Hot and spicy

Spice Communications appears attractively priced given the prospects of consolidation in the industry.

The Indian telecommunications story is not yet over. Right after Vodafone made its costly debut into India, consolidation bells started ringing in the industry, as there was a buzz over the potential merger of Idea Cellular and Spice Communications.

The merger talks apparently did not succeed, but the target – Spice Communications is now knocking at the bourses to raise about Rs 520 crore from the public.

The initial public offering (IPO) consists of 11.31 crore equity shares of face value Rs 10 each, in a price band of Rs 41-46. The shares on offer will comprise of 16.39 per cent of the company's fully diluted post-issue capital.

Spice Communications is promoted by Modi group chairman B K Modi and has Telekom Malaysia (TM), Malaysia's incumbent service provider as a strategic investor, which holds a 47 per cent stake in the company. Post-issue, TM's holding in the company will come down to 39.2 per cent.

Mobile play
Spice operates in two states, --Punjab and Karnataka. The operator ranks second in Punjab with about 23 per cent market share, next to Bharti, and sixth in Karnataka with nearly seven per cent market share.

The eighth largest GSM operator in the country, it has a subscriber base of nearly three million users.

The company now plans to spread its wings across the country, and has applied for licenses for an additional 21 circles throughout India to provide GSM cellular services.

Further, it is also applying for licenses to provide national long distance (NLD) and international long distance (ILD) services.

The company also plans to leverage synergies from its alliance with TM, such as using TM's vast array of submarine cables spread across South East Asia for its ILD services.

Spice operates in the 900 MHz spectrum in Punjab and Karnataka and has installed 1,358 cell sites throughout Punjab, and 1,019 sites throughout Karnataka, as on March 2007.

Cell sites are physical locations equipped with a base station consisting of transmitters, receivers and other equipment used to communicate through radio channels with subscribers' cellular phone handsets.

"We plan to share this network infrastructure with other operators going forward, which would bring down our operating costs significantly," claims Dilip Modi, chairman and managing director, Spice Communications.

These expansion plans will materialise using a half of the issue proceeds. The remaining 50 per cent of the issue proceeds are earmarked to retire part of its Rs 1,000 crore debt.

The company has been operating with a negative networth since June 2002, rendering it ineligible for listing on the National Stock Exchange.

Town and country
The Indian telecommunications industry has metamorphosed itself into a monster growth sector within just a decade.

The Indian telecommunications network is the fifth largest in the world and the second largest among the emerging economies of Asia, with a subscriber base of 167.4 million in April 2007.

The mobile subscriber base grew by a robust 69 per cent in FY07 over the 96 million subscribers in FY06, a net addition of 66 million subscribers, resulting in an average addition of 5.5 million subscribers per month.

Again, the growth in GSM subscriber base (75 per cent in FY07) is faster than that in CDMA subscribers (52 per cent in FY07), which makes GSM service providers hold nearly 75 per cent of the country's mobile industry pie.

The pie is now getting bigger, as the Department of Telecommunications (DoT) is in the process of receiving bids for the provisioning of passive telecom infrastructure in rural areas, for 81 clusters aggregating about 7,871 cell sites.

The country currently has around ten players in the GSM arena, Bharti Airtel being the largest with around 23 per cent share of the market. Spice holds a distant rank, with hardly 2 per cent market share at the national level.

Valuation
Even though Spice has been present in the markets since 1997, it is yet to break even. The company has been profitable at the operating level, but not at a net level, which makes it difficult to value the issue offering using the price-earnings multiple approach.

However, comparing the company with its peers applying other ratios, such as the enterprise value to earnings before interest, tax, depreciation and amortisation (EV/EBITDA) and enterprise value to sales (EV/Sales), the Spice issue appears reasonably priced.

On the flipside, the company has been registering slower revenue growth (about 9 per cent y-o-y) compared to its peers (ranging from 35-60 per cent y-o-y). Its operating margins too are on the lower side (around 22 per cent), while the industry average is of about 35-40 per cent.

Spice is optimistic about growth in its operating and net profit margins following network sharing and launch of NLD and ILD services, and reducing finance costs by retiring debt after the issue. It had recently been in the news over its potential merger with Idea Cellular.

Given the prospects of consolidation in the industry, Spice could well become a target of any such move going forward, once it reduces its debt and moves toward profitability. Put it all together, and the issue appears attractive, both in the short and the long term.