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Chairman's report
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Group chief executive officer's report
 

Group chief executive officer's report

Sipho N Maseko  
  Sipho N Maseko
  Group chief executive officer
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“Despite the current financial position, I see a significant opportunity to transform Telkom into a profitable and sustainable business able to support South Africa’s economic development.”

introduction

Before I begin with the review of Telkom’s performance for the year, I would like to express my condolences on behalf of the Board and management team to the families of the two members of staff, Captain Phopolo Phenya and Mokopa Phillip Swarts, who lost their lives in vehicle accidents during the year. Fatalities are unacceptable in the workplace and we need to ensure that our people are operating in a safe work environment. I will pay particular attention to issues of workplace safety going forward.

Telkom’s performance trajectory has been disappointing in recent years. The erosion of traditional revenue streams in the telecoms industry globally has proven exceptionally challenging for fixed-line incumbents. The contribution of strategic errors and poor decisions towards the Group’s current financial state must also be acknowledged. This has also resulted in a loss of confidence of our stakeholders. I am determined that we will not repeat the mistakes of the past, and while I recognise the challenges that Telkom faces, the potential of its people, technology and infrastructure places it in an inherently unique position within the ICT industry. This opportunity needs to be harnessed to evolve our business into one that better meets the needs of all stakeholder groups: our shareholders, customers, employees and the broader society that Telkom reaches.

As the newly appointed group chief executive officer, I am committed to the transformation of Telkom’s financial performance, restoring confidence of government and our shareholders and rejuvenating Telkom as a national asset.

Financial performance

The 2013 financial results re-affirm the need to act with urgency to turn around the Group’s performance. Headline earnings from continuing operations for the year was 237.7 cents per share (73.2%) lower than the prior year. The decline in headline earnings was largely a result of the cost of voluntary severance packages (VSPs), the provision for the Competition Tribunal fines and continued pressure on our fixed voice revenues.

Basic earnings per share was affected by a R12 billion impairment charge on the carrying value of the Group’s legacy assets resulting in a basic loss per share of 2,276 cents. The impairment charge is a non-cash item and did not impact the significant cash flow (EBITDA) that the Group generates from its operations.

Revenue for the year continued to decline. The Group reported revenue of R32.5 billion, versus R33.1 billion in the prior period as a result of sustained pressure on fixed-line operations. Expenses, excluding the R12 billion impairment of legacy assets, grew 2.2% to R32.0 billion primarily due to provisions for voluntary severance and early retirement packages, as well as a provision for the Competition Tribunal fines.

Lower revenue and higher operating costs placed strain on EBITDA, which declined 16.8% to R7,109 million. Notably, however, free cash flow remained strong at R2,132 million after capital investment of R5,738 million, which increased 20% year-on-year. This can be largely attributed to the substantial investment in the upgrade of the Group’s network. The Group is lowly geared, with year-on-year net debt decreasing 46.0% to R2.1 billion which places us in a solid position to fund our capital expenditure programme.

The Board has reviewed its dividend policy and has chosen to withhold payment of dividends until the Group’s financials show sufficient signs of recovery.

Operational overview

Telkom Business is the Group’s largest revenue generator. This year the business achieved a number of strategic growth deals with key clients across the enterprise and public sector segments.

Through the upgrade of our networks, we were able to provide our customers with faster, better quality broadband. Telkom has an unrivalled network of more than 147,000 cable kilometres of terrestrial fibre which is now widely available to business customers in metro areas across the country. This will secure Telkom Business’ leadership in the data market, thereby preserving existing revenues.

The network upgrade attained full momentum during the financial year under review. We were able to put in place 83 fully operational MSANs. The commercial pilot of this upgrade, consisting of 437 customers, delivered broadband speeds of up to 40 Mbps to 66% of the participants.

While migrating customers onto our IP network, we experienced a fall out rate of less than 5%. This is a tremendous achievement when compared with international benchmarks. We will continue the network migration during the next financial year and preparation of sites is already underway.

The Consumer business continues to face significant challenges of declining fixed-line usage and revenues. This has necessitated consolidation and innovation to defend and grow the subscriber base. Rationalisation of the Consumer voice portfolio has assisted in streamlining the product offering and allowed us to maintain focus on profitable products and services.

While it is encouraging that Telkom Mobile exceeded the targeted 20% reduction in EBITDA losses for the financial year, it continues to face formidable competition from established players in the market. We are undertaking a thorough strategic review of the business to manage the inherent risk around building a mobile business as the fourth entrant. It is our view that mobile is vital to our future, especially from a revenue growth and convergence perspective.

group-wide strategic review underway

Despite the current financial position, I see a significant opportunity to transform Telkom into a profitable and sustainable business able to generate appropriate returns for its shareholders and support South Africa’s economic development. We are in the process of performing a group-wide strategic review as part of this transformation, with a focus on improved operational efficiencies over the short-term and unlocking value through longer-term strategic considerations. A summary of initial thinking can be noted in the table below:

Performance improvement   Strategic focus areas
Focus on operational efficiencies

Maximising NGN efficiencies and returns
Effective management of third party spend
Customer service effectiveness, integration and innovation
HR optimisation and capacity building
  Focus on future operating model

Defining mid to long-term strategy and plan
Wholesale/Retail structural options
Participation in the National Broadband Plan
Effective management of regulatory and policy framework
Mobile/Consumer business options
Telkom Business (government and SMME) value propositions

Greater detail of the revised strategy will be provided during the course of the year once it has been finalised.

The future will be data-led

It has been widely reported globally that mobile handset data and fixed and mobile broadband are expected to be the most important revenue growth areas over the next three to five years. This is being driven by higher data usage and increased penetration of smartphones and broadband services.

In developed markets, we have already seen this change in revenue mix in line with evolving consumer behaviour. Many emerging markets are investing heavily in mobile networks, with mobile data particularly seen as strategic in terms of future growth.

Telkom, through its superior fixed network, is well-positioned to provide quality, high-speed broadband services to customers across market segments. It is therefore crucial to continue to invest in an IP-compliant network. In addition, a well-developed mobile infrastructure will support Telkom’s convergence offering and the rollout of broadband. The abundant spectrum available to us lends an additional competitive advantage in capitalising on the data opportunity.

Profitable market segments and services

A high quality network is meaningless in the absence of a good business model able to drive profitability. As such, Telkom is focusing on profitable market segments and services where there is strong opportunity to grow active users, average revenue per user (ARPU) and stimulate uptake of value added services.

From a wholesale perspective, we need to employ strategies that stimulate widespread data growth in line with government’s broadband strategy, thereby working towards South Africa’s developmental objectives. By reducing the incentive to self-provide, we will also be able to defend and grow our Wholesale business.

Focus on operational efficiency

To improve our performance in the short-term we are reviewing the business from an operational standpoint. Measures to achieve cost reduction and greater efficiency and the identification of growth opportunities, as noted in the table above, have been initiated. Our focus areas in this regard are the effective management of third party spend, HR optimisation and capacity building, rationalising the property portfolio, consolidating the pay phone business and exploring IT adjacencies. We also intend to maximise NGN efficiencies and returns, and improve customer service effectiveness.

Stakeholder relations

Restoring our relationship with government

One of my top priorities is to rebuild Telkom’s relationship with government and other key stakeholders. My early engagements have confirmed that there is substantial goodwill and commitment regarding Telkom within government. We are committed to working with government to discharge our duties as a national incumbent and, through this, re-invigorate the relationship.

I see Telkom playing a meaningful part in the rollout of broadband, however we are mindful of the financial implications involved and we need to guard against any adverse effects to our long-term financial health. We have submitted a proposal to government, which is currently under review. We look forward to further engagements to arrive at a workable and sustainable solution for all parties involved. This will also ensure that the expectations of our minority shareholders are met.

As part of Telkom’s broader role in South Africa’s development, working with government to provide broadband connectivity in schools has been a key focus. In conjunction with the Department of Communication (DoC), Telkom Business is in the process of connecting 1,500 schools across the country, making e-learning and e-education accessible. We are committed to continued collaboration to drive such developments forward.

Mobilising our people

People are Telkom’s greatest asset. The voluntary retrenchment programme that we started in 2013 was, as expected, a difficult but necessary exercise. It is therefore critical that we continue to build upon our relationships with our people, particularly during these times of change.

We will continue to make efforts to increase our levels of employee engagement, satisfaction and motivation to participate in Telkom’s transformation in the years ahead.

Over the course of the year, a reduction in the number of health and safety incidents of 6% was achieved. It is unacceptable however, that we suffered two fatalities during the year and it is my commitment going forward to ensure that our people operate in a safe environment.

Delivering quality customer service

I cannot emphasise enough the importance of our customers. The perceptions of both our business and consumer clients regarding our reputation and the value of our products and services, is central to our success. Our core focus has therefore been to drive quality and innovation to ensure that our customers’ ever-changing needs are consistently met. To achieve this, we need to instil a culture of customer centricity among our employees. It is my hope that, in the years to come, Telkom will report much improved measures in terms of quality of customer service.

Regulatory environment

Competition law compliance

Settlement discussions with the Competition Commission were initiated and successfully concluded in April 2013. This ruling related to the case between Telkom and the South African Value Added Networks Services Association (SAVA) and various other complainants pertaining to alleged anti-competitive behaviour between 1999 and 2002. Telkom and the Commission agreed to withdraw their respective appeals against the Tribunal’s initial ruling in August 2012, resulting in the said ruling remaining unaltered. Accordingly, Telkom will pay the fine that was awarded by the Tribunal in the sum of R 449 million.

We have also subsequently negotiated to settle a second claim relating to a Multiple Complaints Referral by several complainants including Internet Solutions (Pty) Limited, the internet division of MultiChoice Subscriber Management Services (Pty) Limited, Verizon (Pty) Limited and the Internet Service Providers Association.

As part of this settlement, Telkom is required to pay a penalty of R200 million which has been fully provided for. The settlement also requires an undertaking by Telkom regarding the functional separation between the Group’s retail and wholesale divisions.

We are committed to understanding the unique responsibility that we have as the national incumbent. We acknowledge that past actions of the Group have had a negative impact on our business and we take accountability for this. We have been and will continue to uphold responsible conduct and compliance in all our businesses.

Asymmetric termination rates critical to sustainable competition

I strongly believe that the current interconnection rate dispensation hampers competition and new entrants such as Telkom Mobile should be allowed to compete on a level playing field. The current interconnection rates are set at an inappropriate level and are discriminatory towards less established market participants. We have proposed simplified and converged mobile termination rates (MTR) and fixed termination rates (FTR) to the regulator. To this end, Telkom will participate at public hearings to be held by the Portfolio Committee on Communications on this topic and will also participate in the Independent Communications Authority of South Africa’s (ICASAs) process of reviewing the existing regulations, including their “Cost to Communicate” programme.

We are also engaging with the regulator on issues relating to spectrum licensing fees and access, LLU, and relief of universal service obligations as we believe these to be unnecessary burdens on Telkom’s already strained financial position. I intend to deal with all regulatory matters assertively, decisively and expediently going forward.

Appreciation

I would like to thank the Board and our chairman, Jabulane Mabuza, for appointing me to lead Telkom through this period of transition. I would like to congratulate my predecessor Nombulelo Moholi for making progress in key areas, despite the complexities of our operating environment.

I acknowledge the hard work that remains in transforming the business into a highly profitable one that earns a position of leadership in its chosen segments. A fundamental weakness of ours has been our inability to execute and deliver results. With tenacity and renewed focus on execution, I am confident that we can turn around Telkom’s performance. Doing so requires the setting out of clearly defined objectives and performance measures. Developing a successful track record of execution will rebuild our credibility among our stakeholders.

It is up to each and every Telkom employee to rise to this challenge and take an active role in re-invigorating our company.

Sipho N Maseko
Group chief executive officer


 

 

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