3G Migration in India – Real Options Approach

Group 3Neeraj Tharwani (1112033)

Shamik Bhattacharya (1112058)Vijey Kumar (1112069)

IIM Bangalore

BSNL Ltd. - Services

Basic Telephony

Internet

ISDN, X.25

Leased Lines

Cellular Mobile Service

Cellular Mobile

ServicesGSM/GPRS –Band – 900 MHzCoverage – Country wideService – Voice, SMS, voice mail, WAP, MMS.

WLL (M)Band – 800 MHzCoverage – remote areasService - Voice

BSNL Ltd. – Market Share: GSM

Delhi

Mumbai

Chennai

Kolkata

0.0% 5.0% 10.0% 15.0% 20.0% 25.0%

0.0%

0.0%

21.1%

17.6%

Maharashtra

Gujarat

A.P.

Karnatka

T.N.

0.0% 10.0% 20.0% 30.0% 40.0%

22.9%

19.5%

30.2%

24.5%

29.0%

Kerala

Punjab

Haryana

U.P.(W)

U.P.(E)

Rajasthan

M.P.

W.B. & A & N

0.0% 10.0% 20.0% 30.0% 40.0% 50.0%

34.9%

11.3%

35.0%

34.7%

43.9%

34.7%

14.0%

48.9%

H.P.

Bihar

Orissa

Assam

N.E.

J & K

0.0% 20.0% 40.0% 60.0% 80.0%

33.8%

54.0%

63.9%

62.2%

78.6%

66.5%

Market Share: Metros

Market Share: Circle A

Market Share: Circle B

Market Share: Circle C

BSNL Ltd. – Market Share: GSM/CDMA

Market Share: All India

21%

19%

16%15%

8%

6%

4% 4

% 3%2% 1%0%0% 1%

RelianceBhartiBSNLHutchIdeaBPL GroupOthersSpiceEscotelTata/HughesMTNLHFCLShyamHexacomm

BSNL Ltd. – Cellular CoverageBSNL

Circles: 21

Metro: 2

Circle A: 5Circle B: 8Circle C: 6

BPL

Circles: 4

Metro: 1

Circle A: 2Circle B: 1Circle C: 0

RELIANCE

Circles: 7

Metro: 0

Circle A: 0Circle B: 2Circle C: 5

IDEA

Circles: 5

Metro: 1

Circle A: 3Circle B: 1Circle C: 0

BHARTI

Circles: 15

Metro: 4

Circle A: 5Circle B: 5Circle C: 1

HUTCH

Circles: 11

Metro: 4

Circle A: 3Circle B: 4Circle C: 0

MTNL

Circles: 2

Metro: 2

Circle A: 0Circle B: 0Circle C: 0

AIRCEL

Circles: 2

Metro: 1

Circle A: 1Circle B: 0Circle C: 0

SPICE

Circles: 2

Metro: 0

Circle A: 1Circle B: 1Circle C: 0

ESCOTEL

Circles: 3

Metro: 0

Circle A: 0Circle B: 3Circle C: 0

HEXACOM

Circles: 1

Metro: 0

Circle A: 0Circle B: 1Circle C: 0

TDMA/ GSM Service Providers Migration Path

GSM GSM/ GPRS

GSM/GPRS

GSM/GPRS/EDGE

WCDMA

Speed

Spectrum?

Upgrade Requirement

GSM(2G)

14.4 Kbps

-

GPRS(2.5G)

160Kbps

Same

EDGE(2.75G)

384 Kbps

Same

Software / Hardware

upgrade. Tri-band Phone

UMTS(3G)

New

New Cell sites.

Software/Hardware

upgrade.

CDMA/ NMT450 Service Providers Migration Path

cdmaOne

cdma2000 1x EV-

DO

cdma2000 1x EV-

DV

NMT450

Cdma2000 1x-RTT

(cdma450)

Speed

Spectrum?

Salient Features

2G

14.4 Kbps

-

Circuit Switche

d

cdma2000 1x-RTT (3G)

150Kbps

Same

Same cell sites. Increased voice.

cdma2000 1xEV-DO(3G-

Phase 2)

2.4Mbps

Same

Simultaneous data and voice

calls.

CDMA vs GSM - Which path to take?

Infra-structure

Spectrum cost

Usage cost Total0

2

4

6

8

10

12

GSMCDMA

Case Data - CDMA

Year 2004 2005 2006 2007 2008 2009

Subscribers 424652 797569 1497974 2813455 5284156 9924560

Revenues 52690000 98960000 185860000 349090000 655650000 1231430000

NPV CalculationDCF Calculation at WACC 0.15                       Year 0 1 2 3 4 5Cash flow -2400000000 98960000 185860000 349090000 655650000 1231430000Discount factor 1 1.15 1.3225 1.520875 1.74900625 2.011357188Discounted cash flow -2400000000 86052173.91 140536862 229532341.58 374870015.5 612238347.1             NPV -956770259.9          

BSNL: 3G – CDMA Route Valuation

Right, but not obligation to undertake certain business initiatives.

Differs from conventional options as it is –not typically traded as securitiesdo not usually involve decisions on an underlying asset that

is traded as a financial securityR&D managers can use Real Options Valuation to help them

allocate their R&D budget among diverse projects

Real Options Analysis – An approach

Types of Options availableOptions relating to project size

Option to expandOption to contract

Options relating to project life and timingOption to deferOption to abandonSequencing options (parallel / sequentially)

Options relating to project OperationOutput mix options Input mix optionsOperating scale options

Option Valuation ProcessInput parameters –

Spot Price: the starting or current value of the projectVolatility: uncertainty as to the change in value over timeStrike price: corresponds to the investment outlays,

typically the prospective costs of the projectOption term: corresponds to the life of the option. Option Style:

American style: Option can be exercised any time up to the due date.

European style: Option can be exercised only on the due date.

Options – Various Models

Black-Scholes Model

Binomial Lattices

Specialized Monte Carlo Methods

Finite difference methods for option pricing

Real call options for this growth model using black Schloe's calculator

Strike price(million dollars) 2400000000

Current price of asset(present value of future cash flows in million dollars) 0

Price of call Option 499160260

Calculated NPV -956770259.9

Therefore with Real Call option we get a positive NPV (million dollars)of: -457609999.9

BSNL: 3G – CDMA Real Options Analysis

Sensitivity Analysis based on CapEx

2375 2380 2385 2390 2395 2400 2405 2410 2415 2420 2425490

492

494

496

498

500

502

504

506

-464

-462

-460

-458

-456

-454

-452

-450

-448

503.54502.65

501.77500.89

500.01499.14

498.26497.39

496.52495.66

494.79

-453.23-454.12

-455-455.88

-456.76-457.63

-458.51-459.38

-460.25-461.11

-461.98

BSNL: 3G – GSM Route ValuationAverage ARPU (Circle A) - Q4 2007

A' Circle  Oct-Dec 07

Subscriber base

Subscriber base %

 Maharashtra 301.3 2735842 26%

  Gujarat 259.1 1766740 17%  A.P. 314.9 2173710 21%  Karnatka 246.2 1717436 16%  T.N. 239.6 2182974 21%         Average prepaid ARPU 275.4   90% Postpaid ARPU 619  10% Blended ARPU 309.7

Average ARPU (Metro) - Q4 2007

Metro  Oct-Dec 07

Subscriber base

Subscriber base %

  Kolkata 313.9 841578 49%

  Chennai 395.2 870064 51%

         

Average prepaid ARPU 355.2   90% 

Postpaid ARPU 707  10% 

Blended ARPU 390.4

Expected ARPU (BSNL)FY 2007 2008 2009 2010 2011ARPU (Circle A) 309.7 247.78229 198.2258 158.5807 126.8645348ARPU (Metro) 390.4 312.32309 249.8585 199.8868 159.9094234           drop 20%

Expected Subscriber (BSNL)Subscriber Base 2007 2008 2009 2010 2011Circle A 10576702 19778433 36985669 69163201 129335186.7Metro 1711642 3200770.5 5985441 11192775 20930488.32Increase 87%

BSNL: 3G Economics (2007 – 2011)

1 2 3 4 50

50000000

100000000

150000000

200000000

250000000

300000000

350000000

400000000

Circle A Metro All India

1 2 3 4 50.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

400.0

450.0

ARPU (Circle A) ARPU (Metro)ARPU (All India)

Expected Subscriber Base

(2007 – 2011)

Expected ARPU(2007 – 2011)

BSNL: Piloting in MetrosCapex Allocation Assumptions:

Cost at which AT&T wireless rolled out 3G for 60 million customers(million) 4400

Adjusted Capex for Pilot 3G for BSNL (Metro) 234.72317

FY   2008 2009 2010 2011

ARPU (Metro)   370.9 352.3 334.7 318.0Subscriber Base (Metro)  

3200770.5 5985440.9 11192774.5

20930488.3

Revenue in Million dollars   26.4 46.9 83.3 147.9

Pilot capex 234.72        

Spectrum fee for Pilot 0.00        

Total Expenditure 234.72

DCF Calculation at WACC: 0.15Year 0 1 2 3 4Cash Flow -234.72317 26.4 46.9 83.3 147.9Discount Factor 1 1.15 1.3225 1.520875 1.74900625Discounted Cash Flow -234.72317 22.939165 35.43602283 54.74095178 84.5628703

NPV(Metro) -37.044163

using real call options by Black Schole's Method(million dollars)

current price 197.67901

strike price 234.72317

price of call option 87.81

ARPU Sensitivity Analysis for Metros

5% 10% 20%

-150

-100

-50

0

50

100

NPV(Metro)price of call optionNet NPV(million dollars)

  5% 10% 20%

NPV(Metro) -37.0442 -66.5257 -115.062

price of call option 87.81 66.8 35.7

Net NPV(million dollars) 50.76584 0.274289 -79.362

BSNL: Piloting in Circle ACapex Allocation Assumptions:

Cost at which AT&T wireless rolled out 3G for 60 million customers(million) 4400

Adjusted Capex for Pilot 3G for BSNL (Circle A) 1450.4184

FY   2008 2009 2010 2011ARPU (Circle A)   294 280 266 252Subscriber Base (Circle A)   19778433

36985669 69163201 129335187

Revenue in Million dollars   129 230 408 725Pilot capex 1450.42Spectrum fee for Pilot 0Total Expenditure 1450.42

DCF Calculation at WACC: 0.15Year 0 1 2 3 4Cash Flow -1450.42 129.31 229.73 408.11 725.00Discount Factor 1 1.15 1.3225 1.520875 1.74900625Discounted Cash Flow -1450.42 112.45 173.71 268.34 414.52

NPV(Circle A) -481.41

using real call options by Black Schole's Method(million dollars)current price 969.01strike price 1450.42price of call option 364.7

Net NPV(million dollars) -116.71

ARPU Sensitivity Analysis for Circle A

  5% 10% 20%NPV(Circle A) -481.406 -625.923 -863.846price of call option 364.7 271.4 139.1Net NPV(million dollars) -116.706 -354.523 -724.746

5% 10% 20%

-1000

-800

-600

-400

-200

0

200

400

600

NPV(Circle A)price of call optionNet NPV(million dollars)

BSNL: Current Scenario• Currently BSNL has only 4.8 million CDMA customers compared to 93 million GSM /

3G customers.• For private dual technology players like Reliance Communications (Rcom) and Tata

Teleservices (TTL) are pushing GSM /3G instead of CDMA and both are intending to use CDMA network for data only in coming days.

• Aggressive EVDO coverage expansion with ZTE -Though BSNL has quite good coverage in the metro and urban areas, on sub-urban areas especially tier II and III cities BSNL has less than 20% EVDO coverage.BSNL has entered into equipment supply agreement with ZTE, which is one of the world’s top CDMA supplier. BSNL should take care of EVDO expansion via ZTE.

• Investing on EVDO Rev B network -Instead of investing EVDO rev A (3.1 Mbps downlink), BSNL must go for EVDO Rev B technology, preferably Rev B Phase II (supports upto 4.9Mbps per 1.25MHz channel).

• Starting trials of LTE on 800MHz band on 1.4MHz channelsLTE can be deployed in channel widths as small as 1.4 megahertz, and in low spectrum bandwidth, for example, LTE’s very high spectral efficiency and edge of cell performance means that even in a 1.4 MHz channel LTE provides close to the average sector throughput performance of an HSPA 5 MHz carrier. NTT Docomo has already started some trials on LTE over 1.4MHz channels. BSNL can either do their own trials or wait for global LTE roll out on this way.

APPENDIX

Black- Scholes Model

is the cumulative distribution function of the standard normal distribution is the time to maturity is the spot price of the underlying asset is the strike price is the risk free rate (annual rate, expressed in terms of continuous

compounding) is the volatility of returns of the underlying asset

References Migration to 3G Wireless Broadband Internet and Real Options: The Case of an

Operator in India http://www.trai.gov.in http://www.coai.com/ http://

voices.yahoo.com/comparison-between-real-option-valuation-discounted-465727.html

http://en.wikipedia.org/wiki/European_option http://en.wikipedia.org/wiki/American_option http://en.wikipedia.org/wiki/Real_options_valuation http://en.wikipedia.org/wiki/Black%E2%80%93Scholes http://www.auspi.in/