initiating coverage: “lost story securities private...

MTNL Initiating Coverage: “Lost Story-but Hidden Value”

June 8, 2011

Beraam Gazdar

[email protected]

+91.22.6154.4530

Mansi Desai

[email protected]

+91.22.6154.4509

Market Data Rating HOLD

Price ( 7 Jun’11) INR 45

52 Week Range INR 74/ INR 38

Target Price INR 45

Upside(Downside) potential

0%

Div yield (Mar12) 0%

Expected Total Return 0%

Outstanding Shares Mn 630

Mkt. Cap INR Mn 28,602

Mkt. Cap US$ Mn 630

Net Debt INR Mn -33,372

Free float 25%

Returns Sensex MTNL 1 Month 0% 0%

3 Months 2% 11%

6 Months -7% -15%

1 Year 12% -18%

YTD -9% -17%

Shareholders % Holding

Govt. of India 56%

LIC 19%

Others 25%

Sensex vs. MTNL

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© MAPE Securities Private Limited. For private circulation only. Please read important disclaimers on the last page. This document has been prepared from publicly available information and is not an investment advice.

Investment Thesis

Base Case Valuation

Our base case DCF valuation of MTNL on considering as is operations, a marginal reduction in the number of employees of 1,250 per year and improved collection of broadband revenues yields no upside potential from the current market price. Unless the Government of India (GoI) and the Department of Telecom (DoT) help MTNL through financial and other support, the company is likely to destruct further value through operational losses primarily because of high employee costs.

Upside potential for the stock through unlocking value of its assets

Although most of the steps required for unlocking the true potential of its assets are difficult to execute, we believe the GoI and the DoT have been considering a number of measures to help the company stem its operating losses and effect a turnaround, thereby creating upside potential. If all aspects are taken care of, the stock can have a significant re-rating.

→ Franchising or sale of its BWA (Broadband Wireless Access) spectrum, for which the company paid INR 45 Bn in license fees, could unlock upto INR70/share

→ One time grant and support of INR 20 Bn to INR 30 Bn from GoI/DoT for a VRS Program in MTNL which would help reduce its employee count by 15,000 could provide an upside of INR 27/share

→ Use of property and land owned by MTNL in Delhi and Mumbai could offer an upside of INR 1/share

→ A merger with BSNL, coupled with an overall reduction in employees by 25-30% could make the merged company as valuable as Idea Cellular or Reliance Communications or larger, thus providing more upside. We estimate the merged entity to have a market capitalization of INR 595 Bn.

→ Another proposed merger with ITI Limited would enhance revenue streams and enable to reduction of costs of equipment for the entities, although no financial upside/downside can be calculated immediately

BSNL and MTNL merged financials

We have put together a basic financial analysis of a merged BSNL and MTNL (without including ITI in the merger). On a base case basis, the combined entity would have a national presence in 2G, 2.5G, 3G wireless through GSM technology (with 91 Mn users), broadband and landline telephony (landline network of 43 Mn users) besides BWA (or 4G) network which is to be launched in 12-18 months. It would be a full service telecom network operator (similar to China Telecom) and would effectively become the second largest phone company in India.

Minority shareholders in MTNL will own 3% in the combined entity and would benefit for the synergies of the joint operations, which would result in a profit making business valued in the range of US$ 14-15 Bn.

Initiating Coverage with Cautionary Stance

We initiate coverage on MTNL with a HOLD rating, with upside potential if the Government provides financial support for its VRS process to be successful. A merger with BSNL and its potential upside for MTNL shareholders will depend on the merger ratio, which should be determined by the Government based on sound financial analysis of the two businesses. If the combined entity is fairly valued, it would be larger than RCOM and Idea Cellular and should be trading in line with regional telecom incumbent operators such as China Telecom and Singapore Telecom. Telecom etc. providing at least 25-30% upside, if not greater.

Initiating Coverage

Securities Private Limited


Telecom MAPE Securities Private Limited

We initiate our coverage with a HOLD rating on MTNL, with a Target Price of INR 45, with no upside potential using DCF. We believe that MTNL is at a significant disadvantage as compared to its peers for the following reasons: → Large number of employees and employee related costs as compared to its peers affects

MTNL’s profitability. MTNL’s Employee Cost/ Total Service Income was 47%, 76% and 87% in FY2009, FY2010 and FY2011 respectively-considerably higher than the average of its peers at 6% and 5% for FY2009 and FY2010.

→ Poor operational efficiency of MTNL as compared to its peers. As of FY2010, MTNL had 243 Revenue Generating Units (RGUs) per Employee vs. 6,736 RGUs per Employee of its peers. In FY2010, MTNL had 44,910 employees for providing services in Mumbai and Delhi alone, 2.45 times the total number of employees in Bharti Airtel (which provides services across the nation), but only 11 Mn Revenue Generating Units (RGUs) only 8% of Airtel’s RGUs in FY2010.

→ MTNL’s low network utilization rate for wireline operations in Delhi and Mumbai due to cannibalization by wireless services by private operators directly affects top line revenue growth. As of FY2010, wireline utilization rates for Delhi and Mumbai were 55% and 72% respectively. We do not see any significant reasons or drivers for wireline utilization rates to increase in the near future.

→ Wireless penetration levels in Delhi and Mumbai are near saturation levels and close to 150% on an active subscriber base. With limited growth prospects and significant dominance by private wireless operators in these metros, we do not expect MTNL to gain market share from its competitors for either 2G or 3G services. In fact, MNL has been losing market share in Delhi and Mumbai on a combined basis from 12% in FY2009 to 9% in FY2010 and 7% in FY2011. Further, the uptake of 3G services may not be significant due to MTNL’s low ARPU paying subscribers.

In FY2012, MTNL had INR 22,027 Mn in revenues from Basic Telephone services which accounted for nearly 59% of Total Service Revenues down from 68% in FY2008. We believe that, MTNL’s revenue basket is significant skewed towards the legacy wireline business which has negative growth and falling usage ARPUs. We expect the ARPU (from call charges) to fall from INR 186 per month in FY2010 to INR 167 per month by FY2014. Rental ARPU is also expected to decline from INR 223 per month in FY2010 to INR 201 in FY2014. In our base case scenario, we do not expect any significant impact in operational efficiency levels, nor do we expect an increase in market share and other cost control measures post its merger with Bharat Sanchar Nigam Ltd (BSNL). Unbundling of the Local Loop (ULL) whenever it happens will act as a negative catalyst to MTNL since all Internet Service Providers (ISPs) and other Telecom operators will have an access to provide broadband services to MTNL’s existing subscriber base with an average Broadband ARPU of INR 576 as of FY2010. We maintain our base case estimate that MTNL will remain EBITDA and FCF negative for at least next 4 to 5 years due to the burden of substantial employee costs and investors should not expect dividends for the next 3-4 years. We forecast employee costs to be in the range of INR 33.0 Bn to INR 35.5 Bn, which translates to 87% to 76% of total Income from Services for the period FY2012e to FY2014 after reducing ~ 1,250 employees per year (includes employees who have either retired or have opted for voluntary retirement). We do not expect any significant positive changes from operations from FY2011 to FY2014 which would change our forecasts.


MAPE Securities Private Limited MTNL

We estimate that, from FY2011 to FY2014, MTNL will spend most of its growth capex on wireless and broadband services and negligible maintenance capex towards the low growth legacy wireline business. Excluding the onetime 3G and BWA spectrum costs of INR 110 Bn which MTNL spent in FY2010, the Capex/Service Income was 33% (capex of INR 11.9 Bn) in FY2010 and is expected to 29% in FY2012 (capex INR 11.5 Bn as per company guidance). Upside Opportunities:

We believe that there are a few key measures which (if accepted by GoI and in some cases, if implemented by MTNL) might play an important role in driving the stock price of MTNL. These are discussed in depth in the below section. Franchising of 3G Spectrum and or sale of BWA Spectrum

In FY2010, MTNL’s average ARPU from wireless subscribers in Delhi and Mumbai was 38% lower than the national average ARPU of INR 211. We do not believe that MTNL’s subscriber base would avail data services to an extent that would result in the 3G network being utilized to its full extent. We believe that MTNL could enter into a strategic alliance with other private operators or a marketing agency to sell 3G services in Delhi and Mumbai through an MVNO arrangement, provided the Telecom Ministry, DoT, TRAI give necessary permissions. This arrangement would drive new sources of revenue for MTNL for the next 3-4 years. As per its recent announcement, MTNL is not expected to pursue the development of Wimax and we expect that MTNL will either return the BWA spectrum back to GoI and receive cash compensation or auction the BWA spectrum, depending on the guidelines from the New Telecom Policy 2011 (NTP’11) and the committee on the management of natural resources, headed by Mr. Ashok Chawla. If this materializes, we expect a onetime profit/cash inflow of INR 45 Bn or more from returning of the BWA spectrum. This will further add INR 71 per share of MTNL. Reduction in number of employees and Voluntary Retirement Scheme (VRS) Program payments to be made by GoI

With 44,910 employees in FY2010 for a total RGUs of 11 Mn (inclusive of wireline, wireless and broadband), MTNL has to 243 Revenue Generating Units per Employee (RGU/ Employee) as against the industry average of 6,736 RGUs/Employee. In FY2010 employee costs (excluding the one-off payments of arrears of INR 21,298 Mn) at INR 28,388 Mn was 76% of the Total Income from Services and 87% in FY2011 with employee costs at 32,433 Mn extremely high for any telecom service provider. We believe that MTNL is likely to offer the VRS Program to non-core and support staff, following which MTNL will offer the VRS Program to employees who have become redundant due to advancement in technology evolution. If MTNL manages to reduce around 6,000-7,000 employees within the next 3-4 years subject to GoI approval, and if this trend continues over the next 6-7 years, MTNL will have an employee base of 15,000 to 18,000 employees. If the recently announced VRS Program for nearly 15,000 employees is implemented in early FY2012, we expect substantial amount of savings in employee costs over 3 years. MTNL is expected to save IN 23,404 Mn in the next 3 years which works out to be INR 27 per share on a present value basis. MTNL is expected to receive support from GoI in financing the VRS Program for 15,000 employees through onetime payment of INR 20-30 Bn. In this process, we estimate a savings of INR 20 per MTNL share which is in addition to the savings of INR 27. Leasing Space for Commercial use

MTNL has Telephone Exchanges across both these cities in prime areas of Delhi and Mumbai. Any program of densification of employee seating arrangements and relocation of non-core staff to other premises, would lead to releasing substantial amounts of commercial space



which MTNL could lease out for rental income, subject to approvals from the Telecom Ministry approval and local development authorities. In a recent instance, MTNL has released 20,000 Sq. ft of space in one of its telephone exchange in Delhi. MTNL had 554 Exchanges/RLUs as of FY2010 across Delhi and Mumbai and if we assume that 5% of the Exchanges/RLUs have the potential of releasing 20,000 Sq ft space post densification, we have a total 1 Mn Sq. ft available. This could lead to INR 530 Mn in additional annual revenues for MTNL @ a lease of INR 80 /Sq. ft per month. Merger with Bharat Sanchar Nigam Ltd (BSNL)

We expect the merger between MTNL and BSNL being contemplated by the Telecom Ministry, to yield numerous benefits to a small telecom operator like MTNL. The merged entity would be able to offer its retails and corporate customers national services with end to end connectivity. BSNL’s wide spread rural connectivity in wireline and wireless business along with MTNL’s presence in two major metros of Delhi and Mumbai would form a strong platform for converged services at competitive rates. The merged entity could be able to offer wireless voice and data services without any roaming charges. This might act as a significant market disruptor and could help MTNL regain lost market share in the wireless business. In FY 2010, MTNL’s capex (excluding the spectrum charges) was INR 11.8 Bn a mere 4% of BSNL’s capex of INR 288 Bn, which was mainly driven by broadband and wireless expansion. MTNL, post its merger with BSNL would be in a better position to enjoy economies of scale in procurement, spares management, and unified billing and operations. The joint subscriber base of MTNL and BSNL was 113 Mn in FY2010, of which 62% were wireless subscribers, 27% traditional wireline users, 6% broadband and the remaining 6% WLL. Considering residential broadband penetration at 5-6% in India, which is quite low as compared to other emerging countries, we expect the joint entity will be in the best position to gain from the broadband revolution in India mainly because of its existing reach and rural connectivity/presence. Post the merger with BSNL, GoI would be compelled to support the pension program for MTNL like it has being doing for BSNL. With the merged entity having close to 337,010 employees, we are extremely positive that GoI will support multiple VRS programs at regular intervals in various phases to rationalize manpower. On a combined basis, employee costs would be much lower in terms of Employee Costs/Revenues as compared to a standalone basis for MTNL. We expect post-merger EBITDA margins to be in the range of 23% without considering any synergies. Implementation of previously mentioned measures like Pension and VRS Programs, lease of excess commercial space, franchising and sharing of 3G/BWA spectrum will see a further boost to EBITDA margins of the combined entity. Interconnect charges between MTNL and BSNL are also expected to reduce, which will further expand EBITDA margins.



Operating Metrics of Merged Entity: Exhibit 1: MTNL and BSNL merger

Details as of FY2012E MTNL BSNL Combined Entity

Subscribers.

Wireline Subs. (000) 3,438 23,724 27,162

Wireless Subs. (000) 5,917 103,589 109,505

Broadband Subs. (000) 1,249 8,097 9,346

WLL 299 4,800 5,099

Total 10,903 140,210 151,112

ARPU

Wireline INR 455 INR 211 INR 242

Wireless INR 99 INR 116 INR 115

Broadband INR 480 INR 404 INR 414

WLL INR 40 INR 70 INR 68

Avg. ARPU INR 302 INR 186 INR 194

Employees 42,410 276,620 319,030

RGUs / Employee 257 507 474 Source: Company Data

Exhibit 2: Revenues, EBITDA and Capex of Merged Entity:

Details as of FY2012E MTNL BSNL Combined Entity

Revenues

Wireline 18,793 60,086 78,878

Wireless 7,003 144,334 151,337

Broadband 7,193 39,216 46,409

WLL 142 4,022 4,165

Other Services 6,362 64,959 71,321

Total 39,493 312,617 352,109

EBITDA (5,971) 85,253 79,283

EBITDA margins as a % Income from operations -15% 27% 23%

Capex (11,500) (78,154) (89,654)

Capex/ Operating Revenues 29% 25% 25% Source: Company Data

BSNL and Merged Entity Valuation:

We value BSNL and the merged entity using DCF Method and by EV/Sales and EV/EBITDA multiples as shown in the below exhibits. Multiples used are the medians of domestic telecom peers with an applicable discount considering that BSNL and the merged entity are PSUs and other issues related to low efficiency levels, reducing market share, GoI interference, excess staffing and problems related to VRS and Pension pay outs. We have not quantified any synergies from the merged entity and any synergies which are sure to emerge will act as an additional benefit. If BSNL and the combined entity have to pay for onetime Spectrum charges, since both these entities in the merged form hold wireless spectrum in excess of 6.2 MHz, we estimate a reduction in the target price by INR 12.7 per share for BSNL on a standalone basis and a reduction of INR 15.0 per share for the combined entity.



Exhibit 3: Option1: DCF Valuations of MTNL and BSNL:

MTNL Amt. INR Mn Per Share

Cash 33,372 INR 53

EV using DCF (5,151) -INR 8

Shares Oustanding Mn 630

INR 45

Market Cap INR Mn 28,221

Market Cap US$ Mn 638

BSNL Amt. INR Mn Per Share

Cash 288,097 INR 52

EV using DCF 278,319 INR 50

Shares Oustanding Mn 5,550

INR 102


Market Cap US$ Mn 12,815 Source: Company Data, MAPE Estimates

We forecast the EV of BSNL to be INR 278 Bn using DCF methodology with 15.6% WACC and the estimated market capitalization of BSNL to be INR 566 Bn with a swap ratio of 2.28 shares of MTNL for every 1 share of BSNL. This leads to dilution of just 5% in BSNL and the total outstanding shares increasing from the 5,500 Mn in BSNL as a standalone entity to 5,827shares for the merged entity of BSNL and MTNL. The merged entity is expected to have market capitalization of INR 595 Bn (excluding the one off spectrum charges if applicable to be paid by the joint entity). The shareholding pattern of the merged entity will be 98% held by GoI and the remaining 2% held by LIC and other minority shareholders. We expect that GoI will reduce its shareholding in the joint entity and for every 10% stake diluted, GoI will receive INR 60 Bn (US$ 1.35 Bn) Exhibit 4: Holding Structure in MTNL, BSNL and Joint Entity

MTNL BSNL

GoI 354 5,550 5,706

LIC 119 - 52

Others 157 - 69

Total 630 5,550 5,827

GoI 56% 100% 98%

LIC 19% 1%

Others 25% 1%

Total 100% 100% 100%

% Dilution 10%

INR Bn 59.46

US$ Bn 1.35

Current Shareholding New Shareholding

Jt Entity BSNL and MTNL

Source: Company Data MAPE Estimates

Merged Entity Amt. INR Mn Per Share

Cash 321,469 INR 55

Charges for Excess Spectrum - INR 0

EV using DCF 273,168 INR 47

Shares Oustanding Mn 5,827

% Dilution in BSNL 5% INR 102


Market Cap US$ Mn 13,453



Option 2: EV/Sales and EV/EBITDA Multiples with various discount levels. We also value BSNL using FY2012e EV/Sales and EV/EBITDA multiples of its domestic peers shown in the below Exhibit 5. The below exhibits show the matrix of the implied Target Price of BSNL and the merged entity at various discount levels of FY2012e EV/Sales and EV/EBITDA multiples to its domestic peers. By superimposing the DCF based Target Prices of BSNL and the merged entity on the below exhibits individually, we estimate that the market is expected to discount the FY2012e EV/Sales and EV/EBITDA multiples by 50% for valuing BSNL and the merged entity as compared to its domestic peers.

Exhibit 5: BSNL Valuation using EV/Sales and EV/EBITDA Multiples (FY2012)

FY2012E

Revenues INR Mn

FY2012E

EBITDA INR Mn

FY2010

Cash Mkt Cap. INR Mn Mkt Cap. INR Mn Shares Mn Target Price Target Price

312,617 85,253 288,097 5,550

EV/ Sales

Multiple

EV/EBITDA

Multiple

Implied

Market Cap.

Implied

Target Price.

Multiples ----> 1.73 7.19 INR Mn

Using Using Using Using Using Using

EV/Sales EV/BITDA EV/Sales EV/BITDA EV/Sales EV/BITDA

10.0% 487,274 551,505 775,371 839,602 INR 140 INR 151

20.0% 433,132 490,226 721,229 778,323 INR 130 INR 140

30.0% 378,991 428,948 667,088 717,045 INR 120 INR 129

40.0% 324,849 367,670 612,946 655,767 INR 110 INR 118

50.0% 270,708 306,392 558,805 594,489 INR 101 INR 107

60.0% 216,566 245,113 504,663 533,210 INR 91 INR 96

70.0% 162,425 183,835 450,522 471,932 INR 81 INR 85

80.0% 108,283 122,557 396,380 410,654 INR 71 INR 74

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Source: Company Data, Bloomberg, MAPE Estimates

Note: Considering if one time Spectrum fees of INR 70 Bn will have to be paid by BSNL since it has Spectrum above 6.2 MHz, we expect a

further reduction of INR 12.7/BSNL share

Source: Company Reports, Bloomberg, MAPE Estimates

Exhibit 6: Merged Entity Valuation using EV/Sales and EV/EBITDA Multiples (FY2012)

FY2012E

Revenues INR Mn

FY2012E

EBITDA INR Mn

FY2010

Cash

Mkt Cap.

INR Mn

Mkt Cap.

INR Mn

Shares

MnTarget Price Target Price

352,109 79,283 321,469 5,827

EV/ Sales

Multiple

EV/EBITDA

Multiple

Implied

Market Cap.

Implied Target

Price.

Multiples -----> 1.73 7.19 INR Mn

Using Using Using Using Using Using

EV/Sales EV/BITDA EV/Sales EV/BITDA EV/Sales EV/BITDA

10.0% 548,831 512,880 870,300 834,349 INR 149 INR 143

20.0% 487,850 455,893 809,319 777,363 INR 139 INR 133

30.0% 426,868 398,907 748,338 720,376 INR 128 INR 124

40.0% 365,887 341,920 687,357 663,389 INR 118 INR 114

50.0% 304,906 284,933 626,375 606,403 INR 108 INR 104

60.0% 243,925 227,947 565,394 549,416 INR 97 INR 94

70.0% 182,944 170,960 504,413 492,429 INR 87 INR 85

80.0% 121,962 113,973 443,432 435,443 INR 76 INR 75

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Note: Considering if one time Spectrum fees of INR 87.5 Bn will have to be paid by the combined entity since it has Spectrum above 6.2 MHz,

we expect a further reduction of INR 15.0/Combined entity share

Source: Company Reports, Bloomberg, MAPE Estimates



Merger with ITI

In April 2011, the GoI’s proposed the merger of ITI with the merged entity of MTNL and BSNL.. ITI offers complete range of telecom products and total solutions covering the whole spectrum of Switching, Transmission, Access and Subscriber Premises equipment, Digital invertors, SMPS, etc. for commercial and defense. ITI is diversifying into ICT and focusing on convergence services and solutions to its clients for providing Network Management Systems (NMS), Encryption and Networking Solutions. The merged entity of MTNL, BSNL and ITI would be able to provide integrated connectivity and end to end solutions including systems integration to its customers. Currently ITI employs a total of 12,745 employees focused on manufacturing, R&D, servicing, marketing and systems integration and other support activities including administrative and financial departments. We value ITI using Price/Sales multiples of its global peers since it is generating negative EBITDA since FY2010 and FY2011.

Exhibit 7: ITI valuation using EV/Sales and EV/EBITDA Multiples (FY2011)

FY2011

Revenues INR Mn

FY2011

Net DebtMkt Cap. INR Mn Shares Mn Target Price

21,022 3,302 269

EV/ Sales Multiple Implied Market Cap.Implied Target Price.

INR Mn

Multiples -----------> 1.07

Using Using Using

EV/Sales EV/Sales EV/Sales

10.0% 20,244 16,943 INR 63

20.0% 17,995 14,693 INR 55

30.0% 15,746 12,444 INR 46

40.0% 13,496 10,195 INR 38

50.0% 11,247 7,945 INR 30

60.0% 8,998 5,696 INR 21

70.0% 6,748 3,446 INR 13

80.0% 4,499 1,197 INR 4

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Valuation: DCF

We have used two methods to determine MTNL’s Target Price: DCF and Price/Sales. DCF Assumptions: Rolling WACC 15.5%, Beta 1.27, Risk Free Rate 8.0%, Mkt. Risk Premium 6.0%, and Terminal Growth rate 5%.

Exhibit 8: MTNL DCF Valuation DCF FY2012E FY2013E FY2014E FY2015E Y2016E FY2017E

Operating profit (22,401) (23,249) (24,026) (21,810) (20,483) (18,001)

Depreciation 16,430 17,463 18,187 18,757 19,159 19,444

Cash taxes - - - - - -

Working capital 19,006 (4,278) 9,739 9,890 10,305 10,647

Net capital expenditure (11,500) (10,237) (10,266) (9,934) (9,800) (9,822)

Net acquisitions - - - - - - TV

Free cash flow (FCF) 1,536 (20,301) (6,366) (3,098) (819) 2,268 22,427

Tax shield on interest payable 1,132 1,132 1,132 1,358 1,585 1,585

PV of FCF 2,365 (14,697) (3,471) (998) 380 1,652 9,618

Total value of FCF (5,151)

Net Debt (33,372)

Equity 28,221

Shares Outstanding Mn 630

Value per share INR 45 Source: Bloomberg, Company Data, MAPE estimates



Financial Statements (MTNL)

(All values in INR Mn, unless otherwise specified)

Profit & Loss Statement. FY2010 FY2011 FY2012E FY2013E FY2014E

Revenues 51,132 39,512 44,847 47,066 49,583

% growth -22.7% 13.5% 4.9% 5.3%

EBITDA (16,428) (9,615) (5,971) (5,786) (5,839)

D&A (17,720) (14,160) (16,430) (17,463) (18,187)

EBIT (34,148) (23,775) (22,401) (23,249) (24,026)

PBT (34,178) (28,294) (26,929) (27,776) (28,554)

Net Income (26,104) (28,268) (26,929) (27,776) (28,554)

Retained Earnings (23,524) (28,268) (26,929) (27,776) (28,554)

EPS -INR 41.4 -INR 44.9 -INR 42.7 -INR 44.1 -INR 33.3

DPS INR 0.0 INR 0.0 INR 0.0 INR 0.0 INR 0.0

Outsanding Shares Mn 630 630 630 630 1,083


Cash Flow Statement FY2010 FY2011 FY2012E FY2013E FY2014E

Operating Cash Flow 111,523 (7,481) 8,508 (14,591) (628)

Capex (122,866) (8,000) (11,500) (10,237) (10,266)

Sale of fixed assets 55 0 0 0 0

Free cash flow (11,288) (15,481) (2,992) (24,829) (10,894)

Investing cash flow as

reported (110,082) (8,000) (11,500) (10,237) (10,266)

Non-operating cash flow (707) 43,064 0 0 20,000

Net cash inflow/outflow 734 27,583 (2,992) (24,829) 9,106

Key Performance Indicators FY2010 FY2011 FY2012E FY2013E FY2014E

Wireline Subs. (000) 3,497 3,464 3,438 3,420 3,406

Wireless GSM Subs. (000) 4,784 5,199 5,917 6,680 7,495

Broadband Subs. (000) 816 942 1,249 1,603 2,010

Source: Bloomberg, Company Data, MAPE estimates


Balance Sheet Statement FY2010 FY2011 FY2012E FY2013E FY2014E

Cash & equivalents 48,910 76,493 73,501 48,672 57,779

Accounts receivable 7,495 6,781 6,560 6,594 6,810

Inventories 1,597 1,579 1,708 1,615 1,674

Other 108,175 111,231 123,992 120,040 126,641

Current Assets 166,177 196,084 205,761 176,922 192,904

Gross Block 172,980 180,980 192,480 202,718 212,983

less depreciation (107,470) (111,457) (117,714) (125,004) (133,018)

Intangibles 100,807 90,634 80,461 70,288 60,115

Investment in affiliates 3,850 3,850 3,850 3,850 3,850

Other 11,906 11,906 11,906 11,906 11,906

Fixed Assets 182,073 175,913 170,983 163,757 155,836

Total Assets 348,250 371,997 376,743 340,679 348,739

ST Borrowings 0 0 0 0 0

Accounts payable 15,959 15,670 16,848 15,861 16,376

Due to related parties

Other 237,964 247,231 277,727 270,427 286,526

Current Liabilities 253,923 262,901 294,575 286,287 302,902

LT Borrowings 85 43,121 43,121 43,121 43,121

Other 0 2 2 2 2

Long-term Liabilities 85 43,123 43,123 43,123 43,123

Minority Interest 0 0 0 0 0

Shareholders Funds 94,241 65,973 39,045 11,268 2,714

Total funds employed 94,241 65,973 39,045 11,268 2,714

Total Liabilities 348,250 371,997 376,743 340,679 348,739



Annexure:

Wireline Business KPIs: Subscribers, Utilization rates, ARPU and Revenues

We estimate the Wireline Subscribers of MTNL to drop from 3.5 Mn in FY2010 to 3.2 Mn in FY2014e at -1% CAGR. This is mainly due to cannibalization from wireless service providers and new wireline operators who provide services in few high ARPU pockets and business districts of Delhi and Mumbai. We do not see any reason for MTNL’s traditional legacy wireline business to grow in terms of subscribers, ARPU and revenue considering the highly competitive market for business connectivity and telephony in metros.

Exhibit 9: MTNL Wireline (Delhi and Mumbai): Subscribers and Utilization rate (FY2008-FY2014e)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0

500

1,000

1,500

2,000

2,500

FY2008 FY2009 FY2010 FY2011 FY2012e FY2013e FY2014e

Delhi Mumbai Delhi (Utilisation rate) Mumbai (Utilisation rate)

Source: Copany Data, MAPE Estimates

MTNL’s wireline network utilization rates in both Delhi and Mumbai was quite low at 56% and 73% respectively in FY2011, and we do not see any reasons for this utilization rate to increase substantially so as to turnaround the wireline business and to MTNL as a whole. MTNL’s wireline revenues from Rentals and Call charges are expected to decline with 4% CAGR (FY2010-FY2014e). We forecast the rental revenues to decline from INR 9,462 Mn in FY2010 to INR 8,048 Mn in FY2014e. Similarly, we expect revenues from Call charges to decline from INR 7,887 Mn in FY2010 to INR 6,607 Mn in FY2014e.

Exhibit 10: MTNL Wireline (Delhi and Mumbai): Capacity, Subscribers and Utilization rate (FY2008-FY2014e)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0

1,000

2,000

3,000

4,000

5,000

6,000


Wireline Capacity Wireline Subscibers (000) Wireline Utilization rate %




Exhibit 11: MTNL Wireline ARPU and Revenues (FY2008-FY2014e)

INR 0

INR 100

INR 200

INR 300

INR 400

INR 500

INR 600

INR 700

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000


Basic Telephone Revenues Blended ARPU (incl. Rental, Call, I/C)


We do not expect the percentage mix of revenues from the various fixed line wireline business units to change much over the next 3-4 years. We forecast revenues from Rentals and Call charges to contribute in the close range of 43% and 36% respectively for the next three to four years.

Exhibit 12: MTNL Wireline Revenue breakup (FY2008-FY2014e)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


Rentals Calls & Other Charges Franchises Services Rent & Junction Interconnection


Wireless Business KPIs: Subscribers, Utilization rates, ARPU and Revenues

We believe that MTNL is at a significant disadvantage vs. its competitors in metros who have close to national presence in providing wireless services. Various other factors like: interference from Govt. of India (GoI) and various Ministries in day-to-day operations and administration along with hindrances in procurement procedures for increasing telecom infrastructure capacity have seriously dented MTNL’s market competitiveness.



Exhibit 13: MTNL Wireless Subscribers in Delhi and Mumbai and Network Utilization (FY2008-FY2014e)

0%

20%

40%

60%

80%

100%

120%

140%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500


Delhi Mumbai Delhi (Utilisation rate) Mumbai (Utilisation rate)


MTNL has presence in Delhi and Mumbai which has wireless penetration levels of 160% on an active subscriber base as on FY2011, which makes it difficult for MTNL to gain wireless subscribers in the highly competitive well penetrated metros of Delhi and Mumbai. Although wireless GSM subscribers of MTNL had increased from 2.5 Mn in FY2007 to 5.4 Mn in FY2011 at a 21% CAGR(FY2007-FY2011), its competitors have grown from 19.4 Mn in FY2007 to 68.1 Mn in FY2011 at a 37% CAGR (FY2007-FY2011). Thus, MTNL’s market share in Delhi and Mumbai on a combined basis declined from 12% in FY2007 to 7% in FY2011.

Exhibit 14: MTNL Wireless Market Share in Delhi and Mumbai combined (FY2007-FY2011)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

FY2007 FY2008 FY2009 FY2010 FY2011

Bharti Airtel RCOM Idea Vodafone MTNL Others


In the last three years, MTNL’s wireless ARPU has been at a 35% to 38% discount to the national average wireless ARPU and we forecast that this will trend to continue from FY2011 to FY2014e. MTNL’s wireless ARPU declined from INR 233 in FY2008 to INR 130 in FY2010 and during the same period the average wireless ARPU across India declined from INR 358 to INR 211. This signifies that MTNL has low ARPU paying subscribers on its network, and maybe fewer high volume corporate clients. We estimate that revenues generated from 3G services will also be very limited due to the fact that MTNL’s subscriber base may not be the target market for 3G based VAS. We forecast the wireless ARPUs to stabilize post FY2014 when the industry starts consolidating.



Exhibit 15: MTNL wireless ARPU in Delhi and Mumbai vs. Average ARPU across India (FY2007-FY2011)

INR 0

INR 50

INR 100

INR 150

INR 200

INR 250

INR 300

INR 350

INR 400


MTNL Wireless ARPU Avg. Wireless ARPU in India *


Broadband Business KPIs: Subscribers, Utilization rates, ARPU and Revenues

We estimate Broadband revenues to increase from INR 5,219 Mn in FY2010 to INR 11,207 Mn in FY2014 at a 21% CAGR (FY2010-FY2014e). With MTNL’s wireline subscriber base of 3.5 Mn and 0.8 Mn Broadband subscribers in FY2010, we determine that 23% of MTNL’s wireline subscriber base has opted for Broadband services and we forecast that close to 60% of MTNL’s wireline subscribers will use broadband services by FY2014.

Exhibit 16: MTNL Broadband Subscribers and Broadband ARPU (FY2008-FY2014e)

INR 480

INR 500

INR 520

INR 540

INR 560

INR 580

INR 600

0

500

1,000

1,500

2,000

2,500


Broadband Subs (000) Broadband ARPU


The Broadband ARPUs are expected to decline at 3% CAGR (FY2010-FY2014e) due to stiff competition from 2G/3G dongles provided by telecom operators and broadband services from Multi Systems Operators (MSOs) via Local Cable Operators (LCOs), while Broadband subscribers are expected to increase at 25% CAGR in the same time period.



Exhibit 17: MTNL Broadband Revenues and % to Total Service Income (FY2008-FY2014e)

0%

5%

10%

15%

20%

25%

30%

0

2,000

4,000

6,000

8,000

10,000

12,000


Broadband Revenues % of Total Service Income


Total Income from Services: Wireline, Wireless and Broadband

MTNL’s has significant dependence on traditional wireline business, which has negative growth. In FY2010, nearly 60% of the Total Income from Services was contributed by wireline business and is expected to be 39% in FY2014. We forecast wireline revenues to decline from INR 22,072 Mn in FY2010 to INR 18,023 Mn in FY2014e at -5% CAGR mainly due to losing residential subscribers to wireless services and corporate subscribers to competitive wireline service providers who are mainly focused on providing services in the business districts. The top line revenue growth of MTNL is directly impacted by declining wireline business.

Exhibit 18: MTNL Subscriber breakup by Business (FY2008-FY2014e)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


Wireline Wireless Broadband

Source: Company Data, MAPE Estimates

As mentioned earlier in this report, we do not expect MTNL’s wireless service revenues to have a significant impact on the top line revenue growth due to increasing competitive pressure from wireless operators and also due to MTNL’s limited presence in Delhi and Mumbai, which markets are anyways well saturated in terms of wireless penetration levels of 150% on an active subscriber base. The wireless revenues are expected to grow at 7.3% CAGR (FY2010-FY2014e) and are expected to reach INR 9,270 Mn in FY2014e, which is much slower than the growth in the overall wireless industry. Wireless business had 4.8 Mn subscribers in FY2010 which was 53% of the total subscriber base of MTNL, but revenues contributed to the Total Income from services from wireless business was a mere 19% in FY2010 and is expected to be 20% in FY2014e. This is mainly because the MTNL’s wireless ARPU was INR 130 in FY2010 as compared to wireline ARPU of INR 459 and broadband ARU of INR 576. Therefore any



substantial increase in wireless subscribers is not expected to have a significant impact on the top line revenue growth during the forecast period FY2010-FY2014e.

Exhibit 19: MTNL Revenue breakup by Business (FY2008-FY2014e)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


Basic Telephone Cellular Broadband Other Services


Exhibit 20: MTNL ARPU by Business (FY2008-FY2014e)

INR 0

INR 100

INR 200

INR 300

INR 400

INR 500

INR 600

INR 700

Mar'08 Mar'09 Mar'10 Mar'11e Mar'12e Mar'13e Mar'14e

Broadband ARPU Wireline ARPU (incl. Rentals, Usage and I/C Wireless ARPU


Expenses: Staff Costs, Revenue Sharing, License Fee, Admin and Operating Expenditure

MTNL had a huge burden of employee costs in FY2010. We estimate that, in addition to low utilization rate especially for the wireline business and reducing wireless market share in Delhi and Mumbai, employee related costs is also one of the major reasons why MTNL’s stock is underperforming. In our forecast, we assume in our base case that MTNL will reduce approximately 1,250 employees each year for the next 6-7 years, and the total number of employees would reduce from 44,910 in FY2010 to 39,910 in FY2014.



Exhibit 21: MTNL Costs breakup (FY2008-FY2014e)

0%

20%

40%

60%

80%

100%


Staff Costs Revenue sharing (Interconnection Costs)

License fee & Spectrum charges Admn/Op. Expenditure


In order to compare MTNL’s employee efficiency with various other operators in India, we have used the concept of Revenue Generating Units/ Employee (RGUs/Employee). The below exhibit shows the low RGU/Employee of MTNL vs. its domestic peers

Exhibit 22: RGUs/Employee by Operator (FY2007-FY2010)

3,937

7,257

2,207

3,516

6,638

9,437

221 243

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

FY2007 FY2008 FY2009 FY2010

Bharti Airtel RCOM Idea MTNL

Source: Company Data

Exhibit 23: RGU/Employee by Operator (FY2007-FY2014e)

RGU / Employee FY2007 FY2008 FY2009 FY2010

Bharti Airtel 2,146 2,517 3,937 7,257

RCOM 1,370 1,310 2,207 3,516

Idea 3,005 3,930 6,638 9,437

MTNL 174 193 221 243

Discount 20%

Avg RGU/Employee excluding MTNL post discount 5,389

Ideal Employee base of MTNL 2,023 Source: Company Data, MAPE Estimates



Exhibit 24: Total number of Employees by Operator (FY2007-FY2010)

No of employees FY2007 FY2008 FY2009 FY2010

Bharti Airtel 18,123 25,543 24,538 18,354

RCOM 21,894 36,650 37,150 30,974

Idea 4,662 6,107 6,481 6,763

MTNL 48,529 47,422 46,155 44,910 Source: Company Data

Exhibit 25: Total Revenue by Operator (FY2007-FY2010)

Revenue FY2007 FY2008 FY2009 FY2010

Bharti Airtel 183,492 268,728 373,521 418,295

RCOM 171,904 188,274 222,505 214,964

Idea 43,500 67,200 101,313 123,979


Exhibit 26: Staff Costs by Operator (FY2007-FY2010)

Staff Costs FY2007 FY2008 FY2009 FY2010

Bharti Airtel 12,012 14,392 17,023 17,534

RCOM 10,848 11,837 16,766 15,001

Idea 2,609 3,464 5,245 6,451


Exhibit 27: Personnel Costs/Revenues by operator (FY2007-FY2010)

Contribution of Personnel Costs to Revenues FY2007 FY2008 FY2009 FY2010

Bharti Airtel 6.5% 5.4% 4.6% 4.2%

RCOM 6.3% 6.3% 7.5% 7.0%

Idea 6.0% 5.2% 5.2% 5.2%

MTNL 36.7% 34.5% 47.4% 76.5% Source: Company Data

Company Overview

MTNL provides complete telecommunication services in Delhi and Mumbai. MTNL started services by providing fixed line connectivity, following which it ISDN services in 1996 and Internet services by 1999 in these two metros. In the year 2001, MTNL started GSM and WLL CDMA services under various brand names. MTNL was listed at the New York stock Exchange (NYSE) in 2001. In the year 2005, MTNL started offering broadband services to its existing wireline subscribers and also offers wireless 3G services since 2010. MTNL holds BWA Spectrum across Delhi and Mumbai.



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Important Information Related to The Research Report The research analysts responsible for content of this report, whether whole or in part, certify that with respect to securities or issuers covered in this report all the views expressed accurately reflect their personal views; and no part of their compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed. Definitions of Research Ratings

BUY We expect this stock to appreciate by 20% or more over the next 12 months from the price mentioned on the note.

HOLD We expect this stock to stay in the range of -20% to +20% over the next 12 months from the price mentioned on the note.

SELL We expect this stock to go down by more than 20% over the next 12 months from the price mentioned on the note.

Our target prices are on a 12-month horizon basis unless otherwise specifically mentioned.

Disclaimer MAPE Advisory Group Pvt. Ltd. and MAPE Securities Pvt. Ltd. (“MAPE”) are investment bankers, advisors and securities traders on behalf of their clients globally. This report has been prepared by MAPE for its intended recipients only and not for public distribution and should not be reproduced or redistributed without prior approval. Information provided herein with respect to the industry and the competitors has been compiled from publicly available sources, including official publications and research reports, and is given as general information. It has not been independently verified either by MAPE or its Client. Neither MAPE nor its Client or any of their directors, officers, employees, affiliates, representatives and advisors makes any representation or warranty with respect to the accuracy or completeness of the information contained herein. The information contained herein shall not form the basis of any contract. The report may also include analysis and views expressed by our internal research teams which operate independent of the investment banking teams. The report is purely for information purposes and does not construe to be investment recommendation/advice or an offer or solicitation of an offer to buy/sell any securities. The opinions expressed are our opinions as of the date appearing in the material and may be subject to change from time to time without notice. Investors should make their own investment decisions based on their own investigation and analyses of information contained in this report and other sources and they should not solely rely on the information contained in this document. Recipients should not construe any of the contents herein as advice relating to business, financial, legal, taxation or investment matters and are advised to consult their own business, financial, legal, taxation and other advisors concerning any information in the report. MAPE or its affiliates, its clients and/or employees may or may not hold positions in any of the securities mentioned in the document.

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