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VSNL: Time to deliver! - Views on News from Equitymaster
 
 
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  • Aug 17, 2002

    VSNL: Time to deliver!

    Videsh Sanchar Nigam Limited (VSNL) is in the process of re-inventing itself. Deregulation has actually forced the company to rethink its business plan. Apart from what the company is aiming to become, we discuss in detail the possible fallout of the proposed investment by VSNL in Tata Teleservices (TTL) and whether the investment would provide a competitive advantage in the long run. We also take a closer look at the synergies that the Tata Group offers for VSNL and vice versa.

    Consider the key issues first. VSNL derives 90% of its revenues from international long distance telephony (ILD) segment where it has been the monopoly player till March 2002. But there has been a significant change in the ILD regime over the last year. The telecom regulatory authority opened up the segment for private participation in April 2002, after which a number of players including Bharti have received license. Bharti, in fact, launched its ILD service last month.

    VSNL is facing pressure on the revenue side. Without getting into the complexities, the underlying fact is that revenue per minute, which VSNL was receiving for every international call hitherto, has already plummeted by more than 50% in FY03 (a one-minute call to US is now charged at Rs 24 as compared to around Rs 45 per minute previously). Besides, the portion of the ISD charges, i.e. Rs 24 per minute to US, that the company retains is falling at a faster clip. The effect of the decline is already visible in 1QFY03 performance of the company. While revenues have declined by 10%, net profits are lower by 29%.

    Historical ILD division performance…
    (% growth) FY98 FY99 FY00 FY01 FY02
    Paid-minutes (m) 21.7% 14.9% 15.7% 19.7% 15.8%
    ILD revenues (Rs m) 16.6% 8.6% 0.6% 3.1% -11.0%
    (Rs/min) -4.2% -5.4% -13.1% -13.9% -23.2%

    Apart from ILD, the company is one of the market leaders in the Internet segment with a subscriber base of more than 620,000 as of June 2002. However, this business faces competition from basic service providers who are providing free Internet service in a limited way in select cities. Since VSNL does not have the last mile connectivity (basic telephone connection), it is at a disadvantage.

    Another big controversy that had an effect on the stock price is the proposed investment of upto Rs 12 bn for 20%-26% stake in Tata Teleservices (the basic service provider in Andhra Pradesh). VSNL would benefit a large way from this investment, as it would have access to TTL’s growing subscriber base. But the government has expressed its reservations on this front. It has appointed a committee to review VSNL’s investment decision, which is expected to submit its study soon. But it remains to be seen whether a 26% stake in TTL ensures a captive ILD/DLD traffic for VSNL in the future.

    Though one might argue that the drastic fall in ILD tariffs over the last two years have lowered the competitive advantage of the black market, Internet telephony is still a big threat. At the end of the day, Indian consumers are cost conscious and it does not matter even if VSNL provides a quality service at a premium price.

    Off late, the company’s relationship with WorldCom has also come to the fore. As of June 2002, the company had dues receivable from WorldCom to the tune of Rs 4.5 bn that raised serious concerns amongst investors. But the company, usually, receives payment from international carriers after a lag of atleast three months given its complexities. Already, VSNL has received Rs 3 bn and is hopeful of receiving the same in the coming months.

    After having reviewed the challenges staring at the company, consider some of the positives. VSNL has a huge upper hand in domestic long distance telephony front as compared to the likes of Bharti simply because it got the license free of cost. VSNL also does not have the requirement to share its revenues with the government for the first five years.

    The total DLD traffic is estimated to be around 27 bn minutes with a market size of Rs 124 bn (2000 data). Even if VSNL manages to garner 10% market share over the next five years (including TTL and Hughes Tele clients), it would translate into revenues of Rs 12 bn (19% of FY02 revenues). In fact, in the last year’s analyst meet, the company’s management had indicated that it may break-even in the first year of operation if it manages to increase traffic.

    This brings us to next major positive for VSNL, which is infrastructure that is both costly and time consuming. This is where the company’s synergies with the Tata Group gain significance. Both Tata Power and TTL have set up optic fibre cable facilities in select regions of the country. VSNL is also planning to lay such networks in Western India. Therefore, the company can leverage Tata Group’s basic infrastructure.

    Also going forward, one can expect Tata’s ISP division, Tata Nova, with an estimated base of more than 100,000 subscribers, merging with VSNL. There are already reports suggesting merger of Tata Power’s backbone infrastructure with VSNL. As we go forward, integrated telecom players will have a clear superiority over others. On this front, VSNL-cum-Tata’s are well poised.

    VSNL has also made investments in bandwidth in international markets, which include SEA-ME-WE and Flag that provides the company a long-term competitive advantage. VSNL has eight gateways for bandwidth in India unlike Bharti that has one in Chennai. It has already initiated the process of switching from conventional circuit based systems to ATMs (Assynchronised Transfer Mechanism), which would take care of all future traffic requirements.

    On the core business front, the fall in revenues in 1QFY03 was lower than expectations because paid-minute calls increased by 24%. This means that the number of calls have increased after the rate reduction, which is a big positive for the company. We expect paid-minute to grow at a compounded rate of 25% in the next three years. The company also has the advantage of continued relationship with many international telecom operators, which is difficult to replicate within a short span of time.

    The government has promised all ILD calls of MTNL and BSNL to be routed through VSNL in the next two years. This would also provide enough breathing space for VSNL to prepare itself for the onslaught from competition. Currently VSNL pays Rs 230,000 per circuit as license fee to the government. With transfer to a revenue share regime, the company is required to pay 15% of its gross adjusted revenues as license fee. This will also benefit VSNL.

    In the long run therefore, the key lies in diversifying its revenue stream in order to sustain profitability and keep growth ticking. Also the company has to generate enough DLD traffic so as to diversify revenues at a faster rate in the initial years. Coming to the integration, the Tata’s have their own internal issues like cross-holdings that need to be addressed with utmost priority, as the group’s integrity in operations has come under cloud. So this could slower things in the future.

    Keeping all these factors in mind, it is an uphill task ahead and as a result increases the risk profile of the company significantly. It remains to be seen whether VSNL regains its past glory under the new management.

     

     

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