Investors can consider subscribing to the Idea Cellular initial public offering, being made in the price band of Rs 65-75 per share.
Considering the huge untapped demand for mobile telephony in India and the robust subscriber addition of six million per month, the mobile expansion story is expected to sustain over the next few years.
Idea Cellular does not enjoy a pan-India footprint, such as its peers — Bharti Airtel and Reliance Communications — but its strong growth in the four established circles (of the 11 it operates in) of Andhra Pradesh, Delhi, Gujarat and Madhya Pradesh will continue to contribute a substantial part of its revenues.
On the flip side, however, intense competition from established peers and consolidation arising from the Hutchison Essar stake sale would impact standalone players such as Idea Cellular.
Valuation yardstick
Since mobile players are engaged in a major capital investment drive with negative cash flows from operations, conventional valuation yardsticks such as price-earnings multiple may not portray the full picture. Instead, we compared Idea Cellular with its key GSM peer, Bharti Airtel, across three performance metrics: EV (enterprise value; market capitalisation plus debt) to revenues; EV to EBITDA (earnings before interest, tax, depreciation and amortisation) and EV per subscriber.
Based on the annualised third quarter performance of Bharti Airtel, the EV/revenues for its mobile business is 8.1 times. For Idea Cellular, it works out to a much lower multiple of 5.8 times.
Similarly, EV/EBITDA (which reflects the operational cash flows that can be deployed for growth) for Bharti's mobile business works out 22 times vis-a-vs 17 times for Idea. Based on these two metrics, Idea's valuation is at a 20-28 per cent discount to Bharti Airtel. In terms of EV/subscriber (which reflects the potential for future cash flows) it is Rs 19,080 for Idea, over 40 per cent lower than that of Bharti Airtel.
From an investment perspective, this valuation discount of Idea vis-à-vis Bharti makes this offer attractive and leaves potential for capital appreciation. We recommend an investment at the cut-off price.
Key features
The company has operations in 11 circles, which cover 58 per cent of India's population and current subscriber base. Its coverage area includes one metro (Delhi), 3 category A circles (Andhra Pradesh, Gujarat and Maharashtra) and 6 category B circles (Harayana, Kerala, Madhya Pradesh, Rajasthan, UP-East and UP-West) and one category C circle (Himachal Pradesh).
As of December 31, 2006, Idea Cellular had 12.44 million subscribers, enjoying an 8.5 per cent market share. The company is expected to roll out its services in Mumbai and Bihar and has applied for licences in the remaining 10 circles. The category B and C circles are likely to drive subscriber growth in future.
As an original licensee in seven established circles, the company is a market leader in three circles of Haryana, Maharashtra and UP (West). At the same time, it is also substantially dependent on four circles - Andhra Pradesh, Delhi, Gujarat and Maharashtra, which accounted for 63 per cent of its subscriber base, for its overall revenues and growth. And these circles are likely to remain a significant contributor to its revenues and operating profits in the coming years.
Idea Cellular's IPO is to build, strengthen and expand its network in new circles, roll out services in the Mumbai circle, pay the entry fee and capital expenditure for NLD (national long distance) operations and redeem preference shares. Out of Rs 2,125 crore (excluding the greenshoe option of Rs 319 crore), Rs 970 crore is to be utilised towards expansion and strengthening of the networks in Himachal Pradesh, Rajasthan and Uttar Pradesh (East) by March 2008.
From the remaining IPO proceeds, Rs 647 crore is to be utilised for rolling out services in Mumbai, Rs 757 crore towards redeeming preference shares, and Rs 81 crore for payment of entry fee and capital expenditure for NLD. The NLD licence that the company has applied for is expected to facilitate carriage between the 13 circles and reduce the company's operating costs.
Risks and challenges
Idea Cellular is expected to face intense competition from its peers such as Bharti Airtel, Reliance Communications, BSNL and Tata Teleservices, which enjoy a pan-India footprint. Since the mobile market is still a play on subscriber additions, any slowdown in net additions can affect profitability.
For instance, since it is the eighth player to enter the Mumbai mobile market, its ability to penetrate this market will be a tough challenge.
This is despite being a strong player in the Maharashtra circle. In the long run, any slowdown in subscriber growth can lead to a decline in average revenue per user (ARPU), increase its churn and selling and promotional expenses.
The scope for differentiation and new schemes that players such as Reliance Communications have exploited to the hilt in widening and deepening the mobile marketplace may not be fully available to Idea.
Consolidation issues
Being a player operating out of only one metro and three category A circles, Idea has an ARPU that is lower than the leader, Bharti Airtel. For instance, Idea's blended (prepaid and postpaid) ARPU at Rs 338 was lower than Bharti's at Rs 427 for the period ended December 31, 2006. The minutes of usage also was lower at 353 vis-à-vis 467 minutes for Bharti. Though the prepaid customer base was in line with Bharti, the churn was higher.
Second, the outcome of the bidding war for Hutchison Essar's equity stake will be crucial in assessing the changing mobile market dynamics.
If Reliance Communications succeeds in snapping Hutchison, it will not only comfortably march past Bharti in market share, it will be able to use its scale economies to grow its subscriber base at a much faster clip.
If the winner turns out to be Vodafone, it may prove to be an equally aggressive player in the value-added segment of the mobile sweepstakes. Either way, Idea Cellular is likely to face the heat of consolidation.
Offer details: JM Morgan Stanley and DSP Merill Lynch are the lead managers to the offer, with Citigroup and UBS Securities as the co-book running lead managers. The offer opens on February 12 and closes on February 15.