Telkom South Africa

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

2. 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

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

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

5. I. Opportunity • Telecommunications • Telkom • South Africa

6. 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.)

7. 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

8. 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

9. 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

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

11. II. Risks & Concerns • Country Risks • Company Risks

12. 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)

13. 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

14. 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%

15. 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

16. 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

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

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

19. 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

20. 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

21. 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

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

23. Discussion IV. Valuation • Major uncertainties • What actually happened & our model

24. 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

25. 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?

26. Discussion

27. Valuation - Key Results March 1997: Thintana wins the bid

28. Valuation - Key Assumptions Depreciation

29. Tornado Analysis

30. 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

31. WACC = 20.11%

32. Model Results