Mega BSNL Contract Looms

Indian carrier Bharat Sanchar Nigam Ltd. (BSNL) is poised to begin inviting bids next week on a much-anticipated second phase of a cellular upgrade contract that will be worth around $4 billion.

The massive deal has international infrastructure vendors salivating, but if Nortel Networks Ltd. 's experience of winning phase one of the contract is any indication, being selected for phase two could prove to be both a blessing and a curse.

The tender, for 60 million GSM lines, was expected to be issued in October, then December; but the carrier's plan hit several speedbumps as it tried to iron out the technical details of such a large contract.

BSNL had originally planned to issue the contract in two parts -- one for 40 million lines, and another for 20 million in 2007, but has now decided to award the whole lot in one go. It also plans to set aside 25 to 30 percent of the lines for 3G.

The sheer size of the deal has plenty of vendors positioning themselves to grab a piece of the pie. Alcatel (NYSE: ALA; Paris: CGEP:PA) has recently opened a second GSM base station production facility with its local partner, ITI Ltd. , Ericsson AB (Nasdaq: ERIC) has upgraded its base station facilities, while Nokia Corp. (NYSE: NOK) was recently awarded another GSM expansion deal from BSNL. (See Alcatel, ITI Collaborate, Ericsson Expands in India, and Nokia Wins BSNL Deal.)

Lucent Technologies Inc. (NYSE: LU) and Siemens AG (NYSE: SI; Frankfurt: SIE) are also contenders, and ZTE Corp. (Shenzhen: 000063; Hong Kong: 0763) has made noises about its plans to bid on both the GSM and 3G portions, while there's still a question mark over whether Huawei Technologies Co. Ltd. will be allowed to participate following its recent spat with the carrier, which BSNL says it will resolve before inviting bids. (See BSNL Shuns Huawei.)

In a note to clients, Lehman Brothers analysts wrote that although Nortel -- along with Alcatel and Nokia -- won the first phase of BSNL's GSM network buildout, "Early indications...appear to suggest Ericsson, Nokia and Alcatel are likely to be selected with Nortel losing out."

That would be a blow to Nortel, which took a loss on the previous contract in the hopes of gaining a foothold for future business. (See Nortel's Owens: Krazy About Korea and BSNL Selects Nortel.)

Lehman notes, "Nortel lost about $0.50 on every $1 in sales to BSNL in phase 1." On a $500 million contract that's quite a loss -- according to Nortel's third-quarter SEC filing, the vendor lost $160 million in 2004 and an additional $103 million in the first nine months of 2005.

The filing states that the contract included an option for BSNL to increase the deal by an additional 50 percent: "Nortel and BSNL are currently in negotiations for the expansion business which, depending on the outcome of the negotiations, could result in a reduction in the initial revenue estimate...and has the potential to result in additional project losses in the fourth quarter of 2005 and into 2006."

Likewise, whoever wins this contract could well do so at a loss, despite the size of the deal. The bidding process for contracts in India is so competitive that vendors are often prepared to take a loss to reach L1, lowest bidder status, in exchange for a high-volume deal. With the Indian wireless market expanding rapidly, it's hoped incumbent status will translate to follow-on deals -- Lehman notes that "the reason Nortel had sold at a such a deep discount in phase 1 was the company had hoped it could obtain a profitable contract in phase 2."

But with the loss it's taking on the first phase, Nortel appears to be more cautious about bidding on future contracts in the region. CFO Peter Currie told analysts on its third-quarter conference call, "In terms of future business...our intent is to build the business profitably, perspectively. So any future business in India, or other theaters for that matter, we're looking at very carefully to ensure it generates positive returns for Nortel shareholders."

As for the competition on this contract, Lehman says, "We expect the competitive dynamics to remain intense though believe the fierce pricing pressures seen during the first phase of the build (as vendors looked to build footprints in the region) could ease slightly, helped in part by Nortel's weakened positioning."

The mega-contract reflects the rapidly growing demand for telecom services in India, which is adding more than 3 million mobile users every month. BSNL said yesterday it signed up more than one million mobile customers in December, bringing its total to 14 million. Carriers are responding with ambitious plans to build out their mobile networks in particular, which cover just a third of the country, with India's smaller state-run operator, Mahanagar Telephone Nigam Ltd. (MTNL) , planning to invite bids on a contract for 4 million GSM lines.

— Nicole Willing, Reporter, Light Reading

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