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VSNL: No surprises

Nov 20, 2002

After six months of tussle with BSNL and MTNL, VSNL has finalised its revenue share agreement. While the international long distance telephony (ILD) major has agreed to match revenue share for outgoing calls (from India to say US), a compromise formula has been arrived at in the case of incoming calls.Recap
Before going any further, just a brief recap. 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, received licenses.

The underlying fact is that the revenue per minute, which VSNL was receiving for every international call hitherto, has already plummeted. When Bharti launched service in 1QFY03, ILD tariffs fell by as much as 40% (a one-minute call to US is now charged at Rs 24 as compared to around Rs 45 per minute previously). More importantly, portion of the ISD charges, i.e. Rs 24 per minute to US, that VSNL retains was in jeopardy till now. While Bharti as a push strategy offered to transmit international calls at a significantly low share, VSNL wanted a higher revenue share. Bharti, to an extent, has an advantage over VSNL, as it has the last mile connectivity (fixed telephone lines).

New revenue share
How will the new revenue share help VSNL? Without getting into complexities of incoming and outgoing calls, the new agreement will only provide some breathing space for VSNL in the near term. Any decision by BSNL and MTNL to route ILD traffic through private sector players would have been the worst-case scenario. But from a profitability perspective, concerns still remain.

VSNL posted a 30% fall in net profits for 1HFY03 based on adhoc revenue share of FY02. We expect the company to revise its first half and third quarter numbers to reflect the new revenue share. One will not be surprised if the fall in net profit increases to almost 50% based on the new agreement. At the same time, it has to be mentioned that there has been a sharp rise in ILD traffic ever since the tariff reduction started in FY01. VSNL witnessed around 16% rise in ILD traffic in 1HFY03.

After six months, VSNL will have renegotiate ILD revenue share in April 2002. We expect atleast a 35% fall in net retention in outgoing calls for VSNL in FY04.

Domestic long distance telephony (DLD)
Since the core business of the company has come under significant competitive pressure, VSNL hopes to de-risk business by venturing into DLD. Here is where synergies with the Tata Group come into play. Both VSNL and Tata Teleservices are laying backbone network to cater to both voice and data traffic. Tata Power also has backbone infrastructure in select Western and Central regions. Since VSNL received DLD license free of cost as compared to Bharti, the chances of a faster break-even is higher. Having said that, revenues from DLD have to increase at a faster clip to compensate for the loss in revenues on the ILD front. The management, in the last analyst meet had planned a soft launch of the service by September 2002.

The stock currently trades at Rs 99 implying a P/E multiple of 0.6x book value. Assuming a 50% fall in net profits in FY03, P/E multiple works out to 4x. Though valuation may look attractive on the first look, the risk profile of the company is significantly higher from a retail investor’s perspective. Wait and watch. We will be updating our research report along with projection on our website based on new revenue share soon.

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