MTNL: Will it ring a bell?

SPECIAL REPORT/ Going by sheer numbers, MTNL does not seem to be a black sheep in the telecom sector

State-owned telecom firm Mahanagar Telephone Nigam (MTNL) is not the hottest pick in India's rapidly growing telecom market. Yet prospects of it being merged with Big Brother Bharat Sanchar Nigam (BSNL), the country's largest service provider, have compelled market participants to change their ring tones.

Analysts are still weighing cost-benefits of such a merger. But they cite gains from the inter-connect (IUC) regime, introduced in February 2004, as a big plus. For now, concerns about market-share losses due to competition from private players seem to be relegated to the background, especially as the company declared a 30 per cent growth in profits last fiscal.

Analyst say the stock is undervalued based on FY05 earnings estimates, and a possible merger could only mean further upsides for the scrip.

MTNL is a telecom service provider in Delhi and Mumbai with a subscriber base of 62.9 lakhs (including fixed and cellular). It derives its revenues from fixed-line services in local and national long-distance telephony, which include charges for calls made out of its fixed-line and for wireless calls that terminate at its end (called access deficit charges or ADC). On the other hand, the company pays similar charges to wireless operators for its calls that terminate at mobile operators' end.

Last year, MTNL clocked revenues of Rs 6,684 crore and net profits of Rs 1,150 crore. Net profit was up 31 per cent on a year-on-year basis while sales were up 10 per cent. Net profits were accentuated by gains from the IUC regime and consequent savings in cost.

As per the IUC regime, MTNL would get termination charges from wireless and fixed-line players in the ILD and NLD segment. As regards to local calls, MTNL receives termination charges only from wireless operators. ADCs, which are a part of termination charges, have been reduced in the new regime - from Rs 3 to an average of Re 1 in the case of NLD and from Rs 5 to Rs 4.25 for ILD.

For the quarter ended March 31, 2004, MTNL's revenues growth (sequential) was impacted due to lower termination/ADC payments on NLD and ILD apart from lower ILD origination rates. However, some of this impact was offset by lower termination payments to other networks.

Analysts feel MTNL has gained significantly from the IUC regime. Rahul Singh, vice president, SSKI Stock Broking, however, believes that one of the key drivers for MTNL will be the rise in traffic. "With the fixed-line traffic in metros increasing, MTNL's revenues will improve," he says. The company's fixed-line subscribers in March 2004 stood at 59 lakhs.

In subsequent quarters, it will benefit from stable long-distance rates, higher retention on ILD origination, a 200 basis-point fall in license fees and a possible VRS, Singh adds.

After rigorous cuts in the past one year or so, long distance rates are expected to stabilise. Revenues in future would be governed by traffic growth. "We expect robust traffic growth in NLD/ILD on account of price elasticity and narrowing of price differential vis-à-vis wireless," says Singh.

The impact of rate revision on NLD profitability during FY05 will be made up by higher retention on ILD origination calls. MTNL's average retention on ILD calls has increased even after the recent tariff cuts.

The impact of line losses (surrendering of fixed lines) and declining tariffs has been neutralised by an astounding growth in traffic, mainly triggered by the increased mobile subscriber base. Analysts expect traffic to accelerate further with a strong growth in wireless subscriber base.

The 200 basis-point cut in licence fee would save MTNL Rs 110 crore, which is almost equal to its FY04 profits. There could be another revenues stream coming the company's way. The Telecom Regulatory Authority of India (TRAI) is likely to announce its recommendations on local-loop unbundling for broadband access in a while.

Given its ownership of last-mile copper, revenue sharing with third-party broadband access providers would enhance revenues over the next one-two years.

Besides, MTNL is seeking new circles for business in overseas markets like Mauritius and Rwanda. "This will augur well for the company in the long-term," says Anant Katare, analyst with Khandwala Securities.

Concerns persist

But then, there is a larger concern for the company - its inability to retain customers. MTNL has been losing out to its private peers for two reasons. Firstly, with mobiles tariffs coming down rapidly, fixed-line additions have suffered.

Secondly, the wireline service, which constitutes about 97 per cent of MTNL's revenues, has been facing severe competition from private players who have targeted the company's high-end customers. According to estimates, these high-end customers account for only around 12 per cent of lines, but almost 50 per cent of call revenues.

Besides, MTNL is still unable to beef up its mobile business. Till now, MTNL's capacity constraint restricted expansion of the customer base for its cellular service. In May 2004, the company's cellular subscriber base stood at 3.9 lakhs. MTNL's capacity expansion in July 2004 is expected to improve the situation to some extent.

Going forward, the wireless services business is expected to grow at a fast pace, with the company set to add 1.6 million lines in the wireless space this year.

For now, revenues from the cellular business accounts for just around 3 per cent of total revenues. Analysts expect this number to rise but it may take quite some time before it adds up to a substantial portion of profits.

Another contentious issue has been staff costs. Staff costs for the year ended March 31, 2004, stood at 25.4 per cent of sales (Rs 1,619.37 crore). The company cleared a VRS scheme last year which was expected to cut staff strength by 18 per cent and add Rs 100-150 crore to operating profits. But the fate of the scheme still remains uncertain. "The VRS issue may cap some gains for MTNL," says Katare.

Concerns about competition and lack of initiatives to make the firm more efficient have depressed sentiment at the MTNL counter. But the future does not look as bleak, going by the company's business potential and market position.

Analysts expect an earnings growth of 10-15 per cent for FY05, which translates into earnings per share of Rs 20-21. "The stock is attractive at current levels," says Singh after taking into account the stability in revenue streams and the potential value unlocking from a cut in head-count.

At levels of Rs 130, the stock trades at a P/E of 6.5 discounted for FY05 earning and look like a bargain buy.