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Spice Communications IPO: Our view

Jun 25, 2007

Spice Communications Limited (SCL), a small-size player in the Indian telecom market, has launched its initial public offering today. The company has put on offer 113.1 m shares and the offer price is in the range of Rs 41 to Rs 46 per share. At the higher price level, the company will be collecting Rs 5.2 bn from this IPO. The issue will close on June 27, 2007. Here is a brief analysis of the issue. We shall put up a detailed review shortly.

Company background
SCL is a small-size mobile services operator with operations in the states of Punjab and Karnataka. The company commenced its operations in 1997. It current has a combined subscriber base of 3 m in the two states, with Punjab (where SCL is the second largest mobile service operator) contributing to the lion’s share of 68% to the same. OF the total GSM subscriber base in these two states (Punjab and Karnataka), SCL’s market share stands at 28% and 10% respectively (with market leader Bharti being the leader in both states with share of 37% and 51% respectively). SCL’s prepaid subscribers form around 80% of the company’s total subscriber base, very much in line with its peers.

SCL: Subscriber and related data
  FY04 FY05 FY06 1HFY07
Mobile subscribers (m) 0.8 1.0 1.5 1.9
% Change 14.8% 20.9% 51.7% 24.7%
Karnataka (% of total subs.) 28.5% 18.4% 22.1% 27.4%
Punjab (% of total subs.) 71.5% 81.6% 77.9% 72.6%
Blended ARPU (Rs/month)
Karnataka 742 622 515 432
% Change   -16.2% -17.2% -16.1%
Punjab 611 521 402 347
% Change   -14.7% -22.8% -13.7%
Total churn
Karnataka 6.7% 5.2% 3.7% 3.8%
Punjab 4.1% 5.5% 5.8% 4.7%
Source: Company prospectus

According to data compiled by COAI, the Punjab and Karnataka circles in which SCL operates account for nearly 12% of India’s telecom market share as of March 31, 2007, measured by total number of subscribers. Both these states are recognised as major economic hubs of India, with Punjab enjoying the highest per capita income in the country, and Karnataka’s capital Bangalore being the country’s technology capital. However, in order to diversify from this two-state presence, SCL has applied for licences for the remaining 21 telecom circles in India to provide GSM cellular services, in addition to licences for providing NLD and ILD services.

The company’s financial performance, however, is nothing to write home about. During the period FY02 to 1HFY07 (SCL’s follows a July to June fiscal), the company has grown its sales at a compounded rate of only 7%. This pales in comparison to the growth shown by the market leader, Bharti Airtel, which grew its revenues at a compounded annual rate of 65% during the same period, though on a presence in all the 23 telecom circles. Even if one were to take Bharti’s performance in terms of subscriber additions in Punjab and Karnataka, the company has grown its base at compounded annual rates of 110% and 81% respectively, with SCL growing the same at compounded annual rates of only 42% and 39% respectively. Despite maintaining its presence in only 2 circles since the beginning of operations, SCL has not been able to turn profitable except for FY03 and FY05. Not only has the company been able to grow its topline at even an industry growth rate, it has also consistently seen its operating margins decline, from 32% in FY02 to 22% in 1HFY07.

Reasons to apply
Consolidation in the industry: The Indian telecom industry has been witness to consolidation over the past 2 years with bidders pushing up valuations to stratospheric levels. The highest bid that has been seen during this period was the US$ 1,000 Enterprise Value (EV) per subscriber that Vodafone paid to acquire a 10% stake in Bharti Airtel in October 2005. Then, in March 2007, Vodafone paid US$ 814 EV per subscriber to acquire a 67% stake in India’s second largest mobile company, Hutch-Essar.

Indian telecom deals: Soaring valuations
Acquirer Acquired Acquired in Stake
(US$ m)
Subscribers of
Acquired (m)
Vodafone Hutch-Essar Mar-07 67.0% 12,000 22.0 814
Temasek Tata Tele Mar-06 9.9% 335 8.9 380
Telekom Malaysia Spice Mar-06 49.0% 393 1.8 446
Maxis Aircel Jan-06 74.0% 1,080 4.4 332
Vodafone Bharti Airtel Oct-05 10.0% 1,500 15.0 1,000
Hutch-Essar BPL Mobile Sep-05 100.0% 1,154 2.8 412
Source: Company reports, Equitymaster Research

With the field getting smaller in terms of competing players, and with fewer acquisition targets remaining at the national level, we believe that SCL, being a very small player with operating in just 2 circles, can be an acquisition target as well for a larger player. Idea has already shown its interest in the company. The company’s acquisition has the potential to raise its valuations, and this we believe could be the only positive factor that can support an application to this IPO.

Reasons not to apply
Competition at its neck: SCL plans to utilise about 46% of the money raised from the IPO for growth purposes in terms of payment of license fee for national and international long distance telephony and payment to vendors for network equipments. The company has also applied for licences for the remaining 21 telecom circles in India to provide GSM cellular services. However, considering the intensity of competition in the sector, with large players like Bharti, Reliance and Hutch being at each other’s neck when it comes to aggressiveness in growth (product launches and pricing), we believe SCL will not find a place for itself in the growth of the Indian telecom sector in the future. The company has already been a laggard when one was to compare its growth in the existing circles of Punjab and Karnataka with the other players – Bharti, Hutch and BSNL (see table below).

Subscriber base and compounded annual growth
(m) May-04 May-05 May-06 May-07 CAGR
Bharti 0.9 1.3 2.4 4.7 75%
Hutch 0.4 0.6 1.2 1.8 71%
BSNL 0.3 0.8 1.3 1.7 70%
Spice 0.3 0.3 0.5 1.0 42%
Bharti 1.0 1.3 1.9 2.7 40%
Spice 0.9 1.2 1.6 2.1 30%
Hutch 0.0 0.2 0.7 1.3 1732%
BSNL 0.3 0.4 0.4 1.2 58%
Source: COAI, Equitymaster Research

Poor financial record: With a negative net worth for the past five years and consistent losses on the back of sluggish sales growth and margin pressure, SCL does not make it to the grade of companies that can be invested in for their financial performance. The company’s profit and loss statement indicate of a sorry state of affairs, with the company recording lower operating margins with each passing year. Despite the fact that the company has not expanded beyond Punjab and Karnataka since its inception, it has consistently lost market share to competitors, which has shown in topline and bottomline numbers. Also, around 50% of the IPO proceeds will be utilised by the company towards non-growth enhancing avenues like debt repayment. These factors, we believe, make the company an unattractive investment opportunity for investors.

Lack of product diversification: SCL derives 100% of its business revenues by way of providing GSM cellular services. Unlike its peers Bharti and Reliance, who have more than one segment contributing to their revenues (like enterprise and broadband services), the company is dependent on just a single revenue stream. We believe that any change in customer preference for its services will severely dent topline growth, the overall financial performance and prospects of the company in the future.

Comparative Valuations & Comments
Since SCL has been earning losses and has a negative net worth, the only valid comparable valuation parameter will be EV per subscriber, which stands at US$ 348 for the company (at the higher issue price of Rs 46 per share). While this is at discount to what its peers like Bharti, Idea and Reliance Communications are trading at, SCL’s performance in itself leaves little room for the stock to be valued at valuations near to the other companies.

Comparative evaluation
Particulars (FY07) SCL Bharti Idea RCom
Mobile subscribers (m) 3.0 37.1 14.0 28.0
Sales (Rs m) 7,702 184,202 43,664 142,625
Operating profit margins 22.0% 40.4% 33.5% 38.7%
Net profit margins -10.9% 22.1% 11.5% 22.2%
Current market price (Rs) 46 825 117 513
Price to earnings (x) NA 38.6 61.6 33.1
Price to sales (x) 4.1 8.5 6.9 7.4
EV per subscriber (US$) 348 1,063 602 935
* For SCL, higher price of Rs 46 and post diluted capital base of 689.9 m shares is considered for valuation purposes

We recommend investors to ‘Avoid’ the issue on simple grounds of the high levels of risk associated with the company, largely in terms of a deteriorating financial performance and the presence of better investment opportunities in the sector in terms of some of the other listed players.

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Jun 5, 2020 09:13 AM