The Hindu Business Line : More Telecom stocks: Ringing in exciting times

The recent listing of Reliance Communication, and Hutchison Essar simplifying its shareholding structure in the run-up to listing are set to expand the investment basket.

For the average retail investor, the telecom arena is ringing with action, with more players calling the market for investment support. The past year also saw some dramatic changes happen in the telecom space, mainly the relaxation of the foreign direct investment (FDI) ceiling to 74 per cent and the removal of the regulatory cobwebs.

Since early 2002, when Bharti Tele-Ventures came out with its initial public offering, it has remained the only integrated (mobile, fixed and long distance) investment exposure in the sector. The listing of Reliance Communication Ventures (RCV; also an integrated play) on March 6, followed by its recent decision to merge Reliance Infocomm with RCV and assume 100 per cent operating control in its three subsidiaries, has widened the choice.

In preparation for the potential listing of Hutchison Essar (a mobile pure-play) in India, Hutchison Telecommunications International, its Hong Kong-based holding company, has simplified the ownership structure. It may be listed by the end of this calendar.

A peek into operations

For the first time, financial performance numbers are available for the three key unlisted companies, though with limited operational details. We have attempted to examine how the parameters of these three players (especially their core mobile business) — RCV, and Hutchison Essar — stack up vis-à-vis Bharti Tele-Ventures, their only listed peer.

Operating profit margin: Across the three companies, the sequential (quarter-on-quarter) revenue growth of the mobile business for the third quarter ended December 31, 2005 was quite healthy in the 11-14 per cent bracket. But it is the operating profit margin, at 36.5 per cent in the mobile segment, that puts Bharti ahead of the pack and makes it the most efficient. .

Focus on usage: While the average revenue per user (ARPU) is the highest for Hutch at Rs 511 for the third quarter, its average minutes of use per user, is the lowest among the players. Its ARPU is probably higher as it operates in 13 circles (set to increase with the acquisition of BPL), which cover the metros and the key A circles.

Bharti, another GSM player like Hutch, with a nationwide footprint, has an ARPU that is 8 per cent lower at Rs 470, but the usage is higher, at 411 minutes, than Hutch. Compared to these two, RCV, a CDMA player (with some GSM circles in the North-East) has the lowest ARPU of Rs 412. However, its minute of usage is 33 per cent higher than Bharti, at 547 minutes. Going by the revenue and operating profits per minute, RCV's figures are 35 per cent and 43 per cent lower than Bharti's. But in its latest presentation to analysts, RCV claimed that with a lower churn (of 2.2 per cent versus 4-5 per cent for Bharti), a wider distribution reach and mobile plan structures, it will be able to monetise those minutes effectively.

Performance metrics: The mobile market in India, with a subscriber base nearing 100 million, finds itself on the cusp of relative maturity and a high growth phase (compared to 330 million in China). The key performance metrics that reflect this trend are enterprise value (EV; market capitalisation plus debt) to EBITDA (earnings before interest, tax, depreciation and amortisation) and EV/subscriber. The two reflect respectively the operational cash flows that can be deployed for growth and the potential for future cash flows.

Based on the annualised third quarter performance, the EV/EBITDA of the mobile segment of Bharti works out to 16.6 times. RCV's valuation is at a 15 per cent discount to Bharti. For Hutch, the discount is under 5 per cent to Bharti, if the enterprise value is based on Kotak's sale of equity in Hutchison Essar, struck at $6 billion of market capitalisation. The EV on a per subscriber basis for Bharti works out to Rs 32,000. On this metric, RCV trades at 25per cent discount to Bharti, and Hutch about 20 per cent.

Variables to track

The mobile sector is sprinting towards a target subscriber base of 200 million by December 2007. There have been record mobile subscriber additions of 4-5 million in the past couple of months, since the introduction of the lifetime offers for Rs 900 plus and the `One India' tariff scheme. The key variables that could dictate the growth potential over the next couple of years are:

Battle for market share: The market share battles in mature Asian markets such as Korea suggest that the company with the highest market share enjoys operating margins nearly 8-15 per cent higher than the third or fourth player.

With the launch of the lifetime-prepaid scheme, the mobile battle is shifting decisively to the price-sensitive circles with lower disposable incomes. BSNL may have the edge here, but integrated operators RCV and Bharti can give BSNL a run for its money.

Second, the `One India' tariff plan and the reduction in the access deficit charge for long-distance calls are likely to be to the advantage of integrated operators such as RCV and Bharti and, to some extent, BSNL. RCV's domestic and international long-distance business is quite strong relative to Bharti's and its ability to introduce innovative bundled tariffs between local and long distance will be to its advantage. And the focus will also shift towards value-added initiatives such as broadband or data-led growth.

Operational meter: The telecom story is likely to be driven by the scale of investments made by different players as they widen and strengthen their networks across the country. Since expansion of customer base will be the priority, the ARPU and profitability are likely to drop, for all players.

According to Bharti, as long as it remains in the capital investment mode, more than ARPU, it will track its performance across a three-line graph comprising gross revenues, opex productivity (operating expense divided by gross revenues), and capital productivity (gross revenues divided by gross fixed assets and intangibles). As a part of this formula, Bharti believes that as long as absolute revenues keep increasing, productivity of opex either stabilises or keeps coming down and capex keeps improving, the company's overall financial health can be tracked.

This is the metric that will be tracked across companies on a quarterly basis. For 2006-07, Hutch has plans to double its network capacity with a spend of Rs 5,200-5,700 crore, and Reliance will spend over Rs 5,000 crore each year over the next three years.

Regulatory clarity: On the regulatory front, the two niggling issues that still remain unaddressed are: Spectrum allocation and revenue share. Over the next few months, the Government and the regulator are expected to resolve the spectrum dispute between GSM and CDMA operators.

On the issue of revenue share for mobile companies, the Government is still to act on the reduction of revenue share to 6 per cent from an average of 10 per cent across circles. If and when this happens, it will provide greater flexibility in pricing and perk up the margins of most players.

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