Download EVA in Telecom Firms

Value creation in Telcos
G.Alagarsamy
Pr.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
ROCE Trend- BSNL Case
15
13.88
12.32
10
5
10.52 10.16 9.19
ROCE(%)
5.06
4.87
1.48
0
20
0102
20
0203
20
0304
20
0405
20
0506
20
0607
20
0708
20
0809
ROCE Trend-BSNL Vs Bharti
ROCE Trend-BSNL Vs Bharti
ROCE(%)
30
26.2
24.3
24.7
20
10
BSNL
Bharti
9.19
5.06
0
2006-07
2007-08
1.48
2008-09
Value Creation


ROCE high
Is it necessarily value creating?
Dynamic Of Performance Metric
sophistication
Measures of PM
Time
VBM:Returns, growth,
.WACC,FCF
CFROI
Returns, growth,
WACC,
Returns, growth,
Return
EVA/MVA
earnings
ROE,ROCE
,RONA
Single period
Ignores WACC
Ignores growth
EVA-Definition

EVA = Net operating profit after
tax(NOPAT)- Capital charge
= EBIT(1-T)- WACC* CE
where
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

Pre-tax profit

PAT


less interest on loan
xxx
less tax @
xxx
xxx
xxx
Add interest on loan
PAT but before interest
(NOPAT)
xxx
xxx
xxx
less
Capital Charge
(WACC on CE)
xxx
Economic 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 Premium
β : A measure of systematic risk
Cost of Equity-CAPM Approach
RISK
Total
risk Unsystematic risk
Systematic
risk
NO of securities in portfolio
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
Capital Asset Pricing Model (CAPM)
Risk
premium
Ex
pe
cte
d
ret
urn
0.5
1
2
Systematic risk (beta)
Weighted Average Cost of Capital (WACC)
WACC= (E/D+E)*Ke + (D/D+E)*Kd(1-T)
where
E= market value of equity
D= Book value of debt
Ke=Nominal cost of equity
Kd=Nominal cost of debt
T = 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 expenseunusual gain-taxes
Increase
Revenue
How Do You
Achieve EVA
Reduce amount
of capital use in
CA & FA
Eliminate Products
With Negative
Contribution from
Product Portfolio.
Increase Volume of
Sales with Positive
Contribution.
Reduce Cost
of Capital.
Value
metric
Value
components
Value
drivers
Revenue
Critical
Success factors
Increase sales volume
with positive
contribution
Increase revenue
EBIT(1-t)
Operating
cost
Reduce operating
cost
EVA
WACC
Capital
charge
Reduce WACC/
Optimize leveraging
Reduce CE in current
assets/Fixed assets
(CE)Capital
employed
Invest in projects/
Products with
positive NPV
Revenue
realization phase
CASH
Revenue
assurance
phase
CASH
CONVE
RSION
CYCLE
A/R
INV
ASSET
CONVE
RSION
CYCLE
ASSET
Cap
wip
Revenue generation
phase
Y 2006-07
ITEM
Y 2007-08
Bharti
BSNL
BSNL
Year 2008-2009
Bharti
BSNL
Bharti
Capital Employed (in
Cr)
83091
15660
88672
20414
87989
D/E
.06:.94
0.4:0.6
0.04:0.96
04:.0.6
04:0.96
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
31664
04:.0.6
Value Creation- BSNL Vs Bharti
Value Creation- BSNL Vs Bharti
7673.58
10000
EVA
5000
2792.35
4799.33
0
Y 2006-07
-5000 -2764.95
-10000
-15000
BSNL
Y 2007-08
Y2008-09
-8338.23
-11907.73
Bharti
Value Creation Trend- BSNL Case
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)
Sales and Opex Impact on Value CreationBSNL Vs Bharti
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
4.18
(Decrea
se) %
6.89
45.9
42.26
Y 2008-09
34354.21
36961.5
29113.6
2.13
36.8
47.28
35811.92
Increase
(5.89)
(Decrea
se) %
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
WCL and Value Creation- BSNL Vs Bharti
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 Sensitivity Analysis-BSNL Case (200809)
CA
Reducti
on (%)
0.1
WCL
0.54
0.574 0.610 0.649 0.694 0.746 0.806 0.877 0.961
3
ROI will
increas
e by
(%)
5.43
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
11.49 18.29 25.96 34.71 44.75 56.42 70.14 86.48
Cash Lurking in the Business (CLIB)
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
Current Assets Optimality
Policy
Liquidity
Profitability
Risk
A
High
Low
Low
B
Average
Average
Average
C
Low
High
High
Value Creation- How BSNL Stacks up
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 Bharti 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 21060.4
(Cr)
37167.0
20.80
WACC
11.3%
Kept lower
Value Creation- BSNL Vs Bharti
Value Drivers
BSNL performance
Bharti performance
Sales Growth
Stagnant
Steep
Opex growth
Moderate but Revenue
High but Revenue growth
growth < Opex 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 managementUse 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
FG1
C1
PG1
CG1
FG2
C2
PG2
CG2
FG3
C3
PG3
CG3
FGm
Cn
m*n process flows
FG: Functional Group
C: Customer
PGn
CGn
n process flows
PG: Process Group
CG: 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 Creation-Cost Sharing Vs Cost Non-sharing
Value Driver
With Sharing –
Impact
Without SharingImpact
Gross Revenue
Given
Given
Less OPEX (Excluding Decrease
interest)
Increase
EBDIT
Decrease
Increase
Less Interest (only for a Decrease
portion of the asset
shared
financing
involved)
Increase
PBDT
Decrease
Increase
Less Depreciation (only Decrease
for the shareable
component)
Increase
PBT
Decrease or/and negative
Probability
margin
Increase and positive
of positive High
No or very low
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
31
46
51
EBITDA margin (%)
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
-19
14
22
PAT margin (%)
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
Value Propositions
Financial
Customers
Internal Business
Process
Learning and
Growth
Economic Value Added
Accounts
Operating
receivable
expenses
Customer
Satisfaction
On-time delivery
Shorter
cycle time
L
A
G
G
I
N
G
LeadingLagging
Continuum
Lower
rework
Process quality
Employee
Skills
Adapted from Kaplan and Norton (Jan-Feb 1996)
Employee
morale
Employee
suggestions
L
E
A
D
I
N
G
Value opportunity lost
Value Attrition
Investment in
Mobile /ADSL
not accelerated
Investment in Basic
stagnant-Low capital
Base- Incremental
capex sliding
Gro
wth
Market share 80%At the decline phase
of the life cycle-Still
focusing
Com
petiti
ve
Old processes intact
Fin
anci
als
Low cost debt
retired- Moving towards
unlevered statusHigh WACC
Lear
ning
Self centric work cultureStill vertical
structure
Market share 20%At the growth phase
of the life cycleNot pushed enough
Value
Six sigma measuresProject /team work
processes not yet started
Accumulating
idle cash-No radical
growth ideas
Customer centric work
culture not yet
institutionalized
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