Review of Telkom's operations

TELKOM BUSINESS

Telkom Business aims to be the leading provider of fixed and converged communication and network services to the South African business market, and to drive transformation in IT through the Cloud.

During the year under review Telkom Business successfully launched initiatives to create and maintain market leadership in voice and data, convergence, broadband, ISP and value added services.

We were able to deliver pleasing performance for the period under review and will continue to focus on profitable products and services that ensure consistently solid performance for customers and shareholders year after year.

We concluded important strategic growth deals with key clients across our enterprise and public sector segments, which included a number of top JSE listed companies and various government departments. These deals mark solid progress towards sustainable growth and market leadership for Telkom Business.

The delivery of sustainable growth hinges on service perceptions and customer satisfaction. Improving these metrics has been challenging, but over the period we succeeded in moving the dial across all five of the customer groups. We exceeded our targeted improvement, most notably among our large, medium and small business customers. Customer satisfaction in our enterprise segment is now at global benchmark levels.

We saw a rise in operational expenditure for the year resulting from investment in new capabilities and channels. Despite this we were able to contain expenditure below inflation.

During the year we were able to elevate our broadband value proposition through a variety of major initiatives. Foremost is Telkom’s NGN project which enabled the introduction of highspeed 20 Mbps and 40 Mbps broadband services for the mass market segments, using copper-based VDSL technology. The rollout of this broadband network upgrade will continue over the next two years.

The NGN project also includes the deployment of fibre and the migration of copper data services to fibre. Fibre is now widely available to business customers in metro areas across the country.

NGN is a key part of Telkom’s strategy for sustainability and growth; it will secure a leadership position within the Business data market and preserve existing revenues. NGN offers customers much higher speeds and will significantly improve the reliability of the network.

In line with market requirements, more competitive products for our ISP, Telkom Internet, were launched during the year with soft caps and better value uncapped products being made available in March. Hosting Internet Access was also launched as a more cost effective internet access option for customers hosting their infrastructure in the Telkom data centre.

These network upgrades also support migration to VoIP services. The new network also enables Telkom Business to offer best in breed converged, Unified Communications (UC) and networked ICT infrastructure services. This is an opportunity to up sell bandwidth.

SIP trunking was introduced as a NGN alternative to ISDN Primary Rate services and has been well received, with several key customers having already migrated to this new voice technology.

Growing Telkom Business Mobile on the path to convergence is a key driver of the Telkom Business strategy. We are in the process of building out our LTE mobile network in South Africa. Our mobile capabilities, coupled with our fibre based infrastructure, demonstrate Telkom’s ability to offer seamless connectivity in support of genuine convergence.

Initial uptake of Business Mobile services has been slow, but we achieved moderate, encouraging growth in the year under review. In the year ahead we will grow ARPU through more compelling voice offers, with a strong focus on convergence.

Converged products and capabilities that offer savings when buying both fixed and mobile offerings were introduced. These capabilities include single bill and single point of sale for our customers. Until now, Telkom Business has been offering bundled solutions, however the year ahead will see the introduction of more integrated fixed, mobile and IT service offerings that unlock the true value of convergence for our customers.

Our vision is to transform the way that IT is delivered through the Cloud and through convergence. We view IT services as a natural adjacency to Telkom’s fixed and mobile services that will complete our convergence value proposition. We intend to drive the development of IT services through our Cybernest business.

Our roadmap to UC as a Service is evolving fast and a full suite of hosted and enterprise based UC and Collaboration solutions will be available in the 2014 financial year. Telkom already offers a range of solutions in both the hosted and premise based areas, catering for business needs ranging from medium sized companies through to large enterprises.

In a drive to improve operational efficiencies and reduce IT complexity, Telkom Business simplified its product portfolio, removing 450 offerings from the system. We will continue to identify and retire products and services that are underutilised or obsolete.

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, Telkom Business is in the process of connecting 1,500 schools across the country, making e-learning and e-education accessible.

CYBERNEST

We have observed strong growth in the data centre and IT markets. Telkom Business intends to grow organically into adjacent areas like IaaS, SaaS, LAN and Desktop Management, cloud services, UC and IT Outsourcing through closer alignment to our managed IT infrastructure business, Cybernest.

Pleasing progress was made in aligning Cybernest with Telkom Business and our sales channels, resulting in Cybernest performing remarkably well over the period, more than doubling its revenues and achieving a six-fold year-on-year increase in total contract value sold.

By leveraging the scale of Telkom’s infrastructure, Cybernest will transform the way that IT and cloud services are delivered to the business market. With six national data centres, Telkom has the largest operational data centre capacity in the country, enabling lower acquisition costs and greater operational efficiency.

TELKOM consumer services and retail

The improving accessibility and affordability of data has been the catalyst for significant growth in broadband usage in South Africa. This has presented an opportunity for Telkom to increase its broadband subscriber base and data related revenues. The sustained trend of fixed-mobile substitution, although advantageous for our consumer mobile brand, Telkom Mobile, has been detrimental to fixed broadband penetration and, consequently, to our fixed-line business, which experienced 6.8% churn during the period.

During the 2013 financial year, continued pressure was felt on operating revenues from the decline in fixed voice usage. Despite this, the Consumer business was able to grow its data revenues year-on-year by 11%. However, competition in the data market and continued strain posed by fixed-mobile substitution resulted in relatively flat DSL subscriber growth.

Convergence is how Telkom plans to reach a balanced outcome in this situation. By demonstrating the synergies between fixed and mobile as a converged offering, we aim to stabilise declining revenues in our fixed-line business while moving Telkom Mobile to high value segments. Mobile will enable Telkom to capture broadband market share in areas without fixed-line access, while fixed broadband can provide the stability and bandwidth required to support rich media content.

We are constantly seeking ways to improve our value proposition and meet the needs of the connected individual. In a drive to boost the competitiveness of our ISP offering, Telkom Internet, a number of initiatives were implemented. This year we were able to increase our entry-level ADSL speeds, moving the bulk of our customers from 384 Kbps to 1 Mbps and our 1 Mbps customers to 2 Mbps. We also migrated our Telkom Internet customers to a new technology model enabling us to provide a more competitive service and greater value for money. In February 2013 we implemented price cuts on our uncapped Internet products of up to 40%. In addition, we enhanced our capped Internet services with a soft cap. This means that customers are not limited to local data once reaching their Internet cap, and can also access international sites.

Telkom commercially launched its NGN programme in March, which has allowed us to launch our 20 Mbps and 40 Mbps fixed broadband products. During the pilot project a reduction in faults of 67% was observed. The significantly faster speeds and reduction in faults enabled by NGN will allow Telkom Internet to gain market share, improve customer satisfaction and deliver on our promise of value for money.

Resolving service related perceptions that could affect the Telkom brand has been and remains top of mind. As such, one of our primary strategic focus areas for the year under review has been customer experience improvement.

A number of service improvement initiatives aimed at simplifying customer interface processes have been implemented. The changes include an improved online fault logging portal as well as our customer service app for iPad and Android, which has experienced good utilisation since its launch. Telkom is now active on social media site, Twitter, facilitating more direct engagement with customers. We were also able to reduce ADSL installation times, with 90.9% of installations now being completed within seven working days.

As a result of these and other initiatives, we have been able to reduce service related traffic in our retail stores. This has created room for more in-store transactional activity, which now accounts for about 50% to 70% of total activity. This is largely attributed to the expansion of our retail footprint via third party partnerships, and organic growth through Telkom’s owned-and-operated channels.

We were able to exceed the target we set of increasing the total retail channel growth, increasing total Telkom outlets from 117 to 155. Our partnerships with third party retailers have facilitated quick expansion in a cost effective manner. Telkom’s presence within these stores also offers consumers a new level of convenience through enabling the purchase of smart devices and connectivity in one place. We now have a presence in 18 DionWired stores and 10 Pick n Pay Hyper stores. We will continue to assess similar partnership opportunities in the year ahead.

Declining fixed-line voice usage and revenues have necessitated consolidation and innovation to defend and grow our subscriber base. Rationalising our voice portfolio has allowed us to streamline our product offering. This has clarified our value proposition for customers and simplified our sales activities. We also discontinued some value added services and integrated others into the basic cost structure of our voice contracts.

During the year we launched a number of converged products in the data and voice space across fixed and mobile. This year, we launched two new Telkom Mix voice propositions: Telkom Mix 2 and Telkom Mix 3. We also introduced the Telkom Simple product bundle which includes Telkom Mobile data as a standard value add, and an all-inclusive converged voice and data bundle called The Killer Deal.

Bundles that include streaming devices, such as Boxee, were introduced towards the end of 2012 and are available in all TDS stores. By enabling the utilisation of rich media content, we are able to demonstrate the relevance and value of high-speed, uncapped, fixed broadband. This area has the potential to drive broadband growth and is hence a priority for the Consumer business.

Telkom’s pay phone business has come under significant pressure as a result of fixed-mobile substitution. During the year we implemented a commercially led plan to consolidate our pay phone business and we began removing unprofitable phones. We have, however, ensured that phones remained in essential service areas such as prisons, hospitals, clinics, schools and old age homes. We will continually assess the viability of our pay phone business and action our strategy accordingly.

Voice usage is expected to continue its downward trend, but will be offset by increased tariffs on line rentals. During 2013 we began to implement churn reduction initiatives. This, along with channel improvement and expansion, enhancements to the Telkom Internet value proposition and price cuts, is expected to have a positive impact on our DSL subscriber growth in 2014.

TELKOM mobile

Central to the 2014 strategy for Mobile is leadership in broadband, which will position the business to benefit from the steady growth in data usage and declining voice utilisation. The successful launch of LTE in South Africa’s four major metropolitan areas, and continued innovation in convergence, will see us increasing the value gained on our investment in Telkom Mobile in the year ahead.

During March we launched Telkom Mobile, a high-quality network offering great value to data hungry consumers and those making high volumes of voice calls. It is important to note that 8•ta will continue to be the brand name for a differentiated core set of products within Telkom Mobile, which is a business unit within the Telkom Group. 8•ta has developed a strong and loyal following in key segments of the market and will therefore remain as an important product for those customers.

The decision to launch Telkom Mobile was informed by a great deal of investigation into market dynamics, the benefits of leveraging the strong Telkom brand heritage and its unrivalled infrastructure. We believe Telkom Mobile will position the Group uniquely in the convergence arena.

Over the past year we were able to reduce Mobile’s EBITDA losses from R2.2 billion in 2012 to a loss of R1.7 billion, exceeding our loss reduction target of 20%. The allocation of network-related and other costs to Telkom Mobile was done consistently with the methods applied in previous years.

In November 2012, Telkom Mobile launched its free fivemonth non-commercial LTE trial in select parts of Gauteng. The trial was an important milestone in demonstrating Telkom’s ability to bring the fourth-generation (4G) technology to market.

Mobile’s commercial LTE offering was launched in April 2013 in parts of Johannesburg, Pretoria, Durban and Cape Town. The commercially-led rollout focuses on communities without fixed-line access.

Despite this progress, this financial year was a challenging one for the Mobile business. Being the fourth entrant into a highly-competitive, price-driven market has demanded innovative solutions to capture market share and greater efficiencies to improve profitability.

Our focus for the year ahead is to deliver a value for money product offering that will allow us to compete on a basis that is more sustainable than price.

Our value proposition is based firstly on the delivery of high-speed mobile broadband in areas without fixed-line broadband, satisfying a latent demand for broadband and moving our mobile subscriber base of 1.5 million towards critical mass.

The second pillar of our value proposition is convergence, which will allow us to further leverage off our existing fixed-line infrastructure and provide customers with the 24-hour convenience of uninterrupted connectivity. Accordingly, the year ahead is about ensuring the delivery of high- speed broadband across our mobile and fixed-line networks through capacity building, network upgrades and expansion.

To this end, we were able to integrate 637 base stations into the field during the year, bringing the total to 1,985. As at 31 March 2013, Telkom Mobile had 651 integrated LTE base stations.

Given the sustained trend of fixed-mobile substitution, convergence provides an opportunity for Telkom to defend its fixed-line business, while capitalising on the rapid uptake of mobile in South Africa. Our mobile business is not viewed as an alternative to our fixed-line operations, but an opportunity to grow and sustain a single customer base that uses Telkom’s products and services across both platforms. We will, therefore, continue to develop and market fixed-mobile data bundles and converged offerings in the year ahead.

Declining voice utilisation continues to put pressure on revenues. Although data is our primary focus going forward, we will continue to operate at the high end of the voice market. In October 2012, Mobile introduced its R1,199 Unlimited Voice Postpaid contract, a first for the South African mobile market.

Continued retail channel growth is critical to growing our mobile customer base. For the consumer mobile business, expanding Telkom’s retail presence, particularly via third party partnerships, is an efficient and high impact strategy to improve accessibility of our mobile offering. For Telkom Business Mobile, we have entered into a service provider agreement with Nashua Mobile. Organic growth is also being pursued through our owned and operated stores.

In the past, driving customer acquisitions via call centres has focused on the volume of subscribers rather than on quality. We experienced a significant improvement in our debtors’ book due to a reduction in call centre driven sales, the introduction of more stringent credit measures and a renewed value over volume approach to customer acquisitions.

TELKOM WHOLESALE AND NETWORKS

Telkom Wholesale and Networks is driving transformation through the adoption of an IP-compliant network, designed to enable fixed-mobile convergence and high-speed, quality broadband.

Telkom’s network and IT transformation programme, NGN, attained full momentum during the financial year under review. We were able to put in place 52 fully operational Multi-Service Access Nodes (MSAN) in five exchange areas by the second quarter of this financial year. Telkom also commenced the commercial pilot of the NGN programme at the beginning of October 2012 which ran through to the end of February 2013. The participants’ lines were cut-over from TDM exchanges to the MSANs, enabling the delivery of traditional voice, high-speed DSL and new emerging IP-based services from the same hardware. Of the 437 customers who participated in the commercial pilot, 66% attained a broadband speed of 40 Mbps.

The NGN pilot verified the considerable cost savings of the new network, particularly through greater energy efficiency, reduced maintenance costs and better utilisation of Telkom’s workforce.

During the migration to MSANs, seven local exchanges, were completed with high efficiency and low fault rates, with less than 5% fall out rate and no roll back. This is a tremendous achievement when compared to international benchmarks. We will continue to migrate the network during the next financial year and preparation of sites is already underway.

In addition to the 52 pilot MSANs, 31 more were deployed during the year under review and are already fully-commissioned and integrated into the network. Through the deployment, we have achieved an average copper loop length of 800 metres, which will support higher broadband speeds with VDSL technology.

NGN was commercially launched on 4 March 2013. Future expansion will focus on high density areas where significant overhead costs such as trenching can be optimised. In remote exchange areas, we will rely on our fixed wireless or satellite broadband capability to meet customers’ connectivity needs.

Telkom Wholesale and Networks is also in the process of taking fibre deeper into the Telkom network, thanks to new fibre capabilities and leveraging a mix of access technologies including very high-speed DSL technology (VDSL2) in a fibre-to-the-curb configuration and passive optic fibre (PON) configuration directly to the customers’ premises. Telkom’s unrivalled fibre network of more than 147,000 kilometres and 16,500 Fibre Distribution Points, that enable over 107,500 services, is a valuable asset in terms of providing last mile access.

On the enterprise side, 578 priority buildings have been identified for fibre deployment. Of the 578 buildings, 512 have already been completed with 66 more planned for the near future. Telkom will be able to lead in the converged ICT market and benefit from the strong growth expected in the enterprise data segment through the provision of a distinctive customer experience.

However, revenue in the Wholesale business remains under pressure due to increased self-provisioning by MCOs. Wholesale is thus reliant on the Networks business to provide a network that meets its customers’ needs, is efficiently run, well-maintained and available where the demand exists. NGN is therefore critical to contain the effects of self-provisioning and strengthen our position in the wholesale market. Despite this risk, the full impact of self-provisioning has not yet been seen.

In the year under review a number of additional transformation initiatives were successfully completed. In the fixed-line business uncapped ADSL prices were dropped by up to 40% in the Consumer division. We raised the entry-level ADSL speeds from 384 Kbps to 1 Mbps and from 1,024 Kbps to 2 Mbps.

Over the past six months, Telkom has transferred the remaining 2,700 manual customers served by manual boards around the country to a modern, automated technology. The last manual service was decommissioned in February 2013. The new service is provided by satellite technology. Previously these customers could only have basic voice functionality, whereas now they will also have access to broadband.

In May 2012, Telkom launched the ultra-high capacity West African Cable System (WACS), linking Southern Africa and Europe. This is a significant addition to Telkom’s vast international submarine cable portfolio.

Equipped with extensive undersea cable development and maintenance experience as well as the availability of the necessary facilities, Telkom was given the responsibility of landing WACS in South Africa. Since the landing of the cable in April 2011, a new Cable Landing Station has been established in Yzerfontein, north of Cape Town. T he Cable Landing Station is owned, operated and maintained by Telkom. However, the costs of the facilities will be shared by the WACS Consortium parties using the station.

Telkom is pleased to report smooth operations for the duration of the 2013 African Cup of Nations (AFCON) from 19 January 2013 to 10 February 2013. The Group seamlessly delivered a range of critical Information Technology and Telecommunications (IT&T) services for the major sporting event. Optimal technical services were crucial for the success of AFCON and Telkom exceeded all expectations.

Telkom delivered an IP-based Virtual Private Network (VPN) for the sporting event which facilitated voice, data and video traffic. This ensured that the Local Organising Committee’s (LOC) Sandton headquarters were connected in real-time to the five stadiums: Johannesburg, Nelspruit, Durban, Port Elizabeth and Rustenburg.

SUBSIDIARIES

Trudon

Trudon, Telkom’s publisher of local and commercial search directories, and advertiser, experienced a change in ownership in the financial year under review. This was as a result of the TruManCo consortium taking over Truvo’s minority shareholding.

The appointment of Olaf Brinkman, managing director of Purple Cow and his firm’s development of the advertising agency, 360 Eight, will aid Trudon’s communications strategy. This also forms part of Trudon’s strategic objective to become a multimedia organisation that successfully sells across all platforms, offering comprehensive advertising solutions to the SMME market.

Trudon’s digital platforms matured over the financial year, which led to a 423% growth in mobile offerings and an overall online revenue growth rate of 10%, whilst print revenue remained relatively flat.

Yellow Pages increased its internet usage by 125% while the website (IYP) usage achieved 19.3% growth during the financial year. The mobile application increased by over 60,000 downloads, suggesting that users are finding cumulative value in this offering.

The next phase of the Company’s mobile development plan includes user-engagement by means of a geospatial offering.

Trudon has made headway in the social media communications arena this year. This area remains important for the Company in providing products to the SMME market and assists in increasing engagement with customers, creating brand awareness and improving page ranking and revenue. Yellow Pages also increased membership on its Facebook fan page, by 28,000; the social media site has a total reach of 10 million people. The Yellow Pages application for M icrosoft Windows Phone 7 and Windows 8 is unique in the SMME market, and has been well received by customers.

Trudon partnered with the Facebook-approved company, Zibaba, to launch the Facebook Product Suite. The suite of products will enable SMMEs using Yellow Pages products to increase and generate revenue from online sales by opening a new sales channel inside one of the most visited websites on the internet. Advertisers that elect to take the Facebook Product Suite have the added value of featuring in Trudon’s YP Mall, which is the first social directory and virtual mall on Facebook. The YP Mall is a central location for Facebook fans to discover businesses, advertise products and services, take advantage of networking opportunities and gain direct access to new customers.

Trudon also partnered with Google during the year, as the search engine’s SMME partner. This partnership helped generate substantial revenue for the Company for the year.

To grow its product offering further, Trudon launched a hosted and managed online platform for the Namibian market. The MySite and Mobisite product was enhanced to offer users their own domains, which led to an increased uptake of the product.

Toodu was strategically rebranded to Connecto™ during the year. The aim of this was to enable both small and large businesses to engage its customers through an interactive contact profile sent to their mobile phones. Connecto is designed to improve customer loyalty and drive continuous contact with customers.

The decision to expand print products by enlisting the services of Paarl Media, which has state of the art printing technology, has seen Trudon producing more high-end directories lending the Company a competitive advantage.

Telkom’s subsidiary, Trudon (Proprietary) Limited – Registration number 1992/002329/07 – passed a special resolution on 8 November 2012, in terms of which it adopted a new Memorandum of Incorporation.

Swiftnet

Swiftnet continues to offer valuable services in the wireless data credit clearance and debit card market as well as the wireless VPN market. Following a major technology refresh programme towards mobile technology to offer better service coverage and overall service experience to our customers in the M2M, point-of-sale verification, security and fleet management services; the business remained vulnerable to increasing levels of competition and technology changes in the market.

iWayAfrica was formed as a result of integrating the business operations of Africa Online and MWEB Africa. It is a satellite-based (VSAT) ISP aimed at the enterprise market in Africa. Due to the advancement of available technologies across the continent, iWayAfrica has faced serious competition from cheaper offerings in terms of fixed and mobile broadband.

We will review our investments in Africa and those we consider non-core in South Africa. Our aim is to first get the basics of our core business right in South Africa.

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