Telkom

Telkom South Africa: 

Telkom South Africa Madiba Magic James Barber Angela Fung Sandeep Toshniwal Becky Voorheis

Case Background: 

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

Major Themes: 

Major Themes I. Opportunity II. Risks &Concerns III. Thintana Consortium IV. Valuation

Major Themes: 

Major Themes I. Opportunity II. Risks &Concerns III. Thintana Consortium IV. Valuation

I. Opportunity: 

I. Opportunity Telecommunications Telkom South Africa

I. Opportunity: 

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.)

I. Opportunity: 

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

I. Opportunity: 

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

I. Opportunity: 

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 AT&T, Lucent, Motorola, Sprint, Hughes, Iridium

Major Themes: 

Major Themes I. Opportunity II. Risks &Concerns III. Thintana Consortium IV. Valuation

II. Risks & Concerns: 

II. Risks & Concerns Country Risks Company Risks

Country Risks: 

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 Moody’s: Baa3 (non-investment grade)

Country Risks: 

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

Company Risks: 

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%

Company Risks: 

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

Company Risks: 

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 they’re not made of copper

Major Themes: 

Major Themes I. Opportunity II. Risks &Concerns III. Thintana Consortium IV. Valuation

III. Thintana Consortium: 

III. Thintana Consortium Rationale & Structure Telekom Malaysia SBC Communications, Inc.

Rationale & Structure: 

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

Telekom Malaysia: 

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

SBC Communications: 

SBC Communications One of the world’s leading telecom firms Fortune 25 company Rated Most Admired Telecom Co in ‘95 & ‘96 Aggressive M&A activity after deregulation Operations on 5 continents, 8 countries, and 13 U.S. states Focus on high-growth international markets

Major Themes: 

Major Themes I. Opportunity II. Risks &Concerns III. Thintana Consortium IV. Valuation

IV. Valuation: 

IV. Valuation Major uncertainties What actually happened & our model

Major Uncertainties: 

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

Major Uncertainties: 

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?

Discussion: 

Discussion

Valuation - Key Results: 

Valuation - Key Results March 1997: Thintana wins the bid

Valuation - Key Assumptions: 

Valuation - Key Assumptions Depreciation

Tornado Analysis: 

Tornado Analysis

Assumptions: 

Assumptions Growth in sales and costs per line Based on historical figures and Telkom’s 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

WACC = 20.11%: 

WACC = 20.11%

Model Results: 

Model Results