Written by Gracious Mashila – Associate Analyst
Fixed telephone lines were first introduced in South Africa in the late 1800s, when the infrastructure was managed by the Department of Post and Telecommunications. Telkom was incorporated as an independent state-owned company in 1991 and listed on the JSE Securities Exchange in 2003. Telkom, in partnership with Vodafone, was the first to provide mobile telecommunication services in South Africa through the establishment of Vodacom in 1994. They subsequently sold this Vodacom stake.
Telkom’s product and service offering has evolved materially over the last decade to include fixed line and mobile services, along with data and information technology services. We discuss Telkom’s transformation from their roots as a solely fixed line business.
From fixed to mobile
Since the late 2000s, the telecommunications industry has evolved from copper and traditional fixed line offerings to newer and faster technologies such as mobile, fixed wireless and fibre. While maintaining its monopoly in fixed line connectivity, Telkom has undergone a remarkable transformation to become South Africa’s third largest mobile network operator. It has strategically transitioned to its new mobile business, while maximising profitability in the fixed business. The charts below highlight changes in revenue composition over the last few years, with the mobile business now contributing almost half of group revenue and traditional fixed products constituting just 28% of revenue (from over half in 2017).
Fixed line growth inflection on the horizon
Although copper continues to be used for fixed line voice and data services, the shift to new generation technologies such as LTE and fibre has resulted in fixed line revenue continuing to decline. These newer technologies offer vastly higher data transmission speeds.
Despite a sharp fall in revenue for the fixed line business since 2011, Telkom has managed to stabilise profitability through a material reduction in operational costs, including reducing employees by approximately 10 000 over the last decade.
As Telkom continues to invest in new generation fixed line products (mainly optic fibre), we expect to see these products increase revenue to the point where it soon surpasses legacy fixed line revenue. We estimate that Telkom has spent more than R23 billion over the last five years on expanding its fibre network. While fibre investments have a high upfront cost, they can be substantially leveraged as data demand grows and, at full utilisation, fibre infrastructure assets have the potential to deliver high returns to shareholders. Telkom has been very successful at growing fibre asset utilisation rates (charted below) and we expect this to continue on its vast installed base. Fixed line service revenue will grow substantially, along with profitability.
A network advantage
Telkom’s telecommunications network is the largest in South Africa, with over 169 000 kms of copper and fibre. The network is managed through a division called Openserve, which is a very valuable asset of the group.
Openserve is the only infrastructure provider with a regional network touching remote towns across South Africa, therefore most telecommunication companies are reliant on their infrastructure to deliver services to customers. It is also the only network with full network redundancy1 – limiting connection interruptions. The network is a clear competitive advantage and positions the group well for future growth in fibre-related services. It has also been a key growth enabler for Telkom’s mobile business.
1Having multiple, geographically diverse cable routes that service the same client site.
Mobile success story
Initially launched as 8ta in 2010 and rebranded as Telkom Mobile in 2013, this business has had noticeable success after an extended loss-making period in the initial years. Strong subscriber growth over the last decade (charted below) has resulted in a 13% subscriber market share, with more than 15 million subscribers to date.
Telkom has effectively marketed unique all-in-one solutions, for example their ‘FreeMe’ offering. This package is customisable and has enabled data and minute sharing. They have particularly found market success and grown subscribers over the last three years by offering data-focused packages that are relatively affordable compared to competitors.
Telkom’s mobile network was configured to allow for high asset utilisation in that it was purposefully built for carrying data (rather than voice). This has resulted in a lower cost of carrying data versus competitors, enabling Telkom Mobile to enjoy a material cost advantage. In addition, the group benefits from being able to substantially leverage the already established and depreciated fixed line network. These advantages are enduring and should see further growth and market share gains in the mobile business over the medium term.
At the IT helm
Telkom provides information technology (IT) services to the group and external customers through BCX. This business was acquired in 2016 and is one of South Africa’s largest IT companies, providing services such as: converged communications, IT infrastructure management, cloud computing and cybersecurity. BCX is well positioned in the fast-growing datacentre market, currently owning the largest Tier-4 datacentre2 footprint.
Despite its position in growing markets, BCX revenue performance has been weak due to its high exposure to declining voice services. Recent performance has also been negatively impacted by the COVID-19 pandemic, which has led to reduced IT spend by large enterprises. This has forced BCX to focus on restructuring the cost base to maintain profitability but presents an opening for growth once the economy recovers.
2A Tier-4 datacentre is built to be completely fault tolerant and has redundancy for every component to ensure a minimum uptime of 99.995% (26.3 minutes of downtime annually).
New opportunities for expansion
Telkom’s portfolio currently includes businesses that we believe could unlock incremental value for shareholders if unbundled or sold.
Gyro was created in 2017 to house Telkom’s masts and towers infrastructure business, including land and a multi-use property portfolio. Masts and towers carry the radio antenna of mobile telecommunication providers and there is growing demand for well-located sites close to densely populated areas.
Telkom’s legacy fixed line business required a telephone exchange3 in most residential and business areas before they were fully developed. This has resulted in the ownership of large parcels of land in very valuable locations (we estimate 88% of the portfolio is situated in the busiest economic hubs around Gauteng, the Western Cape and KwaZulu-Natal). The tower portfolio is sizeable, currently constituting around 22% of total South African mobile towers, which is proportionately large compared to its market share of subscribers.
Telkom Mobile is an anchor tenant, leasing 44% of the tower portfolio, with the balance leased to other mobile network operators and corporates. The current demand for towers is buoyed by the exponential growth in data consumption and the shift to 5G technology. 4G/5G is deployed at higher spectral frequencies requiring denser networks, ultimately resulting in the need to construct more towers. The main objective for this focused property segment is to unlock value through growing occupancy on masts and towers and by redeveloping land via direct investment or in partnership with property companies.
There is also lots of opportunity to realise growing value from Telkom’s datacentres, of which there are 10 in South Africa, with over 6 000 m2 of combined floor space. While Telkom management does not disclose utilisation rates, we believe that there is ample capacity for growth. Converting these assets to providing a vendor-neutral and open-access service model could lead to substantially higher future returns.
3A central building housing equipment that interconnects phone calls between users.
Reaping investment rewards
The medium-term growth outlook for Telkom is positive and the investment case remains attractive. The mobile business is strong and, after many years of investment, the fixed line business has reached an inflection point, with growth declines expected to moderate materially and eventually turn around. We expect patient shareholders to be rewarded through improving earnings, increasing free cash flow and higher returns.
