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VSNL: The challenge of change

Dec 10, 2001

The current year has been a rough one for Videsh Sanchar Nigam Limited (VSNL), the state owned international telephony service provider. On one hand, there is uncertainty on the disinvestment front. On the other, the tariff rationalisation has had a significant impact on profitability of the company. Meanwhile, the entry norm for private sector players in the international long distance telephony (ILD) is expected to pose a serious threat to VSNL’s core business. We analyse in detail the implications of these on VSNL and where is it headed?VSNL operates the gateway to connect the domestic telecom networks with the foreign networks in coordination with various international carriers. There are two major revenue streams for the company in international telephony. One, it derives revenues from the international carriers for connecting calls, originating abroad, to the Indian telecom network through its gateway. Secondly, it receives a revenue share from the Department of Telecommunications (DoT) for connecting international calls originating from India to the international carriers (the balance is paid to international carriers).

VSNL's sales mix…
(% of sales) FY97 FY98 FY99 FY00 FY01
Telephony94.7%93.9%91.5%90.2%88.8%
Leased lines2.2%3.1%3.6%4.3%4.3%
Internet0.3%0.9%2.5%3.0%4.1%
Others2.7%2.1%2.4%2.4%2.8%
Total100.0%100.0%100.0%100.0%100.0%

The tariff rationalisation by the TRAI on the ILD front has had a significant impact on the average revenue per minute (ARPM) for VSNL. ARPM has been on the decline for the last five years. ARPM has come down from Rs 35 per minute in FY97 to Rs 24 per minute in FY01. ARPU fell by 13.9% in FY01. Given the fact that India’s international call rates are one of the highest in the world, TRAI is expected to rationalise international telephony rate further. As a result, we expect the paid minute calls to increase by 18% in FY02. But ILD revenues are expected to grow at a slower rate. We expect the company to report a 2% growth in revenues and a 17% fall in net profits for FY02. The trend would continue in FY03 and FY04 as well.

But if one were to look at the international telecom market, the scenario is no different. Consider Singapore Telecom. ILD revenues, as a percentage of sales, have come down from as high as 42% in FY98 to 24% in FY01. Competition and tariff reduction resulted in a sharp fall in international long distance rates. ILD revenue per minute has also come down from S$ 2.73 (Rs 57 per minute) in FY98 to S$ 1.17 in FY01 (Rs 25 per minute), a fall of 24% in four years. Korean telecom majors also had to undergo similar situation in the past. But these companies have managed to keep growing even after liberalisation by venturing into other related areas, which we will discuss later.

Apart from international telephony, VSNL is also a market leader in the Internet Service Provider business. The company had 630,970 subscribers in FY01 and a 55% market share. Even after adjusting for the fall in subscriber base recently, a market share of around 50% is commendable. With VSNL extending its services to 9 cities from around 5 cities last year, we expect the subscriber base to increase by 25%-30% per annum in the next three years. Towards addressing the need for higher bandwidth, the company, over the years, has increased capacity and currently VSNL has 1 gigabit of bandwidth.

Another negative for VSNL is a 15% revenue share enacted by the Telecom Regulatory Authority of India (TRAI) for ILD service providers. Currently license fee paid by VSNL to the Department of Telecommunication (DoT) works out to 7.7% of ILD revenues. Assuming an 18% growth in paid-minute calls and a 13% fall in average revenue per minute combined with a 15% revenue share, license fee payable by VSNL would increase by 95% to Rs 10,043 m in 2002. Though VSNL would save on national network charges and lower administration expenses, margins would fall by 300 basis points in FY03.

The revenue share effect…
(Rs m) FY01 FY02E FY03E FY04E
License fee to DoT 4,968 5,133 10,043 10,166
% of sales 6.8%6.9%13.0%12.7%
% of revenues 7.7%7.9%15.0%15.0%
% increase - 3.3%95.6%1.2%

To reduce the impact of falling tariffs and slowing revenue growth VSNL has aggressive plans on the domestic long distance telephony (DLD) front. The company has outlayed Rs 12 bn for its proposed entry into DLD and has already started building up necessary infrastructure. As VSNL does not have presence in the basic telephony segment, international calls, currently, are delivered to either MTNL or DoT’s basic network for which VSNL has to pay interconnection charges. Now, if VSNL has its own DLD infrastructure it can route calls through its own network. The company’s management in the analyst meet said that it could achieve break-even in the first year of operation itself. But with private sector players allowed into the ILD segment, they might also set up their own gateways to transmit international calls. This could dent VSNL’s profitability as well.

Another big threat for VSNL is Voice over Internet Protocol (VoIP), which is illegal in India currently. If permitted, this will have a material impact on VSNL’s profitability. Just to draw a comparison, China Telecom, the incumbent operator in China, revised its tariff plans to align with IP phone tariffs to prevent a sharp fall in profits. VSNL might have to follow a similar strategy to keep volume growth ticking.

But things could change if the disinvestment process goes through smoothly. Currently, as per the basic telephony license agreement, no two operators from a similar promoter background can provide basic services in the same circle. If the company gets disinvested it automatically loses its PSU status and consequently can expand its businesses to basic telephony also (given the cash reserves that it has, it can opt for a acquisition route). This could open new growth avenues for the company. Singapore Telecom, for instance, managed to grow by entering public and private network service, which has seen healthy growth in the last five years. It recently acquired Cable & Wireless Optus, the second largest cellular service provider in Australia.

The attractiveness of VSNL is comparatively higher than MTNL for other reasons as well. VSNL has a solid network infrastructure and its investments in various undersea cable lines (SEA-ME-WE, FLAG and Gulf Cable) and satellites (Intelsat and Immarsat) bode well in the long run. VSNL currently has 38 earth stations, 12 gateway switches, 5 cable systems and 22 Internet network nodes spread across the country. The productivity ratios are also far higher compared with MTNL. VSNL has a workforce of 2,991 as of March 2001 as compared with 60,746 for MTNL.

While other PSU companies were happy managing existing businesses (barring oil companies), VSNL has shown that despite being a PSU undertaking, expansion is critical for growth. Of course, it has had certain hiccups in between like its investment in ICO Global, which turned out to be a sour experience. But a new owner could bring in the additional technical expertise, execution capabilities and broader vision.

Whether VSNL will be able to circumvent falling tariff and boost growth by entering other growth areas remains to be seen. But given the past track record, one hopes that VSNL will accept the challenge of change and show the path for the rest.

Key valuation parameters…
  Units VSNL MTNL
Price (Rs) 233 141
No. of shares (m) 285.0 630.0
Market Cap (Rs m) 66,405 88,830
Price to earnings (x) 4.5 5.7
Price to cash flow (x) 4.0 3.8
Price to book value (x) 1.0 1.1
Market cap to sales (x) 0.9 1.2
EV/EBDITA (x) 0.9 4.3
RONW (%) 27.0%18.7%

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