Telkom South Africa

1
Telkom South Africa

• Madiba Magic
• James Barber
• Angela Fung
• Sandeep Toshniwal
• Becky Voorheis

2
Case Background

• Setting
• February 1997
• Post-apartheid, privatization phase in South
  Africa
• Bidding war for 30 ownership in Telkom
• currently owned 100 by the SA government
• Protagonists
• South African government
• SBC Communications Inc.
• Telekom Malaysia

3
Major Themes

• I. Opportunity
• II. Risks Concerns
• III. Thintana Consortium
• IV. Valuation

4
Major Themes

• I. Opportunity
• II. Risks Concerns
• III. Thintana Consortium
• IV. Valuation

5
I. Opportunity

• Telecommunications
• Telkom
• South Africa

6
I. Opportunity

• Telecommunications
• Lucrative, safe investment in emerging markets
• fairly reliable cash flows
• high growth prospects
• ROE 20-30 for high readiness developing
  countries (McKinsey Co.)
• low betas when regressed on the domestic market
  (higher when regressed on the U.S.)

7
I. Opportunity

• Telkom
• The only wire-line telecommunications provider in
  South Africa
• State-enforced monopoly for 5 more years with an
  option for a 6th (expires in 2003)
• Needs a partner with technical skill
• Open to using outside management expertise

8
I. Opportunity

• South Africa
• End of apartheid opened SA to foreign investment
• new government friendly to foreign investment
• A hybrid of the 1st and 3rd worlds
• highly developed manufacturing sector,
  infrastructure
• A gateway to Africa
• Sets the pace for the rest of Africa.
• the most diverse, advanced economy in Africa
• 40 of telecom traffic in all of Africa
• Real option
• an export/import platform into Africa, Mid-East,
  Asia

9
I. Opportunity

• South Africa (continued)
• high, unmet demand for telecommunications
• growing ability to pay, but still no access
• low teledensity
• 1 line per 100 blacks, 60 lines per 100 whites
• U.S. DoC telecom in SA a leading sector of U.S.
  exports and investment.
• several U.S. telecommunications companies are
  already operating there
• ATT, Lucent, Motorola, Sprint, Hughes, Iridium

10
Major Themes

• I. Opportunity
• II. Risks Concerns
• III. Thintana Consortium
• IV. Valuation

11
II. Risks Concerns

• Country Risks
• Company Risks

12
Country Risks

• Violence
• highest murder rate in the world
• investors cite crime as the biggest deterrent to
  doing business in SA
• Openness to Foreign Investment
• remnants of pre-democratic era remain in foreign
  exchange controls, privatization, and competition
• Credit Rating
• Institutional Investor 46/100
• Moodys Baa3 (non-investment grade)

13
Country Risks

• Poor Economy Income Inequality
• 2nd highest Gini Coefficient in the world (.61)
• Low GDP/Capita, life expectancy, literacy, health
  conditions
• Rand consistently devalued since 1986
• Johannesburg Stock Exchange (JSE) weak in
  recent years
• Political Uncertainty
• unproven leadership
• right-wing backlash

14
Company Risks

• Technical Disrepair
• of customers actually shrinking (unheard of in
  3rd world)
• high prices, slow service, aloof bureaucracy,
  bloated workforce, and a network engineered for
  white neighborhoods.
• Debt Burden
• Telkom had borrowed to meet capital expenditures
• extreme debt levels (some foreign denominated)
• D/E 1.4 in 1996
• average effective rate 16.7

15
Company Risks

• Competition from Cellular Service
• not much more expensive and more reliable
• more cost-effective, especially in rural areas
• Telkom owned 50 of one provider (Vodacom), SBC
  owned 15.5 of the only other one (MTN).
• Racial Tension
• Telkom begins to promote blacks
• white backlash - 5,300 workers strike

16
Company Risks

• Copper Cable Theft
• As soon as we fix one line, another is stolen.
• sold for copper content
• theft a major concern to SBC
• 4,112 cables stolen in 1996 at a cost of 41.1
  million Rand
• switch to fiber-optics ... thieves have to dig up
  to discover theyre not made of copper

17
Major Themes

• I. Opportunity
• II. Risks Concerns
• III. Thintana Consortium
• IV. Valuation

18
III. Thintana Consortium

• Rationale Structure
• Telekom Malaysia
• SBC Communications, Inc.

19
Rationale Structure

• Previously rival bidders
• better chance to beat Deutsche Telekom together
• Joined to leverage their respective strengths
• SBC technology modernization
• Telekom Malaysia developing countries
• 30 would be split
• 18 SBC
• 12 Telekom Malaysia

20
Telekom Malaysia

• Expertise in rural telecommunications
• Presence in a number of emerging markets,
  including Ghana, India, Malawi, Sri Lanka
• Worked with the SA government before
• Largest publicly-listed company in Malaysia
• Profitable

21
SBC Communications

• One of the worlds leading telecom firms
• Fortune 25 company
• Rated Most Admired Telecom Co in 95 96
• Aggressive MA activity after deregulation
• Operations on 5 continents, 8 countries, and 13
  U.S. states
• Focus on high-growth international markets

22
Major Themes

• I. Opportunity
• II. Risks Concerns
• III. Thintana Consortium
• IV. Valuation

23
IV. Valuation

• Major uncertainties
• What actually happened our model

24
Major Uncertainties

• Exchange rates
• consistent devaluation
• Taxes
• effective rate 23, marginal rate 35
• Depreciation on assets
• 12/year vs. accelerated method
• Post-Monopoly scenario
• competition
• revenue decline

25
Major Uncertainties

• Listing of shares
• SA government plan in 2003
• use a P/E model?
• comparables appropriate?
• Management
• 4 board seats enough
• middle managers?
• Cost of capital
• which method?

26
Discussion
27
Valuation - Key Results
March 1997 Thintana wins the bid
28
Valuation - Key Assumptions
Depreciation
29
Tornado Analysis
30
Assumptions

• Growth in sales and costs per line
• Based on historical figures and Telkoms
  statements
• Depreciation
• Allowed rate of depreciation by South Africa
• Tax Rate
• Maximum tax rate applicable in South Africa
• Change in Working Capital
• Linked to operating costs

31
WACC 20.11
32
Model Results