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Idea Cellular: Revving up the ring tones, finally? - Outside View by Luke Verghese
 
 
Idea Cellular: Revving up the ring tones, finally?

Landing on its feet finally

The operations of Idea Cellular are finally falling into place, judging by its latest annual report. Idea primarily operates in 2 business segments: mobility and, long distance. It should on paper see a big boost in its top line in the current year, given the number of revenue boosting chess moves it orchestrated in the past one year. It has, for one, finally put into effect the merger deal with the loss making Spice Communications, effective March 1, 2010. The latter was apparently a sputtering unit all these years, having raked up accumulated losses of Rs 9.3 bn. These losses have now been accounted for in the books of Idea. Spice brought with it its mobility operations in Punjab and Karnataka, and licenses for National and International long distance operations. The Bihar operations which belonged to the domain of Aditya Birla Telecom also got swallowed up by Idea, in the latest accounting year.

Pan India Service Provider

More to the point, the company now claims that it is a pan India service provider, having launched operations in 6 states and the North Eastern service areas, in the past one year. It also states that it has made significant progress in rolling out its National Long Distance (NLD) network and, augmenting the International Long Distance (ILD) network, with a load factor of 70% and 62% of the captive market. Add to this the license that it received in April 2010 to launch pan India Internet Services, and it makes for a pretty good picture, on paper at least.

Heavy Duty Capex

The heavy duty capital investments that it has effected in the last two years, also appears to be largely behind it now. The total capex that it splashed out in FY09 (including the purchase fee for the shares of Spice Communications, and the non compete fee) was a very generous Rs 75 bn. Add to this the capex of Rs 34 bn in FY10, and the total payout on capital account was of the order of Rs 110 bn over 2 years. The explosion in capex over this short time span was a bit too much for the company to shoulder from its own resources. It therefore meant issuing additional equity of Rs 73 bn, and taking on additional debt of Rs 11 bn in FY09. But with the cash flow improving in the latter year, the company was able to prune overall debt by Rs 18 bn.

Funds Management

But the company sure has a way of managing its funds flow. The Rs 65 bn debt at year end is also in part due to the company investing its surplus cash elsewhere. It apparently sees value in investing in liquid debt instruments. The book value of its investment in mutual funds stood at Rs 11 bn. It also had deposits in bodies corporate to the tune of Rs 11.5 bn and deposits with subsidiaries amounting to Rs 3.7 bn. The bulk of these deposits appear to have been made to Idea Cellular Infrastructure, its subsidiary, and Indus Tower, its joint venture. These investments amounting to Rs 26.2 bn at year end and its other cash balances yielded a pretax return of Rs 2.3 bn during the year. (There is also its worthless investment in Aditya Birla Telecom, but then, that is another story.) Apparently the finance department has its work cut out for it.

There is still some big ticket capex still in the offing (unfunded capex to the tune of Rs 10.6 bn), not excluding expenditure on keeping the technology updated in this service sector, which is characterized by constant technology changes. Then there is the payout for the auctioning of the additional 3G spectrum and the BWA spectrum by the DoT. Telecom is also a high capital intensive industry relative to the income generation. The company had an operational gross block of Rs 228 bn at year end, but the revenue flows from this capex in the financial year FY10 was only Rs 118 bn. In such a delicate situation the pricing of the services on offer becomes a very critical factor, as the substantial interest and depreciation charges have to be factored in. In the latest accounting year end the company had a subscriber base of 64 m customers.

Complex Business Segmentation

Though it operates in two business segments - mobility and long distance, it is impossible to get a clear picture of how the company bifurcates the income under the two heads. The segmental breakup of the revenue under the two heads is incomprehensible to the extreme. Whether the information as presented in the annual report also makes any sense to the management is an equally moot point. But from the weird scheme of things, it is the mobility sector which brings home the bacon revenue wise. And, it is the long distance sector which brings home the bacon bottom-line wise. The contribution of long distance revenues to overall revenues appears to be very marginal, but it brought in 38% of all segmental profits. Presumably there will be greater emphasis on long distance revenues in the future. The possible contribution from 3G Spectrum and from the BWA spectrum is of course indeterminate. But, given the interest evinced by the telecom players in offering these services, these new lines apparently have ample scope to add to the company's wellbeing.

Operating Results

The operating revenues grew 20.4% during the year to Rs 118 bn from Rs 98.4 bn in the preceding year. But the way the shoe pinches on the revenue expenditure side of the equation is that, expenses under three heads are crucial to its ability to generate profits. Expenditure debited under the heads of Network operating expenditure, License and WPC charges, and, Roaming and Access charges amounted to Rs 65 bn, and was higher by 30% over that of the preceding year. From the look of it the company may not have much of a say in controlling the bulk of these input costs as they appear to be payments towards statutory charges levied by the telecom ministry. The other big expenditure item is Subscriber Acquisition & Servicing which grew a neat 39% to Rs 11.3 bn. Given the sharper percentage increase in major expenses as compared to the percentage increase in revenues, and the higher depreciation charges on tangible and intangible assets, the profit before interest and depreciation charges grew only marginally to Rs 28.9 bn from Rs 27.8 bn in the preceding year. Creditably enough inspite of the acute competition, it did not have to extend more trade debtors credit to generate more revenues-this would have helped the company save substantially on working capital costs.

The Subsidiary Fiasco

Like all Indian owned companies, Idea too controls a number of subsidiaries-some of the underlying mathematics of these inferior siblings makes no sense on the face of it. Take for example its 100% subsidiary Aditya Birla Telecom, a privately held company. Idea's equity investment in this subsidiary totes up to Rs 16.3 bn which works out to a purchase price of Rs 1633 per share of Rs 10 each face value. This would appear to be an expensive piece of acquisition and, Idea gets not a dime as dividend from this deadwood sibling. But let that be. The paid up capital of this subsidiary is shown as Rs 119 m, though Idea's investment in this subsidiary as per its books works out to only Rs 100 m at face value. But let that also be. Idea has very 'craftily' merged only the telecom operations of the subsidiary with it. The subsidiary is now left holding some nuggets, or so it appears. The subsidiary has zilch revenues but it has investments to the tune of Rs 73 bn - being investments other than investment in subsidiary. What exactly are these goofy humungous investments, and why do they not yield any returns please? Eureka, it also appears that these investments have come for free! The sibling boasts equally hefty reserves of Rs 73 bn. The exact nature of these reserves is not known, and it did not get merged with the parent for reasons best known to the parent. Why do managements resort to such abysmal subterfuges?

Or take the example of another subsidiary Idea Cellular Towers Infrastructure. Idea has invested Rs 0.5 m in the equity of this sibling and then transferred assets worth Rs 16 bn to it. It appears that this subsidiary has got these assets for free from the parent as the only corresponding entry on the liability side of the balance sheet is a figure of Rs 15.7 bn, shown under reserves. This is truly fantastic by any yardstick. It recorded a negative profit of Rs 332 m on a turnover of Rs 1.6 bn for the latest accounting year. How it managed to repay a loan of Rs 710 m advanced to it by the parent in the face of these dismal results is not known. One wonders what the figures are like for its joint venture, Indus Towers, to which it has advanced dollops of credit.

The High Tech Characterisation

In spite of its high tech characterization, telecom companies due to the intense competition are now forced to deliver available value added services at low markups. The flip side of this development is that the subscription base has gone up so sharply, with the result that the penetration of the telecom sector in the subscriber base at over 60% is one of the highest in any new age industry. In other words, the large increases in future revenue streams will have to come with the rolling out of more value added services, as the additional client base for the basic services is fast drying up. This is where success in the spectrum auctioning process becomes so crucial. The operability of the scaled up value added services, including voice, data, and video, will also depend on the rapid increases in the income and literacy levels of the populace, compounded by a sharp increase in their knowledge management skills.

The company on its part soothes shareholder concerns on this score by stating that with the spectrum in 900/1800 MHz and in the 2100 MHz, it has an attractive spectrum footprint to adapt to future technology changes. The company has emerged winner in 11 Service Areas (11 states) at a total cost of Rs 58 bn.

Please note that I am not a shareholder of this company

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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