Two more years of interconnect pain

Lower interconnect rates will continue to hurt SA's telecoms sector for at least another two years until the end of the glide path is reached, wiping billions off their revenue lines.

However, consumers won't immediately benefit from the lower rates as telcos face two more years of pain until March 2013 and aren't anticipated to be able to claw back the lost revenue.

Last March, cellphone operators voluntarily cut the peak interconnect rate from R1.25 to 89c per minute. Then the Independent Communications Authority of SA stepped in to regulate termination rates, setting a path that will see rates settle at 40c per minute by March 2013.

Peak mobile termination rates dropped to 73c, while off-peak dropped to 63c this March. Next year, rates will drop to 56c per minute and then to 52c. Fixed-line rates will also drop, and will settle at 12c for peak and off-peak for local calls, while the rate for national calls will settle at 19c in March 2013.

Vodacom, SA's largest mobile operator, lost R1.5 billion in revenue in the year to March, which resulted in a net interconnect loss of R500 million, says CFO Rob Shuter.

Next year, the company expects a similar hit to its top line, which will result in services revenue growth stagnating in low single digits, says CEO Pieter Uys. “We're talking big numbers.”

It will be another two years before the impact of lower interconnect rates ends, and revenue will grow in low single digits at most, says Uys. For the year to March, Vodacom's cost-efficiency programme trimmed R500 million off its expense line, which offset the net interconnect loss, he notes.

Uys says termination payments in the mobile sector more or less balance out, but the real effect is in lower income from fixed-to-mobile calls, as Telkom is paying out less in interconnect, and subscribers are increasingly using mobile phones to call cellular subscribers, and not landlines.

Shuter says rates have come down aggressively and the volume of calls from fixed-to-mobile numbers is also dropping. Shuter previously said the revenue drop is expected to be between R800 million and R900 million a year, until the final rate of 40c a minute is in place in 2013.

However, the increasing use of data is helping to combat lower termination rates, adds Shuter. During the year, data revenue grew 35.5%, to R6.4 billion, and is expected to continue being a growth driver.

MTN, SA's second largest mobile operator, has also lost revenue due to lower rates. In its full year results to December, it said lower mobile termination rates cost R2.5 billion in revenue, but also lowered outgoing expenses and aided margin growth as more traffic moved on-net.

Group interconnect dropped from R19.5 billion a year ago to R17 billion, but the margin improved as MTN also paid out less. In 2009, the group paid out R14.1 billion, which slowed to R11.5 billion at the end of last year. MTN is affected by regulated termination rates in SA and Nigeria.

Telkom saw R640 million, out of total voice revenue of R6.9 billion, wiped off its revenue line in the six months to September.

Interconnect revenue dropped 37.4%, to R912 million, in the half-year, as subscribers moved away from using landlines to call mobile and international numbers. The fixed-line operator says interconnection revenue will be negatively affected by fixed termination cuts.

Although cellular operators are not passing the lower termination rates directly through to end-users, voice and data charges are coming down. Vodacom's average price per minute is down 11.5% and the average price per Mb is 13.5% lower compared with last year.

Irnest Kaplan, MD of Kaplan Equity Analysts, says there isn't a direct correlation between lower termination rates and the retail cost. Kaplan says retail rates are likely to come down over time instead of dropping dramatically.

Cellular operators will only cut prices aggressively if they want to gain market share, and the local sector is mature, says Kaplan. According to Vodacom, SA's mobile penetration is estimated at 107%.

Kaplan says cellular companies aren't dropping rates, but are instead offering promotional deals, which will trim the average per-minute cost. A massive price drop would put pressure on cellular companies' top lines and affect their ability to operate and invest in networks, he says.

Although the cellular operators are profitable, it's not easy to maintain that level of net growth when the market isn't growing, says Kaplan. “At the end of the day, the networks cost money to run.”

Kaplan says the rates MTN and Vodacom pay each other generally cancel out, but the big effect is in lower revenue from Telkom. Companies will try and claw the loss back through pushing data, but they won't be able to totally offset the lower revenue, he adds.