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MTNL: Call waiting!
May 9, 2006

Performance summary
PSU telecom service provider, MTNL, had recently reported yet another quarter and full year of poor performance. During FY06, while revenues have declined by 6% YoY, net profits have witnessed tremendous pressure, mainly on the back of a contraction in operating margins and an extraordinary payment made to BSNL. But for strong growth in the GSM mobile business, this fiscal’s performance has left much to be desired from the company. The company has underperformed our topline and bottomline estimates by 6% and 37% respectively. If one were to exclude the extraordinary payment, the bottomline is higher by 6% than our FY06 estimate.

Financial performance: A snapshot
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Sales 15,578 14,453 -7.2% 55,924 52,494 -6.1%
Expenditure 10,989 12,524 14.0% 42,446 43,822 3.2%
Operating profit (EBDITA) 4,589 1,929 -58.0% 13,478 8,672 -35.7%
Operating profit margin (%) 29.5% 13.3%   24.1% 16.5%  
Other income 998 1,492 49.5% 4,917 5,361 9.0%
Interest 88 29 -67.6% 358 250 -30.2%
Depreciation 1,543 1,655 7.3% 5,880 6,377 8.5%
Profit before tax 3,956 1,737 -56.1% 12,157 7,406 -39.1%
Tax 723 335 -53.7% 2,672 1,620 -39.4%
Profit after tax/(loss) 3,233 1,403 -56.6% 9,484 5,787 -39.0%
Net profit margin (%) 20.8% 9.7%   17.0% 11.0%  
No. of shares 630.0 630.0   630.0 630.0  
Diluted earnings per share* (Rs)       15.1 9.2  
P/E ratio (x)         23.6  
(* annualised)            

What is the company’s business?
MTNL is the government-owned (56% stake) basic telecom service provider in Mumbai and Delhi, with a subscriber base of around 6 m, including 3.9 m in the fixed line telephony segment and the remaining in the mobile segment. The company has a license to offer basic telephony services in both these metros up to the year 2013. MTNL accounts for around 9% of the all-India fixed line subscriber base. During the period between FY01 and FY06, MTNL's revenues and net profits have declined at compound rates of 2% and 18% respectively.

What has driven performance in FY06?
Not getting the ‘basics’ right: The 6% YoY decline in MTNL’s revenues during the fiscal has solely been a result of the pressure that the company is witnessing in its basis services business (89% of FY06 revenues). Revenues from this business have declined by around 12% YoY during FY06, mainly due to the increased move towards cellular telephony (on the back of lower costs of handsets and improving affordability). Incidentally, this very move towards cellular telephony has pared some of the pressure on the company’s performance, as its cellular business has raked in a superlative performance during the fiscal, with its revenues almost doubling during the period. During the fiscal, MTNL added a net of 1.1 m GSM subscribers in Delhi and Mumbai. Importantly, this has been much faster an addition than what has been recorded by its close rivals in these two circles – Bharti Airtel and Hutch (see left-side chart below).

The fourth quarter also saw the company improving its ARPUs in these circles by 7.3% YoY. However, relative to Bharti, MTNL’s blended ARPUs (inclusive of both prepaid and postpaid connections) continue to be significantly lower (see right-side chart above).

MTNL is rapidly ramping up its GSM capacity to cater to the higher demand for cellular services. During FY06, the company added a GSM capacity of 0.5 m subscribers, from 1.3 m in March 2005 to 1.8 m in March 2006. Even the WLL and broadband capacities are being ramped up aggressively.

Segment-wise performance
  4QFY05 4QFY06 Change FY05 FY06 Change
Basic Services
Revenue 14,679 12,887 -12.2% 53,050 46,884 -11.6%
% of total revenues 94.2% 89.2%   94.9% 89.3%  
PBIT margin 16.7% -8.0%   17.9% 3.2%  
Cellular Services
Revenue 899 1,566 74.1% 2,874 5,610 95.2%
% of total revenues 5.8% 10.8%   5.1% 10.7%  
PBIT margin 42.2% 33.5%   40.8% 30.6%  

Higher revenue-sharing costs dent margins: Apart from the decline witnessed in the topline, higher staff and revenue-sharing costs have dented MTNL’s operating margins during the fiscal. Around 33% of the revenue-sharing costs of Rs 12.3 bn during FY06 were on account of an additional amount payable to BSNL for the period from October 2000 to March 2005, for which the company had not made any provisions in the past.

Based on segments, while PBIT margins of basic services crashed from 17.9% in FY05 to 3.2% in FY06, those for the cellular business have contracted from 40.8% to 30.6%. Capacity expansion and declining ARPUs have played their part in suppressing margins for the cellular segment. Notably, on a peer basis, MTNL’s cellular PBIT margins are around 7% better that those earned by Bharti Airtel during FY06.

It boils down to the bottomline: Despite a decline in interest and tax expenses, MTNL’s bottomline witnessed tremendous pressure during FY06, declining by 39% YoY. This was on the back of lower revenues and a contraction in operating margins.

What to expect?
At the current price of Rs 217, MTNL’s stock is trading at a price-to-earnings multiple of 23.6 times its FY06 earnings. The company’s FY06 performance has been below our estimates and as such, we shall be taking a re-look at our numbers. Despite a string of poor performances from the company, the stock has witnessed tremendous buoyancy in the past couple of months on expectations of a merger with BSNL.

While MTNL continues to perform strongly in the cellular business, competition is catching up fast and sustainability of the growth in subscriber base is highly uncertain, especially with respect to the company’s restricted presence. As such, on an overall basis, we believe that there are better long-term opportunities for investors in the telecom pack.

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