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VSNL’s Teleglobe acquisition: Our view - Views on News from Equitymaster
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VSNL’s Teleglobe acquisition: Our view
Jul 26, 2005

As reported on the BSE website, international long-distance major, VSNL, is acquiring Teleglobe, a provider of voice data, IP and mobile signaling services. As consideration towards acquisition, VSNL will pay the latter’s shareholders a sum of US$ 239 m, which includes assumption of debt and payment of US$ 4.5 per share to Teleglobe’s shareholders.

About Teleglobe
Teleglobe is a leading provider of international voice, data, Internet and mobile roaming services and owns and operates one of the world’s most extensive telecommunication networks. The company connects over 240 countries and provides services to around 1,400 wholesale customers representing the leading global telecom companies like Bell Canada, Telecom Italia and British Telecom. Teleglobe also operates one of the world’s largest VoIP networks, maintains interconnectivity with more than 90% of the worldwide GSM subscriber base and has more than 380 mobile operator customers globally. At the end of 2004, the company had revenues of US$ 1,002 m (1.3 times VSNL’s turnover in FY05) and a net loss of over US$ 21 m (12% of net profit of VSNL). Teleglobe operates at margins of merely 2.3%. It carries over 13 bn minutes of voice traffic globally.

About VSNL
VSNL is India’s largest international long-distance (ILD) services provider. In February 2002, the Government of India divested 26% of VSNL's equity to the Tata Group that now has the management control. Once a monopoly in ILD and a pioneer of Internet services in the country, VSNL provides international telecommunication services, linking the domestic telecommunications network to approximately 237 countries worldwide. The company operates a network of earth stations, switches, submarine cable systems and value added service nodes to provide international telephony, telex and telegraph and Internet services. The company has also started its DLD (domestic long distance) and broadband services in the country. At the end of FY05, VSNL had revenues of US$ 759 m and net profits of US$ 174 m. The company reported operating margins of over 23%.

About the deal
Teleglobe: Coming expensive!
(US$ m) Teleglobe MCI
a. Market cap 164 8,281
b. Debt 104 6,609
c. Cash 29 5,504
EV (a+b-c) 239 9,386
EBIDTA 24 2,245
EV/EBIDTA 10.0 4.2
As indicated above, VSNL will pay a consideration of US$ 239 m to acquire Teleglobe. This payment includes US$ 4.5 per share to be paid to the latter’s shareholders and assumption of around US$ 75 m of net debt (debt minus cash). Thus, VSNL’s payment of US$ 239 m implies an EV/EBIDTA multiple of 10.0 times. Notably, one of the foremost competitors of Teleglobe, MCI Inc. is currently trading at an EV/EBIDTA level of 4.2 times, implying that the VSNL has paid a high cost for acquiring Teleglobe. MCI Inc has relatively higher operating margin of 10.8% as compared to 2.4% for Teleglobe. In this context, even as the net debt level in MCI is significantly higher (US$ 1.1 bn), the fact that MCI is more profitable has to be taken into consideration.

Through this acquisition of Teleglobe, VSNL will have ownership interests in more than 80 sub-sea and terrestrial cables. The company would also access more than 200 direct and bilateral agreements with leading voice carriers.

What to expect?
The management of VSNL has indicated that the company is vying to become a leading global player in wholesale voice, bandwidth and enterprise data services. The application of this growth strategy was evident when the company acquired Tyco Global Network, an undersea cable network that spans a length of 60,000 kms and connects the North American, European and Asian continents. After the government opened up the ILD segment for private sector participation in 2002 and prematurely terminated the monopoly stand of the company, VSNL has faced immense competitive pressure. The acquisition of TGN and now Teleglobe will, thus, bring some respite to the company. The respite, in our view, is from higher contribution from non-ILD services, which have been predominantly voice-based till now.

At the current price of Rs 390, VSNL’s stock is trading at a price to earnings multiple of 26.5 times FY05 earnings, which is at the higher end of the valuation spectrum. With global bandwidth prices under tremendous pressure on account of increased competition and supply combined with the recent TRAI order of a 70% reduction in bandwidth prices, the strategy of VSNL to play the volume game might stand it in good stead in the future. The acquisition of Teleglobe will more than double VSNL’s revenues and the company has indicated that it will take around 5 years to recover the acquisition costs. In our view, the trick lies in increasing the share of value-add segment contribution to revenues in an otherwise commoditised sector. VSNL seem to be taking steps in this direction. But the benefits of such efforts are unlikely to make a meaningful contribution in the next two years.

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