Hope springs eternal, inexplicable as it may be, when it comes to stocks trading in single digits! As of June FY19, individual shareholders (category that includes retail investors) held around 60 crore shares in Vodafone Idea (Vi), representing a 2.09 per cent stake in the company. The share then was trading at around ₹12. Fast forward to today, the same category of shareholders now own 561 crore shares, representing nearly 12 per cent of the company.

A couple of quarters back, prior to the Government of India converting dues from Vi into equity, thereby resulting in dilution of existing investors’ stake, this holding by individual investors represented a significant 18 per cent stake in Vi. Thus, over the last four years, as the institutional investors dumped the stock, individual investors have built up positions while the stock languished in single digits through much of this period.  

In recent weeks Vi has been buzzing again, with the stock up by nearly 30 per cent in the last one month.  Fund raising hopes gaining traction and expectations of a turnaround have got a few investors excited. So, like during the market depths at the time of the early Covid scare of March-April 2020 when investing by individual investors trumped institutional investors, and reaped rewards, can the story repeat for individual investors in Vi?

Assuming most individual investors bought in single digits, they must already be at a profit now.  However, our analysis of the company’s financials and prospects indicates there is not much fundamental upside from current levels and the risks are significantly to the downside even assuming fund raising succeeds. Also importantly, trading at a one-year forward EV/EBITDA of 15 times, Vi is amongst the most expensive telecom stocks globally. Even for well-established companies such a valuation is unsustainable, more so for companies like Vi that are submerged in debt with multiple challenges to tackle.

Hence, we recommend that long-term investors use the recent upside in the stock as an opportunity to exit. The risk-reward at current levels is skewed to the downside.

Debt overhang will remain

Talk of fund raising at Vi has been going on for years, but till now it has been all bark and no bite. While this time, post conversion of some dues into equity by the government, the chances of getting funding are better, it still doesn’t give confidence of a successful turnaround for the long term.

To begin with, the fund raising number floating around in the markets is around ₹20,000 crore with additional support of around ₹2,000 crore from promoters. If the actual fund raise is in the ₹20,000-₹25,000 crore range, it would definitely help Vi to stem subscriber churn and start growing its revenues by investing in much required capex, including in 5G. However, this number still pales in comparison to the monumental debt overhang that VI faces.

As of June 30, Vi has gigantic net debt on books of ₹2,11,000 crore. Based on analyst estimates (Bloomberg consensus) for FY24, its EBITDA is expected at ₹18,232 crore. Given much of any funds raised will be used for growth initiatives, the debt numbers are unlikely to come down significantly. This implies FY24 net debt/EBITDA of 11.24. This is a very uncomfortable leverage situation and will remain a massive overhang for the stock.

In comparison peer Bharti Airtel has a net debt of around ₹2,30,000 crore and FY24 EBITDA is estimated at around ₹80,000 crore. Its estimated FY24 net debt/EBITDA is at a very comfortable 2.8 times. Jio Infocomm balance sheet too is quite strong.

Thus Vi, wth its debt overhang even post fund raise, will be under pressure as its competitors are much better positioned with strong balance sheets and ability to spend on capex and marketing initiatives. If the competitors feel a refreshed Vi post fund raise is gaining market share, they may get more aggressive with pricing/bundling options to defend their turf. Besides its leverage overhang, Vi is also disadvantaged versus peers due to its lack of its own fixedline/broadband offerings. While Airtel and Jio can offer bundling options from within, Vi is offering this by partnering with external companies. Hence while Vi’s current EBITDA margins, currently at around 41 per cent, may see some improvement post fund raising, it will continue to remain well below that of peers, which are at 50 per cent plus.

Weak P&L and expensive valuation

With high debt levels, interest costs will remain a huge blot on Vi’s financials. In FY23, its finance costs, most of it pertaining to interest cost on debt to government for deferred spectrum obligations and AGR dues, was at ₹23,000 crore or a whopping 54 per cent of its revenue. Much of this financial burden will remain for next few years or so and will result in company making net losses for the foreseeable future.

For a company with such weak financials and against formidable competitors, its valuation at EV/EBITDA of 15 times appears irrational. With much better financials and operating profile, Bharti Airtel trades at  9 times.

And here is an interesting math for investors to consider. Vodafone’s net debt is at around 4 times its current market cap. Thus if EV/EBITDA multiple were to compress to peer levels of 9-10 times, given that debt will not change much, its market cap will have to turn negative. Practically that  cannot  happen, but it clearly indicates how overvalued the stock is! Even if one is overly optimistic and factors a miraculous turnaround and assumes FY24 EBITDA at 20 per cent above current estimates, its EV/EBITDA will be at 12 times and amongst the most expensive globally.

Other risks include significant dilution for existing investors depending on the terms of a fund raise. Given the high cost of capital globally after rate increases by central banks, any new investor will likely bargain hard on the valuation table. A ₹20,000 crore fund raise will entail significant dilution.

With so many risks to deal with, the scope for downside in the stock is significant.