Tata communications emerging markets growth strategy

International Business

1. 20% - Does TCL need a second home market? How does expansion into new geographies add value? What did it learn from the Neotel experience?

2. 20% - Is Russia a suitable home market for TCL? How does it compare with other emerging market options?

3. 20% - What are the various entry options for a market like Russia? Compare and contrast acquisitions with alliances as well as with organic/ own play.

4. 20% - Evaluate Pascal as an appropriate entry vehicle into Russia. What are its strengths and weaknesses?

5. 20% - What challenges or risks would TCL face if it acquired Pascal?

100% Total

6. Bonus Points (10%) If TCL were to decide to pursue an investment in Pascal, what should be the valuation? Please state your assumptions.

Instructions:

Must use the IRAC method

Each question must be between 800 - 1000 words, double spaced.

Indian School of Business ISB041

June 25, 2014

Srinivasa Addepalli and Professor Prashant Kale prepared this case solely as a basis for class discussion. This case is not intended to serve as an endorsement, a source of primary data, or an illustration of effective or ineffective management. This case was developed under the aegis of the Centre for Teaching, Learning, and Case Development, ISB. Copyright @ 2014 Indian School of Business. The publication may not be digitised, photocopied, or otherwise reproduced, posted or transmitted, without the permission of the Indian School of Business.

Srinivasa Addepalli | Prashant Kale

Tata Communications: Emerging Markets Growth Strategy

It was the evening before the quarterly board meeting of Tata Communications (TCL) in July 2012. Mukesh Verma, TCL’s Chief Strategy Officer (CSO), reviewed his presentation. It appeared obvious to him that the board would support the concept of expanding into new home markets; he had gathered as much from earlier informal conversations. But his presentation went beyond the concept stage — it included a specific investment proposal. The strategy team had, for several weeks, been hard at work evaluating an opportunity to acquire Pascal,1 a Russian telecommunications company. The team’s recommendation was to make a non-binding offer to Pascal’s private equity investors. But Verma was not sure if it was a simple go/ no-go decision; in fact, he hadn’t even discussed this with many members of the company’s Global Management Committee (GMC). If TCL were to proceed with the non-binding bid due the following week, he would have to convince the Chief Executive Officer (CEO) tonight so that the proposal could be included in the board presentation. Verma needed to make a few calls urgently. THE GLOBAL TELECOMMUNICATIONS INDUSTRY

Globally, telecommunications (telecom) was a US$2.1 trillion industry in 2012, and was expected to grow 5.1% per annum to US$2.7 trillion in 2017.2 Nearly 60% of the total US$2.1 trillion industry was contributed by wireless services. Of the remaining US$800 billion in wireline, over 80% came from basic services such as voice and low-bandwidth data services.3 The market was also segmented based on the type of customers: enterprises, including small businesses, and individuals (usually referred to as consumers). Enterprises were estimated to contribute about US$650 billion to the telecom market in 2012, of which nearly US$250 billion was for wireless services and US$400 billion for wireline voice and data services.4

Enterprises purchased a variety of voice and data services from telecom operators. These included traditional telephone services for voice communications, data lines to link their offices or connect to the Internet, and newer services that included data centers to store their information technology (IT) applications and data, audio and video conferencing solutions and outsourcing of their telecom infrastructure management. 1 Company’s name disguised for confidentiality reasons. 2 “Worldwide Telecommunications Industry Revenue to Reach $2.7 Trillion by 2017, says Insight Research,” The Insight Research Corporation, January 2, 2012, http://www.insight-corp.com/pr/1_2_12.asp accessed on December 10, 2013 3 Ibid. 4 Tata Communications’ internal estimates.

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2 | Tata Communications: Emerging Markets Growth Strategy

In addition, they also paid for wireless voice and data connections for their employees, and were increasingly adopting value added services (e.g. vehicle tracking systems for logistics purposes and remote surveillance solutions for security) using wireless networks. The enterprise wireless market was estimated to grow over 5% per annum to 2017. However, the enterprise wireline market was expected to grow at a slower rate of 3.9% annually, due to a decline in voice services and an almost flattish trend in data connectivity services. Managed services and outsourcing were expected to partially compensate for the decline in traditional wireline services (see Exhibit 1 for a summary of key enterprise service offerings and terms).

The largest players in the enterprise wireline market were the original incumbent telecom operators in the developed market countries. With their ownership of extensive wireline (fiber and copper) networks and strong (though declining) cash flows from providing voice services, incumbents such as AT&T and Verizon in the United States, BT in the United Kingdom, Orange in France, NTT in Japan and Deutsche Telekom in Germany dominated the enterprise markets in their respective countries. Further, with most of the largest multinational corporations (MNCs) having their origins in these five markets,5 these operators tended to be their primary choice for providing telecom services for their cross-border requirements. THE TATA GROUP6

Founded by Jamsetji Tata in 1868, the Tata group of companies was one of the largest Indian conglomerates, with over 100 operating companies in seven business sectors: communications and information technology, engineering, materials, services, energy, consumer products and chemicals. Tata companies employed over 500,000 people worldwide and earned US$100 billion in revenues during 2011-12.7 Nearly 60% of the group’s revenues came from its international operations, from markets outside India. Tata Sons Limited and Tata Industries Limited were the two holding companies that had varying levels of ownership among the group companies. Every Tata company, including 32 that were publicly listed, operated independently and was managed by its respective board of directors.

The Tata group created India’s first and largest IT company, Tata Consultancy Services (TCS), in 1968, long before India became known for its software prowess. TCS, which began its journey as a division of Tata Sons, was hived off and publicly listed in 2004. In 2012, TCS employed over 200,000 people and recorded revenues of US$10 billion. TCS served nearly 1,000 large MNCs around the world and its customer base included 49 of the Fortune 100 companies.8

The Tata group’s first major venture in the communications industry was Tata Teleservices Ltd (TTL), which began in 1996 as a fixed line telephone provider in the southern Indian state of Andhra Pradesh and eventually expanded to become a nationwide provider of mobile services by 2005. In 2009, Japan’s leading mobile operator, NTT DOCOMO, acquired a 26% strategic stake in TTL and the company’s mobile services were rebranded as Tata DOCOMO. A year later, TTL became the first mobile operator to launch third generation (3G) mobile services in India. TTL primarily served consumers and small businesses with predominantly mobile/ wireless offerings. 5293 of the Fortune 500 companies were from the US, UK, France, Germany and Japan. See “Global 500”, CNN Money, July 23, 2012, http://money.cnn.com/magazines/fortune/global500/2012/full_list, accessed on December 10, 2013. 6 Tata Group website, http://www.tata.com/aboutus/sub_index.aspx?sectid=8hOk5Qq3EfQ= accessed on December 10, 2013 7 Tata Group website, http://www.tata.com/htm/Group_Investor_GroupFinancials.htm accessed on December 10, 2013 8 Tata Consultancy Services website, http://www.tcs.com/careers/campus/about_tcs/Pages/default.aspx accessed on December 10, 2013.

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ISB041

Tata Communications: Emerging Markets Growth Strategy | 3

TATA COMMUNICATIONS Origin and Privatization

TCL’s origins can be traced back to the Indian Radio and Cable Communications Company, which began providing international communications services to and from India in 1932. The company became a department of the Indian government following independence in 1947, and in 1986, was incorporated as Videsh Sanchar Nigam Limited (VSNL), a company wholly owned by the government of India. VSNL was the only company with a license to provide international voice and data connectivity in India. In 1999-2000, VSNL became the first Indian government owned company to have a public offering, not just in India but overseas as well. In February 2002, the Tata group acquired a 45% stake and management control in VSNL — the culmination of a long and public divestment process. The Tata group saw VSNL as filling a gap in its goal of providing a wide bouquet of telecom services, including international connectivity, to Indian customers. The government continued to hold a 26% stake in the company, with the rest held by public shareholders. VSNL shares were listed on the Bombay Stock Exchange (BSE) and the National Stock Exchange of India (NSE) and its American depository receipts (ADRs) were listed on the New York Stock Exchange (NYSE).

The government had already decided as part of its liberalization policies that VSNL’s monopoly on international telecom services would end on March 31, 2002. The company faced considerable competition in its core and highly profitable business of carrying international voice calls to and from India. Within two years, its revenues and gross margins from that business fell almost 70-80%. The company’s management was left with the twin challenge of eyeing new revenue sources while undertaking a drastic reduction in its largely fixed cost operations.

VSNL’s infrastructure in 2002 was mostly in the form of capacities on international submarine cables and satellites that helped connect India with the rest of the world. The company management turned its attention to building capabilities within India, rolling out high-speed fiber networks connecting about 400 major cities to each other. In addition, VSNL also laid fiber networks within the top 12 cities to extend international and national connectivity to central business districts. The goal was to provide large corporates, mostly banks and software and outsourcing companies, with very high-speed data networks to their various branch locations or client sites. In 2003-2004, VSNL also began the construction of a submarine cable to connect Chennai on the west coast of India and Singapore; this was expected to primarily serve Indian IT firms that required connectivity to various technology hubs on the west coast of the United States. Global Expansion (2004-07)

The transformation of VSNL from a public sector monopoly to a global challenger was also aided by several overseas acquisitions and investments during 2004-2007. VSNL acquired Tyco Global Network (TGN), a division of Tyco International, for US$130 million in 2004. TGN had submarine cables across the Atlantic and Pacific oceans as well as additional connectivity in Europe. Tyco had built these cables for a reported US$2.5-3 billion during the telecom boom of the early 2000s, but the dot-com crash bankrupted many such cable systems. The acquisition of TGN, combined with the cable systems that VSNL already owned and a few that it built later, made the company a leading provider of intercontinental high-speed connectivity. The subsequent dramatic surge in demand for bandwidth (aided by the growth of services such as Facebook, video conferencing, mobile broadband, etc.), validated the company’s bet on acquiring critical and valuable telecom infrastructure during a downturn.

Within weeks of completing the TGN acquisition, the company announced the purchase of Teleglobe, an NYSE listed company, for US$239 million. Teleglobe was a leading provider of international voice services and operated a global Internet backbone network. Teleglobe was headquartered in Montreal, Quebec and majority owned by the private equity firm Cerberus. The combination of VSNL’s strong international voice position in India and Teleglobe’s global volumes and

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4 | Tata Communications: Emerging Markets Growth Strategy

operating efficiencies created an industry leader in the international voice market. Further, Teleglobe’s Internet backbone and the TGN submarine cable network shared strong synergies.

The VSNL-TGN-Teleglobe consolidation had become a case study on acquisition integration. Recognizing the superior market knowledge and systems that Teleglobe possessed, the combined voice business was integrated into one organization under the leadership of the Teleglobe team. This led to very high levels of goodwill as well as greater than anticipated synergy benefits. VSNL’s leadership believed that in order for the company to be truly global, the organization structure needed to enable the strategy. The best talent should be hired from wherever it was available and located wherever it made the most business sense. Entry into South Africa (2005 onwards)

In 2005, VSNL applied to become the strategic partner (with 26% stake) for a new fixed-line, second national operator license in South Africa with an investment commitment of about US$200 million.9 After several delays in the licensing process and initial hiccups in rolling out its network, Neotel launched its services in late 2006. Finding experienced local managers with skills in next- generation technologies and services was a major challenge for Neotel, an unknown brand in the market. While TCL, as VSNL had been renamed at the end of 2007, had sent some of its experts on deputation to build the business, it decided that Neotel would be developed as a South African company with a local management team. Neotel was also faced with larger than planned investments in building a fiber backbone connecting major cities in South Africa; eventually Neotel agreed to co- build a part of the network along with other operators (who were both competitors and potential customers), in order to improve the economics of the investment. In 2008, the Tata group increased its stake in Neotel to 56% by buying out other shareholders; it was expected that the majority stake would promote faster decision making at Neotel. 10 TCL considered South Africa to be an important market, strategic to its global enterprise and carrier strategy. Africa in general, and South Africa in particular, was on the radar of several MNCs; further, many large South African companies were also seeking to expand into the rest of Africa and Europe. The TCL and Neotel sales teams had successfully bid for a few large, multi-country network deals and the pipeline for such opportunities was increasing. TCL had also helped Neotel pioneer some innovative managed services in the South African market. It was estimated that about 10% of Neotel’s revenues in fiscal 2012 from the enterprise segment were the result of this joint engagement with TCL.

However, it was not all easy going at Neotel. Its losses for fiscal 2010 increased to ZAR 1.15 billion (about US$157 million) from ZAR 739.5 million the previous year. Towards the end of 2010, Neotel announced a major restructuring exercise to right-size and right-skill the organization in light of its slower than anticipated growth. Even so, in 2011, TCL had to increase its stake in Neotel to 61.5% by buying out some shareholders who were not keen to continue funding its operations.

Finally, during the quarter ended September 2011, about five years after it began operations, Neotel became EBITDA11 positive. Although it had been an arduous journey, it was becoming clear that Neotel was a growth driver for TCL’s business portfolio. Neotel’s revenues were at US$360 million (a growth of 19% over the previous year) in fiscal 2012, contributing 12% to TCL’s topline (see Exhibit 2 for TCL’s financials from 2010-2012 and Exhibit 3 for segment-wise performance). The management estimates for fiscal 2013 were to grow revenues by at least 10% and improve EBITDA margins to about 12%. 9 Sanjai, P. R. “VSNL Eyes $1 Bn Revenue from S Africa,” Business Standard, April 21, 2006, http://www.business-standard.com/article/printer-friendly-version?article_id=106042101001_1, accessed on December 10, 2013. 10“Tatas Hike Stake in SA's Neotel to 56%,” ET Bureau, The Economic Times, June 25, 2008, http://articles.economictimes.indiatimes.com/2008-06-25/news/27693357_1_tata- communication-tata-africa-tc, accessed on December 10, 2013. 11 EBITDA refers to earnings before interest, taxes, depreciation and amortization.

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Tata Communications: Emerging Markets Growth Strategy | 5

New World of Communications (2008-12)

The VSNL legacy and the TGN and Teleglobe acquisitions had given TCL a strong presence in the wholesale market, i.e., serving other telecom service providers with voice, data and Internet connectivity. However, the wholesale business was considered a slow growth and relatively low margin business; TCL, like many of its peers, wished to grow its revenues from the enterprise segment, which had stickier relationships and therefore better margins. TCL’s major focus during its first five-year plan period (2007-2012) was to target large corporate customers that wanted multi- country or multi-region telecom services. TCL launched a range of services that leveraged its core infrastructure strengths to provide connectivity (e.g. virtual private networks), collaboration (e.g. video conferencing) and cloud (e.g. storage on demand) services to its customers.

TCL termed its strategy a “New World of Communications” with three major dimensions:

1. Emerging markets focus: TCL’s major competitors were developed market players, unlike TCL, which had its roots in India and investments in Asia, Africa and the Middle East. It sought to position itself as the go-to provider of services when large corporates sought to expand in the emerging market regions.

2. IP and cloud services: Most of TCL’s infrastructure had been built in the 21st century, whereas its competitors had a significant amount of older technologies to grapple with. This enabled TCL to offer customers the latest technologies and standards since it did not have to protect considerably large legacy revenues. Further, TCL sought to offer innovative commercial/ pricing models that enabled customers to reduce upfront technology investments and only pay per use.

3. “Asian touch” customer experience: The telecom industry was infamous for its poor customer service. TCL, as a challenger, tried to be more flexible and responsive than its peers. In fact, the company set itself an audacious goal of becoming the “Singapore Airlines (SQ) of the telecom industry”.

By 2012, TCL was a global telecom service provider offering voice, network, collaboration and IT

infrastructure services to telecom service providers and large enterprises. TCL was the number one provider of network services to enterprises in India. It was also number one globally in international voice traffic with over 45 billion minutes per year. TCL owned and operated the world’s largest submarine cable network — the only network that circumnavigated the globe. It operated a leading Internet backbone, ranked seventh globally12by size and was among the top 10 in most regions worldwide.

TCL’s consolidated revenues in fiscal 2012 were nearly US$3 billion (a 13% growth over the previous year) with an operating margin of 12.6% and a net loss of US$166 million. TCL employed about 7,000 people in March 2012. SECOND HOME MARKET STRATEGY

Ever since TCL embarked on its strategy of targeting large MNCs for their global connectivity and services requirements, it had felt the need for home markets beyond India. In the 2009 strategic planning exercise, TCL’s three-year revenue forecast was compared with that of its major competitors (see Exhibit 4). It was very clear that even with 12-15% annual growth, TCL would be a very small player in the global business-to-business (B2B) communications market. The major cause for this was the relatively small size of the Indian enterprise telecom market compared to the home markets of TCL’s primary competitors such as AT&T, Verizon, BT, Orange Business Services, etc. Given the high fixed costs (operating expense and depreciation) of building and operating global networks and 12Zmijewski, Earl. “A Baker’s Dozen, 2012 Edition,” Renesys, January 17, 2013, http://www.renesys.com/2013/01/a- bakers-dozen-2012-edition/ accessed on March 22, 2014.

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6 | Tata Communications: Emerging Markets Growth Strategy

products, the scale of business had a strong correlation with profitability. TCL’s competitors had average operating margins of about 20%, whereas TCL had just about broken even in its US$550 million enterprise business.

Further, TCL’s network presence outside India was still relatively small. TCL had grown rapidly since 2006 but it still had some weaknesses compared to competitors who had built up their networks over decades. In its 2010 Magic Quadrant for Global Network Service Providers report, leading industry analyst firm Gartner commended TCL as a niche player but also noted, “Outside of India, Tata Communications lacks deep in-country infrastructure, making it less competitive for networks requiring many sites in each country.”

A possible solution was to acquire a meaningful player in one of the developed markets, for instance the US, the UK, France or Germany. TCL evaluated several deals during the 2007 to 2012 period and came close to concluding a few. In early 2012, TCL considered a US$2 billion bid for Cable & Wireless Worldwide (CWW) in the UK. However, a major acquisition would not be easy to pull off without a very strong balance sheet, something that TCL obviously did not have.

The alternative option was to persist with the emerging markets expansion strategy and replicate a Neotel-like presence in other large and growing emerging markets. This would surely require less up- front investment than a large acquisition, but it would also mean a time-consuming journey towards creating the desired scale. TCL’s continued investments and support for Neotel reflected a larger strategic intent, that of making South Africa its second home market after India. In a June 2012 article in the Indian Express, the then corporate strategy head of TCL was reported as saying, "In the global market with entrenched leaders, our brand and credibility is still young … Since pure greenfield venture takes much time, it may be better to acquire companies that have infrastructure, people, systems and processes in place.”13

After TCL’s unsuccessful attempt to acquire CWW, its leadership team revived the plan to aggressively pursue entry into new emerging markets. The company had prioritized and analyzed the top 30 emerging markets, including the identification of possible partners and acquisition targets in key markets. A cross-functional group at TCL had subsequently prepared an updated list of the priority emerging markets, limiting the list to the top 18, primarily from Southeast Asia, the Middle East, Africa and South America (see Exhibit 5). These countries were prioritized on the basis of TCL’s existing network or enterprise business presence in the region.

The board presentation was to highlight the need for a second home market strategy and discuss a possible means of financing the expansion. It was clear that a strong presence in Brazil, Russia, China, Indonesia and Nigeria in addition to India would create a “home market” that by 2020, would be comparable to the entire G7.14 TCL predicted that it could increase its existing home market size, which stood at about US$3 billion in 2011,15 by four to six times by adding these new markets. Such a plan, though ambitious, was not inconceivable. The company had identified one or two possible investment/ partnership opportunities in each of these markets. Verma envisaged an investment of about US$250-300 million during 2013-2016 to stitch together three to four deals of up to US$100 million each. The proposal was to create a special purpose vehicle (SPV) for all these second home market investments (including Neotel) and obtain financing from private equity investors to fund the deals. This would help TCL bypass the constraint of not being able to raise further equity or debt on its own balance sheet. With 60-70% shareholding in this SPV, TCL would be able to exercise management control over these geographically dispersed entities as well as provide the integration services to extract synergies across all the operations.

13Upadhyay, N. and M. G. Arun. “Tata Comm Eyes Deals even as Debt Weighs,” The Indian Express, June 25 2012, http://www.indianexpress.com/news/tata-comm-eyes-deals-even-as-debt-weighs/966281/0, accessed on December 10, 2013. 14G7 or Group of Seven is a coalition of the world’s largest industrialized nations, namely, Canada, France, Germany, Italy, Japan, the United Kingdom and the United States. 15 The size of the enterprise data market in India and South Africa together.

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Tata Communications: Emerging Markets Growth Strategy | 7

PASCAL: THE RUSSIAN OPPORTUNITY

Sometime in the summer of 2012, Vinod Kumar, the CEO of TCL received a call from an old industry friend, Rick Murphy. There was an acquisition opportunity in Russia — an interesting Internet service provider (ISP) called Pascal that had built a strong base of enterprise customers over the past five years. Its investors, mostly private equity firms, were considering an exit. Would Tata Communications consider such an opportunity?

Verma studied the key investment highlights in the teaser document and responded:

I think this is worth looking at. If we aren't going down the developed market home route, we have to create the BRIICS16 market portfolio. Excluding China for the time being due to regulatory reasons, Indonesia, Brazil and Russia have to be on our agenda for us to become the go-to player for emerging markets.

The Pascal leadership team, supported by an investment bank, had put together a comprehensive

information pack that included details on the market, competition, company strategy, product and technology roadmap, sales and marketing, operations and financials. Visa issues prevented the TCL team from actually visiting Moscow, so the two parties held discussions via videoconference for 10-12 hours over a few days. Whatever information was necessary at that stage of the evaluation was obtained. Pascal

Pascal was founded in 2003 by a group of telecom executives led by Rick Murphy, an American with 25 years of B2B telecom sales experience in the US, Europe and Russia. The other founders and key executives were Russians who had worked with Murphy in previous jobs. Pascal’s shareholder group included five private equity firms — the largest, at 25%, was a well-known Russian investor and the others were western European telecom-focused funds. The management team had a stake of approximately 10%.

Pascal was one of the leading providers of broadband wireless services to large and mid-sized businesses in Russia with a market share of about 6% of revenues and 4% of volumes in 2011. Rostelecom, the government owned incumbent, dominated the market with a 46% share of revenues; the other large mobile operators, Vimpelcom and MTS, each had an 8% share.

The large corporate segment17 accounted for 60% of Pascal’s 2011 revenues of US$65 million; the medium segment18 came in next with 30% and small businesses19 contributed 10%. Over 80% of revenues came from domestic connectivity services — Internet leased lines and virtual private networks. The rest was from voice and managed services. Pascal did not offer any international connectivity or voice services.

Pascal’s wireless network, built using worldwide interoperability for microwave access (WiMax) technology, 20 was present in nearly 200 cities in Russia. The company leased bandwidth from Rostelecom and others to connect all these cities on a high-speed national backbone network. In 2011, Pascal employed 1,825 people, of which about 650 were in customer-facing functions, 850 in operations and the rest in administrative functions.

16 BRIICS refers to the countries of Brazil, Russia, India, Indonesia, China and South Africa. 17 Defined as the top 200 companies in Russia, including multinational corporations with a presence in Russia. 18 Russian companies ranking from 200 to 2000. 19 About 50,000 in total. 20 WiMax is a wireless communication standard that provided up to 1 gigabit per second speeds to fixed receivers.

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8 | Tata Communications: Emerging Markets Growth Strategy

Pascal’s plan for 2012 was to grow revenue by 30% to US$85 million and improve EBITDA from US$6.8 million in 201121 to US$20mn in 2012. Over the next five years up to 2017 (see Exhibit 6 for Pascal’s business plan), the management expected to almost double revenues to US$167 million and treble EBITDA to US$67 million. The focus would remain on large corporates and new multinationals that were expected to enter Russia on its accession to the World Trade Organization (WTO) in 2012. Pascal also planned to make use of some of its unutilized spectrum in the 5GHz band to build next- generation wireless networks using long term evolution (LTE) technology. Given that spectrum was scarce and Pascal already had licenses to the spectrum, the management believed this to be an ace up its sleeve. The company had planned for capital expenditure of about US$15 million in 2012; over the subsequent five-year period, it anticipated spending about US$18-20 million per annum in capex. Due Diligence

The TCL team for Project Pascal included senior leaders from enterprise sales, network services product management, network and services engineering and corporate finance, in addition to the corporate strategy team. Following is a summary of the team’s due diligence report:

Russia is growing at a gross domestic product (GDP) rate of 4% and is expected to have continued economic growth that we can leverage and add to our top line. Pascal brings customers, assets and a positive EBITDA business to the table. Overall, telecom market size is expected to grow at 5.5% in Russia; the analyst firm Ovum expects enterprise data revenues to grow 6-7% to 2016. However, according to the IT research firm Gartner, enterprise market growth is likely to stay flat at about US$1 billion. The current business is focused very heavily on wireless connectivity. As is the case in most emerging markets, wireless connectivity is required to get effective coverage; however, TCL must consider additional investment capital expenditure to target the untapped international connectivity market in a few business hubs through a fiber network. A comparison22 of the BRIICS countries (excluding China23) on major macroeconomic parameters shows that Russia is reasonably well-positioned in terms of size and growth (see Exhibit 7). Finance Pascal’s CFO had mentioned that the company’s net working capital was about 5% of sales and that it had a cash balance of about US$3 million. Pascal’s cost of capital was in line with the Russian benchmark of about 11%, but TCL’s cost of capital was 14%. The treasury team confirmed that TCL could easily raise new debt up to three times additional (or acquired) EBITDA. This could be stretched to five times additional EBITDA, but that would come with an additional borrowing cost of at least 150 basis points. Technology Pascal had followed a wireless network strategy similar to TCL’s; its equipment vendors were the same as TCL’s. There could be some knowledge reuse from our India experience of rolling out similar wireless networks for enterprise customers. The wireless equipment used in about 150 cell sites could require upgradation over the next few years because of technology changes. This could add about US$4-5 million in capex between 2014 and 2016.

21 After accounting for a US$2.8 million one-time restructuring cost in 2011 due to headcount reduction. 22 Prepared by the corporate strategy team. 23 TCL had attempted a joint venture investment in China during 2008-10, but abandoned the project because of regulatory issues.

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Tata Communications: Emerging Markets Growth Strategy | 9

We have no internal view or experience in rolling out the next generation of wireless networks or using LTE technology for enterprise customers. A quick Google search pointed to an article that mentioned a 120 cell-site LTE pilot roll-out in Malaysia that incurred capex of US$15 million; however, that operator anticipates having to build at least 1,200 LTE cell sites over two to three years to cover the entire country. Product Pascal’s revenue growth numbers seemed to be reasonable and consistent with past performance trends (but outgrowing the market). Its senior management was very impressive in terms of technology and operations knowledge, and its IT systems (mostly in Russian) appeared to be state-of-the-art and, in some cases, better than those at TCL. Cost forecasts appeared to be aggressive. The question was: as the network expanded to smaller cities, would capacity utilization remain as high as it was currently? The jump in EBITDA (projected) from 10.5% to 23.5% in FY12 was spectacular, almost unbelievable (even after accounting for the one-time cost in 2011). We would be more comfortable with a stable EBITDA margin of about 35%. There could be some cost synergies in reusing TCL’s product capabilities, particularly for managed services, but local customization and language translation would surely be required. Our Neotel experience shows that savings can be at best 5-8% of Pascal’s indirect costs. Enterprise Sales We looked at recent customer requirements related to Russia connectivity from each of the four regions. About 20% of the deals from the Americas and Europe had Russia requirements (mostly for Moscow and one or two other cities), but almost none for Asia and India. Admittedly, Russia connectivity is not a major sales or marketing pitch for TCL at this time.

Deal Mechanics

Pascal’s financial advisors had indicated that the deal was to be for 100% of the shareholding and that the shareholders had invested about US$75 million over the past four years — about US$50 million as equity — mostly in 2008 and 2009, and about US$25 million in shareholder debt during 2010 and 2011.

Even as the teams were going through the due diligence process, Kumar and Verma were debating whether the deal was worth the effort it was beginning to require (see Exhibit 8 for an e-mail exchange between them). Meanwhile, Murphy shared news about a major deal that had recently been announced in the region. Alem Communications, a WiMax provider in Kazakhstan with revenues reportedly under US$50-60 million, had been acquired for US$170 million.24

The strategy team also looked at market valuations for listed telecom companies in the region as well as acquisition multiples for publicly announced deals, although in most deals, accurate information was not available (see Exhibit 9). It was not clear if these multiples could be used to value Pascal. BOARD MEETING

Pascal’s advisors had indicated that the sellers were expecting bids at a valuation north of US$150 million and that a preliminary, non-binding bid was due the following week. Verma had to decide whether there was a reasonable business case to make an investment — either a 100% acquisition or 24 English translation of the report can be accessed at http://www.comnews.ru/print?nid=67367.

For the exclusive use of G. Prieto, 2019.

This document is authorized for use only by Gabriel Prieto in Comparative International Business SU19-ROCKLIN taught by RICHARD YANG, William Jessup University from May 2019 to Nov 2019.

ISB041

10 | Tata Communications: Emerging Markets Growth Strategy

a strategic stake — in Pascal. Finding good acquisition targets in emerging markets, particularly a market like Russia, was not easy. If they delayed responding with their bid, it was possible that some local player might easily acquire Pascal for its spectrum. Thus, it was very important to determine what Pascal was worth to TCL. Moreover, this would not be an easy deal in a familiar market. What challenges should TCL be prepared for?

Tata Communications had taken contrarian market positions on several occasions in the past and those risks had paid off for the most part. Could this be another black swan?

For the exclusive use of G. Prieto, 2019.

This document is authorized for use only by Gabriel Prieto in Comparative International Business SU19-ROCKLIN taught by RICHARD YANG, William Jessup University from May 2019 to Nov 2019.

ISB041

Tata Communications: Emerging Markets Growth Strategy | 11

EXHIBIT 1

ENTERPRISE TELECOM SERVICES OFFERINGS Connectivity Services

Most enterprises or organizations created a private network that securely connected all their servers or computers. Within the same building or premises, this was done using a local area network (LAN); in most cases, these connections were internal to the enterprise. Multiple offices that were geographically distant could be connected directly to each other using high-speed data lines called private leased circuits — these circuits were often leased from telecom service providers. Such a circuit within a country was called a National Private Leased Circuit (NPLC) and one across borders an International Private Leased Circuit (IPLC). These networks could be used to carry both voice and data connections.

Increasingly, employees were required to access their enterprise applications such as e-mail or Intranet from outside their office locations. This required the organization to extend its private network and allow employees to connect from their homes or via mobile phones. Further, there could be several remote branch or warehouse locations that needed to be connected to the corporate network but were too numerous to be economically connected by leased circuits. A Virtual Private Network (VPN) extended the corporate network using the public Internet while retaining the security and control of a private network.

Enterprises also needed to be connected to the Internet for their employees to access websites or e-mail or for their customers or partners to access their websites. An Internet Leased Line (ILL) was a dedicated connection to the Internet provided by an ISP or telecom service provider. ILL speeds typically ranged between 2Mbps and 1Gbps. Managed Services

Managed services was a widely used but loosely defined term to represent various value-added services, often integrating multiple information technology (IT) and telecom components. Further, the term was meant to distinguish complex, “outsourcing-like” services from commoditized voice and data services, with the inherent assumption that managed services led to sticky relationships with customers and greater margins.

In their most complex form, managed services could involve the outsourcing of IT software or applications, the servers on which the software resided, the data centers where the servers were located and the telecom networks that connected the data centers to the corporate offices and the Internet. The trend was not to use customized or dedicated IT software or hardware, but rather to purchase access to the resources as and when needed. Such shared (standard) software or hardware, charged on a pay per use basis and delivered using the Internet, were known as cloud services. Source: Prepared by the authors.

For the exclusive use of G. Prieto, 2019.

This document is authorized for use only by Gabriel Prieto in Comparative International Business SU19-ROCKLIN taught by RICHARD YANG, William Jessup University from May 2019 to Nov 2019.

IS B0

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