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Ringing in value addition - Views on News from Equitymaster
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  • Dec 11, 1999

    Ringing in value addition

    If monopoly is a disease, competition is the cure. Internet users in India know this only too well, and so does Videsh Sanchar Nigam Ltd. (VSNL) - India's sole provider of international voice telephony and the largest Internet service provider (ISP) in the country. From a bureaucracy-ridden, public sector unit, to an efficient, consumer-friendly organisation, the transformation of Videsh Sanchar Nigam Ltd. (VSNL) has come as a pleasant surprise to its consumers and investors alike.

    VSNL is the sole provider of international voice telephony in India, which has its upside and downside. The downside is that lack of competition infused a sense of overconfidence in the company, which is more than evident in its inefficiencies. The upside is that it ensures a steady flow of revenue to the company without looming threat of competition. VSNL's ratio of incoming/outgoing international calls is currently close to 3:1. VSNL receives payments from international telephone companies for incoming calls, while it pays to these companies for outgoing calls. These receipts/payments are based on Tariff Accounting Rates (TAR) which are bilaterally negotiated between the two telephone companies. Due to higher proportion of incoming calls (as opposed to outgoing ones) VSNL witnesses a net inflow of cash. As a result, the depreciation of the rupee increases its rupee revenues. VSNL has a revenue-sharing agreement (RSA) with the DoT. This agreement (expiring in financial year 2002) insulates VSNL from declining accounting rates.

    The international telephony segment will be deregulated in financial year 2004, after which overseas telephone carriers like AT&T, British Telecom (BT) will be allowed to operate in this segment and challenge VSNL's monopoly. Deregulation of international telephony is likely to affect VSNL more than the deregulation of basic telephony has affected MTNL. This is because entry barriers for setting up international telephone operations are lower than those for local loops.

    VSNL became monopoly provider of Internet services in August 1994. Being the sole internet service provider (ISP) spoiled the company's habits. As the number of users increased manifold, VSNL did not update infrastructure to support the increase in traffic. This continued until financial year 1999, when other ISPs (MTNL, Satyam Infoway) were allowed into the business. Until now, the ISPs have been using VSNL's infrastructure (gateways), which will now change as the government has permitted the ISPs to set up their independent gateways.

    Revenue break-up as on 1HFY2000

    But VSNL hasn't been sitting idle. Its taken note of the competition and has added some important plans to its 'Must Do' list. Management has taken a conscious decision to hop onto the portal (site for data, shopping and entertainment) and (business-to-business) e-commerce bandwagons. It is already scouting for a reputed Internet specialist to help it achieve this objective. Direct-to-home (DTH) services is another area which has beckoned VSNL, for which the company will tie-up with a global partner. While VSNL will supply the transponders and market the service to households, the partner will provide the technological inputs. Another area that holds promise for the company is domestic long distance. Its infrastructure makes it an ideal candidate and with its national presence it can easily connect to earth stations across the country.

    However, some of its dreams have turned into nightmares. Its investments in ICO Global (global mobile services) have turned worthless, after the former filed for bankruptcy going the Iridium way. There was more bad news for investors in October when VSNL released its second quarter financial year 2000 results. Net profit slumped by 18.4 percent, while revenues declined by 1 percent. Value-added services (Internet, leased-line) proved to be the damper, while international tariff rationalisation hit the international telephony business.

    (Rs m) 2QFY2000 2QFY1999 Change
    Net Sales 16,632 16,812 -1.1%
    Other Income 1,223 2,205 -44.5%
    Expenditure 12,231 12,414 -1.5%
    Interest - -  
    Depreciation 224 188 19.1%
    Profit before Tax 5,400 6,415 -15.8%
    Tax 1,934 2,168 -10.8%
    Profit after Tax 3,466 4,247 -18.4%
    Net profit margin 20.8% 25.3%  

    But clearly, the future lies in value-added services in general and the ISP business in particular. After Satyam Infoway's successful listing on the NASDAQ, analysts are bullish about VSNL's ISP business valuations. They estimate that the ISP business alone is worth Rs 800-Rs 1,200 per share, which at current market value amounts to more than 85 percent of the share price! No wonder VSNL plans to hive off its Internet business to unlock value for its investors. Moreover, after the government's dilutes its stake further in VSNL, there will be greater flexibility and urgency in decision-making, which is more crucial in the Internet business more than anywhere else.

    VSNL has played its cards right, so far. To continue in this vein, it will have keep pre-empting competition, both in the international telephony and the ISP businesses. While the former will see lower margins and higher competition in future, the ISP business is clearly the ace in its pack.



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