Listed in March at Rs 85, the Idea Cellular stock has since appreciated 47 per cent, and now trades at around Rs 125. The sharp appreciation in the stock's price since listing has significantly narrowed the valuation gap between Idea Cellular and the telecom market leader, Bharti Airtel.
The stock now trades at an enterprise value to EBIDTA multiple that is quite close to that of Bharti, despite a less broad-based business profile. Investors can retain the stock, given the continuing strong subscriber additions and Idea's growing footprint.
However, given the relatively high valuations, the stock may offer opportunities for fresh entry at lower price levels.
Operations
Idea Cellular, which started out in 1997, is a pure-play GSM cellular services provider. It has over the last decade ramped up revenues both through organic growth as well as circle-level acquisitions of companies such as Escotel, RPG Cellular and the Andhra Pradesh operations of Tata Cellular.
These moves have helped Idea Cellular ramp up its geographic presence and acquire a national footprint, with operations now in 11 circles (geographic zones) and a subscriber base of 14.5 million. Idea appears well set in its eight established circles, where it is adding over 4.5 lakh subscribers a month and is the biggest or the No 2 player (based on total GSM subscribers).
In the 11 circles it operates in, eight are profitable, while in three where it started operations recently — Himachal Pradesh, Rajasthan and Uttar Pradesh (East) — the company has reported operating losses.
Operating profits in the eight established circles were at Rs 1,595 crore in the latest financial year, while losses in the three new circles were at Rs 85.7 crore. Idea has also been able to tap the Universal Service Obligation (USO) Fund and has won 27 clusters in the auction process.
This is likely to expand Idea's footprint and also result in savings on operational expenses such as rentals and cell-site maintenance.
Idea Cellular has managed its subscriber base well through such innovative schemes such as two-minute outgoing free, reduced tariff rates for loyal pre-paid subscribers, life-time recharge and so on.
The company has also been among the early movers in offering value added services (VAS) such as ringtone downloads, caller ring-back tone, services catering to more youthful audience .
As for the infrastructure, Idea was the first in India to launch GPRS and EDGE technology-ready mobile networks. These moves have resulted in a rising contribution of VAS to Idea's revenues.
The contribution stood at 9.2 per cent for Idea compared to 10.1 per cent for Bharti Airtel. Idea may be better placed to take advantage of any opportunity arising from third generation mobile services (3G) spectrum policy, which is expected in the next few months.
Taking a cue from Bharti Airtel, Idea has also taken the managed outsourcing route. It recently signed a $700-million agreement with IBM for all its IT infrastructure requirements and inked a $500-million deal with Nokia and Siemens for supply of network equipment.
As a rapidly growing mobile services provider, this move can help Idea reduce overheads and bring greater focus to its core functions. As these deals are recent, and benefits will begin to flow in from the current financial year.
Financials
On the operational metrics, Idea Cellular fares better than the national average for GSM telecom players on metrics such as ARPU (average revenue per user) and churn rate, and compares reasonably with Bharti Airtel on most.
Both Idea and Bharti have similar pre-paid subscriber percentages. Idea's churn rate (customers lost) is lower than the national average of 7 per cent.
Idea has a higher ARPU, of Rs.332, than the national average of about Rs 300, though this pales in comparison with Bharti's Rs 406.
Idea, however, realises more per minute usage revenue at Rs 0.91 compared to Bharti's Rs 0.85.
This is a reflection of Idea's current operations in relatively higher ARPU circles. Going forward, the ARPU is likely to continue to soften across players, but the impact on margins is expected to be made up by a better service mix (with higher VAS and initiatives such as 3G).
Idea's EBITDA (earnings before interest, tax, depreciation and amortisation) margin is relatively high at 34.2 per cent, though this may come down in the near term, in the event of pricing pressure, major network expansion and related operational expenditure.
While margins are on a par with industry average in the established eight circles, it is clear that the three new circles have been a drag on profitability.
But the healthy subscriber additions over the last quarter suggest scope for higher revenues and improved EBITDA in the new circles. This could result in an improvement in the overall profitability for Idea the next fiscal.
Apart from this, the foray into Mumbai could offer Idea the potential for an improvement in margins.
Mumbai is a high ARPU circle and is expected to generate higher revenues and lead to quicker recovery of the capex cost. Idea has indicated a Rs 647-crore spend on initial network building, from its IPO proceeds, for the Mumbai circle.
With increased ARPU in Metro and A category circles, and strong subscriber additions and consolidation elsewhere, Idea could emerge as a leading player in the mobile telephony space.
Possible risks
Though the company boasts of strong growth prospects, investors in the stock have to factor certain risks.
Given that the company is still in the process of ramping up its regional presence, execution risks to its operations are higher than those for Bharti.
Recent cuts in Access Deficit Charge (ADC) on outgoing international calls and roaming charges may also pressure realisations for Idea, if it reduces tariffs. While Bharti and Reliance immediately announced tariff cuts, Idea is yet to do so.
There is speculation on a possible acquisition of Spice Telecom by Idea. Spice has operations in Haryana and Karnataka and has about 2.8 million subscribers.
Though the outcome would depend on the pricing, such a deal can further expand Idea's geographic presence and subscriber base.
Another event that can prove a trigger to the stock price is the possible takeover of Idea Cellular by global telecom majors keen to strengthen their India presence. However, this remains in the realms of speculation.