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Value creation in Telcos

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?

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Value creation in Telcos

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  1. Value creation in Telcos G.Alagarsamy Pr.CCA Tamil Nadu Circle

  2. Of the five business deadly sins, the first and easily the most common is the worship of high profit margins. Peter F . Drucker

  3. Value Questions • Is OR wholesome performance metric? • Is profit positive cash positive? • Is return positive value positive?

  4. ROCE Trend-BSNL case

  5. ROCE Trend-BSNL Vs Bharti

  6. Value Creation • ROCE high • Is it necessarily value creating?

  7. Dynamic Of Performance Metric Time sophistication Measures of PM VBM:Returns, growth, .WACC,FCF CFROI Returns, growth, WACC, EVA/MVA Single period Returns, growth, earnings Ignores WACC ROE,ROCE,RONA Return Ignores growth

  8. 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

  9. 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

  10. Accounting Profit Vs Economic Profit • EBIT xxx less interest on loan xxx • Pre-tax profit xxx less tax @ xxx • PAT xxx • Add interest on loan xxx • PAT but before interest xxx (NOPAT) less Capital Charge (WACC on CE) xxx Economic value added xxx

  11. 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

  12. Cost of Equity-CAPM Approach RISK Total risk Unsystematic risk Systematic risk NO of securities in portfolio

  13. 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

  14. Capital Asset Pricing Model (CAPM) Risk premium Expected return 1 2 0.5 Systematic risk (beta)

  15. 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

  16. 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

  17. Increase Revenue How Do You Achieve EVA Investment with Positive NPV. Reduce Operating Costs Reduce amount of capital use in CA & FA Increase Volume of Sales with Positive Contribution. Eliminate Products With Negative Contribution from Product Portfolio. Reduce Cost of Capital.

  18. Value metric Value components Value drivers Critical Success factors Increase sales volume with positive contribution Revenue Increase revenue EBIT(1-t) Operating cost Reduce operating cost EVA Reduce WACC/ Optimize leveraging WACC Capital charge Reduce CE in current assets/Fixed assets (CE)Capital employed Invest in projects/ Products with positive NPV

  19. Revenue realization phase CASH CASH CONVERSION CYCLE A/R Revenue assurance phase INV ASSET CONVERSION CYCLE ASSET Capwip Revenue generation phase

  20. Value Creation- BSNL Vs Bharti

  21. Value Creation Trend- BSNL Case

  22. Sales and Opex Impact on Value Creation- BSNL Vs Bharti

  23. 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

  24. WCL and Value Creation- BSNL Vs Bharti

  25. WCL and Sensitivity Analysis-BSNL Case (2008-09)

  26. Cash Lurking in the Business (CLIB)

  27. Current Assets Optimality

  28. Value Creation- How BSNL Stacks up

  29. Value Creation-How Bharti Stacks up

  30. Value Creation- BSNL Vs Bharti

  31. How to achieve EVA >0? • Tighten working capital management- Use techniques like supply chain management, e-procurement etc in a big way

  32. 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)

  33. 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

  34. FG1 C1 PG1 CG1 FG2 C2 PG2 CG2 FG3 C3 PG3 CG3 FGm Cn PGn CGn m*n process flows n process flows FG: Functional Group C: Customer PG: Process Group CG: Customer Group

  35. 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

  36. Value Creation-Cost Sharing Vs Cost Non-sharing

  37. How to achieve EVA >0? • Look at the capital structure-Is it optimal and value creating?

  38. How to achieve EVA >0? • Introduce EVA linked compensation/ bonus at all operating and supervisory levels

  39. New Developments- Impact on Value Creation • MNP • MVNOs

  40. How to achieve EVA >0? • Introduce Balanced Score Card approach as strategic and performance metric at all business unit levels-SSA, Circle, Corporate levels

  41. Value Propositions Economic Value Added Accounts Operating receivable expenses L A G G I N G Financial Customer Satisfaction On-time delivery Customers Leading- Lagging Continuum Shorter Lower cycle time rework Process quality Internal Business Process L E A D I N G Employee Employee Skills Employee suggestions morale Learning and Growth Adapted from Kaplan and Norton (Jan-Feb 1996)

  42. Value opportunity lost Value Attrition Investment in Mobile /ADSL not accelerated Investment in Basic stagnant-Low capital Base- Incremental capex sliding Growth Market share 20%- At the growth phase of the life cycle- Not pushed enough Market share 80%- At the decline phase of the life cycle-Still focusing Value Six sigma measures- Project /team work processes not yet started Competitive Old processes intact Low cost debt retired- Moving towards unlevered status- High WACC Financials Accumulating idle cash-No radical growth ideas Self centric work culture- Still vertical structure Learning Customer centric work culture not yet institutionalized

  43. Telcos-EVA values (Dec 2000)

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