Spice IPO: Desperate for funds

Of all the companies that have hit the markets with IPOs this month, none could be as desperate for funds as Spice Communications Ltd. It is out to raise between Rs464 crore and Rs520 crore through an IPO that will be open between 25 June and 27 June 2007. The firm needs funds to expand operations so that it can gain economies of scale and turn from losses.

Spice Communications runs cellular services in Punjab and Karnataka, and hasn’t been able to invest enough in the latter circle because of a shortage of funds. Available lines of credit stood at just $50 million (Rs230 crore then) as on 31 December 2006. Those funds may not last for long. The company generated Rs81 crore in cash in the six-month period ended 31 December 2006, but spent Rs176 crore adding assets.

The company got some reprieve earlier this month, when it made a pre-IPO placement to investors, including Lehman Brothers, raising Rs111.9 crore in the process. But clearly, it’s the larger IPO issuance that would ease things on the financing front for Spice. As on December 2006, the company had negative reserves worth Rs684 crore, which wiped out its entire equity capital of Rs552 crore. Its net debt stood at Rs1,081 crore.

It wouldn’t be surprising if its lenders are jittery. The company’s interest cover (operating profit/interest cost) has been steadily declining—from 3.28 times in financial year 2002-03 (FY03) to 2.83 times in FY05 and just 1.46 times in the first six months of the current financial year.

Worse still, the first instalment of the repayment of Rs967 crore worth debt is due on the 21 July 2007. Raising funds is imperative.

Spice had been in a similar situation before. In fact, things were worse. It defaulted on repayments on equipment financing arrangements in 2001, as well as on dues to its debentureholders. It was finally able to settle the dues in 2006, after the entry of Telekom
Malaysia (TM) as a shareholder. TM not only bought out the 49% stake held by Deutsche Bank AG and Ashmore Investment Management Ltd for $179 million, but also arranged for a refinancing of debt worth $265 million. With the refinancing in place, Spice was able to pay equipment vendors, Siemens AG and Motorola Inc., and settle other dues. The company now needs more funds to start repaying the banks that arranged the refinancing.

But coming close on the heels of two large issues cumulatively worth Rs19,250 crore, getting investors to subscribe to the Spice issue could be a tall order. Thankfully for investors, IPO valuation is not expensive. Assuming a 50% growth in the year till June 2007 (in line with the growth in the company’s subscriber numbers), the company’s EV (enterprise value/Ebitda (earnings before interest, taxes, depreciation and amortization) valuation works out to between 16 and 17 times. The 50% growth projection is optimistic, considering that revenue growth typically tends to be lower because of lower Arpu (average revenue per user). In fact, even profit margins could be under pressure for the same reason. But one could argue that profit margins would pick up once the company infuses IPO funds in the business and gains scale, as well as due to the retirement of debt.

The 16-17 times EV/Ebitda valuation works out to a 20-25% discount to Bharti Airtel, which trades at around 21.5 times trailing Ebitda. This could act as the bait for investors, who would be otherwise cautious given the history of losses.