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
Value Creation- BSNL Vs 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%
ROI will increase by 1.7%
ROI will increase by 5.4%
ROI will increase by 1.9%
ROI will increase by 5.4%
ROI will increase by 2.1%
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
Value Creation- BSNL Vs Bharti
How to achieve EVA >0?
Tighten working capital management- Use techniques like supply chain management, e-procurement etc in a big way
How to achieve EVA >0?
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)
How to achieve EVA >0?
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
How to achieve EVA >0?
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
How to achieve EVA >0?
Look at the capital structure-Is it optimal and value creating?
How to achieve EVA >0?
Introduce EVA linked compensation/ bonus at all operating and supervisory levels
New Developments- Impact on Value Creation
MNP MVNOs
How to achieve EVA >0?
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
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