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.

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Spice Communications IPO Analysis

Small player trying to survive

Promoted by Dilip Modi of the B K Modi group, Spice Communications provides cellular services in Punjab and Karnataka. Telekom Malaysia will hold a 39.2% equity stake post-issue compared with 40.8% of the Modi group. The company was the second largest cellular services provider in Punjab and the fifth largest cellular services provider in Karnataka, measured by the total number of subscribers with a combined market share of 14.49% in these two states (Punjab: 23.9% and Karnataka: 7.5%) end March 2007. The subscriber base was 3 million (2.05 million in Punjab and 0.95 million in Karnataka) with network coverage of 537 towns in Punjab, covering approximately 55% of the state population, and 229 towns in Karnataka, covering 33% of the state population end May 2007.

Spice Communications has pending applications for licences to provide cellular services in additional 21 circles throughout India. The company was recently awarded a national long distance (NLD) licence and international long distance (ILD) licence by the Department of Telecommunications and it intends to initially set up base infrastructure for a capacity of 30 million minutes per month across 15 locations in India.

The current initial public offering (IPO) is to raise Rs 464 crore at the lower band (Rs 41) and Rs 520 crore at the upper band (Rs 46). The net proceeds from the issue are to be used for part repayment of long-term debt, for payment of NLD and ILD licence fee, for meeting related capital expenditures to set up base infrastructure for NLD/ILD amounting to Rs 63.60 crore, for paying vendor(s) for network equipment and other capital expenditure amounting to Rs 177.63 crore, and for general corporate purpose and public issue expenses. Spice Communications has issued 2.49 crore of equity shares at a price of Rs 45 to certain investors pre-IPO and raised Rs 111.93 crore.

Strengths

• Has received NLD and ILD licences and proposes to offer data transmission services and voice transmission for calls originating and terminating on most of India’s and global telecom networks. It will be basically taking capacity on lease rather than setting up its own network. This will improve the operating profit margin.
• One of the objects of the issue is to repay part of debt, which is likely to reduce the interest burden.
• The Indian telecom industry is one of the fastest growing in the world adding nearly six million subscribers a month. The mobile subscribers base is estimated to increase to approx. 210 million by the year ending March 2008 (FY 2008), from the current level of 167.44 million subscribers end April 2007. Factors like falling handset costs, attractive tariffs and extensive reach have reduced the entry barriers for new subscribers and, thus, expanded the markets available to telecommunication service providers. The presence in the country’s richest state, Punjab, is likely to translate into volume growth.

Weaknesses

• In the absence of pan-India presence like other integrated operators, unable to provide seamless roaming services and is forced to share its revenue with other operators with whom it has roaming arrangement for its subscribers. Though licences in other circles have been sought, the current state of financials will hamper expansion in other circles in a major way in foreseeable future.
• Of the last five completed financial years, there were net losses in three years on account of low operating profit margin compared with the industry, high interest and depreciation. Losses have been incurred even in FY 2007. On account of continuous losses, the net worth has eroded. Accumulated losses stand at Rs 684 core (higher than the current issue size of around Rs 500 crore).
• Being a regional service provider, there is significant competition from larger integrated players with pan-India presence and greater financial, technical and marketing resources. In the past, key corporate clients were lost, particularly in Karnataka, primarily due to lack of coverage in certain geographic areas. Not been able to sustain its first mover advantage in both the states it operates.
• The Modi group’s track record is not encouraging.

Valuation

Spice Communication has made net losses in the six months ended December 2006 and year ended June 2006. However, it has been making profit at the cash level. The company will not be listed on NSE as it does not meet the financial track record prescribed by NSE for new listings.

At the price band of Rs 41 - Rs 46, the EV/EBITDA works out to 20.9 – 22.8, respectively. While Bharti Airtel, the largest integrated player in the sector with a pan-India presence in GSM (in all 23 circles), trades at EV/EBITDA of 21.5, and Reliance Communication, with CDMA presence in 21 out of 23 circles and GSM presence in eight circles constituting a pan-India presence in all the 23 circles, is trading at EV/EBITDA of 18.4. Idea Cellular, with operations in 11 circles, trades at EV/EBITDA of 22.6.

On the basis of FY 2007 consolidated revenue, the market capitalisation to sales works out to 8.5 for Bharti Airtel, 7.3 for Reliance Communication, 7 for Idea Cellular, and 3.4 for Tata Teleservices (Maharashtra). It is 3.7-4.1 for Spice Communications. The EV per wireless subscriber for Bharti Airtel, Reliance Communication and Idea Cellular is about Rs 41102, Rs 35382 and Rs 23434, respectively. For Spice Communication, it is Rs 13887 – Rs 15113. But one should also factor in that Spice Communications is operating in only two circles and has a low subscriber base/market share.

The blended average revenue per user (ARPU) of Spice Communication stood at about Rs 370 in the six months ended December 2006 against Rs 427 for Bharti Airtel, Rs 338 for Idea cellular and Rs 328 for Reliance Communication in the quarter ended December 2006.

Spice Communication is one of the suitable candidates for takeover. Earlier attempts have reportedly failed due to pricing issues. The company is not a growth story as it is neither capable of growing organically nor inorganically in a significant way. Ultimately, it will have to get itself taken over by a strong player. That’s the only thing that can add spice to its share price.

Spice Communications IPO opens on 25 June 2007

Price band Rs 41 - 46 per share

Spice Communications intends to garner around Rs 520 crore through its initial public offering, which opens on 25 June 2007.

The issue, having a price band between Rs 41 - 46 a share, will close on 27 June 2007. The company is taking a 100% book-building route for the IPO.

The company will issue 11.31 crore equity shares of Rs 10 each and the issue will comprise 16.39% Spice Communications’ fully diluted post-issue share capital.

The company had earlier raised Rs 112 crore through a pre-IPO placement of 2.48 crore shares at Rs 45 each.

Malaysia’s official service provider Telekom Malaysia (TM) holds 49%, while industrialist and Modi group Chairman B K Modi owns the remaining 51% stake in Spice Communications.

Spice Communications will use around 50% of the total proceeds to retire part of its Rs 1,000 crore debt, while the remaining would be used for expansion plans.

The company’s expansion plans included foraying into national long distance (NLD) and international long distance (ILD) services in the country.

Post IPO, TM’s stake in the company will fall to 39% and the promoter’s holding to 41%, while retail public holding will increase to around 20%.

Spice Communications' net loss of Rs 68.58 crore in the full year ended June 2006 from Rs 6.97 crore in FY 2005. Sales advanced 9.1% to Rs 661.49 crore in FY 2006 (Rs 606.57 crore).

The company's shares would be listed on the BSE. Spice Communications could not list its shares on the National Stock Exchange (NSE), where listing of companies with negative networth is not permitted.

Spice fixes IPO price band at Rs 41-46

Cellular operator Spice Communications Ltd said on 19 June it has fixed the price band of its proposed public issue between Rs41 and Rs46 an equity share of Rs10 each.

“We have recently concluded a pre-IPO placement of 24,837,889 shares at Rs45 per share, thereby raising about Rs112 crore. A clutch of investors led by Lehman Brothers and Sinnaker Investments have picked up a small stake in Spice Telecom,” company chairman and managing director Dilip Modi told reporters at a press conference here.

Following the IPO, the stakes of the both the promoters, B K Modi and Telekom Malaysia, would come down by 10% each.

At present, B K Modi holds 51% and Telekom Malaysia, the remaining 49%.
Post-IPO, Modi will hold 41% while Telekom Malaysia, 39%, with the public holding the remaining 20%.

“We are the second largest operator in Punjab with 1.91 million subscribers and the fifth largest operator in Karnataka, with 0.82 million subscribers,” Modi said.

The company intends to consolidate and boost its presence in both the markets by expanding its coverage with a view to increase its marketshare, he said.

“We also plan to work with our roaming partners to improve and expand our coverage and to provide consistent products and services to our subscribers,” he added.

Idea-Spice deal fails on pricing

Talks between Idea Cellular, India’s sixth-largest wireless operator, and the BK Modi-owned Spice Telecom on a merger have broken down due to differences in price, a person close to the negotiations said. The two sides had held preliminary discussions on the possibility of a merger or an acquisition by Idea three-four weeks ago. Idea, which is present in 11 out of the country’s 23 circles, was keen on expanding its subscriber base. But it baulked at the price being demanded by Spice Telecom.

“Expectations of the Spice management were unrealistic. They were quoting almost twice the value of the company. The merger was called off around a fortnight ago. There is no question of it even after the Spice IPO,” said the person who did not wish to be quoted as he is not authorised to speak. Idea Cellular MD Sanjeev Aga refused to comment. Spice Telecom CMD Dilip Modi could not be reached for comment.

Spice, which offers cellular services in Punjab and Karnataka, had revenues of around Rs 553 crore in 2006. It was looking at a valuation of about $1.3 billion (over Rs 4,300 crore). Idea found it excessive, as Spice does not have a nation-wide presence and continues to make losses.

Analysts say that if Bharti Airtel’s valuation is taken as the benchmark, Spice would command a price of about $1 billion. But Spice is only present in two circles and is a pure-play mobile company compared with Bharti, an all-India integrated operator. Therefore, Spice’s valuation would be at a discount of 30%-35% to Airtel, or about $650 million-$700 million.

Idea officials are also believed to have cited Spice’s weak presence in Karnataka as a dampener. It ranks sixth in the southern state with a share of around 7% despite having made an early start. While most operators have expanded footprint across India after starting with a few circles in the 1990s, Spice has confined to just two circles. It applied for pan-India licences only in September last year.

Idea is present in 11 out of 23 circles and has licences to operate in Mumbai and Bihar where is expects to roll out services as soon as spectrum is allocated. While a merger with Spice would have given it ready presence in two more circles, the price demanded was almost four times Idea would need for rolling out greenfield operations in these two circles. Idea shares gained 0.79% to close at Rs 115.50 on Friday.

The BK Modi group has a 51% stake in Spice, while Telekom Malaysia holds the rest. After the IPO, Telekom Malaysia will hold 39% and the Modis 41%. Another person close to the Modi group said the group had been keen on exiting Spice at a good valuation. “They have been looking for a buyer and while Telekom Malaysia has shown some interest, it will also not pay too high for buying out Modis,” the person, who did not wish to be identified said.

Morgna Stanley on IDEA, SPICE Merger

Morgan Stanley on IDEA-SPICE Merger

Quick Comment: Recent articles in the press (Economic Times) and on news channels (CNBC TV18) have suggested that Idea Cellular will merge with Spice Communications Ltd.

Our key takeaways, assuming that these as yet unconfirmed reports turn out to be correct: For the sector as a whole, we believe that consolidation is good news; in this case, it would reduce the number of players by one. The merged entity would have 17.4mn subscribers and a market share of 10.2%. Such a merger would enhance Idea’s coverage from 11 circles currently to 13 circles and increase effective population coverage from 59% to 66%. However, this entity would not displace any of the top four players in the Indian wireless market.

We believe that EV/EBITDA multiple is a superior valuation tool, but we use EV/sub for our estimates, since Spice is not a listed entity. Based on our estimates, Idea trades at an EV/Sub of US$583, which is close to the industry average. We believe the deal would be value-accretive for Idea if done at under a 15% discount to this EV/Sub, i.e., at approximately US$500. This would imply an EV of US$1.4bn for Spice. Spice had recently filed its draft documents with the Securities and Exchange Board of India (SEBI) for an Initial Public Offering (IPO). This leads us to believe that the merger may not happen unless the Modi Group (promoters) withdraws the document.

Citigroup - IDEA SPICE Merger

Citigroup in their report on IDEA Spice Merger answer some interesting questions

How likely is it? — Recent media reports suggest there is more to Idea-Spice talks
than pure speculation. However, hurdles remain to the timing (Spice’s listing
plans, Idea’s share lock-ins) as well as the modalities (with reported intentions of
both to buy the other one out to fulfil their national ambitions).


What is the rationale? — The footprint, with Spice’s presence in Punjab and
Karnataka, offers a good fit for Idea. While Spice’s weak presence in Karnataka is a
dampener, there is an opportunity to turn it around. Depending on the structure,
TM stands to gain from a stake (albeit smaller) in a larger Indian wireless play.

What will be the relative valuations? — The relative merger/takeout valuations
would reflect our estimates for Spice’s equity value at US$800-1,000m. In a pure
merger scenario, that would translate to Spice promoters owning 9-11% equity in
the potential combined entity (at Idea’s present market cap).


Who else benefits? — Though small in itself, any M&A event would bode well for
sector fundamentals and valuations. Besides, it might also prompt a rethink among
the remaining aspirants, i.e. Maxis-Aircel and RCOM (given the uncertainty on
GSM spectrum). The larger incumbents would also benefit indirectly. The valuation
range implies RM0.40-0.50 per Telekom Malaysia share for TM's 49% stake in
Spice. This is versus RM0.40/share in our current SOTP based target price for TM.

Remain Overweight on Indian wireless — Potential M&A adds to the long list of
positives – accelerated supply-driven rollout, attractive paybacks (on per min
basis), infrastructure sharing and rational competition. Bharti remains our top pick.

Merrill Lynch - IDEA Spice Merger

Media says Spice Tele to merge with Idea; confirm awaited

Media (CNBC) has flashed that Spice Telecom will likely merge with Idea Cellular. Spice shareholders would reportedly own ~12% of the merged entity. As per media the deal values Spice at Rs45-50bn. Idea is yet to confirm the news.

Spice – 2 circle presence; No.2 in Punjab; weak in K’taka
Spice operates in 2 circles - Punjab & Karnataka. The Co’s wireless sub base totaled ~2.8mn subs as of Apr '07 i.e ~1.7% subscriber mkt share on a pan-India basis. In Punjab, Spice is ranked No.2 (behind Bharti) with ~23% share of total subs. In Karnataka, Spice is ranked No.6 with ~7% mkt share. Latest (Sep ’06) financials indicate Spice is EBITDA positive but makes net loss.

Good strategic fitment with Idea
A merger with Spice would take Idea a step closer to becoming a pan-India operator. Currently, Idea does not have any presence in Spice’s circles.