Aban Offshore, ABG Shipyard, ACE, Areva, Banking, Bhagwati Banquets, Capital Goods, Bharati Shipyard, EMCO, Geometric, IVRCL, Ranbaxy

Aban Offshore, ABG Shipyard, ACE, Areva, Banking, Bhagwati Banquets, Capital Goods, Bharati Shipyard, EMCO, Geometric, IVRCL, Ranbaxy, Reliance Communications, XL Telecom, India Technology

XL Telecom, Hindustan Tin Works

XL Telecom, Hindustan Tin Works

XL Telecom Subscription Details

QIB - 9.84

HNI/NII - 10.89

Retail - 7.1

Employees - 0.97

Overall - 8.68

IDBI Capital- XL Telecom

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IPO - XL Telecom

Promoted by Dinesh Kumar, a commerce graduate, XL Telecom assembles CDMA mobile handsets and manufactures switch mode power systems (SMPS), solar photovoltaic systems (SPV) and ethanol. Established in 1985, the company has strategic partnership with international technology companies including Corning (for cable jointing kits and accessories), Kyocera Wireless Corporation (for CDMA handsets) and Axesstel (for CDMA fixed wireless phones). It has a capacity to assemble 10,000 CDMA mobile and fixed wireless sets per day, 600 amps per day of SMPS, 1,667 jointing kits and accessories per day, 1,50,000 liters of ethanol per day, and 3.3 KW of SPV systems per day.

XL Telecom has lined up a public issue to raise Rs 49.46 crore at the lower band (Rs 125) and Rs 59.35 crore at the upper band (Rs 150). The net proceeds from the issue (including internal accruals) comprising Rs 8 crore are to be used for expansion of capacity to make SPV modules from the existing 1 MW per annum to 24 MW per annum, Rs 20.40 crore for creation of SMT line to produce PCBs for CDMA mobile and FWP (fixed wireless phones), repayment of Rs 9-crore IDBI term loan, Rs 20 crore for long-term working capital requirement for FWP business (due to deferred payment model of BSNL), and for issue expenses.

Strengths

• A couple of countries in Europe has made 160 watt to 200 watt solar power generation for every home mandatory. Thus, there is export potential for SPV systems. To tap this opportunity, the company has established an MOU with a Spanish supplier of SPV systems Forta Im Ex SL in Europe with an immediate US 13-million order for 3 MW SPV systems. The minimum commitment by European customers is for 12 MW over three years, which works out to Rs 220 crore at current prices.

Weaknesses

• Competitors like LG and Samsung have established their own units in India to manufacture CDMA handsets. These are the preferred original equipment suppliers of Reliance Communication and Tata Telecom. These companies are cost efficient due to high volume and would compete in the tough, price-sensitive market in India.
• XL Telecom is substantially increasing its SPV capacity from existing 1 MW per annum to 24 MW per annum. This has an inherent a risk of sudden fall in global demand, resulting in underutilisation of capacity.

Valuation

EPS for the year ended June 2006 on post-issue equity works out to Rs 7.4. At the price band of Rs 125 – Rs 150, PE works out to 17.0 to 20.4. There is no comparable listed company. In a normal market, companies with such diverse businesses get discounted poorly due to the unpredictability of their financials.

IPO: XL Telecom: Avoid

Investors can refrain from taking an exposure in the initial public offering of equity by XL Telecom. The offer is being made in the price band of Rs 125 to Rs 150 per share. The company's latest foray into retail marketing of CDMA mobile handsets for high-end models is likely to expose it to fluctuating earnings performance and tighter operating margins. Besides this, the company's core business of CDMA mobile handset assembling/manufacturing technology in partnership with Kyocera, an international brand, is a high-volume, low-margin business, dependent largely on the R&D efforts of its technology partner.

In our view, the expansion in the solar photovoltaic modules business to cater to orders from Europe and the company's entry into ethanol (mixed with petrol) business to service public sector oil units are opportunistic forays, and may not provide any long-term competitive advantage. Moreover, the ethanol business remains subject to regulatory vagaries and order flows from public sector majors.

The XL Telecom stock also appears priced on the higher side at 14.5 times (upper end) its per share earnings for the year ended June 30 vis-à-vis other growth stocks trading at this price earnings multiple with relatively lower risk.

Business units

The company has a CDMA handset assembling/manufacturing unit, a switching mode power system (SMPS) facility that has been operational since 2000, a solar photovoltaic module manufacturing facility, and an ethanol fuel facility with a production capacity of 1.5 lakh litres per day. The supplies from this facility to the PSUs started in 2006.

Through this public offer, expected to garner Rs 59.3 crore (at the upper end of the price band), the company plans to set up surface mounting technology lines to produce PCBs (printed circuit boards) used for CDMA mobile and FWPs (fixed wireless phone) at a project cost of Rs 20.4 crore.

It also plans to expand the solar photovoltaic module plant at a cost of Rs 8 crore to cater to a European order. It has entered into an exclusive distribution agreement with Forta In Ex SL, a Spanish company with a minimum commitment of 3MW per annum, valid for three years, with total commitment of 12 MW. The total contract value is estimated at Rs 220 crore.

In addition, XL Telecom proposes to repay the term loan from IDBI for Rs 9 crore and provide for long-term working capital for fixed wireless phone business (for which it has a partnership with Axesstel of US).

While the growth from the CDMA handset sales business has been robust for the past few years, most of the scale and margin benefits are likely to accrue to telecom service providers such as Tata Teleservices, BSNL, MTNL or Reliance Communications. For other players in the telecom chain, including XL Telecom, it will remain a high-volume, low-margin business. For instance, for the year ended June 30, on revenues of Rs 395 crore, the company recorded an operating margin of 6.8 per cent.

In this backdrop, the recent decision by XL Telecom to go directly to customers through a retail business model for high-end mobile phones is likely to expose them to vagaries of the marketplace. In the absence of any internal R&D, they will remain largely dependent on their partners/service providers to meet customer expectations for new and fancy phones. For low-end models, however, the telecom carriers/service providers will continue to source them in bulk from the company.

Offer details: The post-diluted equity of promoters will be 62.37 per cent. The offer to be listed at BSE and NSE opens on December 4 and closes on December 7. Anand Rathi Securities and Centrum Capital are lead managers to the offer.