Bond strategy

ACC's move to issue FCCBs fits well with plans for eastern market

Associated Cement Companies has issued foreign currency convertible bonds (FCCBs) and GDRs aggregating $100 million to fund the company's purchase of Bargarh Cement (formerly IDCOL Cement), modernisation of its Chaibasa plant and other capital expenditure.

This fits well into the company's strategy of expanding into more profitable markets like eastern India as well as improving supply chain efficiencies for its array of production facilities across the country.

Price fluctuations in the eastern markets have been much smaller than in other parts of the country in recent times.

This is primarily because surplus capacity in the east is approximately half that in the western markets.

This mismatch in capacity utilisation is set to narrow further in the east as demand is currently growing there at approximately 8 per cent compared with an all-India average of around 5.2 per cent.

And the better operating environment in the cast has helped companies to improve price realisations considerably "" rising from Rs 140 per 50 kg of cement in December to Rs 170 currently.

Analysts expect prices to pick up further in this region due to a number of large industrial projects being implemented there.

The expansion of clinkering capacity at Chaibasa unit (Jharkhand) to 1 million tonne would also help to ensure that ACC production facilities in other parts of the company have adequate inputs.

The Tikaria grinding unit (UP) has a capacity of 1.35 million tonne and it will be ramped up to 2 million tonne.

This unit sources clinker from Kymore in MP, and the expansion in capacity at the UP facility, would result in Kymore's inability to meet the needs of other production facilities at Sindri (Jharkahnd) and Damodhar (West Bengal). The expansion at Chaibassa would solve these supply bottlenecks.

What's more, ACC has also been able to finance its expansion plans at a an extremely competitive price "" Indian Hotels' $100 million convertible issue earlier this year was priced at a yield to maturity of 3.15 per cent with a conversion premium of around 15 per cent while ACC's issue was offered at an yield of 2.5 per cent despite having a conversion premium of 35 per cent.

On the flip side, a conversion would result in an equity dilution up to 8 per cent of the paid-up capital, much of which was already factored in by the markets.

A double whammy for VSNL

It's been a double whammy for VSNL this financial year - on the one hand, falling rates have eaten into its margins, while on the other, increased competition has led to a loss in market share.

As a result, the lower rates have not been offset by an increase in volumes, which used to happen in the days when the company enjoyed a monopoly.

But now the loss in market share has kept a check on the increase in volumes - thus, in the nine months ended December 2003, VSNL's revenues had fallen 34 per cent, while profit before exceptionals and tax fell even higher at 58 per cent.

What's more, there seems to be no reprieve for the company as rates will now drop to even lower levels. in the latest round of bidding, VSNL's competitors have bid lower settlement rates to BSNL.

VSNL has been outbid for major markets including the US, UK, Canada, West Asia and Southeast Asia, which account for over 70 per cent of the total ILD (international long distance) market.

VSNL still has the option of lowering rates to match that of competitors, in which case BSNL would continue to route its traffic through it.

While this would protect volumes to some extent, it would obviously be at the cost of much lower rates. VSNL's pre-tax margins have fallen from 27 per cent in FY03 to 17 per cent in the first nine months of this fiscal - there seems to be plenty of room for it to come down further.

The one redeeming factor for the company could be a higher proportion of revenues from value added services and new services like NLD (national long distance). But these currently form a small proportion of revenues.

Besides, being a new entrant in NLD and given the strong competition, the company is not expected to make big inroads in the NLD segment. On the positive side, the market value of the company's investments in Tata Teleservices and Intelsat has appreciated considerably.

While earnings are under pressure, the company's book value continues to be very high at around Rs 200 per share. Besides, the increasing customer base of Tata Teleservices helps VSNL as it gives it access to direct customers.

With contributions from Amriteshwar Mathur and Mobis Philipose