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VSNL: Valuation conundrum

Jun 11, 2002

VSNL’s plan to invest Rs 12 bn for a 26% stake in Tata Teleservices, the basic service provider in select Southern states, has sparked many discussions. The main point of concern is the valuation of Tata Teleservices. We have done a comparative study of valuations of listed basic service providers like MTNL, Hughes Tele and Bharti. But before that we analyse the need for VSNL’s diversification first. There is a mixed reaction from the investing community as to whether Tata’s are justified in their stand. In a opinion poll conducted on Equitymaster, of the 800 odd who participated, 57% opined that government should interfere with VSNL’s decision of investing Rs 12 bn in Tata Teleservices. But at the same time, one has also got to keep in mind the growth prospects of VSNL.

The company derives close to 90% of revenues from providing international long distance (ILD) telephony and has been a monopoly until March 2002. After de-regulation, most of the basic telephony service providers have evinced interest in entering ILD businesses including the likes of MTNL. VSNL’s competitive advantage, frankly speaking, at this stage is just infrastructure facilities across India. However, a new player entering this segment can easily replicate it in a span of less than a year.

Given this backdrop, what is the competitive edge of VSNL? Can it remain a pure ILD service provider forever? While some companies in the US markets have been successful being a pure ILD in the past, it was purely a volume play. Given the fact that elasticity of demand has been on the lower side, not commensurate to the fall in tariffs in India, profitability could be hit adversely. VSNL in FY02 posted an 11% fall in revenues and profits respectively. Moreover, telecommunication technology itself has witnessed sea change over the last few years. Internet telephony poses a great threat to ILD service providers. Therefore, it makes greater sense for VSNL to have last mile connectivity. Instead of starting from scratch, investing in Tata’s, which is estimated to have subscriber base of around 150,000 is an added advantage.

The next question is whether Rs 12 bn for a 26% stake in Tata Tele is high or not? For arriving at a conclusion, we did a comparative study. MTNL’s market capitalisation per subscriber currently stands at Rs 20,219 whereas Hughes Tele, which competes with the PSU major in the same circle has market capitalisation per subscriber of Rs 57,477. Hughes Tele gets a higher valuation because of its focus on higher usage segment that comprises of corporates. Bharti is at a premium because it has presence in both basic and cellular segment.

Comparative table…
Company MTNL Hughes Bharti Tata Tele*
Market Cap (Rs m) 86,940 9,484 64,855 17,243
No. of basic subscribers (nos) 4,300,000 165,000 164,000 300,000
Market cap/sales (x) 1.4 3.8 4.3 NA
Market cap/subscriber (Rs) 20,219 57,477 395,457 57,477
Revenue/subscriber (Rs) 14,296 15,303 91,494 NA
26% stake based on Market Cap (Rs m)       4,483
*On estimated subscriber base 300,000

Tata Tele’s basic subscriber base is estimated at around 150,000. According to the Tata Group’s website, Tata Teleservices network will over the next two years, cover 15 Andhra towns and it will by then also have 300,000 telephone lines in place across the state. Assuming the similar market capitalisation per subscriber of Hughes Tele i.e. Rs 57,477 per subscriber, Tata’s market capitalisation works out to Rs 17.2 bn. Based on this, 25% stake in Tata Tele is estimated at Rs 4.5 bn.

Therefore, the stake is being offered at a huge premium at the current juncture even after factoring in the broadband plans of the Tata’s. After lot of deliberations, a revised agreement is believed to have been agreed upon, according to which, VSNL would invest in Tata Tele in line with Tata’s expansion plans. This makes much better sense, as future course of investment in Tata Tele by VSNL would be based on certain predetermined criteria, which Tata’s have to adhere to. This will also benefit VSNL’s shareholders.

All said and done, the bottomline is that VSNL has to diversify and investing in Tata Tele seems to gel well strategically in the long run. VSNL currently trades at Rs 166 implying a P/E multiple of 3.3x FY02 earnings.

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