Telkom South Africa
Madiba Magic
James Barber
Angela Fung
Sandeep Toshniwal
Becky Voorheis
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
I. Opportunity
II. Risks &Concerns
III. Thintana Consortium
IV. Valuation
Major Themes
I. Opportunity
II. Risks &Concerns
III. Thintana Consortium
IV. Valuation
I. Opportunity
• Telecommunications
• Telkom
• South Africa
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
• 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
• 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
• 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
I. Opportunity
II. Risks &Concerns
III. Thintana Consortium
IV. Valuation
II. Risks & Concerns
• Country Risks
• Company 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
• 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
• 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
• 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
• 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
I. Opportunity
II. Risks &Concerns
III. Thintana Consortium
IV. Valuation
III. Thintana Consortium
• Rationale & Structure
• Telekom Malaysia
• SBC Communications, Inc.
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
• 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
• 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
I. Opportunity
II. Risks &Concerns
III. Thintana Consortium
IV. Valuation
IV. Valuation
• Major uncertainties
Discussion
• What actually happened & our model
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
• 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
Valuation - Key Results
March 1997: Thintana wins the bid
Our Value
Telkom Valuation R 18.47 billion
30% stake
R 5.54 billion
Dollar Value
$ 1.24 billion
SBC Value
R 18.58 billion
R 5.59 billion
$1.261 billion
Valuation Key Assumptions
Growth in Sales per line
Growth in Operating Costs
Depreciation (% of Fixed Assets)
Effective Rate of Tax
Discount Rate
Perpetual Growth Rate
Change in Working Capital Growth
Exchange Rate Depreciation
16.00%
13.90%
12.00%
35.00%
20.11%
2.00%
13.90%
10%
Tornado Analysis
Growth in Sales per line
Growth in Operating Costs
10%
22%
19.80%
8%
Discount Rate
25.22%
15%
Depreciation (% of Fixed Assets)
8%
16%
Effective Rate of Tax
40%
30%
1%
Perpetual Growth Rate
19.80%
8%
Change in Working Capital Growth
(30,000 (20,000 (10,000
,000,00 ,000,00 ,000,00
0)
0)
0)
3%
-
10,000, 20,000, 30,000, 40,000, 50,000, 60,000, 70,000,
000,000 000,000 000,000 000,000 000,000 000,000 000,000
Net Present Value in Rands
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%
Beta
Risk Free Rate of Return
Market Premium
Return on Equity
Return on Debt (before tax)
Tax Rate
Return on Debt (after tax)
Debt to Equity Ratio
1.2
15.39%
7%
23.79%
16.73%
35.00%
10.87%
0.71
Model Results
Net Present Value in Dollars
$
SBC's & Malaysia's stake (30%) in dollars $
NPV of Net Profits
SBC's & Malaysia's stake (30%) in dollars $
776,745,906
233,023,772
2,919,028,182
875,708,455