Should you subscribe to the IPO of RailTel?

Long-term investors can avoid the IPO of RailTel Corporation of India Ltd, a Miniratna Central public sector undertaking. The offer is a secondary sale of 8.7 crore shares by the Centre, representing about 27 per cent of the paid-up capital of the company.

At ₹93-94, it is priced at approximately 23 times its annualised FY21 EPS (based on earnings per share for the first half of FY21 after adjusting for a one-time exceptional expense). This is not cheap given the PSU’s modest earnings growth in recent years and its relative premium valuation vs the PSU universe.

Its dividend yield at IPO price of around 2 per cent (dividend for FY20) is also not attractive, given that this is an additional factor investors consider for investing in PSU stocks. Even when compared on an EV/EBITDA basis —considered an important valuation metric for telecom companies — RailTel trades at around eight times annualised FY21 EBITDA (adjusted) versus larger private companies such as Bharti Airtel trading at around nine times.

Business and prospects

RailTel is an information and communications technology (ICT) infrastructure provider and one of the largest neutral (carrier-agnostic) telecom infrastructure providers in India. Currently, it is mandated the task of building and maintaining a high-speed mobile communication corridor along railway tracks to meet the communication needs of the Indian Railways. It also generates additional revenues by laying optical fibre cables (for broadband and multimedia network) using its ‘right of way’ along the tracks.

The company operates through three main business segments — Telecom Network Services (52 per cent): primarily consists of national long-distance services such as leased line services and virtual private networks, enterprise and retail broadband services (RailWire); Telecom Infrastructure Services (12 per cent): passive infrastructure services for other telecom and networking companies; and Projects (33 per cent): mainly consists of ICT hardware implementation/system integration.

Within the public sector, National Informatics Centre Services, the Railways and the Employees’ State Insurance Corporation (ESIC) are the top customers. The private sector accounts for around 40 per cent of revenues.

The company has advantages such as perpetual ‘right of way’ along railway tracks for network connectivity, favourable business opportunities such as accelerating trends in digitisation, and ability to provide connectivity to rural areas thanks to its network along railway lines.

The company aims to be a key player in digital transformation projects in both public and private sectors, increase its retail subscriber base via the RailWire platform, and target project opportunities in export markets (such as Africa where the Indian Railways has a good track record of project implementation).

RailTel is a debt-free company.

Concerns

The company faces a few challenges that counter these advantages to some extent. To begin with, given its relatively small size, it needs to be seen how it can profitably tap the emerging opportunities.

At the IPO price, its market-cap will be around ₹3,000 crore. It is competing against much larger players in the industry (beyond its exclusivity with the Railways) such as Reliance Jio (valued around ₹4.4-lakh crore in a recent fund-raise) and Bharti Airtel (market-cap of around ₹3.2-lakh crore).

Given its peers’ larger size and resources, RailTel may face tough competition in its telecom services business (approximately 70 per cent of revenue). Also, profitability in the telecom sector is driven by size and scale as we have seen with Jio and its impact on the industry.

While RailTel has an excellent record in project execution, it represents only around 30 per cent of the company’s revenues. By nature, project revenues carry execution risks and also have lower operating margins (10 per cent EBIT margin vs other segments combined at around 20 per cent). In fact, the company has incurred impairment expenses in relation to project business in the past two years.

While RailTel has a good track record of profitability unlike other existing telecom players, the cautionary tale of BSNL, after being in a dominant and cash-rich position a little over a decade back, cannot be ignored. In general, for PSUs, balancing a profit motive while fulfilling the larger mandate of the government is not easy. While the Centre might be indicating its intentions to loosen its reins on PSUs such as RailTel, the proof is in the pudding.

Financials

RailTel’s earnings growth has been flattish over the last two years with the FY18-FY20 CAGR at 3 per cent. The company’s profits stand at ₹141 crore for FY20. Its revenue CAGR during the same period is 7 per cent, and ₹1,128 crore for FY20.

While the management commentary is optimistic and implies that the earnings for FY21 would be better than the annualised number, more clarity is required on the likely earnings growth in the mid-to-long term. Impairment expenses from project-related issues had impacted profits in FY20 and F21. Whether these are one-offs or recurring ones need to be seen.

While RailTel has an opportunity to benefit from its unique customer relationships and the ‘right of way’ along the railway tracks to expand its reach, the company’s results of the past three years do not provide confidence for sustainable double-digit earnings growth as of now.

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