It's been another year of records for SA's telecommunications industry - record sales, record profits, record dividends and record subscriber numbers. But, despite all the euphoria amid surging share prices, the industry is entering an altogether more difficult phase.

Competition is intensifying and developments in technology, coupled with a changing regulatory landscape, will force telecom operators to become more inventive as they strive to meet shareholder expectations for growth.

Given the size and importance of the sector, it's surprising that there are only three shares listed on the JSE: Telkom, MTN and Altech. Together these three are worth a staggering R175bn. That's more than 5% of the combined market capitalisation of all the companies listed on the JSE. Let's take a closer look at the two listed operators, Telkom and MTN, both of which continue to print cash.

First up, Telkom. The group has enjoyed enormous success since it listed in Johannesburg and New York in 2003. Yes, the company has taken full advantage of its privileged position in fixed-line communications - its monopoly is only now coming to an end - but the management team has also done an excellent job in reining in costs.

In its 2005 financial year, Telkom reported pretax profit of R9,9bn, up 56% on 2004, and declared a final dividend of R9/share. Its 2006 financial results, which it was due to report in early June after Top Companies went to press, were expected to reflect further significant revenue and earnings growth. Telkom said in May that it expected EPS to climb 35%-45% in financial 2006.

It might seem odd, then, to suggest that Telkom's future is anything other than bright. Yet there are storm clouds gathering on the horizon that will test the mettle of new CEO Papi Molotsane and his management team. A recent slide in the share price - at the time of writing it was about 25% off its record high of R171 - bears testimony to the fact that investors are concerned about the long-term outlook for the company.

There are a range of factors clouding the view:

• After years of delay, the second network operator has finally been licensed and should begin offering services to consumers in the first quarter of next year. It says it will be able to provide services to corporate SA and to wholesale companies, such as Internet service providers, even sooner. Though SNO Telecom, as the second operator is known for now, says it won't engage in a price war with Telkom, the mere presence of an alternative operator will have some effect on pricing.

• The mobile operators, especially MTN and Vodacom, are becoming increasingly aggressive in competing with Telkom's broadband offerings. Broadband is one of the pillars on which Telkom is building its future growth strategy. If it's not careful, it could lose market share in broadband to the cellphone companies, which are punting their enhanced 3G services, built on a technology called HSDPA, as being faster than Telkom's broadband digital subscriber lines. Then there's iBurst, a smaller wireless operator that has carved a niche for itself in the broadband space, and which is growing fast.

• Government is determined to bring down telecom prices. To this end, it had been expected, after Top Companies went to press, that communications minister Ivy Matsepe-Casaburri would announce a partial or full unbundling of Telkom's local loop, allowing SNO Telecom and possibly other companies access to the last mile of telecom cables that connect consumers to their nearest telephone exchange. This will allow SNO Telecom to serve these customers directly, bypassing Telkom.

• The East Africa Submarine System (Eassy), an undersea fibre-optic cable linking SA with similar systems in the Middle East, is expected to be launched late next year or early in 2008. This cable should dramatically reduce the high cost of international bandwidth, often blamed for keeping Internet access fees in SA high. Though Telkom is participating in Eassy - along with several other SA operators - the project is not good news for the company. It has profited handsomely from the rival Sat-3/Wasc/Safe system, the only high-speed cable system connecting SA with the world. When Eassy comes on stream, Telkom will probably be forced to cut the prices it charges for access to Sat-3 dramatically. Telkom is the only SA shareholder in Sat-3 and pumped US$85m into the project in the late 1990s.

• Government plans to become more involved in the telecom sector. As part of its accelerated economic growth plans, it has agreed, in principle, to supply the money that Sentech, the state-owned broadcasting and telecom company, needs to build a national wireless broadband network. This could be as much as R1,2bn, according to some estimates. If Sentech gets it right - and that's a very big "if" given its past performance in building a wireless network - it will pile further pressure on Telkom.

• Then there's Telkom's regulator, the Independent Communications Authority of SA, which is considering new regulations to govern Telkom's broadband service. The company's annual price adjustments are already subject to regulation.

• Even though there has been no suggestion of this, there's the possibility that government, in its determination to reduce telecom prices, will use its influence - it still holds a 38% stake in Telkom - to try to force down the company's prices.

Molotsane is keenly aware of these challenges. The company is ploughing billions of rand into next-generation network infrastructure and has plans to broaden its focus into new but complementary markets. In the consumer space, it wants to use its broadband lines to deliver new, value-added services, such as Internet television. It's deploying fibre into the suburbs to enable it to deliver the higher-speed lines it will need to do this.

In the business market, Telkom is trying to position itself as a converged solutions company. Its bid for IT group Business Connexion, which is still subject to approval by the competition authorities, is in line with this strategy.

The third pillar of its growth plans involves expansion elsewhere in Africa. The company is yet to make a move in this regard but has expressed interest in operators in important markets such as Kenya (Telkom Kenya) and Nigeria (Nitel). Molo-tsane says every opportunity will be carefully scrutinised. The company, he says, won't do a deal that is not in shareholders' best interests. Its approach, he says, will be conservative.

Telkom's management, though, must envy what cellphone group MTN has managed to achieve on the continent in a relatively short time. MTN has a big head-start on Telkom, and Telkom's 50% associate, Vodacom. The latter's Africa expansion programme has been fraught with difficulties.

With its recent US$5,5bn acquisition of Investcom, MTN, led by group CEO Phuthuma Nhleko, now operates networks in 21 countries in Africa and the Middle East. The combined group has about 30m subscribers. But some analysts are wondering whether the price MTN paid - about $1 100 per Investcom subscriber - was worth it. The share has fluctuated since the deal was announced, dipping at first, then surging before falling back sharply after the group disclosed the financial effects of the deal.

Analysts say MTN has a higher risk profile than Telkom - the latter only operates in SA and is much more conservative in its approach to acquisitions.

However, the potential returns that MTN shareholders could enjoy are also that much higher than the returns likely to be delivered by Telkom.

With the race for Africa far from over, more blockbuster deals are likely to be announced in the months ahead. Hold on tight. This ride is going to be wild.