Neotel worth R7bn because of its spectrum – look again at Telkom

Vodacom is going to be buying fixed-line operator Neotel in a deal worth about R7bn. At first glance, the deal seems a little off-target, given that Vodacom has no fixed-line operations, but in fact, it's a fairly smart move. Buying Neotel will give Vodacom access to the part of the radiowave spectrum that Neotel has been allocated, which will, in turn, help Vodacom maintain its network speeds. This is necessary, because the process for allocating spectrum, which falls under the purview of the Independent Communications Authority of South Africa (ICASA), is slow, laborious, and opaque. Vodacom needs spectrum, but getting it through ICASA would take a long time (and be a gamble). By buying Neotel, Vodacom can avoid all of that. Another aspect of the deal that I approve of is that Vodacom has said it will not be acquiring any of Neotel's (extensive) debts, which Neotel's parent Tata will apparently be paying off. So, all round, this deal has potential. – FD 

ALEC HOGG: In the studio with us is Nadim Mohamed from First Avenue, who is our go-to man when it comes to the telecoms sector. He's been helping us through the price war that's evolved…in fact, before it even started. Nadim, you were explaining what the implications were. It's interesting in these results, that Vodacom still has a massive profit margin of 36.1 percent. All over the world, they'd be licking their lips at that kind of dripping roast, but on the other hand we are seeing that the prices are now finally starting to drop.

NADIM MOHAMED: This is the first time you're really seeing it come through in the results, so if you look for the full financial year, voice revenue is down three-point-five percent and data revenue had to grow to the tune of 24 percent, just to make up for that decline in voice plus the decline in interconnectivity.

GUGULETHU MFUPHI:  It's interesting. Sasha was talking about the apps and the development of technology. Surely, it's well known that data is the new growth point here, but together with this deal regarding Neotel and the assets there, how big does this change the game for Vodacom and Neotel?

NADIM MOHAMED: In my opinion, the Neotel deal is all about the spectrum. We've seen 80 percent increase in usage of data. The trouble is… We don't know exactly, but if data grows at this kind of rate, at some point – probably in the next year or two – the network can't handle this and the speeds start declining, so you need additional spectrum to handle that. The trouble is, the process of allocating and freeing up that spectrum from SABC and the other analogue broadcasters, has taken so long that there's no visibility on that. Vodacom actually needed to do this deal to get to the spectrum. There are other things they need to gain access to: fifteen-thousand kilometres of fibre, which all could be helpful and could be used to their cost structure to offer new services, such as fibre to the home to high-value customers, but I think the key is the spectrum.

ALEC HOGG: It's very small – R190bn market cap Vodacom – R7bn/three-and-a-half percent of their market cap in this transaction… You have to ask yourself, 'did Tata Group do the right thing by investing in South Africa in the first place or have they taken a hiding'?

NADIM MOHAMED: No, they never really got to a decent… They are profitable I believe, but if you look at the beginning of the whole Neotel venture, they planned to spend somewhere to the tune of R11bn in CapEx. I believe they only spent in the region of R5bn and the debt governance around that business has been strangling them. Getting a well-capitalised player like Vodacom could help them turn around and maybe grow the business to scale by merging with some of the existing Vodacom-managed services units. The key is spectrum and that R7bn is not a lot to pay to get access to that.

ALEC HOGG: Well, that's the question: it's a foreign investor, who came into South Africa with much fanfare. I was actually at the launch of Neotel. It was very well done, very expensive, and many promises but we haven't seen much.

NADIM MOHAMED: Yes. Unfortunately, the regulatory environment was not supportive enough and I think it took a long time for them to get anywhere in this market. They also cherry-picked certain areas, which were of a higher value, and they've taken some share away from Telkom but largely, I think the environment was not supportive enough for them to get to the scale they need. You see a similar thing with Cell C. They need to get to a certain scale of 20 to 25 percent of the market in order to be sustainable.

ALEC HOGG: Just to pick up on Cell C: Alan Knott-Craig now stepping away from it…he's been the driving force there in the whole price war and certainly, in bringing Cell C back to a position where it's taken seriously. Now that he's left…

NADIM MOHAMED: Well, he's still involved in the business. What is most striking is that MTN came out with the 79 cents rate, I thought the objective was to try to put Cell C out of business, because we know there's a lot of debt in Cell C and they're not cash-positive yet. Interestingly, last week they came out with a 66 cents per minute price plan and this was actually pushed by shareholders. Shareholders insisted that they do this, so the shareholders are still backing them, willing to invest in them, and help them to the tune of R1.5bn next year and another R3.2bn this year. Cell C is not going away any time soon. If you look at their numbers, they've now reached 16.6 customers. Compare that to Vodacom's 31.5…I think they may well be at scale.

GUGULETHU MFUPHI:  Coming back to a comment that Sasha mentioned to us off-air as he was making his way out of the studio… It goes back to government's stake in Vodacom versus Telkom and it seems as though it's more lucrative for them to have their money in Vodacom where their stake there is worth almost three times more than that in Telkom.

NADIM MOHAMED: Yes. Unfortunately, this is a legacy issue. The two were part of the same group. Government has moved on from the days where it may have been protecting Telkom. You see ICASA now coming out with a much more positive stance on lowering the cost to communicate and improving broadband connectivity. There isn't that much protectionism going on or utilising of golden shares as they were in the olden days, with Telkom.

ALEC HOGG: Does it make sense then for government to get its 'bed hand' off Telkom, sell those shares into the marketplace, and let's see what happens or do you think that might be the death of Telkom?

NADIM MOHAMED: Well, we'll have to see. Telkom is actually doing a very good turnaround right now. They proposed job cuts and normalising the operational cost structure. We'll have to see now – now is the test. Will government block that or not? That's when we'll see what government's true intentions are. Ideally, you would want government to step back because there are some fantastic assets at Telkom, for example the LTE spectrum, which is probably the best spectrum in the country. You'd want to see Telkom monetise that within a free market context.

ALEC HOGG: Just very quickly, you say that Neotel was bought for its spectrum. If you take the LTE spectrum at Telkom, and if it were up for sale, what could it go for?

NADIM MOHAMED: Probably much more than that. It's in a different band. It has much more capacity. There you have another interesting topic. There's been news about MTN and Telkom Mobile joining forces. It's not an MNA or an acquisition. It's just an agreement for MTN to take over the operational management of their base station network and then gaining access to Telkom's 3G spectra. It's the same thing. Data usage is just growing too fast and both Vodacom and MTN actually need this spectrum in order to be viable.

GUGULETHU MFUPHI:  It sounds like a battle for spectrum. Thank you so much to Nadim Mohamed from First Avenue, for joining us today.

On the other company results released today, AngloGold Ashanti reported a rise in first quarter earnings production – up by 17 percent, while costs are down by 22 percent. CNBC Africa spoke to the company's Chief Executive, Srinivasan Venkatakrishnan, for more insight into their numbers and asked how South Africa compared to the rest of the continent, America, and Australia.

SRINIVASAN VENKATAKRISHNAN: Overall, if you look at our performance this quarter, it's been another…