Making the best of a bad situation: Decoding the MTNL-BSNL merger

Of late, the government seems to have found a panacea to all business problems - Mergers. Having taken a few shots at merging various public sector banks, the government has moved on to the next distressed entity in the room, the public sector telecom firms, MTNL and BSNL. In today's post we analyze how this seems like an attempt of making the best of a bad situation, that might still not be enough.

Let's start with understanding why these organizations need to be rescued in the first place. The first less economic, more emotion driven answer is for the jobs and families of the 185,000 people that the two firms employ. The second, more economically and strategically driven answer is that the government views these telecom firms as a core strategic asset. Having a public entity under its ambit allows it to service remote areas that otherwise wouldn't be serviced, as well as maintain control over one part of the industry. BSNL for example services the army, and often provides free call/sms services during disaster relief operations. The rationale is rather weak however, given the level of regulation in the sector, general compliance on part of the firms, and the growing penetration of private telcos, but this is what we will have to go with for now.

Next, let's understand what the government has in store to ensure the success of the merged entity. The government is clearly taking steps to go above and beyond a regular merger process to give the new firm a fair shot at success. The carefully crafted revival package includes four key things. First, a 15,000cr cash infusion, that the government will raise via sovereign bonds, and the merged entity will service. Second, allotment of 4G airwaves at 2016 prices. Third, asset monetization of 38,000cr of assets over a four year period. And lastly, a VRS scheme for its employees above 53.5 years of age.

Let's dissect these piece by piece, and see the benefits they hold.

One of the most common criticism of public sector mergers is that they are unable to realize cost synergies (the benefits you are able to realize in a regular merger by cutting out overlapping costs) due to an inability to fire public sector employees. Even in the statement to the media yesterday, Ravi Shankar Prasad acknowledged that these firms had very high employee costs relative to competition{75% of total expenses vs ~5% for private firms}. So while the VRS certainly isn't the optimal solution, it is the best way out given the nature of our economic and political system.

The next part is the asset monetization, in which the two firms will sell off unused fixed assets. In an internal study done earlier in the year BSNL had identified ~20,000 crores of land assets that it could sell off along with some buildings and fiber assets. Over here too, the steps seem to be in the right direction, with enough time being given to fetch a good value for the assets and time the exits in a proper phased manner. The funds from these could be invested in de-levering or further growth.

Next we come to the cash infusion of ~15000cr, which will serve as a good source of liquidity until the firms can get back on their feet. The fact that this will be financed via sovereign bonds will give the firms access to capital at a lower rate that it would have if it raised the money by itself, another positive for the stressed firm. The move also means that BSNL employees who had gone months without salaries will probably breathe a sigh of relief pre-Diwali.

And finally, the last and possibly the most important piece of the puzzle the 4G spectrum allocation. BSNL had taken a beating on both users and as well as ARPUs after the entry of Jio, since the services it had were to a large degree not able to compete. The allocation of the 4G spectrum will now give BSNL a fighting chance at taking on the larger private players head on.

The government is confident the combination of these four moves will help the combined entity become EBITDA positive in the next two years. However will all private players ratcheting up the competition, and the characteristic cultural drag of public sector firms pulling the MergeCo back, the road ahead will be far from easy. In all likelihood, this will turn out to be a case of pouring good (taxpayer) money over bad.

However to the government's credit, they have positioned the two entities to succeed to the best of their abilities, within the constraints of a socialistic democracy. There are times in life where the optimal option isn't practical, and you have to go with the next best option. The merger and the steps outlined, seem to be an attempt in just that.

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