Six-and-a-half years after launching as SA's first CDMA network and competitor to fixed-line incumbent Telkom, second network operator (SNO) Neotel is rumoured to be up for sale.
While talk of a buyout has had the rumour mill turning for years, recent reports have heightened the hearsay, with SA's two main mobile rivals, Vodacom and MTN, tagged as being in the running.
However, with neither the mobile operators, nor the SNO, willing to entertain the hypothetical hum surrounding the future of Neotel - whose majority shareholder is India's Tata Communications (68.5%) - the industry is left to speculate.
While the notion of a mobile operator buying a fixed-line business may seem incongruous in one of the fastest-growing mobile countries in the world, analysts say such an acquisition would make sense for a number of reasons.
Neotel, still relatively insignificant in comparison to Telkom's empire, has two assets that would significantly boost either Vodacom or MTN's enterprise units and infrastructure reach - an enterprise customer base and extensive fibre network.
Neotel CEO Sunil Joshi reported at the end of May that the company's core customer base - the enterprise sector - was up 29% year-on-year, while what he classifies as the company's consumer customers (small business and retail) had grown 52%.
While the numbers may pale in comparison to Telkom's four-million-odd customers, analysts say Neotel's base of 3 000 business and 152 000 consumer customers would not go amiss for the mobile operators, which have both recently intensified efforts to bolster their respective enterprise units, with a sharp focus on the SME sector.
At the same time, and as part of their enterprise strategies, both Vodacom and MTN have been making a play for fixed-mobile convergence solutions in enterprise.
Neotel, which has spent about R5 billion on infrastructure since inception, has access to about 12 000km of fibre, 6 500km of which is in metro areas. The operator also has space on all of SA's five submarine cables, which give it access to Tata's 365 000km of underwater fibre, connecting 300 cities in 200 countries across six continents.
Buyout benefits
Ian Duvenage, head of ICT, Africa, at Frost & Sullivan, says the consulting firm has not seen or heard any confirmation to support reports that Vodacom and MTN are in the process of bidding for an acquisition of Neotel - but says the mobile entities' interest in the company would not be surprising.
"Neotel has just turned earnings before interest and taxes (EBIT) positive, and is showing positive growth. [An acquisition] would place the purchaser in a position to target larger segments of the enterprise market with a more diverse offering range, including fixed-mobile converged solutions."
Furthermore, says Duvenage, a sale would put the purchaser in the opposite position to where Telkom is at the moment, where the company is trying to grow market share in the mobile environment, and have a well-established client base on the fixed-voice, data and services side. "If one of the operators purchases Neotel, they would be trying to build on the fixed side with a well-entrenched presence in the mobile side."
There are two wins to be had: a substantial urban fibre infrastructure, and a powerful business customer base.
MD of World Wide Worx, Arthur Goldstuck, notes that, for regulatory reasons, it is unlikely that Vodacom or MTN would be among the bidders should Neotel be up for sale, but cites the company's customer base and extensive fibre infrastructure as attractive gains for any telecoms entity in the running.
Hypothetically speaking, should Vodacom or MTN acquire Neotel, Goldstuck says SA would see a fixed-mobile service added to consumer options, "but more importantly, an aggressive move into fibre provision to businesses".
"There are two wins to be had: a substantial urban fibre infrastructure, and a powerful business customer base."
IDC analyst Spiwe Chireka says the sale of Neotel, although unlikely to materialise in its entirety, would place Vodacom or MTN in a position to expand their enterprise bases. "There is only so much mobile can do for you on the enterprise side. Fixed-mobile convergence would certainly be one of the motivations for interest in the company."
Chireka says Neotel's services have historically been steeped in fixed-wireless access provision, without much of a mobile offering. "Their services offer a degree of mobility, but they don't have a standalone mobile offering, so the suggestion that MTN and Vodacom are interested makes sense in that it would boost both sides. But I think Tata would want to keep the wholesale side of the business, and perhaps consider selling the retail side."
Ultimately, she says, the prize for a winning bidder would be twofold - Neotel's fibre infrastructure and its enterprise customer base.
Neotel has been expanding into other southern African markets, providing connectivity services to South African corporates, and in that sense expanding the global Tata operations.
Africa Analysis analyst Dobek Pater says the implications of a sale would depend on which entity would end up buying Neotel. For Vodacom, MTN and Internet Solutions - which has also previously been touted as a prospective buyer - Pater says three key aspects are attractive in Neotel.
"[These are], to varied degrees, spectrum, infrastructure and wholesale/enterprise customer base. It would mean that the buyer would be able to: use the additional spectrum to deploy a national long-term evolution network (without having to refarm the 1 800MHz spectrum in the case of the mobile operators); quickly expand its enterprise customer base (this would be of lesser importance to Internet Solutions, which already has an extensive corporate customer base); and quickly expand its fixed-line footprint - metro/access fibre, national long-haul and international capacity."
The last factor, says Pater, may be of most significance to Internet Solutions, which has the smallest amount of its own infrastructure.
"Ultimately, the operator that controls access to the client (through infrastructure) is strategically positioned to control the services delivered to that end-user. All of the above would allow the buyer to become more competitive in the enterprise market, especially against the large service providers such as Telkom and Internet Solutions."
I think the consumer segment may prove to be their weakness.
Ovum analyst Richard Hurst is also dubious as to the rumours of a buyout, but says Neotel's assets in the form of its fibre network and enterprise customers would prove to be "very attractive" to either Vodacom or MTN.
Hurst notes: "I think it's safe to say that businesses will always be looking at further investment and thus a change in equity status is a natural course of an enterprise's life. Right now, the speculation of a sale of Neotel and its equity is nothing more than speculation. We have had various announcements from the majority shareholder Tata Communications that it would not be selling its stake. Tata Communications executives have indicated in the past that they are extremely happy with the operation and have referred to SA as their second home."
Shareholder stakes
In terms of shareholder impetus behind the possible sale of Neotel, analysts say the company's main shareholder, Tata Communications, also stands to benefit.
Over the last three years, Tata has increased its effective stake in Neotel to 68.5% in a consolidated manner after it increasingly acquired shares from other partners in the joint venture. Neotel's other owners include Tata Africa, CommuniTel (Telkom Namibia) and Nexus.
Goldstuck says Neotel has represented a drain on both financial and strategic resources. "Although it has turned the corner, it will probably be some years before there is a return on investment. Making a profit from an early exit would probably be an attractive option."
The first five years of operation, he notes, saw accumulating losses, "which have probably added up to a significant burden on the parent company. We see Tata as this global giant with endless resources, but it is a company with $2.6 billion turnover, which makes it smaller than our major mobile operators. While its parent company, the Tata Group, is a $100 billion conglomerate, the subsidiary has to perform in its own right within the group, and there may well be pressure from a higher level for it to turn a profit in SA."
Pater mirrors the sentiment, saying: "Neotel is not yet profitable (on a net profit basis) and will not be, given its loans, I suspect. It would have to commit quite a bit more investment, in order to remain competitive in the market. It would probably be another few years before Neotel became profitable on a net basis. Tata may not be prepared to wait that long, and the end result is not guaranteed."
However, from a strategic perspective, Pater says he finds it surprising that Tata would want to dispose of its Neotel shareholding if the company wishes to remain and grow in Africa, unless it is eyeing another investment in Africa in the hope it would be more profitable.
"Neotel has been expanding into other southern African markets, providing connectivity services to South African corporates, and in that sense expanding the global Tata operations."
Duvenage says, depending on the structure of the agreement, a sale could place Tata in a position to access broader markets. "By being involved with MTN or Vodacom, it could place the new partnership in a unique position to have price advantages across that board, with the reach of Tata globally, and the coverage and growth of the mobile operator locally."
He says, as far as Neotel itself goes, the deal might present an opportunity for the company, providing more access to market, and a wider product range to co-develop solutions for the local market.
Hurst presents a slightly different point of view. He says, while the sale of Neotel would give Tata a cash injection, it would also be contrary to its strategy of being able to deliver its enterprise and carrier-grade services in emerging markets.
"[A sale] also seems odd after Neotel having gone through extensive investment required to get the operation profitable and generating cash. To sell it seems to indicate that there must be an alternative motive."
Persistent progress
While Neotel does not disclose revenue, the company's latest annual financial presentation painted a positive picture of its position in the market.
Neotel reported positive operating income for the year to March, hitting one of the milestones on the way to profitability, for the first time since launch. In May, the operator said it had turned EBIT positive, and was now aiming to be positive on a pre-tax basis by year-end. Neotel recorded revenue growth of 12% for the year to March, while earnings before interest, tax, depreciation and amortisation (EBITDA) increased 531% over the same period.
At the time, Joshi said the company, which had been EBITDA positive for the past seven quarters, now aims to focus on becoming profitable before tax.
He noted that, amid what he says is a competitive environment fraught with uncertainty, Neotel managed to surpass the industry growth rate. "Neotel continues to capture market share. While the fixed-line telecommunications market in SA is projected to grow at 1.4% per annum until 2018, Neotel is growing at more than eight times this rate."
Goldstuck says the fact that Neotel has invested billions, and that it has become operationally profitable, is evidence that the company is both sustainable and making a meaningful contribution to the communications environment in SA. "Neotel's long-term potential is huge as it continues to grow, even if slowly."
In December last year, iWeek reported that Neotel was slowly but surely starting to eat into Telkom's market share. Having started out with little more than a laptop and a handful of staff, Neotel today employs around 1 000 people and is able to offer communication services to SA's wholesale, enterprise and consumer segments.
Goldstuck says Neotel is a viable choice for businesses - making it a threat to Telkom's business division - a highly competitive unit in its own right.
Hurst says Neotel has a meaningful role to play in the South African telecoms landscape, both currently and in the longer term. "The company has brought competition to the market although this has been felt more in the enterprise market than the consumer base right now. "Neotel has invested in fibre networks around the country and has contributed to the overall lowering of the cost of bandwidth. Going forward, Neotel is expected to play a role in the country's ongoing investment into fibre and capacity and a possible increase in the content delivery market, as well as continuing to grow their enterprise base. In addition, as enterprises begin to shift their ICT spend to the cloud, Neotel will play a vital role in being able to provision bandwidth to customers, along with their competitors."
Pater says, while Neotel is a serious competitor, this can only be said for certain market segments. "I don't think the operator has become much of a viable alternative in the consumer market, as its infrastructure is still very limited (although targeting mostly the high-end areas of the consumer market).
"However, in the wholesale space and enterprise, it is a fairly serious competitor and its ability to compete (for example, on infrastructure wholesale) would improve with the commercial launch of the national long-distance network."
Duvenage says, while Neotel has gradually been taking market share, the operator is continuously challenged by other industry players - especially in the enterprise space, in which the company predominantly operates. "The pressure on Telkom Enterprise should see Telkom become more aggressive.
"Neotel has most certainly made some inroads in brand recognition and is well recognised as a serious player in the South African market."
Market challenge
Despite the challenges it faces on an ongoing basis, and rumours of a buyout, Neotel continues to strive for market share. Joshi says if Neotel continues to gain more than a percent of the market a year, it will make its target of between 14% and 16% of market share by the 2016/17 financial year. Neotel has also upped its consumer game with several products targeted specifically at that segment, and continues to build up its network.
However, the initial expectation was that Neotel would gain 15% of Telkom's customer base within five years of its launch, a target it has failed to achieve, despite Telkom's declining fixed lines.
Analysts say, amid the highly competitive landscape Neotel operates in, gaining market share will be no mean feat.
Goldstuck says, as it stands, 15% of the market by 2017 "does not yet look doable" for Neotel. While Neotel has become a significant brand for business, he says, it is not yet a strong enough brand to come up automatically as an option when consumers are discussing alternatives.
Hurst says Neotel is doing "exceptionally well" in driving efficiencies in the business and is very focused on winning customers in the enterprise space, and, if the goal of 15% speaks to its enterprise customers, and the operator continues on its current path, 15% will be attainable. However, acquiring 15% of the total market will prove difficult. "I think the consumer segment may prove to be their weakness."
Likewise, Pater says if Neotel is aiming for 15% of the entire market, "it is difficult to see how Neotel could account for 15% in revenue terms. It would mean that it would have to grow its revenue almost seven-fold over the next three to four years. If we only look at the wholesale and fixed market segments, Neotel would still have to triple its revenue."
He says the challenge lies in the fact that Neotel is not the only operator looking for a larger market share. "Other large operators also plan to grow - or at least defend - their current territory. They will not easily give up market share."
At the end of the day, say analysts, whether rumours turn out to be just that - or materialise into a merger or acquisition - the investment and contribution Neotel has made since August 2006 will remain a key part of the local telecoms landscape.
First published in issue 290 of iWeek magazine.
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