BNP Paribas: Upgrade to Buy Idea: Execution should bear fruit

Idea: Execution should bear fruit
􀂃 We expect margins to recover as peak 2G capex is behind us.
􀂃 Smartest 3G bidder, as it gets maximum coverage at low cost.
􀂃 Minutes growth and stable tariff should drive future growth.
􀂃 Upgrade to BUY, with a TP of INR85 (implied 8.3x FY12E EV/EBITDA).
Expect margins to recover
The margins of Idea Cellular have been
under pressure for the last couple of years
as a result of its entry into 11 new circles,
resulting in a 2.43x increase in cell sites, a
34% decline in ARPM (due to the tariff
war as a result of hyper-competition), and
consolidation of the Spice acquisition.
Due to this margin pressure, Idea’s
EBITDA has increased only 23%,
compared to a 68% increase in revenue
over the same period. We expect margins
to bottom in FY11 as higher opex from
expansion into new markets and 3G
rollouts is offset by improving network
utilization and return of pricing stability.
3G: Low spectrum cost, highest subscriber coverage
Idea has adopted a smart 3G strategy and has refrained from bidding
aggressively for Mumbai and Delhi, the two most sought-after and
expensive markets. Instead, the company focused on its strongest
markets which enabled it to achieve 79% coverage of its existing
subscribers at a low price of INR20 per MHzPoP. We believe Idea’s 3G
circles have a modest 3G potential, with average ARPU of INR120-250 in
10 out of 11 circles, and average ARPU exceeding INR250 in the 11th
circle. 3G should allow Idea to incrementally capture a share of the
broadband market, which was elusive until now due to the lack of a wireline
broadband network.
Minutes growth & tariff stability to drive future growth
As the industry consolidates and tariffs stabilize, we believe Idea should
be well positioned to report strong improvement in profitability. Minutes
carried by Idea on its network have increased by 2.49x over the last two
years and we expect this momentum to continue. The industry seems to
be nearing the bottom in terms of a decline in ARPM, as shown in
Exhibits 1 and 2. Strong MOU, coupled with returning pricing stability, will
be the future drivers of Idea’s growth in our view.
Upgrade to BUY (from Hold) with TP of INR85.00
We upgrade Idea to BUY and raise our TP to INR85.00 (from INR65) as
we switch our valuation model from EV/EBITDA to a DCF to reflect the
long-term impact of 3G services. At our TP, the stock would trade on 8.3x
FY12E EBITDA compared to Idea’s average one-year forward
EV/EBITDA of 9.7x. Risks to our thesis are resurgence of tariff war on
introduction of MNP, poor response to 3G in India and implementation of
detrimental TRAI 2G regulations.