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Tata Power–VSNL deal: Our view - Views on News from Equitymaster
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Tata Power–VSNL deal: Our view
Sep 6, 2005

Private sector power major, Tata Power, has entered into an agreement with the group company, VSNL whereby the latter will acquire the former’s wholly owned subsidiary, Tata Power Broadband Company Ltd (TPBC) for a consideration of Rs 2,390 m (US$ 55 m).

About TPBC

TPBC: Key figures (FY05)
Revenue (Rs m) 466
PBT margin 24.9%
PAT margin 23.0%
RoCE 13.4%

TPBC is a wholly owned subsidiary of Tata Power, and operates a 600-km fibre optic network spread across the Mumbai-Pune region. The company has positioned itself as a ‘carrier of carriers’, indicating that it delivers its services to other service providers, such as Internet service providers, cellular services providers, national and long-distance telephone operators, data centres, call centres, cable operators and video service providers. The company had revenues and net profits of Rs 466 m and Rs 107 m respectively at the end of FY05 and operated at net margins of around 23%.

About the deal
As per the agreement, Tata Power will receive a consideration of Rs 2,390 m from the sale of TPBC to VSNL. The book value of this investment is Rs 700 m for Tata Power, thus making the remaining Rs 1,690 m as profit on sale of investments. This amount will be reflected in the company’s FY06 profits and will add around Rs 8.5 to its EPS in the current fiscal. This, along with our expectation of Rs 22.2 per share as EPS in FY06, makes the stock (at the current price of Rs 460) valued at 14.9 times our estimated FY06 EPS, which is attractive. Excluding this extraordinary income, Tata Power’s stock current trades at a price to earnings multiple of 20.7 our estimated FY06 earnings.

TPBC: Expensive buy for VSNL!
(US$ m) Teleglobe TPBC
Revenue 1,002 11
PAT (21) 2
Consideration 239 55
P/S 0.2 5.1
P/E NA 22.3
It is interesting to note that VSNL has agreed to pay such a high premium for TPBC. At s 2,390 (US$ 55 m), VSNL will pay around 5.1 times TPBC’s FY05 sales to Tata Power. This is high, considering the 0.2 times sales that VSNL had paid for acquiring Teleglobe, a leading provider of voice data, IP and mobile signaling services globally (see table below). Also, on a price to earnings basis, the latest deal has been struck at a high level of 22.3 times FY05 earnings of TPBC.

What’s in it for VSNL?
What we understand from VSNL paying such a high price to acquire TPBC is that the company is moving on rapidly towards consolidating its position as a leading bandwidth provider globally. VSNL already ranks in the top three in the segment. The management had earlier cleared its intention of 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 first 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, then Teleglobe and now TPBC will, thus, go towards paring the pressure on its ILD revenues. Also, 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. VSNL seem to be taking steps in this direction. But the benefits of such efforts are likely to make a meaningful contribution only in the long term as the company will take some time to first recover costs of these acquisitions.

What’s in it for Tata Power?
As for Tata Power, this move seems to be in the right direction, as exiting from such a non-core business will not only help the company increase its focus on its core area of power generation, distribution and transmission, but will also free up resources that can be used for future growth. As for its other investments in the telecom sector, Tata Power already holds a 40% stake in Panatone Finvest Limited, which is the largest shareholder in the international long distance major, VSNL. Also, the company holds 20% stake in Tata Teleservices. The current value of these investments works out to over Rs 90 per share for Tata Power and we believe that the company can unlock value from these telecom investments and to that extent there is an upside.

Overall, if one were a Tata Power shareholder, there is everything to cheer about. But if one were a VSNL shareholder, the benefit is not likely to reflect in performance in the near-term.

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