How the mighty fall from grace. And it does not take much for a company to record its nadir. A bumbling management under the supervision of a totally cross wired Department of Telecom (DoT) hastened its downfall. The company has all of two captive clients (BSNL and MTNL) for what it makes, and one of them, BSNL, is itself swimming against the tide for many moons now. It hardly helps that the latter two also report to the same Master of Ceremonies. It is indeed amazing that the very apex body whose writ is to frame policies for the wellbeing of the telecom sector, itself came up short when tending to the well being of its own creation. The net result is that it has accumulated losses of over Rs 36 bn, on an equity capital base of Rs 2.8 bn. It also has a preference capital base of Rs 3 bn. (The dividend on the preference shares have been in arrears since the dual issue of this capital in FY03, and the subsequent year.) The issue of dividend backed preference shares were resorted to, as the management was sensible enough to realize that issuing additional equity would be a totally gone case scenario in the emerging brave new world. And whether by error or by foresight how right they have proved to be.
As a matter of fact the situation was so adverse that the Central government had to provide a cash grant of Rs 28 bn in FY10 to 'clean up' ITI's balance sheet. A part of this largesse was added to its other income. The company promptly went about reducing its borrowings from Rs 21.5 bn at preceding year end to Rs 2.8 bn. It simultaneously credited its reserves and surplus with Rs 25 bn. (And guess who one of the beneficiaries of Operation Clean Up was? The Central Government itself! A GoI loan of Rs 1 bn was repaid. The left hand taking back what the right hand giveth! The other beneficiaries were the PSU banks including SBI). It has also provided a snapshot of its essential financials for the last ten years and it makes for depressing reading. In the immediate last eight of the last 10 years, the company has recorded losses, on a wildly fluctuating turnover each year. The only plus point that one can readily see in this snapshot is that the employee stranglehold has reduced steadily from 22,914 in end FY01 to 11,737 in FY10. This has however not led to a any steady accretion in the value of production per employee.
A bloated board of directors for no purpose
ITI is the acronym for Indian Telephone Industries which was one of the first corporatized public sector undertakings to take wing within 3 years of India gaining independence from British rule. It was the first manufacturer of hardware for the then nascent telecom sector. Whether shortening its name today represents its diminished status, or is an indication of the shape of the good tidings in the making is not very clear. But for the present it is still at sea (customary brave statements from the Chief Executive notwithstanding) and has been so for more than a decade now. The rot of course started even earlier. Its management appears to be totally flummoxed on what monkey tricks it needs to perform, to extricate the company from the morass. On paper it must be getting plenty of advice for sure on what to do. The annual report lists the names of 18 directors, (that's right 18!), including ex-officio directors, - three of the directors retired from the board at various points of time, either before the financial year end, or after the year end. The betting however is that the advice proffered cannot be amounting to much. And, more importantly, the company does not have any in-house access to the technology that it requires, to cater to the needs of telecom service providers of the likes of today.
Two audited statements in a year
It is not very clear how the company resisters its sales revenues. The Chairman crows about the fact that the turnover of Rs 46 bn (including services income of Rs 1.6 bn) that it recorded in FY10 is the highest that it has ever recorded in its history. That is not really saying anything much, especially for a telecom equipment vendor of such vintage, but let it pass. Reading through the report does leave one with a very creepy feeling. And why is that? Well, for starters, this is the second audited statement of accounts that the statutory auditors have signed for the year FY10. The first statement of accounts that the statutory auditors signed, was revised in the light of the observations of the Comptroller and Auditor General. The revised audited accounts were subsequently approved by the directors. But even these audited statements come laced with qualifications (in bold letters at that) from the auditors, albeit of a relatively minor nature. This is well after the company on its own volition has provided for write-offs in the year-end balances of inventory valuations on assorted counts, on account of loans and advances, on account of trade debtors, and on the numerous write-offs in the P&L account, the latter write off alone amounting to Rs 1.3 bn (Rs 455 m).The company appears to be resorting to every trick in the trade to delay downsizing its balance sheet.
A leapfrogging turnover
To get back to the masala mix, the company's turnover leapfrogged to Rs 46.6 bn from Rs 17 bn in the preceding year. This was not due to any magic transformation in is manufacturing prowess, but more on this later on. The loss before tax was Rs 4.3 bn against a loss of Rs 6.5 bn in the preceding year. This is considered a great achievement by the board, which adds that the losses in the current are declining further. The chairman adds in his briefing to the shareholders that the company has signed a MoU with the Government for a gross sales target of Rs 80 bn in the current year. The emphasis of ITI is to be on the rural telecom infrastructure development project. The chairman then adds a curious aside that meeting this MoU target will not be easy as matters are going a bit 'tanda'. How the company plans to manufacture this equipment sans facilities is a point worth pondering.
As stated earlier the company's revenues leapfrogged during the year. And what was the magic mantra here? A ubiquitous item called 'Purchase for Direct Sales' which amounted to Rs 33.7 bn (Rs 9.2 bn).There is no separate schedule appended to this expense item, and neither does there appear to be any additional info on what this item constitutes. Consumption of 'raw materials and production stores' charged to the P&L account amounted to a relatively paltry Rs 8.4 bn (Rs 5.5 bn). However in a separate schedule the company states that it consumed raw materials and stores of the value of Rs 42 bn (Rs 14.8 bn). Thus the figures furnished for 'purchase for direct sales', the 'raw material' expense item, and the schedule for 'raw materials and stores' represent contrary conclusions. This is indeed baffling.
The many bits and ends that make for the turnover
It is of-course impossible to figure out what the company does in the area of manufacture and sales. It has got an exemption from the Central Government from disclosing production cum sales figures - apparently being of national security interest. This is best tactic to adopt to avoid giving detailed information on a company's working. Presently it has the capacity to manufacture Switching Products, Transmission Products, and Terminal Equipments. What revenues it can generate from flogging these capacities is not known either. The company earns its revenues principally from the sale of Electronic Switching Equipments. This revenue source earned the company 87% of all rupee product sales, against 63% in the preceding year. Transmission Equipments and Miscellaneous Products brought in the bulk of the balance moolah in both the years. Presumably for the benefit of the shareholders the company has been kind enough to break down its total revenue receipts into 26 different product items -and this additional info only adds to the confusion. It simply does not tally with the capacities on hand.
It does not quite add up
The jump in turnover has a hidden agenda attached to it. The company has to extend a rather long credit line for the sales that it affects, and this is a most interesting revelation. The trade debtors at year end amounted to Rs 49 bn against Rs 22.7 bn in the preceding year. Juxtapose these figures against the revenues that it recorded, and we have a unique situation of trade debtors being appreciably larger than the revenues itself! What type of nutty business is this company in? I have never come across such a ludicrous situation in the past. This implies that the bulk of its trade debtors not only average above 6 months duration, but above one year duration too. And pray who is the lucky buyer in the government domain of the company's products and services? And if my reckoning is right, then trade debts due above one year should correctly be labeled under Loans and Advances. And, besides, how bright a future does a company possess if it is forced to do business in this manner? Fortunately this did not have any untoward bearing on its working capital costs, as the company merely turned the screws on its creditors by delaying payments for supplies affected by them. Operating in the government domain has its advantages, and besides, this is a fine way to run a business. It should be featured as an apt case for study in the Business Schools.
The schedule which gives its production capacities features a number of new products for which it has been given manufacturing licenses. We are also informed that these licenses are either in the project stage or in the product stage. But there is no sign as yet that the company is treating these licenses very seriously. The company generates negative cash from its operations and besides it will have to find debt resources to implement these projects whose capital costs are unknown. For ITI to load itself with debt immediately after cleaning out its balance sheet of most of its outstanding debt does not look very likely, or sane for that matter at this point of time. For the matter of record the company spent a princely sum of Rs 28 m on gross block addition during the year, and that is small beer by any standard.
The composition of its gross block
As a matter of fact, the composition of its gross block is a real scream. At end March 2010 it boasted a gross block of Rs 36.8 bn. But the catch here is that almost the entire gross block is made up of assets which have been revalued. The consequence of this is that the reserves and surplus have also got a neat boost. The total revaluation account stands at Rs 24.5 bn made up entirely of its land bank and of its buildings. If one were to reduce this revaluation figure from the gross block figure the balance gross block value of all its other fixed assets together would amount to Rs 12.3 bn. If one reduces the accumulated depreciation of Rs 10.9 bn from this figure, then the company will have a net block of a mere Rs 1.4 bn ( on a rough reckoning). And this piddling gross block is spread out over 6 factories to boot. What serious manufacturing can a company attempt with an ossified gross block? This aspect in turn adds to the mystery of how the company generates its revenues.
The second manufacturing bonanza
The directors' report also adds the point that the company is now all set to kick off its second manufacturing bonanza. But the bulk of the investment will apparently be routed through joint ventures in which the collaborators will held the umbrella. Their equity stake will range from 51% to 74% in three JVs that ITI plans to incorporate. These proposed ventures will make WIMAX equipment, Transmission equipment, and IP CORE systems. Going for JVs than for direct manufacture, makes for more eminent sense, as it involves only capital infusion, even though ITI will be the junior partner, as it really has nothing to put on the table. How this proposed diversification will help bring succor to its balance sheet is of course a matter of conjecture.
It is difficult enough to make any sense of this muddle. Hopefully the management will be more forthcoming over time on what the company plans to do to extricate itself from the mess that it has landed itself into.
Disclosure: Please note that i am not a shareholder of this company
This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.
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