Value creation in Telcos G.Alagarsamy Pr.CCA Tamil Nadu Circle.

Value creation in Telcos

G.AlagarsamyPr.CCA

Tamil Nadu Circle

Of the five business deadly sins, the first and easily the most common is the worship of high profit margins.

Peter F . Drucker

Value Questions

Is OR wholesome performance metric?

Is profit positive cash positive? Is return positive value positive?

ROCE Trend- BSNL Case

12.32

4.87

13.8810.52 10.16 9.19

5.061.480

5

10

15

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

ROCE(%)

ROCE Trend-BSNL case

ROCE Trend-BSNL Vs Bharti

9.195.06

1.48

26.2 24.3 24.7

0

10

20

30

2006-07 2007-08 2008-09

RO

CE(

%)

BSNL

Bharti

ROCE Trend-BSNL Vs Bharti

Value Creation

ROCE high Is it necessarily value creating?

Dynamic Of Performance Metric

sophistication TimeMeasures of PM

Return

EVA/MVA

VBM:Returns, growth,

.WACC,FCF CFROI

earnings

Returns, growth,

WACC,

Returns, growth,

ROE,ROCE,RONA Ignores growth

Single period

Ignores WACC

EVA-Definition

EVA = Net operating profit after tax(NOPAT)- Capital charge

= EBIT(1-T)- WACC* CEwhere

WACC : weighted average cost of capital CE : Capital employed

=(ROCE-WACC)* CE

EVA- Definition

EVA is not a percentage return metric- a measure of surplus value –residual income of a business in absolute terms

It is closest to the NPV of a project in capital budgeting

NPV = ΣEVA/(1+Kc)^t

Accounting Profit Vs Economic Profit

EBIT xxxless interest on loan xxx

Pre-tax profit xxxless tax @ xxx

PAT xxx Add interest on loan xxx PAT but before interest xxx

(NOPAT)less Capital Charge (WACC on CE) xxxEconomic value added xxx

Cost of Equity- CAPM Approach

RE = RF + β*(RM-RF)

Where RE : Expected rate of return from equity

RF : Risk free rate of return

RM : Expected rate of return from market portfolio

RM-RF : Market Risk Premiumβ : A measure of systematic risk

NO of securities in portfolio

Systematic risk

Unsystematic risk

Total risk

Cost of Equity-CAPM ApproachRISK

Cost of Equity- CAPM Approach

β = Covariance of stock returns with market returns / variance of market portfolio.

A company’s β is the company’s risk compared to the risk of market portfolio. The more a stock moves up and down with the market, the more non-diversifiable risk it has.

β of market portfolio is ‘1’ If a stock has a β of ‘2’, it is 2 times more

risky than market portfolio. If the β of the stock is 0.5, it is less risky than market portfolio by 0.5 times

Systematic risk (beta)2

Risk premiumEx

pected

return

Capital Asset Pricing Model (CAPM)

0.5 1

Weighted Average Cost of Capital (WACC)

WACC= (E/D+E)*Ke + (D/D+E)*Kd(1-T)whereE= market value of equity

D= Book value of debtKe=Nominal cost of equityKd=Nominal cost of debtT = Tax rate

EVA Adjustments

Economic capital= Shareholders equity+ goodwill written off+ Capitalised cumulative unusual loss+ deferred tax+ minority interests+ Total debt

NOPAT=Operating profit+ interest expense-unusual gain-taxes

How Do You Achieve EVA

IncreaseRevenue

Reduce

Operating C

osts

Increase Volume of Sales with Positive

Contribution.Eliminate Products

With Negative Contribution from Product Portfolio.

Reduce amount of capital use in

CA & FA

Inve

stm

ent w

ith

Positi

ve N

PV.

Reduce Cost of Capital.

EVA

EBIT(1-t)

Capital charge

Revenue

Operating cost

(CE)Capital employed

WACC

Increase revenue

Reduce operating cost

Reduce WACC/Optimize leveraging

Reduce CE in current assets/Fixed assets

Increase sales volume with positive contribution

Invest in projects/Products with positive NPV

Value metric

Value components

Value drivers

Critical Success factors

CASH

INV

Capwip

ASSET

A/R

ASSET CONVERSION CYCLE

CASH CONVERSION CYCLE

Revenue generation phase

Revenue assurance phase

Revenue realization phase

ITEMY 2006-07 Y 2007-08 Year 2008-2009

BSNL Bharti BSNL Bharti BSNL Bharti

Capital Employed (in Cr)

83091 15660 88672 20414 87989 31664

D/E .06:.94 0.4:0.6 0.04:0.96 04:.0.6 04:0.9604:.0.6

Cost of equity(Ke) (%) 14 12.5 14 12.5 14 12.5

Cost of debt(Kd) (%) 12 10 12 10 12 10

WACC(=D/D+E)*Kd(1-T)+(E/D+E)*Ke

13.66 11.3 13.77 11.3 13.77 11.3

PAT (in Cr) 7805.87 4259.6 3009.39 6700.8 574.85 8499.9

NOPAT(Net Operating Profit After Tax)=PAT+ (interest) (in Cr)

8585.28 4562 3871.99 7106.2 1018.35 11251.7

Capital Charge(=capital employed at the beginning*WACC) (in Cr)

11350.23 1769.65 12210.13 2306.87 12116.08 3578.12

EVA=NOPAT-Capital charge (in Cr)

(2764.95)

2792.35(8338.23)

4799.33(11907.73)

7673.58

Value Creation- BSNL Vs Bharti

-2764.95

-8338.23-11907.73

2792.354799.33

7673.58

-15000

-10000

-5000

0

5000

10000

Y 2006-07 Y 2007-08 Y2008-09EVA BSNL

Bharti


Y 2003-04 Y2008-09

Capital Employed (in Cr) 54612 87989

D/E 0.12:0.88 04:0.96

Cost of Equity(%) 14 14

Cost of Debt(%) 12 12

WACC 13.33 13.77

PAT 5976 574.85

NOPAT 6064 1018.35

Capital Charge 7279 12116.08

EVA (1215) (11907.73)

Value Creation Trend- BSNL Case

BSNL Bharti

Sales Opex Sales Opex

Y 2006-07 39715.11 31465.66 18519.6 13894.1

Y 2007-08 38053.4 33636.43 27025.0 19766.9

Increase (Decrease) %

4.18 6.89 45.9 42.26

Y 2008-09 35811.92 34354.21 36961.5 29113.6

Increase (Decrease) %

(5.89) 2.13 36.8 47.28

Sales and Opex Impact on Value Creation- BSNL Vs Bharti

Working Capital Leverage

Sensitivity of ROI to change in the level of current assets

WCL = CA/(TA-ΔCA) in case of decrease in current assets

=CA/(TA+ΔCA) in case of increase in current assets

where CA= Gross CA, FA=Net fixed assets, ΔCA=Change in the level of

current assets ROI will increase /decrease by WCL depending

on decrease/increase of current assets

2006-07 2007-08 2008-09

BSNL Bharti BSNL Bharti BSNL Bharti

Net FA 57933.90 21060.4 54698.49 27595.1 54320.88 37167

CA (Gross) 53747.88 4171.4 58058.43 6298.4 57748.61 9735.5

TA 111681.78 25231.8 112756.92 33893.5 112069.49 46902.5

WCL= CA/(TA-∆CA) (10% reduction in CA)

0.51 0.17 0.54 0.19 0.54 0.21

Impact on ROI

ROI will increase by 5.1%






ROCE(%) 9.19 26.2 5.06 24.3 1.48 24.7

WCL and Value Creation- BSNL Vs Bharti

CA Reduction (%)

0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9

WCL0.54

30.574 0.610 0.649 0.694 0.746 0.806 0.877 0.961

ROI will increas

e by (%)

5.43 11.49 18.29 25.96 34.71 44.75 56.42 70.14 86.48

WCL and Sensitivity Analysis-BSNL Case (2008-09)

Y 2008-09

BSNL (in Cr) Bharti (in Cr)

a) Accounts Receivable

4720.54 1826.2

b) Inventory 4572.58 96.3

c) Accounts payable 7952.92 -

d) CLIB (a+b)-c 1340.2 1922.5

e) Idle Cash 38134.30 1124.1

f) Total Idle Cash (d+e)

39474.5 3046.6

Cash Lurking in the Business (CLIB)

Current Assets Optimality

Policy Liquidity Profitability Risk

A High Low Low

B Average Average Average

C Low High High

EVA- Value Drivers

Y 2003-04 Y2008-09 CAGR(%)

Sales (Cr) 33918.59 35811.92 1

Opex (Cr) 17201.52 25387.55 6.83

Current Assets(Cr)

27584.69 57748.61 13.09

Gross Block (Cr) 95287.89 132242.91 5.59

Net Fixed Assets (Cr)

62861.68 54320.88 (2.45)

WACC 0.12:0.88 0.04:0.96 Almost Unlevered

Value Creation- How BSNL Stacks up

EVA- Value Drivers

Y 2006-07 Y2008-09 CAGR(%)

Sales (Cr) 18519.6 36961.5 25.85

Opex (Cr) 11069.9 21773.7 25.24

Current Assets(Cr)

4171.4 9735.5 32.55

Gross Block (Cr)

27426.6 51622.1 23.44

Net Fixed Assets (Cr)

21060.4 37167.0 20.80

WACC 11.3% Kept lower

Value Creation-How Bharti Stacks up

Value Drivers BSNL performance Bharti performance

Sales Growth Stagnant Steep

Opex growth Moderate but Revenue growth < Opex growth

High but Revenue growth matches with the Opex growth

Opex as percent of Sales 70.89 % 58.91%

Current Assets Moderate High

CA as percent of Sales 160%> Sales

26.34%

CA( without Cash) as percent of Sales

54.77%Cash conversion

efficiency low

23.29%Cash conversion

efficiency high

Gross Block Low High

Net Block Negative growth; Old assets milked

Increase


How to achieve EVA >0?

Tighten working capital management- Use techniques like supply chain management, e-procurement etc in a big way


Put in place value based metric in project appraisal at the micro level to have a line of sight at the value creation at macro level (e.g NPV)


Reduce operating cost-The key is business process re-engineering- Have process groups instead of cadre groups in charge of every one thousand customers

FG2

FG3

FGm

FG1 C1

C2

C3

Cn PGn

PG3

PG2

PG1

CGn

CG3

CG2

CG1

m*n process flows n process flows

FG: Functional GroupC: Customer

PG: Process GroupCG: Customer Group


Capital spending need not be value creating Capital conserving can also be value

creating. Earn more profit without using more capital Invest capital in high return projects Identify the areas/products where capital has

not to be deployed /has to be deployed Value unlocking- Infrastructure sharing

Value Driver With Sharing – Impact

Without Sharing- Impact

Gross Revenue Given Given

Less OPEX (Excluding interest)

Decrease Increase

EBDIT Increase Decrease

Less Interest (only for a portion of the asset shared financing involved)

Decrease Increase

PBDT Increase Decrease

Less Depreciation (only for the shareable component)

Decrease Increase

PBT Increase and positive Decrease or/and negative

Probability of positive margin

High No or very low

Value Creation-Cost Sharing Vs Cost Non-sharing

Tenancy Ratio x 1.0x 2.0x 3.0x

Towers Nos 1000 1000 1000

Total Tenants Nos 1000 2000 3000

Rent per tenant per month Rs 32500 32500 32500

Recoverable charges per tenant per tower per month

Rs 21000 21000 21000

Total Rev Rs in Cr 64.2 128.4 192.6

Recoverable charges per tower per month

Rs 21000 21000 21000

Non recoverable expenses per tower per month

Rs 16000 16000 16000

Total Expenses Rs in Cr 44.4 69.6 94.8

EBITDA Rs in Cr 19.8 58.8 97.8

EBITDA margin (%) 31 46 51

Depreciation Rs in Cr 17.6 17.6 17.6

EBIT Rs in Cr 2.2 41.2 80.2

Interest Rs in Cr 14.6 14.6 14.6

PBT Rs in Cr -12.4 26.6 65.6

Tax Rs in Cr 0.0 9.0 22.3

PAT Rs in Cr -12.4 17.6 43.3

PAT margin (%) -19 14 22


Look at the capital structure-Is it optimal and value creating?


Introduce EVA linked compensation/ bonus at all operating and supervisory levels

New Developments- Impact on Value Creation

MNP MVNOs


Introduce Balanced Score Card approach as strategic and performance metric at all business unit levels-SSA, Circle, Corporate levels

Economic Value AddedAccounts Operatingreceivable expenses

Economic Value AddedAccounts Operatingreceivable expenses

Customer Satisfaction On-time delivery

Customer Satisfaction On-time delivery

Shorter Lowercycle time rework

Process quality

Shorter Lowercycle time rework

Process quality

Employee Employee Skills Employee suggestions morale

Employee Employee Skills Employee suggestions morale

Financial

Customers

Internal BusinessProcess

Learning andGrowth

Adapted from Kaplan and Norton (Jan-Feb 1996)

LEADING

Leading-Lagging

Continuum

LAGGING

Value Propositions

Value

Investment in Basic stagnant-Low capital

Base- Incremental capex sliding

Investment in Mobile /ADSL

not accelerated

Accumulating idle cash-No radical

growth ideas

Low cost debt retired- Moving towards

unlevered status-High WACC

Value Attrition Value opportunity lost

Old processes intact

Six sigma measures-Project /team work

processes not yet started

Market share 80%-At the decline phase of the life cycle-Still

focusing

Market share 20%-At the growth phase

of the life cycle-Not pushed enough

Self centric work culture- Still vertical

structure

Customer centric work culture not yet institutionalized

Growth

Competitive

Financials

Learning

Telcos-EVA values (Dec 2000)

Company Industry EVA ( in US $ thousands)China mobile,Hong kong

Wireless (1,817,509)

Sing Tel Fixed 590,855

Korea Telecom Fixed (1,023,279)

Telecom Malaysia Fixed (385,662)

China Unicom Wireless (435,969)

Chunghwa Telecom (Taiwan)

Fixed 523,962

Taiwan Cellular Wireless 149,200

Value creation in Telcos G.Alagarsamy Pr.CCA Tamil Nadu Circle.

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