Thursday, 27 September, 2007

Idea Cellular - Multibagger

Deven Choksey, KR Choksey

On EV/EBIDTA basis, Idea is trading at 21.5x which is at a discount to TTML and a premium to RCom and Bharti. We believe Idea looks attractive considering its entry into new circles and improvement of margins in the existing ones.

Idea Cellular is a part of the US $ 24 billion Aditya Birla Group and a leading GSM mobile services operator with licenses to operate in 13 telecom service areas in India. The company has operations in Delhi, Himachal Pradesh, Rajasthan, Haryana, Uttar Pradesh (W) & Uttaranchal, Uttar Pradesh (E), Madhya Pradesh & Chattisgarh, Gujarat, Maharashtra & Goa, Andhra Pradesh and Kerala. With the planned expansion into Mumbai, Bihar & Jharkhand.

Idea's footprint will cover nearly 70% of India's telephony potential. Idea Cellular had 16.13 Million subscribers as on June 30, 2007, and had a market share of 15.4% as on June 30, 2007 in its 11 service areas of operation. We think Idea looks impressive due to the following reasons:-

Higher subscriber addition
We expect that the company will see a robust growth in its subscriber base in the coming months in both new as well as existing circles. Moreover it is expected to be allotted spectrum in Mumbai in the coming months.

Improvement in EBITDA margins
The EBITDA margins are expected to improve both in the existing and the new circles. As more and more subscribers will be added and company will enter into new circles, revenue flow will also be higher.

Hiving off tower business
Following the footsteps of Bharti and RCom, Idea Cellular has also decided to hive off its tower business into an independent subsidiary. The Board of Directors (BoD) has approved the demerger plan. So value unlocking is on the cards.

Key Developments
Hiving off tower business
The Board of Directors of the company has approved the demerger of its tower business into an independent subsidiary for possible transfer of passive infrastructure which would lead to substantial value unlocking going forward.

Financial Performance
In Q1 FY08, Idea Cellular’s net profit grew by 259% to Rs 308.5 crore and revenues were at Rs 1477.2 crore showing an increase of 64% on year on year basis. This growth was mainly on account of robust subscriber addition. EBITDA margins stood at 34.7% which also improved on a year on year basis from 33.7% which was largely on account of improvement in network and marketing expenses.

Industry Scenario
While India is now the world’s fastest growing telecom market, our tele-density continues to be lowest at about 20%, taking into account both wireline and wireless phones. It is clear that India has a long way to go before we catch up with the rest of the world or even with other emerging markets. It is expected that telephony will continue to grow at the present rate of 6 to 7 million additions per month over the next several years to reach the 500-million connections mark by the year 2010.

Further growth in the subscribers is likely to come from circle 'c'. Telecom companies have geared up to achieve the target growth in the subscriber numbers and are expected do a capex of Rs 60000 crore in the coming years. Few major developments that are likely to happen in the sector are:-
• Consolidation and M&A in the sector
• Listing of tower subsidiaries
• Launch of 3G services,IPTV,DTH and WIMAX
• Mobile number portability
• "Do-Not-Call Registry"
• Entry of global players

Spectrum Crunch: - Besides, almost each telecom company is facing acute shortage of spectrum which is the indispensable resource for this sector. This problem of spectrum crunch might hinder the growth targets of the companies and also cause deterioration in the quality of service (QoS). Spectrum is yet to be vacated by the defence ministry.

Though the government is keen to carry out the bidding for the additional spectrum, COAI (association of GSM operators) has strongly opposed it and taken the stand that the current policy is based on subscriber base is very clear. They have even hinted to file legal proceedings against the govt. However, AUSPI (association of CDMA operators) have opposed the current policy and is of the opinion that GSM players have already been allotted the extra spectrum. Department of Telecom (DoT) has formed a committee to look at this issue and come out with a report. Seeing the deficiency of spectrum a study regarding the efficient utilization of this
scarce resource will also be conducted.

Tower business hive off
These days almost every telecom operator is hiving off its tower business into an independent subsidiary. Seeing the growth in the subscriber base passive sharing of the infrastructure is a viable option especially when the growth has to come from circle “C” where ARPU is comparatively lower. Total tower requirement is estimated to be at 330000 towers by FY10. Such a model has enormous potential to succeed in India because there are 7-8 operators in India as compared to Europe and China where there are only 2-3 operators. Moreover it is better for an operator to start tower business because their payback period is comparatively lower.

The company has planned to hive off its tower business for possible transfer of passive infrastructure. It would result in significant value unlocking. The company had 13,160 cell sites as of Q1FY08 compared to 10,114 cell sites at the end of Q4FY07. Around 4500 towers are on sharing basis. Out of 8.662 towers about 4,900 are roof top towers and 3,700 are ground based. They have a tenancy ratio 0f 1.3x. Company is expected to increase its cell sites to 20000 by FY08.

Aggressive method of recognizing revenue
Idea recognizes entire processing charge from Lifetime prepaid schemes as revenue upfront, while RCom and Bharti amortize the same over 48 months and 24 months, respectively. Thus, Idea’s ARPU, revenues and margins, to that extent are inflated. In Q1FY08 more than 30% of net additions were from new lifetime prepaid scheme. We believe that the policy of booking entire processing fee as revenues upfront would have contributed almost Rs6 to ARPU.

EBITDA margins increase by 100bps to 34.7%.
EBITDA grew by 69% Y-o-Y. The EBITDA margins in its ‘established’ circles including Delhi, Maharashtra, Gujarat, Andhra Pradesh, Madhya Pradesh, Haryana, Kerala and Uttar Pradesh (W) expanded by 40bps Q-o-Q to 38 percent. Losses in 3 new circles have come down to Rs 24.6 crore (-40% of revenues) from Rs 330 m (-76% of revenues) in last quarter. Company saw reduction in network and marketing expenses as percentage of sales by
160 bps. However access charges increased slightly. PAT increased 259% Y-o-Y due to margin expansion, lower depreciation and interest expense.

At CMP, Idea is quoting at P/E multiple of 44.8x based on TTM basis June 07. EV/Subscriber and EV/EBIDTA for Idea is Rs22630 and 21.5x respectively on TTM basis June 07.

Risks: The risks that could hinder the earnings growth of Idea in time to come are as under:
- Inadequacy of spectrum required for future subscriber additions may hamper the growth process of the company and may even deteriorate the quality of service

- Competitive structure of the industry poses further threat to the company’s vision and it may even hit the operating margins substantially in order to carve a niche in the market.

- Telecom is a highly regulated sector and as such needs many approvals for undertaking a new project. Moreover there is generally a lot of pressure from NGO’s in case of a minor increase in fares. Such oppositions and delay in projects may also cause harm.

- Mobile number portability, if allowed might increase the churn rates.

- If the company enters new circles, incremental revenues will be less than the expenditure done by the company because marketing and license fees will have to be incurred.

Growth: The growth for the company in the coming years is likely to be fueled by the following factors:

- Further penetration into the Indian markets would lead to huge subscriber additions per month.

- Entry into the new circles subject to allotment of spectrum will fuel the growth prospects.

- Inorganic growth may be an option to consolidate its position in the Industry.

- Issue of NLD and ILD licenses to Idea will boost the revenues.

Idea is currently trading at P/E multiple of 44.8x on TTM basis June 07 which is at premium to RCom but at discount to Bharti. On EV/EBIDTA basis, Idea is trading at 21.5x which is at a discount to TTML and a premium to RCom and Bharti. We believe Idea looks attractive considering its entry into new circles and improvement of margins in the existing ones. However if it enters new circles its expenditures would spiral up and will have to face tough competitions from its arch rivals Bharti and Rcom. Hence long term investors can buy the stock.

Disclaimer: As per SEBI requirements it is stated that,Kisan Ratilal Choksey Shares & Sec Pvt Ltd., and/or individuals thereof may have positions in securities referred herein and may make purchases or sale thereof while this report is in circulation.