8 Focus on four key enterprises

Cabinet has instructed the Department of Public Enterprises to give priority to the restructuring of the four largest SOEs, Eskom, Transnet, Telkom and Denel. This will enable Government to maximise the effects of the restructuring programme.

Other SOEs will be restructured concurrently with the four enterprises mentioned above. It is envisaged that the major elements of the restructuring programme will have been completed towards the end of 2004. All restructuring proposals are, however, subject to Cabinet approval. The table below describes the situation for the top 30 public sector firms.⁽¹⁾

Table 2: Top state-owned enterprises

Source: Financial Mail Special Survey Top Companies, 25 June 1999.

Three points should be noted. First, the important SOEs are Eskom, Transnet, Telkom and Denel. They comprise approximately 91 per cent of estimated total assets, provide 86 per cent of turnover and 94 per cent of net income and employ 77 per cent of all employees in the top 30 SOEs. While it can be expected that the estimated 300 other public enterprises can obviously contribute to meeting Government objectives on restructuring, these four companies will have the greatest impact. Second, with the exception of the four large SOEs, the Post Office and Sapekoe, which also have large employee complements (making up 91 per cent of the top 30 companies), the number of employees affected by the restructuring of the other SOEs is not particularly significant. Given that the proportion of employees in SOEs only accounts for approximately 5 per cent of non-agricultural employment, apart from the six large employers identified in the table above, the restructuring of SOEs is unlikely to have a major impact on overall employment trends.⁽²⁾ Finally, it should be noted that enterprises such as Eskom, Transnet and Telkom have a developmental role to play in addition to promoting economic growth.

A summary of the “big four” and the sectors in which they operate is provided below. Details of other restructuring initiatives are described briefly thereafter.

The energy sector

International trends

Significant international shifts have occurred in post-oil-crisis energy policies.

Perhaps the most important shift in international thinking is a realisation that commercial energy will not become scarce in the short or even the medium term.

Energy security is now being achieved through greater diversification and flexibility of supply, including increased cross-border energy trade. One of the implications of this trend is that national uneconomic energy industries are no longer being protected. As a consequence, the role of the state in the energy sector is being redefined and restructured.⁽³⁾

Another trend is the increasing realisation by governments that they do not have to be the providers of services. Governments can achieve their national goals through ensuring that services are delivered rather than providing them themselves.

Greater emphasis is being placed on commercialisation, incorporation and, in some cases, privatisation. Energy markets are being restructured to encourage greater competition, even in the grid-based electricity and natural gas industries, which have traditionally been regarded as natural monopolies. Heightened competition has necessitated the development of increasingly sophisticated regulatory regimes for the licensing of the industry. This has resulted in a trend towards re-regulation of the energy sector. At the same time, however, increasing competition has meant that there is less need for the regulation of prices.

Restructuring initiatives in the industry have involved the unbundling of generation, transmission and distribution. A further trend is the convergence of gas and electricity companies.

The energy sector has significant environmental impacts, and these have become an international issue. For example, the reduction of emissions is becoming increasingly important. Energy investments are subjected to greater environmental scrutiny and there is greater focus on energy end-uses, with policies for encouraging energy efficiency and demand-side management. The research and development of alternative and renewable energy sources are also being promoted. The energy sector is increasingly being funded with private finance. This has had profound effects on the structure of energy investments and energy markets, as domestic and international investment has to be attracted.

As with most sectors of the global economy, technological developments are taking place rapidly. In the electricity industry, size and scale are important in accessing the latest technology. In several markets there has been a trend towards re-aggregation in the industry. In the United Kingdom, for example, the electricity restructuring in the early 1990s resulted in a disaggregation of the industry into a number of companies. More recently, some of the companies have either been taken over or have merged.⁽⁴⁾ In the case of the fossil-based power generator, National Power, however, there has since been further disaggregation.

Legislative and regulatory framework in South Africa

The 1998 White Paper on Energy Policy⁽⁵⁾ sets out the policy objectives of the energy sector. The policy priorities for the energy sector are:

• Increasing access to affordable energy services
• Improving energy governance
• Stimulating economic development
• Managing energy-related environmental impacts
• Securing supply through diversity

The White Paper supported taking gradual steps towards a competitive electricity market in the short term while investigation into the desired form of competition is completed. It notes that Eskom will be restructured into separate generation and transmission companies, and that Government supports the development of the Southern African Power Pool.

The White Paper notes that customers should be given the right to choose.

Government should initiate a comprehensive study on future market structures for the South African electricity supply industry. In particular, the electricity distribution industry requires urgent restructuring. Competition should be introduced into the industry, especially into the generation sector. Open and nondiscriminatory access to the transmission system should be permitted. The private sector should be encouraged to participate in the industry. The White Paper states that, from an energy point of view, natural gas is an attractive option and that Government is committed to the development of this industry. It will legislate for the transmission, storage, distribution and trading of piped gas.

Limited vertical integration will be permitted.

A National Electricity Regulator (NER) was established in 1995 to regulate pricing, national tariff systems and national service and technical standards. The White Paper notes that complete details of the regulatory regime have yet to be finalised. The Department of Minerals and Energy is currently finalising a policy document on the reform of the electricity supply industry.

Background information on Eskom

Eskom is South Africa’s dominant electricity utility and ranks among the world’s top five utilities in terms of capacity. Its regulated business is structured into three main groups, each of which is a ring-fenced business:

• Generation, whose function is to generate electricity
• Transmission, whose function is to transmit electricity across the country via transmission lines
• Distribution, which distributes the energy to its customers

In addition, Eskom has a number of subsidiary companies.⁽⁶⁾ A wholly owned subsidiary, Eskom Enterprises, was created to house all those commercial services that will not be regrouped and that could be developed into viable businesses.

Eskom is at present reputed to be one of the lowest-cost producers of electricity in the world, and ranks among the five top utilities in the world in terms of capacity and sales. It has 24 power stations, with a nominal capacity of 38 872 megawatts. It sells approximately 40 per cent of its electricity to local authorities, which resell it to end-users. It also sells electricity to neighbouring countries (Lesotho, Swaziland, Botswana, Mozambique, Namibia and Zimbabwe) representing 2,4 per cent of total sales. Eskom supplies more than 95 per cent of South Africa’s electricity, which it transmits across the country to customers via 26 443 km of transmission lines. Of the electricity supplied, 90 per cent is generated by fossil fuel fired stations, 7 per cent by nuclear power, 1 per cent by hydro-stations and a small portion is imported. Eskom has 40 399 km of distribution lines and 214 168 km of reticulation lines. It receives revenue of R21 billion. Of this revenue, 39 per cent is from redistributors of electricity, 28 per cent is from industrial customers, 18 per cent is from mining and 7 per cent is from residential and commercial customers.

Restructuring of Eskom

The restructuring of the electricity supply industry needs to be looked at in terms of generation, transmission and distribution activities. Currently, there is a generation oligopoly, a transmission monopoly and distribution is fragmented. As a first step Eskom will be corporatised, with generation, transmission and distribution becoming separate corporate entities. Investigations into achieving this have already begun.

It has been agreed that it is necessary to introduce competition into the generation market by creating independent competing generating companies.

This would result in greater market efficiencies. The most appropriate model is still to be evaluated.

Transmission appears to be a natural monopoly, and this function will probably remain in the hands of the state. This is likely to take the form of a separate independent transmission company. The introduction of a strategic equity partner or of an IPO will have to be evaluated in future.

In terms of distribution, a number of regional electricity distributors (REDs) will be created. These REDs would distribute electricity to the customers, most of whom would be municipalities. It may be possible for large customers to have their electricity distributed directly from the transmission company without going through a RED. A number of issues will have to be addressed in structuring REDs, including the contractual or commercial arrangements between the REDs and customers, as well as between the REDs and the transmission company.

More work will have to be undertaken with regard to the regulatory regime for electricity.

Investigations still need to take place into the restructuring of Eskom to ensure that all the objectives of the restructuring are achieved and the benefits are maximised.

Actions by Government

• Eskom will be corporatised, with transmission, distribution and generation each forming a separate corporate entity.
• A full evaluation of the different models for restructuring Eskom is currently being undertaken by the Department of Public Enterprises, based on a review of the electricity supply industry undertaken by the Department of Minerals and Energy.
• Different generating companies will be formed to promote internal competition prior to the introduction of private sector participation in generation, in conjunction with new power requirements;
• The Department of Minerals and Energy is currently co-ordinating the design and implementation of the REDs.
• Strategic equity partners will be introduced into different Eskom Enterprises business units.

Likely impacts of restructuring Eskom

If the above model for restructuring Eskom is applied, the impacts of the restructuring will be as follows:

• The separation of Eskom into generation, transmission and distribution will result in more transparency and accountability in the electricity supply industry.
• Different generation companies will ensure that there is competition in generation, which should result in enhanced efficiency and effectiveness in this sector.
• The creation of REDs should result in better service delivery to customers and eventually to better prices.
• Government is aware of the social services offered by Eskom in terms of the provision of electricity to the poor in both urban and rural areas. The restructuring plans will ensure that the rollout of electricity to these sections of the population continues.

The transport sector

International trends

One of the most important recent trends in global transport is that many countries have been liberalising and deregulating various aspects of their transport systems. This has particularly been the case in aviation, with growing numbers of countries permitting open skies agreements with little or no protection for national flag carriers. There has also been wide-scale liberalisation of road transport and, in some cases, rail transport. A related trend has been the privatisation and/or commercialisation of parastatal transport operations. Japan and New Zealand, for example, have both completely privatised their rail systems. In other countries, like Argentina, there has been concessioning.⁽⁷⁾ Global shipping lines tend to be privately owned and operated, and there has been increasing competition in maritime transport. In addition, shipping lines are integrating with other modal partners and moving towards bigger ships that require bigger harbours and fewer ports of call. This has led to economies of scale and reduction in prices.

Transport operators tend to consolidate globally through alliances, joint ventures or outright acquisition. There is increased integration between modes, as well as integration within the value chain. This is partially to reduce costs and gain market share but, more importantly, to meet the needs of global customers.

Global high value-added manufacturers have increasingly been able to move towards “just-in-time” manufacturing processes and reducing inventory costs.

Sophisticated information technology and transport logistics enable global manufacturers to source their production from multiple sources around the world.

For this they need global high-precision, flexible, integrated transport services and logistics that deliver to multiple global locations. Technological developments now allow transport operators to offer more precise information to customers.

Legislative and regulatory framework in South Africa

In August 1996, a White Paper on National Transport Policy was released. This was followed in September 1998 by the release of Moving South Africa, which is a 20-year strategy for transport in South Africa to achieve the goals of the White Paper. One of the major goals is “to improve South Africa’s competitiveness and that of its transport infrastructure and operations through greater effectiveness and efficiency to better meet the needs of different customer groups, both locally and globally”. To achieve this, it would be necessary to ensure that the region’s competitive advantages could be accessed and marketed. The transport element of the cost of agricultural products, raw materials and manufactured goods can be a significant and deterring proportion of the final cost of both exports and imports. This goal will require a decrease in transport costs for a given level of service, or an increase in quality of service for a given level of cost, or where possible, both an increase in service and a decrease in cost. It is Government’s view that these goals can best be met by ensuring competition in the provision of infrastructure and operations.

The White Paper notes that intermodal co-ordination, co-operation and sharing of information will be encouraged in both infrastructure provision and operations to optimise customer service, reduce duplication, reduce destructive competition, minimise total costs, and maximise social and economic return on investment. A key driver of reducing costs of transport is capacity utilisation. As such, a goal of infrastructure and modal planning will be to optimise capacity utilisation and to achieve a level of integration between modes. In principle, intermodalism will be fostered by incentives and not by regulation. The White Paper noted that in the past, Government’s dominant role has been that of a regulator of bureaucratic detail, provider of infrastructure, and transport operator, but it has been weak in policy formulation and strategic planning. Government intends to reverse this legacy and to focus on policy and strategy formulation (which is its prime role) and substantive regulation (which is its responsibility) with a reduced direct involvement in operations, and the provision of infrastructure and services (to allow for a more competitive environment).

The White Paper states that a port authority with specific responsibilities for the maintenance and development of port infrastructure will be established. The principle of competition within a port will be supported. The existing policy of economic deregulation of land freight transport within the country is reaffirmed, subject to strict and effective regulation in respect of traffic quality and safety matters. The key issue regarding level playing fields between the transport modes is equity in the recovery of infrastructure provision, management, operation, and maintenance costs. An equitable distribution of infrastructure cost recovery (capital, management, operating and maintenance) will make a positive contribution to reducing artificial modal shifts and distorted tariff structures created by cross-subsidisation. Government will encourage integration, intermodalism, and partnerships between the modes, provided this does not result in monopolies.

Civil aviation should promote the national interests of the country in general, and facilitate and enhance the expansion of trade and tourism. In particular, civil aviation policies should promote the development of an efficient and productive aviation industry that is capable of competing both domestically and internationally. Economic decisions should, as far as possible, be subject to general competitive principles applicable to all industries, with a view to maximising consumer choice and needs satisfaction. Maritime transport policy should attempt to foster and maintain a competitive climate wherever appropriate, and Government will avoid protectionist maritime practices and maintain an “open ports” policy.

The South African transport industry

The South African transport industry is dominated by the parastatal Transnet.

Railway operations are critical to South Africa’s economy, carrying 59 per cent of total freight transport volumes. The rail sector has, however, been declining, as it is experiencing increasing competition from road hauliers. It is argued that the playing fields are not level because road transport does not meet the full costs of utilising road infrastructure. There is a widespread view that the railways reflect old national priorities and do not adequately serve the needs of society. This manifests itself in an oversized network with a high degree of low-density branch lines that are not economically sustainable. At present, freight flows are highly concentrated, particularly on the Gauteng–Durban route. Moving South Africa’s vision of densified corridors for freight based on lowest transport costs to support the South African economy has to be achieved within a sustainable environment.

Spoornet currently invests a mere 20–25 per cent of the long-term capital needed to ensure a sustainable network.

Rail passenger numbers have been falling to the extent that they currently account for about 15 per cent of public transport passenger journeys in urban areas. Bus passenger numbers have also dropped significantly. Over 60 per cent of urban public transport passengers make use of mini-bus taxis, which are privately owned and do not receive any direct subsidies. South Africa is also experiencing a rapid growth in the number of cars on the road. Between 1972 and 1996, the number of motor cars increased by 72 per cent and indications are that these rates of growth are continuing unabated.

There are seven commercial ports in South Africa, all of which are owned and managed by Portnet. In 1998, these ports handled over 153 million tonnes of cargo, of which 1,6 million tonnes were container traffic. They handled 13 559 vessels in the same year. There are growing concerns about bottlenecks at those ports handling container traffic. It is very costly for ships to have to wait to dock and these costs add considerably to the cost of trade with South Africa. It should be noted that all shipping is in private hands and theoretically South Africa operates on an open port system (in practice, congestion at the ports means that liners are not necessarily free to use the ports). Safety in shipping is regulated by the South African Maritime Safety Agency.

There has been a rapid growth in the number of international airlines serving South Africa. Airline operation into South Africa is regulated through bilateral air service agreements. Currently, South African airports handle approximately 180 flights per week operated by foreign carriers. South African Airways (SAA) operates over 230 international flights per week. The Airports Company of South Africa (ACSA) owns and operates the country’s major airports. A strategic equity partner, Aeroporti di Roma, was brought into ACSA and owns a 20 per cent share of the company.

Transnet

Transnet comprises 13 companies involved in multimodal transportation and related services and has over 100 000 employees. It was incorporated in 1990, with Government being the main shareholder. As South Africa’s largest transport operator, Transnet dominates the sector and contributes 3,2 per cent to GDP. Its total operating assets were valued at R43 billion in 1998, its turnover at R22 billion, its profit after financing costs (but excluding pension fund interest charges) was R2,2 billion, and its capital expenditure was R2,9 billion. A major feature in Transnet’s financial position is the pension fund liability relating to the South African Transport Services (SATS) pensioners. There are debentures of R8, 471 billion outstanding plus an additional liability of R3, 442 billion relating to medical aid costs for these pensioners.⁽⁸⁾ Transnet’s profitability is severely affected by this outstanding debt and Government has developed a strategy for resolving this situation.

Spoornet is the largest division of Transnet. It comprises a general freight business (GFB), a heavy haul coal line (Coallink), a dedicated heavy-haul iron ore line (Orex), an intercity passenger service operation (MLPS), the Blue Train luxury train service (LuxRail) and an operation that will address the issue of branch lines (LinkRail). In addition, Spoornet has a division, Rail & Terminal Services (R&TS), which maintains and operates the working railway. Spoornet has faced increasing competition in its general freight business as a result of the deregulation of road hauliers. As a result, GFB has had a large negative cash flow. In the past, such losses were mitigated by strong cash generation by Coallink and, to a lesser degree, by Orex. The results for the year ended 31 March 1999, however, show that Spoornet is R210 million cash negative.

Portnet and Petronet are both highly profitable and cross-subsidise the other divisions of Transnet. Portnet continues to make large profits despite a reduction in net profit in 1999. There is, however, a concern that Portnet has been underspending on capital owing to its need to cross-subsidise the other divisions.

Moving South Africa estimates that current capital spending on ports is only 25 per cent of the long-term capital requirements. Petronet owns, manages and operates a network of 3 000 km of high-pressure petroleum and gas pipelines.

Petronet continues its annual increase in profitability. Unfortunately, because of its need to cross-subsidise other divisions, it has been less able to play a role in the future development of new infrastructure.

Restructuring of the transport sector

The key bottleneck to Transnet restructuring is the pension fund debt, but Government believes that it has a resolution to the debt problem.

SAA has been subject to a turnaround strategy which has reversed its lossmaking situation. Government has realised R1, 4 billion from the sale of 20 per cent of SAA to Swissair, SAA’s new strategic equity partner.

Within Spoornet, the current practice of cross-subsidisation – where losses generated by general freight business (GFB) amounted to R1, 7 billion in the 1999/2000 financial year are offset by the profits generated by Coallink and Orex – places the entire rail system in jeopardy. The restructuring of Spoornet focuses on maximising value for the existing shareholder, securing investment in the underlying business and introducing new management skills. In order to realise these objectives, however, it is necessary to transform Spoornet and, in particular, GFB, prior to restructuring. Initially Spoornet’s various divisions will be corporatised (or, in some cases, shadow corporatised). GFB and the Rail and Terminal Services (R&TS) will be corporatised as one entity. The medium-term intention is to bring a strategic equity partner into GFB and R&TS. There is a possible option of releasing further value in the future through an IPO. LinkRail, the structure that Spoornet proposes to use to operate surplus branch lines of the Spoornet core network, should be concessioned in separate packages, comprising rolling stock and infrastructure. Long-term concessions should be entered into for Coallink, Orex, MLPS and LuxRail.

Currently, a policy process is under way for the restructuring of the ports sector.

The intention is to separate the port authority functions from those of port operations; the latter will then be privatised.

ACSA is partially privatised, with Aeroporti di Roma being its strategic equity partner. An IPO for ACSA is being planned.

Actions by Government

• Transnet debt restructuring is being dealt with. Significant progress in dealing with the pension fund debt has already been made.
• Spoornet will be corporatised, with its different business units becoming separate corporate entities.
• Coallink, Orex, LuxRail and LinkRail will be concessioned.
• Spoornet’s general freight business will be commercialised and then, either an initial public offering (IPO) or a strategic equity partnership (SEP) will be entered into.
• A new ports policy and a ports regulatory framework are being drafted. Portnet will be corporatised to form a port authority entity and a port operations entity. The port operations will then be privatised.
• Subject to shareholder approval, the processing of an IPO for SAA will commence.
• Petronet will be corporatised. There will be an assessment of the synergies with other pipeline projects, and restructuring options will be developed.
• Deadlines for the disposal of non-core units within Transnet will be ongoing.
• The airports regulatory framework is being revised and once this is completed, subject to shareholder approval, an IPO will be processed for ACSA.

Likely impacts of restructuring Transnet

The above restructuring plan is likely to have the following impacts:

• The restructuring of Transnet’s debt will enable the enterprise to operate on commercial principles. It will enable the various divisions to operate as independent business units without cross-subsidising each other’s contributions towards the debt. Transnet and its various business units will be able to make market decisions.
• The concessioning of Coallink, Orex, LuxRail and LinkRail will mobilise private sector capital and expertise (both locally and internationally).
• The commercialisation of Spoornet’s GFB will ensure that it operates on market principles. This should enable it to offer more efficient and effective services. Should it be decided that GFB must offer certain social services, then these will be subsidised in transparent manner rather than through cross-subsidisation. A future IPO or SEP will attract private sector capital.
• Because of the high levels of overemployment in Spoornet, the current transformation process and the envisaged restructuring will result in job losses. Where possible, alternative job opportunities are being investigated.
• The restructuring of the ports is likely to improve their service levels, as well as ensuring that South Africa has ports that are able to meet the needs of a growing economy.
• The separation of the ports into a port authority and port operations will separate the landlord function from the operation of the ports.
• The privatisation of port operations should improve the level of service and the competitiveness of the ports. Private operators of different port services will be better able to focus on the needs of the customers and offer them a more efficient and effective service.
• The restructuring of SAA has already shown benefits in terms of the airline’s efficiency. An IPO for SAA will bring more private sector and international investment into the country.
• The incorporation of Petronet will ensure that it offers a cost-effective service.
• The disposal of non-core units within Transnet will ensure that it focuses on its core business and improves its effectiveness.

The telecommunications sector

International trends

The telecommunications sector is among the fastest growing sectors in the global economy. It is a key platform for the development of all other socio-economic sectors.

Since the late 1980s, there have been trends towards the restructuring of nationalised telecommunications services. New technology has meant that telecommunications is no longer a natural monopoly, and the international trend is towards private sector development in the telecommunications sector and privatisation of state-owned monopoly providers. There is a trend toward vigorous competition, which has lowered prices and improved services.

Independent regulatory institutions have been set up.

International markets have been increasingly willing to provide large amounts of capital for privatised telecommunications companies in countries with sound regulatory frameworks. The growth of mobile services is having a major effect on opening up the telecommunications sector to competition and bringing about rapid structural change. There is an international push towards liberalisation of the telecommunications industry. South Africa is a signatory to the World Trade Organisation, which requires it to liberalise trade in telecommunications.

Technology is also driving the need to liberalise. Satellite operators permit direct access by users, which means that large users can bypass domestic telecommunications networks. Voice telephony via the Internet is also possible.

The South African legal and regulatory framework

In 1991, the South African government separated the activities of the Department of Posts and Telecommunications into the South African Post Office and Telkom.

Telkom duly became a legal entity incorporated under the South African Companies Act. In 1994, the granting of two cellular telephone licences heralded the liberalisation of the South African telecommunications sector. Telkom’s land lines were now subject to competition from mobile telephones, although it retained exclusivity for the provision of fixed-line services.

Consistent with international developments, the 1996 White Paper on Telecommunications Policy and the Telecommunications Act (Act No. 103 of1996)⁽⁹⁾ established a framework for separating the regulatory, operational and policy-making functions of telecommunications. A regulator, the Independent Communications Authority of South African (ICASA), was established to regulate telecommunications and broadcasting in the public interest. In addition, a universal service agency was set up to promote universal service within the broad framework of development planning. The Department of Communications is responsible for advising the Minister on policy matters, including the nature of competition. ICASA has day-to-day responsibility as the regulatory watchdog and is responsible for issuing licences, monitoring compliance and rectifying noncompliance. Customer premises equipment was completely deregulated in terms of the Act, subject only to type approval by the regulator to ensure that no danger is posed to the network. The White Paper also advocates complementarity in the use of the facilities of Telkom and the parastatals, Transtel and Eskom.

Background to Telkom

The South African fixed-line telecommunications industry has grown from over

3,8 million lines in 1995 to over 5,5 million lines currently. This rapid growth can be at least partially ascribed to the aggressive roll-out targets set out for Telkom when an SEP was introduced in 1997. Telkom’s revenue has more than doubled over the last five years from R11 billion to R22, 6 billion.⁽¹⁰⁾ On the technological front, cellular phones, the Internet and e-commerce have significantly contributed to growth. The growth in the cellular market has been remarkable, with over 4,65 million cellular customers signing up since the technology was introduced in 1994.

Telecommunications revenue in South Africa (both fixed-line and cellular) grew from R8, 4 billion in 1994 to R30, 4 billion at the end of March 1999. This gives a compound annual growth rate (CAGR) of 30 per cent over the last five years.

Over the same period, the CAGR for the fixed line sector was 18 per cent and that of the cellular sector 187 per cent. As a proportion of GDP, the telecommunications sector contributed about 4 per cent in 1999. South Africa’s wireline penetration (or teledensity) grew from 9 per cent in 1994 to 11 per cent at the end of March 1999. If Telkom keeps to its agreed roll-out of an additional

2,8 million lines and 120 000 payphones over five years, the teledensity should be approximately 16 per cent by 2003. Although South Africa has one of the highest teledensities in Africa, it lags behind most developed and developing nations. There are predictions that its teledensity will peak at 20 per cent by 2009.

Telkom consists of a traditional fixed-line operation. In addition, it owns a 50 per cent share in Vodacom, the larger of the two cellular telecommunications currently licensed to operate in South Africa. (A third mobile operator is soon to be licensed.) It also has a strong Internet presence in the form of Intekom, the third largest internet service provider in South Africa. Government, which owns 67 per cent of Telkom, has approved Telkom’s listing on the stock exchange in 2001. Seven per cent of Telkom has been earmarked for empowerment groups and employees, and the sale of this share is currently under way.

A decision was taken in 1995 to introduce a strategic equity partner (SEP) into Telkom. A competitive tender process was held but only one final offer was received. In 1997, a 30 per cent stake in Telkom was sold to SBC (18 per cent) and Telkom Malaysia (12 per cent). The interests of SBC and Telkom Malaysia are held via an investment holding company, Thintana Communications LLC.

SBC is the premier local access operator in the United States and Telkom Malaysia is one of the largest Asian telecommunications operators. Three per cent of Telkom was sold to black empowerment groups.

At the time, Telkom was granted exclusivity for the provision of local and long distance telecommunications services, exchanges, international services and public payphone services for five years. Telkom is licensed to operate the public switched telephone network (PSTN) and the public switched data network (PSDN) for the period of exclusivity. Telkom does not have exclusivity for the value added network sector (VANS), which has been opened up to full competition. Telkom agreed to meet stringent licence targets. These include the installation of 2,7 million new telephone lines, the digitalisation of 1,25 million analogue lines and the installation of 120 000 new payphones, as well as customer service targets. According to the licence, Telkom can obtain an additional year of exclusivity if it achieves 90 per cent of the targets set by the end of the fifth year. There are also penalties if the targets are not met.

Telkom has a 50 per cent share in Vodacom, the leading cellular operator in South Africa. It is estimated that Vodacom has an active subscriber base of 2,65 million and 120 000 Internet subscribers, which makes it the second largest Internet service provider in the country. Vodacom is an unlisted company. In addition to its 50 per cent ownership by Telkom, its other shareholders are the Vodafone AirTouch group (31,5 per cent), with the remainder of the shares being owned by the Rembrandt group (13,5 per cent) and Descarte Investment (5 per cent).⁽¹¹⁾ Vodacom currently has approximately 57 per cent of the 4,65 million cellular subscriber market, while MTN has 43 per cent. A third operator is due to enter the market shortly. Vodacom’s subscriber mix is currently 55 per cent prepaid and 40 per cent contract.

In terms of international standards, Telkom productivity per employee is relatively low. Lines per employee have improved from 74 in 1997 to 83 in 1999. This is, however, considerably below the ratio of most operators in the OECD area and Asia, which tends to be in excess of 120 access lines per employee. Telkom’s capex/sales ratio is 47 per cent. This is at the top end of its peer group, but in line with most emerging market operators that are undergoing expansion and modernisation. This ratio is expected to decline in the long run.

Restructuring of Telkom

In August 1999, the IMCC granted the Minister of Telecommunications approval to engage the Telkom minority shareholder, Thintana Communications, in discussions with a view to conducting the necessary preparatory work and processes for arranging an initial public offering (IPO) for Telkom.

Telkom’s exclusivity agreement ends in May 2002. A second network operator will then be introduced. Investors in the planned IPO will need evidence that Telkom can compete once its monopoly has ended. As the market is liberalised, competitors will naturally target the most profitable segments of the market, namely business customers, international services and national long distance callers. The local network requires very large capital expenditure and is only marginally profitable, so competitors are unlikely. Government is currently looking at consolidating the telecommunications capability of the state housed in Eskom and Transtel, with the possibility that these could form a portion of the second network operator.

Future actions by Government

• Work on the proposed IPO for Telkom is in progress.
• Work on a policy and a process for determining the second national operator is already quite advanced.
• Given the possibility of other SOEs becoming involved in the SNO, the Department of Public Enterprises will ensure that a full investigation is undertaken into the costs and benefits, and that appropriate synergies are achieved.

Likely impacts of restructuring Telkom

If the above restructuring plan is followed, the likely impacts are as follows:

• With 30 per cent of Telkom having been sold in 1997, some of the effects of restructuring are already in place.
• The proposed IPO for Telkom will result in a significant sum of private sector capital being mobilised.
• The introduction of a second network operator will increase competitiveness in the telecommunications sector, which should result in increased efficiency and effectiveness.
• An SNO will ensure that customers receive a higher level of service, as they will have a choice of fixed-line service providers.

The defence industry

International trends

With the end of the Cold War, there has been a reduced need for large-scale military operations. In addition, since the early 1990s there has been a decrease in international requirements for armaments, resulting in enormous overcapacity in the global defence and ordnance industries. Globally, defence expenditure has shrunk and the increase in the competition between defence suppliers has eroded the profitability of the industry. Customers often demand total systems capability from suppliers. Developing major weapons systems involves high costs owing to growing technological sophistication. Global aerospace and defence annual sales were US$240 billion in 1999. The ordnance and land systems market is worth approximately 6 per cent of these sales ($15 billion, excluding spares). Of this, approximately $2 billion is spent on light ordnance, $2 billion on heavy ordnance, $4 billion on ammunition and $7 billion on vehicle platforms.

Different threats to security are emerging, including terrorism, the spreading of weapons and failed nation states. Changes in the types of equipment are required. Equipment must preferably be self-contained and portable, interoperable and serviceable at a distance. While defence spending is stagnant, equipment spending is growing.⁽¹²⁾

The ordnance and land systems market remains globally fragmented, having one or more key producers in each of the major aerospace and defence nations. The top five producers are significantly larger than the others. There has, however, been considerable consolidation and reorganisation in the aerospace industry.

Despite the lack of consolidation in the ordnance and land systems, a significant number of product-level alliances reflect the capabilities of each producer. There are, however, several drivers in the industry that are likely to trigger international consolidation in the near term, for example:

• Structural changes in the industry, including converging national requirements for future systems and increasing development costs for next-generation systems
• Lack of internal or export demand

There has been an increase in joint development programmes between countries and companies to share costs. Mergers and acquisitions have increased the average size of companies while decreasing their numbers. Many defence companies have either downsized or closed down. A few large defence companies in the United States and Europe now dominate the industry. Owing to the requirement for long-term support over the full life cycle of systems (which can be 30 years), smaller players find it increasingly difficult to convince customers of their capability. Smaller players are therefore expected to join forces with major international players. They will either have to form part of larger conglomerates and/or fall back to subsystem-level supply positions in niche areas.

The South African regulatory framework

In 1999 Government published the White Paper on South African Defence Related Industries.⁽¹³⁾ The White Paper uses the term “defence industries”, since there is a growing tendency for companies producing defence equipment to make use of civilian technologies or to manufacture dual-use products that can be sold to both defence and non-defence markets. There is also increasing overlap between defence and civilian production within companies. The industrial capability of the South African defence is not a distinct sector of the economy.

The White Paper notes that:

…Government recognises that defence-related industries are an integral part of South Africa’s defence capability. Government also recognises the strategic value of having a local defence industrial capability. However, due to budgetary constraints, and within the framework of broader national industrial strategy, Government will be very selective of which technologies and capabilities are to be retained on the basis that they are strategic or that they constitute a national asset.

Government also has a duty to exercise control over any product, service or technology can be termed an armament.

The White Paper notes that the various broad government goals should be considered when restructuring defence industries. Government needs to articulate a clear vision for the future of defence-related industries, in particular the extent to which it is prepared and willing to support these industries. In order to achieve economies of scale, obtain new technologies and gain entry to international markets, Government will encourage rationalisation in the public and private sectors of the local industry, coupling this to joint ventures with overseas partners and new local empowerment equity partners. Industrial participation obligations of foreign governments arising from major defence equipment replacement programmes offer an ideal opportunity for achieving the above.

The White Paper notes that a restructuring of the public sector defence-related industries, including complete or partial privatisation, will have a profound effect on the nature, composition, ownership, structure and profitability of the domestic defence market. Government will therefore have to consider how such restructuring will impact on private sector defence-related industries. Government should not, however, dictate the nature, pace or process of the restructuring of the latter industries which may occur as a result of the restructuring of the public sector industry.

Background to Denel

Denel is the major player in South Africa’s defence industry-related organisations, having about 50 per cent of the defence industry turnover. Denel dominates four of the seven major areas of the domestic defence market, namely aerospace, ammunition, weapon systems and military vehicles.

The decline in international defence expenditure and the international defence industry environment has caused major international mergers and acquisitions in the last few years. This has resulted in fierce competition for South Africa’s defence industry. Between 1989/90 and 1997/98, the South African defence spending decreased from 4,5 to 1,4 per cent of GDP, which translates to a decline of more than 50 per cent in real terms. With respect to Denel, orders from the SANDF decreased by 57 per cent in real terms between 1992/93 and 1998/99. Expenditure on defence research and development declined by more than 70 per cent during the same period. The decline in South African defence spending made Denel more reliant on the international market, in which it has operated reasonably successfully in the past ten years. It has, however, been detrimentally affected by the slump in the economies of the “Asian Tigers” in 1996/97 and by the effect of declining international oil prices on the economies of the Middle Eastern countries. In the last few months, due to recent defence contracts, there has been an upturn in business for Denel.

Denel comprises a holding company structured into three main groups: Aerospace, Ordnance, and Commercial and IT Business. In order to compensate for the decline in defence spending, Denel embarked on a major drive to increase exports of military products and services, and also initiated a major diversification and commercialisation drive. It had reasonable success with commercialisation in the areas of information technology, properties and electronic manufacturing.

Government believes that it is imperative for the restructuring of Denel’s military business to be part of the globalisation trend to ensure adequate capital injection, increased access to overseas markets, a broader product range and increased capacity utilisation within Denel’s manufacturing facilities.

The Denel Aerospace Group consists of Denel Aviation, Kentron, DPS (Pty) Ltd and OTB, the test range at Arniston. Denel Aviation consists of three business units: Military Aviation, Airmotive and Transport Aircraft Maintenance. It has been recommended that an international equity partner be sought for Denel’s aerospace business.

As South African aerospace industries are smaller than most other similar international industries, they are faced with questions about consolidation. There is not much to be gained from a local consolidation, however, as there are not many organisations with the same focus.

Restructuring of Denel

The White Paper on Defence-related Industries (Department of Defence (1999).) states that Government’s preferred restructuring option for Denel is to break it up and sell off less than 100 per cent of the shares in each cluster (e.g. aerospace, heavy ordnance, light ordnance) or divisions as separate entities. Those clusters or divisions that are easy to privatise, or those defence-dependent divisions that are attractive to local and foreign investors, will be restructured first.

Future actions by Government

• Denel will be corporatised and an initial strategic equity partnering at the business unit level of Denel Ordnance is expected.
• There may be a need for some consolidation of the local ordnance industry, followed by a search for international equity partners at the corporate level.
• An investigation into the consolidation of aircraft maintenance synergies between SAA and Denel is currently being undertaken.
• The Department of Trade and Industry is currently co-ordinating a study into the consolidation of the South African aerospace industry.
• The process of finding a strategic equity partners for Denel Aerospace is currently under way.

Likely impacts of restructuring Denel

If the above restructuring plan for Denel is implemented, the likely impacts would be as follows:

• The introduction of an international equity partner into Denel Ordnance will result in an increase in foreign direct investment in South Africa and also mobilise foreign expertise for Denel. This will improve Denel’s access to international markets.
• Consolidation of aircraft maintenance synergies between SAA and Denel should result in cost savings and should encourage the sharing of skills.
• The introduction of an international equity partner/s for Denel Aerospace will increase foreign direct investment in South Africa and bring new skills into Denel Aerospace. Partnering with other international players will provide access to new markets.
• The restructuring of Denel should improve its competitiveness in international markets.

Other restructuring initiatives

• Safcol: The sale of three packages is being concluded; the remainder will be consolidated and re-offered.
• Information technology consolidation: Options for the consolidation of the information technology capabilities of Datavia, Ariel Technology and Eskom are being assessed.
• Alexkor: A turnaround strategy is being effected with a strategic management partner.
• Aventura: A turnaround strategy is being effected with a strategic management partner; this will be followed by the sale of the entity.
• Post Office: A turnaround strategy is being effected with a strategic management partner.
• Sentech Signal Distribution: The Department of Communications is undertaking a study into a restructuring strategy for the entity.
• SOE property portfolio: The property portfolios of Denel, Eskom and Propnet are being studied with a view to identifying restructuring options.

Notes:

1. The table is slightly misleading since the Financial Mail includes Transnet and its subsidiaries as separate firms. For purposes of this discussion, only Transnet is included.

2. These observations are made without the benefit of an audit of SOEs, and may need to be modified once more accurate figures have been compiled. It is unlikely that the conclusions reached will change substantially.

3. Department of Minerals and Energy. 1998. White paper on energy policy of the Republic of South Africa. Pretoria: Government Printer.

4. Deutsche Bank. 2000. Where next for Eskom? An international perspective on the restructuring options. Johannesburg: Deutsche Bank.

5. Department of Minerals and Energy (1998).

6. Department of Public Enterprises. 1999. Presentation to the Interministerial Cabinet Committee Lekgotla on the Restructuring of State Assets. Pretoria.

7. Department of Transport. 1998. Moving South Africa – towards a transport strategy for 2020: report and strategic recommendations. Pretoria: Department of Transport.

8. All figures are from Transnet’s annual reports.

9. Department of Communications. 1996. White Paper on Telecommunications Policy. Pretoria:Government Printer.

10. Deutsche Bank Securities. 2000. Telkom and Vodacom - the big picture. Sandton: Deutsche Bank.

11. Ibid.

12. Berger, R & Partner GmbH, 2000. Republic of South Africa: issues in the aerospace and defence industry. London.

13. Department of Defence. 1999. White Paper on South African defence-related industries. Pretoria: Government Printer.