Telkom on target to meet licence obligations

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Telkom South Africa, the incumbent, is trying to bring telecoms services to more of the population. This year alone, the telco will install over 600,000 lines. Telkom South Africa's CEO Sizwe Nxasana talks to Mark Holmes about the operator's plans to improve the levels of telecoms service in South Africa.

Telkom South Africa, South Africa's incumbent telco, operates in a unique set of conditions. The legacy of apartheid means that there is a big teledensity disparity between white residential areas and more impoverished areas in the country. In the white neighbourhoods, 97% of people have access to telecoms services whereas in the under-serviced areas, that figure is barely over 50%.

One of the main challenges for Telkom remains the installation of new lines in under-serviced areas. The operator has been given certain licence obligations by the government and plans to have seven million lines operating by the year 2002. The operator will lose its fixed-line monopoly in 2003. The exclusivity period has enabled Telkom to embark on an expensive modernization programme ahead of full-scale competition.

The company benefits from having SBC Communications and Telekom Malaysia as strategic partners. The government sold a 30% stake in May 1997 to the two operators for $710 million. These two operators have been playing an active role in Telkom's modernization process.

One of the key goals of the modernization programme is to improve efficiency levels. The operator announced in July that its annual operating costs rose by 22.1%. The company is implementing a voluntary retirement programme as part of the efficiency drive. By the end of May 1999 the company had received 2,500 applications for voluntary retirement. Over 2,100 of the applications were approved and 200 were rejected owing to the need to retain certain critical skills.

The operator is determined to be the number one provider of high-bandwidth services to corporate customers. Telkom has rolled out ATM (Asynchronous Transfer Mode) services in all the major metropolitan areas of the country.

In an exclusive interview with Global Telecoms Business, the CEO of Telkom South Africa Sizwe Nxasana talks about the different challenges facing the operator over the next two-three years and explains how it aims to provide the necessary quality of services to all different sectors and areas of the country.

When we spoke to Dikgang Moseneke, acting CEO of Telkom South Africa in December 1997, he spoke about the teledensity disparity between white residential areas and other more impoverished areas. How are you bringing telecoms services to more impoverished areas? How big is this imbalance?

Obviously there is still a large imbalance. Our research shows that coverage levels are in the region of 97% in the serviced areas, but only about 53% of people in under-serviced areas have access to a telephone. We are redressing this by installing more than 1.7 million lines of our 2.8 million-line initiative in these under-serviced areas.

How many new lines are you installing in 1999? What are your projected targets for improving teledensity? Are you scheduled to meet government targets to install almost 3 million new lines?

We are already about 100,000 lines ahead of the licence target at this stage. So we don't foresee any problems in meeting the five-year target. We will install 600,000 lines in 1999, bringing the total number of installed lines in the first three years to about 1.5 million. Depending on population growth, we expect that 7 million lines will be in operation in the country by 2002, providing us with an estimated teledensity of about 16% - as opposed to the current 12.5%.

What role do you think that Telkom South Africa could play in the revival of the South African economy? How much annually do you spend on network modernization? How is the weakness of the Rand affecting your operations?

We spent just over R11 billion ($1.8 billion) in capital expenditure in the past financial year, compared to about R9.8 billion in the previous year (1997-1998). That is a significant investment, especially in the context of direct investment in South Africa's infrastructure and the country's economy. Without the investments by Telkom, particularly in infrastructure, the country would have recorded negative GDP growth over the past two quarters. Our expenditure levels ensured positive GDP growth in South Africa.

We are spending a significant amount on modernization. We are deploying ATM technology, have almost completed the construction of our national network operating centre and are currently rolling out SDH across the whole country.

The weakness of the Rand obviously has an impact on our operations, as we import a lot of equipment. The high interest rates over the past year have also had an impact, but we have been working hard to maximize the returns that we are obtaining on any specific investment decisions that we make. By and large we have managed to get through relatively unscathed by tightening up our procurement process and making sure that we really question our investment decisions in any piece of the infrastructure that we invest in.

Telkom South Africa is scheduled to lose its monopoly in 2003. How are you transforming the company into a market-oriented entity? Do you agree with the government's plans to combine Transnet and Eskom into a second national operator? Do you believe that there should be more than two operators?

We are taking a number of steps to become more market-focused, including extensive training to upgrade our people's skills. This has already had an impact on efficiency levels and therefore competitiveness. We are installing new systems and processes, which will improve our ability to identify and roll out new products in the market. We are launching a whole range of new products that will cater for various needs and segments of the market. To improve our response times, we are making sure that we are well prepared in terms of the quality of service that we offer to our customers. So a number of things are currently on the go and are all happening simultaneously within the company as part of our preparation for competition.

I don't believe that it really matters whether we agree or not with the government's plans to combine Transnet and Eskom. What we require is certainty, irrespective of the number of operators, that there will be a secure regulatory environment and a stable licensing regime. We can then adapt our operations to the regulatory framework that we are operating under.

How has the current lack of competition in the domestic market affected your pricing strategy? Do you believe that there will only be widespread price cuts once there is increased competition in the market?

Well there is already competition in the form of the mobile industry, and the network service area is also open. We have exclusivity on the PSTN - the private switched network and services - but the South African market has benefited a great deal from the decision to ensure Telkom's exclusivity status, in the sense that we have invested a lot of money in infrastructure. We have covered a lot more ground than would have been possible without this exclusivity.

If you look at the obligations that we are meeting in terms of modernization and improvement to customer service levels, this has all clearly benefited the South African population. Pricing developments will be determined by the number of operators that enter the market, as well as several other factors, but based on international experience, we expect to see downward pricing pressure.

Telkom will continue its rebalancing drive to bring call charges into line with international norms. While many world-class companies have a price ratio of 1:4.5 between local and long-distance call charges, Telkom's ratio has been far wider. Rebalancing in 1997 and 1998 led to the ratio narrowing to 1:13 and 1:9.2 respectively, and the 1999 adjustment has resulted in a ratio of 1:7.8.

How has Telkom South Africa benefited from Telekom Malaysia and SBC as strategic partners? Have SBC and Telekom Malaysia played a key role in the development of Internet and value-added services?

Telkom has benefited a great deal from a number of perspectives. We have just over 75 managers from SBC and Telekom Malaysia in South Africa, who are adding a lot of value in terms of the transfer of skills, management and new ideas. Thanks largely to them, we offer a whole range of new products and services in the value-added services area. We are involved in the Internet through our subsidiary, Intekom, and also through the infrastructure we provide through SAIX (South African Internet eXchange). Both SBC and Telekom Malaysia have been involved in these developments.

Dresdner Bank and Sumitomo Bank have recently been mandated to arrange a $100 million credit facility for Telkom South Africa. What is the significance of this arrangement for Telkom? Has your debt burden been increased by the need for capital expenditure outlays?

We are obviously spending a lot of money on our capital expenditure programme. Our arrangement with Dresdner and Sumitomo is part of our fund-raising initiative. This facility will be significant when we address our funding requirements. We financed part of the capex programme through our own internally generated revenues and the rest through borrowings. As we are importing a lot of equipment, we will look to foreign loans to make sure that we don't put pressure on our local reserves. That is why we have to look at a combination of local and foreign borrowing.

Our capital expenditure programme and funding requirements would normally put pressure on our debt burden, but in fact our debt-equity ratios are being managed very carefully. Rather, it is a question of looking at our licence obligations and making sure that we are obtaining the corresponding benefits. Both the government and the regulator play a role in making sure that we can work in the environment that was anticipated when the exclusive licence was issued. So it is a question of continuously watching and managing the processes as we go forward.

Could you tell us about the situation which led 10,000 of your 59,000 workforce to go on strike? How did this strike affect your operations? Is a settlement with the Communications Workers Union and the Alliance of Telkom Unions close?

We have reached agreement with both union bodies on their demands after fairly lengthy negotiations and processes, and our workforce is back at work. Of course the strike had an impact on operations, but we had put contingency plans in place, particularly when CWU was on strike. Although our line roll-out targets were affected for the six days they were on strike, I think that we managed really well in terms of addressing service and service delivery targets, resolving faults and addressing customer queries.

Could you tell us about the recent agreement with Telcordia and Hewlett-Packard? Why did you decide on Telcordia's MediaVantage OSS system? What other suppliers have you been working with?

It is all part of improving the level and quality of Telkom's service and efficiency levels. Our billing systems and IT systems play an integral role in improving and delivering customer service. We looked at a number of companies that had submitted bids to improve our billing processes and customer interface system. Telcordia and HP had the most to offer in quality of service, life cycle costs, interoperability with other systems and especially in terms of expertise in this area.

The system will form part of our total package of improving our delivery process, as well as the reliability and quality of the information on which we base decisions in the delivery chain. Our decision was based on very strict criteria which have been applied meticulously and stringently to all bidders. Our main suppliers are Alcatel and Lucent. We also deal with Siemens a lot. From an IT standpoint, we deal with all the major suppliers in the country - Hewlett-Packard, Compaq, Dell and Cisco.

How do you view DSL technology? Which technologies are you trialling? Do you plan to issue a tender for a new billing system? Could you tell us about the ATM network that you are rolling out?

Our view on DSL technology is that we have a significant copper embedded base in the country, and as part of our attempts to improve the capacity and speed of the network, DSL technology, whether ADSL or DSL, would offer us the opportunity to increase this. We are looking at the various forms of DSL technology for various customer needs and are trialling a few of them at the moment, but we haven't made a decision yet on which part of the DSL technology to deploy.

We started deploying ATM quite extensively across the country at the beginning of the year, and are at a point where we have covered practically all the metropolitan areas in terms of ATM availability. Obviously this offers bandwidth on demand, particularly to corporate customers, enabling them to manage the build-out of their bandwidth requirements more effectively and efficiently. We are at the stage where quite a few customers are now being put on ATM, and that process will continue as part of our sales, marketing and customer service initiatives. It significantly improves the flexibility with which we are able to provide certain services.

The tender for our billing system was actually issued last year, and we are further down the line in terms of implementing a new billing system. The tender was awarded to a combination of PQ Africa and Amdocs. We hope to have a major portion of our flexible billing system and billing engine in place within the next month. We already have certain components of the billing system in place and functioning, such as per-second billing which we launched at the beginning of the year.

How have you been using the $710 million that the government handed Telkom as proceeds from the sale of 30% of Telkom to SBC and Telkom Malaysia? How have you been modernizing the telecoms infrastructure in South Africa since then? What do you believe to be your major accomplishments in this time?

The figure you mention - which amounted to about R4.4 billion ($728 million) - has mainly been used to fund the line roll-out programme, to access new technologies as part of our modernization process and to train our people. We have allocated R2.3 billion over five years for training and human resources development.

We have been very successful with our expansion and modernization programme, as evidenced by our success in achieving our licence targets. Another big success story has been our training and human resources development, where we started in 1997 with some 22,000 functionally illiterate people. This figure is now down to 15,000: in other words, we have taken a significant number of people who were functionally illiterate to a situation where we are able to train them to become technicians and operational specialists. By and large I think that the investment has been very well spent in terms of the original objectives.

How do you view the potential for IP telephony? Do you believe the demand for services such as E-commerce will escalate over the next two-three years?

We have done our own projections on the impact of IP telephony on our business, and have no doubt that IP telephony will have an impact on users of the Internet or other devices that will enable them to communicate over IP. When the time is appropriate, we will be able to offer customers services in IP telephony ourselves.

I think that E-commerce will escalate dramatically, particularly in terms of business-to-business transactions. We are taking a number of steps to address E-commerce developments in terms of new products. We launched CYBERtrade earlier this year, which is already meeting the requirements of a whole range of customers. We are considering creating an IP protocol based on the ATM technology that we are deploying which will provide bandwidth. Later we will have high capacity broadband in the whole country to address and meet the demands of corporates, SMEs and residential customers for Internet and E-commerce requirements.

Do you believe that this could become the key area of competition in the future due to the potential revenues that can be derived from the business sector?

I think so. If one looks at developments elsewhere, it is fairly clear that it will be one area of potential competition as we move into the future. Obviously, the development of the Internet and its use generally in South Africa will be dependent on the level of education, coverage and availability of PCs. We are looking at various initiatives in that area in terms of the new products and services that we will provide and how we will package these. At the end of the day, although there will be competition, I think the difference between the companies that succeed or fail will be based on the packaging of products in terms of price, features and so on.

If we could look at cellular, how many subscribers does Vodacom currently have? When do you expect to offer customers enhanced wireless data services?

Vodacom has about 2.2 million subscribers. The provision of wireless data services will obviously depend on the development of third generation technology. If 3G becomes available in 2001, Vodacom is already looking at requirements for handsets, equipment needs, infrastructure and spectrum. They are doing a whole range of things to be ready for the advent of increased demand for data services in mobile.

Do you believe that there should be more than two cellular operators?

That is a moot point. Based on the size of the market, there could conceivably be room for more than one mobile operator, but I don't think there is room for more.

For Telkom, it is the regulatory environment in which these new entrants will operate that is of prime importance. We would like to see a regulatory environment that promotes competition by levelling the playing field for all operators. We strongly believe that there should not be differential treatment of existing and new operators, nor should there be cross-subsidization of inter-connection to assist new entrants.

How are you restructuring the company to make it more efficient? Do you believe that Telkom has to implement a wide-ranging employee reduction programme to have a healthy future? Would this not meet stiff opposition from unions? How are you overcoming this problem?

Staffing costs represent a significant part of our operating costs - in the region of 47%. As we have to increase efficiency levels and sustainable profits in the future, we have to look at all aspects of the business and improve efficiencies, cost-effectiveness and revenues. So a part of the restructuring will have an impact on staff in terms of benchmarks such as employee/line ratios and revenue/line ratios. To that extent, the number of employees will have to fall as part of our restructuring programme. We are committed to a consultative process with our unions, to ensure that we can effectively address the socio-economic impact of restructuring.

In July 1999 Telkom announced year-end revenues of $3.78 billion (R22.6 billion) while profits declined by 6%. Why couldn't you deliver higher profits? Capital expenditure costs are expected to rise by about 50% in 1999. How will you reduce operating expenses to ease financial pressure?

There are many reasons for this. Firstly, we have operated in a very tough economic environment over the past financial year: interest rates were very high, and the level of unemployment was increasing. Therefore the level of affordability was very low in relative terms. This had an impact on both our revenue streams and our expenses.

There are four main drivers of operating expenses within the organization. Firstly, inter-connection. We have an environment where we pay a considerable amount of money to the two mobile operators when calls originate in our network and terminate on the mobile network. Those costs are quite significant, and are based on the inter-connection agreement that we have with both MTN and Vodacom. The second part of our significant expenses relates to staffing costs, which we have just discussed. We need to reduce the staff cost contribution to operating expenses, which is why we are going through a major restructuring.

Thirdly, owing to the high interest rates, our finance costs were quite significant last year. This also had an impact. Finally, our investment in capital expenditure led to a very high depreciation charge. This relates to the contribution to our operating expenses.

If you consider all these things, they contributed to the kind of profit declines that we noticed in the past financial year. We have put a number of processes in place to address these matters. We are also looking at other ways of improving efficiencies and reducing costs.

Operating expenses increased by 24% to reach $3 billion. How do you intend to reduce this figure? How successful have the voluntary retirement packages been?

Just over 2,000 voluntary early retirement packages were granted. We are also spinning off non-core operations such as our vehicle fleet, engineering and electronics workshops and our non-core property portfolio. This will contribute considerably to a future reduction in our operating costs.

However, our operating expenses this year will again be quite significant, as they include the costs of the further restructuring required to improve future profitability. These costs are fairly high - R1.3 billion ($215 million) - owing to our efforts to minimize the socio-economic impact on the people who will be affected. However, this investment is necessary to create sustainable earnings going forward.

What role is Telkom South Africa playing in the development of the SAT-3/WASC/SAFE system? How will the build-out of this network benefit customers in South Africa?

We were the main promoters of the SAT-3/WASC/SAFE submarine cable system. In June we signed the construction and maintenance agreement, involving 40 operators or countries, and are further down the line in awarding contracts to companies that will build the cable. A 40 gigabit system upgradable to 80 gigabits covering over 30,000km, SAT-3/WASC/SAFE starts in Europe with a landing point in Portugal, various landing points on the west coast of Africa, two landing points in South Africa (Cape Town and just north of Durban), Mauritius, India and finally Penang. That links us to both Europe and the rest of the continent.

The system will provide direct links that have a positive impact in reducing tariffs in the continent, and will equip the continent to create a platform on which to build Internet infrastructure and the data networks that are required owing to the increase in data transmission. It will link us to Asia through India and Penang in Malaysia, which are the main routes in terms of the trading activities that we currently have. The capacity that we will have on the submarine cable system should see us through the next 25 years.

What are Telkom South Africa's regional aspirations? Do you hope to become Africa's biggest telecoms hub? Do you plan to make international investments once you lose your monopoly status?

We are already the biggest African operator. We are determined to maintain and increase the lead we have over other African operators. We are creating South Africa as a telecoms hub as we speak. SAFE, the submarine cable system that we are talking about, is part of that strategy. We have another project in the pipeline: to deploy satellites and terrestrial systems to increase our connectivity with the rest of the continent. This will in turn provide opportunities for the rest of the continent to transit through South Africa and therefore promote the strategy of creating South Africa as a telecoms hub on the continent. Right now we are exploring commercially viable options that would add to our profitability, not only in the long term but also in the short-to-medium term.

Do you hope to sell more shares before 2002? Do you believe that the government would sanction such a sale? Would you like the government to relinquish its golden share?

It is up to the shareholders to decide whether to sell shares. Whether they plan to sell shares before the end of the exclusivity period is really up to them to decide. As management we have a responsibility to increase shareholder value, and that is what we are doing. The government plans to sell another 10% of Telkom shares to the empowerment companies, unions and employees, but I can't say at this stage whether they will opt for an IPO and sell more shares.

How successful has Telkom South Africa been in improving service to rural areas? Could you tell us about your roll-out programmes in these regions? Have you been deploying satellite technologies?

We have been very successful in rural areas. This is borne out by our attainment of targets and retention of customers in rural areas. We are deploying wireless local loop, particularly in the under-serviced areas, which has been the ideal vehicle to allow services into rural areas owing to the cost, the speed of deployment and flexibility.

What are your hopes and ambitions for the company over the next two-three years? What are the key challenges for Telkom ahead of widespread competition in the telecoms sector?

I hope that in two-three years we will have substantially completed the restructuring progress, to transform Telkom into a company that is the supplier of choice. I hope that we will reach levels of efficiency comparable with other operators in our peer group, particularly in Europe and South America. The key challenges can be summed up as follows: to meet our licence obligations, achieve that goal efficiently and continue to increase our profits.