities

between growing south-south. This strategic location could prove vital for these areas

success. South Africa can become a telecommunication hub for these plus other

African markets.

Investors around the world are taking South Africa as a gateway to Africa. So that’s

why companies around the globe are investing in South Africa and looking for

opportunities in other African countries.

Government officials are aware of the situation and expressed their opinion regarding

South Africa economic growth and role of telecommunications industry. Officials are

taking some steps regarding this issue.

VIOLENCE

Due to conditions prevailing in the country there are lots of concerns in the mind of

investors. Political conflicts, criminal violence, highest murder rate in the world along
with the hijacking cases are the problems that an investor can face. This problem is

creating a big hurdle in the South Africa’s way to success. Investors around the globe

are quite sensitive to this issue and want a safe and sound environment for their

investment.

Political, economic and social tensions (particularly income inequality) continue to

sustain a high level of violence in South Africa. Political conflict has claimed the

lives of 14,000 South Africans since 1984. In most areas, though, the biggest concern

is criminal violence. A 1995 study by the World Health Organization stated that

South Africa had the highest murder rate in the world, along with high rates of rape

and car/truck hijacks.

OPEN FOREIGN INVESTMENT

Generally people perceive environment for foreign investment friendly from

government point of view because government has same regulations for domestic and

foreign investors. But there are limits on local borrowing for companies whose 25%

or more ownership is with non-residents. This is to ensure adequate capitalization of

foreign investments and to prevent borrowing against share capital. But this could be

a big worry as institution outside South Africa will charge very high rates as compare

to local institutions because government wants to develop economy so interest rates

will fall.

World Bank does not include South Africa in its measurement of FDI because of its

small inflows and outflows. World Bank consider that South Africa attract less than

1% foreign direct investment. USA is investing in emerging markets of Latin

America, South Asia and Eastern Europe. The reason is that system prevailing in

these countries has become stable. Uncertainty level has decreased. Other reason that

could be considered is that some countries in these areas are strategic partner of US.
The big hurdle could be that infrastructure of other African countries is not

satisfactory.

The South African government applies the same regulations to domestic and foreign

investments and, therefore, is perceived as foreign-investment friendly. For example,

there are no caps on percentage ownership, no pre-screenings, and no performance

requirements.

Three issues, foreign exchange control, privatization, and competition, were still

problems for the South African economy. Although these three problems were

priorities for the ANC, the government had been unsuccessful to date in making

progress in loosening foreign exchange controls, accelerating the rate of privatization,

or increasing competition.

CREDIT RATING

The sovereign rating for the Republic of South Africa by Moody’s in 1996 was Baa3

– the top non-investment grade rating. In case of credit rating South Africa is not a

convincing investment for the risk averse investors because international credit rating

agencies are not appreciating investment in this region. Credit rating of South Africa

in 1996 was Baa3- the top non-investment rating. This is due to the worst conditions

prevailed in the country for last few decades. Investors are not satisfied with the

government because they were expecting a healthy change from new government that

did not came into existence. So it put bad impact on investors mind related to this

country future.

Uncertainty prevailing in the country is the big reason for this credit rating.

Government is new and they will take time. At this time to improve the country rating
and confidence of investors’ government should provide better environment for them.

Things like violence and criminal activities should be controlled.

INCOME INEQUALITY

South Africa has one of the most unequal distributions in the world. Social indicators

are quite alarming which includes one of the worst life expectancy and access to safe

waters. South Africa has good fertility rate but infant mortality rate is diminishing

effect of fertility rate. Adult literacy rate is quite better as compare to other countries

with high unequal income distribution.

In case of racial income distribution data is more discouraging. Blacks who are in

majority are living worst lives with lowest income. Whites, Asians and colored who

are minority have better income levels. This is the biggest dilemma that income level

gets improved as we towards minorities (blacks and colored).

These inequalities can effects consumers buying behavior. Investor who will invest in

the areas that will be more with general public consumption will consider this

inequality in depth.

Funding was to come from re-routing government expenditures, supplemented by

foreign aid and joint-financing deals between the government and the private sector.

However, actual spending was sluggish and overall impact on GDP was

disappointing.

The South African economy ranges from the affluence and sophistication of the first

world , including gleaming shopping centers and an advanced financial services

industry – to levels of poverty as extreme as the least developed countries in the

world. South Africa has one of the most unequal distributions of income in the world.
South Africa had made significant economic progress, mostly through the private

sector.

ECONOMY

Economic date of South Africa is not convincing one because in last few years after

depression from 1988 to 1992 figures are not showing convincing growth.

GOVERNMENT SPENDING

Government is spending huge amount to contribute in the way to economic growth

but few people noticed that huge amount of these expenses remained sluggish. Real

GDP growth was negative in early 90’s but in mid 90’s its positive. Even positive

figures in these years cannot consider healthy figures.

INTEREST RATE AND INFLATION (exhibit 5b)

Interest rates in last few years decreased but again moving upwards. Government

wants to decrease inflation. They are increasing interest rates that will push inflation

rates downward. Government is ignoring inflation effect over economic growth

because they are increasing interest rate that is pushing inflation downward even from

international benchmarks.

REAL GDP GROWTH (refer to exhibit 4 and 5a)

Now government should consider these things seriously because any investors coming

to South Africa or any country will consider a real GDP growth around double figure

a healthy one. Government spending should be used more effectively and efficiently.

For the development of economy quality of infrastructure should be improved

because good infrastructure can play effective role in it.

EMPLOYMENT

No doubt South Africa has human capital available but there is problem of

employment. In last decades government did not invested in the development of this

factor of economy. Due to this one can say that productivity of the domestic people

did not improved and they lacked behind developed part of the world in this field. NP

(National Party) ignored Black community and they were in majority so big part of

population remained untrained or undeveloped to take part in development in

economy.

Now investor will look for the people who can run the management of the

organization. Whites are able to run the organizations effectively but government

wants to develop the black community for management and decision-making. So

investor will invest a huge amount on training and development.

Even there are some aspects of South Africa that are not appreciating ones but local

institutions are loaded with cash, stock markets sustained bull run for more than three

years, and the prospects for continued growth in corporate earnings are sound. Private

sector is playing its role quite effectively in this scenario and the positive things are

showing effectiveness of the private sector.

POLITICAL UNCERTAINTY

New government took charge of this country and has no experience of running a

whole country. So it is a big concern that how they will deal with macro level issues.

These officials are not tested before so there are some questions regarding their

performance.

There are some realistic chances that there will be few people in the country who will

create problem for government. So this new government will face lots of challenges.
There will be concerns in the mind of investors that what will happen if this

government fails.

The right-wing AWB and Conservative parties were threatening to become militant in

order to reinstitute a system of apartheid. These right-wing parties placed many

obstacles in the way of political reform.

EXCHANGE RATES (refer to exhibit 11b and a)

South African Rand is losing its value after fluctuations in 80’s. Foreign exchange

reserves of government are quite low nearly for four to six weeks. Investors will

consider this fact quite seriously because their investment will lose value due to this

reason. Investors do not want to lose their money in this manner. Few economists are

expecting that Rand will appreciate.

Current situation of South African economy does not support this idea because there

are lots of problems, which this government is facing. Now after some major

improvements the depreciation rate will first decrease for some time and then Rand

will appreciate.

Overall this country has few bright aspects that an investor will look for. Potential to

grow and strategic location are the points on which investors can concentrate. But

problems are discouraging the thoughts of investors as depreciating exchange rate,

new and inexperienced political setup, high interest rates, income inequality,

economic conditions and violence in the country. International agencies do not rate

South Africa for investment.

SECTOR SPECIFIC

Around the world investment in telecommunication industry is considered safe in

emerging markets. Markets, which are considered unattractive for other sectors, are
considered attractive for telecom sector because of potential growth. Average return

on equity in emerging markets is around 20 to 30%. Emerging markets around the

globe provide incentives and favorable conditions for the investors who want to invest

in this sector.

In South Africa telecommunication sector is comprised of state run

telecommunication service provider Cellular and two cellular companies Vodacom

and Mobile Telephone Network (MTN). These two cellular companies provide

wireless communications and CELLULAR (Telkom) has fifty percent stakes in

Vodacom. Vodacom is the market leader. CELLULAR (Telkom) held a monopoly for

connecting cellular base stations to its backbone network.

South African government is well aware of the problems. They want to improve their

economic conditions. Government is taking steps to develop the human capital. They

are taking some serious steps. South Africa government realized that for the

development of economy telecommunication sector couldn’t be ignored. Integration

of good quality telecommunication services with good infrastructure can improve

economic conditions quickly.

There are lots of attractive and points of concern for the investors that are stated here:

DEMAND

South Africa has over 40% of approximately 10-million lines on the African

continent. South Africa has better teledensity (the number of telephone lines per 100

people) at its GDP group countries. But South Africa has one of the least developed

telecommunications infrastructures in the world in 1997.

When this teledensity is categorized on racial basis then one thing, which become

evident is that there is one telephone line per hundred blacks and sixty telephone lines

per hundred whites. This shows majority of population has been ignored regarding
this facility. These things give rise to the idea of potential growth of demand in

telecom sector. Government is also looking to promote the use of telecommunication

services.

There are lots of concerns related to this demand. One concern is that majority of

population is black and expected demand from their side is more. But on analyzing

economic data on racial basis one thing that becomes clear is that the majority of

population which is not enjoying telecommunication facility as compare to whites is

in worse economic condition. They are mostly from low-income group. Economic

data of South Africa is not showing huge improvements in near future so this

expectation of huge growth in demand becomes vague.

In case of whites and other racial groups they have as good teledensity as there is in

developed markets. So these segments can be declared as mature segments. Expected

demand could be quite low but in case of good quality service this segment could

provide big returns. This segment has better income level and they have better

resources. They can afford better services.

AFRICAN MARKET

Investors who want to invest their money in Africa look South Africa as a gateway.

So in case of telecommunication investors looking for the opportunities in the South

African markets because they feel they can monitor and handle their African

operations from South Africa quite effectively. The reason why investors look South

Africa as a gateway is the availability of better infrastructure in the country.

COMPETITION

Government issued fifteen years license to operate to Vodacom and MTN. Now

government is planning to issue two more cellular licenses within two years to
increase market players. Existing cellular companies are competing against each other

and also creating troublesome for CELLULAR.

After couple of years market competition will increase, as new entrants will enter

market. People will have more choice and quality will increase due to this

competition.

INVESTMENT

Telecommunication sector of South Africa is the leading investment sector for United

States. As government provide better environment by lifting sanctions and

democratization, several U.S telecommunications companies moved in including

AT&T, Lucent Technologies, Motorola, Sprint, Hughes Network Systems, Iridium,

and Teledesic.

Investors are investing their funds in South Africa because they are expecting increase

in African telecommunication markets. As new regulations came into force it

provided favorable opportunities to investors. Investors want to take full advantage of

the opportunity.

COMPANY SPECIFIC

DEAL REQUIREMENTS

Government required new owners in CELLULAR to train blacks for management

posts, roll out at least 2.7 million lines to underserved areas (particularly black

majority areas), and upgrade network capacity. These requirements would cost the

new owner approximately 53 billion Rand for infrastructure upgrades and 2.5 million

Rand for training disadvantaged groups employed by CELLULAR (60% of the funds

would be spent on the literacy and sales and service skills). The objective was to
create a management team with at least 35% of the members coming from

disadvantaged backgrounds. These stringent requirements frightened off several

potential bidders.

Two world-renowned companies Telekom Malaysia and SBC communications are

taking keen interest in this bid and strong contender in this process. They form a

consortium for this bid. But as other bidders they are aware of the concerns related to

the economy and sector in the South Africa.

TECHNICAL FAULTS

By February 1997, Telkom’s infrastructure was in technical disrepair. Faulty lines

went un repaired, public telephones were virtually non-existent. A large percentage of

customers had service suspended for late payment every month, cable theft was

rampant, and the number of Telkom customers was actually shrinking – extremely

unusual in an emerging market. Telkom’s trademarks included “high prices, slow

service, an aloof bureaucracy, a bloated work force, and a network engineered for

white neighborhoods.

DEBT BURDEN

Beginning in 1991, Telkom increased its leverage by borrowing to meet current

capital expenditures. The majority of the debt was secured through Telkom stock as

well as the government’s guarantee. In 1995 and 1996, Telkom had extreme debt

levels on its balance sheets in the form of interest bearing debt, denominated in Rand,

U.S. dollars, Deutschmarks, and Pounds. In 1995 and 1996, Telkom company had

total interest bearing debt of R9.67 billion and R9.99 billion, respectively, with

interest rates ranging from 10% to 18.5% (average effective rate was 16.7%).

Obviously, Telkom relied heavily on debt financing. This made it difficult to borrow

from the capital market at commercial rates. For example, Moody’s Investor Service
assigned a Baa3 rating to a $185 million unsecured bullet loan bank credit agreement

issued to Telkom. Telkom’s aggressive expansion plans required a great deal more

capital.

THREAT OF SUBSTITUTE

Telkom’s monopoly didn’t extend into the cellular sector, although it held a 50%

stake in Vodacom – one of the two cellular license holders in South Africa. The other

cellular service provider was Mobile Telephone Networks (MTN). Vodacom was the

market leader between the two competitors. Both held a 15-year license to operate

competing cellular phone networks in South Africa, the cellular revolution was

incredibly troublesome for Telkom for a number of reasons. First of all, with its

monopoly-based pricing structure, cellular service was only marginally more

expensive than wire-line service from Telkom and often more reliable. Secondly,

cellular service was a very efficient revenue generator due to the fact that more rural

customers could be serviced more cost effectively in a wider area without the burden

of having to lay cables. In addition, wireless technology required less maintenance

and eliminated the threat of copper cable theft.

RACIAL TENSION

In 1993, Telkom was a predominately white male company. After apartheid was

repealed, Telkom launched plans to incorporate more blacks into managerial roles.

The top executives conducted a search to count the number of black managers within

Telkom’s 58,000 employees as of 1994. They found 1. Therefore, Telkom began an

aggressive plan to promote, train and hire more blacks. This resulted in a strike of

5,300 white Telkom employees protesting the new policy to increase black

representation within the company. They cited reverse discrimination as Telkom’s

offensive behavior. In 1995, Telkom had 83 black managers (8% of the managerial
layer). Telkom pledged to increase the percentage of blacks in managerial positions

to more than 35% by 2002.

THEFT

People would dig up cables to sell them for their copper content. Incidents of cable

theft in South Africa were at an all-time high in 1996: 4,112 cables stolen at a cost of

41.1 million Rand.

Several efforts were being made to reduce cable theft including community policing,

legislation to clamp down on sellers of stolen copper, and replacing copper wire with

fiber optic cables. However, these efforts were yet to payoff – especially the fiber

optic cable replacement because thieves would have to dig up the cables to discover

they weren’t composed of copper.

THINTANA

Telekom Malaysia and SBC joined together in a consortium called Thintana to

purchase a 30% interest in Telkom South Africa (18% SBC, 12% Telekom Malaysia).

The partnership was announced in mid-December 1996. Previous to this date,

Telekom Malaysia and SBC were considered rival bidders. “SBC’s role in helping in

the rapid modernization of Telmex, the Mexican phone company, coupled with

Telekom Malaysia’s robust growth in telephone service and technical leadership in

rural telephony provides a unique combination of strengths that make us an ideal

partner for South Africa”.

TELEKOM MALAYSIA BERHAD FACT FILE

Telekom Malaysia has presence in a number of developing countries including India,

Malawi, Sri Lanka, Indonesia, the Philippines and Iran. By early 1997, Telekom

Malaysia was in negotiations for joint ventures in Bosnia-Herzegovina, Oman,

Vietnam, Cambodia and a sub-Saharan nation Telekom Malaysia privatized in 1990

and was the largest publicly listed company in Malaysia.

In December 1996, Telekom Malaysia purchased a 30% stake in Ghana Telecom for

US$38 million. Telekom Malaysia beat out rival bidders Deutsche Telekom, KPN of

the Netherlands, Western Wireless and Lightcom, and CELLULAR South Africa in a

single-round, sealed-bid auction.

SBC COMMUNICATIONS INC. FACT FILE

In 1997 SBC Communications Inc. was one of the world’s leading diversified

telecommunications companies. SBC provided innovative telecommunications

products and services under the Southwestern Bell, Pacific Bell, Nevada Bell, SNET,

and Cellular One brands. Its businesses included wire-line and wireless services and

equipment, cable television and directory advertising and publishing.

SBC was internationally diverse with operations on five continents via strategic

acquisitions and joint ventures. SBC continued to aggressively pursue opportunities

in high-growth international markets. By early 1997, SBC had interests in China,

France, Israel, Mexico, South Korea, Switzerland, Taiwan and Japan.

CHAPTER 5 VALUATION PROBLEM ISSUES

LISTING OF SHARES

The South African government planned to list Telkom’s shares on the Johannesburg

stock exchange after the monopoly expired in 2003. Therefore, Hendricks considered

the benefit of a model based on P/E multiples. He had already collected a list of

comparable companies to estimate Telkom’s beta

Telecom projects are less risky compared with other foreign direct investment

projects (as measured by their betas when regressed on the domestic market).

However, emerging market telecom companies have higher betas (all above 1) when

regressed on the U.S. market.

MANAGEMENT PROBLEMS

If Thintana is chosen for 30% ownership of Telkom, SBC and Telkom Malaysia

would be entitled to influence decision making at Telkom through four seats on

Telkom’s Board of Directors (out of 13 total), split evenly between the two bidders.

Were four seats sufficient to make Thintana voice heard, though? The South African

government was adamant about not giving up more than four seats.

If Thintana is chosen for 30% ownership of Telkom, SBC and Telkom Malaysia

would be entitled to influence decision making at Telkom through four seats on

Telkom’s Board of Directors (out of 13 total), split evenly between the two bidders.

FINANCING

SBC International (SBCI) expected to borrow the funds necessary to purchase 18% of

Telkom through its parent company, SBC. SBC Communications credit rating on long

term borrowings was A-/A2 (S&P/Moody’s) in 1997.

COST OF CAPITAL

One of the biggest areas of uncertainty in the valuation model was the cost-of-capital.

Hendricks had several choices for how to calculate the cost-of-capital and each

method arrived at a significantly different answer.

 Telkom’s expected (post-privatization) debt-to-value ratio was 29%.

 Beta of telecommunications companies in emerging markets was, on average,

1.2 when regressed against the world market.

If Hendricks decides to use the Capital Asset Pricing Model (CAPM), should he

adjust the beta downwards, (from approximately 1.2) to account for the lower risk of

telecommunications? Should he use the CAPM at all? Should DDM be used? How to

determine cost of equity?

Note: The case presented to us had similarities with Telkom SA. Therefore,

CELLULAR and TELKOM are used interchangeably in the case discussion and

solution.

CHAPTER 6 VALUATION ASSUMSIONS AND MODELS

A DCF valuation was performed on CA. P/E ratios valuation model was also used.

P/E MODEL

The P/E model would not be feasible to use. The model could be counted for short

term investors but not the long term investors. Thintana wanted a long term

investment and could not be judged by P/E ratio. The other problem was that average
arithmetic mean of the comparables was used. Mean values could give biased results.

P/E model would have been better to use if it was assumed that monopoly would

expire after 5 years (short term investment). If it is assumed that monopoly would

continue for a decade (long-term 10 years investments), then P/E model should not be

used for valuation.

Exhibit 12 talks about 15 industry players in telecom. The main thing was that SA

govt wanted to list shares on JSE and there was a monopoly period as well. This

approach had some problems as well. The main problem with the model was that

monopoly was ending in 2003. Hendricks collected data from comparables to perform

a P/E analysis. The JSE index fell from 8700 to 7570 in 4 months. The other thing

was that telecom projects when regressed on local markets showed betas higher than

1. The other issue was that comparable companies were listed on NYSE and CA on

JSE. JSE showed uncertain performance. Thintana wanted a long term measure.

The average P/E ratio was 29.4. This was a mean of comparable values. This is a

high value but still makes some sense for short term investors.

ROE

The industry average is 17.1. This is again high. Telecom projects usually promise

ROE for emerging markets bw 20-30%. This has even little difference form industry

average.

DCF MODEL

It is mentioned in the case that the monopoly will expire in the fifth year. We need to

see whether the after 6th years onwards CA enjoys monopoly or severe competition

arises. These assumptions will change the values.

So it is assumed that monopoly will be enjoyed for 10 years. (But could be extended

as well).

DCF ASSUMPSIONS

The CAPM model is still considered the best as for emerging markets.

The growth rates Pre-monopoly period was 16%.

The tax rate is 35%. Planned to make it to 23%, but 35% corporate tax rate is used.

(refer to pg 13).

Monopoly may/may not exist after 5 years. It will exist when all requirements are

met. (refer to pg 1). But lot of ambiguity exists. (refer to pg 14).SATRA still does not

have ways to determine nature and timeframe for telecom market competition. If the

country political end economic conditions improve, then investors may enter into the

SA market and new competitors arise. But if people do not come and pull away

(Deutshe telecom and French telecom did not want to invest in SA), then monopoly

would continue for a decade. One excel sheet shows that CA enjoys monopoly for

five years and new investors come and competition starts. These are conservative

valuations. The excel sheet 3 shows that due to high political risks, black

empowerment problems and economic conditions, new investors do not enter SA

region and monopoly is enjoyed by CA for about 10 years. This is a bit aggressive

valuation.

Depreciation is straight line, years and 12%. It could exercise an option to use

accelerated method as well. (refer to pg 13). But depreciation is charged as 12% of

fixed assets. Fixed assets growth rate is 15% assumed.

The depreciation rate for Rand/USD was 10%. (refer to page 13). It was estimated

that Rand will appreciate versus USD. But this was linked with the credit rating and
economic growth. If they improve, RAND would get stronger.( but this

appreciation/depreciation) would again change the values. Assumed is that Rand

would lose value for 10 years.

Cost of capital calculations was 20.48% (refer to CA excel sheet 1).

Beta used was 1.2, cost of equity was determined by using short term risk free rate on

SA bonds. SA had 16% rate. The equity risk premium was 7%. (values found from

secondary sources, since sensitive to discount rate.)

The return on debt was computed. Refer to excel sheet1. pg 9 shows cost of debt

16.70%. Refer to exhibit 4, last 2 columns; the cost of debt for 1996 is 14.5 %

( dividing debt services by total debt outstanding). The cost of debt for 1997 is

4263/25222= 16.90 est. 16.7 would be used. (Refer to pg 8 and 9). The average

effective rate was 16.7%. The interest rates ranged between 10% to 18.5%.

For example, if an investment in Telkom generated a negative NPV, that cost could be

seen as the price of an exercisable option to control telecommunications throughout

Africa(excel sheets show a negative NPV). The DCF computations show –ve NPV.

If monopoly even ends after 5th year and new competition arises, the sales/line growth

would lower from 16% to 10%. Costs per line would also lower. The growth in fixed

assets and Working capital would lower down to 10%, since it will be a mature

market after 10 years. In the growth stage, the rates may be high.

The consortium offer is of $ 1.261 billion, 60% by SBC and 40% by Telkom M, both

a 30% stake through a new entity Thintana. (SBC investment would be $ 757 million,

and Telkom M investment would be $ 504 million.) The value comes out to be 2.9 b

Rand. ($ 546 m).

ICCRC MODEL

This model has 12 ways to be used. World CAPM model could not be used because

SA was an emerging market. World CAPM is not used for emerging markets. If it is

assumed that SA stock market is integrated with world markets then global CAPM

holds, if it is segregated , then local CAPM, (the one which is used is held). But again

global CAPM holds true for countries with strong equity markets. (SA does not have).

The other model is credit rating model. (Institutional Investor magazine has ranking

of countries on a scale of 0-100, refer to exhibit 12). This takes into account for the

political risk, expropriation risk, exchange rate controls, and volatility. (The main

problem is that figures for 1997 were not available). But this would be the best one to

use and discount all the cash flows for 5 and 10 years and see the NPV.

The Goldman model could not be used. It is only applicable to countries whose

governments issue bonds in US dollars. (Nothing such as is given in the case about

SA). Secondly the company CA is less risky than SA country. Telecom sector has

growth and attractive for investors, but country is more risky than company CA.

S&P 500 variance

 REFERENCES

Africa venture partners, mobile operators

Burgeoning telecoms market, SA national website

IT, telecom: Gateways to Africa, Source: South Africa Business Guidebook,

2002/2003

“How the Telkom privatization was brought to life”, Business Times.

“Understanding value”, Morningstar.com

“SBC Communications & Telekom Malaysia Berhad finalize agreement for

30% stake in Telkom South Africa”, Business Wire 1997.

South Africa country report, 1997

“Telkom stake to net state R6bn”, Business Times.