an international comparison of south african telecommunication

83
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

Upload: others

Post on 03-Feb-2022

2 views

Category:

Documents


0 download

TRANSCRIPT

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 lines 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

i

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

ii

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.

iii

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.

1

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.

2

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).

3

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.

4

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

Australia

Germany

Japan

Kuwait

New Zealand

Russia

South AfricaSwitzerland

United States

United Kingdom

0

60

120

180

240

300

360

420

480

540

600

0 5000 10000 15000 20000 25000 30000 35000 40000GDP per capita

Bu

sin

ess

tele

ph

on

e co

nn

ectio

n c

har

ge

(US

$)

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.

5

Residential telephone connection charge (US$)

Australia

FranceGermanyNew ZealandSouth Africa

Switzerland

United Kingdom

United States

Japan

Russia

0

100

200

300

400

500

600

0 5000 10000 15000 20000 25000 30000 35000 40000GDP per capita

Res

iden

tial t

elep

ho

ne

con

nec

tion

ch

arg

e (U

S$)

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.

6

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

Australia

France

Japan

Kenya

Kuwait

Pakistan South Africa

Spain

Switzerland

United Kingdom

United States

Zambia

Russia

South Africa '040

200

400

600

800

1000

1200

1400

1600

1800

0 5000 10000 15000 20000 25000 30000 35000 40000 45000GDP per capita

Bu

sin

ess

tele

ph

on

e co

nn

ectio

n c

har

ge

(US

$)

Source: ITU 2004

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

Australia

Czech Republic

FranceGermanyGreece

Israel

New Zealand

Nigeria

South Africa

Switzerland

Tunisia

United Kingdom

United StatesSouth Africa '04

0

20

40

60

80

100

120

140

160

180

200

220

240

260

0 5000 10000 15000 20000 25000 30000 35000 40000 45000GDP per capita

Bu

sin

ess

tele

ph

on

e co

nn

ecti

on

ch

arg

e (U

S$)

Average

Source: ITU 2004

7

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

Australia

FranceGermany

Ireland

Japan

New Zealand

South Africa

Switzerland

United Kingdom

United States

South Africa '04

Kuwait

0

20

40

60

80

100

120

140

160

180

200

0 5000 10000 15000 20000 25000 30000 35000 40000 45000GDP per capita

Res

iden

tial t

elep

ho

ne

con

nec

tion

ch

arg

e (U

S$)

Average

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:

8

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

Australia

France

Japan

Kenya

Kuwait

Pakistan South Africa

Spain

Switzerland

United Kingdom

United States

Zambia

Russia

South Africa '040

200

400

600

800

1000

1200

1400

1600

1800

0 5000 10000 15000 20000 25000 30000 35000 40000 45000GDP per capita

Bu

sin

ess

tele

ph

on

e co

nn

ectio

n c

har

ge

(US

$)

Source: ITU 2004

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

Australia

Czech Republic

FranceGermany

Ireland

Japan

Kenya

New ZealandSouth Africa

Switzerland

United Kingdom

United States

Zambia

0

200

400

600

800

1000

1200

0 5000 10000 15000 20000 25000 30000 35000 40000 45000GDP per capita

Res

iden

tial t

elep

ho

ne

con

nec

tion

ch

arg

e (U

S$)

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.

9

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

Australia

Czech Republic

FranceGermanyGreece

Israel

New Zealand

Nigeria

South Africa

Switzerland

Tunisia

United Kingdom

United StatesSouth Africa '04

0

20

40

60

80

100

120

140

160

180

200

220

240

260

0 5000 10000 15000 20000 25000 30000 35000 40000 45000GDP per capita

Bu

sin

ess

tele

ph

on

e co

nn

ecti

on

ch

arg

e (U

S$)

Average

Source: ITU 2004

10

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

Australia

FranceGermany

Ireland

Japan

New Zealand

South Africa

Switzerland

United Kingdom

United States

South Africa '04

Kuwait

0

20

40

60

80

100

120

140

160

180

200

0 5000 10000 15000 20000 25000 30000 35000 40000 45000GDP per capita

Res

iden

tial t

elep

ho

ne

con

nec

tion

ch

arg

e (U

S$)

Average

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.

11

Telephone monthly subscription charges (business and residential)

Definition:

Telephone monthly 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$)

Australia

France

Germany

New Zealand

South Africa

Switzerland

United Kingdom

United States

South Africa '04

Japan

0

5

10

15

20

25

30

35

40

45

0 20000 40000GDP per capita

Bu

sin

ess

tele

ph

on

e m

on

thly

su

bsc

rip

tio

n (U

S$)

Average

Source: ITU 2004

12

Residential monthly telephone subscription (US$)

Australia FranceGermany

Japan

New Zealand

South Africa

Switzerland

United Kingdom

United States

South Africa '04

0

5

10

15

20

25

0 5000 10000 15000 20000 25000 30000 35000 40000GDP per capita

Res

iden

tial m

on

thly

tele

ph

on

e su

bsc

rip

tion

(US

$)

Average

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.

13

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

AustraliaCzech RepublicFrance

Germany

Ireland

Kenya

Kuwait

NigeriaRussia

South AfricaSwitzerland

United KingdomUnited States

Zambia

0

40

80

120

160

200

240

0 5000 10000 15000 20000 25000 30000 35000 40000 45000GDP per capita

Bu

sin

ess

tele

ph

on

e m

on

thly

su

bsc

rip

tion

(US

$)

Source: ITU 2004

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

Australia FranceGermany

IrelandJapan

New Zealand

South Africa SwitzerlandUnited KingdomUnited States

Kenya

Zambia

0

50

100

150

200

250

0 5000 10000 15000 20000 25000 30000 35000 40000 45000GDP per capita

Res

iden

tial m

on

thly

tele

ph

on

e su

bsc

rip

tion

(US

$)

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.

14

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

Australia

Czech Republic

France

Germany

Ireland

Kuwait

New Zealand

Nigeria

Russia

South Africa

Switzerland

United Kingdom

United States

South Africa '04

0

5

10

15

20

25

30

35

40

45

50

55

0 25000 50000GDP per capita

Bu

sin

ess

tele

ph

on

e m

on

thly

su

bsc

rip

tio

n (U

S$)

Average

Source: ITU 2004

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

Australia France

Germany

Ireland

Japan

New Zealand

South Africa

Switzerland

United Kingdom

United States

South Africa '04

0

5

10

15

20

25

30

35

0 5000 10000 15000 20000 25000 30000 35000 40000 45000GDP per capita

Res

iden

tial m

on

thly

tele

ph

on

e su

bsc

rip

tion

(US

$)

Average

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.

15

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.

16

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 $)

AustraliaFrance

Germany

Ireland

Japan

South Africa

Switzerland

Uganda

United Kingdom

United States

South Africa '04

New Zealand0

0.03

0.06

0.09

0.12

0.15

0.18

0.21

0 5000 10000 15000 20000 25000 30000 35000 40000GDP per capita

Co

st o

f a lo

cal 3

min

ute

cal

l (p

eak

rate

$)

Average

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.

17

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

Czech RepublicGermany Japan

Kenya

South AfricaSwitzerland

United Kingdom

United States

Zambia

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

0 5000 10000 15000 20000 25000 30000 35000 40000 45000GDP per capita

Co

st o

f a lo

cal 3

min

ute

cal

l (p

eak

rate

$)

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

Australia

Czech Republic

France

Germany

Ireland

Japan

Nigeria

Russia

South Africa

Switzerland

Taiwan, China

Tunisia

United States

South Africa '04

UK

0

0.04

0.08

0.12

0.16

0.2

0.24

0.28

0.32

0 20000 40000GDP per capita

Co

st o

f a lo

cal 3

min

ute

cal

l (p

eak

rate

$)

Average

Source: ITU 2004

18

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.

19

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

two has an unintended advantage. Because the initial and recurring 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.

20

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.

21

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

Business telephone connection charge (US$) '02

Australia

Germany

South Africa

Switzerland

United Kingdom

South Africa '04

0

20

40

60

80

100

120

140

160

180

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

Bu

sin

ess

tele

ph

on

e co

nn

ecti

on

ch

arg

e (U

S$)

Source: ITU 2004

Residential telephone connection charge (US$)

Australia

FranceGermany

Iran (Islamic Rep. of)

Japan

New ZealandSouth Africa

Switzerland

United Kingdom

United States South Africa '04

0

20

40

60

80

100

120

140

160

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

Res

iden

tial t

elep

ho

ne

con

nec

tion

ch

arg

e (U

S$)

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.

22

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. See 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

Australia

Czech Republic

France

Portugal

South Africa

Switzerland

Taiwan, China

United Kingdom

United StatesSouth Africa '04

0

20

40

60

80

100

120

140

160

180

200

220

240

260

0.00 0.05 0.10 0.15 0.20 0.25 0.30 0.35Cost of a local 3minute call

Bu

sin

ess

tele

ph

on

e co

nn

ectio

n c

har

ge

(US

$)

Source: ITU 2004

23

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

Australia

FranceGermany

Japan

Kuwait

New Zealand

Russia

South Africa

Switzerland

United Kingdom

United States

South Africa '04

0

20

40

60

80

100

120

140

160

180

200

0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4Cost of a local 3 minute call

Res

iden

tial t

elep

ho

ne

con

nec

tion

ch

arg

e (U

S$)

Source: ITU 2004

24

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 contributes 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$)

Australia

France

Germany

New Zealand

South Africa

Uganda

United Kingdom

United States

South Africa '04

Japan

0

5

10

15

20

25

30

35

40

45

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

Bu

sin

ess

tele

ph

on

e m

on

thly

su

bsc

rip

tion

(US

$)

Average

Source: ITU 2004

25

Residential monthly telephone subscription (US$)

AustraliaFranceGermany

Iran (Islamic Rep. of)

Japan

Kuwait

New Zealand

South Africa

Switzerland

Uganda

United Kingdom

United States

South Africa '04

0

5

10

15

20

25

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

Res

iden

tial m

on

thly

tele

ph

on

e su

bsc

rip

tion

(US

$)

Average

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.

26

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

Australia

Czech Republic

France

Germany

New Zealand

Russia

South Africa

United Kingdom

United States

South Africa '04

0

5

10

15

20

25

30

35

40

45

50

55

0.00 0.04 0.08 0.12 0.16 0.20 0.24 0.28 0.32Cost of a local 3 minute call

Bu

sin

ess

tele

ph

on

e m

on

thly

su

bsc

rip

tion

(US

$)

Average

Source: ITU 2004

27

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

AustraliaFrance

Germany

Ireland

Japan

New Zealand

South Africa

Switzerland

Tunisia

United Kingdom

United States

South Africa '04

0

5

10

15

20

25

30

35

0.00 0.04 0.08 0.12 0.16 0.20 0.24 0.28 0.32Cost of a local 3 minute call

Res

iden

tial m

on

thly

tele

ph

on

e su

bsc

rip

tion

(US

$)

Average

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!

28

Comparative costs per basket of calls per year

Total cost for the year US$

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

1000 1500 2000 2500 3000 3500 4000 4500 5000 5500 6000 6500 7000

Minutes

Tota

l cos

t for

the

year

Australia New Zealand South Africa United Kingdom United States South Africa '04

2700 '02

5100 '02 Average South Africa usage 2004 6800

1500 '04

3000 '04

6000 '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

axes 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.

29

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

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

500 1000 1500 2000 2500 3000 3500 4000 4500 5000 5500 6000 6500 7000

Minutes

To

tal c

ost

for

the

year

ad

just

ed fo

r '0

2 P

PP

Australia New Zealand South Africa United Kingdom United States South Africa '04

600 '02

700 '02

1100 '02 6000 '02Average South Africa usage 2004 6800

1600 '04

2000 '04

3500 '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.

30

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.

31

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.

The histogram below compares the average increase in connection, subscriptions and call

costs of selected countries, all in US$ terms.

Average increases since 1995 - 2002

-8

-6

-4

-2

0

2

4

6

8

10

12

14

16

Aus Bot Fra Ger India Ken Moz NZ SA UK US Avg

Ave

rage

%

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.

32

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

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

5500

6000

6500

7000

7500

1994 1995 1996 1997 1998 1999 2000 2001 2002 02 PPP

Cos

t of a

bas

ket o

f goo

ds U

S$

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.

33

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

-55

-50

-45

-40

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

35

1995 1996 1997 1998 1999 2000 2001 2002 Average

Cos

t of a

bas

ket o

f goo

ds U

S$

% c

hang

e

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.

34

Cost of 24 month 3 GB ADSL contract

0

2000

4000

6000

8000

10000

12000

AustraliaTelstra

New ZeelandTelecom

South AfricaTelkom

UK Britishtelecom

US NYBellatlantic

SingaporeSingtel

MexicoTelmex

Cos

t of 2

4 m

onth

AD

SL

cont

ract

R2 GB limit

15 GB limit

Unlimited

Unlimited

Unlimited

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 the 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.

35

Comparisons of demographics related to telecommunication between 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

France

Germany

Israel

Japan

New Zealand

South Africa

United KingdomUnited States

Ireland

0

40

80

120

160

200

240

280

320

360

0 5000 10000 15000 20000 25000 30000 35000 40000GDP per capita

Inte

rnat

ion

al o

utg

oin

g te

lep

ho

ne

traf

fic (m

inu

tes)

Source: ITU 2004

36

Adjusted for extreme data points, the following results.

International outgoing telephone traffic (minutes) per capita

Argentina

France

Germany

JapanMexico

RussiaSouth Africa

Tunisia

United Kingdom

United States

0

20

40

60

80

100

120

140

160

0 5000 10000 15000 20000 25000 30000 35000 40000GDP per capita

Inte

rnat

ion

al o

utg

oin

g te

lep

ho

ne

traf

fic (m

inu

tes)

Source: ITU 2004

37

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 (%)

AustraliaJapan

New ZealandSouth Africa

Switzerland

United States

Germany

30

40

50

60

70

80

90

100

0 5000 10000 15000 20000 25000 30000 35000 40000GDP per capita

Co

vera

ge

of p

op

ula

tio

n (%

)

Source: ITU 2004

38

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

Australia

France

GermanyJapan

Korea (Rep. of)

New Zealand

South Africa

Spain Switzerland

Taiwan, China

United KingdomUnited States

0.01

0.1

1

10

100

1000

0 5000 10000 15000 20000 25000 30000 35000 40000GDP per capita

DS

L In

tern

et s

ub

scri

ber

s p

er 1

000

Source: ITU 2004

39

Internet users per 100 inhabitants

Definition:

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

Internet users per 100 inhabitants

Australia

France

GermanyJapan

Korea (Rep. of)

New Zealand

South Africa

Switzerland

United Kingdom

United States

0

10

20

30

40

50

60

0 5000 10000 15000 20000 25000 30000 35000 40000GDP per capita

Inte

rnet

use

rs p

er 1

00 in

hab

itan

ts

Source: ITU 2004

40

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

following comparison:

Internet users per 100 inhabitants

Argentina

Czech Republic

Korea (Rep. of)

Libya

Mexico

Namibia

New Zealand

Poland

South Africa

Taiwan, China

0

10

20

30

40

50

60

0 3000 6000 9000 12000 15000GDP per capita

Inte

rnet

use

rs p

er 1

00 in

hab

itan

ts

Source: ITU 2004

41

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

Australia FranceGermany

JapanNew Zealand

South Africa

SwitzerlandUnited Kingdom United States

0.1

1

10

100

0 5000 10000 15000 20000 25000 30000 35000 40000GDP per capita

Mai

n te

lep

ho

ne

lines

in o

per

atio

n p

er 1

00

Source: ITU 2004

42

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

Czech Republic FranceGermany

Greece

Israel

JapanKorea (Rep. of)

Portugal

South Africa

Taiwan, China

United Kingdom

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

0 5000 10000 15000 20000 25000 30000 35000GDP per capita

Nu

mb

er o

f lo

cal t

elep

ho

ne

(min

ute

s)

Average

Source: ITU 2004

43

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

France

Germany

Ireland

Japan

Mexico

South Africa

United Kingdom

0

100

200

300

400

500

600

700

800

900

1000

1100

1200

1300

1400

1500

0 5000 10000 15000 20000 25000 30000 35000 40000GDP per capita

Nu

mb

er o

f nat

ion

al te

lep

ho

ne

(min

ute

s)

Source: ITU 2004

44

Total telephone subscribers per 100

Definition:

Total telephone subscribers divided by population multiplied by 100.

Total telephone subscribers per 100

Australia France

Germany

Japan

New Zealand

South Africa

Switzerland

United Kingdom

United States

Taiwan, China

0

20

40

60

80

100

120

140

160

180

0 5000 10000 15000 20000 25000 30000 35000 40000GDP per capita

To

tal t

elep

ho

ne

sub

scri

ber

s p

er 1

00

Source: ITU 2004

45

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

Australia

South Africa

United Kingdom

Kenya

US

0

20

40

60

80

100

120

140

160

0 5000 10000 15000 20000 25000 30000 35000 40000GDP per capita

Tel

eph

on

e fa

ults

per

100

mai

n li

nes

Source: ITU 2004

46

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.

47

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.

48

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.

49

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.

50

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

1

2

3

4

5

6

7

8

9

10

11

12

13

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!

51

Prime Interest Rates

13

14

15

16

17

18

19

20

21

22

23

24

25

26

Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02

%

Prime Prime Adj

52

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

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

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.

53

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

production per worker is unaltered

66 846

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).

54

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.

55

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 operational 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.

56

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

57

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.

58

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.

59

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.

60

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.

61

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).

62

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.

63

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.

64

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.

65

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 compared 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.

66

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.

67

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.

68

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.

69

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 member

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.

70

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

71

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.

72

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

73

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%

74

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 Services 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%

75

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:

76

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

associated with reducing the staff complement amounted to R302m in the financial year to

March 2004. It will be fairly safe to assume that another restructure program will cost a

similar amount.

77

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).