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Idea Cellular Limited
Underweight
IDEA.BO, IDEA IN
A riskier play
Looking to FY12, we see two positives for the Indian Telecom sector – easing
of competitive intensity and regulatory clarity – however we remain cautious
on Idea Cellular. A higher rural presence in its sub/revenue base suggests
continued volume dilution and importantly, any spectrum related payment will
likely add pressure to leverage. Our new Mar-12 value of INR 54 (implying
16% downside from current levels) factors in both a better pricing
environment and the regulatory adjustment. Idea trades at a 73% premium to
Bharti on earnings, for lower growth over the next 2 years. Maintain UW.
• Better H2 FY12 pricing environment, but watch volumes: The hyper
competitive pricing environment in India appears to be easing driven by the
pre-paid segment, and we factor in smaller price declines from H2FY12
(post MNP in H1 FY12). We now forecast 7%/4% voice declines for
FY12/FY13 vs. 11%/5% earlier. However with Idea's net adds being driven
by rural/lower income areas, we expect MOUs to be under pressure.
• Quantifying the regulatory impact: We make a INR 13/share downward
adjustment for risks related to excess spectrum payment and more. While
clarity on M&A policy (expected with NTP 2011) bodes well for Idea, we
believe the 73% premium to Bharti on earnings reflects this. Furthermore
we don’t expect any M&A action in the near term.
• Less cushion to absorb any shocks: D&A and interest expenses account
for 80% of FY12E EBITDA, leaving Idea little room to absorb any
operational disappointments. A small cash balance (US$123 Dec-10)
implies to us that Idea may need to tap debt in case of any one-off spectrum
related charge which we estimate at US$381m, adding pressure to leverage.
• Our Mar-12 price target of INR 54 (vs. INR 60 earlier) is based on a
SOTP of Idea’s core business, Indus Towers and INR 13 downward
regulations-related adjustment. Idea trades at 27x FY12E P/E and 6.9x
EV/EBITDA, a 73% premium and a 6% discount, respectively, to Bharti,
which we see as unjustified. JPMe 2-year EPS CAGR is 19% vs. 31% for
Bharti. Risks: monetization of tower assets, M&A, lower pricing pressure.
Regulations – Less cushion
We estimate ~INR 44 bn of an impact from the known regulatory issues. This
translates into INR 13/share. While the final outcome of the various
recommendations and probes may well be different, we note that Idea is not the best
positioned to absorb the near term one-off expenses given their cash position. We
note that its cash balance as of Dec-10 was US$123m which we forecast will
increase to US$140m by Mar-end. We forecast FCF (EBITDA - capex) of INR 13 bn
in FY12 (US$ 290m) and INR 24 bn for FY13 (US$ 530m).
Idea will need to rely on debt in case of any payment requirements, in our view. We
note that an additional US$300m of debt would take Idea’s FY11 net debt/EBITDA
to 3.3x vs. our current forecast of 3.0x. To de-leverage, Idea may need to monetize its
tower assets rather than that event being an additional source of cash as it would be
for Bharti.
The four issues we consider are [1] a one-off charge for excess spectrum, [2] present
value of payment on renewals on license/spectrum [3] impact from higher spectrum
usage charges and [4] benefits from lower license fees. We note that the TRAI has
also recommended re-farming of 900 MHz spectrum for 1800 Mhz spectrum,
however since we believe that likelihood of this being implemented is low, we do not
factor it in.
Idea is exposed to other risks such as a potential fine for non-compliance of rollout
obligations which press reports indicate could amount to INR 3bn (Economic Times,
Business Standard). The Additional Solicitor General of India (ASGI) stated that
Idea violated M&A norms and suggested the imposition of a INR 3bn fine, and
cancellation of 2G licenses in six circles. Idea has denied any wrongdoing saying its
merger with Spice has been approved by the court. On March 24 CNBC TV18 stated
that the TDSAT had stayed DoT’s fine, suggesting some relief for Idea. This fine is
not factored into our estimates. Idea acquired Spice in 2008. Spice had operations
running in Karnataka and Punjab but had licenses in 4 more circles – Andhra
Pradesh, Delhi, Haryana and Maharashtra. Idea had a pan India license. The latter 4
overlapped with Idea’s existing operations while Karnataka and Punjab (from Spice)
overlapped with Idea’s licenses held there.
[1] One-off excess spectrum charge
Below we estimate the potential payment for Idea spectrum held in excess of
6.2Mhz which has been deemed as the contracted limit. We note that TRAI’s
recommendations on 2G pricing are not clear on the value of 900Mhz vs. 1800Mhz
so we consider three scenarios here
1. Scenario 1 is where we value 900MHz the same as 1800Mhz. We believe
this may be overly conservative given the difference in base station
requirements, coverage, signal propagation, etc.
2. Scenario 2 is where we value 900MHz at 1.5x the value of 1800Mhz, in line
with TRAI’s May 2010 recommendations.
3. Scenario 3 is where we value 900Mhz at 2.5x the value of 1800Mhz. This is
in line with submissions received by the TRAI from various service
providers which state that “the price of 900Mhz band should be between 2.5
and 2.67 times of that of 1800Mhz spectrum price.”
We have also estimated the “extra payout above 8Mhz” as a potential add-on, though
the amount here is less significant.
For Idea, we estimate the payout at Rs17.2B (~US$381MM) or Rs5.2/share. This is a
20% premium to our 3G-linked estimate – incrementally negative for Idea, in our
view.
[2] License renewal charges
Also linked to TRAI’s pricing recommendations are the charges for spectrum
renewal.
Licenses are to be renewed for 10 years (current licence period is 20 years) and at the
time of renewal, telcos will need to pay a renewal fee. Spectrum will be unbundled
from license and must be applied for separately.
Over the next five years (until April 2016), Idea has seven licenses expiring. Under
Scenario 2 (900Mhz = 1.5x 1800Mhz) and using a 6% inflation index we estimate
that at a 10% discount rate, the present value (through 2028) of renewal payments
would be US$1.37B for Bharti or Rs19/share.
[3] Higher spectrum usage charge
The TRAI has recommended that “Spectrum usage charge” be 0.5% per MHz up to
6.2Mhz and 1% beyond that (limit of 10%) for GSM. Based on Idea’s revenue from
each circle (for FY10) we estimate the incremental blended charge for Idea at 1.1pp.
Based on a WACC of 12% and a TGR of 3% we estimate the PV of this at INR 23bn
or INR 7/share.
[4] License fee to be reduced to a uniform 6% over 3 years
TRAI recommended that the license fee should be uniform across all licenses and
service areas. This is to be brought down from 10% (Metro, A circles), 8% (B
circles), and 6% (C circles) to a uniform rate of 6% by FY14.
We estimate the benefit to Idea at INR 58bn or INR 18/share.
Several of the industry participants have recommended reducing the license fee to
6% with immediate effect as opposed to a reduction over 4 years. We believe the
effective rate paid by Idea currently is 8.9% so an immediate reduction to 6% would
imply a cost saving of INR 4.6bn/5.2bn and a positive EPS impact of ~INR 1 in
FY12/FY13 on our estimates.
Valuation and rating analysis
Our March 2012 price target is INR 54. This includes INR51 for Idea’s core wireless
business, INR 17 for its 16% stake in Indus so a total of INR 68 to which we make a
INR 13 downward adjustment for regulatory regime related risks. We use a WACC
of 12% and a terminal growth rate of 3%.
The value of our core business increased by INR 8 to INR 51 from INR 43 driven by
increased estimates for ARPM starting in H2FY12 and higher subscriber net adds.
Table 7: Sum-of-the-parts valuation
Rs
New Old Change
Core business DCF 51 43 8
Indus stake 17 16 0
Value per share (INR) 68 60 8
Risk adjustment (13) 0 (13)
Price Target (INR) 54 60 (5)
Source: J.P. Morgan estimates.
Risks to our ratings and price target are: (1) operators staying away from price
competition post 3G/MNP; (2) faster-than-expected growth in profitability in new
circles; and (3) monetization of tower assets, and (4) consolidation, M&A in the
sector.
On our estimates, Idea trades at 27x FY12 P/E and 6.9x EV/EBITDA, a 73%
premium and a slight 6% discount respectively, to Bharti, which we believe is
unjustified. Idea’s ROE for FY10 was 7%, vs. 28% for Bharti and 12% for RCOM;
we forecast 6.3% ROE for Idea in FY12.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Idea Cellular Limited
Underweight
IDEA.BO, IDEA IN
A riskier play
Looking to FY12, we see two positives for the Indian Telecom sector – easing
of competitive intensity and regulatory clarity – however we remain cautious
on Idea Cellular. A higher rural presence in its sub/revenue base suggests
continued volume dilution and importantly, any spectrum related payment will
likely add pressure to leverage. Our new Mar-12 value of INR 54 (implying
16% downside from current levels) factors in both a better pricing
environment and the regulatory adjustment. Idea trades at a 73% premium to
Bharti on earnings, for lower growth over the next 2 years. Maintain UW.
• Better H2 FY12 pricing environment, but watch volumes: The hyper
competitive pricing environment in India appears to be easing driven by the
pre-paid segment, and we factor in smaller price declines from H2FY12
(post MNP in H1 FY12). We now forecast 7%/4% voice declines for
FY12/FY13 vs. 11%/5% earlier. However with Idea's net adds being driven
by rural/lower income areas, we expect MOUs to be under pressure.
• Quantifying the regulatory impact: We make a INR 13/share downward
adjustment for risks related to excess spectrum payment and more. While
clarity on M&A policy (expected with NTP 2011) bodes well for Idea, we
believe the 73% premium to Bharti on earnings reflects this. Furthermore
we don’t expect any M&A action in the near term.
• Less cushion to absorb any shocks: D&A and interest expenses account
for 80% of FY12E EBITDA, leaving Idea little room to absorb any
operational disappointments. A small cash balance (US$123 Dec-10)
implies to us that Idea may need to tap debt in case of any one-off spectrum
related charge which we estimate at US$381m, adding pressure to leverage.
• Our Mar-12 price target of INR 54 (vs. INR 60 earlier) is based on a
SOTP of Idea’s core business, Indus Towers and INR 13 downward
regulations-related adjustment. Idea trades at 27x FY12E P/E and 6.9x
EV/EBITDA, a 73% premium and a 6% discount, respectively, to Bharti,
which we see as unjustified. JPMe 2-year EPS CAGR is 19% vs. 31% for
Bharti. Risks: monetization of tower assets, M&A, lower pricing pressure.
Regulations – Less cushion
We estimate ~INR 44 bn of an impact from the known regulatory issues. This
translates into INR 13/share. While the final outcome of the various
recommendations and probes may well be different, we note that Idea is not the best
positioned to absorb the near term one-off expenses given their cash position. We
note that its cash balance as of Dec-10 was US$123m which we forecast will
increase to US$140m by Mar-end. We forecast FCF (EBITDA - capex) of INR 13 bn
in FY12 (US$ 290m) and INR 24 bn for FY13 (US$ 530m).
Idea will need to rely on debt in case of any payment requirements, in our view. We
note that an additional US$300m of debt would take Idea’s FY11 net debt/EBITDA
to 3.3x vs. our current forecast of 3.0x. To de-leverage, Idea may need to monetize its
tower assets rather than that event being an additional source of cash as it would be
for Bharti.
The four issues we consider are [1] a one-off charge for excess spectrum, [2] present
value of payment on renewals on license/spectrum [3] impact from higher spectrum
usage charges and [4] benefits from lower license fees. We note that the TRAI has
also recommended re-farming of 900 MHz spectrum for 1800 Mhz spectrum,
however since we believe that likelihood of this being implemented is low, we do not
factor it in.
Idea is exposed to other risks such as a potential fine for non-compliance of rollout
obligations which press reports indicate could amount to INR 3bn (Economic Times,
Business Standard). The Additional Solicitor General of India (ASGI) stated that
Idea violated M&A norms and suggested the imposition of a INR 3bn fine, and
cancellation of 2G licenses in six circles. Idea has denied any wrongdoing saying its
merger with Spice has been approved by the court. On March 24 CNBC TV18 stated
that the TDSAT had stayed DoT’s fine, suggesting some relief for Idea. This fine is
not factored into our estimates. Idea acquired Spice in 2008. Spice had operations
running in Karnataka and Punjab but had licenses in 4 more circles – Andhra
Pradesh, Delhi, Haryana and Maharashtra. Idea had a pan India license. The latter 4
overlapped with Idea’s existing operations while Karnataka and Punjab (from Spice)
overlapped with Idea’s licenses held there.
[1] One-off excess spectrum charge
Below we estimate the potential payment for Idea spectrum held in excess of
6.2Mhz which has been deemed as the contracted limit. We note that TRAI’s
recommendations on 2G pricing are not clear on the value of 900Mhz vs. 1800Mhz
so we consider three scenarios here
1. Scenario 1 is where we value 900MHz the same as 1800Mhz. We believe
this may be overly conservative given the difference in base station
requirements, coverage, signal propagation, etc.
2. Scenario 2 is where we value 900MHz at 1.5x the value of 1800Mhz, in line
with TRAI’s May 2010 recommendations.
3. Scenario 3 is where we value 900Mhz at 2.5x the value of 1800Mhz. This is
in line with submissions received by the TRAI from various service
providers which state that “the price of 900Mhz band should be between 2.5
and 2.67 times of that of 1800Mhz spectrum price.”
We have also estimated the “extra payout above 8Mhz” as a potential add-on, though
the amount here is less significant.
For Idea, we estimate the payout at Rs17.2B (~US$381MM) or Rs5.2/share. This is a
20% premium to our 3G-linked estimate – incrementally negative for Idea, in our
view.
[2] License renewal charges
Also linked to TRAI’s pricing recommendations are the charges for spectrum
renewal.
Licenses are to be renewed for 10 years (current licence period is 20 years) and at the
time of renewal, telcos will need to pay a renewal fee. Spectrum will be unbundled
from license and must be applied for separately.
Over the next five years (until April 2016), Idea has seven licenses expiring. Under
Scenario 2 (900Mhz = 1.5x 1800Mhz) and using a 6% inflation index we estimate
that at a 10% discount rate, the present value (through 2028) of renewal payments
would be US$1.37B for Bharti or Rs19/share.
[3] Higher spectrum usage charge
The TRAI has recommended that “Spectrum usage charge” be 0.5% per MHz up to
6.2Mhz and 1% beyond that (limit of 10%) for GSM. Based on Idea’s revenue from
each circle (for FY10) we estimate the incremental blended charge for Idea at 1.1pp.
Based on a WACC of 12% and a TGR of 3% we estimate the PV of this at INR 23bn
or INR 7/share.
[4] License fee to be reduced to a uniform 6% over 3 years
TRAI recommended that the license fee should be uniform across all licenses and
service areas. This is to be brought down from 10% (Metro, A circles), 8% (B
circles), and 6% (C circles) to a uniform rate of 6% by FY14.
We estimate the benefit to Idea at INR 58bn or INR 18/share.
Several of the industry participants have recommended reducing the license fee to
6% with immediate effect as opposed to a reduction over 4 years. We believe the
effective rate paid by Idea currently is 8.9% so an immediate reduction to 6% would
imply a cost saving of INR 4.6bn/5.2bn and a positive EPS impact of ~INR 1 in
FY12/FY13 on our estimates.
Valuation and rating analysis
Our March 2012 price target is INR 54. This includes INR51 for Idea’s core wireless
business, INR 17 for its 16% stake in Indus so a total of INR 68 to which we make a
INR 13 downward adjustment for regulatory regime related risks. We use a WACC
of 12% and a terminal growth rate of 3%.
The value of our core business increased by INR 8 to INR 51 from INR 43 driven by
increased estimates for ARPM starting in H2FY12 and higher subscriber net adds.
Table 7: Sum-of-the-parts valuation
Rs
New Old Change
Core business DCF 51 43 8
Indus stake 17 16 0
Value per share (INR) 68 60 8
Risk adjustment (13) 0 (13)
Price Target (INR) 54 60 (5)
Source: J.P. Morgan estimates.
Risks to our ratings and price target are: (1) operators staying away from price
competition post 3G/MNP; (2) faster-than-expected growth in profitability in new
circles; and (3) monetization of tower assets, and (4) consolidation, M&A in the
sector.
On our estimates, Idea trades at 27x FY12 P/E and 6.9x EV/EBITDA, a 73%
premium and a slight 6% discount respectively, to Bharti, which we believe is
unjustified. Idea’s ROE for FY10 was 7%, vs. 28% for Bharti and 12% for RCOM;
we forecast 6.3% ROE for Idea in FY12.
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