Telenor Impairment: Has the band lost hope?

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Cellular Mobile Operators (CMOs) in Pakistan are desperately looking for a business model that can help them break out of the vicious cycle of low average incomes and resulting low profit margins. Telenor, being one of the country’s leading CMOs, is caught in this cycle, sparking rumors of its exit from the Pakistani market, every few months. To make matters worse, the latest financial results reported by the company are also not expected to alleviate the situation anytime soon.

On Tuesday last week, shares of Telenor ASA, parent company of Telenor Pakistan, fell as the company posted a loss for the second quarter of 2022 due to impairment of operations in Pakistan. According to Bloomberg, “Shares of Telenor ASA fell after Norway’s largest telecommunications company posted a 2.5 billion kroner ($250 million) writedown on its Pakistani operations due to an increase in financing costs and an unfavorable court decision”.

“There has been a significant increase in interest rates, country risk premium and market premiums, which has had an impact on the weighted average cost of capital,” the company said in its report on Tuesday. second trimester. “This, combined with rising energy prices and increased global inflation, has made Telenor Pakistan’s outlook challenging,” the report added.

Telenor had challenged the Pakistan Telecommunications Authority (PTA) pricing for its spectrum license renewal in 2019 and the case was pending a ruling from the Supreme Court of Pakistan. However, on May 25 this year, the Supreme Court ruled on the case and ruled against Telenor.

“Telenor Pakistan’s 900 MHz and 1800 MHz spectrum license expired on May 25, 2019, and the renewal fee was set at NOK 4.0 billion (USD 449 million) by the Pakistan Telecommunications Authority (PTA) for an extension period of 15 years. Telenor Pakistan disagrees with renewal terms and conditions, mainly on price. Telenor Pakistan estimates that the renewal price should have been NOK 2.5 billion (USD 291 million), which is the same as previous renewals for other operators. Accordingly, Telenor Pakistan has challenged the terms and conditions for the renewal of said license,” reads Telenor’s 2021 Annual Report.

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However, the decision was not the only factor that affected the change in the assessment of operations in Pakistan. The company also considered the unfavorable economic situation in the country in its decision to write down the value of operations in Pakistan.

What is depreciation and how is it calculated?

Impairment is an accounting concept that applies when an entity considers that the balance sheet value of its assets exceeds the amount recoverable by using or selling them.

To further streamline the process of calculating depreciation, there is a concept of cash-generating units (CGUs). These are groups of assets that can independently generate cash flows like subsidiaries and business divisions.

In the case of Telenor, the recoverable amount of the Pakistan CGU is calculated taking into account the expected future cash flows that the assets can generate (value in use), discounted at a specific rate to take into account the time value of the money. (Money loses its value over time)

The main assumptions used by the company to calculate the recoverable amount of its operations include; growth rate, average revenue per user (ARPU), profit margins, capital expenditure and discount rate.

The main contributor to the downward movement in Telenor Pakistan’s valuation, apart from the outcome of the license fee dispute, was the high cost of capital, which is the benchmark rate used to determine the value that cash flows generated in the future would have if compared to today. (For example, a few years ago a 250ml box of juice was priced at 15 PKR, today the same is selling for 25 PKR. Therefore, 15 PKR today is worth less than what they were worth a few years ago.)

Multinational telephone companies operating in Pakistan assess the results of their local operations against the weighted average cost of capital (WACC). This is the recurring cost incurred by the firm on capital raised for investment in a particular project/jurisdiction.

According to Telenor’s annual report, “discount rates are based on the weighted average cost of capital (WACC) derived from the Capital Asset Pricing Model (CAPM) methodology. The cost is derived from its weighted average cost of capital. In economies where the group considers risk-free returns to be unreliable, the WACC rates used to discount future cash flows are based on a 30-year US risk-free interest rate, adjusted for a risk premium country and the inflation differential between the United States and the country concerned. »

“Discount rates consider debt premium, market risk premium, leverage, corporate tax rate, inflation and asset beta. For generating units cash flow in economies with unstable inflation rates, sliding discount rates are applied,” the report adds.

The increase in the WACC for Pakistan was high inflation, increased country risk premium due to continued political and economic uncertainty and jitters of contracting demand felt in capital markets.

Analysis

The financial results of operations in Pakistan during the second quarter of this year were negative. Earnings Before Interest Tax Depreciation and Amortization (EBITDA) was down 15% as operating costs rose 30% due to currency devaluation and high energy costs. (Read more about this in Benefits article: Telco Energy Concerns: Unnecessary Whining or Real Problem?)

The assessment of the trigger event for the depreciation of countries without goodwill such as Pakistan is carried out at the level of individual assets, such as the network or the license. For a triggering event to occur at the level of an individual asset, it would generally require material physical damage to have occurred, for example, flooding, destruction of towers or adverse legal conditions expected to affect the asset, an example of which is license revocation.

Telecom operators with foreign participation, as part of their valuation cycle each year, use their updated business plans to revise actual country valuations without goodwill, with past write-downs on tangible assets and intangible, like Pakistan.

As part of the cycle, the updated valuations of these countries are also included in the overall reconciliation with the market capitalization of the holding company, ensuring that the new value matches the overall market valuation outlook of the foreign holding company.

Any potential increase in value would be recorded as a reversal of impairment, adjusted for amortization and depreciation charges lost since the initial impairment was recorded. Any deterioration in value would require further depreciation.

“Telenor Pakistan has been subject to impairment testing for some time. And in the annual report, we highlighted this sensitivity. Since then, we have seen a deteriorating macroeconomic environment with rising interest rates, a weakening Pakistani rupee and an increasing country risk premium. Compared to the valuation we made at the end of the year, these factors alone have a negative impact on the valuation of around NOK 2 billion ($200 million),” said Tone Hegland Bachke, vice -executive chairman and chief financial officer of Telenor, during an earnings conference call last week. .

“In addition, we have received information about an unfavorable decision in the spectrum renewal case. Based on the updated valuation at the end of June, we arrive at an impairment of NOK 2.5 billion ($250 million). As a result of this impairment, the recoverable value of the assets in Pakistan is estimated at approximately NOK 6 billion ($600 million). It is clear that this activity remains sensitive to the economic and macroeconomic environment. Bachke added.

As the losses from Telenor’s Pakistani operations are felt at the group level, the company may need to rethink its strategy in Pakistan to fuel revenue and profitability growth.

“As we have said before, we are also looking at strategic alternatives in Pakistan. The deterioration of the macroeconomic situation is worrying. This is also the reason why we are carrying out an impairment in Pakistan this quarter. And based on this, we will carry out a strategic review of alternatives with respect to our future operations in Pakistan,” said Sigve Brekke, President and CEO of Telenor ASA, during the Q2 presentation.

“We will certainly look at what creates shareholder value when we do the review, but I don’t want to comment on the content of that review. Of course it’s about looking at the operations, can we run them more efficiently than we already do, but we are also looking at other kinds of alternatives to secure our value in Pakistan,” the CEO added. .

And after?

The CEO’s statement might spark exit rumors, but it has a broader connotation. Strategic overhaul does not necessarily imply market exit, but it can also mean realignment of operations, internal restructuring, spin-off, or mergers and acquisitions.

There are many examples in the local telecommunications industry of such an overhaul. Jazz has transferred its tower sites to a new company, Deodar, and is looking for a buyer. This was a strategic choice made by the company to free up capital and improve profitability, as a company specializing in the operation of towers would bring more synergies.

PTCL sold part of its stake to E& (formerly known as Etisalat) alongside the management right to benefit from the operating experience of the global telecommunications giant. While Jazz, acquired Warid to expand its operations and benefit from the cost savings derived from scale. Telenor’s global operations also launched a merger operation for its local operation in Thailand.

However, Telenor Pakistan’s financial outlook is unlikely to change anytime soon given that global commodity prices are on the rise while central banks are also pushing interest rates higher as a measure of contraction. On top of that, a liquidity crisis threatens the country as it waits for the much-needed IMF loan tranche. The outcome of the recent by-elections has further aggravated political uncertainty contributing to country risk for multinational operators.

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