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Bharti Airtel: An emperor sized operation - Outside View by Luke Verghese
 
 
Bharti Airtel: An emperor sized operation

An Emperor sized operation

Bharti Airtel is an emperor sized operation in every sense of the term, starting with the standalone gross revenues of Rs 356 bn that it recorded, to its gross fixed asset base of Rs 442 bn (that makes it all possible), to its investment portfolio base of Rs 157 bn, to its gross working capital base of Rs 93 bn, to the humungous net cash flow of Rs 127 bn that it generated, to its 22 subsidiaries and fellow subsidiaries, 2 associates, 3 joint ventures and 18 companies where the management exercises control of some sort, to the Rs 8 bn in cash and bank balances, to the 43 companies that it had related party transactions with in FY10, and the Rs 7 bn in services that it rendered to these related parties and the Rs 41 bn in services that it received in return from these related parties. Add to this the Rs 12.4 bn in disputed back taxes demanded by both the direct tax and indirect tax authorities, to the 11.2 bn that it has provided for during the year as bad and doubtful debts on the revenues that it earned during the year, to the Rs 4.4 bn in doubtful debts that it has provided on advances on capital account, to the Rs 21 bn in advances that it has forked out to its subsidiaries, to the corporate guarantees of Rs 8.5 bn given on behalf of group companies, to the Rs 28 bn in advance billings, to the forex losses or gains that it records each year - a gross turnaround of Rs 26 bn in this respect in the latest year, to the Rs 18 bn in forex earnings and the Rs 34 bn in forex outgoings, to the purchase of fixed assets of Rs 72 bn, the list is seemingly endless. Wonder how the accountants managed to put it all together, within the mandated time limit, for the benefit of its shareholders.

Yet the most remarkable aspect of this company is in the management of its working capital resources. It has managed to do with net 'negative' current assets at each year end. (Whether this are mere year ends figures or whether they reflect the business cycle is not known). Whatever, at end FY10, the negative net current assets stood at Rs 36 bn against an even more impressive Rs 42 bn in the preceding year. In strict accounting parlance, the net current assets should be at least 50% higher than the current liabilities (to take care of a sudden free fall in the marketability of its current assets). But this company has chosen to do otherwise. On the one hand this shows its clout in the market place, and the attendant risks that it can expose itself to, and on the other, it helps to save considerably on working capital costs, which get reflected in the interest expense schedule. It is also sticking its neck out in the process.

Age wise, still a kid in knickers

The company per se is not all that old to start with either, having kick started its operations only in 1995 and by a publicly untried and untested management at that. It was only in the other year that it declared its maiden dividend, after having successfully combated the many trials and tribulations that prey on corporate life. On a rupee turnover basis, it is also the largest Indian telecom company today, with a presence in all the 22 licensed jurisdictions or telecom circles. The consolidated sales of the group is much larger at Rs 418 bn, but the profit before tax of the consolidated entity is a lot less lustrous, higher by only Rs 1.9 bn than that of the standalone entity. But when the business operations of its group affiliates in Africa, Bangladesh, Sri Lanka, and such like kick start under the new perspective, the sales and profits of the consolidated entity should hopefully hit a high orbit. But there will be no direct benefits accruing to the parent from these operations, as the parent is working overtime in incorporating a string of holding companies which will control these operations, and future diversifications. This would in reality call for more outlay in the form of portfolio investments, and dishing out loan 'melas' on the part of the parent, and these investments will take their own time to yield any direct benefits.

Its principal growth drivers

The company earns its bread from three major sources, Mobile services, Telemedia services, and Enterprise services, with a total customer base of 131 m at year end (out of a total all India subscriber base of 621 m). Telemedia refers to fixed line services, while Enterprise refers to domestic and international long distance services and, internet and broadband services. It is primarily a Mobility service provider, with 127 m subscribers, and derives a little over 80% of its total service revenues from mobility operations, with Telemedia (3 m subscribers) and Enterprise operations, bringing in 9% of revenues each. Mobility also brings in 61% of the pretax profits, with Enterprise ringing in with 31%, and Telemedia bringing in the tail end at 7%. It is impossible to hazard a guess on the biggest contributor to sales and profits on a segmental asset basis, due to an innocuous item called 'Others', which accounts for 33% of all segmental assets, but has zilch income and profits. Such indeed are the ways of the corporate world.

The biggest operating expense item by far and amounting to Rs 74 bn, comes under the nomenclature of Network operating expenses and includes such revenue generating expense items as Interconnect and port charges of Rs 838 m, and internet access and bandwidth charges of Rs 2.2 bn. These appear to be relatively minor items of expenditure in this grouping, as compared to power, and rent, which together accounts for 75% of all expenditure under this head. The next biggest item is Access charges which is apparently some sort of a statutory expense. But these charges are lower by Rs 8 bn at Rs 44 bn, inspite of an increase in revenues during the year. Next in line is another statutory expense going by the title of Licence fee and Spectrum charges and which has grown by Rs 2 bn to Rs 37.5 bn. (This item of expenditure has strangely enough been grouped separately from the other expense items for whatever reason). If there is any direct nexus between statutory expenses, and revenue generation, then it is not very clearly evident. Sales and marketing, and administrative, and personnel expenses bring up the rear. Other income at Rs 3.8 bn against Rs 5.3 bn in the preceding year is not an inconsequential sum either. But the company has chosen to camouflage this income by merging it with other similar expenses and showing the net effect.

The profitability factor

On a 5% increase in revenues, pretax profits have grown by 31% to Rs 107 bn. But this increase in profits is illusory in a manner of speaking. In the preceding year there was a forex fluctuation loss of Rs 17 bn while in the latter year there was an exchange gain of Rs 8.5 bn on this count. (Such extraordinary profits or losses are both indeterminate and unfathomable, and are the end product of the luck of the draw, and, do not add or reduce from its operational efficiency. Besides, Airtel's derivative exposures are of the bulge bracket variety). In other words there was a turnaround of Rs 26 bn in the bottom-line in the latter year, on the forex account. If one were to remove these extraordinary figures of either year from the respective pretax profits, then the pre-tax profit would amount to Rs 98.4 bn against Rs 98.7 bn in the preceding year. In other words, the competition is hotting up, and revenue increases are slowing. It will now have to depend on its Enterprise operations, and the new value added services like 3G and BWA, and new technologies like HSPA, Wimax, and WiFi to bring in the moolah, and reduce operating costs and improve margins. Besides, any cash return on its humungous investments in its group affiliates will start trickling in only some time into the distant future. The direct tax outgo is still relatively puny, implying that the 'taxable profits scenario' still has some distance to cover.

A few muddles

A puzzling feature in the revenue accounting is that the company has deducted a sum of only Rs 2.3 bn as provision for bad and doubtful debts in the P&L account, and a further Rs 718 m has been written off as bad debts. But the fact of the matter is that the total provision for doubtful debts created during the year (and deducted from trade debtor balance at year end) was Rs 11.2 bn. The provisioning for the year is Rs 2.3 bn more than it made in the preceding year! Add to this the provisioning of Rs 4.4 bn on capital account for advances made, in the normal course of business, and it reveals the picture of a company which is in a hurry to get somewhere, at any cost. It is also not immediately evident how the company has accounted for such a large provisioning in its revenue accounting, and why it provided for such large sums on the loans that it advances in the first place. The pressure to gain additional subscribers also means having to put credit risk assessment on the back burner. But by god's grace, the margins are still sufficient enough to absorb these self inflicted wounds.

Other Income

The manner in which it generated other income, in the midst of all the ongoing action, is yet another eye opener. This income arises from its investments in bank deposits, and separately, in mutual funds, deposits, and bonds which at year end totaled Rs 46 bn. It also makes do from the profit it realized from the sale of current investments. It has during the year bought and sold cumulatively some Rs 600 bn in debt instruments. It is also one of the few companies which has accounted for income being profit from the purchase/ sale of such securities. This exercise brought in a cool Rs 1.8 bn. Not surprisingly its humongous investments in its subsidiaries and affiliates amounting to Rs 111 bn, has yet to contribute a mite in terms of cash returns. The advances to subsidiaries which amount to a considerable Rs 21 bn at year end are also freebies, without any strings attached. The wonder is that it appears to manage its cash flows profitability at the end of the day.

The subsidiaries

Like in all big ticket companies, it is the subsidiaries which provide the fun and games. And Bharti is not to be found wanting in this respect. It has appended the working results of 17 subsidiaries separately. In its portfolio of investments, its biggest outlay is in Bharti Infratel at a total cost of Rs 82 bn, and it accounts for 71% of its total investment in its subsidiaries, etc. The shares were acquired at a price of Rs 164 per share, on a face value of Rs 10 per share. Infratel provides the passive infrastructure services of managing the tower operations of telecom companies in India, through its affiliates. This investment is unlikely to ever yield a dividend return as the very purpose of its existence is more fundamental. Its next biggest investment is Bharti Airtel Singapore, at a cost of Rs 15 bn, and it appears to be one of the two holding companies of its African subsidiary. These shares too were acquired at a price of Rs 49 per share of a face value of 1 Singapore dollar. The next honcho is Bharti Hexacom, which offers mobile and fixed telephony services in the 6 North Eastern states and Rajasthan, in which the parent has an investment outlay of Rs 5.7 bn. The parent controls some 70% of the outstanding equity of this company, which was acquired at an average price of Rs 33 per share, with a face value of Rs 10.

Blockbuster Investments!

But the block buster investments lie elsewhere. Top of the pops is its investment in Bharti USA (which dishes out international calling services) where it has laid out an investment of Rs 509 m. This investment consists of 300 shares of US$ 0.0001 each, at a price of Rs 1.7 m per share, and it must rank as some sort of a world record in pricing a share acquisition, based on its face value. One wonders what high octane mathematical formula the management used to arrive at the purchase cost per share, and Management Institutes should definitely consider including the methodology in their curriculum. The two other nuggets are Bharti Airtel UK (international calling services) with an outlay of Rs 100 m, and Network i2i (of US$ 1 each face value) with an outlay of Rs 5.3 bn, which were acquired at Rs 815 per share and Rs 591 per share respectively. This Mauritius based company is in the principal business of submarine cable systems. However the Sri Lanka (mobile services) and Hong Kong (international calling services) company acquisitions were more earth bound, with Bharti paying a mere Rs 3.9 per share and Rs 5.3 per share respectively. Both these shares were acquired at below the face value. There does not appear to be any method in the madness of how it prices each of these issues of capital.

And how are these investments faring? Bharti Hexacom with an equity base of Rs 2.5 bn is the top dog with revenues of Rs 26 bn and a profit before tax of Rs 7.4 bn. Bharti Infratel too is on a roll with revenues of Rs 24.5 bn, and pretax profits of Rs 3.2 bn. Warid Telecom, its Bangladeshi operations, boasts the highest equity base of Rs 31 bn but is as yet hugely loss making, as is the Sri Lanka operations, whose losses far exceed its revenues. The three companies where it has paid top dollar of sorts for, are inconsequential entities in terms of revenues and profits. But in all probability there must be potential in these investments, or at least one hopes so. But to the credit of the management, one must add that the financial performance of the subsidiaries of Bharti is on a far higher keel than that of many of the Indian MNCs that have been surveyed so far.

PLEASE NOTE THAT I AM A SHAREHOLDER OF THIS COMPANY

This column Cool Hand Luke is written by . 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.

Disclaimer:
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