The list of companies interested in picking up stake in VSNL has been growing shorter by the day, with one company after the other withdrawing from the fray. Telecom analysts attribute the lack of enthusiasm to regulatory uncertainty and doubts over VSNL’s ability to maintain its market share. Where does that leave the VSNL divestment process?

Why has the response to VSNL’s divestment not been so enthusiastic? Any why have some companies dropped out?

Banker
The response for VSNL has been affected by multiple factors. These include uncertainty regarding guidelines for entry of competition into the ILD business post-April 2002 and therefore ambiguity about the impact on VSNL and the dynamics of some prospective bidders in terms of their own current strategies in the sector and lack of fit. There is a growing realization that some of the intangible assets of VSNL, such as international connectivity contracts, can today be replicated and at reasonable cost.

Vishvjeet Kanwarpal
Timings and terms are the key to maximization of divestment value. The right time for divestment for VSNL would have been two years ago or more when players were ready for heady premiums to gain the golden foothold. With its monopoly status slated to be dismantled by April 2002, the ability of VSNL to maintain its revenue position, market share and profits is in serious doubt. The government’s plan for the cash reserves is another key issue. These factors all account for the less than enthusiastic response to VSNL’s divestment.

Mohit Saraf
Interest in VSNL’s divestment was expected to be very high. But some important facts have dampened the response. Of the current holding of 52.97 per cent in VSNL, the cabinet decided to sell 25 per cent stake to a strategic partner, while the government would retain 26 per cent. Employees would be offered 1.97 per cent as stock options. Therefore, the share purchaser is not being offered a controlling interest. The new partner would need to buy 1 per cent stake from the open market to achieve the crucial figure of 26 per cent that would allow him to veto special resolutions.

There is a hitch for foreign companies. The government has a cap of 49 per cent on foreign equity in telecom companies. In VSNL, the foreign equity component is already 38 per cent.
Bharti has taken a strategic decision to stay out in the wake of winning six-seven mobile licences. Others wish to pursue the international voice telecom business when it opens up. However, even after Bharti’s pull-out, it still leaves corporate heavyweights such as the Tatas and Reliance in the fray. Therefore, this can hardly be called a poor response.

Mahesh Uppal
The main reason for the dismal interest in VSNL’s divestment is that the regulatory regime that governs the ILD market is undergoing a massive change. There is no clarity on who the competitors to VSNL will be when its ILD monopoly ends next year. We do not know the number of players and when they would actually be licensed. There is no clarity on whether internet telephony will be opened up and if so, when. There are confusing signals from the government about whether VSNL will be allowed to enter other services. Recently it was barred from entering cellular services on the grounds that it would end up competing with other government-owned companies like BSNL/MTNL. The same argument is not being applied to the internet business where VSNL and BSNL/MTNL are allowed to compete. It is this lack of clarity, compounded by contradictory statements from politicians, bureaucrats and vested interests that makes it impossible for any serious investor to evaluate the attractiveness of this opportunity.

What are VSNL’s key strengths and weaknesses?

Banker
Its strengths lie in the existing network of nodes and gateways and wide coverage across India. Its consistent profitability over the years, its cash reserves, and its having tapped the international equity markets are all good indications of its financial position. VSNL’s weakness is that the very significant infrastructure it has at its command is today probably not required to make an entry into the field and the critical assets can be replicated at a lower cost.

Vishvjeet Kanwarpal
VSNL’s main strengths are its monopoly in international telephony and associated international telephony and associated international agreements, satellite holdings, real estate and brand name. It also has the largest bandwidth among Indian companies and is the largest ISP in India.
VSNL’s weaknesses are its absence of a field organization, dependence on BSNL for interconnection, lack of effective marketing and the fact that it is government controlled. Cash reserves of several thousand crores by a monopoly PSU are indicative of prices that do not reflect costs. Also, VSNL has no last mile connectivity or access to the local loop and does not bill its international voice customers. Hence, it is in a precarious position of being a golden gateway that could be bypassed, with private players setting up satellite and submarine cable gateways. The projected loss of market share and revenues is significant.

Mohit Saraf
VSNL has cash reserves and surplus of more than 60 million as in end-March 2000 and profits of over Rs.8 billion last year. It is the leading ISP in the country with over half a million subscribers. It is the sole provider of all ILD services, which, however, will be opened up by 2002. The partner company investing in VSNL would gain access to its international telecom agreement. AS part of the compensation package, the government has promised that all international traffic emanating from BSNL and MTNL would be carried through VSNL till 2004. Further, the revenue-sharing agreement with BSNL provides that VSNL’s revenues would be insulated from changes in tariff and exchange rates. This would help the top line grow at the prevailing rates.

However, under government control, VSNL has not been able to do business on purely commercial terms. Neither has it been able to tap new synergistic businesses to help diversify revenue streams and expand the top line. Flexibility of operations and marketing ability are missing.

Mahesh Uppal
Its current monopoly, its business arrangements with international carriers, its successful internet business and big cash reserves are its biggest strengths. Its weakness is that its monopoly is to end soon. VSNL has few assets that cannot be replicated cheaply and fast. Its chief source of profits is the accounting system settlements it receives for India being a net receiver of international calls. But the accounting system has all but crashed and international carriers have found creative ways to beat the system by use of new technologies, rerouting calls, etc.

Is VSNL prepared for the end of its international calling monopoly in 2002?

Banker
In the near term, yes, given the momentum its existing network and operations provide, whereas the earliest private sector competitor is likely to emerge in a major way only after a couple of years. However, with regard to its cream clientele, it may face attrition as new players cherry-pick the lucrative clients with superior price-value propositions. VSNL has also to reconcile to the fact that one of the sharpest tariff drop and it must therefore focus on its cost base in order to remain competitive.

Vishvjeet Kanwarpal
VSNL has yet to position projects and schemes that would sustain it after the end of its monopoly. It has added services such as dedicated international leased lines, managed data networks, satellite mobile, and internet. But, diversification into NLD, cellular and basic services has not fructified. There will be significant pressures of competition and lower tariffs in its core business of international telephony, which will impact its bottomline. In addition, VoIP may erode as much as 10-15 per cent of the already declining or reverse calling of outgoing international traffic.

Mohit Saraf
Divestment is the first step towards the end of its international calling monopoly. Although VSNL derives roughly 87 per cent of its revenues from international telephony now, this is one stream of revenue that is definitely going to get hit post-2002. The margins will certainly come under pressure. What VSNL needs is a dynamic private sector management team that will help it to diversify into new areas.

Though VSNL has a competitive advantage in the domestic long distance market due to its infrastructure, it needs to act fast. An important aspect is strong and sustained growth in non-telephony value-added services. The company has revised its capex plan to invest Rs.59.11 billion in various capital expenditure programmes as part of the Ninth Five Year Plan. The challenge would be for VSNL to emerge as a provider of integrated communication services with other telecom companies. The challenge is to think big. The geographical area of operations also should not be limited to India. VSNL has the capacity to become a telecom multinational offering a full range of communication services at least cost to other developing countries.

Mahesh Uppal
The loss of monopoly will be a big blow but there is no serious problem of technical preparedness. The issue is whether the new players are ready to exploit the opening up of the market.

What are VSNL’s long-term prospects in the internet sector? Can it hold market share and grow? Can it make money?

Banker
There is no reason why VSNL’s prospects or market share should suffer, if managed properly, given its existing strengths and financial muscle. About making money, in this sector the business models are still dynamic and its difficult to predict the outcome at this stage.

Vishvjeet Kanwarpal
VSNL held an enormous advantage in the early years. However, competition has steadily chipped away at its near-monopoly position. Additionally, customer service till recently has not been given adequate attention. However, many ISPs that eroded VSNL’s market share based on free email and below-cost access and freebies are beginning to feel the heat and charge for services. If VSNL can aggressively capitalize on this consolidation in the ISP sector, it could continue its dominant position as an ISP. However, the internet business is only a small part of VSNL’s valuation as almost 90 per cent of its revenues come from international telephony.

Mohit Saraf
VSNL is the only operator with submarine gateways in India and it has bought equity in submarine cables to ensure cable and bandwidth availability. VSNL is also the predominant ISP in India today. However, the ISP market is overcrowded. And since margins would be thin, VSNL could gain only by expanding its reach.

Mahesh Uppal
I see these prospects as fair to good. The ISP business is a tough one. But VSNL has important advantages – especially ownership of infrastructure, incumbency, a large customer base and, importantly, a service comparable to most of its competitors’, if not better. That should give it enough strength to put up a good fight and possibly do well if the current regulatory confusion does not impede it.

In your opinion, is VSNL currently under-valuded or overvalued?

Banker
Undervalued, but not significantly.

Vishvjeet Kanwarpal
In tangible terms, the gateways and real estate are the assets of VSNL. Other assets such as international agreements and brand name need to be revalued in the light of the dismantling of monopoly status and may not account for considerable value. Towards end-August, VSNL share prices were trading around Rs.290. This is approximately the valuation, which almost totally discounts the cash reserves and compensation expected from the government for loss of monopoly in international telephony. These two factors are the prime questions that plague the valuation over and above the projected position of VSNL post-April 2002. If one includes these in the short run, an optimistic valuation should be in the range of Rs.500. From this perspective, the stock is undervalued in the short run. Much depends on the bids VSNL receives. These are being projected in the range of Rs.400 to Rs.600. However, if a less than spectacular response depresses bids, not much upside remains.

Mohit Saraf
In the stock market, VSNL is one of the cheapest telcos on a PER basis and has consistently underperformed due to state control and uncertainty over divestment. With this decision, the stock is likely to get rerated and there is significant upside.

Valuation can swing from one extreme to the other, depending on the kind of assumptions you make. You might value the company at a certain amount. But the buyer will quote a price depending on what value he feels he can derive from the company. Once telecom accounting rates come down, there will be erosion of value. VSNL does not own any end-use customers. In fact, lack of clarity in policy could also drastically alter valuations. IN VSNL’s case, the imponderables are many. For one, there is talk of the government increasing the FDI limit. This could affect valuations by attracting more foreign bidders and increasing competition. But policies that appear to restrict the number of bidders might just beat down valuations. The government still hasn’t clarified the compensation package. The rebalancing of international telecom rates could also affect cash flows.

Mahesh Uppal
It is being devalued every day by poor and casual handling of the core regulatory issues and our inability to clarify what the market will look like post-2002. Every off-the-cuff remark by somebody in power has an immediate impact on VSNL’s value because of the confusion it adds to an already messy issue. If this does not stop, VSNL will soon look overvalued !.